Capital Requirements of Swap Dealers and Major Swap Participants, 57462-57576 [2020-16492]

Download as PDF 57462 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations Intermediary Oversight, Commodity Futures Trading Commission, 525 West Monroe Street, Suite 1100, Chicago, IL 60661. SUPPLEMENTARY INFORMATION: COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 23, and 140 RIN 3038–AD54 Capital Requirements of Swap Dealers and Major Swap Participants Commodity Futures Trading Commission. ACTION: Final rule. AGENCY: The Commodity Futures Trading Commission (‘‘Commission’’ or ‘‘CFTC’’) is adopting new regulations imposing minimum capital requirements and financial reporting requirements on swap dealers (‘‘SDs’’) and major swap participants (‘‘MSPs’’) that are not subject to a prudential regulator. The Commission is also amending existing capital requirements for futures commission merchants (‘‘FCMs’’) to provide specific capital deductions for market risk and credit risk for swaps and security-based swaps entered into by an FCM. The Commission is further adopting amendments to its regulations to permit certain entities dually-registered with the Securities and Exchange Commission (‘‘SEC’’) to file an SEC Financial and Operational Combined Uniform Single Report in lieu of CFTC financial reports, to require certain Commission registrants to file notices of certain defined events, and to require notices of bulk transfers to be filed with the Commission electronically and within a defined period of time. DATES: Effective date: November 16, 2020. Compliance date: October 6, 2021 FOR FURTHER INFORMATION CONTACT: Joshua Sterling, Director, 202–418– 6056, jsterling@cftc.gov; Thomas Smith, Deputy Director, 202–418–5495, tsmith@cftc.gov; Joshua Beale, Associate Director, 202–418–5446, jbeale@ cftc.gov; Jennifer Bauer, Special Counsel, 202–418–5472, jbauer@ cftc.gov; Rafael Martinez, Senior Financial Risk Analyst, 202–418–5462, rmartinez@cftc.gov, Division of Swap Dealer and Intermediary Oversight; Paul Schlichting, Assistant General Counsel, Office of the General Counsel, 202–418– 5884, pschlichting@cftc.gov; Lihong McPhail, Research Economist and Head of Academic Outreach, 202–418–5722, lmcphail@cftc.gov, Office of the Chief Economist; Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; or Mark Bretscher, Special Counsel, 312–596–0598, mbretscher@ cftc.gov; Division of Swap Dealer and jbell on DSKJLSW7X2PROD with RULES3 SUMMARY: VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Table of Contents I. Introduction A. Background and Statutory Authority B. Proposed Rulemakings and Reopening of the Comment Period C. Consultation With U.S. Securities and Exchange Commission and Prudential Regulators II. Final Regulations and Amendments to Existing Regulations A. Capital Framework for FCMs, Covered SDs, and Covered MSPs B. Capital Requirements for Stand-Alone FCMs and FCM–SDs 1. Introduction to General Capital Requirements for Stand-Alone FCMs and FCM–SDs 2. Minimum Capital Requirement for Stand-Alone FCMs and FCM–SDs a. Minimum Fixed-Dollar Amount of Net Capital b. Minimum Capital Requirement Based on 8% Risk Margin Amount 3. Stand-Alone FCM and FCM–SD Calculation of Net Capital and Adjusted Net Capital a. Stand-Alone FCM and FCM–SD Standardized Market Risk Capital Charges b. FCM and FCM–SD Standardized Counterparty Credit Risk Capital Charges c. Model-Based Market Risk and Counterparty Credit Risk Capital Charges (i) FCMs That Are SEC-Registered ANC Firms (ii) Market Risk and Credit Risk Capital Models for FCM–SDs That Are Not SECRegistered BDs C. Capital Requirements for Swap Dealers and Major Swap Participants 1. Introduction to Covered SD and Covered MSP Capital Requirements 2. Capital Requirement for Covered SDs Electing the Net Liquid Assets Capital Approach a. Computation of Minimum Capital Requirement b. Computation of Net Capital To Meet Minimum Capital Requirement (i) Swap Dealers Not Approved To Use Internal Capital Models (ii) Swap Dealers Approved To Use Internal Capital Models 3. Capital Requirement for Covered SDs Electing the Bank-Based Capital Approach a. Computation of Minimum Capital Requirement 4. Capital Requirement for Covered SDs Electing the Tangible Net Worth Capital Approach 5. Capital Requirements for Covered MSP 6. Requirements for Market Risk and Credit Risk Models a. VaR Models b. Stressed VaR Models c. Specific Risk Models d. Incremental Risk Models e. Comprehensive Risk Models PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 f. Credit Risk Models 7. Model Approval Process for Covered SDs and FCM–SDs 8. Liquidity Requirements for Covered SDs and FCM–SDs 9. Equity Withdrawal Restrictions for Covered SDs and Covered MSPs 10. Leverage Ratio Requirements for Covered SDs D. Swap Dealer and Major Swap Participant Financial Recordkeeping, Reporting and Notification Requirements 1. Routine Financial Reporting and Recordkeeping Requirements 2. Swap Dealer and Major Swap Participant Notice Requirements 3. Swap Dealers and Major Swap Participants Subject to the Capital Rules of a Prudential Regulator 4. Public Disclosures 5. Electronic Filing Requirements for Financial Reports and Regulatory Notices 6. Swap Dealer and Major Swap Participant Reporting of Position Information 7. Reporting Requirements for Swap Dealers and Major Swap Participants Approved To Use Internal Capital Models 8. Weekly Position and Margin Reporting E. Comparability Determinations for Eligible Covered SDs and Covered MSPs F. Additional Amendments to Existing Regulations 1. Financial Reporting Requirements for FCMs or IBs That Are Also Registered SBSDs 2. Amendments to the FCM and IB Notice Provisions in Regulation 1.12 3. FCM and IB Unsecured Receivables From Swap Transactions 4. Amendments to FCM and IB Notice and Disclosure Requirements for Bulk Transfers 5. Conforming Amendments to Delegated Authority Provisions in Regulation 140.91 G. Effective Date and Compliance Date III. Related Matters A. Regulatory Flexibility Act B. Paperwork Reduction Act 1. Background 2. New Information Collection Requirements and Related Burden Estimates i. FOCUS Report ii. Notice of Failure To Maintain Minimum Financial Requirements iii. Requests for Extensions of Time To File Financial Statements iv. Capital Requirements Elections v. Application for Use of Models vi. Equity Withdrawal Requirements vii. Financial Recordkeeping, Reporting and Notification Requirements for SDs and MSPs viii. Capital Comparability Determinations IV. Cost Benefit Considerations A. Background B. Regulatory Capital C. General Summary of Rulemaking D. Baseline E. Overview of Approaches 1. Bank-Based Capital Approach 2. Net Liquid Assets Approach 3. Alternative Net Capital (‘‘ANC’’) E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 4. Tangible Net Worth 5. Substituted Compliance F. Entities 1. Bank Subsidiaries 2. SD/BD (Without Models) 3. SD/BD/OTC Derivatives Dealers (Without Models) 4. FCM–SD (Without Models) 5. ANC Firms (SD/BD and/or FCMs That Use Models) 6. Stand-Alone SD (With and Without Models) 7. Non-Financial SD (With and Without Models) 8. MSP 9. Substituted Compliance G. Liquidity Requirements H. Equity Withdrawal Restrictions I. Reporting and Recordkeeping Requirements J. Section 15(a) Factors 1. Protection of Market Participants and the Public 2. Efficiency, Competitiveness, and Financial Integrity of Swaps Markets 3. Price Discovery 4. Sound Risk Management Practices 5. Other Public Interest Considerations K. Attachment A to Cost Benefit Considerations I. Introduction jbell on DSKJLSW7X2PROD with RULES3 A. Background and Statutory Authority The Commission is adopting capital and financial reporting requirements for SDs and MSPs, and is amending existing capital rules for FCMs to provide explicit capital requirements for proprietary positions in swaps and security-based swaps that are not cleared by a clearing organization. The adoption of the capital requirements for SDs and MSPs completes the Congressional mandate directing the Commission to adopt rules imposing both capital requirements on SDs and MSPs that are not subject to a prudential regulator, and imposing initial and variation margin on uncleared swaps entered into by SDs and MSPs that are not subject to a prudential regulator.1 Title VII of the Dodd-Frank Act established a new regulatory framework for swap and security-based swap transactions.2 The legislation was enacted, among other reasons, to reduce risk, increase transparency, and promote market integrity within the financial system, including by: (i) Providing for 1 The term ‘‘prudential regulator’’ is defined for purposes of the section 4s(e) capital and margin requirements to mean the Board of Governors of the Federal Reserve System (‘‘Federal Reserve Board’’); the Office of the Comptroller of the Currency (‘‘OCC’’); the Federal Deposit Insurance Corporation (‘‘FDIC’’); the Farm Credit Administration; and the Federal Housing Finance Agency. See section 1a(39) of CEA (7 U.S.C. 1 et. seq.). 2 See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at https://www.cftc.gov/ LawRegulation/OTCDERIVATIVES/index.htm. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 the registration and comprehensive regulation of SDs, security-based swap dealers (‘‘SBSDs’’), MSPs and major security-based swap participants (‘‘MSBSPs’’); (ii) imposing clearing and trade execution requirements on swaps and security-based swaps, subject to certain exceptions; (iii) creating rigorous recordkeeping and real-time reporting regimes; and (iv) enhancing the rulemaking and enforcement authorities of the Commissions with respect to, among others, all registered entities and intermediaries subject to the Commission’s oversight. The DoddFrank Act further established a jurisdictional boundary by authorizing the Commission to regulate ‘‘swaps,’’ and granting the SEC authority to regulate ‘‘security-based swaps.’’ 3 Sections 721 and 761 of the Dodd-Frank Act also added definitions of the terms ‘‘swap dealer,’’ ‘‘security-based swap dealer,’’ ‘‘major swap participant,’’ and ‘‘major security-based swap participant’’ to the CEA and Exchange Act.4 An additional provision of the new swap regulatory framework, section 731 of the Dodd-Frank Act, amended the CEA 5 by adding section 4s, which requires an entity meeting the definition of an SD or an MSP to register with the Commission.6 Section 4s authorizes the Commission to adopt rules requiring such SDs and MSPs to maintain daily trading records of their swaps and all related records (including related cash or forward transactions) and recorded communications.7 Section 4s further requires each SD or MSP to conform with the business conduct standards prescribed by the Commission that relate to: (i) Fraud, manipulation, and other abusive practices involving swaps; (ii) diligent supervision of the business of the SD or MSP; (iii) adherence to applicable position limits; and (iv) such other matters as the Commission determines appropriate.8 Section 4s(e) also addresses minimum capital requirements for SDs and MSPs, and imposes initial and variation margin obligations on swaps entered into by SDs and MSPs that are not cleared by a registered derivatives clearing organization.9 Section 4s(e) applies a bifurcated approach with respect to capital and margin by requiring each SD and MSP subject to regulation by a prudential regulator to meet the minimum capital and margin requirements adopted by the applicable prudential regulator, and requiring each SD and MSP not subject to regulation by a prudential regulator to meet the minimum capital and margin requirements adopted by the Commission.10 Therefore, the Commission’s authority to impose capital and margin requirements extends to SDs and MSPs that are nonbanking entities that are not subject to a prudential regulator, including nonbanking subsidiaries of bank holding companies regulated by the Federal Reserve Board. SDs and MSPs subject to the Commission’s capital and margin requirements are referred to in this document as ‘‘covered SDs’’ and ‘‘covered MSPs,’’ respectively. SDs and MSPs subject to the margin and capital requirements of a prudential regulator are referred to in this document as ‘‘bank SDs’’ and ‘‘bank MSPs,’’ respectively. The Commission previously adopted rules imposing margin requirements for uncleared swap transactions entered into by covered SDs and covered MSPs as required by section 4s(e).11 The prudential regulators also adopted rules imposing margin requirements for uncleared swap and security-based swap transactions entered into by bank SDs or bank MSPs.12 The prudential regulators further adopted capital requirements applicable to bank SDs 97 U.S.C. 6s(e). U.S.C. 6s(e)(1). 11 The Commission adopted final rules on December 18, 2015 imposing initial and variation margin requirements on covered SDs and covered MSPs for swap transactions that are not cleared by a registered derivatives clearing organization (‘‘DCO’’). See, Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016). The margin rules, which became effective on April 1, 2016, are codified in part 23 of the Commission’s regulations (17 CFR 23.150–23.159, 23.161). In May 2016, the Commission amended the margin rules to add Commission regulation § 23.160, providing rules on the cross-border application of the margin rules. See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—CrossBorder Application of the Margin Requirements, 81 FR 34818 (May 31, 2016). 12 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). 10 7 3 The term ‘‘swap’’ is defined in section 1a(47) of the CEA (7 U.S.C. 1a(47)) and Commission regulation § 1.3 (17 CFR 1.3). The term ‘‘securitybased swap’’ is defined in section 3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68)). Commission regulations referred to in this release are found at 17 CFR chapter I (2019), and are accessible on the Commission’s website at https://www.cftc.gov/ LawRegulation/CommodityExchangeAct/index.htm. 4 See CEA sections 1a(33) and (49) (7 U.S.C. 1a(33) and (49)) for the definition of the terms ‘‘major swap participant’’ and ‘‘swap dealer,’’ respectively; See Exchange Act section 3(a)(67) and (71) (15 U.S.C. 3(a)(67) and (71)) for the definition of the terms ‘‘major security-based swap participant’’ and ‘‘security-based swap dealer,’’ respectively. 5 7 U.S.C. 1 et seq. 6 7 U.S.C. 6s(a). 7 7 U.S.C. 6s(g). 8 7 U.S.C. 6s(h). PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 57463 E:\FR\FM\15SER3.SGM 15SER3 57464 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 and bank MSPs that incorporate swap and security-based swap transactions into the capital framework.13 Furthermore, section 764 of the DoddFrank Act added section 15F to the Exchange Act to address capital and margin requirements associated with security-based swaps. Section 15F(e)(1)(B) directs the SEC to adopt capital and margin requirements for SBSDs and MSBSPs that do not have a prudential regulator (‘‘nonbank SBSDs’’ and ‘‘nonbank MSBSPs’’). The SEC adopted final capital rules for nonbank SBSDs and nonbank MSBSPs, as well as final margin rules for security-based swaps entered into by nonbank SBSDs and nonbank MSBSPs, in June 2019.14 In addition to the new capital authority over covered SDs and covered MSPs, the Commission also has separate statutory authority to adopt rules imposing minimum capital requirements on FCMs.15 The Commission expects that certain FCMs will engage in a level of swap dealing activity that will require their registration as SDs with the Commission. Such FCMs that are dually-registered as SDs (‘‘FCM–SDs’’) will be subject to the Commission’s long-standing FCM capital rules. In addition, other FCMs may engage in a level of swap dealing activity that is less than what is required to register as an SD; FCMs may engage in swaps and security-based swaps as part of their business to, for example, hedge financial and commercial risks (‘‘standalone FCMs’’). Although the general capital treatment of unsecured market gains as non-current assets and the capital charges for inventory and fixed price commitments have been applied as applicable to the market and credit risk of swap positions for FCMs, to now 13 The prudential regulators have adopted capital rules addressing capital requirements for swap and security-based swap transactions. In this regard, the Federal Reserve Board and OCC have adopted revised capital rules to incorporate Basel III capital adequacy requirements. See, Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 78 FR 62018 (Oct. 11, 2013). 14 Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers, Exchange Act Release No. 86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019) (‘‘2019 SEC Final Capital Rule’’). The compliance date for these rules is October 6, 2021. 15 Section 4f(b) of the CEA (7 U.S.C. 6f(b)) authorizes the Commission to establish minimum financial requirements for FCMs. The Commission previously adopted minimum capital requirements for FCMs, which are set forth in Commission regulation § 1.17 (17 CFR 1.17). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 explicitly address both the market and credit risk of these positions for FCM– SDs and stand-alone FCMs, the Commission is adopting rules to specifically incorporate uncleared swaps and security-based swaps into the existing FCM capital framework by defining specific market risk charges and credit risk charges for such transactions. The Commission’s FCM regulations are consistent with its authority under section 4f(b) of the CEA, which authorizes the Commission to impose minimum financial requirements, including capital requirements, on FCMs. This authority extends to establishing capital requirements with respect to all of an FCM’s activities, including activities involving swaps and security-based swaps.16 Under the Commission’s final rules, an FCM–SD and a stand-alone FCM are subject to the FCM capital requirements set forth in regulation 1.17. The Commission also is adopting financial reporting and recordkeeping requirements for SDs and MSPs. Section 4s(f)(2) of the CEA directs the Commission to adopt rules governing financial condition reporting and recordkeeping for SDs and MSPs, and section 4s(f)(1)(A) requires each registered SD and MSP to make such reports as are required by Commission rule or regulation regarding the SD’s or MSP’s financial condition.17 The Commission also is adopting record retention and inspection requirements consistent with the provisions of section 4s(f)(1)(B).18 The final reporting requirements require covered SDs and covered MSPs to file periodic unaudited financial statements and an annual audited financial report with the Commission and with the registered futures association (‘‘RFA’’) of which they are a member.19 The final regulations further 16 Section 4s(e)(3)(B) (7 U.S.C. 6s(e)(3)(B)) of the CEA provides that the nothing in section 4s shall limit, or be construed to limit, the authority of the Commission to set financial responsibility rules for an FCM. 17 See 7 U.S.C. 6s(f)(1) and (2). 18 The Commission previously finalized certain record retention requirements for SDs and MSPs regarding their swap activities. See, Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 76 FR 20128 (Apr. 3, 2012). 19 Section 3 of the CEA states that a purpose of the CEA is to establish a system of effective selfregulation under the oversight of the Commission. Consistent with the self-regulatory concept established under section 3, section 17 of the CEA provides a process whereby an association of persons may register with the Commission as an PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 require covered SDs and covered MSPs to file certain regulatory notices with the Commission and with the RFA of which they are a member. The notices are comparable to the existing FCM notices, and are intended to alert the Commission and RFA to scenarios that may indicate potential financial or operational issues, including instances of undercapitalization and failure to maintain current books and records. Covered SDs and covered MSPs are also required to file notice if certain triggering events regarding the failure to post or collect initial or variation margin with swap counterparties occur. The Commission also is adopting a program for non-U.S. domiciled covered SDs or covered MSPs to petition the Commission for a program of substituted compliance. Non-U.S. domiciled covered SDs or covered MSPs may seek a determination from the Commission that they operate in a jurisdiction that has comparable capital adequacy and financial reporting objectives and goals as set forth by the Commission in the final regulations. Non-U.S. domiciled covered SDs or MSPs that operate in a jurisdiction that the Commission has determined meets the capital adequacy and financial reporting objectives of the CEA and the Commission’s regulations may meet some or all of their capital and financial reporting requirements by complying with their home country jurisdiction requirements. The Commission is also adopting several amendments to existing regulations as part of the proposed capital and financial recordkeeping and reporting requirements. The Commission is amending regulation 1.12 to require an FCM or an introducing broker (‘‘IB’’) that is subject to the capital rules of both the Commission and the SEC to file a notice with the Commission if the FCM or IB fails to meet the SEC’s minimum capital requirement. The Commission is also adopting amendments to regulation 1.12 to require an FCM or an IB that is also registered with the SEC as an SBSD or an MSBSP to file a notice if the SBSD’s or MSBSP’s net capital falls below the ‘‘early warning level’’ established in the rules of the SEC.20 The Commission is also adopting amendments to the bulk RFA. Currently, the National Futures Association (‘‘NFA’’) is the only RFA under section 17 of the CEA. 20 The SEC requires each SBSD for which there is no prudential regulator to provide notice within 24 hours if the SBSD’s net capital or tentative net capital (as applicable) falls below 120% of the SBSD’s minimum net capital or tentative net capital requirement. An MSBSP is required to provide notice within 24 hours if its tangible net worth falls below $20 million. See 17 CFR 240.18–8(b). E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations transfer provisions of regulation 1.65 by expanding from 5 to 10 days the advance notice that an FCM or an IB must provide to the Commission prior to the transfer. The Commission is further revising the bulk transfer rules to provide that the notice of the bulk transfer must be filed with the Commission electronically, and delegating the authority to accept delivery of such notice in a period shorter than 10 days to the Director of the Division of Swap Dealer and Intermediary Oversight, provided that the notice must be provided as soon as practicable and in no event later than the day of the transfer. The Commission also proposed specific quantitative liquidity requirements for certain SDs. As discussed in section II.C.8. below, the Commission has determined to defer consideration of the proposed liquidity requirements at this time. Accordingly, the Commission is not adopting the proposed liquidity requirements in this final rulemaking. SDs will continue to be subject to the existing risk management program requirements, including the liquidity requirements, set forth in regulation 23.600. The Commission intends to monitor the impact of the capital and financial reporting requirements being adopted today using data received from covered SDs and covered MSPs once they are subject to these capital and financial reporting requirements. Information that the Commission will receive and observe includes data regarding the level of capital that the covered SDs and covered MSPs are required to maintain, the level of capital actually maintained, the liquidity that the firms maintain, the leverage the firms employ, and the scale and types of swaps and other transactions that they are engaged in. The Commission also will continue to consult with the prudential regulators and the SEC to assess the capital adequacy of SDs, MSPs, SBSDs, and MSBSPs. The Commission will monitor the data resulting from the adoption of today’s rules and general market events and consider modifications to the capital and financial reporting requirements in light of this information. The Commission also will monitor the information that it receives to assess the adequacy of the liquidity of SDs and, if appropriate, will consider proposing additional liquidity requirements as necessary. B. Proposed Rulemakings and Reopening of the Comment Period The Commission initially proposed capital and financial reporting requirements for covered SDs and VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 covered MSPs in 2011.21 The Commission received comments from a broad spectrum of market participants, industry representatives, and other interested parties. The commenters addressed numerous topics including the permissible use of models for computing market risk and credit risk capital charges and the need for harmonization of the Commission’s capital and financial reporting requirements for covered SDs with the capital and financial reporting rules of the prudential regulators for bank SDs and with the rules of the SEC for nonbank SBSDs. Commenters particularly emphasized a need for the harmonization of regulatory requirements for covered SDs that also are registered with the SEC as SBSDs. Shortly after the Commission issued the 2011 Capital Proposal, the Basel Committee on Banking Supervision (‘‘BCBS’’) and the International Organization of Securities Commissions, in consultation with the Committee on Payment and Settlement Systems and the Committee on Global Financial Systems, formed a working group (the ‘‘WGMR’’) to develop internationally harmonized standards for margin requirements for uncleared swaps. Representatives of more than 20 regulatory authorities participated in the WGMR including the Commission, the SEC, Federal Reserve Board, OCC, FDIC, and the Federal Reserve Bank of New York. The Commission elected to defer consideration of the SD and MSP capital and financial reporting rules until the WGMR had completed its work and the Commission had adopted margin requirements for uncleared swap transactions. As noted above, the Commission subsequently adopted final margin requirements for uncleared swaps in December 2015, and the compliance period for the final rules is being phased-in through 2021.22 In 2016, in consideration of the substantial amount of time that had passed since the 2011 Capital Proposal, the Commission re-proposed the capital and financial reporting rules for SDs and MSPs to provide commenters with an opportunity to provide further comment in recognition of the significant developments in the swaps marketplace since the 2011 Capital 21 See Capital Requirements of Swap Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011) (the ‘‘2011 Capital Proposal’’). 22 See 81 FR 636 (Jan. 6, 2016) and Commission regulation § 23.161 (17 CFR 23.161)). The Commission also has proposed to extend the compliance date for the final phase-in period to September 1, 2022. See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 85 FR 41463 (July 10, 2020). PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 57465 Proposal.23 These marketplace developments included more than 100 entities provisionally registering with the Commission as SDs, the Commission adopting final margin rules for uncleared swaps, the prudential regulators adopting final capital and margin rules for swap and securitybased swap transactions, and the SEC proposing capital, margin, segregation and financial reporting requirements for SBSDs and MSBSPs. The Commission again received comments from a broad spectrum of market participants and other interested parties. The commenters raised several issues with regards to the 2016 Capital Proposal, including the appropriateness of basing a capital requirement on initial margin requirements, the appropriateness of a liquidity requirement for covered SDs, the use of models to compute market risk and credit risk capital charges, and the need for harmonization of the Commission’s rules with the rules of the prudential regulators and the SEC. Commenters also requested that the Commission provide an additional opportunity for public comment on the 2016 Capital Proposal once the SEC finalized its capital, margin, and financial reporting requirements for SBSDs and MSBSPs. The commenters noted the particular necessity for an opportunity to provide further comment on the 2016 Capital Proposal as the Commission’s Proposal would permit a covered SD to compute its capital as if it were a SBSD subject to the SEC’s SBSD capital requirements. The commenters noted that the SEC had received many substantial comments on its proposed nonbank SBSD and nonbank MSBSP capital requirements. The commenters further stated that they would need to review the SEC’s final capital, margin and financial reporting rules, including the SEC’s response to the many comments on its proposal, in order to provide full comments on the 2016 Capital Proposal. The Commission ultimately reopened the comment period for the 2016 Capital Proposal.24 The 2019 Capital Reopening 23 Capital Requirements of Swap Dealers and Major Swap Participants, 81 FR 91252 (Dec. 16, 2016) (the ‘‘2016 Capital Proposal’’ or the ‘‘Proposal’’). The comment letters for the 2016 Capital Proposal are available at: https:// comments.cftc.gov/PublicComments/ CommentList.aspx?id=1769 (the public comment file). Commenters included financial services associations, agricultural associations, energy associations, insurance associations, banks, brokerage firms, investment managers, insurance companies, pension funds, commercial end users, law firms, public interest organizations, and other members of the public. 24 See Capital Requirements of Swap Dealers and Major Swap Participants, 84 FR 69664 (Dec. 16, E:\FR\FM\15SER3.SGM Continued 15SER3 57466 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 was published after the SEC had adopted final capital, margin, segregation, and financial reporting requirements for SBSD and MSBSPs. Accordingly, the 2019 Capital Reopening provided interested parties with an additional opportunity to provide comments on the 2016 Capital Proposal after the SEC finalized its capital and financial reporting rules. One commenter stated that the Commission could not finalize the 2016 Capital Proposal due to the lack of cost benefit analysis related to additional questions contained in the 2019 Capital Reopening and was unable to fully assess the potential modifications to the proposed rules without re-proposal.25 The commenter further argued that the 2019 Capital Reopening contained only questions and requests for comment with no specific rule text or accompanying explanation, including evaluation of costs and benefits as the commenter believed required. As a result of this, the commenter posited any final rulemaking following the 2019 Capital Reopening failed to provide adequate notice of identifiable regulatory outcomes to commenters and therefore, would not satisfy APA considerations for notice and comment rulemaking.26 The Commission disagrees. The 2019 Capital Reopening provided an additional opportunity for commenters to address aspects of the 2016 Capital Proposal in light of the SEC’s final capital rule for SBSDs and MSBSPs, which was itself incorporated by reference into the 2016 Capital Proposal. In 2016, the Commission re-proposed the SD Capital rules for a second time.27 In that release, the Commission specifically noted that it had considered the comments from the 2011 proposal in developing the 2016 Capital Proposal.28 The 2016 Capital Proposal again proposed complementary financial reporting rules and recognized the expected use of models. Further, the Commission stated at the time that it had also considered capital rules adopted by the prudential regulators 2019) (the ‘‘2019 Capital Reopening’’). The comment letters for the 2019 Capital Reopening are available at: https://comments.cftc.gov/ PublicComments/CommentList.aspx?id=1769 (the public comment file). Commenters included financial services associations, agricultural associations, energy associations, insurance associations, banks, brokerage firms, investment managers, insurance companies, pension funds, commercial end users, law firms, public interest organizations, and other members of the public. 25 See Letter From Dennis M. Kelleher, President and CEO, Better Markets Inc. (March 3, 2020) (Better Markets 3/3/2020 Letter). 26 Id. at page 7. 27 81 FR 91252 (Dec. 16, 2016). 28 Id. at 91254. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 and capital rules proposed by the SEC for security-based swap dealers and major security-based swap participants.29 As such, the Commission specifically said that it had to a great extent drawn upon the SEC capital rules in developing the proposed capital requirements.30 The 2019 Capital Reopening did not change the 2016 proposed framework, which has largely remained intact since the original proposal in 2011—such as, what method an entity could use to calculate its required capital and the various capital minimums dependent upon the characteristics of the registered entity, while seeking to maintain comparability to the other capital regimes of the Prudential Regulators and the SEC, as statutorily required. The 2019 Capital Reopening sought to specifically respond to commenters who had asked for an additional opportunity to comment on the 2016 Capital Proposal following the finalization of capital rules for SBSDs by the SEC. It gave commenters the opportunity to provide their views on whether certain items should be included or how the process should account for them.31 Each of the areas addressed in the 2019 Capital Reopening signaled potential modifications that the Commission was considering in light of comments received, including modifications adopted by the SEC.32 Modifications in the final rule, including a discussion and specific inclusion of various approaches, are therefore the logical outgrowth of the 2016 Capital Proposal. In addition, the 2016 Capital Proposal included a comprehensive cost benefit consideration section, addressing the Section 15(a) factors in detail. The costbenefit analysis discussed an elective approach utilizing similar tailored minimums depending on the characteristics of the registered entity— a net liquid asset approach incorporating the traditional FCM and SEC registered broker or dealer (‘‘BD’’) capital framework, a bank-based approach incorporating again the riskweighted assets framework from banking rules, and again a tangible net worth approach for certain eligible firms. The 2016 Capital Proposal again proposed complementary financial reporting rules and recognized the expected use of models. The public was asked to comment on all aspects of the 29 Id. In this regard, Section 4s(e)(3)(D) of the CEA provides that the CFTC, SEC, and prudential regulators shall, to the maximum extent practicable, establish and maintain comparable minimum capital requirements for SDs and MSPs. 30 Id. 31 See 84 FR 69665. 32 Id. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 proposal, and several comments were received in response. A more fulsome discussion is in the Cost-Benefit Consideration section of this document; however, as noted above, the potential modifications described in the 2019 Capital Reopening, including a discussion and specific inclusion of potential rule language, were logical outgrowths of the 2016 Capital Proposal. C. Consultation With U.S. Securities and Exchange Commission and Prudential Regulators The Dodd-Frank Act amended the CEA and the Exchange Act to require the Commission, SEC, and prudential regulators to coordinate and develop comparable capital requirements for SDs and SBSDs, and for MSPs and MSBSPs. Section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D), in conjunction with section 15F(e)(3)(D) of the Exchange Act (15 U.S.C. 78o–10(e)(3)(D)), provides that, to the maximum extent practicable, the Commission, SEC and the prudential regulators shall establish and maintain comparable minimum capital requirements for SDs and SBSDs, and for MSPs and MSBSPs. Further, section 4s(e)(3)(D) and section 15F(e)(3)(D) provide that staff of the CFTC, SEC, and prudential regulators shall meet periodically, but no less frequently than annually, to consult on minimum capital requirements. Consistent with this Congressional mandate, the respective staffs of the Commission, SEC, and the prudential regulators have regularly shared drafts of proposed and final rulemakings with staffs of the other agencies for review and comment before taking final action with respect to the proposed or final rulemakings. Consistent with this approach, the Commission provided the SEC and prudential regulators with drafts of the final rules for review and comment, and the final rulemaking reflects comments received from the SEC and prudential regulators. II. Final Regulations and Amendments to Existing Regulations A. Capital Framework for FCMs, Covered SDs, and Covered MSPs FCMs are subject to existing capital requirements set forth in regulation 1.17. The Commission is amending regulation 1.17 to establish capital requirements explicitly for swap and security-based swap transactions entered into by FCMs. The Commission is also amending regulation 1.17 to require an FCM–SD to comply with the amended FCM capital requirements. A discussion of the amendments to E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations regulation 1.17 for FCMs and FCM–SDs is contained in section II.B. of this release. The Commission is also adopting final capital rules for covered SDs that are not FCM–SDs, and is adopting final capital rules for covered MSPs. The Commission is adopting a flexible approach that allows covered SDs to elect one of three alternative capital frameworks for establishing their minimum capital requirements and for computing their regulatory capital. The three alternative approaches draw to a great extent on the existing CFTC capital requirements for FCMs contained in regulation 1.17, as well as the SEC’s capital requirements for BDs and nonbank SBSDs, and the prudential regulators’ capital requirements for bank SDs. Specifically, the Commission’s final capital rules, depending on the characteristics of a covered SD, permit such SD to elect: (i) A capital requirement consistent with the SEC’s final capital requirements for SBSDs, as well as the existing CFTC capital rules for FCMs and the existing SEC capital rules for BDs (the ‘‘Net Liquid Assets Capital Approach’’); (ii) a capital requirement consistent with the prudential regulators’ capital requirements for bank SDs, and that is based on existing Federal Reserve Board capital requirements for bank holding companies (the ‘‘Bank-Based Capital Approach’’); or (iii) a capital requirement based on the covered SD’s tangible net worth, provided that the covered SD or its parent entity is predominantly engaged in non-financial activities as defined in the rule (the ‘‘Tangible Net Worth Capital Approach’’). Each of the approaches is discussed in section II. below. With respect to covered MSPs, the Commission is adopting a minimum regulatory capital requirement based upon the tangible net worth of the MSP. While there currently are no provisionally-registered MSPs or entities pending registration as MSPs, the Commission is adopting final capital requirements in the event that entities seek registration in the future. A capital requirement based upon the tangible net worth of the MSP is consistent with the approach adopted by the SEC for nonbank MSBSPs, as discussed in section II.C.5. of this release. Broadly speaking, in developing the proposed capital requirements, the Commission strived to advance the statutory goal of helping to protect the safety and soundness of covered SDs and covered MSPs, while also taking into account the diverse nature of the entities registered as SDs, and the existing capital regimes that apply to VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 covered SDs and/or their financial group. In this regard, as of June 30, 2020, there were 108 provisionally registered SDs. Fifty-two of the provisionally registered SDs are bank SDs, subject to a prudential regulator. The remaining 56 SDs are covered SDs, subject to the Commission’s capital rules. While each of the 56 covered SDs is registered with the Commission as a result of their swap dealing activities, the SDs represent a broad range of business activities and a diverse population of swap counterparties. Several of the covered SDs are primarily engaged in commodity-focused swap transactions with commercial counterparties, while other covered SDs are focused primarily with financial related swaps, including interest rate, foreign currency, and credit default swaps, and have a broad range of swaps counterparties that includes both commercial and financial counterparties. The 56 covered SDs subject to the Commission’s capital requirements are associated with 21 corporate families, with several families having more than 1 provisionally-registered covered SD. Many of these corporate families are part of U.S. bank or foreign bank holding companies that offer global financial services and are subject to prudential capital regulation, including BCBS-based capital requirements that may extend to some of the provisionally-registered covered SDs. The alternative capital approaches adopted by the Commission are intended to mitigate potential competitive disadvantages and unnecessary costs that might otherwise arise if the Commission were to impose a single capital approach in light of the existing different operating and corporate structures of the covered SDs. The Commission further believes that the flexibility of the capital approaches will potentially benefit market participants by providing a tailored capital regime that encourages SDs that are not part of global financial firms to continue to provide liquidity in the swaps market, particularly to smaller financial or commercial end users that do not have relationships with the large financial SDs. As mentioned above, FCM–SDs are subject to the FCM capital requirements set forth in regulation 1.17. Covered SDs that are not FCM–SDs and covered MSPs that are not FCM–MSPs are subject to the final capital requirements set forth in regulation 23.101. Regulation 23.101 details the minimum capital requirements for each of the three capital approaches for covered SDs and the eligibility criteria (as PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 57467 applicable), and further defines the capital computations for each approach, including various market risk and credit risk capital charges. Regulation 23.101 also defines the minimum capital requirements for covered MSPs and defines the capital computation for covered MSPs. Each of these capital approaches is discussed below. B. Capital Requirements for StandAlone FCMs and FCM–SDs 1. Introduction to General Capital Requirements for Stand-Alone FCMs and FCM–SDs The capital requirements for FCMs are set forth in regulation 1.17 and require each FCM to maintain a minimum level of ‘‘liquid assets’’ in excess of the firm’s liabilities to provide resources for the FCM to meet its financial obligations as a market intermediary in the regulated futures and cleared swaps markets. As a market intermediary, an FCM provides services to its customers and the marketplace, including, in the event of a customer default, guaranteeing the financial performance of each customer to clearing organizations that clear the customers’ futures and cleared swap transactions. To ensure that an FCM is capable of meeting its financial obligations, regulation 1.17 requires an FCM to hold at all times more than one dollar of highly liquid assets for each dollar of liabilities (e.g., money owed to customers, counterparties and creditors), excluding certain subordinated debt.33 The FCM capital requirements also are intended to ensure that an FCM maintains a sufficient level of liquid assets in excess of its liabilities in order to effectively and efficiently wind-down its operations by transferring customer positions and funds to other FCMs in the event that the FCM voluntarily or involuntarily ceases operations. The FCM capital requirement contains two components. The first component is a minimum level of ‘‘adjusted net capital’’ that an FCM is required to maintain at any given time. The minimum adjusted net capital requirement is generally the greater of the following: (i) A fixed-dollar amount; (ii) an amount computed based upon the clearing organization margin imposed on customer and noncustomer futures, foreign futures, and cleared swap 33 Commission regulation § 1.17(h) (17 CFR 1.17(h)) permits an FCM to exclude certain qualifying subordinated debt from its liabilities in computing its net capital. In order to qualify, the person lending cash to the FCM must subordinate its claim against the FCM to all other creditors of the FCM in addition to agreeing to other conditions, including potential restrictions associated with scheduled repayments of the debt. E:\FR\FM\15SER3.SGM 15SER3 57468 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations positions carried by the FCM; (iii) the amount of net capital required by the SEC for FCMs that are dually-registered as BDs (‘‘FCM/BDs’’); or, (iv) the amount of adjusted net capital required by an RFA of which the FCM is a member.34 The second component of the FCM capital requirement is the amount of adjusted net capital that an FCM actually maintains based upon the assets and liabilities of the firm. In determining its adjusted net capital, an FCM is first required to compute its net worth under generally accepted accounting principles (‘‘GAAP’’) as adopted in the United States, and then is required to apply certain rule-based adjustments to reduce its net worth to the extent it contains illiquid assets such as fixed assets and unsecured receivables. The resulting calculation reflects the FCM’s ‘‘net capital.’’ The FCM is then required to apply certain rule-based capital charges or haircuts to reflect market risk associated with its liquid assets. The resulting calculation reflects the FCM’s ‘‘adjusted net capital.’’ The calculation of adjusted net capital in this manner is intended, as noted above, to ensure that the FCM holds at least one dollar of highly liquid assets to meet each dollar of liabilities, excluding certain qualifying subordinated liabilities. The Commission proposed several amendments to regulation 1.17 in recognition that the current capital requirements do not explicitly reflect FCMs transacting in uncleared swap or security-based swap transactions, or engaging in swap dealing activities. The Commission also proposed to require FCM–SDs to comply with the FCM capital requirements.35 The Commission proposed to require FCM–SDs to comply with regulation 1.17 due to the Commission’s experience regulating FCMs and its belief that the FCM capital requirements, with its emphasis on liquidity, are well-designed to ensure that an FCM will be able to continue to perform its critical functions in the futures and cleared swaps marketplace. As noted above, FCMs are market intermediaries that provide customers with access to the futures and cleared swaps markets. As market intermediaries, FCMs play a central role in the daily settlement process at derivatives clearing organizations by jbell on DSKJLSW7X2PROD with RULES3 34 See Commission regulation § 1.17(a)(1)(i) (17 CFR 1.17(a)(1)(i)). 35 Section 4s(e)(3)(B)(i) of the CEA (7 U.S.C. 6s(e)(3)(B)(i)) states that nothing in section 4s(e) imposing capital and margin requirement on SDs and MSPs limits, or shall be construed to limit, the authority of the Commission to set financial responsibility rules for FCMs pursuant to section 4f(a). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 paying or collecting their customers’ initial and variation margin obligations. FCMs also guarantee their customers’ financial performance to each DCO, and contribute to DCO guarantee funds. FCMs also provide numerous services for their customers, including providing confirmations of each transaction and periodic account statements. Based on its experience with FCMs, the Commission believes that the FCM capital rule, which is a liquidity-based capital rule, is appropriate for FCM– SDs. 2. Minimum Capital Requirement for FCMs and FCM–SDs a. Minimum Fixed-Dollar Amount of Net Capital Regulation 1.17(a)(1)(i) requires an FCM to maintain a minimum amount of adjusted net capital that is equal to or greater than the highest of: (i) $1 million; (ii) for an FCM that engages in off-exchange foreign currency transactions with retail forex customers,36 $20 million, plus 5% percent of the FCM’s liabilities to the retail forex customers that exceed $10 million; (iii) 8% percent of the sum of the risk margin of futures, options on futures, foreign futures, and swap positions cleared by a clearing organization and carried by the FCM in customer and noncustomer accounts; (iv) the amount of adjusted net capital required by the RFA of which the FCM is a member; and (v) for an FCM that is also registered with the SEC as a BD, the amount of net capital required by the rules of the SEC.37 The term ‘‘risk margin’’ is defined in regulation 1.17(b)(8) as the level of maintenance margin or performance bond required for the customer or noncustomer positions by the applicable exchanges or clearing organizations, and, where margin or performance bond is required only for accounts at the clearing organization, for purposes of the FCM’s risk-based capital calculations applying the same margin or performance bond requirements to customer and noncustomer positions in accounts carried by the FCM, subject to the following: (i) Risk margin does not include the equity component of short or long option positions maintained in an account; (ii) the maintenance margin 36 Commission regulation § 5.1(k) (17 CFR 5.1(k)) defines the term ‘‘retail forex customer’’ as a person, other than an eligible contract participant as defined in section 1a(18) of the CEA, acting on its own behalf in any account agreement, contract or transaction described in section 2(c)(2)(B) or 2(c)(2)(C) of the CEA (7 U.S.C. 2(c)(2)(B) or 2(c)(2)(C)). 37 See Commission regulation § 1.17(a)(1)(i) (17 CFR 1.17(a)(1)(i)). PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 or performance bond requirement associated with a long option position may be excluded from risk margin to the extent that the value of such long option position does not reduce the total risk maintenance or performance bond requirement of the account that holds the long option position; (iii) the risk margin for an account carried by an FCM which is not a member of the exchange or the clearing organization that requires collection of such margin should be calculated as if the FCM were such a member; and (iv) if an FCM does not possess sufficient information to determine what portion of an account’s total margin requirement represents risk margin, all of the margin required by the exchange or the clearing organization that requires collection of such margin for that account, shall be treated as risk margin.38 The Commission proposed amending regulation 1.17(a)(1)(i)(A) to increase the minimum fixed-dollar amount of adjusted net capital from $1 million to $20 million for FCM–SDs. The Commission did not propose to amend the required minimum fixed-dollar amount of adjusted net capital for standalone FCMs that may engage in swap activities at a level that does not require registration as an SD, as the Commission believed that the existing minimum fixed-dollar amount of required adjusted net capital was properly calibrated for such firms. The Commission believes that the proposed higher minimum dollar amount of adjusted net capital for FCM– SDs is appropriate given the enhanced risk that an FCM–SD assumes in engaging in swap dealing activities, while also continuing to carry futures and cleared swaps customers.39 As noted above, FCMs act primarily as market intermediaries for futures and cleared swaps customers and typically do not use their balance sheet to facilitate customer transactions. Absent a customer default, an FCM does not take on market risk of its customers’ positions in performing this market intermediary function. FCMs that are FCM–SDs, however, are engaging in swap dealing activities. As dealers, FCM–SDs use their balance sheet to facilitate customer transactions as they are counterparties on swap positions in addition to performing market intermediary functions for their customers. Dealing activities present additional risks to FCM–SDs. As dealers, an FCM–SD is potentially exposed to market risks on uncleared 38 Commission regulation § 1.17(b)(8) (17 CFR 1.17(b)(8)). 39 2016 Capital Proposal, 81 FR 91252. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations swap positions, and is exposed to counterparty credit risk from swap counterparties. FCM–SDs also may be required to post initial margin and pay variation margin to swap counterparties on a daily basis for their proprietary uncleared swap positions. The proposed increase in the fixed-dollar amount of the minimum adjusted net capital was intended to address the potential increase in risks posed to FCM–SDs from dealing activities, including the impact that dealing may have on the liquidity of FCM–SDs. The proposed increase in the minimum capital requirement also was intended to otherwise help ensure the safety and soundness of the FCM–SD, as the insolvency of an FCM–SD could have potential adverse consequences to the efficient operation of the market, particularly as the insolvency impacts the futures and cleared swaps customers of the FCM–SD. The Commission further noted that the proposed $20 million minimum adjusted net capital requirement was consistent with the $20 million minimum dollar amount of adjusted net capital imposed by Congress and the Commission on retail foreign exchange dealers (‘‘RFEDs’’) or FCMs that enter into off-exchange foreign currency transactions with retail persons under section 2(c)(2)(C) of the CEA and regulation 5.7(a). The Commission also proposed amending regulation 1.17(a)(1)(ii) to require an FCM–SD that receives approval from the Commission or from an RFA of which it is a member to use internal market risk or credit risk models to compute capital charges in lieu of the standardized capital charges or deductions to maintain net capital equal to or in excess of $100 million, and adjusted net capital equal to or in excess of $20 million. The requirement to maintain a minimum $100 million fixed-dollar amount of net capital was intended to address the issue that while models are more risk sensitive and generally result in substantially lower market risk and credit risk capital charges than standardized charges, models may not capture all risks, including extreme market losses (i.e., tail risk) or liquidity concerns. The requirement for an FCM–SD that is approved to use capital models to maintain a minimum of $100 million of net capital and $20 million of adjusted net capital is consistent with the SEC’s final capital rule for SBSDs that are not registered BDs (‘‘stand-alone SBSDs’’) and that are approved to use internal models to compute market risk and credit risk capital charges. These entities are required to maintain fixed- VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 dollar tentative net capital of $100 million and fixed-dollar net capital of $20 million.40 The Commission did not receive comment on the proposed $20 million fixed-dollar amount of adjusted net capital required of FCM–SDs. The Commission received a comment stating that the proposed $100 million net capital requirement for FCM–SDs that have approval to use internal models to compute market risk or credit risk capital charges in lieu of the standardized capital charges would create an unnecessary barrier to entry.41 The Commission has considered the proposed amendments of the minimum fixed-dollar amount of net capital and adjusted net capital that FCM–SDs would be required to maintain and is adopting the amendments as proposed.42 As noted above, FCMs play a central role as market intermediaries for futures and cleared swaps transactions, including guaranteeing each customer’s financial performance to clearing organizations or carrying FCMs. An adequate level of capital is necessary to ensure that FCMs meet their financial obligations, which in turn promotes customer protection and helps ensure the cleared futures and cleared swaps markets operate efficiently. The increase in adjusted net capital for FCM–SDs to $20 million is also necessary to address the additional risk that is inherent in an SD’s dealing activities. As a dealer, an FCM–SD uses its balance sheet to facilitate customer swap transactions, is a counterparty in swap transactions, and is obligated to post and collect initial margin and settle variation margin with swap counterparties. Furthermore, the final requirement for an FCM–SD to maintain a minimum of $20 million of adjusted net capital is consistent with the Commission’s required minimum adjusted net capital of $20 million for RFEDs, and is consistent with the SEC’s final minimum capital requirements for SBSDs. With respect to the comment that a $100 million minimum net capital requirement for FCM–SD’s seeking approval to use capital models may act 40 See SEC rule 18a–1(a)(2) (17 CFR 240.18a– 1(a)(2)). 41 See Letter from Joanna Mallers, FIA Principal Traders Group (May 24, 2017) (FIA–PTG 5/24/2017 Letter). 42 The 2019 SEC Final Capital Rule requires BDs that use internal models to compute market risk and credit risk capital charges in lieu of standardized capital charges to maintain $5 billion of net capital and $1 billion of adjusted net capital. FCM/SDs that also are registered with the SEC as BDs are required to comply with the SEC’s capital requirements in meeting the Commission’s minimum capital requirement. PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 57469 as a barrier to entry, the Commission notes that the regulation was designed to account for the fact that model-based market risk and credit risk capital charges, while more risk sensitive than standardized capital charges, tend to be substantially lower than standardized charges. The $100 million of net capital is intended to address potential model errors and tail risk and other factors that may not be fully or accurately captured in the models. The Commission further notes that currently the only FCM–SDs provisionally registered are four BD/ FCMs that are subject to substantially higher minimum capital requirements under SEC and CFTC rules as discussed in section II.B.3.c.(i). below. Accordingly, no provisionally-registered FCM–SD will be subject to the $100 million minimum net capital requirement based on the current list of provisionally registered SDs. b. Minimum Capital Requirement Based on 8% Risk Margin Amount Another component of the minimum capital requirements in regulation 1.17 provides that each FCM must maintain adjusted net capital equal to or greater than 8% of the risk margin amount associated with the futures, foreign futures, and cleared swaps positions carried by the FCM in customer and noncustomer accounts.43 As discussed in section II.B.2.a. above, the term ‘‘risk margin’’ for an account generally means the level of maintenance margin or performance bond required for customer and noncustomer positions by the applicable exchanges or clearing organizations.44 Clearing organizations generally set initial margin requirements for futures, foreign futures, and cleared swap positons at a level to cover oneday market moves with a 99% level of confidence.45 In computing the 8% risk margin amount, an FCM is required to compute risk margin on the positions of each customer on a customer-by-customer basis, and multiply the resulting aggregate risk margin amount by 8%. The 8% risk margin amount is a risk 43 A noncustomer account is an account that an FCM carries for persons that generally are officers or employees of the FCM (i.e., the persons are not customers of the FCM and the account is not the proprietary account of the FCM). See Commission regulation § 1.17(b)(4) (17 CFR 1.17(b)(4)). 44 See Commission regulation § 1.17(b)(8) (17 CFR 1.17(b)(8)). 45 See, for example, Commission regulation § 39.13(g) (17 CFR 39.13(g)) which provides that a derivatives clearing organization must set margin for futures and swaps on agricultural commodities, energy commodities, and metals using a one-tailed 99% confidence interval with a minimum one-day liquidation period, and must set margin for all other swaps using a one-tailed 99% confidence interval with a minimum five-day liquidation period. E:\FR\FM\15SER3.SGM 15SER3 57470 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 sensitive calculation in that an FCM’s minimum capital requirement is tied to the level of exchange or clearing organization margin associated with each customer’s and noncustomer’s account. Accordingly, an FCM’s minimum capital requirement increases or decreases as the aggregate of its customer and noncustomer risk margin increases or decreases. The 8% risk margin amount is also a volume-based metric as it requires an FCM to compute the risk margin amount on each individual customer and noncustomer account, with no offsets between accounts to reflect offsetting positions or to reflect margin collected on the accounts. As a volume-based metric, an FCM’s minimum capital requirement increases or decreases based upon the aggregate amount of risk margin required of each customer and noncustomer account carried by the FCM. The Commission proposed amending the minimum capital requirement in regulation 1.17(a)(1)(i)(B) by expanding the types of positions that an FCM–SD must include in the 8% risk margin amount calculation. The Commission did not propose to expand the types of positions that must be included in the risk margin amount calculation for stand-alone FCMs. An FCM that is not an FCM–SD must continue to calculate the 8% risk margin amount based upon the customer and noncustomer futures, foreign futures, and cleared swap positions carried by the FCM.46 Regulation 1.17(a)(1)(i)(B) currently requires an FCM, as noted above, to include the risk margin associated with the futures, foreign futures, and cleared swap positions carried in customer and noncustomer accounts in the 8% risk margin amount calculation. The 2016 Capital Proposal expanded the list of products that an FCM–SD must include in the 8% risk margin amount calculation to further include the cleared security-based swap positions carried for customers and noncustomers, as well as the FCM–SD’s proprietary cleared swaps and proprietary cleared security-based swap positions. The positions in the risk margin amount calculation was 46 A commenter noted an ambiguity in the 2016 Capital Proposal in that the Commission stated in the preamble that the proposed increases in the minimum capital requirements would be applicable only to FCM–SDs and not to stand-alone FCMs, but that the proposed rule text in Commission regulation § 1.17 did not clearly draw that distinction. See Letter from Walt Lukken, Futures Industry Association, March 3, 2020 (FIA 3/3/2020 Letter). The Commission confirms that the proposed increases in the minimum capital requirements were only applicable to FCM–SDs, and has modified the final rule text to clarify this point. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 proposed to be further extended to include the FCM–SD’s uncleared swap and uncleared security-based swap positions. The Proposal required an FCM–SD to include all swaps and security-based swaps in the risk margin amount calculation, including swaps that are excluded from the Commission’s margin rules for uncleared swaps and any security-based swaps that the SEC excluded from its margin rules. Specifically, the proposal provided that an FCM–SD must include in its computation of the risk margin amount each outstanding uncleared swap, including swaps exempt from the scope of the Commission’s uncleared swaps margin rules by regulation 23.150 (‘‘TRIPRA Exemption),47 legacy swaps, foreign exchange swaps as the term is defined in regulation 23.151, or netting set of swaps or foreign exchange swaps, for each counterparty, as if the counterparty were an unaffiliated SD. The Proposal further required an FCM– SD to include the initial margin for all uncleared swaps that would otherwise fall below the $50 million initial margin threshold amount or the $500,000 minimum transfer amount, as defined in regulation 23.151, for purposes of computing the uncleared swap margin amount.48 The Commission received comments on various aspects of the proposed 8% risk margin amount calculation for FCM–SDs. Commenters to the 2016 Capital Proposal and the 2019 Capital Reopening objected to including cleared and uncleared security-based swaps in the 8% risk margin amount calculation for FCM–SDs.49 Commenters stated that the Commission should not include security-based swaps in the 8% risk margin amount calculation as securitybased swaps are products regulated by the SEC, and that including SECregulated products in the Commission’s minimum capital requirement is inconsistent with long-standing CFTC 47 Title III of the Terrorism Risk Insurance Program Reauthorization Act of 2015 amended sections 731 and 764 of the Dodd-Frank Act to provide that the Commission’s margin requirements shall not apply to a swap in which a counterparty: (i) Qualifies for an exception under section 2(h)(7)(A) of the CEA; (ii) qualifies for an exemption issued under section 4(c)(1) of the CEA for cooperative entities as defined in such exemption; and (iii) satisfies the criteria in section in section 2(h)(7)(D) of the CEA. See Public Law 114–1, 129 Stat. 3. 48 2016 Capital Proposal, 81 FR 91252 at 91258. 49 See FIA 3/3/2020 Letter; Letter from Briget Polichene, Institute of International Bankers, Scott O’Malia, International Swaps and Derivatives Association, and Kenneth Bentsen, Jr., Securities Industry and Financial Markets Association (March 3, 2020) (IIB/ISDA/SIFMA 3/3/2020 Letter). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 and SEC capital requirements for FCMs and BDs.50 A commenter noted that a duallyregistered FCM/BD is generally required to maintain adjusted net capital equal to the greater of (i) 8% of the margin required for futures, foreign futures, and cleared swaps carried by the FCM for customers and noncustomers, or (ii) 2% of the debit items calculated in respect of the BD’s customer securities positions.51 The commenter further stated that the approach of setting separate, as opposed to aggregate, requirements for Commission and SEC regulated products allows the agency that Congress selected to regulate a given product to determine the appropriate balance between robust capital cushions and robust market liquidity.52 The commenter further noted that the 2019 SEC Final Capital Rule continued this historical approach as the SEC elected to include in its minimum capital requirement the initial margin associated only with customer and noncustomer cleared security-based swaps and the SBSD’s uncleared security-based swaps.53 The SEC’s final rule did not incorporate initial margin associated with customer cleared swap positions or uncleared swap positions, or otherwise include positions that are not subject to the SEC’s jurisdiction. One commenter stated that FX forwards and swaps should be excluded from the 8% risk margin amount calculation as Congress gave the United States Treasury Department the authority over these products.54 The Commission has considered the proposal and the comments received, and is adopting a minimum capital requirement based upon a percentage of the risk margin amount. The Commission is modifying the final rule, however, to exclude cleared securitybased swap and uncleared securitybased swap positions from the risk margin amount calculation. The Commission acknowledges that in setting minimum capital requirements for FCMs, including FCMs that are dually-registered as FCM/BDs, it has historically considered only the futures related activities of an FCM. In this regard, the Commission’s initial minimum capital requirement was based upon a percentage of futures customer and noncustomer funds held by an FCM, and was subsequently 50 See IIB/ISDA/SIFMA 3/3/2020 Letter. 51 Id. 52 Id. 53 Id. 54 See Letter from Joanna Mallers, FIA Principal Traders Group (March 3, 2020) (FIA–PTG 3/3/2020 Letter). E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 amended to be based upon a percentage of the risk margin associated with futures and cleared swaps customer and noncustomer positions carried by an FCM.55 The Commission has not historically required an FCM/BD to maintain a level of minimum capital necessary to meet the aggregate of the CFTC’s minimum requirement and the SEC’s minimum requirement, which is based on the FCM/BD’s securities activities. The Commission believes that the overall adequacy of the minimum capital requirement at an FCM–SD should be based upon the activities of the FCM–SD in CFTC-regulated markets. This allows the Commission to monitor the adequacy of the minimum capital requirements based upon its expertise and experience with Commission-regulated products and markets. In addition, an FCM–SD that is also registered as a BD would continue to be subject to the minimum capital requirements established by the SEC for BDs in addition to the minimum capital requirements established by the Commission for FCM–SDs. The Commission’s current capital rule requires an FCM/BD to maintain a minimum level of capital that is greater than the higher of the CFTC minimum requirement for FCMs or the SEC minimum requirement for BDs.56 Therefore, an FCM–SD that is registered as a BD will have to maintain minimum capital in an amount based upon the greater of the CFTC or SEC minimum requirement. This would help ensure the safety and soundness of the FCM– SD by providing readily available financial resources to address operational, legal, compliance, or other risks, and, if necessary, by providing financial resources to assist with the orderly liquidation of the FCM–SD in the event of its insolvency. Commenters also stated that the Commission’s proposed inclusion of the proprietary futures and proprietary cleared swap positions in an FCM–SD’s 8% risk margin amount calculation would duplicate existing capital charges required under regulation 1.17.57 The commenters noted that regulation 1.17(c)(5)(x) currently requires an FCM to take a capital charge in an amount equal to 100% or 150% of the margin required by a clearing organization for proprietary futures and cleared swap 55 See Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers, 69 FR 49784 (Aug. 12, 2004). 56 See Commission regulation § 1.17(a)(1)(i)(D) (17 CFR 1.17(a)(1)(i)(D)). 57 See FIA 3/3/2020 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 positions 58 in computing its adjusted net capital.59 Another commenter stated that including margin associated with proprietary cleared swaps in the 8% risk margin amount was not necessary as proprietary cleared positions present minimal credit risk to an FCM–SD as the only credit exposure is to a clearing organization or broker.60 The proprietary futures and cleared swaps capital charge also would apply to FCM–SDs under the Commission’s Proposal, as FCM–SDs are required to comply with regulation 1.17. One commenter also stated that the SEC in its final rules requires a BD or SBSD to take a standardized capital charge for cleared security-based swaps equal to 100% of the margin required by a clearing agency, and does not impose a 150% charge for positions held by nonclearing BDs or SBSDs.61 The commenter stated that if the Commission adopts this capital charge, it should do so in a manner that is consistent with the SEC’s final rule. The Commission has reconsidered the Proposal and the comments received and is modifying final regulation 1.17(a)(1)(i)(B) to not include proprietary futures, foreign futures, and proprietary cleared swaps from the risk margin amount calculation. The Commission believes that the requirement for an FCM–SD to take a capital charge equal to 100% or 150% of the required initial margin or required maintenance margin, as applicable, on its proprietary cleared positions adequately accounts for the risk associated with those positions, as it reflects the potential market risk presented by the positions as determined by a clearing organization or broker and further recognizes that the 58 Commission regulation § 1.17(c)(5)(x) (17 CFR 1.17(c)(5)(x)) currently requires an FCM that is a clearing member of a clearing organization to take a capital charge equal to 100% of the margin required by the clearing organization for the cleared positions. FCMs that are not clearing members are required to take a capital charge equal to 150% of the maintenance margin required by the applicable clearing organization for the cleared positions. 59 See Letter from Stephen Berger, Citadel Securities (May 15, 2017) (Citadel 5/15/2017 Letter); Letter from Mary Kay Scucci, Securities Industry and Financial Markets Association (May 15, 2017) (SIFMA 5/15/2017 Letter); Letter from Walter Lukken, Futures Industry Association (May 15, 2017) (FIA 5/15/2017 Letter); FIA–PTG 5/24/ 2017 Letter; FIA 3/3/2020 Letter; FIA–PTG 3/3/2020 Letter. 60 See IIB/ISDA/SIFMA 3/3/2020 Letter. 61 See IIB/ISDA/SIFMA 3/3/2020 Letter. See also, SEC rule 15c3–1(c)(2)(vi)(O) (17 CFR 240.15c3– 1(c)(2)(vi)(O)) which provides that capital charge for a proprietary cleared security-based swaps is the margin amount of the clearing agency or, if the security-based swap references an equity security, the broker or dealer may take a deduction using the method specified in rule 15c3–1a (17 CFR 240.15c3–1a). PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 57471 initial margin posted with the clearing organization or broker is no longer available for use in the FCM–SD’s business and, thus, warrants at least a 100% capital charge. The market risk capital charge imposed on proprietary futures and cleared swaps for FCM–SDs approved to use capital models for market risk would be model-based and not the margin imposed by a clearing organization. Since a market risk charge would reduce the FCM–SD’s capital, the Commission believes that it is appropriate to exclude the proprietary cleared positions from the 8% risk margin amount calculation. The Commission believes that under such circumstances it is not necessary to impose an additional capital requirement in the form of an increase in the minimum capital requirement equal to 8% of the margin associated with the FCM–SD’s proprietary cleared futures, foreign futures, and swaps positions. In this regard, the Commission notes that an FCM–SD’s credit exposure is limited on cleared positions to either a clearing organization or to an FCM that carries the FCM–SD’s account (or in the case of foreign futures, a foreign broker that carries the FCM–SD’s account). The credit exposure on such cleared positions is limited as clearing organizations and FCMs/foreign brokers are regulated entities that are generally subject to financial requirements, including capital, margining, and financial reporting requirements. Clearing organizations and FCMs/ foreign brokers are also subject to regulations regarding the holding of customer funds to ensure that such funds are used solely for the benefit of the customer and not for the benefit of other customers or of the clearing organization or FCM/foreign broker.62 Furthermore, as noted above, an FCM– SD will be required to maintain a level of net capital that is sufficient to cover the market risk charges associated with the proprietary cleared futures, foreign futures, and cleared swap positions. The Commission is also modifying the final regulation to set the risk margin amount multiplier for uncleared swaps at 2% of the ‘‘uncleared swap margin’’ amount required on such positions. The term ‘‘uncleared swap margin’’ is defined in regulation 1.17(b)(11) to mean the amount of initial margin that the FCM–SD would compute on each uncleared swap position pursuant to the calculation requirements of regulation 23.154. The FCM–SD must include all uncleared swap positions in the 62 See, e.g., Commission regulations §§ 1.20, 1.22, and 39.15 (17 CFR 1.20, 1.22 and 39.15). E:\FR\FM\15SER3.SGM 15SER3 57472 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations calculation of the uncleared swap margin amount, including uncleared swaps that are exempt from the scope of the Commission’s margin regulations for uncleared swaps pursuant to regulation 23.150, exempt foreign exchange swaps or foreign exchange forwards, or netting set of swaps or foreign exchange swaps, for each counterparty, as if the counterparty was an unaffiliated swap dealer. Furthermore, in computing the uncleared swap margin amount, an FCM–SD may not reduce the uncleared swap margin amount to reflect the initial margin threshold amount or the minimum transfer amount as such terms are defined in regulation 23.151.63 The Commission is modifying the risk margin amount multiplier in recognition that the Commission’s margin requirements generally impose a higher margin requirement on uncleared swap positions relative to cleared swaps and futures positions. Minimum initial margin requirements for cleared futures and swap transactions are generally set by clearing organizations. In this regard, the FCM minimum capital requirement of 8% of the risk margin amount on futures and cleared swaps is based upon margin calculations using clearing organization models that require a 99% one-tailed confidence interval over a minimum liquidation period of one day for futures, agricultural swaps, energy swaps, and metal swaps, and a minimum liquidation period of five days for all other swaps, including financial swaps such as interest rate swaps.64 In contrast, initial margin for uncleared swaps is required to be calculated at a 99% one-tailed confidence interval over minimum liquidation period of 10 business days (or the maturity of the swap if shorter).65 The greater margin period of risk for uncleared swaps generally requires a higher level of initial margin, which would increase the FCM–SD’s minimum capital requirement for uncleared swaps relative to cleared transactions. The modification of the final rule to set the risk margin amount multiplier at 2% for uncleared swap positions is appropriate given the generally higher initial margin requirements imposed on such positions under the Commission’s regulations relative to cleared positions. In addition, as noted above, FCM–SD’s will also be jbell on DSKJLSW7X2PROD with RULES3 63 The Commission is modifying the definition of the term ‘‘uncleared swap margin’’ in final paragraph (b)(11) of Commission regulation 1.17 (17 CFR 1.17(b)(11)) to align the wording of the regulation to be consistent with the definition of the term ‘‘uncleared swap margin’’ in regulation 23.100 for SDs that are not also registered FCMs. 64 See Commission regulation § 39.13(g) (17 CFR 39.13(g)). 65 See Commission regulation § 23.154(b)(2) (17 CFR 23.154(b)(2)). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 required to take market risk charges for each of its proprietary positions, including uncleared swaps, in computing its adjusted net capital. As noted by a commenter, the 8% risk margin amount was proposed in 2003, and subsequently adopted in 2004, based upon an analysis and comparison of the then existing FCM capital regime that was based on a percentage of the customer funds held by an FCM, with a minimum capital requirement based upon risk margin associated with the customer positions carried by the FCM.66 Staff also had the benefit of observing data of the actual performance of the two capital regimes for an extended period of time as each FCM was required to calculate its minimum capital requirement based on customer funds and its capital requirement based on a percentage of its risk margin amount for approximately two years as part of a pilot program.67 The Commission does not have the benefit of similar comprehensive data regarding the multiplier for the uncleared swaps risk margin amount at this time. However, the Commission’s decision to modify the final rule by removing cleared and uncleared security-based swaps, as well as proprietary futures, foreign futures, and cleared swaps positions from the risk margin amount calculation, and to set the multiplier at 2% should mitigate many of the commenters’ concerns that the proposed 8% risk margin amount calculation was over inclusive of the types of positions included in the calculation and was set at a percentage that was too high. The modification to remove proprietary futures, foreign futures, cleared swap, and cleared and uncleared security-based swap positions from the risk margin amount calculation also mitigates concerns raised by commenters that the capital rule ‘‘double counts’’ positions by requiring an FCM–SD to include such positions in its minimum capital requirement while also requiring the FCM–SD to take market risk and credit risk charges in computing its adjusted net capital. The modifications to the final rule also more closely aligns the Commission’s minimum capital requirement for FCM– 66 See Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers, 68 FR 40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004). See also, CFTC Division of Trading and Markets, Review of Standard Portfolio Analysis of Risk Margining System Implemented by the Chicago Mercantile Exchange, Board of Trade Clearing Corporation, and the Chicago Board of Trade (Apr. 2001) (‘‘T&M 2001 Report’’). See IIB/ISDA/SIFMA 3/3/2020 Letter. 67 See T&M 2001 Report. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 SDs with the approach adopted by the SEC for setting minimum capital requirements for BDs that are SBSDs and stand-alone SBSDs. The Commission will review within five years of the effective date of this rule, the impact that the 2% risk margin amount has on the level of minimum capital required of FCM–SDs after the compliance date of the rules. The Commission will use the financial statements and other information that it will receive from FCM–SDs under existing FCM financial reporting requirements to assess whether the minimum capital requirements for FCM–SDs are adequately calibrated to ensure their safety and soundness. The information that the Commission will receive will allow it to determine if it would be appropriate to propose amending the minimum capital requirement by, among other things, increasing or decreasing the risk margin amount multiplier. 3. Stand-Alone FCM and FCM–SD Calculation of Net Capital and Adjusted Net Capital As previously noted, the second component of the FCM and FCM–SD capital requirement is the computation of the firm’s adjusted net capital based upon the assets and liabilities of the firm. Regulation 1.17(c)(5) defines the term ‘‘adjusted net capital’’ as an FCM’s ‘‘current assets’’ (i.e., current, liquid assets excluding, however, most unsecured receivables), less all of the FCM’s liabilities (except certain qualifying subordinated debt). An FCM is further required to impose certain prescribed capital deductions (‘‘capital charges’’ or ‘‘haircuts’’) from the current market value of the FCM’s proprietary positions (e.g., futures, securities, debt instruments, money market instruments, and commodities) in computing its adjusted net capital to reflect potential market risk associated with the firm’s proprietary positions, as well as to provide a capital cushion against other potential risks, including liquidity, legal, and operational risk. Regulation 1.17(c)(5) establishes specific standardized capital charges for market risk for an FCM’s proprietary positions in physical inventory, forward contracts, fixed price commitments, and securities. Regulation 1.17(c)(5), however, did not explicitly address market risk capital charges for uncleared swap or security-based swap positions. While FCMs have not historically engaged in a significant level of swaps or security-based swap transactions, the Commission has required FCMs to use the standardized market risk capital charges specified in regulation E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 1.17(c)(5)(ii), or the standardized market risk capital charges established by SEC rule 15c3–1 (17 CFR 240.15c3–1) (‘‘SEC rule 15c3–1’’) for dually-registered FCM–BDs, to compute market risk capital charges for uncleared swap and security-based swap positions.68 The Commission proposed amendments to regulation 1.17(c)(5) to more explicitly provide for specific standardized market risk capital charges for an FCM’s or FCM–SD’s proprietary positions in uncleared swaps and security-based swaps.69 The Proposal further provided that an FCM or FCM– SD that obtained approval to use internal market risk capital models could use such models in lieu of the standardized market risk charges. In order to use capital models, an FCM–BD must have obtained SEC approval to use capital models. These dually-registered FCM–BDs are referred to as ‘‘Alternative Net Capital Firms’’ (‘‘ANC Firms’’), and are subject to enhanced minimum capital requirements as discussed below. An FCM which is not a BD, but also is registered as an SBSD would also be subject to the approval of both the Commission and the SEC to use models, but with lesser applicable fixed dollar net capital and adjusted net capital thresholds. The proposed standardized market risk charges and model-based charges are also discussed below. a. Stand-Alone FCM and FCM–SD Standardized Market Risk Capital Charges FCMs currently are required to take standardized market risk charges for proprietary positions in computing their adjusted net capital under regulation 1.17. The current standardized market risk charges are aligned with the SEC’s market risk capital charges for BDs, and reflect the two agencies’ long-standing efforts of maintaining a uniform capital rule for FCMs and BDs as most FCMs are dually-registered as BDs. In this regard, regulation 1.17 requires FCMs that hold positions in securities and securities-related products, such as U.S. Government securities, equity securities and options, municipal securities, commercial paper, and certificates of jbell on DSKJLSW7X2PROD with RULES3 68 For example, existing Commission regulation § 1.17(c)(5)(ii)(C) (17 CFR 1.17(c)(5)(ii)(C)) imposes a market risk capital charge on inventory positions held by an FCM equal to 20% of the market value of the inventory, and § 1.17(c)(5)(ii)(G) (17 CFR 1.17(c)(5)(ii)(G)) imposes the same market risk capital charge of 20% on the value of fixed price commitments and forward contracts. FCMs holding agricultural swaps or energy swaps have been required to take a market risk capital charge equal to 20% of the notional value of the swap under the application of either of these two provisions. 69 2016 Capital Proposal, 81 FR 91252 at 91266– 67. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 deposit, to take market risk capital charges on such positions in the manner and amount specified by SEC rule 15c3– 1 and rule 15c3–1a (17 CFR 240.15c3– 1a) (‘‘SEC rule 15c3–1a’’). FCMs that hold positions in commodities, including foreign currency and physical commodities, are required to take market risk capital charges set forth in Commission regulation 1.17(c)(5). For example, regulation 1.17(c)(5) requires an FCM to take a capital charge equal to 0% to 20% of the market value of inventory depending on whether the FCM’s inventory position is adequately offset (or ‘‘covered’’) by proprietary futures positions.70 The standardized Commission and SEC market risk capital charges are generally computed based upon the market value of the position multiplied by a percentage factor set forth in the rule or regulation. Regulation 1.17 and SEC rules, however, did not provide explicit market risk capital charges for swaps or security-based swaps. To the extent an FCM engages in uncleared swap or security-based swap transactions, the FCM is required to take a market risk capital charge based upon the standardized capital charges contained in SEC rules 15c3–1, 15c3–1a, or Commission regulation 1.17(c)(5) that are applicable to proprietary positions in securities, inventory, foreign currency, fixed price commitments, or forward contracts. For example, an energy swap is treated as a fixed price commitment under regulation 1.17(c)(5), and an FCM is required to take a market risk capital charge equal to 20 percent of the notional value of the swap.71 The purpose of the market risk capital charge is to require an FCM, in computing its adjusted net capital, to reserve a minimum level of capital to cover potential future losses in the value of the swap. The 2016 Capital Proposal proposed amending the standardized market risk capital charges to explicitly reflect uncleared swap and security-based swap positions. The Commission proposed to amend regulation 1.17(c)(5)(iii) to provide a schedule of standardized market risk capital charges for positions in uncleared credit default swaps, interest rate swaps, foreign exchange swaps, commodity swaps, and all other uncleared swaps.72 The 70 See Commission regulation § 1.17(j) (17 CFR 1.17(j)) for the definition of the term ‘‘cover.’’ 71 For example, swaps with a reference asset of a physical commodity are subject to a capital charge equal to 20% of the notional value of the contract (See Commission regulation § 1.17(c)(5)(ii)(G) (17 CFR 1.17(c)(5)(ii)(G)). 72 See 2016 Capital Proposal, 81 FR 91252 at 91266–67. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 57473 Commission also proposed that an FCM or an FCM–SD must take the applicable standardized capital charge in SEC rule 15c3–1, as such rule was proposed to be amended, for proprietary positions in uncleared security-based swaps, including uncleared security-based credit default swaps and equity swaps.73 Credit default swaps are generally defined by the reference asset or entity, the notional amount, the duration of the contract, and credit events. The Commission proposed standardized market risk capital charges for credit default swaps using maturity grids. The ‘‘maturity grid’’ was based on a ‘‘maturity grid’’ approach that was proposed and subsequently adopted by the SEC for credit default swaps and security-credit default swaps.74 Market risk capital charges for uncleared credit default swaps were proposed to be based on two variables under the 2016 Capital Proposal: (i) The length of time to maturity of the credit default swap; and (ii) the amount of the current offered basis point spread on the uncleared credit default swap. The standardized market risk charge for an unhedged short position in a credit default swap was the applicable percentage specified in the grid. The deduction for an unhedged long position was 50% of the applicable deduction specified in the grid.75 The 2016 Capital Proposal also permitted an FCM to net long and short positions where the uncleared credit default swaps reference the same entity or obligation, reference the same credit events that would trigger payment by the seller of the protection, reference the same basket of obligations that would determine the amount of payment by the seller of protection upon the occurrence of a credit event, and are in the same or adjacent maturity and spread categories (as long as the long and short positions each have maturities within three months of the other maturity category). In this case, the FCM was required to take the specified market risk percentage deduction only 73 The SEC proposed amending rules 15c3–1 and 15c3–1b to establish standardized capital charges for security-based swaps and swaps that would apply to stand-alone BDs and BDs that are also registered SBSDs. See Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for BrokerDealers, 77 FR 70214 (Nov. 23, 2012) (‘‘SEC 2012 Proposed Capital Rule’’). 74 SEC rule 15c3–1(c)(2)(vi)(P)(1) (17 CFR 240.15c3–1(c)(2)(vi)(P)(1)). 75 See proposed paragraph (c)(5)(iii)(A) of Commission regulation § 1.17; 2016 Capital Proposal, 81 FR 91252 at 91307. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57474 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations on the notional amount of the excess long or short position.76 For uncleared interest rate swaps, the Commission proposed a standardized market risk capital charge approach that required multiplying the notional amount of the swap by a stated percent.77 The percentage that applied to the notional amount was determined by referencing the standardized haircuts in SEC rule 15c3–1(c)(2)(vi)(A) for U.S. government securities with comparable maturities to the interest rate swaps maturities, and would range from 0% (for interest rate swaps with a remaining time to maturity of less than 3 months) to 6% (for interest rate swaps with a remaining time to maturity of 25 years or more). The 2016 Capital Proposal further provided that an FCM may net certain long and short uncleared interest rate swaps to reduce the net notional amount of the interest rate swaps subject to the market risk capital charge. The net amount of the long and short interest rate swaps was determined based upon the existing SEC netting schedule for government securities, which is based upon the time to maturity of the interest rate swaps. For example, long and short interest rate swaps with maturity dates ranging between 3 years to less than 5 years are subject to market risk capital charge equal to 3% on the net long or short interest rate swap position. The Proposal further provided that the market risk capital charge for interest rate swaps must not be less than 0.5% of the amount of the long position that was netted against a short position, notwithstanding that the netting provisions contained in SEC rule 15c3– 1 does not impose a market risk capital charge on U.S. government securities with less than 3 months to maturity.78 The 0.5% floor on the total amount of the long interest rate swaps netted against the short interest rate swaps was designed to account for potential differences between the movement of interest rates on U.S. government securities and interest rates upon which swap payments are based. The Commission also proposed specific market risk capital charges for foreign currency swaps, commodity swaps, security-based swaps, and all other uncleared swaps. The Proposal requires FCM and FCM–SDs to take a market risk capital charge for foreign currencies swaps that is consistent with the standardized market risk charges for foreign currency positions and foreign currency forwards contained in regulation 1.17(c)(5). Specifically, the Commission proposed market risk charges equal to 6% of the notional value of a foreign currency swap that references euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs. Foreign currency swaps that reference any other currency are subject to a market risk capital charge equal to 20% of the notional value of the respective swap. With respect to swaps referencing a physical commodity, the Proposal required FCM and FCM–SDs to take a market risk capital charge equal to 20% of the market value of the relevant commodity underlying a commodity swap. Consistent with the foreign currency and interest rate swaps, the proposed commodity swap market risk capital charge was based upon the existing capital charges for physical commodities set forth in regulation 1.17(c)(5). The Proposal further required an FCM or FCM–SD to take the market risk capital charges specified in SEC rules for security-based swaps, which would include equity swaps, and for any swap that has a reference asset that is subject to specific SEC market risk capital charges and is not otherwise subject to a Commission imposed capital charge. Commenters objected to the proposed standardized market risk capital charges as being too punitive and not tailored to the risk posed by the relevant portfolios of positions.79 Specifically, commenters noted that the proposed standardized market risk charges for interest rate swaps are substantially higher than the capital charges based on clearing house maintenance margin requirements for cleared interest rate futures contracts.80 One commenter provided a sample matched book portfolio of interest rate swaps demonstrating that an FCM would have substantially higher capital charges under the proposed standardized approach as compared to the model approach or as compared to clearing house maintenance margin requirements.81 These commenters indicated that the excessive capital requirements derived from the proposed 76 See 2016 Capital Proposal, 81 FR 91252 at 91267. 77 Id. 78 The SEC proposed minimum standardized market risk charge of 1% of the net notional value of the interest rate swaps for SBSDs and 0.5% for BDs. See SEC Proposed Capital Rule, 77 FR 70214 at 70345; Proposed rule 18a–1b(b)(2)(C) for SBSDs and proposed rule 15c3–1b(2)(ii)(C). 79 See SIFMA 5/15/2017 Letter; Letter from Michael Sharp, Jefferies Group LLC (May 12, 2017) (Jefferies 5/12/2017 Letter). 80 SIFMA and Jefferies each estimated that the proposed standardized market risk charges for uncleared interest rate swaps would be substantially higher than the clearing house margin requirements. See Id. 81 See Jefferies 5/12/2017 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 standardized market risk capital charges would particularly impact small to midsized SDs that are not approved or otherwise do not use internal market risk capital models.82 Commenters also requested that the Commission reconsider the standardized capital charge on currency swaps.83 The commenters noted that an FCM or FCM–SD would have to take a market risk capital charge equal to 20% of the notional amount of an uncleared foreign currency non-deliverable forward contract, while the standardized (or grid-based) initial margin requirements on such a contact is 6% of the notional amount.84 One commenter recommended that the final rule align the capital charge with the volatility and liquidity conditions of the relevant currency pair.85 Another commenter stated that the standardized capital charge is too high for a product that is highly liquid and recommended that the capital charge be aligned with the standardized initial margin requirement of 6% under the uncleared margin rules.86 Another commenter stated that a covered SD that enters into a swap with uncleared swap contracts containing a flip-clause should require a charge for required margin on such contract plus market risk.87 The Commission acknowledged in the 2019 Capital Reopening that the proposed standardized market risk charges would impact FCMs, FCM–SDs, and covered SDs that do not have approval to use internal market risk capital models, which are more likely to be smaller to mid-sized firms that may not be part of a financial group that has the approval of the SEC, a prudential regulator, or a foreign regulator to use internal capital models. The Commission further believed that establishing a more appropriate market risk capital charge for uncleared interest 82 See proposed Commission regulation § 23.101(a)(1), 2016 Capital Proposal, 81 FR 91252 at 91310–11. See SIFMA 5/15/2017 Letter; Letter from Ryan Hayden, ED&F Man Derivative Products, Inc./INTL FCStone Markets, LLC (March 3, 2020) (ED&F Man/INTL FCStone 3/3/2020 Letter); IIB/ ISDA/SIFMA 3/3/2020 Letter; FIA 3/3/2020 Letter; Letter from Alexander Lange, ABN AMRO Securities (USA) LLC; Michael Bando, ING Capital Markets LLC; Adam Hopkins, Mizuho Capital Markets LLC; David Moser, Nomura Holding America Inc. (January 29, 2018) (ABN/ING/Mizuho/ Nomura 1/29/2018 Letter). 83 Letter from Stephen John Berger, Citadel Securities, March 3, 2020 (Citadel 3/3/2020 Letter); FIA–PTG 3/3/2020 Letter. 84 IIB/ISDA/SIFMA 3/3/2020 Letter; Citadel 3/3/ 2020 Letter. 85 Citadel 3/3/2020 Letter. 86 FIA–PTG 3/3/2020 Letter. 87 Letter from William Harrington (3/3/2020) (Harrington 3/3/2020 Letter). E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations rates swaps, in particular, given the relatively high market risk capital charge would benefit market participants by encouraging smaller to mid-sized FCMs, FCM–SDs, and covered SDs to remain in the market or to enter the market. Accordingly, the Commission requested further comment on the proposed standardized market risk charge for uncleared interest rate swaps. The Commission also noted that the SEC’s final capital rule for BDs and SBSDs imposed a minimum capital requirement for uncleared interest rate swaps equal to 1⁄8 of one percent (0.125%) and only applicable to the matched long position that is netted against a short position in the case of a uncleared interest rate swap with a maturity of three months or more.88 The Commission has considered the comments and is adopting the proposed standardized market risk charges for uncleared swaps and uncleared security-based swaps as proposed, with several modifications that are discussed below. The standardized market risk capital charges being adopted are generally based on existing Commission and SEC standardized market risk charges for positions in foreign currencies, commodities, U.S. treasuries, equities and other instruments, which, in the Commission’s long experience, have generally proven to be effective and appropriately calibrated to address potential market risk in the positions. The Commission believes at this time that this approach, in conjunction with other charges discussed herein, appropriately accounts for the wide variety of possible uncleared swap transactions that FCMs, FCM–SDs, and covered SDs may engage in, including bespoke swap transactions involving flip-clauses or other unique features. Overtime, the Commission may consider adjusting these charges as a result of experience with their impacts on required capital in these firms and as market developments may warrant. In response to several commenters, the Commission recognizes that standardized market risk charges are not as risk sensitive as market risk models, and generally result in higher market risk capital charges than internal models. The Commission notes, however, the lower capital charges for firm’s approved to use market risk model is one of the reasons that model approved firms are subject to the higher minimum capital requirements. As 88 See 2019 SEC Final Capital Rule, rule 18a– 1b(b)(2)(ii)(A)(3) (17 CFR 240.18a–1b(b)(2)(ii)(A)(3) for SBSDs and rule 15c3–1b(b)(2)(ii)(A)(3) (17 CFR 240.15c3–1b(b)(2)(ii)(A)(3)) for BDs. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 noted in section II.B.2.a. above, FCM– SDs that are approved to use internal market risk models are required to maintain net capital of at least $100 million and adjusted net capital of $20 million, while FCM–SDs that are not approved to use internal market risk models are required to maintain $20 million of adjusted net capital, but are not subject to the $100 million dollar net capital requirement. The imposition of $100 million net capital requirement is to provide protection for potential model errors or the failure of the models to address all applicable risks. The Commission believes that it is appropriate to require FCM–SDs that do not use internal models and therefore have a lower capital requirement to be subject to the higher standardized market risk capital charges. The approach is also consistent with the approach adopted by both the Commission and SEC with respect to ANC Firms that have been approved to use internal capital models and, which under the 2019 SEC Final Capital Rule, are subject to a minimum capital requirement of $5 billion of tentative net capital and $1 billion of net capital.89 In addition, the Commission believes that FCM–SDs will seek approval to use model-based market risk charges. There currently are four FCM–SDs provisionally-registered with the Commission. Each of the FCM–SDs is an ANC Firm that is approved to use market risk capital models and, which under the 2019 SEC Final Capital Rule, is subject to the SEC’s minimum capital requirement of $5 billion of tentative net capital and $1 billion of net capital. In order to effectively compete with the existing FCM–SDs and other covered SDs, any new FCM–SD registrant would need to obtain model approval. The Commission is also modifying the final regulation by reducing the minimum capital charge for a portfolio of interest rate swaps to align with the SEC’s final capital requirement for BD’s and SBSD’s using standardized capital charges. In reviewing the comments, the Commission realizes that the standardized market risk charges for interest rate swaps that it proposed in its 2016 Capital Proposal was too high relative to the market risk of the positions. The Proposal’s imposition of a minimum market risk capital charge of .5% of the notional amount of the matched long interest rate swaps has been shown by commenters to be poorly calibrated to the market risk of the positions. Therefore, under the final regulation, an FCM–SD or FCM is 89 SEC rule 15c3–1(a)(7) (17 CFR 240.15c3– 1(a)(7)). PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 57475 required to take a capital charge of at least 1⁄8 of one percent (0.125%) of the matched long interest rate swap positions that is netted against a short interest rate swap positions with a maturity of three months or more. The Commission believes that in making this change, the overall effect on the amount of capital held by an FCM or an FCM– SD will not have a substantial adverse impact on the safety and soundness of these entities. The Commission, however, will monitor the standardized capital charges and refine the percentages as it obtains experience with the level of interest rate swaps transactions entered into by stand-alone FCMs and FCM–SDs and magnitude of the market risk charges on such positions. The Commission is also making a technical modification to the final capital rule for credit default swaps. As noted in the 2019 Capital Reopening, the 2019 SEC Final Capital Rule includes the same standardized capital charges for credit default swaps for BDs and SBSDs as proposed by the Commission for FCMs, FCM–SDs, and covered SDs. There is a slight difference between the Commission’s Proposal and the SEC’s final rule, however, in applying the capital charges based upon the time to maturity. Specifically, the maturity grids differ by one month, and there are some slight changes to the rule text. The Commissions is modifying the time to maturity grids and the wording in the final rule to align with the SEC’s final rule to avoid having duallyregistered entities being subject to slightly different regulatory requirements with respect to market risk charges for credit default swaps. The Commission believes that this modification will have no material impact on its capital requirements. The Commission is also modifying the final rule to provide that an FCM or FCM–SD may reduce market risk charges for uncleared swap positions, other than credit default swaps which as proposed provided for netting, to account for comparable offsetting positions.90 The Commission noted in the 2019 Capital Reopening that the SEC adopted a netting proviso applicable to both BDs and SBSDs, permitting a reduction of the resulting market risk capital charge by an amount equal to any reduction recognized for comparable long or short positions in the reference asset or interest rate under 90 See paragraph (c)(5)(iii)(D) of Commission regulation § 1.17, as amended (17 CFR 1.17(c)(5)(iii)(D)). E:\FR\FM\15SER3.SGM 15SER3 57476 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 regulation 1.17 or SEC rule 15c3–1.91 For example, an FCM or FCM–SD that is required to take market risk charges on equal and opposite legs of a portfolio of foreign currency swaps is permitted to net the market risk charges on the long and short positions to the extent that the positions are comparable. The Commission stated in the 2019 Capital Reopening that it intended to maintain consistency with the 2019 SEC Final Capital Rule with respect to the applicability of the standardized market risk charges for uncleared currency and commodity swaps, and requested comment on including the same netting proviso to regulation 1.17(c)(5)(iii).92 Commenters to the 2019 Capital Reopening generally supported the netting provision.93 One commenter stated that such an approach would be consistent with common and current risk management practices and would allow non-financial SDs to be more responsive to customer needs.94 The Commission believes that it is appropriate that an FCM or an FCM–SD be permitted to net offsetting swap positions in computing the market risk on the portfolio of swap positions in an identical fashion as the SEC has adopted for BDs and SBSDs. Otherwise, the capital rule would require individual capital charges on each swap position without any consideration of the actual risk of the positions. Such an approach would discourage FCMs or FCM–SDs from hedging their exposures and from participating in the swaps market. The ability to net offsetting positions in computing market risk is also a fundamental approach that has been adopted by other regulators including the SEC, prudential regulators, and others. Therefore the Commission is adopting the netting provision as set forth at regulation 1.17(c)(5)(iii)(D). FCMs currently are required by regulation 1.17(c)(5)(x) to take standardized capital charges on proprietary cleared futures and cleared swap positions. The capital charge is equal to 100% of the margin requirement imposed by the clearing organization on the positions if the FCM is a clearing member of such clearing organization. For FCMs that are not 91 SEC rule 15c3–1b(b)(2)(ii)(B) (17 CFR 240.15c3–1b(b)(2)(ii)(B)) for BDs and rule 18a– 1b(b)(2)(ii)(B) (17 CFR 240.18a–1b(b)(2)(ii)(B)) for SBSDs. 92 See 2019 Capital Reopening, 84 FR 69664 at 69672. 93 See Citadel 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 Letter; Letter from Alexander Holtan, Commercial Energy Working Group (March 3, 2020) (CEWG 3/3/2020 Letter); Letter from Sebastian Crapanzano and Soo-Mi Lee, Morgan Stanley (March 3, 2020) (MS 3/3/2020 Letter). 94 See Citadel 3/3/2020 Letter page 5. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 clearing members of the clearing organization that clears the positions, the capital charge is equal to 150% of the applicable maintenance margin requirement of the applicable board of trade or clearing organization, whichever is greater. FCM–SDs also are subject to these capital charges as such firms must comply with the FCM capital requirements set forth in regulation 1.17. Several commenters requested that the Commission eliminate the requirement for an FCM to take capital charges equal to 150% of the margin for proprietary futures or cleared swap positions. One commenter stated that there is no justification for a higher capital charge as market risk is independent of whether the firm is or is not a clearing firm.95 This commenter also noted that the SEC’s final capital rules for SBSDs impose a capital requirement for proprietary cleared positions equal to 100% of the required clearing organization margin, and do not require a non-clearing SBSD to take a higher capital charge of 150% of required margin.96 Another commenter stated that there is no justification for assessing covered SDs that are nonclearing members the higher 150% charge and imposing such a requirement is placing the SDs at an unnecessary competitive disadvantage. The commenter recommended that all SDs should be able to take a standardized market risk charge equal to the clearing organizations’ margin requirement.97 The Commission has considered the Proposal and comments and is not revising regulation 1.17(c)(5)(x). The capital requirement for FCMs to take a capital charge for cleared proprietary positions has been in place for many years. The higher capital charge for nonclearing FCMs takes into consideration that such firms are not subject to heightened capital and other requirements that are imposed by clearing organizations on clearing members. FCM clearing members also are required to post guarantee fund contributions to clearing organizations to support their financial obligations, and are subject to clearing organization assessment authority in the event that a shortfall results from the default of a fellow clearing member. The higher capital charge for non-clearing FCMs and FCM–SDs is intended to ensure that such firms retain an appropriate level of capital and liquid resources to meet their financial obligations, including to their carrying FCMs and ultimately to 95 See IIB/ISDA/SIFMA 3/3/2020 Letter. 96 Id. 97 See PO 00000 FIA–PTG 3/3/2020 Letter. Frm 00016 Fmt 4701 Sfmt 4700 clearing organizations, and the Commission believes that the 150% capital charge is appropriate to help ensure the safety and soundness of the FCM or FCM–SD. b. FCM and FCM–SD Standardized Counterparty Credit Risk Capital Charges FCMs currently are required to take standardized capital charges to reflect counterparty credit risk associated with uncleared swap and security-based swap positions. The Commission’s capital rule requires an FCM that holds swap or security-based swap positions to mark the positions to their respective fair market values in their financial records.98 Swap and security-based swap positions that have mark-tomarket losses result in the FCM recognizing variation margin payables to swap and security-based swap counterparties. Such losses reduce the FCM’s capital either by the payment of variation margin or the recognition of a liability. Swap and security-based swap positions that have mark-to-market gains result in the FCM recognizing variation margin receivables from the swap and security-based swap counterparties. The variation margin receivables, however, are subject to a 100% counterparty credit risk capital charge unless the receivables are secured by readily marketable collateral.99 The Commission proposed to retain the 100% counterparty credit risk charges for unsecured receivables from swap and security-based swap counterparties in the Proposal, and further proposed extending this treatment to FCM–SDs. The Proposal further imposed the 100% counterparty credit risk treatment applied to all swap and security-based swap counterparties of the FCM or FCM–SD, including commercial end users, that are exempt from the requirement to exchange variation margin.100 The FCM or FCM– SD also would be required to take a 100% capital charge on unsecured receivables resulting from transactions that are exempt from the margin requirements, including legacy swap and security-based swap transactions and foreign exchange forward and swap 98 Commission regulation § 1.17(c)(1) (17 CFR 1.17(c)(1)). 99 See Commission regulation § 1.17(c)(1) and (2) (17 CFR 1.17(c)(1) and (2)), which defines the term ‘‘net capital’’ and requires an FCM to include unrealized gains and losses in the computation of net capital, and further provides that an FCM must generally exclude unsecured receivables (including unsecured receivables from swap and securitybased swap counterparties). 100 See Commission regulation § 23.150 (17 CFR 23.150). E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations transactions, as well as any receivables from counterparties that are subject to a $500,000 minimum transfer amount.101 The Commission proposed the 100% capital charge on unsecured receivables from swap and security-based swap counterparties as it is was consistent with the Commission’s general approach of requiring an FCM to exclude unsecured receivables from its adjusted net capital. As noted above, the Commission’s capital rule focuses on the liquidity of the FCM and unsecured receivables do not reflect a liquid asset to the FCM that it may use in order to meet its own financial obligations. The Proposal effectively required an FCM or FCM–SD that did not have approval to use models to compute counterparty credit risk to take a 100% capital charge for unsecured receivables due from swap and security-based swap counterparties. This would include counterparties that are not obligated to exchange variation margin with the FCM or FCM–SD, including commercial end users, affiliates, and counterparties engaging foreign exchange swaps as the term is defined in regulation 23.151. FCM–SDs are also subject to the Commission’s margin rules for uncleared swap transactions and may be directly or indirectly subject to the SEC’s margin rules for uncleared security-based swaps. Under the Commission’s margin rules, an FCM–SD is generally required to post initial margin for uncleared swap transactions entered into with other SDs or financial end users with a third-party custodian and may post initial margin with the custodian for security-based swaps. Stand-alone FCMs that engage in swaps and security-based swaps also may be obligated or elect to post initial margin for such transactions with a third-party custodian in accordance with the Commission’s or the SEC’s respective uncleared swap and security-based swap margin rules. Such deposits would generally be treated under the Commission’s capital rule as an unsecured receivable from the thirdparty custodian, and subject to a 100% capital charge. The Commission proposed to amend regulation 1.17(c)(2)(ii)(G) to permit an FCM or an FCM–SD to include initial margin funds it deposited with thirdparty custodians for uncleared swaps and uncleared security-based swaps in its capital computation, provided that the margin is held in accordance with the requirements established by the applicable Commission or SEC margin rules.102 The Commission proposed to permit FCMs and FCM–SDs to include initial margin posted with third-party custodians as capital in recognition that the Commission’s capital rules require an FCM–SD or stand-alone FCM to post initial margin for their uncleared swap transactions with third-party custodians to ensure that the FCM–SD or FCM meets its financial obligations to swap counterparties. The Commission also believes that the FCM–SD has minimal credit risk from the third-party custodian as the Commission’s margin regulations require that the FCM–SD enter into a custodial agreement with the third-party custodian that prohibits the custodian from rehypothecating, repledging, reusing, or otherwise transferring (including though repurchase agreements) the collateral held by the custodian.103 The custodial agreement also must be a legal, valid, binding, and enforceable agreement under the laws of all relevant jurisdictions including in the event of a bankruptcy, insolvency, or similar proceeding.104 The Commission is adopting the amendment to regulation 1.17(c)(2)(ii)(G) to permit FCMs and FCM–SDs to recognize margin posted with a third-party custodian for swap and security-based swap transactions as a current asset in computing their adjusted net capital. In order to qualify as a current asset, the initial margin must be deposited by the FCM or FCM– SD with a third-party custodian in accordance with the requirements specified in the Commission’s uncleared swap margin rules set forth in regulations 23.150 through 23.161, or the SEC’s uncleared security-based swap margin rules. The Commission is modifying the final regulation to clarify that initial margin posted by an FCM or FCM–SD with third-party custodians for uncleared swaps or uncleared securitybased swaps entered into with bank SDs subject to the margin rules of a prudential regulator and entered into with foreign registered SDs that operate in a jurisdiction that has received a margin Comparability Determination by the Commission under regulation 23.160 also may be recognized as a current asset in computing adjusted net capital. The Commission also proposed to require an FCM–SD to take a capital 101 Commission regulation § 23.153 (17 CFR 23.153), provides that a covered SD is not required to collect or post variation margin with a particular swaps counterparty until the combined initial and variation margin required to be exchanged with the counterparty exceeds $500,000. 102 See 2016 Capital Proposal, 81 FR 91252 at 91306–07, proposed paragraph (c)(2)(ii)(G) of Commission regulation § 1.17. 103 See Commission regulation § 23.157 (17 CFR 23.157). 104 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 57477 charge to reflect undermargined uncleared swap positions with a counterparty.105 A capital charge for undermargined positions protects the FCM–SD by ensuring that it maintains capital to cover potential future credit exposure to swap counterparties, which is consistent with the statutory objective of ensuring the safety and soundness of the FCM–SD. The proposed undermargined capital charge further provided that an FCM–SD could reduce the amount of the capital charge by any amount owed by the FCM–SD to the counterparty resulting from uncleared swap transactions. The undermargined capital charge for uncleared swap positions is consistent with existing Commission undermargined capital charges for customer and noncustomer futures, foreign futures, and cleared swap accounts carried by an FCM.106 The Commission did not receive comments on the proposed capital charges, and is adopting the undermargined capital charges with modifications as discussed below. The Commission is modifying final paragraph (c)(5)(xv) of regulation 1.17 by adopting two separate paragraphs. Final regulation 1.17(c)(5)(xv) requires an FCM–SD to take a capital charge in an amount necessary for a swap counterparty or security-based swap counterparty to meet its respective Commission margin requirement for uncleared swap positions and the SEC margin requirement for uncleared security-based swap transactions to the SD. The final regulation would apply only to uncleared swaps and uncleared security-based swaps that are subject to the Commission’s or SECs’ margin requirements under applicable regulations. The final regulation further provides that the FCM–SD may reduce the amount of the undermargined charge to reflect calls for margin issued by the FCM–SD to the counterparty that are outstanding within the respective time frames established in the margin rules of the Commission and SEC, as applicable, to collect margin from a counterparty. This provision replaces 105 Proposed paragraph (c)(5)(xv) of Commission regulation § 1.17 did not specifically impose undermargined capital charges for security-based swaps. See 2016 Capital Proposal, 81 FR 91252 at 91308. Such charges, however, are applicable to an FCM–SD under Commission regulation § 1.17(b)(1) (17 CFR 1.17(b)(1)), which provides that an FCM (including an FCM–SD) that has an asset or liability defined in the capital rules of the SEC shall treat such assets or liabilities for capital purposes in accordance with the rules of the SEC, provided that the Commission did not define a specific capital treatment in regulation 1.17. 106 See Commission regulation § 1.17(c)(5)(viii) and (ix) for undermargined capital charges for customer and noncustomer futures, foreign futures, and cleared swap accounts. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57478 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations the proposed language in regulation 1.17(c)(5)(xv) that would have permitted a covered SD to reduce the undermargined capital charge by any amount owed by the counterparty to the SD. The modified provision more accurately reflects the process of an SD calling for outstanding margin and is consistent with the undermargined capital charges for an FCM carrying customer and noncustomer accounts and the undermargined capital charge adopted by the SEC for SBSDs. Final regulation 1.17(c)(5)(xvi) requires an FCM–SD to take a capital charge for uncleared swaps and uncleared security-based swaps that are exempt or excluded from the Commission’s or SEC’s margin requirements, such as commercial end users and transactions entered into prior to the compliance date of the margin regulations (i.e., legacy swaps). In this regard, swaps entered into prior to the Phase 6 uncleared margin compliance date or with excluded counterparties for which no margin has been collected are treated no differently than other uncollateralized exposures under the Commission’s rules. Such treatment for capital purposes of these counterparty exposures is consistent with the capital rules of both the SEC and prudential regulators as applied to their respective registrants.107 The final regulation further provides that the FCM–SD may reduce the amount of the undermargined capital charge by any funds deposited by the counterparty to margin its swaps or security-based swap positions. These deposits would include funds deposited by the counterparty and held by third-party custodians or held by the FCM directly. The Commission also modified the final rule text to clarify that the undermargined swap capital charges in regulation 1.17(c)(5)(xv) and (xvi) are applicable only to FCM–SDs and not FCMs, as FCM–SDs are subject to the Commission’s margin requirements for uncleared swap transactions. Standalone FCMs, however, are not directly subject to the Commission’s uncleared swap margin requirements as they are not SDs. Final regulations 1.17(c)(5)(xv) and (xvi) also have been modified to align the regulatory text more closely with the comparable SEC rule text requiring SBSDs to take capital charges for undermargined uncleared securitybased swap and uncleared swaps positions from counterparties.108 As noted above, the final regulation is designed to help ensure the safety and soundness of the FCM–SD by requiring the firm to reserve capital in the event a counterparty defaults on its swaps and security-based positions that are undermargined. The Commission also requested comment on whether FCM–SD’s or covered SD’s should be permitted to recognize alternative forms of collateral (e.g., letters of credit and liens) provided by commercial end-users that are exempt from clearing and from the uncleared margin requirements in computing the FCM–SD’s or SD’s counterparty credit risk charges for uncleared swap transactions.109 Several commenters supported such alternative or non-financial collateral. One commenter stated that alternative forms of collateral, such as parent guarantees, letters of credit, or liens on assets are frequently used by SDs as credit risk mitigants when non-financial end-users do not post cash collateral on uncleared derivatives.110 The commenter stated that allowing FCM–SDs to recognize alternative forms of collateral in computing credit risk charges is consistent with Congressional intent that FCM–SD capital requirements should not be punitive to end-users. This commenter further stated that permitting FCM–SDs to recognize noncash collateral as a credit risk mitigant is consistent with the prudential regulators’ final rule on the standardized approach to counterparty credit risk (‘‘SA–CCR’’), which provides that banks may take into account noncash collateral in computing credit risk charges for OTC derivatives. Another commenter stated that non-cash collateral allows for the value of the commercial market participant’s assets making it an effective method for satisfying credit requirements without unnecessarily setting aside capital from a productive use.111 One commenter also stated that the Commission could require FCM–SD’s to appropriately haircut non-cash collateral to address the general illiquid nature of non-cash collateral.112 The Commission has considered the comments and is not modifying the credit risk charges to recognize non-cash collateral. Margin provides an FCM–SD or a covered SD with protection from a potential counterparty default. In a default situation, non-financial collateral may not be immediately available, or the collateral may be 109 See 107 See, e.g., SEC rule 18a–1(c)(1)(viii) (17 CFR 240.18a–1(c)(1)(viii)). 108 See SEC rule 18a–1(c)(viii) (17 CFR 240.18a– 1(c)(1)(viii)). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 2019 Capital Reopening, at 69681. CEWG 3/3/2020 Letter; NCGA/NGSA 3/3/ 2020 Letter; Shell 3/3/2020 Letter. 111 See NCGA/NGSA 3/3/2020 Letter. 112 See Shell 3/3/2020 Letter. 110 See PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 available but may take time to liquidate. This may exacerbate potential losses to the FCM–SD or covered SD or expose such firms to additional risk by, for example, leaving them exposed to the market risk of cash market positions that were being hedged by the swap. While the Commission is not modifying the final rules to reflect non-cash collateral, it will continue to monitor and assess FCM–SD’s and covered SD’s acceptance of non-cash collateral from commercial end-users and consider possible revisions to its rules after it gains further experience with the capital condition of such firms. c. Model-Based Market Risk and Counterparty Credit Risk Capital Charges (i) FCMs That Are SEC-Registered ANC Firms Commission regulation 1.17(c)(6) permits an FCM that is dually-registered with the SEC as a BD to use internal models to compute market risk and credit risk capital charges in lieu of standardized capital charges in computing its adjusted net capital under Commission regulation 1.17 provided that the SEC has approved the FCM/ BD’s use of such models for computing net capital under SEC rule 15c3–1. The SEC has approved certain FCM/BDs to use internal models to compute market risk capital charges for proprietary positions in securities, debt instruments, futures, security-based swaps and swaps in lieu of standardized capital charges contained in SEC rules 15c3–1 or 15c3–1b. The SEC also has approved the use of internal models to compute credit risk charges associated with exposures from swap and securitybased swap counterparties in lieu of the standardized 100% unsecured receivable capital charges. As noted in section II.B.3. above, these FCM/BDs are referred to as ANC Firms. Five FCMs currently are ANC Firms, with four of the firms also provisionally-registered SDs. Regulation 1.17(c)(6) requires an ANC Firm to file a notice with the Commission in order to use the SEC’s approved capital models. The notice must include the SEC’s approval order and other information, including: (i) A list of the categories of positions that the ANC Firm holds in its proprietary accounts, and, for each such category, a description of the methods that the ANC Firm will use to calculate its deductions for market risk and credit risk, and also, if calculated separately, deductions for specific risk; (ii) a description of the value at risk (VaR) models to be used for its market risk and credit risk E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations deductions, and an overview of the integration of the models into the internal risk management control system of the ANC Firm; (iii) a description of how the ANC Firm will calculate current exposure and maximum potential exposure for its deductions for credit risk; (iv) a description of how the futures commission merchant will determine internal credit ratings of counterparties and internal credit risk weights of counterparties, if applicable; and (v) a description of the estimated effect of the alternative market risk and credit risk deductions on the amounts reported by the ANC Firm as net capital and adjusted net capital. Further qualitative and quantitative requirements for such market risk and credit risk models are discussed in section II.C.6. of this release. ANC Firms also are subject to heightened SEC capital requirements as a condition of using the capital models. The 2019 SEC Final Capital rule requires an ANC Firm, including an FCM that is dually-registered as an ANC Firm, to maintain tentative net capital of at least $5 billion and net capital of not less than the greatest of $1 billion or the sum of (i) 2% of the risk margin amount associated with customer cleared security-based swaps and uncleared security-based swaps and (ii) the aggregate indebtedness of the ANC Firm or 2% of the aggregate debit items computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (Exhibit A to rule 15c3–3).113 The 2019 SEC Final Capital rule also requires an ANC Firm to provide the SEC, and CFTC if dually-registered as an FCM, with a written notice if its tentative net capital falls below $6 billion.114 The Commission proposed to retain the above notice and filing process to permit ANC Firms that register as FCMs or FCM–SDs to use the SEC-approved internal capital models in lieu of the standardized market risk and credit risk capital charges in computing their adjusted net capital under regulation 1.17. Currently, only four of the 56 provisionally-registered covered SDs are FCMs, and each of the FCM–SDs is an ANC Firm with capital model approval from the SEC. Accordingly, such FCM– SDs will be required to maintain tentative net capital of no less than $5 billion and net capital of no less than $1 billion upon the compliance date of the 113 See 2019 SEC Final Capital Rule, 84 FR 43872 at 43874; 17 CFR 240.15c3–1(a)(7). All ANC firms currently use the 2% aggregate debit item financial ratio (the ‘‘alternative standard’’) under rule 15c3– 1(a)(1)(ii). 114 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 2019 SEC Final Capital Rule.115 The Commission is electing to retain regulation 1.17(c)(6) to permit ANC Firms to engage in swap and securitybased swap transactions under the existing regulatory structure, including the SEC’s revised minimum capital requirements, as it believes that the minimum capital requirements are adequately designed to help ensure the safety and soundness of the FCM–SD. (ii) Market Risk and Credit Risk Capital Models for FCM–SDs That Are Not SECRegistered BDs The Commission proposed amending regulation 1.17(c)(6) to permit FCM–SDs that are not SEC registered BDs to apply to the Commission, or an RFA of which the FCM–SD is a member, for approval to use internal market risk or credit risk models in lieu of the standardized capital charges. If an FCM or covered SD is also a registered BD, it may only use market risk and credit risk capital models if the SEC has approved such firm to use such models and the firm meets the capital requirements of an ANC Firm. Therefore, the Commission’s proposal to extend the use of capital models to FCM–SDs is only applicable to FCM–SDs that are not registered with the SEC as BDs. The purpose of the amendment proposed in regulation 1.17(c)(6) was to provide FCM–SDs that were not dually-registered as BDs with the ability to use internal capital models in lieu of the standardized capital charges and to establish a mechanism for the FCM–SDs to obtain approval for such models. FCM–SDs that may also be registered as SBSDs or OTC Derivatives Dealers but not BDs would also be able to use this provision with respect to the use of models; however, they would separately need to obtain the SEC’s approval to use models as registered SBSDs and OTC Derivatives Dealers. While currently the only FCMs that are provisionally-registered as SDs are the four ANC Firms, the Commission believed that other stand-alone FCMs may register as SDs and that the regulations should provide an opportunity for such firms to use capital models to compute market and credit risk. Proposed regulation 1.17(c)(6)(v) required an FCM–SD to apply in writing, and further required that the 115 The Commission’s term ‘‘net capital’’ is equivalent to the SEC’s term ‘‘tentative net capital’’ and the Commission’s term ‘‘adjusted net capital’’ is equivalent to the SEC’s term ‘‘net capital.’’ The term ‘‘tentative net capital’’ is generally defined as an entity’s assets less liabilities (excluding certain qualifying subordinated debt), and ‘‘net capital’’ as tentative net capital less certain capital deductions such as market risk and credit risk deductions. See 17 CFR 240.18a–1. PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 57479 market risk and credit risk models contain specified qualitative and quantitative requirements proposed to be established by the Commission in new regulation 23.102 and Appendix A to regulation 23.102.116 The qualitative and quantitative requirements for the FCM–SD’s models are comparable to the existing SEC model requirements for ANC Firms and non-BD SBSDs, and the Commission’s proposed model requirements for covered SDs. The qualitative and quantitative requirements for the capital models are discussed in detail in section II.C.6. of this release. The Commission also proposed enhanced fixed-dollar minimum capital requirements as a condition for an FCM–SD to obtain capital model approval. Specifically, the Commission proposed that FCM–SDs must maintain net capital of no less than $100 million and adjusted net capital of no less than $20 million in order to use capital models. The $100 million net capital requirement was in recognition that model-based capital charges are generally substantially lower than the Commission’s standardized capital charges, and that models may not fully capture all risks at all times.117 The minimum fixed-dollar capital requirement is also consistent with the Commission’s proposed minimum fixed-dollar capital requirement for covered SDs, and is consistent with the SEC’s minimum fixed-dollar capital requirement for OTC derivative dealers and non-BD SBSDs.118 The proposed $100 minimum fixeddollar amount of net capital for FCM/ SDs, however, is not consistent with the SEC’s current approach for ANC Firms or SBSDs/ANC Firms approved to use internal models. As noted above, ANC Firms are subject to minimum fixeddollar tentative net capital requirement of $5 billion, and a minimum fixeddollar net capital requirement of $1 billion. The Commission stated in the Proposal that it believed that FCM/SDs that are not BDs do not raise the same types of risks as ANC Firms that would 116 Please note that due to changes in Federal Register publication requirements, the appendix that had been referred to as Appendix A to section 23.102 in previous documents is being published in this final rule as Appendix A to Subpart E of Part 23. 117 See section II.B.2.a. above for a discussion of the fixed-dollar minimum capital requirements for FCM–SDs. 118 See sections II.C.2.a. and II.C.3.a. of this release for a discussion of the Commission’s minimum capital requirements for covered SDs. See SEC rule 15c3–1(a)(5) (17 CFR 240.15c3–1(a)(5)) for minimum capital requirements for OTC Derivative Dealers that are not SBSDs and rule 18a–1(a)(2) (17 CFR 240.18a–1(a)(2)) for SBSDs that are not BDs, other than OTC Derivatives Dealers. E:\FR\FM\15SER3.SGM 15SER3 57480 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 warrant a $5 billion minimum tentative net capital requirement. The Commission noted that ANC firms represent the largest BDs and are engaged in significant brokerage businesses including providing customer financing for securities transactions, engaging in repurchase transactions and other activities. FCMs generally have limited proprietary futures trading and operate primarily as market intermediaries for customers trading futures and foreign futures transactions. In this capacity, FCMs receive and hold customer funds in segregated accounts that are used to satisfy the customers’ financial obligations to clearing organizations. Even in their capacity as SDs, the margin regulations mitigate the risks to and from the FCM as they generally are required to exchange variation margin on swaps on a daily basis with all other SDs and financial end users, and to post and collect initial margin with counterparties that are SDs and financial end users. The Commission did not receive specific comments on the use of models by FCM–SDs that are not ANC Firms. The Commission has considered the issue and is adopting the proposed amendment to regulation 1.17(c)(6) to provide a model approval process for FCM–SDs that are not BDs substantially as proposed, but with a modification to not adopt the proposed liquidity requirement and also to comport with the final model process requirements for covered SDs.119 While the four FCM– SDs provisionally-registered with the Commission are ANC Firms and already approved to use models, the Commission believes that other, non-BD FCM–SDs have the potential to enhance market liquidity in certain sections of the swaps market, particularly with smaller counterparties and less frequently traded products. The Commission believes that it is important to provide an opportunity for such firms to potentially enter the market and service counterparties that may not have significant choice in selecting SDs. For example, FCM–SDs may be more willing to make markets in commodity swaps to agricultural firms and smaller commercial end users such as farmers 119 Commission regulation § 1.17(c)(6) (17 CFR 1.17(c)(6)) provides that an FCM–SD may apply for model approval with the Commission or with an RFA of which it is a member. See section II.C.7. below for a discussion of model approvals, including the Commission’s standards and process for reviewing and approving capital models, and the process that the Commission will use in determining whether NFA’s approval of an FCM– SD’s capital models may serve as an alternative means of complying with the Commission’s model approval requirement. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 and ranchers that might not otherwise be able to use such markets to manage risks in their businesses or might have to pay higher fees to engage in swaps if the number of SDs was limited. The Commission further believes that given the nature of the business operations of FCM–SDs, the proposed minimum capital requirement of $100 million of adjusted net capital is consistent with the objective of section 4s(e) of the CEA of helping to ensure the safety and soundness of the FCM–SD. 1. Introduction to Covered SD and Covered MSP Capital Requirements The Commission is adopting final capital requirements for covered SDs and covered MSPs in order to help ensure the safety and soundness of the SDs and MSPs by requiring such firms to maintain a minimum level of financial resources that is based upon the level of margin associated with the uncleared swaps entered into by the firms. The appropriate setting of minimum capital requirements will help ensure that covered SDs and covered MSPs are able to meet their respective financial obligations to swap and security-based swap counterparties, and to creditors generally. The ability of the covered SDs and covered MSPs to meet their financial obligations will provide for a more efficient and effective swaps marketplace for participants by reducing the potential for covered SDs or covered MSPs to default on their obligations to swap and security-based swap counterparties. There are currently 56 covered SDs subject to the Commission’s capital requirements. As noted in section II.A. above, these 56 covered SDs represent a diverse group of corporate entities, ranging from subsidiaries of major global financial and banking institutions to entities that are primarily engaged in physical commodities such as agriculture and energy. The Commission also understands that these 56 covered SDs have a significant level of diversity in swap counterparties, ranging from financial end users to commercial enterprises. The Commission is providing flexibility to address the diversity of the business models of the covered SDs by permitting each SD that is not also a registered FCM to elect one of two possible capital alternatives.120 The first alternative is the Net Liquid Assets Capital Approach, which is based on the liquidity-based capital rule for FCMs in regulation 1.17, as well as the liquiditybased capital requirements imposed on BDs and SBSDs by the SEC. The second alternative is the Bank-Based Capital Approach, which is based on the capital requirements established by the Federal Reserve Board for bank holding companies and is generally consistent with the prudential regulators’ capital rules applicable to bank SDs. The flexibility provided by the Commission’s covered SD capital rules is consistent with the Congressional mandate in the Dodd-Frank Act directing the Commission, SEC, and prudential regulators to adopt, to the maximum extent practicable, comparable minimum capital requirements for SDs and SBSDs.121 The Commission’s final rule further allows certain eligible covered SDs to elect to compute their regulatory capital under the Tangible Net Worth Capital Approach. The Tangible Net Worth Capital Approach requires a covered SD to maintain a tangible net worth, computed in accordance with GAAP, equal to or greater than the highest of: (i) $20 million, plus the market risk and credit risk exposures associated with its swap and related hedge positions that are part of the covered SD’s dealing activities; (ii) 8% uncleared swap margin associated with the covered SD’s swaps positions; and (iii) the amount of capital required by an RFA of which the covered SD is a member. To use the Tangible Net Worth Capital Approach, a covered SD must be predominantly engaged in non-financial activities, or be part of a corporate parent entity that is predominantly engaged in non-financial activities. The Commission is adopting the Tangible Net Worth Capital Approach as it would be available only for covered SDs that, either directly or at their corporate parent level, are primarily involved in non-financial, commercial activities. As the Commission has previously noted, financial firms generally present a higher level of systemic risk to the financial system than commercial firms as the profitability and viability of financial firms are more tightly linked to the health of the financial system than commercial firms.122 The Commission’s final capital requirements for covered MSPs require such firms to maintain a positive 120 SDs that are FCM–SDs are required to comply with the FCM capital requirements contained in Commission regulation § 1.17 (17 CFR 1.17), as amended by this final rulemaking. See section II.B. above for a further discussion. 121 See section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D)) and section 15F(e)(3)(D)(ii) of the Exchange Act (15 U.S.C. 78o–10(e)(3)(D)(ii)). 122 See 2016 Capital Proposal, 81 FR 91252 at 91255. C. Capital Requirements for Swap Dealers and Major Swap Participants PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations tangible net worth. The final MSP capital requirements are discussed in section II.C.5. below. 2. Capital Requirement for Covered SDs Electing the Net Liquid Assets Capital Approach a. Computation of Minimum Capital Requirement jbell on DSKJLSW7X2PROD with RULES3 The Commission’s capital requirements for covered SDs electing the Net Liquid Assets Capital Approach generally incorporate by reference the SEC’s capital requirements contained in rule 18a–1 for SBSDs that are not also registered as BDs.123 The capital requirements are set forth in regulation 23.101, and are comprised of two components. The first component of the capital rule requires a covered SD to compute the minimum amount of capital that the SD is required to hold at any given point in time. The second component of the capital rules requires a covered SD to compute, based upon its balance sheet and certain adjustments including market risk and credit risk capital charges to its swaps, securitybased swaps, and other proprietary positions, the actual amount of capital that the covered SD maintains. The covered SD’s actual capital must be equal to or greater than its minimum capital requirement at all times in order for the covered SD to be in compliance with the rules. The 2016 Capital Proposal required a covered SD electing the Net Liquid Assets Capital Approach to maintain a minimum level of net capital 124 equal to or greater than the highest of the following criteria: (1) $20 million; or (2) Net capital equal to or greater than 8% of the sum of: (a) The amount of ‘‘uncleared swap margin’’ (as that term was proposed to 123 Rule 18a–1 (17 CFR 240.18a–1) (‘‘rule 18a–1’’) also applies to SBSDs that are OTC derivatives dealers, as that term is defined in SEC Rule 3b–12 (17 CFR 240.3b–12). 124 As noted above, covered SDs electing the Net Liquid Assets Capital Approach are subject to the SEC’s capital requirements for SBSDs set forth in SEC rule 18a–1, which has been incorporated into the Commission’s rules by reference. The Commission and SEC use different terms to express capital requirements. The Commission’s term ‘‘net capital’’ is equivalent to the SEC’s term ‘‘tentative net capital’’ and the Commission’s term ‘‘adjusted net capital’’ is equivalent to the SEC’s term ‘‘net capital.’’ The term ‘‘tentative net capital’’ is generally defined as an entity’s assets less liabilities (excluding certain qualifying subordinated debt), and ‘‘net capital’’ as tentative net capital less certain capital deductions such as market risk and credit risk deductions. See 17 CFR 240.18a–1. This document will use the SEC defined terms for purposes of the discussion of the Net Liquid Assets Capital Approach. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 be defined in regulation 23.100) 125 for each uncleared swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to Commission regulation 23.154 (17 CFR 23.154); (b) The amount of initial margin required for each uncleared securitybased swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to SEC Rule 18a–3(c)(1)(i)(B) (17 CFR 240.18a–3(c)(1)(i)(B)), without regard for any amounts that may be excluded or exempted under the SEC’s rules; (c) The amount of ‘‘risk margin requirement’’ (as that term is defined in Commission regulation 1.17(b)(8) (17 CFR 1.17(b)(8))) for the covered SD’s cleared futures, foreign futures, and swaps positions open on the books of the covered SD; and (d) The amount of initial margin required by a clearing organization for proprietary cleared security-based swaps positions open on the books of the covered SD; or (3) The capital required by the RFA of which the covered SD is a member.126 The 2016 Capital Proposal also required a covered SD that received approval from the Commission, or from an RFA of which the covered SD was a member, to use internal models to compute market risk and credit risk capital charges for its swaps, security-based swaps, and other proprietary positions when computing its capital, as described in section II.C.2.a. of this release, to maintain a minimum level of tentative net capital equal to $100 million. Fixed-Dollar Capital Requirement for Net Liquid Assets Capital Approach The first criterion under the Net Liquid Assets Capital Approach required a covered SD to maintain a minimum of $20 million of net capital and, if the covered SD was approved to use market risk or credit risk models, 125 The term ‘‘uncleared swap margin’’ is defined in Commission regulation § 23.100 to mean the amount of initial margin that a swap dealer would be required to collect from each swap counterparty pursuant to the margin rules for uncleared swap transactions (Commission regulation § 23.154 (17 CFR 23.154)). The term ‘‘uncleared swap margin’’ includes all uncleared swaps that an SD is required to collect margin for under the margin regulations, and also includes all uncleared swaps that are exempt or excluded from the margin requirements including swaps with commercial end users, swaps entered into prior to the respective compliance dates of the Commission’s margin requirements set forth in Commission regulation § 23.161 (17 CFR 23.161) (i.e., legacy swaps), and excluded swaps with an affiliated entity. 126 See 2016 Capital Proposal, 81 FR 91252 at 91260–61. PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 57481 $100 million of tentative net capital and $20 million of net capital.127 The Commission requested comment in the 2016 Capital Proposal on the appropriateness of the fixed-dollar capital requirements of $100 million of tentative net capital and $20 million of net capital.128 The Commission received one comment regarding the proposed requirement that covered SDs must maintain a minimum of $20 million of net capital, and a minimum of $100 million of tentative net capital and $20 million of net capital if approved to use market risk or credit risk models.129 The commenter stated that the requirement that SDs using internal models must have $100 million in tentative net capital would create an unnecessary barrier to entry.130 The Commission recognizes the commenter’s concern but believes that covered SDs must maintain a minimum of $100 million of tentative net capital if approved to use models in order to provide an appropriate buffer of capital to protect against model errors and to protect against the models not recognizing all types of risk, such as operational risk, compliance risk, legal risk, and liquidity risk. Models will result in substantially lower market risk charges than the standardized market risk charges, which will allow a covered SD to engage in more of the transactions than they otherwise would be able to enter into at the same level of capital. In order to protect against model errors, the Commission believes that it is necessary to have an enhanced minimum capital requirement. The Commission has considered the Proposal further and is adopting the requirements as proposed. The Commission believes, given the role that covered SDs play in the financial markets by engaging in swap dealing activities, it is appropriate to require all covered SDs to maintain a minimum level of net capital, stated as an absolute fixed-dollar amount, that does not fluctuate with the level of the firms’ dealing activities to help ensure the safety and soundness of the covered SDs. The $20 million minimum net capital requirement also is consistent with the minimum regulatory capital requirements adopted for covered SDs that elect the Bank-Based Capital Approach or the Tangible Net Worth Capital Approach, as discussed in sections II.C.3. and II.C.4., respectively, of this release. Furthermore, the $20 127 See 2016 Capital Proposal, 81 FR 91252 at 91261. 128 See 2016 Capital Proposal, 81 FR 91252 at 91262. 129 See FIA–PTG 5/24/2017 Letter. 130 Id. at 3–4. E:\FR\FM\15SER3.SGM 15SER3 57482 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations million minimum net capital requirement for covered SDs that elect the Net Liquid Assets Capital Approach is consistent with the minimum capital requirements adopted by the SEC for SBSDs.131 In addition, the requirement for a covered SD to maintain a minimum of $100 million of tentative net capital if approved to use models is consistent with the SEC minimum capital requirement for stand-alone SBSDs approved to use capital models.132 Risk Margin Amount Calculation Under Net Liquid Assets Capital Approach jbell on DSKJLSW7X2PROD with RULES3 The second criterion under the proposed Net Liquid Assets Capital Approach required a covered SD to maintain a minimum level of net capital equal to or greater than 8% of the sum of: (i) The amount of ‘‘uncleared swap margin’’ (as that term was proposed to be defined in regulation 23.100) for each uncleared swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to Commission regulation 23.154; (ii) the amount of initial margin required for each uncleared securitybased swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to SEC rule 18a–3(c)(1)(i)(B) without regard to any initial margin exemptions or exclusions that the rules of the SEC may provide to such security-based swap positons; (iii) the amount of ‘‘risk margin’’ (as defined in Commission regulation 1.17(b)(8)) required by a clearing organization for the covered SD’s futures, swaps, and foreign futures positions that are open on the books of the covered SD; and (iv) the amount of initial margin required by a clearing organization for securitybased swaps that are open on the books of the covered SD.133 The proposed 8% risk margin amount required a covered SD to include all swaps and securitybased swaps in its computation of the margin for uncleared swaps and security-based swaps subject to the 8% risk margin amount calculation, including any swaps positions that are not included in the margin requirements under Commission regulations 23.150 through 23.161, and any security-based swaps positions that are exempt or excluded from the SEC’s margin requirements in rule 18a–3(c)(1)(i)(B). 131 See SEC rule 18a–1(a)(2) (17 CFR 240.18a– 1(a)(1)). 132 See SEC rule 18a–1(a)(2) (17 CFR 240.18a– 1(a)(2)). 133 See paragraph (a)(1)(ii)(A)(1) of proposed Commission regulation § 23.101. See 2016 Capital Proposal, 81 FR 91252 at 91310. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 The proposed 8% risk margin amount was based on the Commission’s minimum capital requirements for FCMs, which includes a requirement that each FCM must maintain a level of adjusted net capital that is equal to or greater than 8% of the risk margin amount associated with the futures, foreign futures, and cleared swap positions carried in customer and noncustomer accounts.134 This requirement was intended to ensure that a covered SD electing the Net Liquid Assets Capital Approach maintains a minimum level of capital that is proportionate to all risks associated with the SD’s operations and activities. The Commission believed that the proposed 8% risk margin amount was an appropriate approach as the minimum capital requirement was correlated with the ‘‘risk’’ of the SD’s futures, foreign futures, swaps, and security-based swaps positions as measured by the margin required on the positions. Specifically, a covered SD’s minimum capital requirement would increase or decrease in proportion to the number, size, complexity, and market risk inherent in the SD’s derivatives business.135 The proposed 8% risk margin amount also was consistent with the proposed minimum capital requirements for covered SDs that elect the Bank-Based Capital Approach, as discussed in section II.C.3. below, and was consistent with the capital requirements of the Tangible Net Worth Capital Approach, discussed in section II.C.4. below. The proposed 8% risk margin amount also was comparable with the SEC’s capital requirements for SBSDs, with the exception that the SEC’s proposal required a SBSD to include a significantly more limited set of positions in the 8% risk margin amount calculation. Specifically, a SBSD’s risk margin amount would include only customer cleared security-based swaps and uncleared security-based swaps.136 The Commission received numerous comments regarding the proposed 8% risk margin amount in response to the 134 See section II.B. above for a discussion of the minimum capital requirements for FCMs. 135 See 2016 Capital Proposal, 81 FR 91252 at 91258. 136 See SEC 2012 Proposed Capital Rule, 77 FR 70214 at 70223. The SEC modified the capital requirement in the final rule to require a SBSD to maintain net capital in excess of 2% of the risk margin amount, with the possibility of the SEC increasing the percentage amount to 4% or less after the third anniversary of the rule’s compliance date, and then to 8% or less after the fifth anniversary of the rule’s compliance date. The rule further provides that the SEC will only raise the 2% risk margin amount multiplier after publishing a notice of the potential change. See rule 18a–1(a)(1) (17 CFR 240.18a–1(a)(1)). PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 2016 Capital Proposal. One commenter strongly supported the 8% risk margin amount threshold on a comprehensive basis.137 The commenter noted a concern that basing capital requirements on internal models could be manipulated, and that a floor based on 8% of initial margin of a covered SDs positions was appropriate as a counterbalance to ensure that internal modelling does not reduce loss absorbency.138 Commenters, however, raised concerns with the proposed 8% risk margin amount.139 Commenters stated that the proposed 8% risk margin amount has a limited relationship to the actual risk of the covered SD’s swaps, SBS, futures, and foreign futures positions.140 Commenters noted that the 8% risk margin amount is computed on a counterparty-by-counterparty basis and not on the aggregate of all of the covered SD’s positions across all counterparties, which may overstate the covered SD’s risk by not taking into account offsetting positions across multiple counterparties, including hedging positions.141 A commenter also noted that the 8% risk margin amount did not reflect the actual risk of a covered SD’s proprietary cleared swap, cleared security-based swaps, futures, and foreign futures positions, as the risk margin amount is required to be computed on a clearing organization-byclearing organization basis and, therefore, does not recognize hedging and risk-reducing portfolio margin across multiple clearing organizations.142 Commenters further noted that the Net Liquid Assets Capital Approach double counts the risks of various positions held by a covered SD.143 The commenters stated that the 8% risk 137 See Letter from Marcus Stanley, Americans for Financial Reform (May 15, 2017) (AFR 5/15/2017 Letter). 138 Id. 139 See, e.g., SIFMA 5/15/2017 Letter; FIA 5/15/ 2017 Letter; Citadel 5/15/2017 Letter); Letter from William Dunaway, INTL FCStone Markets, LLC (May 15, 2017) (IFM 5/15/2017 Letter); Letter from Sebastien Crapanzano and Soo-Mi Lee, Morgan Stanley (May 15, 2017) (MS 5/15/2017 Letter); Letter from Christine Stevenson, BP Energy Company (May 15, 2017) (BPE 5/15/2017 Letter); Letter from Steven Kennedy, International Swaps and Derivatives Association (May 15, 2017) (ISDA 5/15/2017 Letter); Letter from the Japanese Bankers Association (March 14, 2017) (JBA 3/14/2017 Letter); and, FIA–PTG 5/24/2017 Letter. 140 Id. 141 See, e.g., ISDA 5/15/2017 Letter; JBA 3/14/ 2017 Letter; SIFMA 5/15/2017 Letter. 142 See FIA–PTG 5/24/2017 Letter. 143 See SIFMA 5/15/2017 Letter; ISDA 5/15/2017 Letter; FIA 5/15/2017 Letter; FIA–PTG 5/24/2017 Letter; JBA 3/14/2017 Letter; Letter from Sunhil Cutinho, CME Group, Inc. (May 15, 2017) (CME 5/ 15/2017 Letter); and Citadel 5/15/2017 Letter. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 margin amount requires a covered SD to hold net capital equal to or in excess of the 8% risk margin amount, while also requiring the covered SD to reduce the amount of capital it actually holds by the amount of market risk and credit risk charges associated with the covered SD’s positions.144 The commenters noted that including these positions in the 8% risk margin amount effectively results in both an increase in the amount of capital that a covered SD is required to hold to meet its minimum requirement and a decrease to the amount of capital the covered SD actually maintains due to the market risk and credit risk charges. Several commenters also generally stated that the 8% risk margin amount was both too high of a percentage and over-inclusive of the various types of business activities engaged in by covered SDs.145 One commenter suggested that the Commission consider limiting the 8% risk margin amount solely to uncleared swaps subject to the Commission’s uncleared margin rules,146 and another commenter requested the Commission to reconsider the application of the 8% risk margin threshold to cleared swaps.147 Several commenters also stated that if the Commission were to retain the 8% risk margin amount as a component of the minimum capital requirement for covered SDs, that the Commission adjust the 8% to a lower multiplier, such as 2%, for a period of time to allow the Commission to gather empirical data in order to determine an appropriate level.148 The Commission acknowledged in the 2019 Capital Reopening the receipt of a significant number of comments concerning the proposed 8% risk margin amount and the potential impact that it may have on driving a covered SD’s minimum capital requirement, and, consequently, the funding and business activities of the covered SD. The 2019 Capital Reopening invited interested parties to comment on all aspects of the proposed 8% risk margin amount. The Commission also requested comment and supporting data on the quantification of the potential minimum capital requirements required of covered SDs electing the Net Liquid Assets Capital Approach as a result of the proposed 8% risk margin amount threshold. The Commission further requested comment and supporting data 144 Id. See also IIB/ISDA/SIFMA 3/3/2020 Letter. 145 Id. 146 See IFM 5/15/2017 Letter. ISDA 5/15/2017 Letter. 148 See SIFMA 5/15/2017 Letter; MS 5/15/2017 Letter. 147 See VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 on how the amount of potential minimum capital based upon the 8% risk margin requirement compared with the amount of capital currently maintained by entities that are provisionally registered as covered SDs, and how such amounts compared with the amounts of capital required of SBSDs under the 2019 SEC Final Capital Rule.149 The 2019 Capital Reopening also requested comment and supporting data on whether the proposed 8% risk margin amount should be modified for covered SDs electing the Net Liquid Assets Capital Approach to a lower percentage requirement, such as 4%, or to another percentage, and requested that commenters state why the suggested percentage was an appropriate percentage properly calibrated to the inherent risk of a covered SD and the activities that it engages in.150 The Commission further requested commenters to quantify the difference in the amount of capital that would be required of a covered SD pursuant to the proposed 8% risk margin amount and 4%, or any other suggested lower percentage, of risk margin amount, and to the extent possible to model the impact of different percentages of risk margin on the minimum capital requirements for an actual or hypothetical portfolio of positions.151 The 2019 Capital Reopening also requested comment on whether the proposed 8% risk margin amount should be harmonized with the approach adopted by the SEC for SBSDs in the 2019 SEC Final Capital Rule.152 Specifically, the Commission requested comment on whether the proposed regulation should be revised to lower the risk margin amount percentage from 8% to 2%, and whether the regulation should be further modified to authorize the Commission by order to increase the risk margin amount percentage in stages from 2% to 4% or less, and from 4% to 8% or less based upon the Commission’s future experience with covered SD capital levels after the implementation of the final regulations.153 The Commission received several comments in response to the 2019 Capital Reopening addressing the 8% risk margin amount. One commenter stated that the Commission should eliminate the 8% risk margin amount 149 See 2019 Capital Reopening, 84 FR 69664 at 69668–69 (Dec. 19, 2019). 150 Id. 151 Id. 152 Id. 153 Id. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 57483 requirement for covered SDs from the Net Liquid Assets Capital Approach.154 This commenter stated that while the Commission based the 8% risk margin amount on an existing requirement of an FCM to maintain adjusted net capital in excess of 8% of the risk margin amount for futures, foreign futures, and cleared swap positions carried by the FCM in customer and noncustomer (i.e., affiliates) accounts, there are fundamental differences between the business activities of FCMs and covered SDs that makes the application of the 8% risk margin amount requirement to covered SDs illogical.155 This commenter further stated that the 8% risk margin amount is not necessary to ensure that covered SDs maintain appropriate capital levels, noting that market risk and credit risk charges will apply to all of the covered SD’s derivatives positions under the proposed Net Liquid Assets Capital Approach, and noting that other applicable regulatory authorities do not impose a requirement similar to the 8% risk margin amount, which indicates that it is not necessary for a robust capital framework.156 The commenter also stated that the 8% risk margin requirement would discourage covered SDs from hedging market risk.157 This commenter noted that a covered SD enters into swaps and other derivatives transactions as a counterparty, which exposes the derivative positions to market risk. The commenter further noted that the covered SD may hedge this market risk by entering into offsetting positions with other counterparties. The commenter stated that instead of recognizing the risk-mitigating effects of entering into hedged positions, the Proposal penalizes the covered SD by requiring the initial margin of both the original and hedge positions to be subject to the 8% risk margin amount, which increases costs to the covered SD and discourages risk management.158 Commenters also stated that the 8% risk margin amount fails to recognize the risk-reducing effects resulting from 154 See IIB/ISDA/SIFMA 3/3/2020 Letter. 155 Id. 156 Id. The commenter noted that the capital rules of the prudential regulators rely on setting a minimum capital requirement based on the riskweighted assets of prudentially-regulated institutions, including bank SDs, without any 8% risk margin amount add-on. The commenter stated that the Commission did not articulate a rationale for departing from the approaches of other regulators, and that the CEA requires the Commission, SEC, and prudential regulators to maintain comparable minimum capital requirements to the maximum extent practicable. 157 Id. 158 Id. E:\FR\FM\15SER3.SGM 15SER3 57484 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 the collection of initial margin.159 One commenter noted that the proposed 8% risk margin amount would impose the same minimum capital requirement on a covered SD regardless of whether the SD collected initial margin from the counterparty.160 Another commenter stated that the 8% risk margin amount would be improved through the recognition of initial margin that is collected by the covered SD and held by an independent custodian as required by the Commission’s margin rules.161 The commenter stated that the collection of initial margin reduces the potential credit risk exposure that a covered SD has from a counterparty, which should be reflected in the minimum capital requirements.162 One commenter stated that the 8% risk margin amount would impose significant and expensive operational burdens on covered SDs.163 The commenter noted that proposed 8% risk margin amount requires a covered SD to include positions in the calculation that are not subject to the Commission’s uncleared swap margin rules. The commenter stated that the requirement to include positions, such as certain foreign currency forwards and foreign currency swaps, legacy swaps and other swaps and security-based swaps that are excluded from the Commission’s or SEC’s uncleared margin rules in the 8% risk margin amount calculation will potentially require a covered SD to obtain approval from NFA to use a model to compute initial margin for these positions in order to avoid having to include the initial margin requirements based upon the standardized table in the Commission’s margin rules. The commenter further noted that notwithstanding the burden and potential costs associated with obtaining model approval for these positions that are otherwise exempt from uncleared margin requirements, there is a burden and cost associated with computing margin for swaps and security-based swaps that are not subject to the Commission’s or SEC’s margin requirements. The commenter also noted that the traditional 8% risk margin amount under the FCM capital rules does not present the same challenges and costs as the traditional FCM rule applies only to cleared customer and noncustomer transactions where clearing organizations provide the relevant initial margin requirements.164 This commenter also stated that the proposed 8% risk margin amount could make it difficult for covered SDs and other market participants to enter into swaps that facilitate the transition from interbank offered rates (‘‘IBORs’’) to other risk-free rates.165 The commenter stated that the Commission has previously recognized that market participants may seek to transition swap or other portfolios that reference IBORs to an alternative reference rate by means of a basis swap that swaps the entire IBOR basis of a portfolio with an alternative reference rate basis.166 The commenter note that the basis swaps and other similar transactions serve to reduce risk, both to covered SDs and to their counterparties. The transactions, however, may also increase the aggregate gross notional amount of a covered SD’s swaps as well as the initial margin that a covered SD is required to collect, and that absent a revision in the final rule, the transactions may also increase the minimum capital requirement under the 8% risk margin amount.167 The commenter also stated that the 8% risk margin amount would exacerbate the impacts resulting from the current limited availability of portfolio margining.168 The commenter noted that under current Commission and SEC margin rules, a duallyregistered SD/SBSD is required to compute initial margin separately for uncleared swaps and security-based swaps with a single counterparty, which prevents the SD/SBSD from recognizing the risk-reducing impacts of offsetting swaps and security-based swap positions. The commenter stated the Commission was distorting the minimum capital requirement by establishing an 8% risk margin amount that scaled up with the initial margin requirements and not the actual risk of the positions viewed from a portfolio basis.169 Several commenters stated that certain elements of the 8% risk margin amount calculation should be revised if the Commission were to adopt it as part of a covered SD’s minimum capital requirements. Commenters stated that the Commission should revise the 8% risk margin amount contained in the Net Liquid Assets Capital Approach to 164 Id. 165 Id. 159 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter. 160 See IIB/ISDA/SIFMA 3/3/2020 Letter. 161 See MS 3/3/2020 Letter. 162 Id. 163 See IIB/ISDA/SIFMA 3/3/2020 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 166 See Letter No. 19–28 (Dec. 17, 2019); Letter No. 19–27 (Dec. 17, 2019); Letter 19–26 (Dec. 17, 2019). 167 See IIB/ISDA/SIFMA 3/3/2020 Letter. 168 See IIB/ISDA/SIFMA 3/3/2020 Letter. 169 Id. PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 eliminate the ‘‘double-counting’’ of a covered SD’s positions.170 These commenters noted that under the proposed Net Liquid Assets Capital Approach, a covered SD is required to maintain capital equal to 8% of the risk margin amount computed on the covered SD’s futures, foreign futures, cleared and uncleared swaps, and cleared and uncleared security-based swaps positions. The covered SD is also required to subtract the amount of the market risk and credit risk associated with its proprietary positions in futures, foreign futures, cleared and uncleared swaps, and cleared and uncleared security-based swaps in determining the amount of capital that the covered SD has in order to meet the minimum capital requirement. The commenters stated that the proposed Net Liquid Assets Capital Approach double counts a covered SD’s proprietary positions as the approach both reduces the covered SD’s net capital (through the proposed market and credit risk charges) and increases the covered SD’s minimum capital requirement (through the proposed 8% risk margin amount). The commenters stated that the Net Liquid Assets Capital Approach’s doublecounting overstates the risk that swaps present to the covered SD, and places the covered SD at a competitive disadvantage relative to covered SDs that elect the Bank-Based Capital Approach, which does not double-count a covered SD’s proprietary positions.171 Commenters stated that the Commission should address the ‘‘double-counting’’ issue by revising the final Net Liquid Assets Capital Approach to impose the 8% risk margin amount as a capital requirement prior to the imposition of proprietary market and credit risk charges.172 Under this approach, a covered SD electing the Net Liquid Assets Capital Approach would be required to maintain minimum tentative net capital equal to or greater than 8% of the risk margin amount. Commenters also stated that the Commission should reduce the multiplier if it adopts the 8% risk margin amount.173 Commenters noted 170 See FIA–PTG 3/3/2020 Letter. fn 143. See also IIB/ISDA/SIFMA 3/3/ 2020 Letter. As discussed further in section II.C.3.a. below, under the Bank-Based Capital Approach, a covered SD is required to maintain a minimum amount of regulatory capital that is equal to or in excess of the greater of 8% of (i) the risk margin amount or (ii) the SD’s risk-weighted assets. A covered SD that elects the Bank-Based Capital Approach is not required to deduct the market risk or credit risk associated with its proprietary positions in computing its regulatory capital necessary to meet the above to minimum standards. 172 Id. 173 Id. 171 Supra E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 that the 8% risk margin amount was based upon the Commission’s capital requirements for FCMs, which imposes an obligation on FCMs to maintain adjusted net capital of at least 8% of the margin required on customer and noncustomer futures, foreign futures, and cleared swaps positions.174 One commenter stated that there is no evidence to support a conclusion that an 8% calibration is appropriate in the context of non-cleared swaps markets, with fundamentally different regulatory standards and risk management principles than FCM’s customers and noncustomer clearing activities.175 Another commenter stated that the FCM capital requirement based on 8% of customer and noncustomer margin was never intended to apply broadly to the uncleared swaps market.176 This commenter stated that data collected almost two decades ago in the context of futures positions does not provide a logical foundation for the adoption of the 8% risk margin requirement, as it does not reflect appropriately the risks faced by covered SDs on their positions, particularly their uncleared positions, which are subject to higher margin requirements based on a 10-day liquidation horizon as opposed to a 1day horizon common for futures. The commenter also stated that if the Commission did not modify the 8% risk margin amount requirement to reflect the ‘‘double-counting’’ discussed above, then reducing the 8% risk margin amount multiplier would be necessary to prevent competitive disparities. The commenter also stated that based on data it had compiled, an 8% multiplier for the risk margin amount would be high for covered SDs that elect the Net Liquid Assets Capital Approach.177 Such a requirement would dramatically increase the amount of capital required to support the derivatives activities well beyond any current capital requirements applicable to such SDs.178 Further, this same higher required capital would occur on covered SDs regardless of the elected approach under the Commission’s proposed framework or relative to capital requirements for bank SDs on portfolios of similar positions.179 Commenters also explicitly stated that if the Commission adopts a minimum 174 See Commission regulation § 1.17(a)(1)(i) (17 CFR 1.17(a)(1)(i)). 175 See MS 3/3/2020 Letter. The commenter further noted, for instance, that SDs act as counterparties to market participants, and not as financial guarantors of their customers. 176 See IIB/ISDA/SIFMA 3/3/2020 Letter. 177 See IIB/ISDA/SIFMA 3/3/2020 Letter. 178 Id. 179 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 capital requirement based upon the initial margin of a covered SD’s proprietary positions, the multiplier should be reduced from 8% to 2%.180 The commenters further stated that a 2% risk margin amount would be consistent with the 2019 SEC Final Capital Rule. One of the commenters also stated that consistency with the SEC’s 2% calibration is particularly important for dually-registered SD/ SBSDs, otherwise the Commission would be setting the risk margin multiplier for security-based swaps, which effectively undermines the SEC’s capital approach to SBSDs that are also covered SDs.181 Commenters also stated that the Commission should exclude proprietary futures, cleared swaps and cleared security-based swaps from the calculation if the Commission adopts the 8% risk margin amount.182 One commenter stated that including proprietary futures, cleared swaps and cleared security-based swaps in the 8% risk margin amount fails to recognize the limited risks and leverage associated with proprietary cleared positions. Unlike customer cleared positions or proprietary uncleared swaps and security-based swaps, proprietary positions present minimal credit risk as the covered SD’s only exposure is to clearing organizations. The commenter further noted that centrally cleared transactions present limited leverage since the initial margin associated with such transactions is not reused, but maintained at the clearing organization or custodian. The commenter further stated that the proposed 8% risk margin amount would treat proprietary cleared positions no differently from uncleared swaps, thereby eliminating the incentive to clear transactions and subjecting product types that present markedly different risks to the same capital treatment.183 Another commenter stated that including a covered SD’s cleared futures, swap and security-based swap positions in the 8% risk margin amount fails to recognize the risk mitigating nature of centralized clearing.184 The Commission has considered the comments on the 8% risk margin amount and continues to believe that a minimum capital requirement based on initial margin is an appropriate component of a covered SD’s minimum capital requirement under the Net 180 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter; FIA–PTG 3/3/2020 Letter. 181 See IIB/ISDA/SIFMA 3/3/2020 Letter. 182 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter; FIA–PTG 3/3/2020 Letter. 183 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter. 184 See FIA–PTG 3/3/2020 Letter. PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 57485 Liquid Assets Capital Approach. The Commission acknowledges commenters’ views that the risk margin amount could more precisely measure portfolio-related risks if it were to recognize the risk mitigating effects of margin collateral received from counterparties or if it was computed on a total portfolio basis as opposed to being computed on a counterparty-by-counterparty basis. However, the intent of the risk margin amount requirement was to establish a method of developing a minimum amount of capital for a covered SD to meet all of its obligations as a SD to market participants, and to cover potential operational risk, legal risk, and liquidity risk, and not just the risks of its trading portfolio. The Commission believes that the risk margin amount is a minimum capital requirement that provides a floor based on a measure of the risk of the positions, the volume of positions, the number of counterparties and the complexity of operations of the covered SD. Initial margin reflects the degree of risk associated with the positions, with lower risk positions having lower initial margin requirements and higher risk positions having higher initial margin requirements. Therefore, the amount of the minimum capital required of a covered SD under the risk margin amount calculation is directly related to the volume, size, complexity and risk of the covered SD’s positions, however, the minimum capital requirement is intended to cover a multitude of potential risks faced by the SD. This concept is generally consistent with the FCM capital rule, which bases the minimum capital requirement on margin associated with customer and noncustomer futures, foreign futures and cleared swaps transactions, but is intended to address the general risks of operating an FCM such as operational, legal, liquidity and other risks in addition to risks arising from carrying customer accounts. Therefore, the Commission believes that it is appropriate to set a minimum capital requirement for covered SDs that is a floor that reflects the risk margin associated with the SD’s uncleared swap positions. The Commission, however, is modifying the final rule in response to its reconsideration of the issues and the comments received. The Commission is modifying the proposed risk margin amount by removing cleared and uncleared security-based swap positions from the calculation. As noted in section II.B.2.b. above, the Commission believes that a registrants’ minimum capital requirements should be based upon the transactions that are within E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57486 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations the Commission’s jurisdiction and not the jurisdiction of another regulatory agency. This allows the Commission to set minimum capital requirements for registrants, including covered SDs, based upon markets and products that the Commission regulates and for which it has expertise. Modifying the proposed risk margin amount by removing security-based swaps also maintains a consistency with the long-standing historical approach that the Commission and SEC have followed with respect to duallyregistered FCM/BDs. Under the existing FCM/BD capital rules, the Commission sets minimum capital requirements for FCMs based upon the firm’s futures and cleared swaps activities, and the SEC sets the minimum capital requirements based upon the firm’s securities activities.185 As noted by commenters above, the proposed inclusion of security-based swap positions in the Commission’s minimum capital requirement for dually-registered SD/ SBSDs not only goes against this historical approach, it also effectively overrides the SEC’s decision regarding the appropriate level of capital that should be imposed on SBSDs with respect to SEC-regulated security-based swap products, particularly if the Commission’s and SEC’s multiplier are different. In addition, the Commission notes that security-based swaps have only been excluded from the risk margin amount, which establishes the minimum capital requirement. To the extent that a covered SD engages in security-based swaps or other proprietary transactions, including equities, foreign currencies, physical commodities, futures, and swaps, the covered SD is required to reflect these transactions in its capital in the form of market risk and, as appropriate, credit risk charges, and the SD is required to hold capital in an amount sufficient to cover such charges. The exclusion of the security-based swaps from the risk margin amount addresses commenters concern that the proposed Net Liquid Assets Capital Approach ‘‘double counts’’ the covered SD’s security-based swap positions in the capital computation by including such positions in the both the computation of net capital and in the calculation of the minimum capital requirement. The Commission also notes that to the extent a covered SD is also a registered SBSD, it will be subject to a minimum capital requirement established by the SEC, which requires the SBSD to maintain minimum net capital equal to the greater of $20 million or 2% of the risk margin amount associated with the SBSD’s uncleared security-based swaps and customer cleared security-based swaps. Therefore, to the extent a covered SD that is dually-registered as a SBSD engages in a substantial amount of security-based swaps such that its SEC minimum capital requirement is greater than the CFTC minimum capital requirement, the SD would have to maintain compliance with the higher SEC minimum capital requirement in order to comply with the SEC rules. The Commission is also modifying the proposed risk margin amount calculation to exclude proprietary futures, foreign futures, and cleared swap transactions. The Commission believes that it is appropriate to revise the proposed risk margin amount to exclude proprietary cleared positions from the minimum capital requirement as the covered SD’s credit exposure is limited on such positions to either a clearing organization or to an FCM that carries the SD’s account (or in the case of foreign futures, a foreign broker that carries the SD’s account). The credit exposure on such cleared positions is limited relative to swap counterparties as clearing organizations and FCM/ foreign brokers are regulated entities that are generally subject to financial requirements, including capital, margining, and financial reporting requirements. Clearing organizations and FCM/foreign brokers are also subject to regulations regarding the holding of customer funds to ensure that such funds are used solely for the benefit of the customer and not for the benefit of other customers or of the clearing organization or FCM/foreign broker.186 The clearing of the positions also ensures that the potential default by the SD is reduced as it is obligated to post initial margin with an FCM/foreign broker or clearing organization, and to settle open positions on a daily basis. Therefore, any default on the part of the SD is promptly identified by the FCM/ foreign broker or clearing organization and steps are taken to mitigate the potential losses resulting from the default. These types of restrictions on the holding of customer funds by FCMs, foreign brokers, and clearing organizations and the clearing organizations’ daily margining processes mitigate the risk associated with the covered SD’s cleared futures, foreign futures, and cleared swaps transactions. Furthermore, while the cleared proprietary positions are being excluded from the minimum capital requirement 185 See Commission regulation § 1.17(a)(1)(i) (17 CFR 1.17(a)(1)(i)) and SEC rule 15c3–1. 186 See, e.g., Commission regulations §§ 1.20, 1.22 and 39.15 (17 CFR 1.20, 1.22 and 39.15). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 based upon the risk margin amount, the positions are reflected in the covered SD’s capital in the form of market risk and credit risk charges and the covered SD is required to hold capital sufficient to cover those charges. The Commission is also modifying the proposed 8% risk margin amount for covered SDs electing the Net Liquid Assets Capital Approach by setting the multiplier at 2%. The Commission has reviewed the proposed capital requirements and has considered the comments received and believes that it is appropriate to modify the risk margin amount multiplier in the Net Liquid Assets Capital Approach, and to retain the 8% risk margin amount multiplier in the Bank-Based Capital Approach and the Tangible Net Worth Capital Approach. Therefore, under the final regulation, a covered SD that elects the Net Liquid Assets Capital Approach must maintain a minimum level of net capital that is equal to or greater than 2% of the initial margin of its uncleared swaps, computed on a counterparty-bycounterparty basis. The Commission believes that modifying the risk margin amount multiplier under the Net Liquid Assets Capital Approach is appropriate due to (i) differences in the assets that comprise regulatory capital under the Net Liquid Assets Capital Approach relative the Bank-Based Capital Approach and the Tangible Net Worth Capital Approach, and (ii) differences in how the minimum capital requirement is applied under the Net Liquid Assets Capital Approach relative the BankBased Capital Approach and the Tangible Net Worth Capital Approach. As previously discussed, the Net Liquid Assets Capital Approach is a liquiditybased capital approach that requires a covered SD to hold at least one dollar of highly liquid assets for each dollar of the firm’s liabilities (excluding qualifying subordinated debt). With respect to the assets that comprise net capital under the Net Liquid Assets Capital Approach, a SD is required to calculate its net worth in accordance with U.S. GAAP, and subtract all illiquid assets, such as fixed assets and intangible assets, and deduct all of the firm’s liabilities (except certain qualifying subordinated debt) to determine its tentative net capital. The SD then deducts market risk charges on all of its proprietary positions, including uncleared swap and security-based swap positions, and credit risk charges on its exposures to counterparties on its derivative positions, to determine its net capital. In contrast to the liquidity-based approach of the Net Liquid Assets E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations Capital Approach, the Bank-Based Capital Approach and the Tangible Net Worth Capital Approach are more properly viewed as solvency-based capital requirements that require a covered SD to maintain positive balance sheet equity. Under the Bank-Based Capital Approach and Tangible Net Worth Capital Approach, a covered SD is not required to deduct fixed assets or other illiquid assets from its balance sheet equity.187 A covered SD is also not required to deduct market risk and credit risk charges from its balance sheet equity. Therefore, the capital that is available and that may be used to meet the minimum capital requirement is substantially more conservative under the Net Liquid Assets Capital Approach than it is under the Bank-Based Capital Approach and the Tangible Net Worth Capital Approach. In addition to what assets qualify as capital, the risk margin amount requirement is applied in a more conservative manner to covered SDs under the Net Liquid Assets Capital Approach than it is under the BankBased Capital Approach and the Tangible Net Worth Capital Approach. Under the proposed Net Liquid Assets Capital Approach, a covered SD was required to maintain a level of net capital (as defined above) that equaled or exceeded 8% of the risk margin amount. Covered SDs electing the proposed Bank-Based Capital Approach or Tangible Net Worth Capital Approach were required to maintain balance sheet equity (without deductions for fixed assets and market risk and credit risk charges) that equaled or exceeded 8% of the risk margin amount. Therefore, covered SDs electing the Bank-Based Capital Approach or Tangible Net Worth Capital Approach may have substantially more assets that qualify as capital to meet the proposed 8% risk margin amount requirement. The Commission recognizes that the differences in the capital approaches discussed above may provide a competitive advantage to covered SDs electing the Bank-Based Capital Approach and Tangible Net Worth Capital Approach due to the ability of such SDs to include fixed assets and not have to deduct market and credit risk charges. To address this potential competitive disadvantage, the Commission is modifying the regulation by setting the risk margin amount multiplier at 2% under the Net Liquid Assets Capital Approach. Given the differences in the operation of the respective capital approaches as 187 SDs electing the Tangible Net Worth Capital Approach are required to deduct intangible assets. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 discussed above, the Commission believes that setting the risk margin amount multiplier at 2% for covered SDs electing the Net Liquid Assets Capital approach imposes a minimum capital requirement that is more equivalent to the 8% risk margin amount requirement for Bank-Based Capital Approach and Tangible Net Worth Capital Approach SDs. Setting the risk margin amount at 2% also mitigates commenters’ concern that the Net Liquid Assets Capital Approach results in ‘‘double counting’’ of positions in the capital computation. The Commission proposed an 8% risk margin amount multiplier based upon its experience with FCM capital requirements, which requires each FCM to maintain a minimum capital requirement based upon 8% of the risk margin on the futures, foreign futures, and cleared swap positions carried in customer and noncustomer accounts. As noted by a commenter, the 8% risk margin amount was proposed in 2003 and adopted in 2004 based upon an analysis and comparison of the capital regime in effect at the time, which was based on a percentage of the customer funds held by an FCM, with a minimum capital requirement based upon risk margin associated with the customer positions carried by the FCM.188 Staff also had the benefit of observing data of the actual performance of the two capital regimes for an extended period of time as each FCM was required to calculate its minimum capital requirement based on customer funds and its capital requirement based on a percentage of its risk margin amount for approximately three years as part of a pilot program.189 The Commission does not have sufficient data to perform a quantitative analysis of the optimal level to set the multiplier for the risk margin amount at this time. However, the Commission’s decision to modify the final rule by removing cleared and uncleared security-based swaps, as well as proprietary futures, foreign futures, and cleared swaps positions from the risk margin amount calculation and to set the multiplier at 2% should mitigate many of the commenters’ concerns that the proposed 8% risk margin amount calculation was over inclusive of the types of positions included in the 188 See Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers, 68 FR 40835 (July 9, 2003) (‘‘2003 Proposed Risk-based Capital Rulemaking’’). The final rule is available at 69 FR 49784 (Aug. 12, 2004). See also, IIB/ISDA/SIFMA 3/3/2020 Letter. 189 See 2003 Proposed Risk-based Capital Rulemaking, 68 FR 40835 at 40839. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 57487 calculation and was set at a percentage that was too high. In addition, as the commenters noted, the FCM capital requirement of 8% of the risk margin on futures, foreign futures and cleared swaps is based upon margin calculations using clearing organization models that require the clearing organization to use a 99% one-tailed confidence interval over a minimum liquidation period of one day for futures, agricultural swaps, energy swaps, and metal swaps of one day, and a minimum liquidation period of five days for all other swaps.190 In contrast, initial margin for uncleared swaps is required to be calculated at a 99% onetailed confidence interval over minimum liquidation period of 10 business days (or the maturity of the swap if shorter).191 The greater minimum holding period for uncleared swaps generally requires a higher level of initial margin, which would increase the covered SD’s minimum capital requirement relative to cleared transactions. Also, the Commission’s final approach is consistent with the Congressional mandate to adopt capital requirements that are to the maximum extent practicable, comparable with the SEC and prudential regulators’ capital requirements. The SEC’s final rules require a SBSD to maintain net capital (not tentative net capital) that is equal to or greater than 2% of the risk margin amount calculated on its customer cleared security-based swaps and uncleared security-based swaps. Therefore, the Commission’s final regulation is comparable with the SEC’s final rule for SBSDs.192 The Commission believes it will be necessary to monitor and evaluate whether the numerical percentage is effective in achieving the statutory requirement for capital. Therefore, unlike the SEC, the Commission is not committing to a predetermined upward ratcheting percentage, but will 190 See Commission regulation § 39.13(g) (17 CFR 39.13(g)). 191 See Commission regulation § 23.154(b)(2) (17 CFR 23.154(b)(2)). 192 Under the Commission’s final rule, a covered SD will be required to maintain a minimum level of adjusted net capital equal to or greater than 2% of the risk margin associated with the SD’s proprietary uncleared swap transactions. Under the SEC’s final rule, a stand-alone SBSD will be required to maintain a minimum level of net capital equal to or greater than 2% of the sum of the SBSD’s customer cleared security-based swaps and uncleared security-based swaps. Covered SDs that clear customer swaps would be required to register as an FCM and will be subject to the FCM–SD capital requirements discussed in section II.B. above, which includes a minimum capital requirement of 8% of the risk margin amount associated with the FCM–SD’s cleared customer futures, foreign futures, and cleared swap positions. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57488 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations continually monitor and evaluate, which provides the Commission more flexibility in making fact-based assessments about the efficacy of the final rule in the future. The Commission will monitor the impact that the 2% risk margin amount has on the level of minimum capital required of covered SDs electing the Net Liquid Assets Capital Approach after the compliance date of the rules. The Commission intends to use the financial statements and other information that it will receive from covered SDs under the financial reporting requirements discussed in section II.D. below to continually monitor the minimum capital requirements under the final rule, ensuring the Commission’s capital requirements are adequately calibrated to protect the safety and soundness of the covered SDs. The information that the Commission will receive will allow it to determine if it would be appropriate to propose amending the minimum capital requirements by, among other things, increasing or decreasing the risk margin amount multiplier. The Commission also has considered the comments that the minimum capital requirement should be revised to require a covered SD to maintain tentative net capital in excess of the risk margin amount as opposed to the proposed net capital requirement. The Commission is not modifying the final rule to reflect these comments. While the Commission acknowledges that a covered SD electing the Net Liquid Assets Capital Approach is required to both include its uncleared swaps in the 2% risk margin amount calculation in order to establish its minimum capital requirement and to take capital charges for market risk and credit risk on the uncleared swaps in computing the amount of capital the covered SD holds, the Commission does not believe that it would be appropriate to revise the final rule at this time to only apply to tentative net capital. If the Commission were to revise the final regulation consistent with the comments, then a covered SD would be subject only to the minimum fixed-dollar net capital requirement of $20 million (and those approved to use capital models, a tentative net capital requirement of $100 million). Including the uncleared swaps in establishing a minimum capital requirement is intended to provide a floor of net capital that each SD following the Net Liquid Assets Capital Approach is required to maintain to cover all risks to the firm, including market, credit, operation, liquidity, and legal risk. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 With respect to commenters’ concerns that the proposed risk margin amount would exacerbate the impact of a covered SD’s inability to portfolio margin uncleared swaps and uncleared security-based swaps with a counterparty in a single account, the Commission recognizes the capital and margin efficiencies that portfolio margining provides to covered SDs and counterparties. The Commission also recognizes that the inability of a covered SD that is dually-registered with the SEC as a SBSD to portfolio margin uncleared swaps and uncleared security-based swaps impacts the SD’s ability to compete with bank SDs that may margin uncleared swaps and security-based swaps in a single account, subject to the rules of the applicable prudential regulator. Under the Dodd-Frank Act framework, the Commission has the authority to establish margin requirements for swaps and the SEC has the authority to establish margin requirements for security-based swaps. Therefore, the respective Commissions need to take coordinated action in order for a duallyregistered covered SD and SBSD to margin uncleared swaps and securitybased swaps with a counterparty in a single account. The Commission will consult with the SEC regarding portfolio margining and, as part of such consultation, address capital issues. With respect to comments that the risk margin amount may make it difficult for covered SDs and other market participants to enter into swaps that facilitate the transition from interbank offered rates to other risk-free rates, the Commission invites market participants that may be impacted by the capital rule to seek guidance from Commission staff. As noted above, Commission staff has provided noaction relief, including margin relief, to facilitate a covered SD’s transition of open swaps with an interbank offered rate to other rates. Minimum Capital Requirement of a Registered Futures Association Under Net Liquid Assets Capital Approach The third criterion of the proposed Net Liquid Assets Capital Approach required a covered SD to maintain net capital that was equal to or greater than the amount of net capital required by an RFA of which the covered SD was a member. As noted in the 2016 Capital Proposal, the proposed minimum capital requirement based on membership requirements of an RFA is consistent with section 17(p)(2) of the PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 CEA and current regulation 1.17 for FCMs and IBs.193 Section 17(p)(2) of the CEA provides, in relevant part, that an RFA must adopt rules establishing minimum capital and other financial requirements applicable to the RFA’s members for which such requirements are imposed by the Commission.194 Section 17(p)(2) further requires an RFA to implement a program to audit and enforce its members’ compliance with such capital and other financial requirements. As noted above, the NFA currently is the only RFA, and each SD is required to be a member of NFA.195 The 2016 Capital Proposal noted that NFA is required by section 17 of the CEA to adopt SD capital rules once the Commission imposes capital requirements on SDs, and that NFA’s capital rules must be at least as stringent as the Commission’s capital requirements on covered SDs.196 The Commission’s proposed Net Liquid Assets Capital Approach incorporated the NFA minimum capital requirement into the Commission’s capital rule, which would make a violation of the NFA’s rule also a violation of the Commission’s rule in a manner that is consistent with the current FCM capital rules.197 The Commission received several comments regarding the proposed requirement that a covered SD must meet the capital rules adopted by the NFA. Several commenters stated that any future NFA capital rules for covered SDs should be subject to public comment.198 One commenter also stated that creating, revising and implementing 193 See Commission regulations §§ 1.17(a)(1)(i)(C) and 170.16 (17 CFR 1.17(a)(1)(i)(C) and 170.16). 194 See section 17(p)(2) of the CEA (7 U.S.C. 21(p)(2)), which requires RFAs to adopt rules establishing minimum capital and other financial requirements applicable to its members for which such requirements are imposed by the Commission, provided that such requirements may not be less stringent than the requirements imposed by the CEA or by Commission regulations. 195 Commission regulation § 170.16 (17 CFR 170.16) provides, in relevant part, that each person registered as an SD must become and remain a member of at least one futures association that is registered with the Commission under section 17 of the CEA and provides for the membership of SDs. NFA is currently the only RFA and accepts SD members. 196 See 2016 Capital Proposal, 81 FR 91252 at 91259 and footnote 87 at 91269. 197 Commission regulation § 1.17(a)(1)(i)(C) (17 CFR 1.17(a)(1)(i)(C)) currently incorporates NFA’s minimum capital requirement for an FCM into the Commission’s minimum capital requirement by providing that each person registered as an FCM must maintain adjusted net capital required by an RFA of which the FCM is a member. 198 ED&F Man/INTL FCStone 3/3/2020 Letter; Letter from Scott Earnest, Shell Trading Risk Management LLC (March 2, 2020) (Shell 3/3/2020 Letter). E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 systems, controls, processes, reporting and related internal mechanisms requires ample notice of uninterrupted requirements that could be jeopardized by an inconsistent NFA capital requirement.199 To address this issue, the commenter requested that the Commission require NFA to establish a public comment period to solicit feedback on any covered SD capital requirements prior to mandating compliance with such requirements.200 Another commenter stated that the Commission’s efforts to obtain public input pursuant to the 2016 Capital Proposal and the 2019 Capital Reopening may be nullified if the NFA adopts capital rules that are different from the Commission’s final rules.201 The commenter requested that the Commission require NFA to adopt capital rules that closely mirror the Commission’s final capital rules, or, at the least, require NFA to conduct a rigorous notice and comment process prior to finalizing its capital rules.202 The Commission appreciates the commenters concerns regarding the need for conformity between its final capital rules governing covered SDs and those that may be adopted by NFA as an RFA in the future. The Commission believes, however, that the concerns are largely mitigated by the existing statutory and Commission regulatory requirements as well as the internal governance structure of NFA, which was established to comply with these requirements. Section 17(j) of the CEA, for example, requires NFA to file with the Commission any change in or addition to its rules. Any such change or addition is effective within 10 days of submission unless NFA requests, or the Commission notifies NFA of its intent to subject the filing to, a review and approval process.203 To the extent NFA plans to adopt significant new rules, it typically has worked very closely with Commission staff to ensure, among other things, consistency with existing Commission regulations. The current capital and financial requirements applicable to FCMs and IBs, are essentially the same under both Commission regulations and NFA rules.204 Further, the statutory and Commission regulatory requirements and NFA’s governance structure ensure that SDs are represented and given a 199 ED&F Man/INTL FCStone 3/3/2020 Letter. 200 Id. 201 See Shell 3/3/2020 Letter. 202 Id. 203 See section 17(j) of the CEA (7 U.S.C. 21(j)). Commission regulation § 1.17 (17 CFR 1.17) with NFA Financial Requirements. 204 Cf. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 voice in the potential adoption of NFA rules, including capital and financial reporting rules, that may impact them. Specifically, section 17(b)(5) of the CEA and regulation 170.3 require generally that the rules of an RFA assure fair representation of its members in the adoption of any rule, in the selection of its officers, directors, and in other aspects of its administration.205 In this regard, NFA’s Articles of Incorporation require that its Board of Directors include 5 elected representatives of registered (or provisionally-registered) SDs, registered (or provisionally registered) major swap participants and registered RFEDs. Of these representatives, at least 2 must be SDs that are Large Financial Institutions 206 (as of June 30 of the prior calendar year) and at least 2 others must be representatives of SDs, MSPs or RFEDs that are not Large Financial Institutions.207 In light of NFA’s governance structure, the Commission’s review process with respect to new NFA rules and the typically close interaction between Commission and NFA staff with regard to NFA’s adoption of new rules, the Commission believes that an additional mandatory public comment period for NFA capital rules would be unnecessary. Accordingly, the Commission is adopting the third criterion that a covered SD electing the Net Liquid Assets Capital Approach must maintain capital in an amount equal to or in excess of an amount of capital, if any, imposed by an RFA of which the covered SD is a member. b. Computation of Net Capital To Meet Minimum Capital Requirement The second component of the proposed Net Liquid Assets Capital Approach required a covered SD to compute the amount of ‘‘tentative net capital’’ and ‘‘net capital’’ that the SD maintains in order to satisfy its minimum capital requirement. Proposed 205 7 U.S.C. 21(b)(5) and Commission regulation § 170.3 (17 CFR 1.17). See also, section 17(b)(11) of the CEA (7 U.S.C. 21(b)(11)) which requires that an RFA provide for meaningful representation on the governing board of such association of a diversity of membership interests and provides that no less than 20 percent of the regular voting members of the board be comprised of qualified nonmembers of or persons not regulated by such association. 206 The term ‘‘Large Financial Institution’’ is defined in Article XVIII(n) of NFA’s Articles of Incorporation as ‘‘a Swap Dealer included in a well defined, publicly available and independent list of financial institutions that the Board of Directors identifies by resolution from time to time.’’ 207 Article XVII, Section 2A(d) of NFA Articles of Incorporation. Article VIII, Section 3(c)(iv) requires that NFA’s Executive Committee composition include 13 Directors, 2 of whom represent SDs, MSPs or RFEDs. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 57489 regulation 23.101(a)(1)(ii) required each covered SD electing the Net Liquid Assets Capital Approach to compute its tentative net capital and net capital in accordance with the SEC’s computation of tentative net capital and net capital for nonbank SBSDs under Rule 18a–1 as if the covered SD was a nonbank SBSD, subject to several adjustments.208 The Net Liquid Assets Capital Approach and the SEC capital approach for SBSDs are based on the existing FCM and BD capital rules and place an emphasis on liquidity of the entity. The FCM and BD capital rules are liquiditybased capital requirements that generally require a firm to maintain at all times at least $1 dollar of highly liquid assets to cover each dollar of its unsubordinated liabilities, which is generally money owed to customers, counterparties and creditors. A covered SD electing the Net Liquid Assets Capital Approach will compute net capital by first determining its net worth under U.S. GAAP, which generally reflects the firm’s total assets less its total liabilities. The covered SD would then adjust its net worth by deducting certain assets such as unsecured receivables and undermargined counterparty accounts. The covered SD would also be able to add back to its net worth certain qualifying subordinated liabilities. The result of these adjustments would be the covered SD’s ‘‘tentative net capital.’’ The covered SD will then compute its ‘‘net capital’’ by deducting from ‘‘tentative net capital’’ prescribed capital charges from the mark-to-market value of its proprietary swap, securitybased swap, equities, and commodity positions. The prescribed capital charges for the covered SD’s proprietary positions are the existing standardized capital charges set forth in Commission regulation 1.17 for FCMs and SEC rule 15c3–1 for BDs. The Proposal also provided that a covered SD could seek approval from the Commission or an RFA to use internal models to compute market risk and credit risk capital charges in lieu of the standardized capital charges. The application and approval process for market risk and credit risk capital models is discussed in section II.C.7. below. (i) Swap Dealers Not Approved To Use Internal Capital Models The 2016 Capital Proposal required a covered SD electing the Net Liquid Assets Capital Approach to apply, in computing its net capital, standardized market risk and credit risk capital 208 See 2016 Capital Proposal, 81 FR 91252 at 91260–61. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57490 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations charges set forth in SEC Rule 18a–1, and the appendices thereto, for positions in swaps, security-based swaps, and other proprietary positions, if the covered SD had not obtained Commission or RFA approval to use internal models. The standardized market risk charges under SEC rule 18a–1 are rules-based capital charges that require a covered SD to compute market risk capital charges for swaps, security-based swaps, and other positions by multiplying the notional amount or fair market value of the positions by a specified percentage set forth in SEC rule 18a–1.209 The resulting market risk charges would be deducted from the covered SD’s tentative net capital to arrive at the firm’s net capital. Standardized credit risk charges under SEC Rule 18a–1 generally provide that unsecured receivables are subject to a 100 percent credit risk capital charge (i.e., the covered SD would have to deduct 100 percent of any unsecured receivable balance, including receivables from swap and securitybased swap counterparties for unpaid variation margin or mark-to-market gains, from tentative net capital in computing net capital).210 Accordingly, under the proposed standardized credit risk charges, covered SDs were required to deduct any unsecured receivables arising from not collecting variation margin from any counterparty, including counterparties that are exempt or excepted from having to pay and collect variation margin with the covered SD. Therefore, covered SDs would have to take a capital charge for any exposures arising from unpaid variation margin to any counterparties, including commercial end users and counterparties excluded from or exempt from the requirement to exchange variation margin with the covered SD. The Commission proposed several adjustments that a covered SD electing the Net Liquid Assets Capital Approach could make to the standardized credit risk capital charges set forth in SEC rule 18a–1. In this regard, the Commission proposed that a covered SD, in computing its regulatory capital, may recognize unsecured receivables from third-party custodians as a current asset in computing its regulatory capital, where the receivable represents the amount of initial margin that the covered SD posted with the third-party custodian for uncleared swaps or uncleared security-based swaps pursuant to the margin rules of the 209 See, 210 See e.g., SEC rule 18a–1. 2019 SEC Final Capital Rule, 84 FR 43872 at 44053. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Commission or SEC, as applicable.211 Absent this modification of the application of Rule 18a–1, a covered SD would have to take a 100% capital charge for the receivables from the third party custodians.212 The Commission proposed this modification to rule 18a– 1 to take into account that covered SDs are required to post initial margin for all swaps with SD counterparties and with all financial end users with material swaps exposure under the uncleared swap margin rules, while the SEC’s final rules do not require a SBSD to post initial margin for security-based swaps with other SBSDs or with financial end users.213 The Commission received a comment on the proposed adjustment to permit covered SDs to recognize receivables from third-party custodians as a current asset in computing their net capital under SEC rule 18a–1.214 The commenter stated that it supported the proposed adjustment, but noted that the rule was too restrictive by recognizing initial margin held by third-party custodian pursuant to the Commission’s rules and the rules of the SEC. The commenter noted that covered SDs may enter into uncleared swap or securitybased swap transactions with SDs that are subject to the margin rules of a prudential regulator, or a SD that operates in a foreign jurisdiction that has received a margin comparability determination from the Commission. The commenter stated that in order to avoid creating unwarranted disparities depending on the parties with which a covered SD trades, the Commission should expand the adjustment to allow an SD to recognize IM posted in accordance with the margin rules of a prudential regulator or foreign jurisdiction for which the Commission has made a comparability determination.215 211 See paragraph (a)(1)(ii)(A)(4) of proposed Commission regulation § 23.101; 2016 Capital Proposal, 81 FR 91252 at 91310. 212 The 2019 SEC Final Capital Rule provides interpretive guidance stating that a BD or a standalone SBSD does not have to take a capital charge for initial margin for swaps and security-based swaps that is posted with a third-party custodian if: (i) The initial margin requirement is funded pursuant to a fully-executed written loan agreement with an affiliate of the stand-alone BD or SBSD; (ii) the loan agreement provides that the lender waives re-payment of the loan until the initial margin is returned to the stand-alone BD or SBSD; and (iii) the liability of the stand-alone BD or SBSD to the lender can be fully satisfied by delivering the collateral serving as the initial margin to the lender. See 2019 SEC Final Capital Rule, 84 FR 43872 at 43887. 213 Commission regulation § 23.152 (17 CFR 23.152). 214 See IIB/ISDA/SIFMA 3/3/2020 Letter. 215 Id. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 The Commission has considered the comment and is modifying the final regulation to allow a covered SD electing the Net Liquid Assets Capital Approach to recognize initial margin for uncleared swaps and security-based swaps deposited with third-party custodians as a current asset in computing its net capital. The covered SD must deposit the initial margin with a third-party custodian in accordance with the applicable rules of the Commission, SEC, prudential regulators, or a foreign jurisdiction that has obtained a margin comparability determination from the Commission. The modification of the final regulation is consistent with the original intent of the proposed regulation, which was to permit covered SDs to recognize initial margin posted with third-party custodians pursuant to the new margin framework which requires a SD to both post and collect initial margin with a swap dealer counterparty or with a financial end user with material swaps exposure.216 The modification more fully and accurately reflects the types of counterparties that a covered SD may transact with, and the regulations that may govern such uncleared swap and security-based swap transactions. The Commission also proposed to permit a covered SD that elects the Net Liquid Assets Capital Approach to exclude a capital charge contained in proposed SEC rule 18a–1(c)(viii). Applying SEC proposed rule 18a– 1(c)(viii) would require a covered SD to take a capital charge to the extent that standardized market risk charges computed on a portfolio of customer security-based swaps exceeded the clearinghouse margin associated with such cleared security-based swaps positions.217 The SEC did not include this capital charge in its final rules, and the Commission is deleting the exception from this capital charge in final regulation 23.101(a)(1)(ii) as it is no longer necessary. 216 The term ‘‘material swaps exposure’’ is defined by Commission regulation 23.150 (17 CFR 23.150) to mean that the entity and its margin affiliates have an average daily aggregate notional amount of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards, and foreign exchange swaps with all counterparties for June, July and August of the previous calendar year that exceeds $8 billion. 217 See SEC 2012 Proposed Capital Rule, 77 FR 70214 at 70335. The SEC also requested comment on proposed rule text that extended the capital charge to cleared swaps in addition to cleared SBS. See Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers, 83 FR 53007 (Oct. 19, 2018). E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 (ii) Swap Dealers Approved To Use Internal Capital Models The 2016 Capital Proposal permitted a covered SD electing the Net Liquid Assets Capital Approach to seek Commission or RFA approval to use internal models to compute market risk and credit risk capital charges on its swaps, security-based swaps and other proprietary positions in lieu of the standardized deductions contained in the SEC Rule 18a–1.218 In order to be considered for approval, the SD’s models must meet the qualitative and quantitative requirements set forth in proposed regulation 23.102 and Appendix A to regulation 23.102. The Commission noted in the 2016 Capital Proposal that the Federal Reserve Board had adopted quantitative and qualitative requirements for internal models used by bank holding companies to compute market risk and credit risk capital charges.219 In developing the proposed market risk and credit risk requirements for covered SDs, including the proposed quantitative and qualitative internal model requirements, the Commission incorporated the market risk and credit risk model requirements adopted by the Federal Reserve Board.220 The Commission’s proposed model requirements are also comparable to the SEC’s model requirements for SBSDs and for BDs.221 The model requirements and the process for obtaining Commission or RFA review is set forth in section II.C.7. of this release. The Commission’s 2016 Capital Proposal required a covered SD electing the Net Liquid Assets Capital Approach to compute its credit risk charges as if the covered SD were a SBSD subject to SEC rule 18a–1.222 The SEC 2012 Proposed Capital Rule limited the use of credit risk models to transactions with commercial end users.223 The 218 The Commission proposed that a covered SD’s market risk models must calculate the total market risk for its proprietary positions under SEC rule 18a–1(d) (17 CFR 240.18a–1(d)) as the sum of the VaR measure, stressed VaR measure, specific risk measure, comprehensive risk measure, and incremental risk measure of the portfolio of proprietary positions in accordance with proposed Commission regulation § 23.102 and proposed Appendix A of regulation § 23.102. See paragraph (a)(1)(ii)(A)(2) of proposed Commission regulation § 23.101; 2016 Capital Proposal, 81 FR 91252 at 91310. 219 See 2016 Capital Proposal, 81 FR 91252 at 91258; See, 12 CFR 217, subparts E and F. 220 See 2016 Capital Proposal, 81 FR 91252 at 91258. 221 See 2016 Capital Proposal, 81 FR 91252 at 91278. 222 See 2016 Capital Proposal, 81 FR 91252 at 91310; Proposed regulation 23.101(a)(1)(ii). 223 See SEC 2012 Proposed Capital Rule, 77 FR 70214 (Nov. 23, 2012) at 70245–46. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Commission, however, believed that a covered SD should be able to use credit risk models to compute capital charges for uncleared swap and security-based swap transactions with all counterparties, and not just commercial end users. In this regard, the Commission proposed that covered SDs that elect the Net Liquid Assets Capital Approach or the Bank-Based Capital Approach, and FCM–SDs could use models to compute credit risk charges for swap and security-based swaps counterparties. Therefore, the Commission proposed to add paragraph (a)(1)(ii)(A)(3) to regulation 23.101 to allow a covered SD electing the Net Liquid Assets Capital Approach to use credit risk models to compute credit risk charges for uncollected variation margin and initial margin from swap and security-based swap counterparties. In its final rule adopting capital requirement for SBSDs, the SEC modified its rule 18a–1 from the proposal to permit SBSDs approved to use credit risk models to use such models to compute credit risk capital charges from all classes of swap and security-based swap counterparties and not just commercial end users.224 Therefore, the Commission has modified the final regulation 23.101 by deleting paragraph (a)(1)(ii)(A)(3) as the provision is no longer necessary as the SEC and CFTC rules are aligned in that a covered SD may use an approved model to compute counterparty credit risk charges for swap and security-based swap transactions with all counterparties. 3. Capital Requirement for Covered SDs Electing the Bank-Based Capital Approach a. Computation of Minimum Capital Requirement The 2016 Capital Proposal provided covered SDs with an option of electing the Bank-Based Capital Approach, which is based on the Federal Reserve Board’s capital requirements for bank holding companies.225 The Federal Reserve Board’s bank holding company capital requirements are consistent with the bank capital framework adopted by the BCBS.226 The BCBS framework is an 224 See 2019 SEC Final Capital Rule, 84 FR 43872 at 43902–93. 225 See paragraph (a)(1)(i) of proposed Commission regulation § 23.101, 2016 Capital Proposal, 81 FR 91252 at 91310. 226 BCBS is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Institutions represented on the BCBS include the Federal Reserve Board, the European Central Bank, Deutsche Bundesbank, Bank of France, Bank of England, Bank of Japan, and Bank of Canada. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 57491 internationally-recognized framework for setting capital requirements for banks and bank holding companies, and was developed to provide prudential standards to help ensure the safety and soundness of bank and bank holding companies. The Bank-Based Capital Approach also offers a covered SD that is part of bank holding company structure with potential efficiencies as the covered SD may maintain financial accounting records in a manner that provides for the efficient consolidation of the SD into the financial reporting requirements of the bank-holding company. The Commission’s Bank-Based Capital Approach was set forth in proposed regulation 23.101(a)(1)(i), and required a covered SD to maintain a minimum level of regulatory capital that is equal to or in excess of the greatest of the following four criteria: (1) $20 million of common equity tier 1 capital, as defined under the bank holding company regulations in 12 CFR 217.20, as if the SD itself were a bank holding company subject to 12 CFR part 217; 227 (2) common equity tier 1 capital, as defined under the bank holding company regulations in 12 CFR part 217.20, equal to or greater than 8% of the SD’s risk-weighted assets computed under the bank holding company regulations in 12 CFR part 217 as if the SD were a bank holding company subject to 12 CFR part 217; (3) common equity tier 1 capital, as defined under 12 CFR 217.20, equal to or greater than 8 percent of the sum of: (a) The amount of ‘‘uncleared swap margin’’ (as that term is defined in proposed regulation 23.100) for each uncleared swap position open on the books of the SD, computed on a counterparty by counterparty basis pursuant to regulation 23.154; (b) the amount of initial margin that would be required for each uncleared security-based swap position open on the books of the SD, computed on a counterparty-by-counterparty basis pursuant to proposed SEC Rule 18a– 3(c)(1)(i)(B), without regard to any initial margin exemptions or exclusions that the rules of the SEC may provide to such security-based swap positions; and (c) the amount of initial margin required by a clearing organization for cleared proprietary futures, foreign 227 Common equity tier 1 capital is defined in 12 CFR 217.20 of the Federal Reserve Board’s rules. Common equity tier 1 capital generally represents the sum of a bank holding company’s common stock instruments and any related surpluses, retained earnings, and accumulated other comprehensive income. E:\FR\FM\15SER3.SGM 15SER3 57492 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations futures, swaps, and security-based swap positions open on the books of the SD; or (4) the capital required by an RFA of which each SD is a member. Commenters generally supported the proposed Bank-Based Capital Approach as it represents an internationally recognized capital regime for establishing capital that is designed to promote the safety and soundness of banking institutions under standards issued by the BCBS. One commenter stated that the Bank-Based Capital Approach is a significant and necessary pillar in the Commission’s proposed regulatory framework as it fosters greater comparability of covered SDs with bank SDs, provides a risk-sensitive capital methodology for covered SD business models that are not adequately captured in traditional net capital calculations, and provides covered SD subsidiaries of bank holding companies with potential risk management and operational synergies.228 Another commenter supported the Bank-Based Capital Approach noting that the Commission’s proposal of offering distinct capital approaches recognizes that covered SDs have a wide range of business models, many of which do not fit easily within other proposed capital frameworks.229 This commenter further stated that covered SDs that are not dually-registered as SBSDs or FCMs generally do not maintain custody of customer assets nor are they subject to insolvency regimes premised on liquidation and the return of customer assets and, therefore, it makes sense for the Commission not to apply the Net Liquid Assets Capital Approach or FCM approach which are premised on the customer profile and insolvency regime applicable to SBSDs and FCMs, respectively.230 jbell on DSKJLSW7X2PROD with RULES3 Fixed-Dollar Minimum Capital Requirement Under Bank-Based Capital Approach The first criterion under the Commission’s Proposal required covered SDs electing the Bank-Based Capital Approach to maintain a minimum of $20 million of common equity tier 1 capital. The Commission believed that given the role that a SD performs in the financial markets by engaging in swap dealing activities that it was appropriate to require each SD to maintain a minimum level of capital, stated as an absolute dollar amount, that does not fluctuate with the level of the 228 See 229 See MS 3/3/2020 Letter. IIB/ISDA/SIFMA 3/3/2020 Letter. 230 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 firm’s dealing activities to help ensure the safety and soundness of the SD. The proposed $20 million of minimum capital also was consistent with the minimum regulatory capital requirements proposed by the Commission for SDs that elect the Net Liquid Assets Capital Approach or the Tangible Net Worth Capital Approach as discussed in sections II.C.2.a. and II.C.4., respectively, of this release. The proposed $20 million minimum capital requirement also was consistent with the net capital requirements adopted by the SEC for SBSDs, and was consistent with the current minimum net capital requirements for OTC derivatives dealers registered with the SEC.231 The Commission did not receive comment on the proposed $20 million dollar minimum capital requirement, and is adopting the requirement as proposed. Minimum Capital Based on RiskWeighted Assets Under Bank-Based Capital Approach The second criterion of the minimum capital requirement for covered SDs electing the Bank-Based Capital Approach required a covered SD to maintain common equity tier 1 capital equal to or greater than 8% of the covered SD’s risk-weighted assets computed under the bank holding company regulations in 12 CFR part 217 as if the covered SD was a bank holding company. In effect, this provision of proposed regulation 23.101(a)(1)(i) imposed a capital approach on a covered SD that is generally consistent with the capital approach that the Federal Reserve Board imposes on bank holding companies.232 For purposes of the 2016 Capital Proposal, as is also the case for the Federal Reserve Board’s minimum ratio requirement, the assets and off-balance sheet transactions or exposures of the bank holding company 231 The SEC capital requirements for SBSDs impose a minimum net capital requirement of $20 million for SBSDs that are not approved to use internal capital models and a $100 million dollar tentative net capital and $20 million net capital requirement for SBSDs that are approved to use internal capital models See 2019 SEC Final Capital Rule, 84 FR 43872 at 43884. SEC rule 15c3–1(a)(5) (17 CFR 240.15c3–1(a)(5)) currently requires an OTC derivatives dealer that has obtained approval to use capital models to maintain a minimum of $100 million of tentative net capital and $20 million of net capital. See 2019 SEC Final Capital Rule, 84 FR 43872 at 44042, 44052. 232 As discussed further below, the Commission’s Proposal differed from the rules of the Federal Reserve Board in that the Commission’s Proposal would require a covered SD to adjust its riskweighted assets calculation by including the market risk capital charges computed in accordance with Commission regulation § 1.17 (17 CFR 1.17) if the covered SD had not obtained approval from the Commission or from an RFA to use internal market risk models. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 would be weighted relative to their respective risk.233 Thus, under the 2016 Capital Proposal, the greater the perceived risk of the assets and the offbalance sheet items, the greater the weighting for the risk and the greater the amount of capital necessary to cover 8% of the risk-weighted assets.234 The Commission believed it was important to include this criterion in its minimum capital requirements so that a covered SD maintained a level of common equity tier 1 capital that was comparable to the level that the SD would maintain if it were subject to the capital rules of the Federal Reserve Board. Proposed paragraph (a)(1)(i) of regulation 23.101 required a covered SD electing the Bank-Based Capital Approach to compute its risk-weighted assets in accordance with the Federal Reserve Board’s capital requirements contained in 12 CFR part 217. The Proposal included two general approaches to computing risk-weighted assets under 12 CFR part 217. The first approach was for covered SDs that did not have Commission or RFA approval to calculate their risk-weighted assets using internal market risk or credit risk models. Proposed regulation 23.103 required these covered SDs to use a standardized, or rules-based, approach to computing their risk-weighted assets. Under the standardized approach, the covered SDs would use the credit risk charges from the Federal Reserve Board’s standardized approach under subpart D of 12 CFR 217 and the standardized market risk charges for FCMs set forth in regulation 1.17.235 As discussed in section II.B.3.a. above, regulation 1.17 contains the standardized market risk capital charges that have been imposed on FCMs for many years and is being amended by this rulemaking to reflect explicit 233 See 12 CFR 217 subparts D, E, and F. complex banks also must make further adjustments to these risk-weighted assets, calculated pursuant to approved models, for the additional capital they must hold to reflect the market risk of their trading assets See 12 CFR 217 subpart F. The market risk requirements generally apply to Federal Reserve Board-regulated institutions with aggregate trading assets and trading liabilities equal to 10 percent or more of total assets or one billion dollars or more. 235 The Federal Reserve Board’s standardized approach under subpart D of 12 CFR 217 applies only to credit risk charges; the Federal Reserve Board has not adopted standardized market risk charges. Bank and bank holding companies that are subject to market risk charges are required to use internal models and, accordingly, subpart D of 12 CFR 217 does not include a standardized approach for computing market risk charges. To address this issue, the Commission proposed that a covered SD that had not obtained Commission or RFA approval to use internal market risk models must apply the standardized market risk capital charges contained in Commission regulation § 1.17 (17 CFR 1.17) in computing its total risk-weighted assets. 234 Large, E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 standardized capital charges for swap and security-based swap positions that are aligned with the SEC’s standardized market risk capital charges. Generally, market risk charges are computed under regulation 1.17 by multiplying the notional value or market value of the position or asset by a fixed percentage set forth in the regulation.236 The market risk charges are then multiplied by a factor of 12.5 and added to the total risk-weighted assets of the SD.237 The second approach to computing risk-weighted assets permitted covered SDs that have Commission or RFA approval to use internal market risk and credit risk models to use such models to calculate their risk-weighted assets. The models would have to meet the qualitative and quantitative requirements set forth in proposed regulation 23.102 and Appendix A to regulation 23.102 in order to be approved. The qualitative and quantitative requirements were based on the Federal Reserve Board’s qualitative and quantitative requirements for capital models in 12 CFR part 217.238 The proposed qualitative and quantitative requirements for the models, and the proposed model submission process, are discussed in section II.C.7. of this release. The Commission acknowledged in the 2016 Capital Proposal that limiting a covered SD’s ability to use only common equity tier 1 capital to meet its minimum capital requirement based upon 8% of its risk-weighted assets was a departure from the Federal Reserve Board’s requirements, which allow a bank holding company to meet its 236 For example, U.S. Treasuries are subject to capital charges of between zero and six percent depending on the time to maturity of each treasury instrument, and readily marketable equity securities are subject to a 15 percent capital charge. See Commission regulation § 1.17(c)(5)(v) (17 CFR 1.17(c)(5)(v)), which references SEC rule 15c3– 1(c)(2)(vi) (17 CFR 240.15c3–1(c)(2)(vi)). SEC rule 15c3–1(c)(2)(vi)(A)(1) (17 CFR 240.15c3– 1(c)(2)(vi)(A)(1)) provides that a BD shall take a capital charge on U.S. Treasuries of between zero and six percent of the fair market value of the instrument depending upon the time to maturity. SEC rule 15c3–1(c)(2)(vi)(J) (17 CFR 240.15c3– 1(c)(2)(vi)(J)) provides a capital charge for equities equal to 15 percent of the fair market value of the securities. 237 The 12.5 multiplication factor is necessary to ensure that the SD maintains a level of common equity tier 1 capital to cover the full amount of the market risk charge. Since the SD is required to maintain common equity tier 1 capital equal to or in excess of 8% of the risk-weighted assets, the market risk charge is multiplied by 12.5, which effectively requires the SD to hold common equity tier 1 capital in an amount equal to the full amount of the market risk charge. This approach is consistent with the Federal Reserve Board’s approach to bank holding companies. 238 Federal Reserve Board model-based capital charges for credit risk and market risk are set forth in 12 CFR part 217 subparts E and F, respectively. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 minimum capital requirements with a combination of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital.239 The Commission stated in the 2016 Capital Proposal that it was proposing the stricter standard as common equity tier 1 capital is a more conservative form of capital than additional tier 1 or tier 2 capital, particularly as it relates to the permanence of the capital and its availability to absorb unexpected losses.240 The Commission also proposed the stricter common equity tier 1 requirement as it did not propose to include in the SD’s minimum capital requirement certain of the prudential regulators’ capital add-ons, including the capital conservation buffer and the countercyclical capital buffer.241 The Commission received comments regarding the proposed limitation of the type of capital that a covered SD may use under the Bank-Based Capital Approach in satisfying its 8% of riskweighted assets to common equity tier 1 capital ratio requirement. One commenter supported the proposed limitation noting that the more conservative common equity tier 1 capital is appropriate given the Commission’s Proposal does not include all of the capital add-ons and supervisory safeguards that are set forth in the prudential regulators’ capital framework.242 Other commenters stated that the proposed minimum capital requirement of common equity tier 1 capital equal to or greater than 8% of risk-weighted assets would impose a capital requirement on covered SDs that is materially higher and more restrictive than the prudential regulators’ capital requirement for banks and bank holding 239 Under the Federal Reserve Board’s rules, a bank holding company’s total capital must equal or exceed at least 8% of its risk-weighted assets. In addition, at least six percent of the bank holding company’s capital must be in the form of tier 1 capital, and at least 4.5 percent of the tier 1 capital must qualify as common equity tier 1 capital. The remaining two percent of capital may be comprised of tier 2 capital. Tier 1 capital includes common equity tier 1 capital and further includes such instruments as preferred stock. Tier 2 capital includes certain types of instruments that include both debt and equity characteristics (e.g., certain perpetual preferred stock instruments and subordinated term debt instruments). See 12 CFR 217.10. 240 See 2016 Capital Proposal, 81 FR 91252 at 91259–60. 241 See 12 CFR 217.11. The capital conservation buffer and the countercyclical capital buffer represent capital ‘‘add-ons’’ to the bank capital requirements and are intended to require entities subject to the rules to have certain levels of capital in order to make capital distributions and discretionary bonuses. 242 See AFR 5/15/2017 Letter. PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 57493 companies.243 These commenters noted that the prudential regulators’ minimum capital requirements provide that an entity is ‘‘adequately capitalized’’ if its common equity tier 1 capital is equal to or greater than 4.5% of the SD’s riskweighted assets, and is ‘‘well capitalized’’ if its common equity tier 1 capital is at least 6.5% of its riskweighted assets.244 These commenters further stated that the Commission’s proposed ‘‘early warning capital requirement’’ would effectively require SDs to maintain common equity tier 1 capital equal to at least 9.6% (120% × 8%) of risk-weighted assets as entities subject to the ‘‘early warning capital requirements’’ generally ensure that their regulatory capital exceeds such requirements.245 Another commenter stated that the Proposal may make it difficult for covered SDs subject to the Commission’s capital rule to compete with bank SDs subject to the capital rules of a prudential regulator, and more generally would deviate from the more tailored risk-based approach taken by the prudential regulators.246 In addition, a commenter requested that the Commission revise its BankBased Capital Approach to recognize subordinated debt as capital in meeting the 8% of risk-weighted assets capital ratio.247 This commenter noted that prudential regulators’ capital requirements permit a bank or a bank holding company to recognize certain subordinated debt as capital in meeting the 8% of risk-weighted assets capital ratio requirement.248 The Commission requested additional comment in the 2019 Capital Reopening on whether the proposed minimum capital requirement based upon a covered SD’s common equity tier 1 capital was appropriate.249 The Commission also requested comment on whether a covered SD should be able to 243 See ISDA 5/15/2017 Letter; MS 5/15/2017 Letter; SIFMA 5/15/2017 Letter. 244 Id. 245 Id. The 2016 Capital Proposal required each covered SD subject to the Bank-Based Capital Approach, the Net Liquid Assets Capital Approach, or the Tangible Net Worth Capital Approach to provide written notification to the Commission within 24 hours of the covered SD’s regulatory capital falling below 120 percent of the SD’s minimum requirement. This proposed notice provision, which is consistent with current FCM requirements in Commission regulation § 1.12 (17 CFR 1.12), is generally referred to as the ‘‘early warning capital requirement.’’ The proposed ‘‘early warning capital requirement’’ for SDs was included in paragraph (c)(2) of proposed Commission regulation § 23.105. See 2016 Capital Proposal, 81 FR 91252 at 91318. 246 See JBA 3/14/2017 Letter. 247 See SIFMA 5/15/2017 Letter. 248 Id. 249 See 2016 Capital Proposal, 81 FR 91252 at 91260. E:\FR\FM\15SER3.SGM 15SER3 57494 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations use additional tier 1 and tier 2 capital, including subordinated debt, in addition to common equity tier 1 capital in meeting the 8% of its risk-weighted assets requirement.250 jbell on DSKJLSW7X2PROD with RULES3 Common Equity Tier 1 Capital The Commission received comments in response to the 2019 Capital Reopening generally supporting the minimum capital requirement based on a percentage of the covered SD’s riskweighted assets, including the requirement for covered SDs electing the Bank-Based Capital Approach to maintain common equity tier 1 capital equal to a specific percentage of the risk-weighted assets. Commenters, however, stated that the proposed requirement that a covered SD maintain only common equity tier 1 capital in excess of 8% of its risk-weighted assets was not consistent with prudential regulators’ requirements and was higher than the comparable requirements imposed by the Federal Reserve Board for bank holding companies.251 These commenters noted that the prudential regulators requirements permit banks to use a combination of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital in meeting their regulatory capital requirements.252 Several commenters further noted, consistent with comments received from the 2016 Capital Proposal, that the Commission was effectively imposing a requirement for a covered SD electing the Bank-Based Capital Approach to maintain common equity tier 1 capital in excess of 9.6 percent of the SD’s riskweighted assets due to the proposed ‘‘early warning capital requirements’’ that requires a covered SD to notify the Commission if its regulatory capital falls below 120 percent of its minimum requirement.253 Commenters further stated that the resulting 9.6% common equity tier 1 capital requirement is not consistent with any bank-based capital methodology.254 Commenters suggested that the Commission align the proposed 8% common equity tier 1 capital requirement with the Federal Depository Insurance Corporation’s prompt corrective action (‘‘PCA’’) framework, which is calibrated based on the U.S. Basel III risk-weighted average framework.255 Under the PCA framework, a bank is deemed ‘‘adequately capitalized’’ if it maintains 250 Id. 251 See, e.g., MS 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 Letter. 252 Id. 253 Id. 254 See MS 3/3/2020 Letter. 255 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 common equity tier 1 capital of at least 4.5 percent of the bank’s risk-weighted assets, and is deemed ‘‘well capitalized’’ if it maintains common equity tier 1 capital of at least 6.5 percent of the bank’s risk-weighted assets.256 Commenters recommended revising the final regulations to provide that a covered SD that elects the Bank-Based Capital Approach must maintain common equity tier 1 capital at a level that is not less than 4.5 percent of the SD’s risk-weighted assets, and must maintain common equity tier 1 capital in excess of 6.5 percent of the SD’s riskweighted assets in computing the ‘‘early warning capital requirement’’ under proposed regulation 23.105(c)(2).257 Another commenter suggested that the Commission adopt a risk-weighted asset ratio that is tiered based on the size and complexity of the covered SD’s business (e.g., a 4.5% common equity tier 1 requirement with the tier 2 capital being eligible for the remaining 3.5%).258 The Commission has considered the proposed requirement for a covered SD electing the Bank-Based Capital Approach to maintain common equity tier 1 capital equal to or in excess of 8% of the SD’s risk-weighted assets, and has considered the comments that have been received. The Commission is adopting the requirement as a component of the final capital rule for covered SDs electing the Bank-Based Capital Approach, subject to the following modifications. The Commission is retaining the minimum requirement for a covered SD to maintain capital at a level equal to or in excess of 8% of the SD’s risk-weighted assets. The Commission is modifying the final regulation, however, to require that at least 6.5% of the minimum 8% capital requirement must be common equity tier 1 capital, with the remaining 1.5% to be comprised of common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, as defined by the Federal Reserve Board in 12 CFR 217.20. The Commission is further modifying the final rule to provide that any capital that is in the form of subordinated debt must meet the conditions adopted by the SEC for qualifying subordinated debt for SBSDs set forth in rule 18a–1d (17 CFR 240.18a–1d). In addition, a covered SD may use additional tier 1 and tier 2 capital (including qualifying 256 See 12 CFR 208.43(b) for the Federal Reserve Board’s capital measures and capital levels that are used for determining the supervisory actions for insured depository institutions that are not adequately capitalized. 257 See IIB/ISDA/SIFMA 3/3/2020 Letter. MS 3/3/ 2020 Letter at 8. 258 See Shell 3/3/2020 Letter. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 subordinated debt) to meet the early warning capital requirement above the 6.5% of common equity tier 1 capital. The Commission is adopting these modifications as it believes that it establishes an appropriate balance between ensuring that a covered SD maintains an appropriate level of permanent capital in the form of common equity tier 1 capital and permitting an SD to use other forms of capital formation, including qualifying subordinated debt. As noted below, the subordinated debt qualifications require the lender to subordinate their claims against the covered SD to the claims of all other creditors, which is comparable to the position of holders of common equity capital. The subordinated debt regulations further place restrictions on the ability of the SD to repay the subordinated debt if it would adversely impact the capital of the SD.259 In addition, final regulation 23.104 imposes limitations on the withdrawal of equity from a covered SD by actions of its shareholders, including paying dividends and similar distributions, if such distributions would result in the SD holding less than 120% of its minimum capital requirement.260 These additional regulatory requirements effectively ensure that the capital, including capital provided in the form of subordinated debt, is retained in the covered SD ensuring its safety and soundness. The final rule is also consistent with the Commission’s capital rules for FCMs, the SEC’s rules for BDs and SBSDs, and the prudential regulators’ rules for banks and bank holding companies, all of which recognize certain qualifying subordinated debt as capital.261 The final regulations also impose identical terms and conditions on qualifying subordinated debt under the Bank-Based Capital Approach and the Net Liquid Assets Capital Approach as covered SDs electing either approach 259 See, e.g., SEC rule 18a–1d(b)(7) (17 CFR 240.18a–1(b)(7)) which suspends a SBSD’s obligation to make a scheduled payment on a subordinated loan agreement if, after giving effect to the payment obligation (and to any other payment obligations under other subordinated debt agreements that are scheduled to be paid on or before the payment date of the subordinated loan agreement in question), the SBSD’s net capital would fall below 120 percent of the SBSD’s minimum net capital or tentative net capital requirement, as applicable. 260 See final Commission regulation § 23.104. 261 See, e.g., Commission regulation § 1.17(h) (17 CFR 1.17), SEC rules 15c3–1d and 18a–1d (17 CFR 240.15c3–1d and 17 CFR 240.18a–1d), and Federal Reserve Board rule 217.20 (12 CFR 217.20) for rules governing subordinated debt as capital for FCMs, BDS and SBDS, and banks and bank holding companies, respectively. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 are subject to the subordinated debt provision of SEC rule 18a–1d.262 The SEC’s qualification conditions in Rule 18a–1d require that the loan agreement must: (i) Be in writing and have a minimum term of at least one year; (ii) be a valid and binding obligation enforceable in accordance with its terms against the SD and the lender; and (iii) effectively subordinate any right of the lender to receive any payment with respect to the loan agreement to the prior payment in full of all claims of all present and future creditors of the covered SD arising out of any matter occurring prior to the date on which the related payment obligation matures, except for claims which are the subject of subordinated loan agreements that rank on the same priority as, or junior to, the claim of the lender under the subordinated loan agreement. Rule 18a–1d also contains conditions intended to ensure that the SBSD does not make payments on subordinated loans if such payments would reduce the SBSD’s net capital below 120% of its minimum capital requirement. These terms and conditions effectively result in the subordinated debt having the characteristics of common equity as the issuances of the subordinated loan rank just above common equity holders in the event of the insolvency of the covered SD. Therefore, the Commission believes that it is appropriate to recognize subordinated debt that meets the conditions of SEC rule 18a–1d to qualify as tier 2 capital under the Commission’s final regulation. Calculation of Risk-Weighted Assets As noted above, the Proposal required a covered SD electing the Bank-Based Capital Approach to compute its riskweighted assets in accordance with the Federal Reserve Board’s capital requirements contained in 12 CFR part 217. Covered SDs using the standardized approach were required to use the credit risk charges from the Federal Reserve Board’s standardized approach under subpart D 12 CFR part 217. Covered SDs using internal capital models were required to use models that met the qualitative and quantitative requirements set forth in proposed regulation 23.102 and Appendix A to regulation 23.102. The qualitative and quantitative requirements set forth in regulation 23.102 and Appendix A were based on the Federal Reserve Board’s qualitative and quantitative 262 A covered SD that elects the Net Liquid Assets Capital Approach is permitted under SEC rule 18a– 1 (17 CFR 240.18a–1) to recognize subordinated debt that meets the qualification standards in SEC rule 18a–1d (17 CFR 240.18a–1d) in meeting its minimum capital requirements. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 requirements for capital models in 12 CFR part 217. Federal Reserve Board model-based capital charges for credit risk and market risk are set forth in 12 CFR part 217 subparts E and F, respectively. Commenters noted that the Federal Reserve’s capital approach is currently undergoing significant transformation as it implements the revised Basel III framework adopted in 2017.263 One commenter stated that the Federal Reserve Board’s implementation of certain fundamental aspects of the Basel III framework, including approaches for credit, market, and operational risks remain pending, and further noted that the BCBS is also making further revisions to the credit valuation adjustment risk framework to further align it with other capital requirements.264 Another commenter stated that there are significant ongoing efforts to revise specific credit risk and market risk methodologies, which will likely require at least two, and potentially several, years to reach finalization.265 The commenters stated that it is essential that the Commission adopt a Bank-Based Capital Approach that provides covered SDs with certainty of application despite these and other future changes to the bank capital framework.266 The commenters stated that given the ongoing revisions to the banking regulators’ capital requirements, the Commission should revise its rules to incorporate the Federal Reserve Board’s rules by reference instead of setting forth explicit capital model provisions and quantitative and qualitative capital requirements in Appendix A of regulation 23.102. The commenters also specifically stated that given the current unsettled nature of the prudential regulators’ requirements, covered SDs electing the Bank-Based Capital Approach that are approved to use internal market risk and credit risk models should be permitted to choose whether or not to apply the Federal Reserve Board’s provisions for advanced approaches for Federal Reserve Board-regulated institutions.267 The Commenter further stated that covered SDs should also be permitted to compute their credit risk-weighted assets using the current exposure method (‘‘CEM’’), the internal models 263 IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter. 264 IIB/ISDA/SIFMA 3/3/2020 Letter. 265 MS 3/3/2020 Letter. 266 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter. 267 Id. PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 57495 method (‘‘IMM’’), or SA–CCR with certain modifications.268 The Commission has considered the Proposal and the comments requesting flexibility in adopting the Bank-Based Capital Approach. The Commission understands that some critical elements of Basel III are still being revised and adoption by the Federal Reserve Board is an ongoing process that may span several years, which makes incorporating specific market risk and credit risk components of the Federal Reserve Board’s rules into Appendix A of regulation 23.102 difficult. In this process the Federal Reserve Board also may allow for alternative calculation methods, some transitionally and some permanently, which further makes specific incorporation of bank capital requirements into Appendix A challenging. The Commission does not want to introduce conflicting deadlines, contradictory guidance, or cause firms to incur duplicative model implementation costs during this implementation process. Thus, the Commission is modifying the final rules to incorporate the Federal Reserve Board’s market risk and credits requirements by referencing the applicable sections of the Federal Reserve Board’s regulations in 12 CFR part 217 instead of incorporating specific market risk and credit risk requirements contained in 12 CFR part 217 into Appendix A of regulation 23.102. This modification of the rule text will provide legal certainty to the covered SDs that future changes to the relevant market risk and credit risk requirements in 12 CFR part 217 will be appropriately incorporated into the Commission’s capital requirements without further Commission action, such as a rulemaking. The Commission will retain Appendix A of regulation 23.102 as it will be applicable to covered SDs electing the Net Liquid Assets Capital Approach or the Tangible Net Worth Capital Approach to compute market risk and credit risk capital charges. The Commission is also modifying the final rule to provide that where the Federal Reserve Board’s rules allow for alternative calculation methods, the Commission’s final rule also allows for the same alternatives. For example, commenters noted that subpart D of 12 CFR part 217 currently provides that bank holding companies may compute standardized credit risk charges for OTC 268 Id. The CEM, IMM, and SA–CCR approaches for computing credit risk are set forth in the Federal Reserve Board’s capital rules for bank holding companies, 12 CFR part 217. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57496 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations derivative transactions using either the CEM or SA–CCR calculation methods. The Commission’s final rule permits covered SDs to elect to use either method, recognizing that both CEM and SA–CCR are part of the BCBS international capital framework and have been adopted by the prudential regulators. Furthermore, the choice of calculation method elected by a covered SD does not have to be the same as the calculation method the covered SD’s banking parent or affiliate elects to use or is required to use under the Federal Reserve Board’s rules. For example, a covered SD may elect to use the CEM method notwithstanding that its banking affiliate uses the SA–CCR method. However, a covered SD must address these differences in its model application, particularly if it relies upon or uses model documentation provided by a banking affiliate to prudential regulators as part of a model approval or oversight process by the prudential regulators. The covered SD also must inform the Commission or NFA if another regulator has denied its or its affiliate’s use of an alternative calculation. In choosing an alternative calculation the non-bank SD must adopt the entirety of the alternative. The Commission understands that some alternatives may include charges or deductions for risks not otherwise part of market and credit risk models described in this rule (e.g., operational risk), however, the Commission is not prepared to accept partial application of alternative calculation methods or to compensate this inclusion by reducing other charges calculated per this rule outside of the market and credit risk models. The Commission is implementing the above revisions to the final rules by modifying regulation 23.100 to include a definition of the term ‘‘BHC equivalent risk-weighted assets’’ that defines the method that a covered SD that elects the Bank-Based Capital Approach uses to compute market risk and credit risk using either models or standardized charges in computing its regulatory capital. Under the BHC equivalent riskweighted assets definition, a covered SD that is not approved to use models would compute market risk in accordance with the standardized charges in Commission regulation 1.17 and SEC rule 18a–1, and would compute credit risk charges in accordance with the standardized charges using the bank holding company regulations in subpart D of 12 CFR part 217. Covered SDs approved to use models would compute market risk in accordance with the bank holding VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 company requirements set forth in subpart F of 12 CFR part 217, and would compute credit risk charges in accordance with the bank holding company requirements in subpart E of 12 CFR part 217. The Commission also is modifying regulation 23.103 to remove the calculation of market and credit risk under the Bank-Based Capital Approach as it is now contained in revised regulation 23.100, and modifying definitions in regulation 23.100 to define the terms ‘‘advanced approaches Board-regulated institution’’ and ‘‘OTC derivative contract’’ to effect the above revisions to the rule text. Commenters also requested that the Commission modify the final rules by providing an adjustment to the Federal Reserve Board’s SA–CCR credit risk calculation when the SD applies SA– CCR in computing its capital.269 One commenter stated that the Federal Reserve Board’s SA–CCR rules set a ‘‘supervisory factor’’ for energy derivatives of between 18%, for oil and natural gas transactions, and 40%, for electricity transactions.270 The commenter represented that when adopting the calibrations, the Federal Reserve Board calibrated the supervisory factors to spot prices rather than forward prices. The commenter stated that SDs active in the oil, natural gas, and electricity markets are heavily concentrated in forward markets, which have very different volatilities and credit risk profiles than those of spot markets. The Commission is not modifying the final regulations to reset the supervisory factors adopted by the Federal Reserve Board for derivative transactions. This is an issue that the Commission will assess during the implementation of the rule. Minimum Capital Requirement Based on Risk Margin Amount Under BankBased Capital Approach The third criterion comprising the minimum capital requirement under the proposed Bank-Based Capital Approach required a covered SD to maintain common equity tier 1 capital equal to or in excess of 8% of the sum of: (i) The covered SD’s uncleared swap margin requirements for uncleared swaps transactions; (ii) the initial margin that would be required for each uncleared security-based swap transaction pursuant to SEC’s proposed Rule 18a– 3(c)(1)(i)(B), without regard for any amounts of security-based swaps that may be exempted or excluded under the SEC’s proposal; (iii) the risk margin 269 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter. 270 See MS 3/3/2020 Letter. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 required on the covered SD’s cleared futures, foreign futures, and swaps positions; and (iv) the amount of initial margin required by a clearing organization that clears the covered SD’s proprietary security-based swaps.271 This requirement was intended to ensure that a covered SD electing the Bank-Based Capital Approach maintains a minimum level of capital that is comprehensive with respect to all of the SD’s operations and activities. The Commission believed that the proposed 8% risk margin amount was an appropriate approach as the minimum capital requirement was correlated with the ‘‘risk’’ of the covered SD’s futures, foreign futures, swaps, and securitybased swaps positions as measured by the margin required on the positions. Specifically, a covered SD’s minimum capital requirement would increase or decrease in proportion to the number, size, complexity and all risks inherent in the SD’s customer, client, and proprietary derivatives business.272 Commenters generally raised the same concerns regarding the 8% risk margin amount as discussed in detail in section II.C.2.a. above for the covered SDs electing the Net Liquid Assets Capital Approach. Specifically, commenters stated the 8% risk margin amount is too high a percentage and includes too many types of derivatives products. Commenters also stated that the risk margin amount is not a good measure of the risk of the positions to the covered SD. One commenter also stated that the Commission should not adopt the 8% risk margin amount for covered SDs electing the Bank-Based Capital Approach. One commenter stated that prudential regulators do not have a minimum capital requirement based on a bank SD’s risk margin amount.273 One commenter stated that if the Commission adopted the risk margin amount, the Commission should modify the final regulation to permit covered SDs electing the Bank-Based Capital Approach to include additional tier 1 capital and tier 2 capital in addition to common equity tier 1 capital in meeting the risk margin amount.274 The Commission has considered the proposed risk margin amount requirement for covered SDs electing the Bank-Based Capital Approach and has considered the comments received, and is adopting the requirement with 271 See 2016 Capital Proposal, 81 FR 91252 at 91258–59. 272 See 2016 Capital Proposal, 81 FR 91252 at 91258. 273 IIB/ISDA/SIFMA 3/3/2020 Letter. 274 Id. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations several modifications. The final regulation will require a covered SD electing the Bank-Based Capital Approach to maintain a combination of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital in an amount equal to or greater than 8% of the covered SD’s uncleared swap margin. The term ‘‘uncleared swap margin’’ is defined in regulation 23.100, and means the amount of initial margin computed in accordance with the Commission’s uncleared margin rules (regulation 23.154; 17 CFR 23.154) that a SD would be required to collect from each counterparty for each outstanding swap position of the SD, including all swap positions that are excluded or exempt from the uncleared margin rules under regulation 23.150 (17 CFR 23.150), legacy swap positions, exempt foreign exchange swaps or foreign exchange forwards. As discussed in section II.C.2.a. above, the Commission believes that a minimum capital requirement based on initial margin is an appropriate component of a covered SD’s minimum capital requirement. The intent of the risk margin amount requirement was to ensure that a covered SD has a sufficient level of capital to meet its obligations as a SD, and to cover potential operational risk, legal risk, and other risks, and not just the risks of its trading portfolio. The Commission believes that the risk margin amount is a minimum capital requirement that provides a floor based on a measure of the risk of the swap positions, the volume of positions, the number of counterparties and the complexity of operations of the covered SD. The risk margin amount is based on the initial margin that is computed on the proprietary positions held by the covered SD. Initial margin reflects the degree of risk associated with the positions, with lower risk positions having lower initial margin requirements and higher risk positions having higher initial margin requirements. Therefore, the Commission believes that because the risk margin amount calculation is directly related to the volume, size, complexity and risk of the covered SD’s uncleared swap positions, it serves as a good proxy for inherent risk in the SD’s positions, operations, and other risks, and is used to calibrate the amount of the minimum capital required of a covered SD. The Commission, however, is not modifying the regulation by lowering the risk margin amount multiplier from 8% to 2% or to a different percentage. As discussed in section II.C.2.a. above, the minimum capital requirement based upon the risk margin amount is applied VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 57497 Minimum Capital Requirement of a Registered Futures Association Under Bank-Based Capital Approach of an RFA.275 As further noted above, the Proposal is also consistent with section 17(p)(2) of the CEA, which provides, in relevant part, that an RFA must adopt rules establishing minimum capital and other financial requirements applicable to the RFA’s members for which such requirements are imposed by the Commission.276 The Proposal recognizes that the NFA, as the only RFA, would be required by section 17 of the CEA to adopt capital rules for covered SDs once the Commission imposes capital requirements on covered SDs, and would incorporate the NFA minimum capital requirements into the Commission’s regulation. The Commission received general comments regarding the proposed requirement that a covered SD must meet the capital rules adopted by the NFA. Several commenters stated that any future NFA capital rules for covered SDs should be subject to public comment.277 Another commenter stated that the Commission’s efforts to obtain public input pursuant to the 2016 Capital Proposal and the 2019 Capital Reopening may be nullified if the NFA adopts capital rules that are different from the Commission’s final rules, and requested that the Commission require NFA to adopt capital rules that closely mirror the Commission’s final capital rules, or, at the least, require NFA to conduct a rigorous notice and comment process prior to finalizing its capital rules.278 As discussed in section II.C.2.a. above, the Commission believes that commenters’ concerns are largely mitigated by the existing statutory and Commission regulatory requirements as well as the internal governance structure of NFA, which was established to comply with these requirements. Section 17(j) of the CEA requires NFA to file with the Commission any change in or addition to its rules. Any such change or addition is effective within 10 days of submission unless NFA requests, or the Commission notifies NFA of its intent to subject the filing to, a review and approval process.279 Further, NFA’s governance structure ensures that SDs are represented in the The fourth criterion of the proposed minimum capital requirements required a covered SD to maintain the minimum level of capital required by an RFA of which the covered SD is a member. As noted above, the proposed minimum capital requirement based on membership requirements of an RFA is consistent with current FCM capital requirements under regulation 1.17, and reflects Commission regulations that require each covered SD to be a member 275 See Commission regulations §§ 1.17(a)(1)(i)(C) and 170.16 (17 CFR 1.17(a)(1)(i)(C) and 170.16). 276 See section 17(p)(2) of the CEA, which requires RFAs to adopt rules establishing minimum capital and other financial requirements applicable to its members for which such requirements are imposed by the Commission, provided that such requirements may not be less stringent than the requirements imposed by the CEA or by Commission regulations. 277 ED&F Man/INTL FCStone 3/3/2020 Letter; Shell 3/2/2020 Letter. 278 See Shell 3/2/2020 Letter. 279 See section 17(j) of the CEA (7 U.S.C. 21(j)). in a different manner in the Bank-Based Capital Approach as compared with the Net Liquid Assets Capital Approach. Under the Bank-Based Capital Approach, a covered SD is required to maintain balance sheet equity in excess of 8% of the risk margin on uncleared swap positions. This approach is a less conservative approach than the Net Liquid Assets Capital Approach, which requires a covered SD to maintain current, liquid assets, less market risk and credit risk capital charges on proprietary positions including swaps and security-based swaps, in excess of 2% of the risk margin amount on uncleared swaps. Due to the different approaches, the Commission believes that it is appropriate to set the risk margin amount multiplier at 8% under the Bank-Based Capital Approach to help ensure that the minimum capital requirement ensures the safety and soundness of the covered SD. The Commission also believes that many of the commenters’ concerns are mitigated by the modifications that the Commission is making to the final regulation. Consistent with its approach for FCM–SDs and Net Liquid Assets Capital Approach, the Commission is modifying the final regulation to exclude cleared and uncleared securitybased swap positions, and proprietary futures, foreign futures, and cleared swap positions from the risk margin amount calculation. In addition, as noted above, the Commission will monitor the risk margin amount after the compliance date of the regulations to assess whether adjustments are necessary to the regulations to ensure the safety and soundness of the covered SD. The Commission will use the information that it obtains from financial reports submitted by covered SDs and from the Commission’s and NFA’s ongoing oversight of the SDs to continually monitor and evaluate the adequacy of the minimum capital requirements. PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 E:\FR\FM\15SER3.SGM 15SER3 57498 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations potential adoption of NFA rules, including capital and financial reporting rules, that may impact them. As noted in section II.C.2.a. above, section 17(b)(5) of the CEA and regulation 170.3 require generally that the rules of an RFA assure fair representation of its members in the adoption of any rule, in the selection of its officers, directors, and in other aspects of its administration.280 Therefore, the Commission is adopting this component of the minimum capital requirements of the Bank-Based Capital Approach as proposed. Final Minimum Capital Requirement for Covered SDs Electing the Bank-Based Capital Approach As noted above, the Commission proposed that a covered SD electing the Bank-Based Capital Approach must maintain common equity tier 1 capital equal to or greater than the greatest of (i) $20 million, (ii) 8% of the covered SD’s risk margin amount, (iii) 8% of the covered SD’s risk-weighted assets, or (iv) the amount of capital required by an RFA. Also as noted above, the Commission is modifying the final regulation to permit a covered SD to hold common equity tier 1, additional tier 1, and tier 2 capital to meet the 8% of the risk margin amount and to meet the 8% of risk weighted assets. Therefore, the Commission is modifying the final minimum capital requirement to require a covered SD to satisfy each of the four minimum capital requirements. This modification is intended to align the final rule with the original proposal, which required a covered SD to hold a sufficient amount of common equity tier 1 capital to meet each of the four minimum capital requirements. Under the final rule, the covered swap dealer will continue to have to meet each of the four criteria, but may use capital other than common equity tier 1 capital to meet such requirements consistent with the rule. 4. Capital Requirement for Covered SDs Electing the Tangible Net Worth Capital Approach The Commission proposed to permit covered SDs that are ‘‘predominantly engaged in non-financial activities,’’ as defined below, to elect a capital requirement based on the SD’s tangible net worth (the ‘‘Tangible Net Worth jbell on DSKJLSW7X2PROD with RULES3 280 7 U.S.C. 21(b)(5) and Commission regulation § 170.3 (17 CFR 1.17). See also, section 17(b)(11) of the CEA (7 U.S.C. 21(b)(11)) which requires that an RFA provide for meaningful representation on the governing board of such association of a diversity of membership interests and provides that no less than 20 percent of the regular voting members of[the board be comprised of qualified nonmembers of or persons not regulated by such association. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Capital Approach’’).281 The term ‘‘tangible net worth’’ was proposed to be defined as the net worth of a covered SD, as determined in accordance with U.S. GAAP, excluding goodwill and other intangible assets.282 The 2016 Capital Proposal further required a covered SD, in computing its tangible net worth, to include all liabilities or obligations of a subsidiary or affiliate that the covered SD guaranteed, endorsed, or assumed either directly or indirectly to ensure that the tangible net worth of the covered SD reflects the full extent of the covered SD’s potential financial obligations.283 The proposed definition further provided that in determining net worth, all long and short positions in swaps, security-based swaps, and related positions must be marked to their respective market values to ensure that the tangible net worth reflected the current market value of the covered SD’s swap and security-based swap positions, including any accrued losses on such positions.284 The Commission further proposed that a covered SD eligible for the Tangible Net Worth Capital Approach must maintain tangible net worth in an amount equal to or in excess of the greatest of: (1) $20 million plus the amount of the covered SD’s market risk exposure requirement and credit risk exposure requirement associated with the covered SD’s swap and related hedge positions that are part of the covered SD’s swap dealing activities; (2) 8% of the sum of: (a) The amount of uncleared swap margin (as that term was defined in regulation 23.100) for each uncleared swap position open on the books of the covered SD, computed on a counterparty by counterparty basis pursuant to regulation 23.154 without regard to any initial margin exemptions or thresholds that the Commission’s margin rules may provide; (b) the amount of initial margin that would be required for each uncleared security-based swap position open on the books of the covered SD, computed on a counterparty by counterparty basis pursuant to 17 CFR 240.18a–3(c)(1)(i)(B) without regard to any initial margin exemptions or exclusions that the rules of the SEC may provide to such security-based swap positions; and 281 See proposed Commission regulation § 23.101(a)(2)(ii), 2016 Capital Proposal, 81 FR 91252 at 91311. 282 See proposed Commission regulation § 23.100, 2016 Capital Proposal, 81 FR 91252 at 91309–10. 283 See proposed definition of ‘‘tangible net worth’’ in Commission regulation § 23.100, 2016 Capital Proposal, 81 FR 91252 at 91310. 284 Id. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 (c) the amount of initial margin required by clearing organizations for cleared proprietary futures, foreign futures, swaps and security-based swaps positions open on the books of the covered SD; or (3) The amount of net capital required by the registered futures association of which the covered SD is a member. The 2016 Capital Proposal further provided that a covered SD could use internal models to compute market risk and credit risk capital charges provided that the models were approved by the Commission or an RFA.285 A covered SD that did not obtain Commission or RFA approval to use internal models was required to compute standardized market risk and credit risk charges for its proprietary swaps, security-based swaps, or other financial positions in accordance with the FCM standardized market risk and credit risk capital charges set forth under regulation 1.17, as proposed to be amended.286 The Commission also proposed that to be eligible to use the Tangible Net Worth Capital Approach, a covered SD’s financial activities must be de minimis in relation to its overall financial and non-financial activities. Specifically, the 2016 Capital Proposal provided that the covered SD must be ‘‘predominantly engaged in non-financial activities.’’ The term ‘‘predominantly engaged in non-financial activities’’ was proposed to be defined by referencing the definition of the term ‘‘financial activities’’ under the Federal Reserve Board’s regulations establishing criteria for determining if a nonbank financial company is ‘‘predominantly engaged in financial activities’’ and therefore, subject to Federal Reserve Board oversight.287 Title I of the Dodd-Frank Act established the Financial Stability Oversight Council (‘‘FSOC’’), which, among other authorities and duties, may subject a nonbank financial company to supervision by the Federal Reserve Board and consolidated prudential standards if the FSOC determines that material financial distress at the nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the company’s activities, could pose a threat to the financial stability of the U.S. Title I of the Dodd-Frank Act defines a ‘‘nonbank financial company’’ to include both a U.S. nonbank financial 285 See proposed Commission regulation § 23.102(a), 2016 Capital Proposal, 81 FR 91252 at 91311. 286 See section II.B.3.a above for a discussion of the standardized market risk and credit risk capital charges for FCMs and FCM–SDs. 287 See 12 CFR 242.3. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations company and foreign nonbank financial company that, among other things, are ‘‘predominantly engaged in financial activities.’’ For purposes of Title 1 of the Dodd-Frank Act, a company is considered to be ‘‘predominantly engaged’’ in financial activities if either (i) the annual gross revenue derived by the company and all of its subsidiaries from financial activities, as well as from the ownership or control of an insured depository institution, represented 85 percent or more of the consolidated annual gross revenues of the company; or (ii) the consolidated assets of the company and all of its subsidiaries related to financial activities, as well as related to the ownership or control of an insured depository institution, represent 85 percent or more of the consolidated assets of the company. The Commission proposed to adopt this Federal Reserve Board standard to distinguish covered SDs that are predominantly engaged in financial activities from covered SDs that are predominantly engaged in non-financial activities. The Commission, however, modified the test for purposes of the eligibility of the Tangible Net Worth Capital Approach to provide that a covered SD would be considered ‘‘predominantly engaged in nonfinancial activities’’ if: (i) The consolidated annual gross financial revenues of the covered SD in either of its two most recently completed fiscal years represented less than 15 percent of the consolidated gross revenue in that fiscal year (‘‘15% Revenue Test’’); and (ii) the consolidated total financial assets of the covered SD at the end of its two most recently completed fiscal years represented less than 15 percent of the consolidated total assets as of the end of the fiscal year (‘‘15% Asset Test’’). The 2016 Capital Proposal also proposed to define the financial activities covered by the 15% Revenue Test and 15% Asset Test by reference to the listed financial activities set forth in Appendix A of 12 CFR part 242, which covers an extensive range of financial activities and services.288 The financial activities set forth in Appendix A of 12 CFR part 242 include, among other things: (i) Lending, exchanging, transferring, investing for others, or safeguarding money or securities; (ii) insuring, guaranteeing, or indemnifying against loss or harm, damage or death in any state; (iii) providing financial, investment, or economic advisory 288 See definition of ‘‘predominantly engaged in non-financial activities’’ in proposed Commission regulation § 23.100, 2016 Capital Proposal, 81 FR 91252 at 91309. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 services; (iv) issuing or selling interests in a pool; (v) underwriting, dealing in, or making a market in securities; and (vi) engaging as principal in the investment and trading of certain financial instruments. The Commission, however, proposed to explicitly provide that accounts receivable from nonfinancial activities, which may meet the definition of financial activities under 12 CFR part 242, may be excluded by the covered SD from the computation of its financial activities.289 The Commission stated that the purpose of providing this exclusion was to prevent the covered SD’s non-financial activities from becoming part of the computation of the covered SD’s financial activities merely on the basis that the nonfinancial activities result in the covered SD recognizing receivables. The Commission proposed the Tangible Net Worth Capital Approach in recognition that certain entities that engage predominantly in non-financial activities may currently or in the future meet the statutory and regulatory definition of the term ‘‘swap dealer’’ and, therefore, will be required to register as such with the Commission.290 The Commission stated that while these entities may meet the definition of a ‘‘swap dealer’’ they may also be primarily commercial entities engaged predominantly in non-financial activities.291 The Commission further recognized that covered SDs that are primarily engaged in commercial activities differ from financial entities in various ways, including the composition of their respective balance sheets (e.g., the types of assets they hold), the types of transactions they enter into, and the types of market participants and swap counterparties that they deal with. Because of these differences, the Commission stated that application of the Bank-Based Capital Approach or the Net Liquid Assets Capital Approach could result in inappropriate capital requirements that would not be proportionate to the risk taken by such covered SDs, and proposed to permit these covered SDs to have an option of electing the Tangible Net Worth Capital Approach.292 The Commission, however, modified the standards established by the Federal 289 Id. 290 The term ‘‘swap dealer’’ is defined by section 1a(49) of the CEA and Commission regulation § 1.3 (17 CFR 1.3). Regulation 1.3 provides that an entity may apply to limit its designation as an SD to specified categories of swaps or specified activities in connection with swaps. 291 See 2016 Capital Proposal, 81 FR 91252 at 91255. 292 Furthermore, as an SD, the firm is subject to the Commission’s final swaps margin requirements. PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 57499 Reserve Board as it believed that covered SDs that engage in anything more than a de minimis level of financial activities must be subject to either the Net Liquid Assets Capital Approach or the Bank-Based Capital Approach in order for the Commission’s regulations to achieve the Congressional mandate that the SD capital requirements ensure the safety and soundness of the SD. The Commission received comments generally supporting the proposed Tangible Net Worth Capital Approach, but also stating that the qualifying criteria were overly narrow and entity specific.293 Commenters generally noted that a parent entity that is ‘‘predominantly engaged in nonfinancial activities’’ as defined by the regulation would not be permitted in any practical way to establish a covered SD subsidiary that would qualify to use the Tangible Net Worth Capital Approach as the swaps activity of the SD subsidiary would be considered financial activities.294 Another commenter stated that commercial firms often establish subsidiaries to perform centralized risk management operations for the full commercial enterprise, including entering into swap transactions, and that such subsidiaries should have the ability to elect a Tangible Net Worth Capital Approach.295 Commenters further noted that the proposed Tangible Net Worth Capital Approach would discriminate against corporate entities that are predominantly engaged in non-financial activities but elect to maintain their swap dealing activities in separate legal entities.296 Several commenters suggested that the Commission should address these concerns by modifying the Proposal to permit a covered SD to elect the Tangible Net Worth Capital Approach if the SD or its parent meets the qualifying criteria of ‘‘predominantly engaged in nonfinancial activities.’’ 297 In reopening the comment period in 2019, the Commission requested further 293 See, e.g., Letter from Phillip Lookadoo, and Jeremy Weinstein, International Energy Credit Association (May 15, 2017) (IECA 5/15/2017 Letter); Letter from Scott Earnest, Shell Trading Risk Management LLC (May 15, 2017) (Shell 5/15/2017 Letter); Letter from David McIndoe, Commercial Energy Working Group (May 15, 2017) (CEWG 5/ 15/2017 Letter); and Letter from Michael P. LeSage, Cargill Risk Management, a unit of Cargill, Inc. (May 15, 2017) (Cargill 5/15/2017 Letter). 294 See IECA 5/15/2017 Letter; Shell 5/15/2017 Letter; CEWG 5/15/2017 Letter. 295 See Letter from National Corn Growers Association and National Gas Supply Association, (May 15, 2017) (NCGA/NGSA 5/15/2017 Letter). 296 See, e.g., Shell 5/15/2017 Letter. 297 See IECA 5/15/2017 Letter; CEWG 5/15/2017 Letter; NCGA/NGSA 5/15/2017 Letter. E:\FR\FM\15SER3.SGM 15SER3 57500 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 comment on the Tangible Net Worth Capital Approach based upon issues raised in the 2016 Capital Proposal.298 The Commission requested comment on whether a covered SD that does not meet the ‘‘predominantly engaged in non-financial activities’’ standard should be eligible to use the Tangible Net Worth Capital Approach if its parent entity, or the ultimate parent of its consolidated ownership group, satisfies the qualifying standards.299 The Commission further requested comment on whether a covered SD that relies on a parent entity to satisfy the ‘‘predominantly engaged in nonfinancial activities’’ criteria should be required to obtain parent guarantees, or some other form of financial support, for its swaps obligations.300 The Commission also requested comment in the 2019 Capital Reopening on whether a covered SD that was primarily engaged in commodity swaps should be permitted to use the Tangible Net Worth Capital Approach notwithstanding that its parent entity does not meet the ‘‘predominantly engaged in non-financial activities’’ requirements (i.e., the parent is primarily engaged in financial activities).301 Finally, the Commission requested comment regarding modifications that commenters believed the Commission should consider to the 15% Asset Test and/or the 15% Revenue Test, and requested that commenters explain why such modifications were necessary to achieve the purpose and objective of the Tangible Net Worth Capital Approach.302 The Commission received comments in response to the 2019 Capital Reopening, and the commenters continued to generally support a Tangible Net Worth Capital Approach.303 Several commenters, however, continued to express the concern that the eligibility criteria, as expressed in the 15% Asset Test and the 15% Revenue Test, are not broad enough and should be expanded to provide more covered SDs with the ability to elect the Tangible Net Worth 298 See 2019 Capital Reopening, 84 FR 69664 at 69674–75. 299 Id. 300 Id. 301 Id. 302 Id. 303 See, e.g., IIB/SIFMA/ISDA 3/3/2020 Letter; MS 3/3/2020 Letter; CEWG 3/3/2020 Letter; Letter from Jennifer Fordham, National Corn Growers Association/Natural Gas Supply Association (March 3, 2020) (NCGA/NGSA 3/3/2020 Letter); ED&F Man/INTL FCStone 3/3/2020 Letter; and Shell 3/3/ 2020 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Capital Approach.304 One commenter stated that the Commission should revise the qualifications to permit more covered SDs to elect the Tangible Net Worth Capital Approach, which the commenter viewed as a more suitable approach than the Bank-Based Capital Approach and the Net Liquid Assets Capital Approach.305 Other commenters stated that the Commission should revise the eligibility criteria for the Tangible Net Worth Capital Approach to provide that a covered SD may use such capital approach if it is part of a holding company or corporate structure that is itself ‘‘predominantly engaged in nonfinancial activities’’ and satisfies the 15% Asset Test and the 15% Revenue Test.306 Several of these commenters noted that parent entities that are nonfinancial entities often ‘‘ring-fence’’ financial activities (including swap dealing activities and treasury functions) in affiliates that are standalone legal entities, and that the Commission’s Proposal effectively prevents such stand-alone entities from being eligible for the Tangible Net Worth Capital Approach as they are not ‘‘predominantly engaged in nonfinancial activities.’’ 307 A commenter stated that centralizing financial functions into a single subsidiary provides efficiencies for some holding companies that are primarily involved in non-financial businesses, such as energy production or agriculture, and that the Commission’s rules should be corporate-structure neutral.308 An additional commenter stated that the ultimate parent level is the proper level at which to determine whether a corporate enterprise, and its subsidiaries, is predominantly engaged in non-financial activity.309 Another commenter stated that a covered SD that otherwise qualifies for and elects the Tangible Net Worth Capital Approach should not be required to obtain a parent guarantee for obligations arising from its swaps activities.310 304 See, e.g., Shell 3/3/2020 Letter; CEWG 3/3/ 2020 Letter; MS 3/3/2020 Letter; IIB/SIFMA/ISDA 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter. 305 See NCGA/NGSA 3/3/2020 Letter. The NCGA/ NGSA suggested that the Commission base the eligibility of the Tangible Net Worth Capital Approach based on the definition of the term ‘‘financial entity’’ contained in section 2(h)(7)(C)(i)(VIII) of the CEA (7 U.S.C. 2(h)(7)(C)(i)(VIII)). 306 See Shell 3/3/2020 Letter; CEWG 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter. 307 See Shell 5/15/2017 Letter; NCGA/NGSA 3/3/ 2020 Letter. 308 See NCGA/NGSA 3/3/2020 Letter. 309 See CEWG 3/3/2020 Letter. 310 See Shell 3/3/2020 Letter. PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 The Commission also received comments that the eligibility criteria for the Tangible Net Worth Capital Approach should be modified to permit a covered SD to use such approach if the SD’s swap dealing activity is focused on agricultural and exempt swap transactions (a ‘‘commodity-focused covered SD’’), even if the covered SD is part of a financial holding company or a corporate parent that provides general financial services.311 Two entities submitted a joint comment stating that the Commission’s capital rules should recognize unique issues of small, commodity-focused covered SDs by expanding the eligibility criteria for the Tangible Net Worth Capital Approach to include smaller covered SDs with portfolios predominantly centered around counterparties that qualify for the hedging end user exception under section 2(h)(7) of the CEA.312 The joint comment stated that smaller commodity-focused covered SDs do not present the type of interconnectedness and systemic risk to the broader financial markets in comparison to other covered SDs, in part due to (i) relatively lower trading volumes (i.e., market impact); and (ii) the non-financial and hedging nature of their customer base.313 The joint commenters further stated that a significant percentage of the customer base and trading activities of smaller commodity-focused covered SDs may qualify for the hedging end user exception under section 2(h)(7) of the CEA, entering into swap transactions for the purpose of hedging physical commodity risk. The commenters claim that as a result of the end user exception from clearing and margin, smaller commodity-focused covered SDs may not collateralize these relationships fully or the extent they would otherwise be required when dealing with financial entities or financial end users, and that they would be required to internalize capital charges for all uncollateralized exposures, placing burdensome costs on these SDs, their market presence, and ultimately commercial end user customers.314 The commenters suggest that the Commission should modify the final rule by adopting an additional qualifying test for smaller commodity311 See ED&F Man/INTL FCStone 3/3/2020 Letter; MS 3/3/2020 Letter; CEWG 3/3/2020 Letter. 312 See ED&F Man/INTL FCStone 3/3/2020 Letter. 313 Id. To demonstrate the nature of their customer base as commercial end users, and the relative size of their trading activities, the two commenters represent that as of March 3, 2020, the two firms have not come into scope for complying with the Commission’s margin requirement for uncleared swap transactions. 314 Id. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations focused covered SDs with portfolios predominantly centered on counterparties that are commercial end users.315 One commenter stated that it agreed with comments filed in response to the 2016 Capital Proposal, which supported an expansion of the eligibility for the Tangible Net Worth Capital Approach to covered SDs that provide access to physical hedging markets.316 Commenters also suggested that the Commission should modify the ‘‘predominantly engaged in nonfinancial activities’’ criteria by, for instance, providing that covered SDs whose swaps notional amounts are at least 85 percent concentrated in commodity reference assets (e.g., agricultural and exempt commodities) are eligible for the Tangible Net Worth Capital Approach.317 Commenters also suggest modifications to the 15% Assets Test and 15% Revenue Test. One commenter stated the respective tests should consider the assets and revenue derived from trading and investing in physical commodities to be non-financial in nature.318 This commenter further suggested that all hedges of commercial risk should be considered non-financial in nature as the activity is more indicative of an entity being a commercial end user rather than an entity engaged in activity that is financial.319 Another commenter stated that the Commission should exclude financial hedges of physical commodity, interest rate, or other corporate risks from being considered ‘‘financial activities’’ for purposes of the 15% Assets Test and the 15% Revenue Test.320 This commenter asserted that the use of financial derivatives to manage commercial risk is common for non-financial entities and is not indicative of an entity being engaged in financial activity.321 The commenter further stated that the Commission should consider assets and revenue derived from trading and investing in jbell on DSKJLSW7X2PROD with RULES3 315 Id. 316 See ED&F Man/INTL FCStone 3/3/2020 Letter (citing Letter from Christine Stevenson, BP Energy Company (May 15, 2017), Letter from William Dunaway, INTL FCStone Inc. (May 15, 2017), and Shell 5/15/2017 Letter). 317 See MS 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/ 2020 Letter; CEWG 3/3/2020 Letter. 318 See Shell 3/3/2020 Letter. See also, CEWG 3/ 3/2020 Letter representing that the inclusion by the Federal Reserve Board of trading and investing in physical commodities in the definition of activities that are ‘‘financial in nature’’ was because certain banks need the ability to transact in physical commodity markets to support their derivatives activity. 319 Id. 320 See CEWG 3/3/2020 Letter. 321 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 physical commodities to be nonfinancial in nature as including such activity as ‘‘financial in nature’’ under the Federal Reserve Board’s definition of that term, was not because such activity is financial, but because certain banks need the ability to transact in physical commodity markets to support their financial derivatives activity.322 The Commission has considered the comments received on the proposed Tangible Net Worth Capital Approach and is adopting the regulations as proposed, subject to the following modifications. The Commission is modifying the definition of the term ‘‘predominantly engaged in nonfinancial activities’’ in regulation 23.100 to effectively extend the eligibility of the Tangible Net Worth Capital Approach to covered SDs that are subsidiaries of parent entities that are commercial enterprises. Specifically, the definition in regulation 23.100 is modified to provide that a swap dealer is predominantly engaged in non-financial activities if: (1) The swap dealer’s consolidated annual gross financial revenues, or if the swap dealer is a wholly owned subsidiary, then the swap dealer’s consolidated parent’s annual gross financial revenues, in either of its two most recently completed fiscal years represents less than 15 percent of the swap dealer’s consolidated gross revenue in that fiscal year, and (2) the consolidated total financial assets of the swap dealer, or if the swap dealer is wholly owned subsidiary, the consolidated total financial assets of the swap dealer’s ultimate parent, at the end of its two most recently completed fiscal years represents less than 15 percent of the swap dealer’s consolidated total assets as of the end of the fiscal year. The modifications to the definition of the term ‘‘predominantly engaged in non-financial activities’’ will permit a covered SD that either directly satisfies the 15% Asset Test and the 15% Revenue Test, or is a subsidiary of an ultimate parent entity that satisfies the 15% Asset Test and the 15% Revenue Test, to elect the Tangible Net Worth Capital Approach. The Commission is adopting this modification as it recognizes that certain corporate entities that are predominantly engaged in nonfinancial activities establish separate legal entities to operate as financial affiliates to act on behalf of itself and the other affiliates of the corporate enterprise. The Commission believes that by allowing the ultimate consolidated parent entity to conduct the test it provides a better indication as to whether the overall 322 Id. PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 57501 entity is commercial in nature or financial in nature, and whether the covered SD should be viewed as a commercial SD or financial SD. The Commission does not believe that covered SDs that are separately established subsidiaries of commercial entities should be precluded from electing the Tangible Net Worth Capital Approach as it was not the intent of the Proposal to prohibit a commercial enterprise from establishing financial subsidiaries that otherwise meet the definition of a swap dealer due to their support of the activities of their parent entity, affiliates, and their respective commercial customers from electing a Tangible Net Worth Capital Approach. The Commission is not modifying the final rule to require a covered SD that is eligible to elect the Tangible Net Worth Capital Approach as a result of its parent satisfying the ‘‘predominantly engaged in non-financial activities’’ standard to obtain any specific financial support or guarantees from its parent. The test to determine whether a SD can elect the Tangible Net Worth Capital Approach at the ultimate parent level is only to determine whether the consolidated entity is commercial in nature; however, the final Tangible Net Worth Capital Approach requires the covered SD to maintain its own regulatory capital in the form of tangible net worth equal to or greater than $20 million plus the amount of market risk charges and credit risk charges associated with the covered SD’s swaps and related hedge positions that are part of the its swap dealing activities. In addition, the covered SD is required to reflect its positions in swaps, securitybased swaps, and related positions at fair market value, which ensures that all market-to-market losses are deducted from the SD’s tangible net worth. The tangible net worth is intended to ensure that a covered SD has an appropriate level of financial resources available to directly meet its obligations as they arise, which will ensure the safety and soundness of the covered SD. Furthermore, covered SDs electing the Tangible Net Worth Capital Approach are subject to the risk management requirements of Commission regulation 23.600, which requires the SD, among other things, to assess its liquidity resources and outlays on a daily basis, including margin obligations, to ensure that it has both the financial resources and liquidity to meet its financial obligations to swap counterparties. The Commission also is not modifying the final regulation to allow commodity-focused covered SDs that are direct or indirect subsidiaries of global financial holding companies to E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57502 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations elect the Tangible Net Worth Capital Approach. As noted above, the Commission proposed the Tangible Net Worth Capital Approach in recognition that not all covered SDs would be financial firms and able to satisfy the Net Liquid Assets Capital Approach or the Bank-Based Capital Approach due to the measurement of illiquid assets necessary to commercial activities. The Commission limited the availability of the Tangible Net Worth Capital Approach to covered SDs that are not predominantly engaged in financial activities. Further, as discussed above, the Commission believes that it is appropriate to extend the Tangible Net Worth Capital Approach to accommodate covered SDs that are direct or indirect subsidiaries of holding companies or corporate parent entities that are not predominantly engaged in financial activities, in order to allow such holding companies or corporate parent entities to establish separate SD subsidiaries to provide financial services for the corporate group, including engaging in swaps on behalf of the corporate group. In such situations, the covered SD is established to act on behalf of the commercial parent entity by, for example, entering into swaps with commercial end users that are seeking to manage their commercial risks with swaps, and to offset the risks incurred by its commercial affiliates by entering into swaps with counterparties, including other SDs or financial end users. Covered SDs that are subsidiaries of financial holding companies or corporate entities, however, present different issues. While the covered SD may engage in commodity-focused swaps and may also engage in trading of physical commodities, it is doing so as a subsidiary of a financial parent entity. The Commission has generally perceived greater risk from global financial entities than it does from commercial enterprises, and, for this reason does not believe that it would be appropriate to extend the more limited capital treatment of the Tangible Net Worth Capital Approach to such covered SDs. Therefore, the Commission is adopting the Tangible Net Worth Capital Approach as proposed, without requiring parent guarantee and subject to the limited modification to eligibility discussed above, in order to be neutral as to the overall corporate structure employed by commercial entities. directed by section 4s(e) of the CEA.323 An MSP is defined as a person that is not a swap dealer and that: (i) Maintains a substantial position in swaps, excluding positions held to hedge or mitigate commercial risk; (ii) has outstanding swaps that create ‘‘substantial counterparty exposures that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets;’’ or (iii) is a financial entity that is highly leveraged, is not subject to capital requirements of a prudential regulator, and has a substantial position in swaps, including positions used to hedge and mitigate commercial risk.324 Proposed regulation 23.101(a)(2)(ii) required a covered MSP to maintain the greater of (i) positive tangible net worth, or (ii) the amount of capital required by the RFA of which the covered MSP was a member. The term ‘‘tangible net worth’’ was proposed to be defined as the net worth of a covered MSP as determined in accordance with US GAAP, excluding goodwill and other intangible assets. The Proposal further required a covered MSP in computing its tangible net worth to include all liabilities or obligations of a subsidiary or affiliate that the covered MSP guarantees, endorses, or assumes, either directly or indirectly, to ensure that the tangible net worth reflects the full extent of the covered MSP’s potential financial obligations. The proposed definition further provided that in determining net worth, all long and short positions in swaps, security-based swaps and related positions must be marked to their market value to ensure that the tangible net worth reflects the current market value of the covered MSP’s swaps and security-based swaps, including any accrued losses on such positions. A positive tangible net worth standard was proposed for MSPs, rather than an alternative approach, including the Net Liquid Assets Capital Approach, BankBased Capital Approach, or Tangible Net Worth Capital Approach, as the Commission anticipated that entities that register as MSPs may be engaging in a range of business activities that are different from, and broader than, the activities of covered SDs. In addition, covered MSPs are expected to use swaps for different purposes (e.g., hedging or investing) than covered SDs, which generally engage in swaps as a dealing activity. Covered MSP’s also may engage in commercial activities that require the holding of a substantial amount of fixed assets or engage in financial activities that are beyond swap dealing activities, which results in the holding of assets that are not consistent with the general Net Liquid Assets Capital Approach or the Bank-Based Capital Approach, such as fixed assets or intangible assets. The 2016 Capital Proposal also considered the impact of the final margin rules for uncleared swap transactions in developing the proposed positive tangible net worth requirement for covered MSPs. Covered MSPs subject to the Commission’s margin regulations are required to post and collect initial margin and variation margin with SDs, other MSPs, and financial end users (subject to certain thresholds and minimum transfer amounts).325 The exchanging of variation margin and the exchange of initial margin by covered MSPs and certain of their counterparties would substantially reduce the uncollateralized exposures that the covered MSPs and the counterparties have to each other, which mitigates the possibility that covered MSPs could destabilize the financial markets or present systemic risk. Lastly, the Commission’s proposed covered MSP capital standards are comparable with the SEC’s capital standards for MSBSPs subject to the SEC’s capital requirements, and are intended to require a covered MSP to maintain a sufficient level of assets to meet its obligations to counterparties and creditors and to help ensure the safety and soundness of the covered MSP.326 The Commission requested additional comment on the proposed capital requirements for covered MSPs in the 2016 Capital Proposal. Specifically, the Commission requested comment on whether the positive tangible net worth capital requirement was an appropriate standard for MSPs; whether the Net Liquid Assets Capital Approach or the Bank-Based Capital Approach would be a more appropriate method for establishing capital requirements for covered MSPs; and whether other capital approaches should be considered for covered MSPs.327 The Commission further requested comment on whether the positive tangible net worth capital requirement should include a minimum fixed-dollar amount requirement, for example, equal to $20 million or some other amount, and 5. Capital Requirements for Covered MSPs The Commission proposed to establish a minimum capital requirement for covered MSPs as 323 See 2016 Capital Proposal, 81 FR 91252 at 91264–65. There currently are no MSPs provisionally registered with the Commission. 324 See Commission regulation § 1.3 (17 CFR 1.3). There currently are no MSPs provisionally registered with the Commission. 325 See 17 CFR part 23, subpart E (Capital and Margin Requirements for Swap Dealers and Major Swap Participants). 326 See 17 CFR 240.18a–2. 327 See 2016 Capital Proposal, 81 FR 91252 at 91264–25. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations whether the positive tangible net worth capital requirements should include a requirement for a covered MSP to maintain positive tangible net worth in an amount in excess of the market risk and credit risk charges on the covered MSP’s swap and security-based swap positions.328 The Commission did not receive comments addressing these issues. The Commission has considered the proposed capital requirements for covered MSPs, and is adopting the capital requirements as proposed. The Commission believes that it is appropriate to impose a capital requirement on a covered MSP that requires such entity to maintain the greater of (i) positive tangible net worth, or (ii) the amount of capital required by an RFA of which the covered MSP is a member. The Commission also recognizes that the positive tangible net worth capital requirement is a less rigorous requirement than the Net Liquid Assets Capital Approach or the Bank-Based Capital Approach. The Commission believes, however, that the positive tangible net worth capital requirement is appropriate to help ensure the safety and soundness of the covered MSP. Under the final rule as adopted, a covered MSP is required to maintain the greater of (i) positive tangible net worth, or (ii) the minimum amount of capital required by an RFA of which the covered MSP is a member.329 The final rule further requires a covered MSP to mark its swaps, security-based swaps and related positions to their market values in computing its tangible net worth, and to include in its liabilities obligations of a subsidiary or affiliate that the covered MSP guarantees, endorses, or assumes either directly or indirectly, to ensure that the tangible net worth of the covered MSP reflects the extent of such potential financial obligations.330 As noted above, there are no MSPs currently provisionally-registered with the Commission, and only two firms have ever provisionally-registered as MSPs. Therefore, the Commission has limited experience with MSPs and such experience does not provide reliable information or data on how such firms may be structured or operate in future. This lack of information and data makes establishing a more tailored capital requirement beyond the positive tangible net worth requirement 328 Id. 329 See paragraph (a)(2) of Commission regulation § 23.101, as adopted. 330 See definition of the term ‘‘tangible net worth’’ in Commission regulation § 23.100, as adopted. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 challenging. Accordingly, the Commission will monitor any future developments with MSPs and assess the appropriateness of the positive tangible net worth capital requirement to such firms to ensuring the safety and soundness of the MSPs. The Commission will consider any rule amendments that may be necessary based upon the information and data that it will receive from any registered MSP. In addition, the final capital rule provides that an MSP must also maintain a level of capital as established by the RFA of which it is a member. This provision is consistent with section 17 of the CEA, which provides that an RFA must establish minimum capital requirements for members that are at least as stringent as applicable capital requirements adopted by the Commission. This provision authorizes NFA, as the only RFA, to adopt capital requirements for its member MSPs that are higher than the Commission’s MSP capital requirement. This provides an additional level of assurance that the Commission or NFA can adjust, if necessary, capital requirements relative to the business activities of any MSPs that the Commission in the future believes present systemic risk. 6. Requirements for Market Risk and Credit Risk Models The Commission’s Proposal recognized that internal market risk and credit risk capital models, including value-at-risk (‘‘VaR’’) models, can provide a more effective means of measuring economic risk from complex trading strategies involving swaps, security-based swaps, and other proprietary positions than the standardized market risk and credit risk charges set forth in regulation 1.17. In order to use internal capital models to compute its capital, the covered SD or FCM–SD must obtain the approval of the Commission or an RFA of which it was a member. In developing the specific proposed market risk and credit risk models requirements, including the proposed quantitative and qualitative requirements of the models discussed below, the Commission incorporated the market risk and credit risk model requirements adopted by the Federal Reserve Board for bank holding companies, including the value at risk (‘‘VaR’’), stressed VaR, specific risk, incremental risk, and comprehensive risk qualitative and quantitative standards and requirements. The Commission’s proposed qualitative and quantitative requirements for capital models also are comparable to the SEC’s existing capital model requirements for PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 57503 ANC Firms and the capital model requirements adopted for SBSDs. a. VaR Models Proposed regulation 23.102 required that a VaR model’s quantitative criteria include the use of a VaR-based measure that incorporates a 99 percent, onetailed confidence interval.331 The VaRbased measure must be based on a price shock equivalent to a ten business-day movement in rates or prices. Price changes estimated using shorter time periods must be adjusted to the tenbusiness-day standard. The minimum effective historical observation period for deriving the rate or price changes is one year, and data sets must be updated at least quarterly or more frequently if market conditions warrant. The Commission noted that for many types of positions it would be appropriate for a covered SD or FCM–SD to update its data positions more frequently than quarterly. In all cases, a covered SD or FCM–SD must have the capability to update its data sets more frequently than quarterly in anticipation of market conditions that require such updating. The covered SD or FCM–SD also would not need to employ a single internal capital model to calculate its VaR-based measure. A covered SD or FCM–SD may use any generally accepted approach, such as variancecovariance models, historical simulations, or Monte Carlo simulations, based on the nature and size of the positions the model covers. The internal capital model must use risk factors sufficient to measure the market and credit risk inherent in all positions. The risk factors must address the risks including interest rate risk, credit spread risk, equity price risk, foreign exchange risk, and commodity price risk. For material positions in the major currencies and markets, modeling techniques must incorporate enough segments of the yield curve—in no case less than six—to capture differences in volatility and less than perfect correlation of rates along the yield curve. The internal capital model may incorporate empirical correlations within and across risk categories, provided that the covered SD or FCM– SD validates and demonstrates the reasonableness of its process for measuring correlations. If the internal capital model does not incorporate empirical correlations across risk categories, the covered SD or FCM–SD must add the separate measures from its internal capital models for the 331 2016 Capital Proposal, 81 FR 91252, 91269– 72. E:\FR\FM\15SER3.SGM 15SER3 57504 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 appropriate risk categories as listed above to determine its aggregate VaRbased measure of capital. The VaR-based measure must include the risks arising from the nonlinear price characteristics of options positions or positions with embedded optionality and the sensitivity of the fair value of the positions to changes in the volatility of the underlying rates, prices or other material factors. A covered SD or FCM– SD with a large or complex options portfolio must measure the volatility of options positions or positions with embedded optionality by different maturities and/or strike prices, where material. The internal capital model also must be subject to backtesting requirements that must be calculated no less than quarterly. A covered SD or FCM–SD must compare its daily VaR-based measure for each of the preceding 250 business days against its actual daily trading profit or loss, which includes realized and unrealized gains and losses on portfolio positions as well as fee income and commissions associated with its activities. If the quarterly backtesting shows that the covered SD’s or FCM–SD’s daily net trading loss exceeded its corresponding daily VaRbased measure, a back-testing exception has occurred. If a covered SD or FC–SD experiences more than four back-testing exceptions over the preceding 250 business days, it is generally required to apply a multiplication factor in excess of three when it calculates its VaR-based capital requirements. The qualitative requirements proposed would specify, among other things, that: (i) Each VaR model must be integrated into the covered SD’s or FCM–SD’s daily internal risk management system; (ii) each VaR model must be reviewed periodically by the firm’s internal audit staff and annually by a third party service provider; and (iii) the VaR measure computed by the model must be multiplied by a factor of at least three but potentially a greater amount if there are exceptions to the measure resulting from quarterly backtesting results. A covered SD or FCM–SD would also be subject to on-going supervision by staff of the Commission and RFA with respect to its internal risk management, including its use of VaR models. b. Stressed VaR Models The Commission proposed that covered SDs or FCM–SDs approved to use VaR models to compute market risk deductions also must include a stressed VaR component in the calculation. The stressed VaR measure supplements the VaR measure, as the VaR measure’s VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 inherent limitations produced an inadequate amount of capital to withstand the losses sustained by many financial institutions in the financial crisis of 2007–2008.332 The stressed VaR measure also should contribute to a more appropriate measure of the risks of a covered SD’s or an FCM–SD’s positions as stressed VaR is intended to account for more volatile and extreme price changes. The 2016 Capital Proposal required a covered SD or FCM–SD to use the same model that it uses to compute its VaR measure for its stressed VaR measure. The model inputs however would be calibrated to reflect historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the covered SD’s or FCM–SD’s portfolio. The stressed VaR measure must be calculated at least weekly and be no less than the VaR measure. The Commission further noted that it expected that the stressed VaR measure would be substantially greater than the VaR measure. The Commission also required that the stress tests take into account concentration risk, illiquidity under stressed market conditions, and other risks arising from the covered SD’s or FCM–SD’s activities that may not be captured adequately in the covered SD’s or FCM–SD’s internal VaR models. For example, it may be appropriate for the covered SD or FCM–SD to include in its stress testing large price movements, one-way markets, nonlinear or deep outof-the-money products, jumps-todefault, and significant changes in correlation. Relevant types of concentration risk include concentration by name, industry, sector, country, and market. The Proposal also provided that a covered SD or FCM–SD must maintain policies and procedures that describe how it determines the period of significant financial stress used to compute its stressed VaR measure and be able to provide empirical support for the period used. These policies and procedures must address: (i) How the covered SD or FCM–SD links the period of significant financial stress used to calculate the stressed VaR-based measure to the composition and directional bias of the covered SD’s or FCM–SD’s portfolio; and (ii) the covered SD’s or FCM–SD’s process for selecting, reviewing, and updating the period of significant financial stress used to calculate the stressed VaR measure and 332 See Revisions to the Basel II market risk framework, published by the Basel Committee on Banking Supervision for an explanation of the implementation of the stressed VaR requirement. PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 for monitoring the appropriateness of the 12-month period in light of the covered SD’s or FCM–SD’s current portfolio. Before making material changes to these policies and procedures, a covered SD or FCM–SD must obtain approval from the Commission or RFA. The Commission or the RFA also may require a covered SD or FCM–SD to use a different period of stress to compute its stressed VaR measure. c. Specific Risk Models The Commission proposed to allow covered SDs or FCM–SDs to model their specific risk. Under the Proposal, the specific risk model must be able to demonstrate the historical price variation in the portfolio, be responsive to changes in market conditions, be robust to an adverse environment, and capture all material aspects of specific risk for its positions. The Proposal required that a covered SD’s or FCM– SD’s models capture event risk (such as the risk of loss on equity or hybrid equity positions as a result of a financial event, such as the announcement or occurrence of a company merger, acquisition, spin-off, or dissolution) and idiosyncratic risk, and capture and demonstrate sensitivity to material differences between positions that are similar but not identical, and to changes in portfolio composition and concentrations. If a covered SD or FCM– SD calculates an incremental risk measure for a portfolio of debt or equity positions under paragraph (I) of proposed 23.102 Appendix A, the covered SD or FCM–SD is not required to capture default and credit migration risks in its internal models used to measure the specific risk of these portfolios. The Commission noted in the Proposal that it understood that not all debt, equity, or securitization positions (for example, certain interest rate swaps) have specific risk. Therefore, the Commission proposed that there would be no specific risk capital requirement for positions without specific risk. A covered SD or FCM–SD, however, must have clear policies and procedures for determining whether a position has specific risk. The Commission also stated in the Proposal that it believed that a covered SD or FCM–SD should develop and implement VaR-based models for both market risk and specific risk. A covered SD’s or FCM–SD’s use of different approaches to model specific risk and general market risk (for example, the use of different models) would be reviewed to ensure that the overall capital requirement for market risk is E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations commensurate with the risks of the covered SD’s or FCM–SD’s positions. jbell on DSKJLSW7X2PROD with RULES3 d. Incremental Risk Models The Commission proposed an incremental risk requirement for covered SDs or FCM–SDs that measures the specific risk of a portfolio of debt positions using internal models. Incremental risk consists of the default risk and credit migration risk of a position. Default risk means the risk of loss on a position that could result from the failure of an obligor to make timely payments of principal or interest on its debt obligation, and the risk of loss that could result from bankruptcy, insolvency, or similar proceeding. Credit migration risk means the price risk that arises from significant changes in the underlying credit quality of the position. A covered SD or FCM–SD also may include portfolios of equity positions in the incremental risk model with the prior permission from the Commission or RFA, provided that the covered SD or FCM–SD consistently includes such equity positions in how it internally measures and manages the incremental risk for such positions at the portfolio level. Default is assumed to occur with respect to an equity position that is included in its incremental risk model upon the default of any debt of the issuer of the equity position. e. Comprehensive Risk Models The 2016 Capital Proposal required a covered SD or FCM–SD to compute all material price risks of one or more portfolios of correlation trading positions using an internal model. The Commission required the model to measure all price risk consistent with a one-year time horizon at a one-tail, 99.9 percent confidence level, under the assumption either of a constant level of risk or of constant positions. The Commission stated that it expected that the covered SD or FCM–SD remains consistent in its choice of constant level or risk or positions, once it makes a selection. Also, the covered SD’s or FCM–SD’s choice of a liquidity horizon must be consistent between its calculation of its comprehensive and incremental risk. The Commission also required a covered SD’s or FCM–SD’s comprehensive risk model to capture all material price risk, including, but not limited to: (i) The risk associated with the contractual structure of cash flows of each position, its issuer, and its underlying exposures (for example, the risk arising from multiple defaults, including the ordering of defaults in tranched products); (ii) credit spread risk, including nonlinear price risks; VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 (iii) volatility of implied correlations, including nonlinear price risks such as the cross-effect between spreads and correlations; (iv) basis risks; (v) recovery rate volatility as it relates to the propensity for recovery rates to affect tranche prices; and (vi) to the extent that the comprehensive risk measure incorporates benefits from dynamic hedging, the static nature of the hedge over the liquidity horizon. The Commission noted that additional risks that are not explicitly discussed but are a material source of price risk must be included in the comprehensive risk measure. The Commission also required a covered SD or FCM–SD to have sufficient market data to ensure that it fully captures the material price risks of the correlation trading positions in its comprehensive risk measure. Moreover, a covered SD or FCM–SD must be able to demonstrate that its model is an appropriate representation of comprehensive risk in light of the historical price variation of its correlation trading positions. A covered SD or FCM–SD also would be required to inform the Commission and RFA if the covered SD or FCM–SD plans to extend the use of a model that has been approved to an additional business line or product type. The Proposal required that the comprehensive risk measure must be calculated at least weekly. In addition, a covered SD or FCM–SD must at least weekly apply to its portfolio of correlation trading positions a set of specific stressed scenarios that capture changes in default rates, recovery rates, and credit spreads, and various correlations. A covered SD or FCM–SD must retain and make available to the Commission and the RFA the results of the stress testing, including comparisons with capital generated by the covered SD’s or FCM–SD’s comprehensive risk model. A covered SD or FCM–SD must promptly report to the Commission or the RFA any instances where the stress tests indicate any material deficiencies in the comprehensive risk model. f. Credit Risk Models The 2016 Capital Proposal required covered SDs or FCM–SDs seeking to obtain Commission or RFA approval to use internal models to compute credit risk to submit credit risk models that satisfy the quantitative and qualitative requirements set forth in Appendix A to proposed regulation 23.102. With respect to uncleared derivatives contracts, a covered SD or FCM–SD would need to determine an exposure charge for each counterparty to its PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 57505 uncleared derivatives positions. The exposure charge for a counterparty that is insolvent, in a bankruptcy proceeding, or in default of an obligation on its senior debt, is the net replacement value of the uncleared derivatives contracts with the counterparty (i.e., the net amount of uncollateralized current exposure to the counterparty). The counterparty exposure charge for all other counterparties is the credit equivalent amount of the covered SD’s or FCM– SD’s exposure to the counterparty multiplied by an applicable credit riskweight factor multiplied by 8%. The credit equivalent amount is the sum of the covered SD’s or FCM–SD’s (i) maximum potential exposure (‘‘MPE’’) multiplied by a backtesting determined factor; and (ii) current exposure to the counterparty. The MPE amount is a charge to address potential future exposure and is calculated using the VaR model as applied to the counterparty’s positions after giving effect to a netting agreement, taking into account collateral received, and taking into account the current replacement value of the counterparty’s positions. The Commission in its margin requirements (see Commission regulations 23.150 through 23.161) set forth the requirements for eligible collateral for uncleared swaps. In order to account for collateral in its VaR model for the credit risk charges, the Commission stated that it expected a covered SD or FCM–SD to account only for the collateral that complies with Commission regulation 23.156 and is held in accordance with regulation 23.157 for uncleared swaps that are subject to the Commission’s margin rules. A covered SD or FCM–SD would be able to take into consideration in its VaR calculation collateral that does not comply with regulation 23.156 and is not held in accordance with regulation 23.157, for uncleared swaps that are not subject to the Commission’s margin rules. The Commission proposed to allow covered SDs or FCM–SDs to use internal methodologies to determine the appropriate credit risk-weights to apply to counterparties, if it has received the Commission’s or the RFA’s approval. A higher percentage credit risk-weight factor would result in a larger counterparty exposure charge amount. The Commission stated that it expected that the counterparty credit risk-weight should be based on an assessment of the creditworthiness of the counterparty. The Commission stated that its proposed approach to calculating credit risk charges is appropriate given that its requirements are based on a method of E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57506 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations computing capital charges for credit risk exposures in the international capital standards for banking institutions. Since credit risk is the risk that a counterparty could not meet its obligations on an OTC derivatives contract in accordance with agreed terms (such as failing to pay), the considerations that inform a covered SD’s or FCM–SD’s assessment of a counterparty’s credit risk should be broadly similar across the various relationships that may arise between the dealer and the counterparty. Therefore, the Commission believes that its approach is a reasonable model, as the SEC also uses a similar approach for its ANC BDs and SBSDs using models. The Commission also proposed that covered SDs or FCM–SDs that are subject to the Bank-Based Capital Approach requirement could also request Commission or RFA approval to use the Federal Reserve Board’s internal ratings-based and advanced measurement model approaches to compute risk-weighted assets for the credit exposures listed in subpart E of 12 CFR 217. The covered SD or FCM– SD would have to include such exposures in its application to the Commission and RFA, and explain how its proposed models are consistent with the Federal Reserve Board’s model criteria in subpart E of 12 CFR 217. The Commission received several comments concerning the use of internal capital models. One commenter expressed a strong concern regarding the 2016 Capital Proposal’s potential heavy reliance on the use of internal models.333 The commenter stated that a reliance on internal models can permit regulated entities to manipulate risk controls to increase their own profits at the cost of increasing risks to the public. The commenter pointed out that analysis of the financial crisis experience evidenced manipulation of models to reduce capital charges. While the commenter acknowledged postcrisis refinements to internal model requirements, both in technique and governance, it argued that resource limitations at regulators, as well as continuing pressure from industry, may limit regulators’ ability to prevent weakening standards and model misuse. The commenter thus advocated for strong limitations and floors to counterbalance the use of internal models.334 The Commission appreciates the commenter’s concerns regarding models generally, and the need for the Commission to maintain strong limitations and floors. In this regard, the 333 See AFR 5/15/17 Letter. 334 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Commission is providing that only capital models that satisfy specified quantitative and qualitative requirements set forth in the regulations will be approved for use by covered SDs. Such requirements are consistent with the standards established by the BCBS and SEC for banking institutions and BDs, respectively. In addition, the Commission plans to work with NFA to establish a comprehensive ongoing examination program over the capital models used by covered SDs, which will be designed to identify and address issues with model performance through such means as back-testing results. These steps should assist with mitigating concerns regarding model performance. Other commenters generally supported the Commission’s Proposal to permit internal capital models in lieu of standardized market and credit risk capital charges.335 Another commenter stated that it strongly supports permitting SDs the flexibility to use internal models, when appropriate.336 Two commenters stated that the detailed quantitative and qualitative requirements for market risk and credit risk models set forth in Appendix A of proposed regulation 23.102 do not reflect the requirements of all of the models that a bank or bank holding company may use for market risk and credit calculations under the capital rules of the Federal Reserve Board.337 One of the commenters stated that the prudential regulators have undertaken an extensive effort to revise U.S. Basel III risk-weighted asset standards, which has includes significant ongoing efforts to revise specific credit risk and market risk methodologies that will require several years to finalize.338 One of the commenters stated that the differences between the Federal Reserve Board rules and the requirements of Appendix A would require a covered SD electing the Bank-Based Capital Approach to submit a model application that contains more information than the information required by the Federal Reserve Board.339 The commenters also state that the calculations of market risk and credit risk under some of the Federal Reserve Board rules differ from the calculation requirements under proposed Appendix A of regulation 23.102. The commenters recommended that the Commission modify proposed regulation 23.102 and appendix A to 335 See, e.g., ISDA 5/15/17 Letter; SIFMA 5/15/17 Letter; MS 5/15/17 Letter. 336 See IFM 5/15/17 Letter. 337 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter. 338 Id. 339 IIB/ISDA/SIFMA 3/3/2020 Letter. PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 allow a Bank-Based Capital Approach to use models approved to calculate market risk and credit risk exposures if the model satisfies the relevant Federal Reserve Board requirements for market risk and credit risk models, as appropriate. The commenters also recommended that the Commission permit a covered SD that has obtained approval to use credit risk models to calculate its credit risk exposure using the Federal Reserve Board’s advance approaches capital framework, contained in subpart E of 12 CFR part 217, and further permit a covered SD that has obtained approval to use market risk models to calculate its market risk using the Federal Reserve Board’s rules contained in subpart F of 12 CFR part 217. The commenters stated that the above modifications would allow covered SDs electing the Bank-Based Capital Approach to calculate market risk and credit risk consistently with how bank SDs and many foreign SDs calculate their exposures for capital purposes. The Commission recognizes that the Federal Reserve Board’s capital rules are continuing to evolve and will evolve further in the future as global banking regulators continue to harmonize capital requirements under the Basel capital framework. The Commission proposed the Bank-Based Capital Approach in recognition that it reflected a global banking capital regime that was designed for safety and soundness. The proposed approach also provided covered SDs that are non-bank subsidiaries of bank holding companies the ability to use capital models approved by prudential regulators for their bank affiliates. The Commission understands that model requirements set forth in proposed Appendix A of regulation 23.102 do not reflect fully the market risk and credit risk options available at this time to banking organizations under the rules of the Federal Reserve Board. The Commission also understands that each of the market risk and credit risk options under the Federal Reserve Board’s rules are, and will continue to be, based on Basel capital requirements, and thus appropriate for calculating market risk or credit risk for covered SDs. Therefore, the Commission is modifying regulation 23.102 to both clarify and expand the market risk and credit risk models that may be used by a covered SD such that the requirement aligns with requirements of the Federal Reserve Board. Specifically, the Commission is modifying paragraph (c) of regulation 23.102 to provide that a covered SD’s application for market risk models must include the information E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations specified in Federal Reserve Board’s rules contained in subpart F of 12 CFR part 217, and the information required under subpart E of 12 CFR part 217 for credit risk models. The Commission believes that the modifications are appropriate in that they provide model requirements that are identical to the Federal Reserve Board’s requirements and, by incorporating the Federal Reserve Board’s rules by reference, address concerns raised regarding the ongoing revisions to the rules as Basel enhancements continue to be adopted. jbell on DSKJLSW7X2PROD with RULES3 7. Model Approval Process for Covered SDs and FCM–SDs The Commission’s Proposal required each covered SD and FCM–SD to submit an application for approval to use internal capital models to compute market risk or credit risk capital charges to the Commission and to the RFA of which the SD or FCM–SD was a member.340 The Proposal provided that a covered SD’s or FCM–SD’s application must be in writing and must be filed with the Commission and with an RFA in accordance with applicable filing requirements. Proposed Appendix A to regulation 23.102 required the application to include: (i) A list of categories of positions that the covered SD or FCM–SD holds in its proprietary accounts and a brief description of the methods the covered SD or FCM–SD would use to calculate market risk and credit risk charges; (ii) a description of the mathematical models to be used to price positions and to compute market risk and credit risk; (iii) a description of how the covered SD or FCM–SD would calculate current exposure and potential future exposure for its credit risk charges, and (iv) a description of how the covered SD or FCM–SD would determine internal credit risk-weights of counterparties, if applicable. The Commission or RFA also may require a covered SD or FCM–SD to supplement its application with additional information necessary for a proper evaluation.341 The Proposal also provided that the Commission or RFA could deny the application or approve the application, subject to any conditions or limitations that the Commission or RFA may require, if such denial or approval is found to be in the public interest. In 340 See 2016 Capital Proposal, 81 FR 91252 at 91269–70. FCMs and FCM–SDs that also are registered BDs would have to obtain SEC approval as an ANC Firm in order to use market risk and credit risk models in lieu of taking standardized capital charges. See Commission regulation § 1.17(c)(6)(i), as adopted. 341 See 2016 Capital Proposal, 81 FR 91252 at 91269–70. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 making a public interest determination, the Commission will consider whether the applicant’s models meet the quantitative and qualitative requirements, and assess the governance structure regarding the development, operation, and ongoing monitoring of the models. The Commission will further assess the qualification of personnel with the responsibility for operating the models and the personnel with responsibility for supervising the daily operations and reporting to senior management. The Commission’s assessment is intended to determine that the use of capital models does not impair the overall safety and soundness of the covered SD or FCM–SD. The Commission also will consider the potential benefits that models provide by more appropriately reflecting market and credit risk as compared to standardized capital charges, which encourages FCM–SDs and covered SDs to provide markets to market participants and provides for a more efficient use of FCM–SD and covered SD capital. A covered SD or FCM–SD also would be required to cease using the models if: (i) The models are altered or revised materially, or if the SD’s or FCM–SD’s internal risk management is materially changed, and such changes have not been submitted to the Commission and RFA for approval; (ii) the Commission or RFA determines that the models are no longer sufficient or adequate to compute market or credit risk charges; (iii) the SD or FCM–SD fails to comply with the regulations governing the use of models; or (iv) the Commission by written order finds that permitting the SD or FCM–SD to continue to use the internal models is no longer appropriate. The Commission requested comment in the 2016 Capital Proposal on all aspects of the proposed model review process, including the viability of the proposed model review process given the number of provisionally-registered covered SDs, the number of capital models that may be required to be approved for each provisionallyregistered covered SD, and the complexity of the models that may be submitted for approval.342 The Commission also requested comment on whether the regulation should include a process for the automatic approval or temporary approval of capital models that had been reviewed and approved by a prudential regulator or an appropriate foreign regulator.343 342 See 2016 Capital Proposal, 81 FR 91252 at 91272–73. 343 Id. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 57507 Commenters generally stated that it was necessary for the Commission to develop an efficient approach for the review and approval of internal models and noted that covered SDs or FCM–SDs that did not have model approval at the compliance date would be at a significant competitive disadvantage relative to covered SDs and FCM–SDs that had the approval to use models at the compliance date. In this connection, one commenter stated that in no event should a covered SD be required to use the proposed standardized capital charges while awaiting model approval at the compliance date.344 Another commenter requested that the Commission clarify that no covered SD would be required to use the proposed standardized capital charges while awaiting model approval.345 Other commenters suggested various approaches that the Commission should adopt to ensure that covered SDs and FCM–SDs have the ability to use capital models at the compliance date. One commenter stated that capital models should be deemed ‘‘provisionally approved’’ while under review by the Commission or NFA at the compliance date.346 Several commenters stated that the Commission should automatically approve market risk models and credit risk models of covered SDs or FCM–SDs that have already been approved by a prudential regulator, the SEC, or certain foreign regulators.347 One commenter stated that Commission’s final rule should provide for the recognition of internal capital models used throughout corporate families if such models have been approved by a prudential regulator, the SEC, or a foreign regulator in a jurisdiction that has adopted the Basel capital requirements, provided that the relevant regulatory authority has ongoing periodic assessment power with regard to the model and provides the CFTC and the NFA with appropriate information.348 The Commission invited interested persons to provide additional comment on the model approval process in the 2019 Capital Reopening. Commenters generally reiterated their views that the Commission needed to adopt an efficient and effective model review process that recognizes the complexity of the undertaking, and ensures that all covered SDs and FCM–SDs that want to use models have authorization to use such models at the compliance date in 344 See ISDA 5/15/17 Letter. IFM 5/15/17 Letter. ISDA 5/15/17 Letter. 347 See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter. See also, ABN/ING/Mizuho/Nomura 1/29/ 2018 Letter. 348 See ISDA 5/15/17 Letter. 345 See 346 See E:\FR\FM\15SER3.SGM 15SER3 57508 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 order to avoid competitive disadvantages for firms not permitted to use models.349 One commenter stated that the failure to create and implement a flexible capital model approval process and timeline creates a competitive disadvantage for smaller covered SDs (including smaller commodity-focused covered SDs) relative to bank and bank holding company-affiliate SDs.350 The commenter noted that many larger SDs currently operate with approved models, and noted that smaller SDs do not have off-the-shelf or pre-approved internal models that can be used or leveraged for capital compliance purposes, and anticipate significant expense and resource will be necessary for the development of counterparty credit risk and market risk model procedures, processes, and systems.351 One commenter stated that firms submitting models for the first time must be provided with sufficient time to complete the approval process.352 Another commenter stated that commodity-focused covered SDs should be subject to models that focus on risks associated with the physical commodity market, and the capital model should not need to account for non-applicable risks.353 The commenter requested that the Commission confirm that a commodity-focused covered SD’s capital model needs only to account for the positions and risks relevant to the applicable business and does not need to address every risk and requirement set forth in proposed Appendix A to regulation 23.102.354 Commenters also expressed the view that the Commission should provide automatic model approval or provisional model approval to SDs and FCM–SDs that use models that have been reviewed and approved by the SEC, a prudential regulator, or a qualified foreign regulator. One commenter also stated that the Commission should provide provisional approval for models submitted by covered SDs in good faith, subject to further review and approval if necessary.355 349 See, e.g., NCGA/NGSA 3/3/2020 Letter; CEWG 3/3/2020 Letter; FIA–PTG 3/3/2020 Letter. 350 See ED&F Man/INTL FCStone 3/3/2020 Letter. 351 Id. 352 See FIA–PTG 3/3/2020 letter. 353 See CEWG 3/3/2020 Letter. 354 Id. 355 See NCGA/NGSA 3/3/2020 Letter. The NCGA/ NGSA also stated that the Commission’s capital rules should allow for the use of unencumbered cash to be considered part of a covered SD’s capital base even when the cash is swept into a corporate omnibus account and held overnight at a financial institution. The Commission acknowledges that under the proposed Tangible Net Worth Capital VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 NFA expressed its willingness to undertake the review of covered SDs and covered FCM–SDs capital models for compliance with the regulatory requirements.356 NFA noted that it currently has a team with significant model experience that has been focusing on the review, approval, and ongoing monitoring of covered SD’s initial margin models for uncleared swaps. NFA stated that it would leverage the experience it has gained in reviewing and approving initial margin models, and would allocate similar resources to the review of covered SDs’ internal capital models for compliance with the Commission’s requirements. NFA also commented, however, that the capital model review process will be significantly more complex than the process conducted for initial margin models. The additional complexity is attributable in part to the lack of an industry-wide, standardized internal capital model and the fact that each covered SD may have several models under the proposed capital rules to address various aspects of market risk (e.g., VaR models and stressed VaR models). The review process is further challenged in that the Commission did not propose a multi-year compliance schedule that would allow capital models to be phased-in over a sufficiently long period of time comparable to the now six-year phasein schedule for initial margin requirements for uncleared swaps.357 NFA estimated that as many as 51 covered SDs (from 21 corporate families) could be subject to the Commission’s capital rules and may seek model review and approval prior to the compliance date. NFA also commented that it would need to build systems and processes to receive the requisite model information from covered SDs and FCM–SDs, and that its review would need to occur over a period of time given the complexity of the market and credit risk models. To address these concerns, NFA suggested several modifications that the Commission could make to the process of reviewing and approving capital models. Specifically, NFA suggested that a covered SD electing a Bank-Based Capital Approach that uses the internal Approach, unencumbered cash deposits, including cash transferred to an affiliate, would be considered a tangible asset and part of the capital base. See also, CEWG 3/3/2020 Letter. 356 See Letter from Carol Wooding, National Futures Association (March 2, 2020) (NFA 3/2/2020 Letter). 357 Id. The Commission’s margin rules for uncleared swap transactions are subject to a phasein period that extended from September 1, 2016 to September 1, 2021. See Commission regulation § 23.161 (17 CFR 23.161). PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 market and credit risk capital models previously reviewed by a prudential regulator for an affiliated SD (e.g., a bank holding company) be permitted to use such models without a formal review or approval of the covered SD’s capital models prior to the compliance date. NFA also stated that the Commission should consider implementing a similar process for covered SDs that use internal market risk and credit risk models that have been reviewed or approved for the covered SD’s use or for use by an affiliate of the covered SD by a foreign regulator in a jurisdiction that has implemented the Basel III capital standards. NFA stated that for covered SDs or covered FCM–SDs that are permitted to use capital models without a pre-compliance date review and approval as outlined above, it would review the SDs’ or FCM–SDs’ overall capital compliance, including their use of models after the compliance date through NFA’s examination process and ongoing compliance monitoring program. NFA commented that if the above framework is implemented, it will work with the Commission to develop a precompliance date model review and approval process, including appropriate information gathering and certification requirements for covered SDs with models that have not been reviewed by a prudential or qualified foreign regulator, as well as an appropriate postcompliance date model review and monitoring process. NFA stated that it is committed post compliance date to monitor the overall governance and use of market and credit risk models by all covered SDs that are subject to a model pre-approval process or postcompliance model review including, at a minimum, assessing model performance test results and monitoring for compliance with the Commission’s SD capital rules. NFA further estimated that if the above framework is adopted that as many as 12 covered SDs that are provisionally-registered may require immediate capital model review. These 12 covered SDs have not obtained direct regulatory approval to use capital models and are not part of corporate families that have obtained any other regulatory approval to use capital models. NFA also estimated that it will take approximately 15 months to review and approve capital models for these 12 covered SDs. NFA also recommended a modification to the final rule language. NFA stated that to make the postcompliance date framework effective, since NFA will not formally approve a E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 covered SD’s use of market and credit risk models previously reviewed by a prudential regulator a qualified foreign regulator, it believed that it is important that the Commission and/or NFA reserve the authority to require that a covered SD cease at any time using internal models if the covered SD is not in compliance with the Commission’s capital requirements. To address this issue, NFA recommended that the Commission modify regulation 23.102(e) to clarify the Commission’s and NFA’s authority to rescind a covered SD’s use of models that were not formally ‘‘approved’’ prior to the requirements compliance date.358 The Commission has considered the Proposal and the comments received, and is adopting the model approval process as proposed with several modifications discussed below. The Commission recognizes the substantial resources that are necessary in order to effectively and efficiently review and approve capital models submitted by covered SDs, and further recognizes that Commission staff would not be able to perform such reviews in a reasonable period of time. Therefore, final regulations 1.17(c)(6)(v) and 23.102 provides two alternative approaches for FCM–SDs and covered SDs, respectively. An FCM–SD or a covered SD may submit an application to the Commission for approval to use internal models to compute market risk and credit risk capital charges in lieu of standardized charges. In the alternative, an FCM–SD or a covered SD may submit an application to NFA (as an RFA) to use internal models provided that the Commission has made a determination that NFA’s process to approve internal models is consistent with the Commission’s approval process and NFA’s approval would be accepted as an alternative means of compliance with the Commission’s model requirements and approval as contained in Regulation 23.102.359 In this release, the Commission is setting forth a process for determining whether the NFA’s standard and process for reviewing and approving an FCM– SD’s and a covered SD’s capital models is comparable to those of the Commission’s. As part of the 358 NFA noted that proposed Appendix A to Commission regulation § 23.102, which provides that the Commission or an RFA may revoke a covered SD’s internal market and credit risk models. NFA stated that this provision of Appendix A should be modified to clarify that the Commission or an RFA may revoke a covered SD’s ability to use internal market and credit risk models that have been approved by a prudential regulator or qualified foreign regulator. See NFA 3/2/2020 Letter. 359 At this time, NFA is the only RFA. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Commission’s assessment, the Commission will perform a review of the NFA’s FCM–SD and covered SD capital requirements for consistency with the Commission’s requirements. The Commission also will assess the sufficiency of the NFA’s planned model review process and procedures to ensure that such processes and procedures are adequate for providing NFA with an appropriate basis for determining whether an FCM–SD’s or a covered SD’s capital models satisfy the NFA’s model requirements. Based on these assessments, the Commission will issue a determination that the NFA’s approval of an FCM–SD’s or a covered SD’s capital models may serve as an alternative means of complying with the Commission’s model approval requirement. The Commission is delegating authority to issue the determination to the Director of the Division of Swap Dealer and Intermediary Oversight under the revisions to regulation 140.91. Due to limited Commission resources, the Commission anticipates that FCM– SDs and covered SDs will seek model approval from the NFA in order to help ensure a timely review. As noted in its comment letter, NFA has devoted substantial efforts to obtain the personnel and other resources necessary to perform the review, approval, and ongoing assessment of FCM–SDs’ and covered SDs’ models to calculate initial margin for uncleared swaps, and plans to leverage these resources and experience in its review and assessment of capital models. In addition, as noted in section II.B.2. above, NFA is required by section 17(p) of the CEA to adopt capital requirements for SDs that are at least as stringent as the Commission’s capital requirements for covered SDs. In this regard, the Commission has approved NFA Compliance Rule 2–49, which incorporates the Commission’s part 23 rules into NFA’s rules. Therefore, the capital and financial reporting requirements set forth in this final rulemaking will become NFA requirements 60 days after the publication of this Federal Register release (the effective date). The NFA SD capital requirements will include the options for market risk and credit risk models and will require SDs to obtain NFA approval to use such models under the NFA SD capital rules.360 360 The Commission also revised paragraph (c) of Appendix A of final regulation 23.102 to provide that a covered SD that files a model application with the Commission may request confidential treatment under the Freedom of Information Act. Paragraph (c) of Appendix A does not apply to PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 57509 The Commission further acknowledges that the model review process will require a period of time that will prevent the Commission or NFA from reviewing and approving models for all covered SDs that seek model approval prior to the compliance date of the regulations. The Commission also recognizes that a process that results in some covered SDs receiving approval to use capital models while the capital models of other covered SDs are under review at the compliance date solely due to the inability of the Commission or NFA to complete the necessary review would place the nonmodel covered SDs at a substantial competitive disadvantage. To address this issue, the Commission is modifying regulation 23.102 by providing a new paragraph (f) to provide that a covered SD may use capital models after filing an application for model approval with the Commission, and pending approval by the Commission or the NFA, provided that the covered SD submits a certification to the Commission and to NFA certifying that the models have been approved for use by the covered SD, or an affiliate of the covered SD, by the SEC, a prudential regulator, a foreign regulatory authority in a jurisdiction that the Commission has found to be eligible for substituted compliance under Commission regulation 23.106, or a foreign regulatory authority whose capital adequacy requirements are consistent with the BCBS bank capital requirements. The certification must be signed by the covered SD’s Chief Executive Officer, Chief Financial Officer, or other appropriate official with knowledge of the covered SD’s capital requirements and the capital models, and must include a representation that the models are in substantial compliance with Commission’s model requirements. The final rule further requires a covered SD to revise its certification to address any material changes or revisions to the models, or to reflect any regulatory restrictions placed on the models by the regulatory authority that approved the models. The covered SD is also required to cease using the models if the regulatory authority that previously approved the models for use by the SD, or by the SD’s affiliate, withdraws its approval prior to the Commission or NFA approving the models. To clarify, the covered SD is not required to submit a model application to NFA with its certification. NFA will applications filed with the NFA, which is not subject to the Freedom of Information Act. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57510 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations obtain any necessary documentation and model information as part of its ongoing examination and monitoring of the covered SD, including the information necessary to approve the models of the covered SD. The covered SD will be subject to the Commission’s and NFA’s supervision and ongoing monitoring pending the Commission’s or NFA’s final determination to approve or not approve the application. This supervision and monitoring will include the review of the models performance and compliance with Commission requirements through examination and review of periodic reports, including back-testing results. The Commission is not, however, adopting a process to permit FCM–SDs to use capital models pending the Commission’s or NFA’s approval. FCM– SDs must have approval in order to use capital models. The Commission is making this distinction as FCM–SDs carry customer and noncustomer funds, and act as intermediaries in the futures markets by performing daily settlement cycles on behalf of customers and noncustomers, and guaranteeing their customers’ and noncustomers’ financial performance to clearing organizations and other FCMs. As noted above, capital models have the potential to substantially reduce the market risk and credit risk capital charges that an FCM must take relative to the standardized charges. The Commission believes that given the important role that FCMs perform in the futures markets, and in order to provide greater protection to customers and their funds, that FCM– SDs must have model approval prior to using such models to compute their adjusted net capital. Furthermore, the Commission notes that currently the only FCM–SDs provisionally-registered with the Commission are four ANC Firms that have existing approvals to use capital models and may continue to use such models after the compliance date of these rules. The 2016 Capital Proposal also included proposed amendments to the Commission’s delegation of authority to the Director of the Division of Swap Dealer and Intermediary Oversight contained in regulation 140.91. The proposed amendments delegated to the Director the authority of the Commission to approve capital models submitted to the Commission under regulation 23.102 and Appendix A. The authority to revoke a previously approved model was not delegated to the Director. The Commission did not receive comments on the proposed amendments to the delegation of authority under regulation 140.91 and, VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 for the reasons discussed in the 2016 Capital Proposal, is adopting the amendments substantially as proposed. 8. Liquidity Requirements for Covered SDs and FCM–SDs The 2016 Capital Proposal required FCM–SDs and covered SDs electing the Bank-Based Capital Approach or the Net Liquid Assets Capital Approach to satisfy specific liquidity requirements.361 The 2016 Capital Proposal did not proposed liquidity requirements for covered SDs electing the Tangible Net Work Capital Approach, covered MSPs, bank SDs, or bank MSPs. Proposed regulation 23.104(a)(1) required covered SD electing the BankBased Capital Approach to meet the liquidity requirements established by the Federal Reserve Board for banking entities. Specifically, proposed regulation 23.104(a)(1) required covered SDs to comply with the liquidity coverage ratio requirements set forth in 12 CFR part 249, and apply such requirements as if the covered SD were a bank holding company subject to 12 CFR part 249.362 The proposed liquidity coverage ratio required the SD to maintain each day an amount of high quality liquid assets (‘‘HQLAs’’), as defined in 12 CFR 249.20, that is no less than 100 percent of the SDs total net cash outflows over a prospective 30 calendar-day period (the ‘‘HQLA Proposal’’).363 The Commission proposed several adjustments to the liquidity coverage ratio to better reflect the business of an SD. For example, the Commission proposed to permit a covered SD to consider cash deposits that are readily available to meet the general obligations of the SD as a level 1 liquid asset in computing its liquidity coverage ratio.364 The Commission also proposed modifying the liquidity coverage ratio so that covered SDs organized and domiciled outside of the U.S. could recognize certain foreign deposited assets in computing its liquidity coverage ratio. Finally, the Commission’s Proposal required a covered SD to maintain a contingency funding plan component, as well as, 361 See 2016 Capital Proposal, 81 FR 91252 at 91273–75. 362 Id. 363 See 12 CFR 249.10. Federal Reserve Board rules require a regulated institution to maintain a liquidity coverage ratio of HQLA to net cash outflows that is equal to or greater than 1.0 on each business day. 364 See proposed Commission regulation § 23.104(a)(1); 2016 Capital Proposal, 81 FR 91252 at 91317. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 certain internal senior management notifications and approvals.365 Proposed regulation 23.104(b) required covered SDs electing the Net Liquid Assets Capital Approach and FCM–SDs to adopt a liquidity stress test requirement that addressed the types of liquidity outflows experienced by SECregistered BDs that are ANC Firms in times of stress (the ‘‘LST Proposal’’). Under the Commission’s proposed LST Proposal, a covered SD or FCM–SD would be required to perform a liquidity stress test at least monthly that took into account certain assumed conditions lasting for 30 consecutive days. The results of the liquidity stress test would be reviewed by senior management periodically. The covered SD or FCM– SD also would be required to have a contingency funding plan to address potential liquidity issues. In proposing these requirements, the Commission intended to address the potential risk that a covered SD or FCM–SD may not be able to meet both expected and unexpected current and future cash flow and collateral needs as a result of adverse events impacting the covered SD’s or FCM–SD’s daily operations or financial condition. Further, the proposed liquidity requirements were consistent with those that had been proposed at the time for SBSDs by the SEC and the existing liquidity requirements adopted by the Federal Reserve Board for bank holding companies.366 The Commission received comments on the proposed HQLA Proposal and the LST Proposal. One commenter suggested that covered SDs should be able to elect either the HQLA Proposal or the LST Proposal, without regard to the SD’s chosen capital approach.367 Another commenter stated that the requirements of the HQLA Proposal and the LST Proposal should be revised to be more similar to each other given that both approaches have the comparable regulatory objective of helping to ensure that a covered SD or FCM–SD has sufficient access to liquidity to meet its obligations during periods of expected and unexpected market activity.368 The commenter specifically noted that the LST Proposal’s definition of liquidity reserves is materially narrower than the HQLA Proposal’s definition of HQLA, and that the Commission should expand the definition under the LST Proposal to match the definition under the HQLA 365 See proposed Commission regulation § 23.104; 2016 Capital Proposal, 81 FR 91252 at 91317–18. 366 See SEC proposed rule 18a–1(f), 77 FR 70213 (Nov. 23, 2012), and 12 CFR part 249. 367 See, e.g., MS 5/15/17 Letter. 368 See SIFMA 5/15/17 Letter. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations Proposal so as to recognize the full range of assets that are actually available to a firm to support its liquidity needs.369 Commenters also raised the concept of a third alternative, which would be the application of a more qualitative than quantitative requirement applicable to covered SDs that are subsidiaries of bank holding companies and already subject to comprehensive overall liquidity risk management program requirements at a parent level. The Commission requested additional comments regarding the proposed liquidity requirements in the 2019 Capital Reopening. The Commission requested specific comment on whether it was necessary for the proposed SD capital rules to include additional liquidity requirements given that the Commission had previously adopted a risk management program set forth in regulation 23.600 for both bank SDs and covered SDs that includes liquidity requirements. The Commission received comments in response to the 2019 Capital Reopening. Several commenters suggested that the Commission defer adopting separate and distinct quantitative liquidity requirements as part of the SD capital rule given that the SD risk management program adopted by the Commission in regulation 23.600 requires a covered SD to assess liquidity risk.370 One commenter stated that the Commission should not adopt the proposed specific liquidity requirement as SDs have a diversity of business models, making standard quantitative liquidity requirements difficult to apply across SDs. The commenter further stated that the Commission should instead rely on the qualitative liquidity requirements in regulation 23.600, and evaluate the sufficiency of the liquidity program based on the specific business and associated risks of the covered SD.371 The commenter noted that regulation 23.600 is tailored specifically to address liquidity needs associated with posting margin and performing on swap transactions. In this regard, the commenter stated that a covered SD is required under regulation 23.600 to measure liquidity needs on a daily basis, assess procedures to liquidate non-cash collateral in a timely manner without significant effect on price, and apply appropriate collateral haircuts that accurately reflect market risk and credit risk, as well as requiring a covered SD to establish and enforce a 369 Id. 370 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter; Shell 3/3/2020 Letter. 371 See IIB/ISDA/SIFMA 3/3/2020 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 system of risk management policies and procedures to monitor and manage market and credit risk associated with its dealing activities. The commenter further stated that the requirements of regulation 23.600 achieve the objective of ensuring SD liquidity in a flexible manner, without imposing a separate and standardized quantitative approach for firms that have different operations. One commenter noted that many covered SDs engage in multiple business lines, not just swap dealing, which may be subject to separate regulatory frameworks which address liquidity risk. For example, a dualregistered BD/SD would be subject to either the Net Liquid Assets Capital Approach or the FCM approach if the SD is also a registered FCM, which is a liquidity-based capital requirement that requires the entity to take net capital deductions for nonmarketable or otherwise illiquid assets.372 In addition, this commenter noted that a quantitative standard applicable at a covered SD level may trap liquid assets within the covered SD and make such assets unavailable at the SD’s holding company level.373 The commenter stated that this may make the holding company and other affiliates of the covered SD less resilient by removing the flexibility to liquidate assets held at the covered SD and deploy the cash where and when it is needed most.374 Commenters also noted that many of the covered SDs are directly or indirectly already subject to various forms of quantitative liquidity requirements due to their status as subsidiaries of large U.S. bank holding companies. One commenter stated that liquidity coverage ratios and Federal Reserve regulation YY-mandated internal liquidity stress testing programs apply and operate on a consolidated basis across large U.S. bank holding companies, ensuring that liquidity risks arising in covered SDs are addressed in consolidated liquidity requirements. This commenter further noted that U.S. bank holding companies subject to Recovery and Resolution Planning requirements are required to consider funding and liquidity requirements of SDs that are ‘‘material operating entities’’, which may result in a requirement to preposition liquidity and funding in a covered SD. The Commission has considered the comments received and assessed the additional proposed liquidity requirements and has determined to 372 See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter; Shell 3/3/2020 Letter. 373 See IIB/ISDA/SIFMA 3/3/2020 Letter. 374 Id. PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 57511 defer the adoption of final rules at this time. As noted by the Commission in the 2019 Capital Reopening and by many of the commenters, regulation 23.600 currently imposes liquidity requirements on covered SDs. Regulation 23.600 requires each SD to establish, document, maintain, and enforce a system of written risk management policy and procedures designed to monitor and manage the risk associated with the covered SD’s swaps activities. A covered SD’ risk management policies and procedures must take into account market, credit, foreign currency, legal, operational, settlement, and any other applicable risks in addition to liquidity risk. With respect to liquidity risk, the risk management policies and procedures must, at a minimum, monitor and/or manage the daily measurement of liquidity needs and include an assessment of the procedures to liquidate non-cash collateral in a timely manner and without significant effect on the price realized for the non-cash collateral. Moreover, staff’s review of covered SDs’ risk exposure reports has revealed that there is a wide disparity in how covered SDs establish their liquidity risk management policies and procedures, and assess their liquidity needs. This disparity is in part due to the variety of provisionally-registered SDs under the Commission’s jurisdiction. Some covered SDs are subsidiaries of much larger parent organizations, many of which are banking entities, that are subject to sophisticated liquidity risk management policies and procedures at both the parent and subsidiary levels. Other covered SDs are not part of a large bank holding company or financial organization and have different, less sophisticated liquidity policies and procedures that are more suited to the type of swaps activities that they engage in with counterparties. Given the diversity of the provisionally-registered SDs, the Commission believes that it is not advisable to impose a single, mandated method of measuring liquidity needs at a covered SD, and the Commission has determined to defer the adoption of detailed quantitative liquidity requirements at this time. Commission staff will monitor covered SDs’ liquidity as part of its ongoing monitoring of the financial reporting submitted by covered SDs and will reassess the appropriateness of recommending to the Commission additional liquidity risk management requirements that are a supplement to, enhancement of, or replacement of, the E:\FR\FM\15SER3.SGM 15SER3 57512 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 current liquidity risk management requirements in regulation 23.600. Such additional liquidity requirements would be based upon the Commission staff’s assessment and experience with actual liquidity practices and procedures used by covered SDs and would be tailored to address any potential deficiencies or lapses in liquidity risk management. 9. Equity Withdrawal Restrictions for Covered SDs and Covered MSPs The 2016 Capital Proposal proposed to prohibit certain withdrawals of equity capital from covered SDs.375 The restrictions were based upon existing equity withdrawal restrictions for FCMs set forth in regulation 1.17(e). The Proposal generally provided that the capital of a covered SD, or any subsidiary or affiliate of the covered SD that has any of its liabilities or obligations guaranteed by the covered SD, may not be withdrawn by action of the covered SD or by its equity holders if the withdrawal, and any other similar transactions scheduled to occur within the succeeding six months, would result in the covered SD holding less than 120 percent of the minimum regulatory capital that the covered SD is required to hold pursuant to proposed regulation 23.101. The Proposal also included an exception permitting the covered SD to pay required tax payments and reasonable compensation to equity holders of the SD. In addition to the equity withdrawal restrictions, proposed regulation 23.104(d) authorized the Commission to issue an order to restrict for up to 20 business days the withdrawal of capital from a covered SD, or to prohibit the covered SD from making an unsecured loan or advance to any stockholder, partner, member, employee or affiliate of the covered SD. The Proposal further authorized the Commission to issue an order restricting or prohibiting the withdrawal of capital if, based upon the information available, the Commission concludes that the withdrawal, loan or advance may be detrimental to the financial integrity of the covered SD, or may unduly jeopardize the covered SD’s ability to meet its financial obligations to counterparties or to pay other liabilities which may cause a significant impact on the markets or expose the counterparties and creditors of the covered SD to loss.376 As noted in the Proposal, the proposed equity withdrawal restrictions 375 See 2016 Capital Proposal, 81 FR 91252 at 91275. 376 Id. The Proposal further provided that the covered SD may request a hearing on the order, which must be held within two business days of the date of the written request by the covered SD. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 discussed above are consistent with existing equity withdrawal restrictions imposed on FCMs and BDs, and with equity withdrawal restrictions adopted by the SEC for SBSDs.377 In addition, the grant of authority to the Commission to issue an order temporarily restricting certain unsecured loans or advances is consistent with the existing Commission authority under regulation 1.17(g)(1) for FCMs and with the SEC’s authority over BDs and SBSDs.378 Further, the Commission proposed to make the existing language of 1.17(g)(1) as applicable to FCMs more consistent with same language contained in final SEC equity withdrawal restrictions for BDs and SBSDs, and received no comments thereon. The Commission did not receive comments on the proposed equity withdrawal requirements. The Commission has considered the Proposal and for the reasons set out in the 2016 Proposal is adopting them with a minor modification. The equity withdrawal restrictions were proposed in paragraphs (c) and (d) of regulation 23.104. The Commission is redesignating paragraphs (c) and (d) of regulation 23.104 as paragraphs (a) and (b) in the final rule to reflect the removal of the proposed liquidity requirements in proposed regulation 23.104(a) and (b) as discussed above. The Commission is further adopting the amendment to 1.17(g)(1) as proposed to make the language of the FCM equity withdrawal order restriction consistent with the same language as effective for BDs and SBSDs, and now regulation 23.104 for SDs. 10. Leverage Ratio Requirements for Covered SDs The Commission requested comment in the 2019 Capital Reopening as to whether it would be appropriate for the Commission, at a future date after notice and comment, to revise the covered SD capital requirements by adopting a leverage ratio for SDs in lieu of the proposed percentage of the risk margin amount, if adopted as final. The Commission also requested comment on the cost, if any, in terms of additional required capital that a leverage ratio requirement would impose on a covered SD relative to the Net Liquid Assets Capital Approach, Bank-Based Capital 377 Equity withdrawal restrictions for FCMs are set forth in Commission regulation § 1.17(e) (17 CFR 1.17(e)), and for BDs are set forth in SEC rule 15c3– 1(e)(2) (17 CFR 240.15c3–1(e)(2)). SEC equity withdrawal restrictions for SBSDs are contained in SEC rule 18a–1(h)(2) (17 CFR 240.18a–1(h)(2)). 378 See SEC rule 15c3–1(e)(3) (17 CFR 240.15c3– 1(e)(3)) for BDs and rule 18a–1(h)(3) (17 CFR 240.18a–1(h)(3)) for SBSDs. PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 Approach, and Tangible Net Worth Capital Approach, and how the adoption of a leverage ratio requirement would affect the efficiency, competitiveness, integrity, safety and soundness, and price discovery of the swap markets.379 Commenters generally opposed the adoption of a leverage ratio. One commenter stated that while leverage ratios have been argued to serve as effective backstops to guard against miscalculations of market risk or credit risk, leverage ratios are very blunt instruments that create perverse incentives.380 This commenter noted that a leverage ratio would discourage a covered SD from maintaining a reserve of safer, lower-yielding, securities and cash positions, despite the liquidity and safety and soundness benefits of such instruments.381 The Commission is not adopting a leverage ratio as part of its capital requirements at this time. D. Swap Dealer and Major Swap Participant Financial Recordkeeping, Reporting and Notification Requirements. Section 4s(f) of the CEA requires SDs and MSPs to make any reports regarding transactions and positions, as well as any reports regarding financial condition, that the Commission adopts by rule or regulation.382 Consistent with section 4s(f), the Commission proposed new regulation 23.105, which require SDs and MSPs to satisfy current books and records requirements, ‘‘early warning’’ and other notification filing requirements, and periodic and annual financial report filing requirements with the Commission and with any RFA of which the SDs and MSPs are members. The notice and financial reporting requirements proposed by the Commission differentiate covered SDs and covered MSPs from bank SDs and bank MSPs.383 For covered SDs and covered MSPs, the Commission proposed a financial reporting, notification and recordkeeping approach that was modelled after the existing reporting regimes followed by FCMs and BDs, and that was proposed by the SEC for SBSDs. Where applicable, the Commission proposed flexibility for foreign-domiciled SDs and MSPs recognizing that a significant number of these SDs and MSPs would likely be subject to existing financial 379 See 2019 Capital Reopening, 84 FR 69664 at 69669. 380 See IIB/ISDA/SIFMA 3/3/2020 Letter. 381 Id. 382 7 U.S.C. 6s(f). 383 See proposed Commission regulation § 23.105(a)(2); 2016 Capital Proposal, 81 FR 91252 at 91318. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 reporting requirements. For bank SDs and bank MSPs, the Commission proposed more limited requirements as the financial condition of these entities will be predominantly supervised by the applicable prudential regulator and subject to its capital and financial reporting requirements. The recordkeeping, reporting and notification requirements in the 2016 Capital Proposal were intended to facilitate effective oversight over the Commission’s capital requirements and improve internal risk management, via requiring robust internal procedures for creating and retaining records central to the conduct of business as an SD or MSP.384 The 2016 Capital Proposal proposed to require covered SDs and covered MSPs to, among other things: (i) Maintain current ledgers and other similar records summarizing transactions affecting their assets, liabilities, income, and expenses; (ii) file notices of certain events with the Commission, including notices of failing to comply with the applicable minimum capital requirements; (iii) file monthly unaudited and annual audited financial statements with the Commission; and (iv) provide the Commission with additional information as requested.385 The Proposal also required bank SDs and bank MSPs to file certain information with the Commission. Such information included: (i) Quarterly statements of financial condition, regulatory capital computations, and aggregate swaps position information; (ii) notice filings, including notice of a failure to maintain the minimum applicable capital requirement; and (iii) additional information as requested by the Commission.386 The Commission received several detailed comments regarding the 2016 proposed financial reporting, notification and recordkeeping requirements. Several commenters noted the importance of harmonizing the Commission’s financial reporting and notification requirements with the requirements of other regulators, namely the SEC and the prudential regulators.387 Commenters generally supported the Commission’s approach of permitting non-U.S. SDs and MSPs to use International Financial Reporting Standards (‘‘IFRS’’) in lieu of U.S. GAAP in the preparation of required financial statements, but some asked that the Commission remove the foreign 384 See 2016 Capital Proposal, 81 FR 91252 at 91295. 385 See Proposed Commission regulation § 23.105; 2016 Capital Proposal, 81 FR at 91252 at 91318– 22. 386 Id. 387 See SIFMA 5/15/17 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 domicile requirement to use IFRS.388 Several commenters to the Proposal also expressed concern that the 60-day timeline for annual certified financial statement reporting was not practical for many large non-financial companies as they are typically permitted to provide audited financial statements within 90 days of the end of their fiscal year.389 Other commenters expressed concern for the weekly position reporting requirements.390 Several covered SDs that are subsidiaries of non-financial public companies requested that the posting period for public disclosures be extended or eliminated altogether, noting that additional time would be necessary to allow for internal and external auditors to review the information.391 In the 2019 Capital Reopening, the Commission asked several additional questions in response to these comments. The Commission specifically asked whether the IFRS requirement should be expanded to include a broader set of eligible covered SDs and whether the annual audit reporting timelines for certain covered SDs should be lengthened to 90 days.392 The Commission also asked whether it should harmonize certain requirements, including the public disclosure timelines of bank SDs, with the finalized reporting, notification and recordkeeping requirements of SBSDs adopted by the SEC.393 The Commission received several comments in response to the questions.394 Certain commenters stated that the Commission should permit nonU.S. covered SDs and U.S. covered SDs that are subsidiaries of non-U.S. parent companies to use IFRS, one stating that there would be no material difference in its financial statements if they were produced under IFRS versus GAAP.395 Several commenters did not believe that the Commission should adopt the weekly margin position reporting requirements, citing that information required under the reporting is 388 See, e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter. 389 See, e.g., Shell 5/15/17 Letter; Cargill 5/15/17 Letter. 390 See MS 5/15/17 Letter at 9; SIFMA 5/15/17 Letter at 29. 391 See Shell 5/15/17 Letter; NCGA/NGSA 5/15/ 2017 Letter; and CEWG 5/15/2017 Letter. 392 See 2019 Capital Reopening, 84 FR 69664 at 69678 (Dec. 19, 2019). 393 Id. See also, Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers, 84 FR 68550 (Dec. 16, 2019). 394 Shell Trading 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 Letter. 395 See Shell 3/3/2020 Letter at 3: CEWG 3/3/2020 Letter at 5–6; NCGA/NGSA 3/3/2020 at 6–7; IIB/ ISDA/SIFMA 3/3/2020 Letter at 52. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 57513 duplicative of information received or proposed to be received under the Commission proposed part 45 data requirements.396 Several commenters also stated that the Commission should harmonize public disclosure requirements with those adopted by the SEC for stand-alone SBSDs.397 One commenter stressed that the Commission should not adopt any financial reporting requirements for bank SDs, and that covered SDs following the Bank-Based Capital Approach should be subjected to the same reporting timeline (45 days after quarter end) as a bank.398 After considering those comments and in light of the final financial reporting, notification and recordkeeping requirements for MSBSP and SBSDs adopted by the SEC,399 the Commission is adopting the recordkeeping, notice and financial reporting requirements as proposed with the following modifications. 1. Routine Financial Reporting and Recordkeeping Requirements Proposed regulation 23.105(b) required a covered SD or a covered MSP to prepare current ledgers or other similar records showing or summarizing each transaction affecting its asset, liability, income, expense, and capital accounts.400 The accounts must be classified in accordance with U.S. GAAP provided, however, that if the covered SD or covered MSP is organized under the laws of a foreign jurisdiction and is not otherwise required to prepare its records or financial statements in accordance with U.S. GAAP, the SD or MSP may prepare the required records in accordance with IFRS issued by the International Accounting Standards Board.401 The Commission also proposed to require covered SDs and covered MSPs to file periodic financial 396 See NCGA/NGSA 3/3/2020 Letter; IIB/ISDA/ SIFMA 3/3/2020 Letter at 53. 397 See CEWG 3/3/2020 Letter at 6; IIB/ISDA/ SIFMA 3/3/2020 Letter. 398 See IIB/ISDA/SIFMA 3/3/2020 Letter at 50–51. 399 Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major SecurityBased Swap Participants, and Broker-Dealers, 84 FR 68550 (Dec. 16, 2019). 400 These proposed requirements are based upon existing FCM and BD financial recordkeeping and reporting requirements. Commission regulation § 1.18 (17 CFR 1.18) requires each FCM to prepare and keep current ledgers or other similar records which show or summarize, with appropriate references to supporting documents, each transaction affecting its asset, liability, income, expense and capital accounts. SEC rule 17a–3 (17 CFR 240.17a–3) requires a BD to make and maintain comparable ledgers and other similar records reflecting its assets, liabilities, income and expenses. 401 FCMs are required to classify accounts only in accordance with U.S. GAAP. E:\FR\FM\15SER3.SGM 15SER3 57514 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 reports with the Commission and with the SDs’ or MSPs’ RFA.402 In proposed regulation 23.105(d)(2) and (e)(3), the monthly unaudited and annual audited financial statements must also be prepared in accordance with U.S. GAAP, provided, however, that the Commission proposed to permit covered SDs or covered MSPs that are organized and domiciled outside of the U.S., and otherwise are not required to prepare financial statements in accordance with U.S. GAAP, to prepare the financial statements in accordance with IFRS or another local accounting standard, after requesting approval by the Commission, which is discussed below, in lieu of U.S. GAAP.403 Commenters generally supported the Commission’s approach of permitting non-U.S. covered SDs and covered MSPs to use IFRS in lieu of U.S. GAAP in the preparation of required financial statements. However, several commenters requested that the proposed regulation be modified to permit U.S.based covered SDs that are subsidiaries of non-U.S. parent entities to prepare required financial statements in accordance with IFRS.404 These commenters stated that U.S. covered SDs that are subsidiaries of foreignbased holding companies may prepare their financial statements in accordance with IFRS as the subsidiary is consolidated with the parent in producing the parent’s consolidated financial statements, and further stated that requiring U.S. GAAP financial statements in such situations would impose unnecessary costs on covered SDs without providing substantial enhancements to the regulatory objectives.405 Three commenters to the 2019 Capital Reopening stated that the Commission should permit non-U.S. covered SDs and U.S. covered SDs that are subsidiaries of non-U.S. parent companies to use IFRS, one stating that there would be no material difference in its financial statements if they were 402 As noted in the proposal, these periodic financial reporting requirements are consistent with existing requirements for FCMs and BDs. See Commission regulation § 1.10 (17 CFR 1.10), which requires FCMs to submit unaudited monthly and audited annual financial reports to the Commission and to the FCMs’ respective designated selfregulatory organization. SEC rule 17a–5 (17 CFR 240.17a–5) directs BDs to file unaudited monthly reports and annual audited reports with the SEC. 403 See proposed Commission regulations §§ 23.105(d)(2) and (e)(3), 2016 Capital Proposal, 81 FR at 91252 at 91319. Commission regulation § 1.10 (17 CFR 1.10) provides that FCMs must present its unaudited monthly reports and audited annual reports in accordance with U.S GAAP. 404 See, e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter. 405 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 prepared in accordance with IFRS versus U.S. GAAP.406 The Commission is adopting regulation 23.105(b), (d)(2) and (e)(3) as proposed with the exception of a modification to the eligibility requirement for the use of IFRS to address concerns raised by commenters. The Commission is generally comfortable with both U.S. GAAP and IFRS accounting standards for covered SDs and covered MSPs, especially as both standards continue to move towards greater convergence. However, the Commission’s preference continues to be U.S. GAAP, and therefore, the Commission is requiring that covered SDs or covered MSPs that are not included in the exception described below, must prepare their financial statements in accordance with U.S. GAAP. In response to commenters, the Commission has removed the requirement that an eligible covered SD or covered MSP must be domiciled outside the U.S in order to be permitted to use IFRS. However, all covered SDs and covered MSPs that are also registered as FCMs or BDs must continue to prepare their financial statements in accordance with U.S. GAAP and are not eligible to use IFRS. The Commission notes that foreign domiciled covered SD or covered MSP may also apply under final regulation 23.106 for a Capital Comparability Determination and has retained language in regulation 23.105(o) to make clear that such a determination could consider different, yet comparable financial reporting requirements including the use of a local accounting standard other than U.S. GAAP or IFRS. The Commission proposed in regulation 23.105(d)(1) to require a covered SD or covered MSP to file a monthly unaudited financial report within 17 business days of the close of business each month, and proposed in regulation 23.105(e)(1) to require a covered SD or covered MSP to file an annual audited financial report within 60 days of the close of the SD’s or MSP’s fiscal year-end date. Proposed regulation 23.105(e)(2) required the annual financial statements to be audited by a public accountant that is in good standing in the accountant’s home country jurisdiction.407 406 See Shell 3/3/2020 Letter at 3: CEWG 3/3/2020 Letter at 5–6; NCGA/NGSA 3/3/2020 at 6–7; IIB/ ISDA/SIFMA 3/3/2020 Letter at 52. 407 The monthly unaudited and the annual audited financial reports must be prepared in the English language and denominated in U.S. dollars. The proposal also required that the monthly unaudited and annual audited financial reports include: (1) A statement of financial condition; (2) a statement of income or loss; (3) a statement of PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 The 2019 Capital Reopening asked several questions regarding whether it would be appropriate to expand the 60day annual audit reporting requirement.408 In response, the Commission received several comments advocating for extending the financial reporting timelines in general, not just the 60-day audit requirement. One commenter requested that the Commission permit covered SDs that elect to use the Bank-Based Capital Approach to submit quarterly reports, as opposed to monthly, and that such reports should be filed within 45 days of the end of the quarter, as is currently required of banks and bank holding companies by regulations of prudential regulators.409 Another commenter supported the proposition that monthly financial reporting be eliminated for non-bank covered SDs.410 Other commenters supported an extension of the annual audited financial statement requirement from 60 to 90 days after the end of the covered SD’s fiscal year.411 As noted in the Proposal, the timing of the proposed financial reporting requirements is consistent with the existing requirements for FCMs, which is harmonized with that required of BDs and SBSDs by the SEC.412 Timely financial reporting is the Commission’s primary method for routine monitoring for compliance with the Commission’s capital rule across multiple registrants. The Commission does not expect this timing to be operationally challenging for non-commercial covered SDs, as many of these registrants already prepare financial reports within the organization on a routine basis. In addition, several of these firms are expected to be dually registered with the SEC as either a SBSD or BD, and will be subject to a monthly financial reporting requirement and 60-day reporting timeline for annual audited financial statements.413 On the other hand, covered SDs eligible to use the Tangible Net Worth Capital Approach and who are not dually-registered with the SEC could engage in a wide variety of business cash flows; (4) a statement of changes in ownership equity; (5) a statement of the applicable capital computation; and (6) any further materials that are necessary to make the required statements not misleading. Proposed Regulation 23.105(e)(4)(iii) would further require that the annual audited financial statements also include any necessary footnote disclosures. See 2016 Capital Proposal, 81 FR 91252 at 91320. 408 2019 Capital Reopening at 69679. 409 See IIB/ISDA/SIFMA 3/3/2020 Letter at 52. 410 See NCGA/NGSA 3/3/2020 at 6. 411 See NCGA/NGSA 3/3/2020 at 6. 412 See Commission regulation § 1.10(b) (17 CFR 1.10(b)), and 17 CFR 240.17a–5, and 240.18a–7. 413 See 17 CFR 240.18a–7(a)(1) and (c)(5). E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 operations and may be closely held corporations, partnerships or subsidiaries thereof. These covered SDs may not be subject to routine reporting requirements and could require longer periods to perform year-end audit requirements based on the composition of their balance sheet and financial statements. Therefore, the Commission is modifying the timeline for commercial firms by moving the monthly unaudited requirement to a quarterly requirement, and expanding the annual audit timeline for these firms to 90 days. This expanded approach will only be available to covered SDs that elect the Tangible Net Worth Capital Approach under regulation 23.101(a)(2). The Commission notes that regardless of a covered SD’s reporting timeline or elected approach, compliance with the Commission’s capital rule is an ‘‘at all times’’ requirement. As such, covered SDs should routinely monitor their capital position and notify the Commission and its RFA of material changes in accordance notification requirements discussed herein. In this regard, regulation 23.105(h) provides that the Commission or RFA may, by written notice, require any covered SD or covered MSP to file financial or operational information to the Commission or RFA.414 Accordingly, covered SDs and covered MSPs eligible to file financial information on a quarterly basis in accordance with regulation 23.105(d), may be required by the Commission or RFA to furnish such information on a monthly or more frequent basis as provided by such notices under regulation 23.105(h). As such, covered SDs and covered MSPs should therefore maintain their books and records in a manner capable of furnishing such information upon request by the Commission or RFA under a written notice issued under regulation 23.105(h) and to be able to demonstrate compliance with notification requirements under regulation 23.105(c). Therefore, the Commission is adopting the financial reporting process and timelines for covered SDs as proposed in regulation 23.105(d)(1), 23.105(e)(1), and 23.105(h) with the modifications discussed above for covered SDs and covered MSPs 414 As discussed in the 2016 Capital Proposal, the Commission’s intention is to require all covered SDs and covered MSPs to file financial reports and notices required under regulation 23.105 with both the Commission and the RFA. As noted, this is consistent with the existing approach under Commission regulations §§ 1.10 and 1.12 (17 CFR 1.10 and 1.12) applicable to FCMs and IBs. Regulation 23.105(h) and elsewhere in regulations 23.105(c), (d), and (e), have been modified to clarify such reporting requirements. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 eligible to use the Tangible Net Worth Capital Approach and regarding furnishing additional reports as requested by the Commission or RFA. The Commission also proposed in regulation 23.105(d)(3), (4) and (e)(5) to permit a covered SD or covered MSP that is registered with the Commission as an FCM or registered with the SEC as a BD to satisfy the Commission’s SD or MSP financial statement reporting requirements by submitting a CFTC Form 1–FR–FCM or its applicable SEC Financial and Operational Combined Uniform Single (‘‘FOCUS’’) Report in lieu of the specific financial statements required under proposed regulation 23.105.415 Similarly, the Commission proposed to permit covered SDs and covered MSPs dually registered with the SEC as either SBSDs or MSBSPs to comply with the Commission’s financial reporting and notification requirements under regulation 23.105 by filing simultaneously with the Commission all applicable notices or reports required under the SEC’s rules.416 This proposed framework is consistent with the Commission’s long history of permitting SEC registrants to meet their financial statement filing obligations with the Commission by submitting a FOCUS Report in lieu of CFTC Form 1–FR–FCM and reduces the burden on dually registered firms by not requiring two separate financial reporting requirements. The SEC finalized reporting requirements which require SBSDs and MSBSPs to file a FOCUS form X–17A– 5 Part II, no longer requiring a separate FORM SBS as proposed.417 The 415 FCMs are required to file monthly unaudited and annual audited Forms 1–FR–FCM with the Commission and with their designated selfregulatory organization. The Forms 1–FR–FCM include, among other information, a statement of financial condition, a statement of income or loss, a statement of changes in ownership equity, a statement of liabilities subordinated to the claims of general creditors, a statement of the computation of regulatory minimum capital, and any further information as may be necessary to make the required statements not misleading. See Commission regulation § 1.10(d) (17 CFR 1.10(d)). SEC FOCUS Reports are required to contain, among other statements and information, a statement of financial condition, a statement of income or loss, a statement of changes in ownership equity, a statement of liabilities subordinated to the claims of general creditors, and a statement of the computation of regulatory minimum capital. See SEC rule 17a–5 (17 CFR 240.17a–5). 416 See Commission regulation § 23.105(c)(5) (17 CFR 23.105(c)(5)) referencing proposed 17 CFR 240–18a–8 for notification requirements for SBSDs and MSBSPs. See § 23.105(d)(3) and § 23.105(e)(5) (17 CFR 23.105(d)(3) and 23.105(e)(5)) referencing proposed 17 CFR 240.18a–7, for monthly and annual financial reporting requirements for SBSDs and MSBSPs. 417 See Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 57515 Commission is not changing its approach permitting dual registrants the ability to file SEC forms in lieu of the financial reporting and notification requirements of the CFTC. Accordingly, regulation 23.105(d) and (e) have been modified to permit these dual registered covered SDs to file FOCUS reports as discussed in lieu of the Commission’s financial reporting requirements. The Commission has made further technical modifications to the general financial reporting requirements to align them with existing rules for FCMs and dually-registered SBSDs and BDs. The Commission is making these modifications to prevent different treatment between dually-registered SDs and stand-alone SDs. The Commission is modifying regulation 23.105(d) to remove the statement of cash flows, as this schedule is not necessary to assess the financial condition and safety and soundness of the covered SD, nor required of existing FCMs under regulation 1.10 or for BDs under 17 CFR 240.17a–5. For the same reasons, regulation 23.105(d) is also modified to include a statement of changes in liabilities subordinated to the claims of general creditors and references to the annual audited or certified financial report throughout regulation 23.105 have been renamed annual financial report. The Commission has also included references to SEC rule § 240.17a–5 to paragraphs (d)(3) and (e)(5) of regulation 23.105, as SBSDs and MSBSPs which are dually-registered BDs file financial reports in accordance with that rule. The Commission did not receive comments on the other aspects not discussed herein in regards to regulation 23.105(d) and (e) and is adopting such provisions substantially as proposed. 2. Swap Dealer and Major Swap Participant Notice Requirements The 2016 Capital Proposal required SDs and MSPs to file certain regulatory notices with the Commission and with the RFA of which the SDs or MSPs are members if certain defined events occurred.418 Certain of the notice provisions applied solely to covered SDs and covered MSPs, while other notice provisions applied solely to bank SDs and bank MSPs. The Commission also proposed notice provisions that applied to all registered SDs and MSPs. The proposed notice provisions were based on the existing notice provisions Broker-Dealers, 84 FR 68550 (December 16, 2019). See SEC rule 18a–7 (17 CFR 240.18a–7), 84 FR 68550 at 68662–67; SEC rule 18a–10 (17 CFR 240.18a–10), 84 FR 68550 at 68668–69. 418 See 2016 Capital Proposal, 81 FR 91252 at 91277–78. E:\FR\FM\15SER3.SGM 15SER3 57516 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 applicable to FCMs, and are intended to require registrants to provide the Commission and RFA with notice of certain events that may indicate that the registrants are experiencing an actual or a potential adverse event, affecting their financial or operational condition.419 Upon filing of a notice, the Commission or an RFA would initiate an inquiry, including engaging directly with the SD or MSP as necessary, to assess if the notice is an indication of potential issues with the registrant regarding its ability to meet its obligations to customers, counterparties, clearing organizations, creditors, and the marketplace in general. The Commission proposed in regulation 23.105(c) to require a covered SD or a covered MSP to provide the Commission and RFA with immediate written notice when the firm is: (i) Undercapitalized; (ii) fails to maintain capital at a level that is in excess of 120 percent of its minimum capital requirement; or (iii) fails to maintain current books and records. Proposed regulation 23.105(c) also required a covered SD or covered MSP, as applicable, to provide notice to the Commission and to an RFA within 24 hours of: (i) Failing to comply with the liquidity requirements under proposed regulation 23.104, (ii) experiencing a 30 percent reduction in capital as compared to the last reported capital in a financial report filed with the Commission, or (ii) failing to post or collect initial margin for uncleared swap and security-based swap transactions or exchange variation margin for uncleared swap or security-based swap transactions as required by the Commission’s uncleared swaps margin rules or the SEC’s uncleared securitybased margin rules, respectively, if the total amount that has not been exchange is equal to or greater than: (1) 25 percent of the SD’s or MSP’s required capital under final regulation 23.101 calculated for a single counterparty or group of counterparties that are under common ownership or control; or (2) 50 percent of the SD’s or MSP’s required capital under final regulation 23.101 calculated for all of the SD’s counterparties.420 Proposed regulation 23.105(c) also required a covered SD or covered MSP to provide the Commission and an RFA with a minimum two days advance notice of an intention to withdraw 419 See Commission regulation § 1.12 (17 CFR 1.12), which requires FCMs to file notices with the Commission and with the FCMs’ designated selfregulatory organizations of certain events, including a firm being undercapitalized or failing to maintain current books and records. 420 See Commission regulations §§ 23.152 and 23.153 (17 CFR 23.152 and 23.153). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 capital by an equity holder that would exceed 30 percent of the SD’s or MSP’s excess regulatory capital.421 Finally, the proposal required a covered SD or covered MSP that is dually-registered with the SEC as an SBSD or MSBSP to file with the Commission and with its RFA a copy of any notice that the SBSD or MSBSP is required to file with the SEC under SEC Rule 18a–8 (17 CFR 240.18a–8). SEC Rule 18a–8 requires SBSDs and MSBSPs to provide written notice to the SEC for comparable reporting events as proposed by the Commission in regulation 23.105(c), including if a SBSD or MSBSP is undercapitalized or fails to maintain current books and records.422 The Commission proposed to require covered SDs and covered MSPs that are dually-registered with the SEC to file copies with the Commission of notices filed with the SEC under Rule 18a–8 to allow the Commission to be aware of any events that may indicate that the SD or MSP is unable to meet its operational or financial obligations on an ongoing basis. The Commission did not receive comments on the proposed notice provisions in regulation 23.105(c). The Commission has considered the proposal, and is adopting the SD and MSP notice requirements as proposed, with a modification to eliminate the notice provision relating to liquidity requirements that the Commission did not adopt. 3. Swap Dealers and Major Swap Participants Subject to the Capital Rules of a Prudential Regulator The Commission proposed limited financial reporting for bank SDs and bank MSPs that are subject to the capital requirements of a prudential regulator, as these SDs and MSPs are already subject to existing financial reporting requirements by such prudential regulator. As such, the Commission did not propose to require a bank SD or bank MSP to file monthly unaudited or annual audited financial statements with the Commission or with the RFA of which the SD or MSP is a member. The Commission also did not propose to require such bank SDs or bank MSPs to file notifications contained in Regulation 23.105(c) with the Commission or with an RFA. The Commission did, however, propose to require bank SDs and bank MSPs to file 421 The term ‘regulatory capital’’ is defined in proposed Commission regulation § 23.100 and means the relevant capital approach applicable to the SD under proposed Commission regulation § 23.101. See 2016 Capital Proposal, 81 FR 91252 at 91309–11. 422 See 17 CFR 240.18a–8. PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 quarterly unaudited financial reports. The Commission also proposed certain regulatory notices that bank SDs and bank MSPs must file with the Commission and with an RFA. Under the Proposal, bank SDs and bank MSPs were required to file financial reports and specific position and margin information with the Commission and with the RFA of which the SDs and MSPs are members within 17 business days of the end of each calendar quarter. The financial reports and specific position information that would be required under this requirement was set forth in a separate Appendix B to proposed Regulation 23.105(p). The information required on Appendix B was intended to be identical to that required by the SEC for SBSDs subject to the capital rules of a prudential regulator.423 These quarterly unaudited reports filed with the Commission were largely based on existing ‘‘call reports’’ that the bank SDs and bank MSPs are required to file with their respective prudential regulator.424 In addition, proposed regulation 23.105(p) required bank SDs and bank MSPs to file certain notices with the Commission and their RFA following the occurrence of certain events. Proposed regulation 23.105 (p)(3)(i) required a bank SD or bank MSP to file a notice with the Commission and with an RFA if the SD or MSP filed a notice of change of its reported capital category with the Federal Reserve Board, the OCC, or the FDIC. Proposed regulation 23.105(p)(3) also required a bank SD that is a foreign bank to notify the Commission if the SD files a notice of a change in its capital category or a notice of falling below its minimum capital requirement with a prudential regulator or with its home country supervisor.425 Proposed regulation 23.105(p)(3) also required a bank SD or bank MSP to file notices in the event the SD or MSP fails to post or collect initial margin for uncleared swap transactions 423 See 2016 Capital Proposal, 81 FR 91252 at 91279. 424 See proposed Commission regulation § 23.105(p) and Appendix B; 2016 Capital Proposal, 81 FR 91252 at 91321–22 and 91329–32. See also, Consolidated Reports of Condition and Income for a Bank with Domestic and Foreign Offices (‘‘call reports’’); 12 U.S.C. 324; 12 U.S.C. 1817; 12 U.S.C. 161; and 12 U.S.C. 1464. The proposed financial reporting requirement was consistent with the SEC proposed filing requirement for SBSDs that are subject to the capital rule of a prudential regulator. See proposed SEC rule 17 CFR 240.18a–8. Specifically, the Commission proposed that the SDs and MSPs submit to the Commission Appendix B of proposed Commission regulation § 23.105, which is largely based on the SEC’s proposed Form SBS part 2 and part 5. 425 These notices are identical to those finalized for SBSDs by the SEC in 17 CFR 240.18a–8(c). E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 or post or collect uncleared swap variation margin as required under the respective prudential regulators’ rules subject to certain thresholds.426 Finally, proposed regulation 23.105(p) also included an identical oath and affirmation provisions and electronic filing requirements for bank SDs and bank MSPs as the Commission proposed under paragraphs (f) and (n) of regulation 23.105 for covered SDs and covered MSPs. The 2019 Capital Reopening noted that the SEC finalized its recordkeeping, reporting and notification requirements for SBSDs and MSBSPs, which include requiring SBSDs and MSBSPs subject to the capital rules of a prudential regulator to report quarterly unaudited financial information and provide notices of change in its capital category or falling below its minimum capital requirement with the a prudential regulator.427 The 2019 Capital Reopening asked whether it was appropriate to make specific changes to proposed regulation 23.105(p) Appendix B in this regard, and to make such schedule align with that finalized by the SEC under Form X–17a–5 FOCUS Part IIC.428 Several commenters noted that the 17 business day timeline for the quarterly unaudited financial reporting requirement for bank SDs and bank MSPs was inconsistent with existing banking requirements which permit between a 30-day or 45 calendar day timeline depending on size. In addition, the SEC amended their requirements for SBSDs subject to the capital rules of a prudential regulator to 30 calendar days, making slight adjustments to the schedules in order to make them more consistent with existing call reports. As noted previously, the Commission wishes to harmonize the reporting requirements for bank SDs and bank MSPs to the maximum extent practicable. The Commission is modifying final regulation 23.105(p) to require a 30 calendar day reporting timeline comparable to that required by SBSD subject to the capital rules of a prudential regulator. The Commission is also adopting the notification requirements relating to the notices of change in capital category or failing below its minimum capital requirement with a prudential regulator. The Commission, however, is not adopting the additional requirements relating to 426 These notices are identical to those required for SDs and MSPs subject to the capital rules of the Commission and proposed under 23.105(c). See 2016 Capital Proposal, 81 FR 91252 at 91318. 427 See 17 CFR 240.18a–7(a)(2) and 240.18a–8(c). 428 2019 Capital Reopening, 84 FR 69664 at 69680. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 posting and collecting of initial and variation margin under certain thresholds as these notices are not required for SBSDs subject to the rules of a prudential regulator. The Commission further notes in this regard that bank SDs and bank MSPs are also not subject to the Commission’s rules for uncleared margin. The Commission is making technical amendments to the Appendix B to align the schedule with that required of SBSD subject to the capital requirements of a prudential regulator under FORM x–17a–5 FOCUS Part IIC, which have been aligned primarily with FFIEC Form 031. 4. Public Disclosures The Commission proposed to require covered SDs and covered MSPs to provide public disclosure on their website of required financial reporting, including a statement of financial condition and of the amount of minimum regulatory capital required and the amount of regulatory capital of the SD or MSP no less than quarterly, with the same information provided from an audited financial statement no less than annually.429 The Commission also proposed to require bank SDs and bank MSPs to make publically available no less than quarterly similar financial information.430 In both instances, the proposed public disclosures were required to be posted to the SD’s or MSP’s website within ten business days after the SD or MSP is required to file the financial information with the Commission. The Commission noted in the 2016 Capital Proposal that its approach was consistent with the financial reporting information the Commission had previously determined should not qualify as exempt from the Freedom of Information Act for FCMs.431 For bank SDs and bank MSPs, the Commission noted the Proposal was consistent with publically available information provided by bank entities in call reports.432 Several covered SDs that are subsidiaries of public companies requested that the posting period on firm’s website be extended from ten days to 20 days for the quarterly information, noting that additional timeframe would be necessary to allow for internal and external auditors to 429 See Proposed Commission regulation § 23.105(i)(3); 2016 Capital Proposal, 81 FR 91252 at 91320. 430 See Proposed Commission regulation § 23.105(p)(7); 2016 Capital Proposal, 81 FR 91252 at 91322. 431 See 2016 Capital Proposal, 81 FR 91252 at 91277. 432 Id. PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 57517 review the information.433 One commenter stated that public disclosure of financial reports will be onerous for commercial covered SDs, while others requested elimination of public disclosures by bank SDs.434 In the 2019 Capital Reopening, the Commission asked questions regarding the practicality of moving the posting deadline from ten business days to 30 calendar days to be consistent with the final requirements adopted by the SEC for SBSDs. Further, the Commission asked whether it was appropriate to remove the public disclosure requirement for bank SDs and bank MSPs under the rationale that this information is already provided to the public on a timely basis as a result of separate disclosure requirements imposed by the prudential regulators.435 In response, commenters confirmed that a longer period for public disclosure would be preferred and that imposing an additional Commission requirement for bank SDs is duplicative and would override existing balances that were struck.436 One commenter suggested harmonizing the public disclosure requirement for stand-alone SDs with the biannual requirement required by the SEC for stand-alone SBSD.437 Another commenter recommended that an exemption be provided for commercial firms which meet a certain threshold of minimum capital.438 The Commission believes that is best to harmonize public disclosure requirements to the maximum extent practicable with that required of SBSDs by the SEC. Thus, the Commission is not adopting public disclosure requirements for bank SDs and bank MSPs as these SDs and MSPs will already be providing public disclosures of key financial information as part of the ‘‘call report’’ process. Covered SDs and covered MSPs will be required to bi-annually make available on its website basic financial information 30 calendar days following when such information is filed with the Commission. This approach will harmonize the Commission’s public disclosure requirements with those required of the stand-alone SBSDs under 17 CFR 240.18a–7(b). Therefore, the Commission is not adopting proposed regulation 23.105(p)(7) 433 See Shell 5/15/17 Letter; NCGA/NGSA 5/15/ 2017 Letter; CEWG 5/15/2017 Letter. 434 See Shell 5/15/17 Letter; SIFMA 5/15/17 Letter; MS 5/15/17 Letter. 435 See 2019 Capital Reopening, 84 FR 69664 at 69680, questions 13–a and 13–b. 436 See NCGA/NGSA 3/3/2020 Letter at 6; IIB/ ISDA/SIFMA 3/3/2020 Letter at 52. 437 See Shell 3/3/2020 Letter at 4. 438 See Cargill 3/3/2020 Letter at 3. E:\FR\FM\15SER3.SGM 15SER3 57518 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 regarding public disclosures requirements for bank SDs and bank MSPs. The Commission is adopting regulation 23.105(i) as proposed with modification to the timelines as discussed above. 5. Electronic Filing Requirements for Financial Reports and Regulatory Notices Proposed regulation 23.105(n) required all notifications and financial statement filings submitted to the Commission pursuant to regulation 23.105 to be filed in an electronic manner using a user authentication process approved by the Commission. Proposed regulation 23.105(f) and (p) required each filing made pursuant to Regulation 23.105 include an oath or affirmation signed by an appropriate SD or MSP personnel that the information provided in the filing was true and correct. The Commission notes that many SDs and MSPs are already familiar with the Commission approved WinJammer filing system maintained jointly by NFA and Chicago Mercantile Exchange. WinJammer currently allows Commission registrants that are authorized to use the electronic system to file financial reports and notices with the Commission and NFA simultaneously. The Commission views this system, as well as other future Commission approved systems, as the most effective way to ensure that the filings required under proposed regulation 23.105 would be submitted promptly and directly to the Commission. One commenter to the 2016 Proposal asked that the Commission provide clarity with the requirements of the oath or affirmation.439 Another commenter, while generally supportive of the proposed requirements, encouraged the Commission to either adopt standard forms or mandate that the financial filings be accomplished in a form and manner prescribed by an RFA.440 This commenter further suggested that the Commission consider the SEC’s final adopted forms as a starting point for the Commission’s forms and encouraged the Commission to parallel any financial reporting requirements for prudentially regulated SDs and those relying on substituted compliance with the SEC’s filing requirements for these firms.441 As with other requirements regarding financial reporting for SDs and MSPs, the Commission wishes to harmonize these rules to the maximum extent practicable with that adopted by the 439 SIFMA 440 NFA 5/15/17 Letter at 28. 3/2/2020 Letter at 6, 7. 441 Id. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 SEC. The Commission expects that those registrants that are duallyregistered with the SEC as either BDs or SBSDs, including those that are also subject to the capital rules of a prudential regulator, would fully comply with the Commission’s reporting requirements by filing forms adopted by the SEC. Accordingly, to ensure that bank SD or bank MSP duly registered with the SEC will not be subject to two separate filing requirements, the Commission is amending 23.105(p) by including a provision that a bank SD or bank MSP may file a Form X–17A–5 FOCUS Part IIC in lieu of the forms required under 23.105(p). The Commission wishes to add clarity that while it is adopting specific schedules in Appendix A and B with regard to swap position information, it is not adopting a standard form for the other routine monthly or annual filing requirements as discussed above.442 Nonetheless, the Commission may approve additional procedures developed by an RFA, which could include standard forms or procedures necessary to carry out the Commission’s filing requirements. The Commission notes that an RFA is required to adopt minimum capital, segregation, and other financial requirements applicable to its members, in accordance with section 17(p)(2) of the CEA. In this regard, each self-regulatory organization, which includes an RFA, must have minimum financial and related reporting requirements that are the same as or more stringent than the Commission’s requirements.443 The Commission is not modifying the proposed language related to the oath or affirmation that financial reports be true and correct. This language is identical to that required in regulation 1.10(d)(4) and that is required by the SEC in 240.17a– 5(e)(2) and 240.18a–7(d)(1). In order to ensure that the oath and affirmation is harmonized with SEC for duly registered SBSDs, the Commission is modifying the application of the oath or affirmation to only apply to financial reports, and not to notice or other filings as proposed. For the same reasons, the Commission is modifying the language that for corporations, the oath and affirmation must be signed by the duly 442 Please note that due to changes in Federal Register publication requirements, the appendices that had been referred to as Appendix A to section 23.105 and Appendix B to section 23.105 in previous documents are being published in this final rule as Appendix B to Subpart E of Part 23 and Appendix C to Subpart E of Part 23, respectively. 443 See also Commission regulation § 1.52 (17 CFR 1.52). PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 authorized officer. The Commission is adopting all other aspects of regulation 23.105(f) and (p) as proposed. 6. Swap Dealer and Major Swap Participant Reporting of Position Information Proposed regulation 23.105(l) required each covered SD or covered MSP to file monthly swap and securitybased swap position information with the Commission and with the RFA of which the SD or MSP is a member. This information was proposed to be reported using Appendix A to regulation 23.105, and was based upon the information proposed to be filed with the SEC by SBSDs.444 Accordingly, covered SDs or covered MSPs that are dually-registered as SBSDs would be subject to file the same position information with both regulators. In this regard, all covered SDs or covered MSPs were permitted under proposed 23.105(d)(3) to file SEC forms in lieu of the Commission’s financial reporting requirements. The position information that was proposed in regulation 23.105(l) would include a covered SD’s or covered MSP’s: (i) Current net exposure by the top 15 counterparties, and all other counterparties combined; (ii) total exposure by the top 15 counterparties, and all others combined; and, (iii) the internal credit rating, gross replacement value, net replacement value, current net exposure, total exposure, and margin collected for the top 36 counterparties. The covered SD or covered MSP would also have to provide current exposure and net exposure by country for the top 10 countries. The Commission also proposed in 23.105(m) to require covered SDs and MSPs to file with the Commission information about their custodians that hold margin for uncleared swaps pursuant to regulations 23.152 and 23.153 and the aggregate amounts of margin held at such custodians, as well as, the aggregate amount required to be posted and collected pursuant to such rules. The Commission indicated this information will be necessary component of its financial surveillance program to monitor the financial condition and positions of SDs and MSPs. In the 2019 Capital Reopening, the Commission noted that a commenter had raised issue with the fact that the proposed appendices did not contain accompanying form instructions, despite having defined terms in both 444 See E:\FR\FM\15SER3.SGM SEC proposed Form SBS part 4. 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations column headings and rows.445 In this regard, the Commission asked whether it would be appropriate to incorporate by reference the form instructions published alongside of finalized SEC form X–17a–5 FOCUS Part II and IIC on the proposed appendices to regulation 23.105. Further, the Commission asked whether it was appropriate to modify the proposed Appendices to align certain column headings and rows to that finalized by the SEC in their aforementioned forms. The Commission received one comment in support of adding the explanatory note incorporating by reference the form instructions published by the SEC.446 Therefore, the Commission is making technical modifications to the Appendix A to align the schedules with that required of SBSDs under Form X–17a–5 FOCUS Report Part II and incorporate by reference their form instructions. In this regard, the headings of Schedules 2, 3, and 4 of Appendix A have been modified to indicate that these will be required to be completed by Covered SDs authorized to use models. Much of the information on these schedules is required under regulation 23.105(k), and is consistent with that required by the SEC under their form schedules. In addition, Schedule 1 of Appendix A contains general position information and utilizes identical column and row headings as the comparable SEC schedule and applies generally to all covered SDs. All other aspects of regulation 23.105(l) and the incorporated Appendix A are being adopted as proposed. The Commission did not receive comment on the monthly custodian reporting in regulation 23.105(m) and is adopting as proposed. jbell on DSKJLSW7X2PROD with RULES3 7. Reporting Requirements for Swap Dealers and Major Swap Participants Approved To Use Internal Capital Models The Commission proposed reporting requirements for covered SDs that have received approval from the Commission or from an RFA under proposed regulation 23.102(d) to use internal models to compute market risk capital charges or credit risk capital charges. The Commission’s proposed requirements for the collection of model information are largely based on existing requirements for ANC Firms under regulation 1.17 and the rules of 445 See 2019 Capital Reopening, 84 FR 69664 at 69680 footnote 121, citing to SIFMA 5/17/17 Letter. 446 IIB/ISDA/SIFMA 3/3/2020 Letter at 50, fn. 108. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 the SEC, and on SEC rules for SBSDs and BDs. Regulation 23.105(k) required a covered SD to file, on a monthly basis, a listing of each product category for which the covered SD does not use an internal model to compute market risk deductions, and the amount of the market risk deduction; a graph reflecting, for each business line, the daily intra-month VaR; the aggregate VaR for the SD; for each product for which the SD uses scenario analysis, the product category and the deduction for market risk; and, credit risk information on swap, mixed swap, and securitybased swap exposures, including: (A) Overall current exposure, (B) current exposure listed by counterparty; (C) the 10 largest commitments listed by counterparty, (D) the SD’s maximum potential exposure listed by counterparty for the 15 largest exposures; (E) the SD’s aggregate maximum potential exposure, (F) a summary report reflecting the SD’s current and maximum potential exposures by credit rating category, and (G) a summary report reflecting the SD’s current exposure for each of the top 10 countries to which the SD is exposed. Regulation 23.105(k) also required each covered SD approved to use internal capital models to submit a report identifying the number of business days for which the actual daily net trading loss exceeded the corresponding daily VaR and the results of back-testing of all internal models used to compute allowable capital, including VaR, and credit risk models, indicating the number of back-testing exceptions. All of the information required to be submitted to the Commission or RFA under proposed regulation 23.105(k) would be required to be filed within 17 days of the close of each month, with the exception of the report identifying the number of business days for which the actual daily net trading loss exceeded the corresponding daily VaR, which would be required on a quarterly basis. The Commission did not receive comment on the proposed reporting requirements for covered SDs and MSPs who have been approved to use models under regulation 23.102(d). The Commission also notes that such reporting requirements are identical to that finalized by the SEC for SBSDs and MSBSDs who have been approved to use models to calculate their market and credit risk charges under the SEC’s rules. As such, the Commission is adopting regulation 23.105(k) with slight technical amendments to align such requirements with that finalized by the SEC. PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 57519 8. Weekly Position and Margin Reporting The Commission proposed weekly reporting of position and margin information for the purposes of conducting risk surveillance of SDs and MSPs. This requirement would apply to SDs and MSPs subject to the capital and margin rules of either the Commission or a prudential regulator. Similar reporting is currently provided on a daily basis by DCOs for cleared swaps.447 Proposed regulation 23.105(q)(1) would require SDs and MSPs to report position information, in a format specified by the Commission, (i) by counterparty, and (ii) for each counterparty, by the following asset classes—commodity, credit, equity, and foreign exchange or interest rate. Under the uncleared margin rules, these are asset classes within which margin offsets may be taken.448 Proposed regulation 23.105(q)(2) would require SDs and MSPs to report margin information, in a format specified by the Commission, showing: (i) The total initial margin posted by the SD or MSP with each counterparty; (ii) the total initial margin collected by the SD or MSP from each counterparty; and (iii) the net variation margin paid or collected over the previous week with each counterparty. Several commenters noted that the weekly position requirement was duplicative of information provided as part of the Commission’s Part 45 program.449 Other commenters noted ambiguities in the Commission’s proposed requirements and indicated that any weekly reporting requirement would likely be very costly to implement.450 As noted in the Proposal, the Commission currently uses positon and margin information filed by DCOs to identify and to take steps to mitigate the risks posed to the financial system by participants in cleared markets including DCOs, clearing members, and large traders.451 In addition, the Commission has collected specific transactional swap data as part of its Part 45 program and uses such data in various surveillance and oversight 447 Commission regulation § 39.19(c)(1) (17 CFR 39.19(c)(1)). 448 17 CFR 23.154(b)(2)(v). 449 See ISDA 5/15/2017 Letter; Cargill 5/15/2017 Letter. 450 See INTL FCStone 5/15/2017 Letter; CEWG 5/ 15/2017 Letter; BPE 5/15/2017 Letter; SIFMA 5/15/ 2017 Letter. 451 See 2016 Capital Proposal, 81 FR 91252 at 91279–80. E:\FR\FM\15SER3.SGM 15SER3 57520 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations functions.452 The Commission has recently proposed revisions to the Part 45 data collection, including several additional fields, such as initial and variation margin.453 Therefore, the Commission at this time believes that imposing an additional weekly position reporting requirement for SDs and MSPs would be duplicative of these efforts. The Commission will revisit the need for a separate weekly position and margin reporting requirement once the routine financial reporting requirements of SDs and MSPs are effective. Accordingly, the Commission is not adopting the weekly position and margin reporting requirements in proposed regulation 23.105(q) at this time. E. Comparability Determinations for Eligible Covered SDs and Covered MSPs The Commission proposed a substituted compliance framework that would permit covered SDs and covered MSPs that were organized and domiciled in a foreign jurisdiction to rely on compliance with their applicable home country regulator’s capital and financial reporting requirements in lieu of meeting all or parts of the Commission’s capital adequacy and financial reporting requirements.454 The availability of substituted compliance was conditioned upon the Commission issuing a determination that the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements are comparable with the Commission’s corresponding capital adequacy and financial reporting requirements (i.e., a ‘‘Capital Comparability Determination’’). Furthermore, FCM– SDs and dually-registered FCM/MSPs (‘‘FCM–MSPs’’) were not eligible for substituted compliance as FCMs are required to comply with the capital and financial reporting requirements in part 1 of the Commission’s regulations.455 The proposed Capital Comparability Determination framework established a standard of review for determining whether some or all of the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements are comparable with the Commission’s corresponding capital adequacy and financial reporting requirements. This 452 See 85 FR 21578 at 21579, 21584. 85 FR 21578 at 21649–51. 454 See 2016 Capital Proposal, 81 FR 91252 at 91280–81. 455 Two FCMs currently are organized and domiciled outside of the U.S., and neither is provisionally-registered as an SD or MSP. Accordingly, the Commission does not view the inability of an FCM–SD or an FCM–MSP to avail itself of substituted compliance to present any issues to registrants. jbell on DSKJLSW7X2PROD with RULES3 453 See VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 framework, as detailed below, is generally consistent with the approach adopted by the Commission in assessing substituted compliance of the margin rules for covered SDs engaging in crossborder uncleared swap transactions. Proposed regulation 23.106 provided that any eligible covered SD or covered MSP, and any foreign regulatory authority that has direct supervisory authority with respect to capital and financial reporting over one or more eligible covered SDs or covered MSPs, is permitted to request a Capital Comparability Determination. The Commission further proposed that eligible covered SDs and covered MSPs may coordinate with their home country regulators in order to simplify and streamline the process for obtaining a Capital Comparability Determination.456 Persons requesting a Capital Comparability Determination are required to submit to the Commission: (i) Copies of the relevant foreign jurisdiction’s capital and financial reporting requirements (including English translations of any foreign language documents); (ii) descriptions of the objectives of the relevant capital and financial reporting requirements and how such requirements are comparable to, or different from, the Commission’s capital and financial reporting requirements (e.g., the Net Liquid Assets Capital Approach and Bank-Based Capital Approach), international standards such as Basel bank capital requirements, if applicable; and, (iii) descriptions of how such requirements address the elements of the Commission’s capital and financial reporting rules. A person requesting a Capital Comparability Determination is further required to identify the regulatory provisions that correspond to the Commission’s capital and financial reporting requirements (and, if necessary, identify whether the foreign jurisdiction’s capital requirements do not address a particular element). A person requesting the determination is also required to provide a description of the ability of the relevant foreign regulatory authority or authorities to supervise and enforce compliance with the applicable capital and financial reporting requirements, and to provide any other information and documentation the Commission deems appropriate. The proposal identified certain key factors that the Commission would consider in making a Capital 456 The Commission also confirms that a trade association or similar organization may submit a Capital Comparability Determination on behalf of one or more eligible covered SDs or covered MSPs. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 Comparability Determination. Specifically, the Commission would consider: (i) The scope and objectives of the relevant foreign jurisdiction’s capital requirements; (ii) how and whether the relevant foreign jurisdiction’s capital adequacy requirements compare to international Basel capital standards for banking institutions or to other standards such as those used for securities brokers or dealers; (iii) whether the relevant foreign jurisdiction’s capital requirements achieve comparable outcomes to the Commission’s corresponding capital requirements; (iv) the ability of the relevant regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements; and (v) any other facts or circumstances the Commission deems relevant. The Commission further stated that a foreign capital regime may be deemed comparable in some, but not all, elements of the Commission’s capital and financial reporting requirements. Proposed regulation 23.106 further provided that any covered SD or covered MSP that, in accordance with a Capital Comparability Determination, complies with a foreign jurisdiction’s capital and financial reporting requirements, would be deemed in compliance with the Commission’s corresponding capital adequacy and financial reporting requirements. Accordingly, the failure of such an SD or MSP to comply with the relevant foreign capital and financial reporting requirements may constitute a violation of the Commission’s capital adequacy and financial reporting requirements. In addition, all covered SDs and covered MSPs relying on substituted compliance would remain subject to the Commission’s examination and enforcement authority regardless of the Commission issuing a Capital Comparability Determination. The Commission also retained the authority to impose any terms and conditions it deems appropriate in issuing a Capital Comparability Determination and to further condition, modify, suspend, terminate or otherwise restrict any Capital Comparability Determination it had issued in its discretion. Such revisions or termination of the Capital Comparability Determination could result from, for example, changes in foreign laws or regulatory oversight. In this regard, the Capital Comparability Determinations issued by the Commission would require that the Commission be notified of any material changes to information submitted in support of a Capital E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 Comparability Determination, including, but not limited to, changes in the relevant foreign jurisdiction’s supervisory or regulatory regime. Commenters generally supported the Commission’s proposed substituted compliance framework.457 One commenter stated that less than full acceptance of foreign regulation by the Commission would result in substantially increased costs to non-U.S. covered SDs and to U.S. covered SDs with non-U.S. parent entities.458 Several commenters stated that the Commission should streamline or simplify the proposed substituted compliance process for certain non-U.S. covered SDs. In this regard, one commenter requested that the Commission grant automatic qualification for substituted compliance with the Commission’s capital rules for any non-U.S. covered SD that is subject to Basel-compliant home country capital requirements administered by a regulatory authority that is either in a G20 jurisdiction or is a member of the BCBS or IOSCO.459 Another commenter requested that the Commission exempt non-US covered SDs from the substituted compliance approval process in cases where the covered SDs are subject to capital standards in their home countries that the Federal Reserve Board has determined in the context of foreign banking organizations to be consistent with the Basel III standards.460 One commenter stated that the Commission should clarify that a non-U.S. SD that qualifies for substituted compliance with the Commission’s capital requirements can also meet any relevant Commission notification requirements in proposed regulation 23.105(c) by meeting comparable home country notice requirements.461 One commenter also requested that the Commission’s assessment of the capital framework of a foreign jurisdiction be performed in a holistic manner, as opposed to narrowly focusing on a line-by-line comparison of regulatory requirements.462 In addition, one commenter stated that the Commission issue Capital 457 See, e.g., ISDA 5/15/2017 Letter; SIFMA 5/15/ 2017 Letter; MS 5/15/2017 Letter; JBA 3/14/2017 Letter; Letter from Sarah Miller, Institute of International Bankers (May 15, 2017) (IIB 5/15/2017 Letter); IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/ 2020 Letter; Letter from Atsushi Hirayama, International Bankers Association of Japan (February 27, 2020) (IBAJ 2/27/2020 Letter); and NFA 3/2/2020 Letter. 458 See SIFMA 5/15/2017 Letter. 459 See IIB 5/15/2017 Letter. 460 See JBA 3/14/2017 Letter. 461 See IIB/ISDA/SIFMA 3/3/2020 Letter. 462 See IBAJ 2/27/2020 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Comparability Determinations well in advance of the compliance date, which will help alleviate potential issues with eligible covered SDs having to seek capital model approval.463 NFA also requested that the Commission revise proposed regulation 23.106(a)(4), which provides that a covered SD that intends to comply with the capital adequacy and financial reporting requirements of a foreign jurisdiction that has received a Capital Comparability Determination to file a notice to that effect with NFA, and further requires NFA to confirm that the covered SD may comply with some or all of the requirements of the foreign jurisdiction in lieu of the Commission’s requirements.464 NFA suggested that the requirement be revised to require that a non-U.S. covered SD make only a notice filing similar to the substituted compliance process for margin and entity-level requirements.465 The Commission has reviewed the proposed substituted compliance framework and considered the comments received and is adopting the framework with several modifications as discussed below. There currently are 24 non-U.S. covered SDs provisionally registered with the Commission. These 24 non-U.S. covered SDs are located in a total of 7 foreign jurisdictions, with 12 SDs located in the United Kingdom. The Commission also understands that many, if not all, of the 24 non-U.S. covered SDs are subject to regulatory requirements in their respective home country jurisdictions, including capital and financial reporting requirements. The Commission’s approach to substituted compliance is a principlesbased, holistic approach that focuses on whether the foreign regulations are designed with the objective of ensuring overall safety and soundness of the nonU.S. covered SD in a manner that is comparable with the Commission’s overall capital and financial reporting requirements and is not based on a lineby-line assessment or comparison of a foreign jurisdiction’s regulatory requirements with the Commission’s requirements. The Commission also will seek to address applications for Capital Comparability Determinations in as expeditious manner, which should provide adequate notice to market participants of its determination prior to the compliance date of these rules. The Commission is retaining the requirement in proposed regulation 23.106(a)(2) that requires a person to submit a written request to Commission 463 See NFA 3/2/2020 Letter. 464 Id. 465 Id. PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 57521 for a Capital Comparability Determination. The Commission is not revising the framework to permit certain non-U.S. covered SDs to satisfy their CFTC regulatory requirements through a process of automatic qualification of substituted compliance with the capital or financial reporting requirements of a foreign jurisdiction, including foreign jurisdictions that are compliant with Basel capital standards. The Commission believes that appropriate capital and financial reporting are fundamental to the Commission’s statutory mandate of promoting the safety and soundness of covered SDs, and helping to ensure that such firms meet their financial obligations to swap counterparties. Accordingly, the Commission believes that a non-U.S. covered SD seeking to comply with the Commission’s capital and financial reporting requirements must submit information that demonstrates how the foreign regulatory requirements achieve comparable outcomes to the Commission’ requirements. The Commission believes that the proposal provides sufficient flexibility for persons seeking Capital Comparability Determinations in that it permits regulatory authorities as well as nonU.S. covered SDs to submit the required materials for the Commission’s consideration. Proposed regulation 23.106(a)(1) provided that a covered SD, covered MSP, or a foreign regulatory authority that has direct supervisory authority over one or more covered SDs or covered MSPs that are eligible for substituted compliance may request a Capital Comparability Determination. The Commission is modifying regulation 23.106(a)(1) by providing that a trade association or other similar group also may request a Capital Comparability Determination on behalf of its member covered SDs and covered MSPs. The purpose of this modification is to provide greater flexibility and efficiencies in the substituted compliance framework by allowing trade associations to request Capital Comparability Determinations for multiple covered SDs or covered MSPs that may be in a particular jurisdiction. This modification potentially allows the Commission to focus its limited resources on a smaller number of requests and will allow covered SDs and covered MSPs to reduce costs by not having to submit individual Capital Comparability Determination requests. The Commission also is modifying proposed regulation 23.106(a)(3), which provided that the Commission would consider all relevant factors in assessing whether a foreign jurisdiction’s capital E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57522 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations and financial reporting requirements are comparable to the Commission’s, including whether or how the foreign jurisdiction’s capital adequacy requirements compare to the capital standards issued by the BCBS for banking institutions or to other standards used for securities brokers or dealers. The Commission is removing this specific reference to BCBS capital standards and to broker-dealer standards in the final rule. As noted above, the Commission’s approach to substituted compliance is a principlesbased, holistic approach that focuses on whether the foreign regulations are designed with the objective of ensuring overall safety and soundness of the nonU.S. covered SD or MSP in a manner that is comparable with the Commission’s overall capital and financial reporting requirements. While a foreign jurisdiction’s incorporation of BCBS standards or broker-dealer standards are approaches that the Commission would consider for substituted compliance, it was not the Commission’s intent to limit the regulatory approaches, or to appear to limit the regulatory approaches, that it would deem acceptable for substituted compliance. To clarify the rule, and to avoid any potential confusion, the Commission is removing the references to BCBS and broker-dealer standards from the rule. This modification, however, does not represent any change in the Commission’s stated approach to substituted compliance. Proposed regulation 23.106(a)(4) required a non-U.S. covered SD or a non-U.S. covered MSP to file with an RFA a notice of the SD’s or MSP’s intent to comply with the requirements of a foreign jurisdiction that had received a Capital Comparability Determination. Regulation 23.106(a)(4) further provided that the RFA would determine the information that was necessary to be included in the notice and would provide a confirmation to the non-U.S. covered SD or non-U.S. MSP of its ability to meet the Commission’s requirements through substituted compliance. The Commission is modifying the notice and confirmation provisions in final regulation 23.106(a)(4) to require a non-U.S. covered SD or non-U.S. covered MSP to file a notice of its intent to avail itself of a Capital Comparability Determination with the Commission. As the capital and financial reporting requirements are entity-level requirements, it is necessary for the Commission to assess whether each non-U.S. covered SD or non-U.S. covered MSP that files a notice of its VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 intent to meet the Commission’s capital and reporting requirements through substituted compliance satisfies any conditions set forth in the applicable Capital Comparability Determination issued to applicable foreign jurisdiction. Upon receipt of a notice, Commission staff will engage with the non-U.S. covered SD or non-U.S. covered MSP to determine the extent to which the foreign regulation that it is subject to is consistent with the Commission’s Capital Comparability Determination. As part of the determination, the Commission will review the foreign jurisdiction’s regulations, process, and/ or procedures, as applicable, for assessing the ongoing financial condition of a covered SD or a covered MSP in determining whether it is appropriate to extend substituted compliance to the notice provisions contained in regulation 23.105(c). Regulation 23.106(a)(4) also provided that the failure of a non-U.S. covered SD or non-non-U.S. covered MSP operating under substituted compliance to comply with the capital adequacy or financial reporting requirements of the relevant foreign jurisdiction may constitute a violation of the Commission’s capital adequacy and financial reporting requirements. The Commission is modifying this provision in final regulation 23.106(a)(4)(ii) to explicitly provide that the Commission may initiate an action for a violation of the Commission’s rules when a covered SD or covered MSP subject to a capital comparability determination has failed to comply with a foreign jurisdiction’s corresponding capital adequacy and financial reporting requirements. This modification is intended to provide clarity to the final rule by providing that the Commission may initiate an action against a non-U.S. covered SD or nonU.S. covered MSP for failure to comply with the relevant Commission capital and financial reporting requirements when it violates the corresponding foreign jurisdiction’s requirements. Regulation 1.10 requires each FCM to file an unaudited monthly financial report with the Commission and with the FCM’s designated self-regulatory organization (‘‘DSRO’’) within 17 business days of the close of each month.466 An FCM’s monthly financial reports must be submitted on CFTC Form 1–FR–FCM. FCMs also are required to file an audited annual financial report with the Commission and with the firm’s DSRO within 60 days of the end of the FCM’s fiscal year end. An FCM’s annual financial report may be submitted on Form 1–FR–FCM or, subject to certain conditions, presented in a manner consistent with U.S. GAAP.467 Regulation 1.10 requires each IB to file with NFA an unaudited financial report on a semi-annual basis, and an audited annual financial report.468 The IB unaudited reports must be submitted on Form 1–FR–IB within 17 business days of the date of the report. IB annual reports may be filed on Form 1–FR–IB or, subject to certain conditions, presented in a manner consistent with U.S. GAAP. IB annual financial reports must be filed within 90 days of the IB’s fiscal year end.469 Regulation 1.10(h) currently streamlines the financial reporting requirements imposed on FCMs and IBs that are dually-registered as BDs. Such dual-registrants are permitted to file with the Commission and with the firms’ DSRO the SEC’s FOCUS Reports, in lieu of a Form 1–FR–FCM or Form 1– FR–IB. The 2016 Capital Proposal proposed amending regulation 1.10(h) to permit an FCM or IB that is duallyregistered as a SBSD or MSBSP to file an SEC FOCUS Report in lieu of a CFTC Form 1–FR–FCM or CFTC Form 1–FR– IB.470 The proposed amendment is consistent, as noted above, with the current provisions that authorize duallyregistered FCMs/BDs and IBs/BDs to file FOCUS Reports in lieu of the CFTC financial forms. Furthermore, the Commission’s experience with F. Additional Amendments to Existing Regulations 466 The term ‘‘self-regulatory organization’’ (‘‘SRO’’) is defined in Commission regulation § 1.3 (17 CFR 1.3) as a contract market, a swap execution facility (all as further defined under§ 1.3), or an RFA under section 17 of the CEA. The term ‘‘designated self-regulatory organization’’ is also defined in Commission regulation § 1.3 and generally means the SRO that has primary financial surveillance responsibilities over a registrant. 467 See Commission regulation § 1.10(d)(3) (17 CFR 1.10(d)(3)). 468 See Commission regulation § 1.10(b)(2)(i) (17 CFR 1.10(b)(2)(i)). An IB is required to file its unaudited financial report as of the middle and the end of its fiscal year end. 469 Commission regulation § 1.10(b)(2)(ii)(A) (17 CFR 1.10(b)(2)(ii)(A)). 470 See 2016 Capital Proposal, 81 FR 91252 at 91281–82. 1. Financial Reporting Requirements for FCMs or IBs That Are Also Registered SBSDs The Commission is amending regulation 1.10 to authorize duallyregistered FCM/SBSDs and IB/SBSDs to file SEC Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934, Part II, Part IIA, or Part II C (‘‘FOCUS Report’’), as applicable, in in lieu of CFTC Form 1–FR–FCM or Form 1–FR– IB. PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations regulation 1.10(h) has been that the FOCUS Reports include information that is substantially comparable to the Forms 1–FR and provide the information necessary for the Commission to conduct financial surveillance of the registrants. Regulations 1.10(f) and 1.16(f) also currently provide that a duallyregistered FCM/BD or IB/BD may automatically obtain an extension of time to file its unaudited and audited financial reports required under regulation 1.10 by submitting a copy of the written approval for the extension issued by the BD’s securities designated examining authority (‘‘DEA’’).471 The 2016 Capital Proposal proposed amending regulations 1.10(f) and 1.16 to provide that an FCM or IB that is also registered with the SEC as an SBSD or an MSBSP may obtain an automatic extension of time to file its unaudited or audited FOCUS Report with the Commission and with the firm’s DSRO, as applicable, by submitting a copy of the SEC’s or the DEA’s approval of the extension request. The proposed amendment maintains the intent of the current regulations by retaining a consistent approach to the granting to dual registrants extensions of time to file financial reports. The Commission also proposed a technical amendment to regulation 1.16 to correct a cross reference to SEC rule 17a–5 (17 CFR 240.17a–5) for extensions of time to file audited financial statements. The Commission did not receive any comments related to the proposed amendments to the provisions of regulations 1.10 and 1.16 noted above. After further consideration and for the reasons stated in the 2016 Capital Proposal, the Commission is adopting these amendments substantially as proposed. jbell on DSKJLSW7X2PROD with RULES3 2. Amendments to the FCM and IB Notice Provisions in Regulation 1.12 Regulation 1.12 requires an FCM or IB to file a notice with the Commission and with the registrant’s DSRO when certain prescribed events occur that trigger a notice filing requirement.472 Such events include the registrant: (i) Failing to maintain compliance with the Commission’s capital requirements or the capital rules of a SRO; (ii) failing to hold sufficient funds in segregated or secured amount accounts to meet its regulatory requirements; (iii) failing to maintain current books and records; and 471 Commission regulations §§ 1.10(f) and 1.16(f) (17 CFR 1.10(f) and 1.16(f)). 472 Commission regulation § 1.12 (17 CFR 1.12). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 (iv) experiencing a significant reduction in capital from the previous month-end. The Commission proposed amending regulation 1.12(a) to require an FCM or IB that is a dual registrant with the SEC to file a notice if the FCM or IB fails to meet any applicable SEC’s minimum capital requirements. The Commission stated that such notice is appropriate as it provides Commission staff with the opportunity to assess the potential impact of the dually-registered FCM’s or IB’s failure to meet SEC minimum capital requirements on the respective firm’s CFTC regulated activities, and to initiate discussions with the SEC regarding the capital deficiency.473 Commission regulation 1.12(b) requires an FCM or IB to file notice with the Commission and with the firm’s DSRO if a firm’s adjusted net capital falls below the applicable ‘‘early warning level’’ set forth in the regulation.474 The Commission proposed amending regulation 1.12(b) to require an FCM or IB that is also registered with the SEC as a SBSD or a MSBSP to file a notice if the SBSD’s or MSBSP’s capital falls below the ‘‘early warning level’’ established in the rules of the SEC. The proposal was intended to provide additional information to the Commission in its efforts to monitor the financial condition of its registrants. The Commission did not receive any comments related to the above proposed amendments to regulation 1.12. For the reasons stated in the 2016 Capital Proposal, the Commission is adopting the amendments as proposed. 3. FCM and IB Unsecured Receivables From Swap Transactions Regulation 1.17 provides that an FCM or IB, in computing its net capital, must exclude unsecured receivables except for certain specified unsecured receivables, including interest receivable, floor broker receivable, commissions receivable from other brokers or dealers, mutual fund concessions receivable and management receivable from registered investment companies and commodity pools. The regulation further provides that an FCM or IB must exclude these otherwise permitted unsecured receivables from current assets in computing its net capital if the receivable is outstanding longer than 30 days from the payable 473 See 2016 Capital Proposal, 81 FR 91252 at 91282. 474 If an FCM’s or IB’s adjusted net capital falls below a certain threshold, such as 120 percent of its minimum adjusted net capital requirement, the firm is deemed to be maintaining adjusted net capital at a level below its ‘‘early warning level.’’ PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 57523 date.475 The operation of the regulation effectively allowed an FCM or IB to reflect commissions due from FCMs that carried customer accounts introduced by the FCM or IB as a current asset in computing its net capital, as the FCMs generally paid these commissions within 30 days from the payable date. The Commission proposed to amend regulation 1.17(c)(2)(ii)(B) to codify several staff no-action letters that provided that staff would not recommend an enforcement action against an IB that reflect certain commissions receivable balances from swap transactions that are outstanding no more than 60 days from the monthend accrual date as current assets in computing its net capital, provided that the commissions are promptly billed.476 The staff no-action letters were issued to accommodate the long-standing commission billing practices in the swaps market that differed from the futures markets. Commissions for swaps transactions are often billed and paid in a process that exceeds 30 days. The final rule adopted by the Commission would allow both FCMs and IBs to recognize unsecured commissions receivable resulting from swap transactions in computing their net capital, provided that the unsecured receivables are not outstanding more than 60 days from the month end accrual date and the commissions are billed promptly after the close of the month. The Commission also proposed amending regulation 1.17(c)(2)(ii)(B) by adding a new provision that allows FCMs and IBs to recognize dividends receivable that are not outstanding more than 30 days. This proposed amendment was to further align the Commission’s capital rules with the SEC’s capital, which specifically addressed the capital treatment of dividends. The Commission received no comments on the proposed amendments to regulation 1.17(c)(2)(ii)(B). After considering the issue, and for the reasons stated in the 2016 Capital Proposal, the Commission has determined to adopt the amendments to regulation 1.17(c)(2)(ii)(B) as proposed. 4. Amendments to FCM and IB Notice and Disclosure Requirements for Bulk Transfers Regulation 1.65 provides that an FCM or IB must obtain a customer’s specific consent prior to transferring the customer’s account to another FCM or 475 Commission regulation § 1.17(c)(2)(ii) (17 CFR 1.17(c)(2)(ii)). 476 See 2016 Capital Proposal, 81 FR 91252 at 91282. E:\FR\FM\15SER3.SGM 15SER3 57524 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 IB, except if the account is transferred at the customer’s request.477 Regulation 1.65 further provides that an FCM or IB may transfer a customer’s account without the customer’s specific consent if the FCM’s or IB’s account agreement with the customer contains a valid consent by the customer to a prospective transfer of the account; the customer is provided with written notice of, and a reasonable opportunity to object to, the transfer; and, the customer has not objected to the transfer or given other instructions as to the disposition of the account. The written notice provided to the customers is required to contain certain prescribed information including, the reason for the transfer, a statement that the customer is not required to accept the proposed transfer and may direct that the account be liquidated or transferred to an FCM or IB of the customer’s choosing, and a clear statement of how the customer is to provide notice that it does not consent to the proposed transfer.478 An FCM or IB is also required to file with the Commission notice of a transfer of customer accounts at least five business days prior to the transfer if the transfer involves more than 25 percent of the FCM’s or IB’s total accounts (or 50 percent if the FCM or IB has less than 100 accounts).479 The notice must be submitted to the Commission by mail, addressed to the Deputy Director, Compliance and Registration Section, Division of Swap Dealer and Intermediary Oversight.480 Finally, the notice must be filed with the Commission as soon as practicable and no later than the day of the transfer if the FCM or IB cannot file the notice at least five business days prior to the transfer.481 The FCM or IB is required to file a brief statement explaining the circumstances necessitating the delay in filing. The Commission proposed to amend regulation 1.65 noting that it had found that five days’ notice, when given, often is not a sufficient amount of time to allow the Commission to effectively monitor the bulk transfer of customer accounts.482 Specifically, the Commission proposed to amend 477 Commission regulation § 1.65(a)(1) (17 CFR 1.65(a)(1)). 478 Commission regulation § 1.65(a)(2) (17 CFR 1.65(a)(2)). 479 Commission regulation § 1.65(b) (17 CFR 1.65(b)). 480 Commission regulation § 1.65(d) (17 CFR 1.65(d)). 481 Commission regulation § 1.65(e) (17 CFR 1.65(e)). 482 See 2016 Capital Proposal, 81 FR 91252 at 91282. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 regulation 1.65(b) to require that the notice of a bulk transfer of customer accounts must be filed with the Commission at least ten business days in advance of a transfer. The Commission noted that the bulk transfers of customer accounts are generally planned well in advance such that the FCM or IB should be able to provide the Commission ten days advance notice of such a transfer. The Commission also proposed to amend regulation 1.65(d) to require the notice to be filed by the FCM or IB electronically, which is consistent with the filing requirements of other notices and financial forms filed by FCMs or IBs with the Commission. The Commission noted that the electronic system to file such notices already exists and has been used by FCMs and IBs for many years. Accordingly, the Commission believed that the proposed electronic filing of notices of bulk transfers would not result in any additional costs either to the Commission or to FCMs and IBs. The Commission also proposed to amend regulation 1.65(d) to provide that the notices shall be considered filed with the Commission when submitted to the Director of the Division of Swap Dealer and Intermediary Oversight. The Commission proposed to require the notices of bulk transfer to be addressed to the Director of the Division of Swap Dealer and Intermediary Oversight to reflect organizational changes since the rule was last revised, and to ensure that such notices are reviewed promptly upon receipt. The Commission further proposed to amend regulation 1.65(e) to delegate to the Director of the Division of Swap Dealer and Intermediary Oversight the authority to accept a lesser time period for the notification provided for in regulation 1.65(b). However, the notice must be filed as soon as practicable and in no event later than the day of the transfer. This provision is deemed necessary as certain transfers may be performed under exigent circumstances where 10 days advance notice is not possible, such as situations where the FCM or IB becomes insolvent and is required to terminate its business. The Commission did not receive any comments regarding the proposed amendments to the bulk transfer provisions of regulation 1.65. The Commission has considered the proposed amendments and, for the reasons stated in the 2016 Capital Proposal, has determined to adopt the amendments as proposed. PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 5. Conforming Amendments to Delegated Authority Provisions in Regulation 140.91 Commission regulations 1.10, 1.12, and 1.17 reserve certain functions to the Commission, the greater part of which the Commission has delegated to the Director of the Division of Swap Dealer and Intermediary Oversight through the provisions of regulation 140.91.483 The Commission proposed to amend regulation 140.91 to provide similar delegations with respect to functions reserved to the Commission in part 23. Regulation 23.101(c), as adopted, requires a covered SD or covered MSP to be in compliance with the minimum regulatory capital requirements at all times and to be able to demonstrate such compliance to the Commission at any time. Regulation 23.103(d), as adopted, requires a covered SD or covered MSP, upon request, to provide the Commission with additional information regarding its internal models used to compute its market risk exposure requirement and OTC derivatives credit risk requirement. Regulation 23.105(a)(2), as adopted, requires a covered SD or covered MSP to provide the Commission with immediate notification if the SD or MSP fails to maintain compliance with the minimum regulatory capital requirements, and further authorizes the Commission to request financial condition reporting and other financial information from the covered SD or covered MSP. Regulation 23.105(d), as adopted, authorizes the Commission to direct a bank SD or bank MSP that is subject to capital rules established by a prudential regulator, or has been designated a systemically important financial institution by the Financial Stability Oversight Council and is subject to capital requirements imposed by the Board of Governors of the Federal Reserve System, to file with the Commission copies of its capital computations for any periods of time specified by the Commission. The Commission proposed to amend regulation 140.91 to delegate to the Director of the Division of Swap Dealer and Intermediary Oversight, or the Director’s designee, the authority reserved to the Commission under regulations 23.101(c), 23.103(d), and 23.105(a)(2) and (d).484 The Commission did not receive any comments regarding the proposed amendments to regulation 140.91 to delegate the functions noted above to DSIO staff and has determined 483 Commission regulation § 140.91 (17 CFR 140.91). 484 See 2016 Capital Proposal, 81 FR 91252 at 91282–83. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations to adopt the amendments substantially as proposed. The delegation of such functions to staff of the Division of Swap Dealer and Intermediary Oversight is necessary for the effective oversight of SDs and MSPs compliance with minimum financial and related reporting requirements. The delegation of authority is also comparable to the authorities currently delegated to staff under regulation 140.91 regarding the supervision of FCMs compliance with minimum financial requirements. jbell on DSKJLSW7X2PROD with RULES3 G. Effective Date and Compliance Date The proposed amendments and new regulations adopted by the Commission shall be effective 60 days after publication in the Federal Register. Several commenters requested that timeline for implementation be extended to allow for approval of capital models.485 Specific concerns included comments that the implementation timeline should not create competitive disparities between SDs utilizing models approved by other regulators and SDs seeking model approval for the first time from the Commission and NFA.486 Another commenter stated SDs that did not have model approval at the compliance date would be at a significant competitive disadvantage relative to covered SDs and FCM–SDs that had the approval to use models at the compliance date because such SDs would be required to use the proposed standardized capital charges while awaiting model approval at the compliance date.487 Several commenters further stated that the Commission should automatically approve market risk models and credit risk models of covered SDs or FCM–SDs that have already been approved by a prudential regulator, the SEC, or certain foreign regulators.488 In view of these concerns, the Commission is extending the compliance date for the amended regulations and the new regulations until October 6, 2021. Additionally, the Commission has provided for the ability of SDs to use capital models pending Commission/NFA approval, provided the SD files the certification required under Commission regulation 23.102(f) and the model has been approved by the SEC, prudential regulators, or qualified foreign regulators. Further, the Commission has provided for a substituted compliance program. By 485 See Citadel 5/15/2017 Letter; SIFMA 5/15/ 2017 Letter; FIA 5/15/2017 Letter; FIA–PTG 5/24/ 2017 Letter. 486 See Citadel 5/15/2017 Letter. 487 See ISDA 5/15/17 Letter. 488 See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter. See also, ABN/ING/Mizuho/Nomura 1/29/ 2018 Letter. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 setting the compliance date as October 6, 2021, the Commission has addressed commenters’ concerns by allowing SDs a sufficient period of time to develop policies, procedures, and systems, to implement new financial reporting regimes and to develop capital models, as applicable, to meet the new regulatory requirements while also maintaining consistency with the SEC’s compliance date for rules imposing capital, margin, segregation, and financial reporting obligations for SBSDs, and amending existing rules for BDs. The coordination of the compliance date will assist duallyregistered entities with meeting their CFTC and SEC regulatory requirements. III. Related Matters A. Regulatory Flexibility Act The Regulatory Flexibility Act (‘‘RF Act’’) requires that agencies consider whether the regulations they propose will have a significant economic impact on a substantial number of small entities.489 This rulemaking would affect the obligations of SDs, MSPs, FCMs, and IBs. The Commission has previously determined that SDs, MSPs, and FCMs are not small entities for purposes of the RF Act.490 Therefore, the requirements of the RF Act do not apply to those entities. The Commission has found it appropriate to consider whether IBs should be deemed small entities for purposes of the RF Act on a case-by-case basis, in the context of the particular Commission regulation at issue.491 As certain IBs may be small entities for purposes of the RF Act, the Commission considered whether this rulemaking would have a significant economic impact on such registrants. Only a few of the regulations included in this rulemaking, the amendment of Commission regulations 1.10, 1.12, 1.16 and 1.17, will impact the obligations of IBs. These amendments will permit the filing and harmonization of financial reporting and notification rules as adopted by the SEC for dual registered SBSD and MSBSPs and accommodate common billing practices in the swap industry surrounding the collection of commission receivables. The Commission believes that these 489 5 U.S.C. 601 et seq. Policy Statement and Establishment of Definitions of ‘‘Small Entities’’ for Purposes of the Regulatory Flexibility Act, 47 FR 18618 (Apr. 30, 1982) (FCMs) and Registration of Swap Dealers and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (SDs and MSPs). 491 See Introducing Brokers and Associated Persons of Introducing Brokers, Commodity Trading Advisors and Commodity Pool Operators; Registration and Other Regulatory Requirements, 48 FR 35248, 35276 (Aug. 3, 1983). 490 See PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 57525 amendments will have a minimal effect on IBs, and are not expected to impose any new burdens or costs on them. The Commission does not, therefore, expect small entities to incur any additional costs as a result of this proposed rulemaking. Accordingly, for the reasons stated above, the Commission believes that this rulemaking will not have a significant economic impact on a substantial number of small entities. Therefore, the Chairman, on behalf of the Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the regulations being published today by this Federal Register release will not have a significant economic impact on a substantial number of small entities. B. Paperwork Reduction Act 1. Background The Paperwork Reduction Act of 1995 (‘‘PRA’’) 492 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. The rule amendments adopted herein results in an amendment to existing collection of information ‘‘Regulations and Forms Pertaining to Financial Integrity of the Market Place; Margin Requirements for SDs/MSPs’’ 493 as discussed below. The responses to this collection of information are mandatory. 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 issued by the Office of Management and Budget (‘‘OMB’’). The Commission did not receive any comments regarding its PRA burden analysis in the preamble to the Proposal. The Commission is revising collection number 3038–0024 to reflect the adoption of amendments to Parts 1 and 23 of its regulations, as discussed below, with changes to reflect adjustments that were made to the final rules in response to comments on the Proposal. The Commission does not believe the rule amendments as adopted impose any other new collections of information that require approval of OMB under the PRA. 492 44 U.S.C. 3501 et seq. OMB Control No. 3038–0024, https:// www.reginfo.gov/public/do/PRAOMBHistory? ombControlNumber=3038-0024. 493 See E:\FR\FM\15SER3.SGM 15SER3 57526 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations provide conservative estimates, the Commission anticipates receiving 10 such notices in the aggregate annually, and that preparing such a notice will consume five burden hours, resulting in an annual increase in burden of 50 hours in the aggregate. 2. New Information Collection Requirements and Related Burden Estimates 494 Currently, there are approximately 108 SDs and no MSPs provisionally registered with the Commission that may be impacted by this rulemaking and, in particular, the collection of information contained herein and discussed below. jbell on DSKJLSW7X2PROD with RULES3 i. FOCUS Report The amendments to Commission regulation 1.10(h) allow an FCM or IB that is also an SEC-registered securities BD to file, subject to certain conditions, its FOCUS Form X–17a–5–Part II in lieu of its Form 1–FR. Because these amendments provide an alternative to filing Form 1–FR, the Commission believes that the amendments would not cause FCMs or IBs to incur any additional burden. Rather, to the extent that the rule provides an alternative to filing a Form 1–FR and is elected by FCMs or IBs, it is reasonable for the Commission to infer that the alternative is less burdensome to such FCMs and IBs. The amendments to Commission regulation 1.10(f) allow an FCM or IB that is dually-registered with the SEC as either a SBSD or MSBSP to request an extension of time to file its uncertified FOCUS Report. The Commission is unable to estimate with precision how many requests it would receive from registrants under § 1.10(f) in relation to FOCUS Report annually. The Commission anticipates that it will receive one such request in the aggregate annually, and that preparing such a request will consume five burden hours, resulting in an annual increase in burden of five hours in the aggregate. ii. Notice of Failure To Maintain Minimum Financial Requirements Commission regulations 1.12(a) and (b) currently require FCMs and IBs, to file notices if they know or should have known that certain specified minimum financial thresholds have been exceeded. The amendments to Commission regulation 1.12(a) and (b) add as an additional threshold for such notices certain financial requirements of the SEC if the applicant or registrant is registered with the SEC as an SBSD or MSBSD. The Commission is unable to estimate with precision how many additional notices it would receive from such entities as a result of the additional minimum threshold. In an attempt to 494 This discussion does not include information collection requirements that are included under other Commission regulations and related OMB control numbers. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 iii. Requests for Extensions of Time To File Financial Statements The amendments to Commission regulation 1.16(f) allow an FCM or IB that is registered with the SEC as an SBSD or MSBSP to request an extension of time to file its audited annual financial statements.495 The Commission is unable to estimate with precision how many of such requests it would receive from such entities. The Commission anticipates receiving one such request in the aggregate annually, and that preparing the request will consume five burden hours, resulting in an annual increase in burden of five hours in the aggregate. iv. Capital Requirement Elections Amended Commission regulation 23.101(a)(7) requires that certain SDs that wish to change their capital election submit a written request to the Commission and provide any additional information and documentation requested by the Commission. The Commission is unable to estimate with precision how many of such requests it would receive from such entities. The Commission anticipates that it would receive one such request in the aggregate annually, and that preparing such a request would consume five burden hours, resulting in an annual increase in burden of five hours in the aggregate. v. Application for Use of Models Commission regulation 23.102(a) allow an SD to apply to the Commission or a RFA of which it is a member for approval to use internal models when calculating its market risk exposure and credit risk exposure under Commission regulations 23.101(a)(1)(i)(B), 23.101(a)(1)(ii)(A), or 23.101(a)(2)(ii)(A), by sending to the Commission and such RFA an application, including the information set forth in Appendix A to Commission regulation 23.102 and meeting certain other requirements. Amended Commission regulation 1.17(c)(6)(v) relatedly allows an FCM that is also an SD to apply in writing to the Commission or an RFA of which it is a member for approval to compute 495 The registrant would also be required to promptly file with the DSRO and the Commission copies of any notice it receives from its designated examining authority to approve or deny the requested extension of time. PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 deductions for market risk and credit risk using internal models in lieu of the standardized deductions otherwise required under Commission regulation 1.17.496 Appendices A and B to Commission regulation 23.102 contain further related information collection requirements, including that the SD: (i) Provide notice to the Commission and RFA and/or update its application and related materials for certain inaccuracies and amendments; (ii) notify the Commission or RFA before it ceases to use such internal models to compute deductions; (iii) if a VaR model is used, have an annual review of such model conducted by a qualified third party service, (iv) conduct stress-testing, retain and make available to the Commission and the RFA records of the results and all assumptions and parameters thereof, and notify the Commission and RFA promptly of instances where such tests indicate any material deficiencies in the comprehensive risk model; (v) demonstrate to the Commission or the RFA that certain additional conditions have been satisfied and retain and make available to the Commission or the RFA records related thereto; and (vi) comply with additional conditions that may be imposed on the SD by the Commission or the RFA. As discussed above, there are currently 108 SDs and 0 MSPs provisionally registered with the Commission. Of these, the Commission estimates that approximately 56 SDs and no MSPs would be subject to the Commission’s capital rules as they are not subject to the capital rules of a prudential regulator. The Commission further estimates conservatively that 32 of these SDs would seek to obtain Commission approval to use models for computing their market and credit risk capital charges. The Commission staff estimates that an SD approved to use internal models would spend approximately 5,600 hours per year to review and update the models and approximately 640 hours per year to back-test the models for the aggregate of 6,240 annual burden hours for each SD. Consequently, Commission staff estimates that reviewing and backtesting the models for the 32 SDs will result in an aggregate annual hour burden of approximately 199,680 hours. 496 Note that the changes to Commission regulation § 1.17(c)(6)(i) (17 CFR 1.17(c)(6)(i)), which permit any dual registered FCM BrokerDealer who has received approval by the SEC under § 240.15c3–1(a)(7) (17 CFR 240.15c3–1(a)(7)) to use models to calculate its market and credit risk charges, do not add an additional collection of information and therefore are not considered in this analysis. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations vi. Equity Withdrawal Requirements. Commission regulation 23.104 adds equity withdrawal restrictions on certain SDs. Commission regulation 23.104(a) allows an SD to apply in writing for relief from restrictions on certain equity withdrawals. Commission staff estimates that 28 of the 107 currently provisionally registered SDs would be subject to this regulation. Commission staff estimates that each of these 28 SDs would file approximately two notices annually with the Commission and that it would take approximately 30 minutes to file each of these notices. This results in an aggregate annual hour burden estimate of approximately 28 hours. jbell on DSKJLSW7X2PROD with RULES3 vii. Financial Recordkeeping, Reporting and Notification Requirements for SDs and MSPs Commission regulation 23.105 requires that each SD and MSP maintain certain specified records, report certain financial information and notify or request permission from the Commission under certain specified circumstances, in each case, as provided in the proposed regulation. For example, the regulation requires generally that SDs and MSPs maintain current books and records, provide notice to the Commission of regulatory capital deficiencies and related documentation, provide notice of certain other events specified in the rule, and file financial reports and related materials with the Commission (including the information in Appendix A and B to the regulation, as applicable). Regulation 23.105 also requires the SD or MSP to furnish information about its custodians that hold margin for uncleared swap transactions and the amounts of margin so held, and for SDs approved to use models (as discussed above), provide additional information regarding such models, as further described in regulation 23.105(k). The Commission estimates that there are 28 SD firms which will be required to fulfill their financial reporting, recordkeeping and notification obligations under regulation 23.105(a)– 23.105(n) because they are not subject to a prudential regulator, not already registered as an FCM, and not dually registered as a SBSD. The Commission expects these 28 firms will apply to use models. Commission staff estimates that the preparation of monthly and annual financial reports for these SDs, including the recordkeeping, related notification and preparation of the specific information required in Appendix A to 23.105, would impose an VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 on-going burden of 250 hour per firm annually. The Commission further estimates it will cost each SD $300,000 to retain an independent public accountant to audit its financial statements each year. Thus, the total burden hours estimated for compliance with 23.105(a)–23.105(n) for these 28 SD firms would be 7,000 hours annually. Regulation 23.105(p) and its accompanying Appendix B impose a quarterly financial reporting and notification obligations on SDs which are subject to a prudential regulator. The Commission expects that approximately 52 of the 108 currently provisionally registered SDs are subject to a prudential regulator. The Commission estimates that these reporting and notification requirements will impose a burden of 33 hours on-going annually. This results in a total aggregate burden of 1,716 hours annually. viii. Capital Comparability Determinations Commission regulation 23.106 allows certain SDs, MSPs, and foreign regulatory authorities to request a Capital Comparability Determination with respect to capital adequacy and financial reporting requirements for SDs or MSPs, as discussed above. As part of this request, persons are required to submit to the Commission certain specified supporting information and further information, as requested by the Commission. Further, if such a determination was made by the Commission, an SD or MSP would be required to file a notice with the RFA of which it is a member of its intent to comply with the capital adequacy and financial reporting requirements of the foreign jurisdiction. Moreover, in issuing a Capital Comparability Determination, the Commission would be able to impose any terms and conditions it deems appropriate, including additional capital and financial reporting requirements. The Commission expects that 43 firms out of the 108 currently provisionally registered SDs would seek Capital Comparability Determinations. These 24 firms are located in five different jurisdictions, all of which appear to have adopted some level of Basel compliant capital rule or another capital rule that would apply to SDs. As such, Commission staff estimates that it will take approximately ten hours per firm annually to prepare and submit requests for Capital Comparability Determinations and otherwise comply with the requirements of proposed regulation 23.106, resulting in aggregate annual burden of 240 hours. PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 57527 IV. Cost Benefit Considerations A. Background Section 15(a) of the CEA requires the Commission to consider the costs and benefits of its discretionary actions before promulgating a regulation under the CEA or issuing certain orders.497 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. In this cost benefit section, the Commission discusses the costs and benefits resulting from its discretionary determinations with respect to the section 15(a) factors.498 In addition, in Attachment A to this section, the Commission, using available data, estimates the cost of the final rule to each type of SD or MSP. This rulemaking implements the new statutory framework of Section 4s(e) of the CEA, added by Section 731 of the Dodd-Frank Act, which requires the Commission to adopt capital requirements for SDs and MSPs that do not have a prudential regulator (i.e., ‘‘covered swap entities’’ or ‘‘CSEs’’) and amends Commission regulation 1.17 to impose specific market risk and credit risk capital charges for uncleared swap and security-based swap positions held by an FCM.499 Section 4s(e) of the CEA requires the Commission to adopt minimum capital requirements for CSEs that are designed to help ensure the CSE’s safety and soundness and be appropriate for the risk associated with the uncleared swaps held by a CSE. In addition, section 4s(e)(2)(C) of the CEA, requires the Commission to set capital requirements for CSEs that account for the risks associated with the CSE’s entire swaps portfolio and all other activities conducted by the CSE. Lastly, section 4s(e)(3)(D) of the CEA provides that the Commission, the prudential regulators, and the SEC, must ‘‘to the maximum extent practicable’’ establish and maintain comparable capital rules. The rulemaking also includes certain financial reporting requirements related to an SDs and MSPs financial condition and capital requirements. In the following cost-benefit considerations, the Commission has 497 7 U.S.C. 19(a). Commission notes that the costs and benefits in this rulemaking, and highlighted below, have informed the policy choices described throughout this release. 499 See section 4s(e)(2)(B). 498 The E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57528 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations evaluated the costs and benefits of this rulemaking. In this section the Commission will: (i) Discuss the general benefits and costs of regulatory capital; (ii) summarize the rulemaking; (iii) describe the baseline for which the cost and benefits of this rulemaking were considered; (iv) provide an overview of the different capital approaches set out in this rulemaking and the rationale for each approach; (v) describe the costs and benefits to each type of SD and MSP under their corresponding capital approaches; (vi) discuss the reporting requirements; and (vii) an analyze the rulemaking as it relates to each of the 15(a) factors. Where reasonably feasible, the Commission has endeavored to estimate quantifiable costs and benefits. Where quantification is not feasible, the Commission identifies and describes costs and benefits qualitatively. The Commission acknowledges that it is limited in estimating the actual cost of its final capital rule. First, the initial and recurring costs for any particular registrant will depend on, among other things, its size, organizational structure, swap dealing activity, other business activities, modelling capacities, practices, and cost structure. In the 2016’s proposal’s cost-benefit considerations, the Commission estimated the cost of its capital proposal using SDR data on interest rate swaps for the purposes of extrapolating certain possible ranges regarding the possible cost of capital at Commission registered SDs. Interest rate swaps served as a proxy for all covered swap positions held by all covered SDs and then estimated the initial margin based on that portfolio. Interest rate swaps were selected because they represented a majority of the swaps notional reported to swap data repositories. The Commission did not receive any data or comments specifically addressing this analysis. Upon further review, the Commission has concluded that because this approach considered only one type of swap, the Commission does not believe that this estimate was helpful in understanding the range of possible cost outcomes that could have flowed from the proposal. In order for the Commission to be able to develop a credible estimate, it would need access to proprietary information for each swap dealer. Among some of the information that the Commission currently lacks and would be relevant are: (i) Position level data, sufficient to estimate risk margins; (ii) for the BankBased Capital Approach, data about the registrant’s Risk-Weighted Assets (RWAs); and (iii) for the Net Liquid Assets Capital Approach and the VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 tangible net worth approach, data about market risk and credit risk charges. For these reasons, the Commission has not quantified the costs of the rule in terms of the level of capital charges the rule may require. Instead, the Commission has attempted to quantify costs in terms of how implementation of the rule may affect registrants’ capital requirements in comparison to their existing capital levels and other circumstances. As detailed in Attachment A, the Commission has compiled available capital data and considered whether additional capital would be required to meet the Commission’s capital requirements. In considering the effects of the final rule and the resulting costs and benefits, the Commission acknowledges that the swaps markets have many types of market participants including SDs and their clients (who could be professional investors, public and non-public operating firms) and function internationally with: (i) Transactions that involve U.S. firms occurring across different international jurisdictions; (ii) some entities organized outside of the United States that are prospective Commission registrants; and (iii) some entities that typically operate both within and outside the United States. Where the Commission does not specifically refer to matters of location, the discussion of costs and benefits below refers to the effects of the amendments on all relevant swaps activities, whether based on their actual occurrence in the United States or on their connection with, or effect on U.S. commerce pursuant to, section 2(i) of the CEA.500 B. Regulatory Capital Regulatory capital is designed to ensure that a firm will have enough capital, in times of financial stress, to cover the risk inherent of the activities in the firm. Regulatory capital’s framework can be designed differently, but its primary purpose remains the same—to meet this objective. Although a firm may mitigate its risks through other methods, including risk management techniques (e.g., netting, credit limits, margin), capital is viewed as the last line of defense of an entity, ensuring its viability in times of 500 Pursuant to section 2(i) of the CEA, activities outside of the United States are not subject to the swap provisions of the CEA, including any rules prescribed or regulations promulgated thereunder, unless those activities either have a direct and significant connection with activities in, or effect on, commerce of the United States; or contravene any rule or regulation established to prevent evasion of a CEA provision enacted under the Dodd-Frank Act, Public Law 111–203, 124 Stat. 1376. 7 U.S.C. 2(i). PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 financial stress. In adopting this rulemaking, the Commission was cognizant of the purpose of capital and the potential trade-off between the costs of requiring additional capital and the Commission’s statutory mandate of helping to ensure the safety and soundness of SDs and MSPs thereby promoting the stability of the U.S. financial system. C. General Summary of Rulemaking The Commission designed this rulemaking on well-established existing capital regimes. The framework, which draws upon the principles and structures of bank-based capital, brokerdealer capital, and FCM capital, provides CSEs, operating under a current capital regime, with the ability to continue to comply with that regime, with minor adjustments to account for the inherent risk of swap dealing and to mitigate regulatory arbitrage. The Commission, in developing its capital framework, provides CSEs with the flexibility to continue operating under a similar capital framework, which should mitigate disruptions to the markets and mitigate the possibility of duplicative or even conflicting rules, while helping to ensure the safety and soundness of the CSE and the stability of the U.S. financial system. The final rule detail minimum capital requirements for different ‘‘types’’ or ‘‘categories’’ of CSEs and further define the capital computations, including various market risk and credit risk charges, whether using models or a standardized rules-based or table-based approach, to determine whether a CSE satisfies the minimum capital requirements. The Commission’s final rules permit SDs that are neither registered as FCMs nor subject to the capital rules of a prudential regulator to elect a capital requirement that is based on existing bank holding company (‘‘BHC’’) capital rules adopted by the Federal Reserve Board or a capital requirement that is based on the existing FCM/BD net capital rules. The Commission’s final rule also permits certain SDs that meet defined conditions designed to ensure that they are ‘‘predominantly engaged in nonfinancial activities’’ to compute their minimum regulatory capital based upon the firms’ tangible net worth. Further, the Commission is allowing SDs to obtain approval from the Commission, or from an RFA of which the SDs are members, to use internal models to compute certain market risk and credit E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations risk capital charges when calculating their capital.501 The Commission is also imposing certain restrictions on the withdrawal of capital from SDs if certain defined triggers are breached. The final rules also establish a program of ‘‘substituted compliance’’ that will allow a CSE that is organized and domiciled in a non-U.S. jurisdiction (‘‘non-U.S. CSE’’) (or an appropriate regulatory authority in the non-U.S. CSE’s home country jurisdiction) to petition the Commission for a determination that the home country jurisdiction’s capital and financial reporting requirements are comparable to the CFTC’s capital and financial reporting requirements for such CSE, such that the CSE may satisfy its home country jurisdiction’s capital and financial reporting requirements (subject to any conditions imposed by the Commission) in lieu of the Commission’s capital and financial reporting requirements (i.e., ‘‘Comparability Determination’’). Consistent with section 4s(f), the Commission is requiring SDs and MSPs to satisfy current books and records requirements, ‘‘early warning’’ and other notification filing requirements, and periodic and annual financial report filing requirements with the Commission and with any RFA of which the SDs and MSPs are members. D. Baseline In determining the costs and benefits of this rulemaking, the Commission’s benchmark from which this rulemaking was evaluated was the market’s status quo, i.e., the swap market as it exists today. As this final rule will implement capital and financial reporting on CSEs and recordkeeping requirements on SDs and MSPs, the Commission will discuss the incremental costs and benefits to each type or category of SD and MSP, as to their current capital and financial reporting and recordkeeping requirements. As each CSE or its parent holding company may be complying with current capital requirements, based on capital requirements that are a result of the entity or its parent entity registering with a financial agency, as a jbell on DSKJLSW7X2PROD with RULES3 501 Section 17 of the CEA sets forth the registration requirements for RFAs. RFAs are defined as self-regulatory organizations under Commission regulation § 1.3 (17 CFR 1.3). The Commission recognizes that SDs that seek model approval from the Commission or from an RFA will be required to submit documentation addressing several capital models including value at risk, stressed value at risk, specific risk, comprehensive risk and incremental risk. To the extent that models are reviewed and approved by an RFA, additional costs may be incurred by the RFA which may be passed on to the SDs. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 result of it being a financial intermediary (e.g., as an BD, FCM or BHC), the Commission has set different baselines for each type or category of entity. In the case that a CSE does not have current capital requirements, the Commission considered the full cost and benefit of its amendments on the entity. The following is a list of types or categories of registered entities and their corresponding capital regimes that the CSE currently complies with, if there is any, and their corresponding financial reporting and capital requirements. 502 Therefore, the Commission is using the status quo or baseline to evaluate the costs and benefits of these final rules for the following types or categories of CSEs: SDs That Are Bank Subsidiaries • Capital. Currently U.S. CSEs that are bank subsidiaries and are not a BD or an FCM are not subject to capital requirements; however, as part of a BHC or a subsidiary of a bank, the CSE’s parent entity must comply with the prudential regulators’ capital requirements. In addition, certain nonU.S. CSEs that are subsidiaries within a bank holding company and are not BDs or FCMs are currently complying with a foreign jurisdiction’s capital, liquidity and financial reporting requirements and these CSEs are covered below, in the Substituted Compliance section. • Reporting. These SDs do have reporting requirements, but not for the information that is requested in this rulemaking; however, a BHC must report the requested information to the Federal Reserve Board, which includes certain swap and security-based swap positions held at its SD subsidiary. SDs That Are BDs (Including, OTC Derivatives Dealers) (With and Without Models) • Capital. If a CSE is also registered as a BD with the SEC, the CSE is already meeting the SEC’s BD capital requirements. • The SEC currently imposes the Net Liquid Assets Capital Approach on BDs. However, the SEC has modified certain parts of this approach to address certain types of BDs (i.e., ANC Firms and OTC 502 The baseline of this CBC doesn’t include those SDs that are also registered with the SEC as Security-based Swap Dealers (SD–SBSDs), as the SEC’s rule will become effective at the same time as the Commission’s Final rule. Therefore, unless SD–SBSDs are registered as another category of registered entities that impose capital requirements, this CBC will treat these entities as currently having no current capital requirements. However, the Commission recognizes that to the extent that the SEC’s capital requirements for these dual registered SD–SBSDs require greater minimum capital than the Commission’s Final Rule, the costs discussed below with be mitigated. PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 57529 derivatives dealers). As discussed below, an ANC Firm is currently approved by the SEC to use capital models to calculate certain market and credit risk charges. In addition, OTC derivatives dealers may be approved by the SEC to use capital models provided that they maintain a minimum of $100 million in tentative net capital and at least $20 million in net capital. Certain non-U.S. SDs are already complying with capital, liquidity and reporting requirements in other jurisdictions. Therefore, the Commission will cover these SDs in the Substituted Compliance section. • Reporting. As a BD, these SDs must comply with the SEC’s BD reporting requirements (the Commission’s amended reporting requirements are based on the SEC reporting requirements). SDs That are FCMs and not BDs (With and Without Models) • Capital. For CSEs that are also registered with the Commission as FCMs, the Commission’s Net Liquid Assets Capital Approach that is similar to the capital requirements of a registered BD. • Reporting. As an FCM, these SDs must comply with the Commission’s FCM reporting requirements (the Commission’s amended reporting requirements are based on these). SDs That Are BDs and/or FCMs (ANC Firms With Models and One Other SD) • Capital. For CSEs that are also registered as BDs/FCMs (using approved models), a significant percentage of these SDs are currently using the ANC capital approach, as discussed below. There is currently one other SD that is not an ANC Firm, but meets the requirements set out above for SD/BDs and FCM–SDs. • Reporting. As an ANC firm, these SDs must comply with the SEC’s and the CFTC’s ANC firm reporting requirements. Stand-Alone SDs and Commercial SDs (With and Without Models) • Capital. Currently a CSE that is a stand-alone SD has no capital requirements; however, certain non-US Stand-alone SDs are complying with a foreign jurisdiction’s capital, liquidity and reporting requirements and, therefore, will be included in the Substituted Compliance benchmark below. • Reporting. As CSEs, these entities have reporting requirements, but not for the information required requested in this rulemaking. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57530 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations MSPs • Capital. Although there are no MSPs at this time, it is possible that an MSP in the future may have existing capital requirements. For example, if a bank is determined to be an MSP or an insurance company, these entities may have existing capital requirements. • Reporting. As MSPs, these entities have reporting requirements, but not for the information required in this rulemaking. informed by these foreign regulators, are similar to the Net Liquid Assets Capital Approach. • Reporting. The Commission understands that some of these non-U.S. CSEs are currently complying with a foreign jurisdiction’s financial reporting requirements; however, these financial reporting requirements may not be the same as the Commission is requiring in this rulemaking. Substituted Compliance 503 • Capital. As discussed above, there are certain non-U.S. CSEs that comply with a foreign jurisdiction’s capital and financial reporting requirements. Commission staff understands that generally these foreign capital requirements are either a bank-based capital regime or a dealer-based regime, which, as the Commission has been • Reporting. These SDs comply with their applicable prudential regulator’s reporting requirements. Prudentially Regulated SDs 504 E. Overview of Approaches In developing the capital approaches required herein, the Commission selected from well-established frameworks. As a result of the financial crisis and over the years after the crisis, each of the approaches has undergone significant analysis and changes. The Commission is providing certain CSEs with an option to choose between a Bank-Based Capital Approach (similar to the prudential regulators’ capital approach) and a net Liquid Assets Capital Approach (similar to the SEC’s and CFTC’s capital approach). As detailed below, the Bank-Based Capital Approach is designed to require an SD to have enough equity, including common equity tier 1 capital (as defined above), to absorb losses in a time of stress, while the net liquid assets method is designed to require an SD to hold at all times more than one dollar of highly liquid assets for each dollar of unsubordinated liabilities. The following table summarizes the Commission’s capital rules followed by a summary of each approach: Approaches SD entities Equity type The greatest of the following: Net Liquid Assets Capital, Regulation 1.17, FCM Approach. SD–FCM ....................................... Net Liquid Assets (Assets¥ Liabilities¥Market Risk¥ Credit Risk). ANC, Regulation 1.17 and SEC Rule 15c3–1. SD–FCM–ANC Approved Firm .... Net Liquid Assets (Assets¥ Liabilities¥Market Risk¥ Credit Risk). Net Liquid Assets Capital, SEC Rule 15c3–1 or 18a–1. SD–BDs, SD–BDs (OTC Derivatives Dealers), SD–Non-Bank Subsidiaries of BHC, SD. Net Liquid Assets (Assets¥ Liabilities¥Market Risk¥ Credit Risk). Bank-Based Capital ....................... SD–Non-Bank Subsidiaries of BHC, SD. Common Tier 1 Equity, Tier 1 or Tier 2, subject to limits 505. Tangible Net Worth Capital Approach. SDs–Non-financial Entities (15% test). Basic Equity (Assets¥Liabilities¥ Goodwill). MSPs ............................................. MSP .............................................. Equity ............................................ $20 million or $100 million if approved to use capital models. 8% of the total customer and noncustomer cleared margin, plus an additional 2% of the total amount of a swap dealer’s initial margin on uncleared swaps. RFA. $5 billion tentative net capital (not discounted). $6 billion early warning net capital (not discounted). $1 billion Net Discounted Assets. 8% of the total customer and noncustomer cleared margin, plus an additional 2% of the total amount of a swap dealer’s initial margin on uncleared swaps. RFA. $20 million. 2% of the total amount of a swap dealer’s initial margin on uncleared swaps. RFA. $20 million. 8% of RWA. 8% of the total amount of a swap dealer’s initial margin on uncleared swaps. RFA. $20 million plus market and credit risk charges. 8% of the total amount of a swap dealer’s initial margin on uncleared swaps. RFA. ≥$0. RFA. 503 The Commission estimates that there are 24 SDs that may be eligible for substituted compliance under this rulemaking. 504 The Commission notes that under section 4s(e) of the CEA, these SDs must comply with the prudential regulators’ capital requirements, but VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 must also comply with the Commission’s reporting and recordkeeping requirements. 505 Under the final rule, 6.5% of RWA must be met using CET1, the remaining amount is permitted to be met with capital in the form of Tier 1 or Tier 2, provided that subordinated debt meets the PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 conditions in Commission regulation 18a–1d (17 CFR 240.18a–1d). In addition, $20 million must be comprised of CET1, and 8% of total amount of swap dealer’s initial margin on uncleared swaps must be comprised of CET1, Tier 1 or Tier 2 capital as defined under banking rules. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 1. Bank-Based Capital Approach Under the Bank-Based Capital Approach a CSE would need to maintain regulatory capital that meets the following: • $20 million of common equity tier 1; • Six point five percent (6.5%) of common equity tier 1 capital equal to the sum of the following: (i) The amount of its risk-weighted assets (‘‘RWA’’), which is the market risk capital charge under a VaR computation or a standardized formula table (Reg. 1.17); (ii) the amount of current counterparty credit risk (‘‘CCR’’), which is the sum of the default risk capital charge and a credit value adjustment (‘‘CVA’’) risk capital charge, which is under either a standardized formula table or a VaR method, provided that an additional one point five percent (1.5%) of capital may be met with common equity tier 1 capital, additional tier 1 capital, or tier 2 capital (including subordinated debt subject to the conditions in SEC rule 18a–1d; • Eight percent (8%) of the total amount of a swap dealer’s uncleared swap initial margin comprised of common equity tier 1, additional tier 1, or tier 2 capital; and • The amount required by its RFA. As noted above, the Commission is requiring a $20 million fixed-dollar floor, as this is the minimum amount of required capital under all approaches. The Commission is requiring this minimum level as it believes that this is the minimum amount of capital that should be required for a CSE, without regard to the volume of swaps the CSE engages in, to conduct its dealing activity. As noted above, this amount is based on the Commission’s experience with other registered entities that are currently subject to capital requirements. The Commission is also adopting, an eight percent (8%) of uncleared swap initial margin requirement, as through its experience in supervising FCMs, it recognizes that this capital computation is a determinative condition in computing their required capital and requires an SD to maintain a higher level of capital as the operational and other risks associated with its dealing activity base increases, as measured by the initial margin requirements on the swaps positions. As discussed above, under the Bank-Based Capital Approach, the Commission is maintaining the 8% level of initial margin requirement. The Commission believes that the 8% level is properly calibrated for the BankBased Capital Approach method in determining capital. Unlike the Net VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Liquid Assets Capital Approach, which leaves higher quality assets in determining the required level of capital, the Bank-Based Capital Approach uses its entire balance sheet in determining the amount of required capital. As a result of including all of its assets (e.g., property, plant and equipment (‘‘PP&E’’)) in determining the capital requirement under the BankBased Capital Approach, the Commission believes that the 8% requirement is properly set, ensuring that the Commission meets its statutory requirements for harmonization. In addition, the Commission has determined to include only a SD’s initial margin amount on its uncleared swaps in calculating its capital requirement under this prong of the Bank-Based Capital Approach. As discussed above in section II.C.3., the Commission did not include other instruments that require initial margin because it believes that these other instruments either do not contain the same level of risk to the SD as uncleared swaps (e.g., cleared swaps) or are not within the products or markets for which the Commission typically regulates. The Commission recognizes that by not including these margined instruments in the minimum calculation, it may be decreasing the amount of required capital; however, these instruments are not removed from the required amount of capital component, which includes these positions net of applied market and credit risk charges. The Commission believes this approach better harmonizes the minimum calculation across the different elective approaches under the Commission’s framework and in comparison to other regulators (namely, the SEC and the Federal Reserve Board and OCC). In addition, the Commission has included a standardized table for market risk that is currently not part of the BCBS or prudential regulator capital framework. The Commission included the standardized table in calculating an SD’s market risk charges to address SDs that do not use approved models in computing market risk charges. The Commission included the regulation 1.17 standardized market risk charges, as it believes these charges result in adequate capital computations for the level of market risk inherent in these financial instruments. In addition, the Commission is currently using these standardized charges in computing an FCM’s market risk charges on the same financial instruments for an FCM’s required capital. PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 57531 2. Net Liquid Assets Capital Approach Under this approach, an SD is required to maintain minimum net capital equal to or exceeding the greatest of: • $20 million; or • Two percent (2%) of the total amount of a swap dealer’s uncleared swap initial margin. Net capital is generally defined as an SD’s current and liquid assets minus its liabilities (excluding certain qualifying subordinated debt), with the remainder discounted according to either a CFTC or RFA approved VaR-based model or a standardized rules-based approach set out in regulation 1.17. As noted and discussed above, under this approach, the Commission requires a $20 million fixed-dollar floor. In addition, the Commission is adopting, under this approach, a net liquid assets test that is designed to allow an SD to engage in activities that are part of its swaps business (e.g., holding risk inherent in swaps into its dealing inventory), but in a manner that places the SD in the position of holding at all times more than one dollar of highly liquid assets for each dollar of unsubordinated liabilities (e.g., money owed to customers, counterparties, and creditors). The Commission believes that the Net Liquid Assets Capital Approach, although structurally different than the Bank-Based Capital Approach, ensures the safety and soundness of the SD, while providing the same protections to the financial system. As discussed above, under the Net Liquid Assets Capital Approach, the Commission is changing the proposed 8% level of initial margin requirement to 2%. The Commission believes that, under this approach, the 2% level is properly calibrated in determining an SD’s capital requirement. As discussed above in section II.C.1., as a concept an 8% risk margin amount capital minimum component was originally proposed by the Commission in 2003, and subsequently adopted in 2004, to apply to FCMs. At the time, the Commission justified this minimum amount component based on an analysis and comparison of the amount to then existing FCM capital regime, which used a percentage of the customer funds held by an FCM as the minimum.506 506 See Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers, 68 FR 40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004). See also, CFTC Division of Trading and Markets, Review of Standard Portfolio Analysis of Risk Margining System Implemented by the Chicago Mercantile Exchange, Board of Trade Clearing Corporation, E:\FR\FM\15SER3.SGM Continued 15SER3 57532 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 The Commission originally proposed to use this same concept and percentage for use in determining SD minimum capital as means to harmonize the SD approach with Commission’s experience and familiarity with its use in the existing FCM approach. Yet, the Commission recognizes that the Commission’s margin requirements for uncleared swap positions generally impose a higher initial margin requirement relative to cleared futures positions, which justify using a different multiplied in the Net Liquid Assets Capital Approach. Minimum initial margin requirements for cleared futures transactions are generally set by clearing organizations and typically have a different margin period of risk. In this regard, the FCM minimum capital requirement of 8% of the risk margin amount on futures is based upon margin calculations using clearing organization models that require a 99% one-tailed confidence interval over a minimum liquidation period of one day for futures.507 In contrast, initial margin for uncleared swaps is required to be calculated at a 99% one-tailed confidence interval over minimum liquidation period of 10 business days (or the maturity of the swap if shorter).508 The greater margin period of risk for uncleared swaps generally requires a higher level of initial margin, which when used in determining minimum capital results in a higher level of required capital relative to if cleared futures margin was alternative used. The modification of the final rule to set the risk margin amount multiplier at 2% for uncleared swap positions is therefore appropriate given the generally higher initial margin requirements imposed on such positions under the Commission’s regulations relative to cleared positions. As noted above, a 2% multiplier using uncleared swap margin is also justified under the Net Liquid Assets Capital Approach as compared to a 8% multiplier in Bank-Based Capital Approach and Tangible Net Worth Approach because of differences in the composition of capital under the approaches. Bank-Based Capital Approach and Tangible Net Worth Capital Approach do not account for illiquid assets when determining the amount of capital, thereby including a much greater composition of assets as compared to that under the Net Liquid and the Chicago Board of Trade (Apr. 2001) (‘‘T&M 2001 Report’’). See, IIB/ISDA/SIFMA 3/3/2020 Letter. 507 See Commission regulation § 39.13(g) (17 CFR 39.13(g)). 508 See Commission regulation § 23.154 (b)(2) (17 CFR 23.154(b)(2)). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Assets Capital Approach. Applying a higher more comparable multiplier percentage under Net Liquid Assets Capital Approach would result in much more stringent capital requirement and could make competition among SDs utilizing this approach exponentially more difficult, especially for SDs which may be required to use this approach as a result of dual-registration with the SEC as either a BD or SBSD. 3. Alternative Net Capital (‘‘ANC’’) Under the ANC approach, an SD/BD or FCM would need to maintain its net capital in accordance with the following requirements: • $1 billion net capital; 509 • $5 billion tentative net capital; 510 and • $6 billion early warning net capital.511 An SD that is registered with the SEC as a BD and is approved by the SEC to use internal models to compute certain market risk and credit risk capital charges (an ‘‘ANC Firm’’) will be able to continue to use the ANC approach in calculating its SD capital; however, with enhancements to the minimum capital requirements as adopted by the SEC. An ANC Firm must maintain, at all times, tentative net capital, which is the net capital of an ANC Firm before deductions for market and credit risk, of $5 billion. In addition, an ANC Firm must maintain, at all times, early warning tentative net capital, which is the net capital of an ANC Firm before deductions for market and credit risk, of $6 billion. Lastly, an ANC Firm must maintain, at all times, $1 billion of net capital, which is net discounted assets (discounted by VaR models for market and credit risk). In adopting this approach, the Commission recognizes that ANC Firms are dual registrants with the Commission and SEC that offer a widerange of financial services and act as different types of intermediaries (e.g., BD, FCM, SD). As a result of the additional complexity and risk inherent in these entities, and the Commission’s experience with these ANC Firms, the Commission is increasing their minimum capital requirements consistent with the SEC. The Commission expects that SDs that are ANC Firms will elect to use this capital approach for their swaps transactions. The Commission believes that since this approach has been in effect for more than 10 years and it 509 See SEC rule 15c3–1(a)(7) (17 CFR 240.15c3– 1(a)(7)). 510 See Id. 511 See Id. PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 properly accounts for the inherent risk and complexity of these firms, including their swap dealing activities, that it is appropriate to permit ANC Firms to continue using this approach, but with some enhancements based on the Commission’s experience. As discussed above, the Commission is increasing the minimum capital requirements for ANC Firms in a manner consistent with the SEC’s increases for ANC Firms. The Commission believes that the increases are appropriate to reflect the potential increase in swaps activities that ANC Firms may engage in, particularly if affiliates move their swaps activities into the ANC Firms to more efficiently use the capital held by the ANC Firms. 4. Tangible Net Worth The Commission is adopting a Tangible Net Worth Capital Approach for both SDs and MSPs. With respect to SDs, the Commission is requiring an SD to maintain minimum net capital equal to or in excess of the greater of: • $20 million plus market and credit risk charges; • Eight percent (8%) of the total amount of a swap dealer’s uncleared swap initial margin; or • The amount required by its RFA. The term tangible net worth is defined to mean an SD’s net worth as determined in accordance with generally accepted accounting principles in the United States, excluding goodwill and other intangible assets. As noted above, the Commission is adopting this approach as it recognizes that certain SD’s that are primarily engaged in non-financial activities may engage in a diverse range of business activities different from, and broader than, the dealing activities conducted by a financial entity. An SD, availing itself of this approach, must meet the Commission’s 15% revenue test and 15% asset test as discussed in section II.C.4. to demonstrate that entity or its parent/consolidated entity is primarily engaged in non-financial activities. As discussed below, the Commission believes that the Tangible Net Worth Capital Approach meets statutory mandate, as it is designed to help ensure the safety and soundness of the SD, while calibrated to the inherent risk of the uncleared swaps held by the SD and the overall activity of the SD. As the Tangible Net Worth Capital Approach would only be available to SDs that are primarily engaged in non-financial activities, the Commission believes that this approach has proper controls to ensure that it is only able to be utilized by SDs which could not likely meet the other tests due to their unique position E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations in commercial markets as well as the swap dealing markets. With respect to MSPs, the Commission is requiring an MSP to maintain net tangible net worth in the amount equal to or in excess of the greater of the MSP’s positive net worth or the amount of capital required by an RFA of which the MSP is a member. There are currently no MSPs and the only previously registered MSP were required to register as a result of their legacy swaps and not any current swap activity. The Commission believes that the capital requirements for MSPs are appropriate given that no entities are currently registered and the Commission is uncertain of the types of entities that may register in the future. As noted above, the Commission has taken this uncertainty into consideration by proposing to allow an RFA to establish an MSP’s minimum capital requirements. Such RFA’s are required under section 17 of the CEA to establish capital requirements for all members that are subject to a Commission minimum capital requirement. Accordingly, RFAs may adjust their rules going forward depending on the nature of any entities that may seek to register as MSPs, and adopt minimum capital requirements as appropriate. Such RFA rules must be submitted to the Commission for review prior to the rules becoming effective. As discussed above, the Commission is maintaining the 8% level of initial margin requirement under the Tangible Net Worth Capital Approach. Similar to the discussion above in the Bank-Based Capital Approach, the Commission believes that the 8% level is properly calibrated. Unlike the Net Liquid Assets Capital Approach, which leaves higher quality assets in determining the required level of capital, the Tangible Net Worth Capital Approach uses a SD’s entire balance sheet in determining the amount of required capital. As a result of including all assets, including illiquid assets (e.g., PP&E) in determining the capital requirements, the Commission believes that the 8% requirement is properly set, ensuring that the Commission meets its statutory requirements. For the same reasons discussed above with the other approaches, the Commission also decided to include only a SD’s initial margin amount on its uncleared swaps in calculating its capital requirement under this prong. 5. Substituted Compliance As described above, the Commission is providing certain non-U.S. CSEs with the ability to petition the Commission for approval to comply with comparable VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 foreign capital and financial reporting requirements in lieu of some or all of the Commission’s requirements. The Commission recognizes that this may provide these CSEs with cost advantages by avoiding the costs of potentially duplicative or conflicting regulation. In limiting the scope of substituted compliance, the Commission does not believe it should make available substituted compliance to all CSEs. The Commission is adopting substituted compliance only to non-U.S. CSEs, as it believes that it is necessary that its capital requirements apply to U.S. CSEs, as they are integral to the U.S. swaps market and critical in ensuring the stability of the U.S. financial system. Additionally, the Commission recognizes that substituted compliance, to the extent that it puts conditions on its comparability determination, may result in additional costs to these CSEs; however, the Commission believes that providing a substituted compliance regime that allows for conditions instead of an all-or-nothing approach will benefit these CSEs and provide for a more competitive swaps market. Moreover, to the extent that a non-U.S. CSE must comply with a foreign regime and the Commission does not find that regime comparable, the Commission recognizes that these non-U.S. CSE may be burdened with additional costs and subject to conflicting and/or duplicative costs. F. Entities The following section discusses the related incremental costs and benefits of the rulemaking’s capital approaches and reporting requirements on each type or category of SDs and MSPs. The Commission understands that certain SDs and MSPs organized and domiciled outside of the U.S. would be included in these types or categories of entities. These non-U.S. SDs and MSPs are discussed in the Substituted Compliance section below. 1. Bank Subsidiaries Currently, all U.S. CSEs that are subsidiaries in a BHC and are not a BD or FCM currently are not subject to capital requirements; 512 however, their 512 The Commission acknowledges that some subsidiaries in a BHC may be an insurance company and, therefore, may have capital requirements set by its insurance regulator. Such entities are outside the scope of the Commission’s rulemaking as these entities are currently not registered with the CFTC as an SD or MSP. The Commission further acknowledges that there are some non-U.S. subsidiaries that are part of a bank and those subsidiaries and/or their parent may be subject to the capital regime of a foreign regulator. The Commission believes that in such a case, the capital regime that is likely to be applicable would PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 57533 parent BHC complies with the Federal Reserve’s capital requirements. Under the Federal Reserve Board’s capital requirements, which are based on Basel III requirements, a BHC must maintain adequate capital for the entire consolidated entity.513 That is, all the assets and liabilities of the BHC’s consolidated subsidiaries are consolidated into the holding company. The Federal Reserve Board’s capital requirements are then imposed on the BHC, requiring the BHC to maintain capital levels according to those requirements. As these CSEs are not currently required to be separately capitalized, the Commission understands that this may add incremental cost to the consolidated entity and/or the CSE as they may have to retain earnings or further capitalize the CSE to the required capital levels. However, the Commission recognizes that a consolidated entity may capitalize one of its subsidiaries in many different ways, including retaining earnings from the CSE or from within the consolidated group. Even with this requirement imposing capital on the subsidiaries, as noted above, the BHC must maintain capital levels in accordance with the Federal Reserve Board’s capital requirements, which are calculated on a consolidated basis; therefore, incremental costs may be mitigated, as it may be possible for the consolidated entity to keep the same level of capital within the BHC, but reallocated among its subsidiaries.514 In addition, the Commission recognizes that earnings may now have to be retained in the CSE and may no longer be available to be reallocated to fund other more profitable activities within the consolidated group or to be returned to shareholders; however, the Commission believes that by providing these CSEs with the option of differing capital approaches, these CSEs will select the capital approach this is optimal for its operations, financial structure and which will reduce duplicative or conflicting rules and the administrative costs of calculating and maintaining additional sets of books and records. be either the Basel III-based approach or a version of the net liquid assets approach. 513 See Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule; Final Rule, 78 FR 62018 (Oct. 11, 2013). 514 The Commission notes that the bank or an insurance company in a BHC must maintain certain capital and as such, may not be able available to capitalize the CSE. E:\FR\FM\15SER3.SGM 15SER3 57534 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations The Commission believes that although the capital approaches adopted herein may be structurally different, they each require a CSE to maintain adequate capital levels commensurate to its regulated swap dealing activities, which should help ensure the safety and soundness of the CSE and the stability of the U.S. financial system. In requiring capital for a bank subsidiary that is an SD, as discussed above, the SD may incur additional costs. As a result of the additional costs, some SDs may be put at a competitive disadvantage, when compared to those dealers with lesser capital requirements or with no capital requirements. As a result of this additional cost, some swap dealing activity may become too costly—becoming a low margin activity—and, therefore, some SDs may limit their dealing activity or exit the swaps market. Additional costs may also be passed on to customers in the form of higher prices; however, if these SDs are to remain competitive in the swaps market, they must compete by matching or beating prices of their competitors or provide other additional services to their customers. In addition, as most of the largest swap dealers are part of a BHC, these SDs are already incurring capital charges at the consolidated level, and, therefore, the incremental cost and the effect on competition and pricing of swaps may be mitigated. Because these SDs have the option to select the most optimal capital approach for them, they can control some of the burdens placed on them by the rules and thereby, mitigate the rulemaking’s effect on pricing. jbell on DSKJLSW7X2PROD with RULES3 2. SD/BD (Without Models) 19:50 Sep 14, 2020 An SD that is registered with the SEC as an OTC derivatives dealer will have the option to comply with either the Bank-Based Capital Approach or the Net Liquid Assets Capital Approach. As OTC derivatives dealers, these SDs already comply with the SEC’s net liquid assets capital requirements. OTC derivative dealers also may be approved by the SEC to use internal models to calculate market and credit risk charges in lieu of standardized, rules and tablebased capital charges for swaps, security-based swaps and other financial instruments. The Commission believes that since SDs that are registered OTC derivatives dealers are already complying with the SEC’s Net Liquid Assets Capital Approach, they will select this approach in meeting with the Commission SD’s proposed capital requirements. The Commission believes that allowing these entities to continue using current capital requirements will reduce the possibility of duplicative or conflicting rules and administrative costs of calculating and maintaining additional sets of books and records. The Commission believes that this will result in only a small incremental cost to OTC derivative dealers. The Commission recognizes that OTC derivatives dealers already have received approval from the SEC to use models in computing their current capital requirements and, therefore, will not incur any additional costs in developing and implementing this model-based approach in computing capital charges. 4. FCM–SD (Without Models) An SD that is also a BD that does not use SEC/CFTC-approved models to calculate its market and credit risk charges has the option to use either the Bank-Based Capital Approach or the Net Liquid Assets Capital Approach, but with standardized capital charges for market risk and credit risk. The Commission recognizes that although it is giving an option to these SDs to comply with either approach, these SDs must still meet the SEC’s BD capital requirement. The standardized capital charges impose significant capital requirements for uncleared swaps primarily in the form of rules-based market risk charges and credit risk charges. The Commission does not anticipate that many SD/BDs engaging in significant swaps activity will do so using the standardized capital charges for market and credit risk. VerDate Sep<11>2014 3. SD/BD/OTC Derivatives Dealers (Without Models) Jkt 250001 An SD that is also registered with the Commission as an FCM that does not use models to calculate market and credit risk charges, must compute its capital in accordance with the standardized market and credit risk charges set forth in regulation 1.17. The Commission is amending certain provisions of regulation 1.17 to reduce the burden on an FCM engaging in swaps. The amendments align the FCM capital requirements with that of the Net Liquid Assets Capital Approach for SDs in regulation 23.101. In amending the requirements, the Commission believes that it is reducing the burden placed on SDs/FCMs, as the amount of capital on uncleared swaps would have been significantly higher under the current requirements and would have placed FCM–SDs at a competitive disadvantage. Specifically, regulation 1.17 currently does not allow an FCM to PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 recognize collateral held at a third-party custodian as capital. Therefore, under regulation 1.17 an FCM–SD would have to take a 100 percent capital charge for margin posted with third-party custodians even though the Commission’s uncleared margin rules require initial margin to be held at a third-party custodian. This is true even though the custodian has no ability to rehypothecate the initial margin and the SD has the ability to retrieve the initial margin back from the custodian with no encumbrance. Therefore, the Commission believes that its amendments to regulation 1.17 to allow an FCM–SD to recognize margin posted with third-party custodians in accordance with the Commission’s margin rules allows an FCM–SD to meet its minimum level of required capital while also requiring an FCM–SD to maintain adequate capital levels, when considering the amount of initial margin that the SD has at its disposal in the event of a counterparty default. As a result of the amendments, FCM– SDs should benefit from lower capital charges and should allow these FCM– SDs to continue to comply with one capital rule, which should mitigate some of the administrative costs and reduce the possibility of duplicative or conflicting rules. The Commission is not providing these SDs with an option to use the Bank-Based Capital Approach, as the Commission believes that this option is unnecessary and costly, and the current FCM capital approach reflects that the firm is not only a SD, but acts as an intermediary for customers on futures markets. The Commission has made amendments to account for FCM–SDs’ swap activities and in allowing these FCMs to change their current capital method, the Commission believes that this would add an additional layer of complexity and costs to the FCMs, as the FCMs would have to change, modify or migrate all of their current systems to a new capital regime. In addition, the Commission believes that requiring the same capital regime, with beneficial amendments, is more appropriate in transitioning the Commission’s capital requirements to these entities, as it should result in fewer burdens and a simple transition in implementing the Commission’s amended capital requirements. Further, the Commission believes that this would simplify the Commission’s ability to supervise these entities, as the Commission will be able to seamlessly transition from its current capital regime to these new requirements; however, the Commission recognizes that by not providing these E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations SDs with the option to use the BankBased Capital Approach it may be foreclosing the ability of these SDs to use a capital approach that may be more cost effective. The Commission recognizes that by amending regulation 1.17 capital charges it is reducing the burden currently placed on FCM–SDs’ swaps activities, which may result in greater liquidity in the swaps market, as this activity will be less costly and may incentivize these entities to engage in more swap dealing activity. As a result of the amendments to regulation 1.17, these FCM–SDs may be able to realize some of the cost saving of the amendments when competing with other dealers for counterparties. This cost savings may also result in more efficient pricing for their counterparties. However, the Commission notes, as stated above, that as a result of the Commission’s margin requirements for uncleared swaps these benefits may be limited. jbell on DSKJLSW7X2PROD with RULES3 5. ANC Firms (SD/BDs and/or FCMs That Use Models) An SD that is an ANC Firm (i.e., also a BD and/or FCM, with approval by the SEC/CFTC to use models in computing market risk and credit risk charges), will incur minimal additional capital charges, as a result of the amendments. The Commission is retaining this approach for these firms, but with an increase in the capital thresholds, as noted above. The Commission is making these amendments based on market experience in supervising ANC Firms, and in recognition that the amendments are consistent with the SEC’s capital increases for ANC Firms. The Commission notes that the current ANC Firms are already maintaining more than the amended thresholds; however, by increasing these capital requirements the Commission recognizes that this may have an additional cost, as ANC Firms will now be required to maintain these capital levels, as under the current capital thresholds, these were held at their discretion. The Commission recognizes that ANC firms already have received approval from the to use models in computing their current capital requirements and, therefore, they will not incur any additional costs in developing and implementing this model-based approach in computing capital charges. 6. Stand-Alone SD (With and Without Models) A stand-alone SD is provided with an option to comply with either the BankBased Capital Approach or the Net Liquid Assets Capital Approach. In VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 providing this option, the Commission, as discussed above, believes that both options provide adequate capital requirements and account for the financial activities of an SD. Therefore, the Commission believes that these SDs will benefit, as these SDs will have the ability to select the most optimal approach, based on their organizational and operational structure and the composition of their assets. In addition, this option will also reduce the possibility of duplicative or conflicting rules and administrative costs of calculating and maintaining additional sets of books and records. A stand-alone SD that does not use models must compute their market risk and credit risk charges in accordance with rules-based requirements and standardized tables. The Commission recognizes that under the Bank-Based Capital Approach, market risk charges are calculated with a prudential regulator’s approved model; however, to allow stand-alone SDs to use the BankBased Capital Approach without a model, the Commission is incorporating regulation 1.17 market risk charges into the framework. In providing this alternative, the Commission is providing an option to those stand-alone SDs that do not have Commissionapproved models. In doing so, the Commission is providing these SDs with a benefit, as they are still able to choose the most efficient capital approach. The Commission incorporated regulation 1.17 market risk charges, as amended, as it believes that this is a well-established method that properly accounts for market risk charges. However, the Commission recognizes that many of these entities are not currently subject to minimum capital requirements, and as such, will incur additional costs on all of their financial activities, including their swap activities, which may result in possible increases in costs and pricing. In addition, a stand-alone SD selecting to use models in computing its market and credit risk charges may incur additional costs in developing and implementing these models. The Commission recognizes that by requiring capital for SDs this may put these SDs at a competitive disadvantage, when compared to those dealers with a lesser capital requirement or with no additional capital requirements as a result of these rules. As a result of this additional cost, some swap activities may become too costly and, therefore, some SDs may limit their activity or exit the swaps market. This additional cost may in turn be passed on to customers in the form of higher prices; however, if these SDs are to remain competitive in PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 57535 the swaps market, they must compete by matching or beating prices of their competitors or provide other additional services to their customers. If an SD decides to limit its activity or withdraw from the swaps market, this may result in a reduced level of liquidity in the swaps market. In requiring minimum capital requirements, the Commission believes that it is complying with its statutory mandate, as these standards are calibrated to the level of risk in an SD and are designed to help ensure safety and soundness of the SD and the stability of the U.S. financial system. In addition, the Commission’s proposal is modeled after two well-established capital regimes, which should help ensure safety and soundness of the SD and competition among all registered SDs. 7. Non-Financial SD (With and Without Models) An SD or an SD that has a parent that is predominantly engaged in nonfinancial activities, as defined in regulation 23.100 (85% non-financial threshold), may use the Tangible Net Worth Capital Approach. This approach is designed after GAAP’s tangible net worth computation and excludes intangibles and goodwill.515 The Commission is also requiring that the non-financial SD include in its capital requirement its market risk and credit risk charges. The Commission believes that this approach, which is tailored to nonfinancial entities that are SDs or have a SD in its corporate family, provides these entities with the flexibility to meet an appropriate capital requirement, without requiring the firms to engage in costly restructuring of their operations and business. The Commission recognizes that these SDs deal in swaps, but the Commission also recognizes that these entities or their parent entity are primarily engaged in commercial activities and these SDs primarily transact with commercial clients. BCBS and the Commission did not fully consider this type of business model when developing the Bank-Based Capital Approach and the Net Liquid Assets Capital Approach. In allowing these entities to maintain their current structure, the Commission believes that its approach will allow for less disruption to these SDs and in the markets, as these SDs may serve smaller clients that would not otherwise be able to participate in the swaps market 515 Under GAAP, tangible net equity is determined by subtracting a firm’s liabilities from its tangible assets. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57536 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations without these SDs. However, the Commission, in helping to ensure the safety and soundness of these SDs, is requiring that these entities maintain a level of tangible net worth equal to or greater than the greatest of (i) $20 million plus the SD’s market and credit risk charges, (ii) eight percent of its uncleared swaps initial margin amount or (iii) the amount of capital required by an RFA, as this would account for the SD’s exposure (market and credit risk) to the swaps markets, without penalty to the SD’s or the SD’s parent’s commercial activities. In developing this approach, the Commission also recognizes that the commercial activities of a commercial SD could affect the overall financial health of the SD. That is, in the event of a substantial loss emanating from its commercial activities, this loss may have a substantial negative affect on the SD, which may find itself in financial distress. As the Commission is not accounting for the risk in the commercial activities, it is possible that the amount and type of capital that a commercial SD is required to maintain may not be adequate to prevent the failure of the SD, which then will affect all of its swap counterparties. However, in tailoring this method to these commercial SDs, the Commission is taking a position that is consistent with the Commission’s prior positions on commercial entities, as it believes these commercial entities and their corresponding activities present less default and systemic risk than a financial entity.516 The Commission recognizes that these entities are not currently subject to minimum capital requirements, and as such, will incur additional costs due to the imposition of a capital requirement on all of their swap dealing activities, which may result in possible increases in pricing; however, as the Commission has developed its capital requirements to better account for activities in these commercial SDs, it believes that the additional cost should be mitigated by this approach. In addition, as the Commission expects that many of these SDs will use models in computing its market and credit risk charges, this may also result in additional costs in developing and implementing these models; however, this cost should be mitigated by the savings that may be realized by using such models. 8. MSP An MSP must maintain capital (i.e., tangible net worth) of the greater of 516 See e.g., 17 CFR 39.6. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 positive tangible net worth or the amount of capital required by a RFA of which the MSP is a member. This approach is designed after GAAP’s tangible net worth computation and excludes intangible assets and goodwill. Currently there are no MSPs. The Commission cannot determine if other entities will register in the future as MSPs, however, the Commission is required to adopt a capital requirement to address potential future registrants. In adopting the Tangible Net Worth Capital Approach for MSPs, the Commission is allowing these entities to continue their operations if they become registered as MSPs with little to no changes to the entities’ structures. In providing for this, the Commission believes that these entities if they become registered as MSPs will incur minimal additional costs to comply with the proposed requirements. The Commission believes that the adopted capital requirements will help ensure the safety and soundness of MSPs, as these entities will typically be posting and collecting margin on all of their new uncleared swaps and, therefore, as these MSPs are registered only as a result of being an end user of swaps and not a swap dealer, the margin requirements satisfy most of the safety risk for these entities, which is on a $1 for $1 basis, than through more burdensome capital requirements. Therefore, the Commission is only requiring MSPs to maintain solvency, while noting that the entity may be subject to other capital requirements and hence required to comply with those capital requirements. As the Commission’s capital requirements will result in minimal additional costs to these MSPs, there should be little to no effect on competition, as they are end users (i.e., price takers) and little to no incremental effect on pricing. 9. Substituted Compliance A non-U.S. CSE that is already complying with a comparable foreign jurisdiction’s capital or financial reporting regime is provided with the ability to meet the Commission’s capital requirements by meeting the foreign jurisdiction’s capital requirements. In providing these CSEs with the ability to continue to comply with their current capital and financial reporting regimes the Commission believes that it is limiting the potential for conflicting and duplicate capital requirements. In addition, as each foreign jurisdiction must be determined to be of comparable effect, which mitigate the possible negative impacts on the U.S. financial system. PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 The Commission further recognizes that non-U.S. CSEs that use conditional substituted compliance may incur additional costs; however, the Commission believes that conditional substituted compliance provides an offsetting benefit to these CSEs as it allows for a conditional substituted compliance determination instead of an all-or-nothing approach, which may result in the Commission not recognizing a foreign jurisdictions capital requirements, resulting in more substantial additional cost, including possible conflicting and/or duplicative requirements. G. Liquidity Requirements The Commission proposed to require FCM–SDs and covered SDs electing the Bank-Based Capital Approach or the Net Liquid Assets Capital Approach to satisfy specific liquidity requirements.517 The proposal required covered SD electing the Bank-Based Capital Approach to meet the liquidity coverage ratio requirements set forth in 12 CFR part 249.518 In addition, the proposal required covered SDs electing the Net Liquid Assets Capital Approach and FCM–SDs to adopt a liquidity stress test requirement that was similar to those undertaken by SEC ANC Firms.519 The Commission proposed these requirements to address the potential risk that a covered SD or FCM–SD may not be able to meet both expected and unexpected current and future cash flows, including collateral needs. As noted above, the Commission is not adopting these requirements. Therefore, by not including these requirements, the Commission recognizes that it may be increasing risk to the financial system. The Commission realizes that it is possible for a firm to have enough capital, but not enough liquidity to continue its operations as an ongoing business. These requirements were intended to ensure that SDs would have enough liquid assets to meet liabilities, which would help it during a liquidity crisis—ensuring the short-term continuing operations of the SD. However, the Commission believes this increased risk to the financial system is mitigated by the Commission’s regulation 23.600, which imposes liquidity requirements on covered SDs. Regulation 23.600 requires each SD to establish, document, maintain, and enforce a system of written risk management policy and procedures designed to monitor and manage the 517 See 2016 Capital Proposal, 81 FR 91252 at 91273–75. 518 Id. 519 Id. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 risk associated with the covered SD’s swaps activities, including liquidity risk. In addition, for those SDs that are part of a bank holding company, the bank holding company must comply with high quality liquid asset requirements, which should mitigate this increased risk at these SD. Finally, this risk is greatly reduced for firms electing the Net Liquid Assets Capital Approach, which already incorporates a liquidity component into its primary determination of the capital amount. In not adopting these requirements, the Commission believes that SDs will be provided with greater flexibility in meeting its current liquidity needs. This should allow SDs to allocate their funds in a more efficient manner, which may result in a greater return on capital, as they will no longer need to set aside funds in low-returning assets. H. Equity Withdrawal Restrictions In the Final Rule, the Commission is prohibiting certain withdrawals of equity capital from covered SDs.520 The equity withdrawal restriction generally provides that the capital of a covered SD, or any subsidiary or affiliate of the covered SD that has any of its liabilities or obligations guaranteed by the covered SD, may not be withdrawn by action of the covered SD or by its equity holders if the withdrawal would result in the covered SD holding less than 120 percent of the minimum regulatory capital that the covered SD is required to hold pursuant to proposed regulation 23.101. As discussed above in section II. C. 9., the Commission adopted these requirements to ensure the safety and soundness of the covered SD and the integrity of the financial system, because the Commission believes that the withdrawal, loan or advance may be detrimental to the financial integrity of the covered SD. In addition, these transactions may unduly jeopardize the covered SD’s ability to meet its financial obligations to counterparties or to pay other liabilities which may cause a significant impact on the markets or expose the counterparties and creditors of the covered SD to loss. However, the Commission notes that in adopting these requirements, the Commission may be limiting the consolidated entity’s, including the covered SDs and their affiliates, financial flexibility. That is, these requirements may limit the ability of the consolidate entity to allocate capital, at a critical time, to an entity that may need funding or an entity with a greater rate of return. The Commission recognizes this, but, as stated above, believes that if it permitted 520 See 23.104(a) and (b). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 this activity, it may cause significant impact on the financial system. I. Reporting and Recordkeeping Requirements The recordkeeping, reporting and notification requirements set out in this rulemaking are intended to facilitate effective oversight and improve internal risk management, via requiring robust internal procedures for creating and retaining records central to the conduct of business as an SD or MSP. Requiring registered SDs and MSPs to comply with recordkeeping and reporting rules should help ensure more effective regulatory oversight. The amendments will help the Commission determine whether an SD or MSP is operating in compliance with the Commission’s capital requirements and allow the Commission to assess the risks and exposures that these entities are managing. As detailed above in Section II.D., the Commission is requiring all SDs to file certain financial information pertaining to their capital requirements. Those SDs that are prudentially regulated are provided with the option to submit their financial information that is reported to their prudential regulator to the Commission. In addition, those SDs that are also FCMs may file their financial information pertaining to their capital requirements with the Commission, including notices, in the same manner as they currently report. For those SDs that are also registered with the SEC as a BD or a SBSD, these SDs may file the same financial information to the Commission, as they file with the SEC. In filing the required financial information with the Commission, these entities must file through the Winjammer electronic filing system. Alternatively, these same SDs have the option to report their financial information like stand-alone SDs, commercial SDs and MSPs report their financial information to the Commission. The Commission is providing this option, as the information reported to the Commission under this proposal and that is filed with the Commission or other financial regulatory agencies are similar, as the information provides the Commission with the ability to assess and monitor an SD’s financial condition and whether the SD is currently meeting the Commission’s capital requirements. In permitting these SDs to use their current required information, the Commission believes that this should mitigate some additional costs to prepare and report this information to the Commission. In addition, these SDs should already have developed policies, procedures and PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 57537 systems to aggregate, monitor, and track their swap dealing activities and risks. As such, this should also mitigate some of the costs incurred under the rulemaking. Those SDs and MSPs that are not subject to current capital requirements will have to develop and establish policies, procedures and systems to monitor, track, calculate and report the required information. In developing these policies, procedures and systems, these SDs will incur costs; however, as these entities are registered with the Commission as SDs, the Commission believes that they should already have developed policies, procedures and systems to aggregate, monitor, and track their swap activities and risks, as is required under the Commission’s swap dealer framework. This should mitigate some of the burdens of the reporting and recordkeeping requirements. In addition, as the information that the Commission is requiring is based on GAAP or another accounting method, this information is already being prepared for other purposes and therefore, should again mitigate the costs in meeting these requirements. The Commission also believes that as a result of the reporting and recordkeeping requirements, SDs should be able to more effectively track their trading and risk exposure in swaps and other financial activities. To the extent that these SDs can better monitor and track their risks, this should help them better manage risk. As noted in the section F.9., the Commission is providing substituted compliance to certain non-U.S. CSEs. As discussed above and for the same reasons, the Commission believes that, in regards its reporting requirements, providing substitute compliance to these non-U.S. CSEs it should reduce the possibility of additional costs and duplicative or conflicting requirements. J. Section 15(a) Factors The following is a discussion of the cost and benefit considerations as it relates to the 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. 1. Protection of Market Participants and the Public The rules are intended to strengthen the swaps market by requiring all CSEs to maintain a minimum level of capital. These minimum capital requirements should enhance the loss absorbing E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57538 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations capacity of CSEs and reduce the probability of financial contagion in the event of a counterparty default or a financial crisis. In addition, capital functions as a risk management tool by limiting the amount of leverage that a CSE can incur. Financial reporting requirements for CSEs should help the Commission and investors monitor and assess the financial condition of these CSEs. As this rulemaking is designed to protect financial entities from default, this should have a direct benefit to the public, as the failure of these CSEs could result in a financial contagion, which could negatively impact the general public. On the other hand, the capital rules may require additional capital to be raised and will increase the cost of swaps for all market participants, as described above. prudential regulators’ regime, SEC’s regime or in other jurisdictions, certain CSEs may have a competitive advantage or disadvantage; however, the Commission, in developing the capital rule, harmonized it with those of the prudential regulators and the SEC to the maximum extent practicable. As noted above, the Commission, recognizing that SDs are critical to the financial integrity of the financial markets, designed their capital requirements to help ensure the safety and soundness of these SDs. In doing so, this should protect an SD in the event of a default by its counterparty or a financial crisis, which the Commission determines should reduce the probability of financial contagion. 2. Efficiency, Competitiveness, and Financial Integrity of Swaps Markets The Commission seeks to promote efficiency and financial integrity of the swaps market, and where possible, mitigate undue competitive disparities. Most notably, the Commission aligned the regulations with that of the prudential regulators’, SEC’s and the Commission’s current capital frameworks to the greatest extent possible. Doing so should promote greater operational efficiencies for those SDs that are part of a BHC or are also registered with the SEC as a BD or the Commission as an FCM, as they may be able to avoid creating duplicative compliance and operational infrastructures and instead, rely on the infrastructure supporting the other registered entities. In addition, this approach should also enhance efficiency and limit conflicting rules, as these entities can continue to operate under their current regimes. Moreover, the amendments permit CSEs to calculate credit and market risk charges under a standardized or model-based approach, which allows them to choose the methodology that is the most suitable for their asset composition. The Commission notes that the capital rule, like other requirements under the Dodd-Frank Act, could have a substantial impact on competition in the swaps market. As the Commission’s capital rule will result in additional costs to certain CSEs that do not have current capital requirements, these CSEs may either limit their swap activities or withdraw from the swaps market. In this event, it is possible that this may result in less competition and increases in prices of swaps. Depending on the relative cost of the Commission’s capital requirements compared with corresponding requirements under As noted above, the capital rule may have a negative effect on competition, as a result of increasing costs, which may result in some SDs limiting or withdrawing from the swaps markets. In that event, this negative effect on competition could result in a less liquid swaps market, which will have a negative effect on price discovery. However, as discussed above, most of the larger SDs or their parent entities are already subject to capital requirements that impose capital charges for their swap activities and, therefore, the rule’s negative impact on competition, liquidity and price discovery should be limited, and in any event is outweighed by the increased benefit of the longer term safety and soundness of the entities that provide price discovery. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 3. Price Discovery 4. Sound Risk Management Practices A well-designed risk management system helps to identify, evaluate, address, and monitor the risks associated with a firm’s business. As discussed above, capital plays an important risk management function and limits the amount of leverage an entity can incur. In addition, capital serves as the last line of defense in the event of a counterparty default or severe losses at a firm. The Commission’s capital rule is developed from two wellestablished capital regimes. Therefore, the Commission’s capital rule should promote increase risk management practices within a CSE. Moreover, the Commission believes that as a result of the reporting and recordkeeping requirements, SDs may more effectively track their trading and risk exposure in swaps and other financial activities. To the extent that these SDs can better monitor and track their risks, this should help them better manage risk within the entity. PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 5. Other Public Interest Considerations The Commission has not identified any additional public interest considerations related to the costs and benefits of the proposed rule. K. Attachment A to Cost Benefit Considerations i. Minimum Capital Requirement Due to data availability, the Commission’s analysis is focused on cost arising from minimum capital requirements. As discussed above, this rulemaking would prescribe capital requirements for SDs and MSPs that are not subject to a prudential regulator, and amendments to existing capital rules for FCMs would prescribe capital requirement for FCMs that are also registered as SDs and increase capital requirement for FCMs to account for risk arising from their swaps and security-based swaps. The Commission discusses cost at the entity level. The analysis below makes many assumptions that assume away complex details and the marginal cost resulting from the final rule would be much larger and proportionally larger for smaller entities. Please note that the true magnitude of cost is unknown. As of June 3, 2020, there are approximately 108 SDs and no MSPs provisionally registered with the Commission. The Commission estimates that out of the 108 provisionally registered SDs, 15 U.S. Prudential Regulated Registrants SDs are exempt from the Commission’s capital requirement; 38 SDs which are Non-U.S. Registrants Overseen by the FRB are also exempt from the Commission’s capital requirement. For the rest of the 56 provisionally registered SDs, 4 SDs are also registered with the Commission as FCMs, while the other 52 SDs are not FCMs. The cost benefit considerations noted in the 2016 Capital Proposal included an analysis of interest rate swap position data for the purposes of extrapolating certain possible ranges regarding the possible cost of capital at Commission registered SDs. The Commission noted at the time that this was because interest rate swaps represent a majority of the swaps notional reported to swap data repositories. The Commission received no comments specifically addressing this analysis and upon further review has concluded that utilizing Part 45 data for this exercise could be problematic; drawing conclusions of estimated capital costs from the one particular type of swap data does not adequately reflect the variety of SDs and their respective dealing books under the E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations Commission’s jurisdiction. The Commission has updated other tables that were included to reflect current registrations. The quantitative data noted herein reflect data either reported on existing Commission filings from these registrants or is readily available to the public as part of the bank or financial holding company public disclosure process. Discussing Capital Requirement Cost at Entity Level The Commission collects monthly financial and capital information from FCMs. There are currently four SDs that are also registered as FCMs. For the purpose of discussing cost of complying 57539 with these minimum capital requirements, the Commission further separates these SDs that are also FCMs into two categories: SDs that are also SEC registered ANC firms, and FCMs that are not ANC firms registered with the SEC. 1. SDs That Are FCMs and ANC Firms With the SEC TABLE 1—CAPITAL FOR SDS THAT ARE ALSO FCMS AND ANC FIRMS AS OF APRIL 30, 2020 Registered as Name of swap dealers CITIGROUP GLOBAL MARKETS INC ....................................... GOLDMAN SACHS & CO .......................................................... JP MORGAN SECURITIES LLC ................................................ MORGAN STANLEY & CO LLC ................................................ FCM FCM FCM FCM BD BD BD BD SD SD SD SD Adjusted net capital $9,448,443,343 19,731,764,252 23,422,668,118 12,993,998,405 Net capital requirement $ 4,041,143,110 4,116,348,831 5,808,368,054 4,109,846,691 Excess net capital $5,407,300,233 15,615,415,421 17,614,300,064 8,884,151,714 Source: FCM financial data as of April 30, 2020. The Commission estimates that four SDs are already registered as ANC BDs with the SEC. Under the 2019 SEC Final Capital Rule, ANC firms registered with the SEC are required to maintain a minimum of five billion dollars of tentative net capital and a minimum of one billion dollars of net capital. In addition, all ANC firms use models for risk charge computations. These minimum capital requirements for ANC firms by the SEC are much higher than the minimum capital requirements adopted by the Commission, thus are more likely the binding constraints for these firms. Based on financial information reported by these SDs in their monthly reports filed with the Commission, these four SDs maintain a significant amount of net capital in excess of SEC’s requirement and the Commission’s capital requirement. Therefore, the Commission expects that the likelihood of these entities needing to raise additional capital due to this rule might be low; however, there may be other significant costs for these entities to comply with this capital requirement. The true magnitude of these costs is hard to predict due to the complexities of these rules. jbell on DSKJLSW7X2PROD with RULES3 2. SDs That Are FCMs but Currently Are Not ANC Firms Registered With SEC There are currently no provisionally registered swap dealers which are registered as FCMs but not ANC firms registered with the SEC. As noted in the 2016 Proposal, there were four previously provisionally registered SDs in this category, but withdrew their registration. The Commission understands that a majority of these SDs engaged in forex dealing business exited swaps dealing as result of the adoption of other regulatory requirements, VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 namely the uncleared margin rules. Accordingly, the Commission does not expect there to be any other type of FCM registered as a SD and thus is not further considering the costs of capital for these entities. For SDs that are not FCMs, the Commission prescribes the following minimum capital requirements depending on whether SDs are financial entities or commercial entities. Standardized approach to calculate credit and market risk may not be tailored to specific business models of SDs. Developing risk models for capital purposes and going through model approval process might be much more costly for SDs that currently do not have a formal model approval process in place. For the purpose of discussing the cost of complying with minimum capital requirement, the Commission separated stand-alone SDs into following categories. 3. Nonbank U.S. Subsidiaries of Bank Holding Companies (BHCs) or Financial Holding Companies Subject to Basel III Capital Regime These SDs currently do not have any capital requirement, and the capital requirement resulting from this final rule may increase cost to these SDs as it may have to raise capital to the required level. However, U.S. parents of the SDs in this category are currently subject to the Federal Reserve’s capital requirements on a consolidated basis, including U.S. Basel III capital requirement and also are participants of the Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act Stress Test (DFAST). CCAR evaluates the capital planning process and capital adequacy of the largest U.S.based BHCs, including the firms’ PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 planned capital actions. The DoddFrank Act stress tests are a forwardlooking component to help assess whether firms have sufficient capital to absorb losses and have the ability to lend to households and businesses even in times of financial and economic stress. Similarly, other SDs in this category are subsidiaries of foreign BHCs or a foreign financial holding company (FHC), which already comply with Basel III risk-based capital requirements and having common equity tier 1 capital ratio at consolidated level exceeding eight percent. The parent BHCs of these nonbank SDs, set out in the table below, are well capitalized due to these requirements, as indicated by their common equity tier 1 capital ratio at the consolidated level, which is much higher than eight percent. Therefore, assuming that these SDs would use the Bank-Based Capital Approach, the final rule requires common equity tier 1 capital, additional tier 1 capital, or tier 2 capital to be equal or greater than the minimum requirement, that is, max [$20mm, 8%* RWA, 521 8% * Risk Margin, RFA requirement] to be considered wellcapitalized. Assuming risk margin based requirement is not the binding constraint, and CET1 qualified instruments are the same across jurisdictions, the additional CET1 capital required from the Commission’s capital requirement may not be significant, as it may be possible for the consolidated entity to keep the same 521 Under the final rule, 6.5% of RWA must be met using CET1, the remaining amount is permitted to be met with capital in the form of Tier 1 or Tier 2, provided that subordinated debt meets the conditions in Commission regulation 1.17(h) (17 CFR 1.17(h)). E:\FR\FM\15SER3.SGM 15SER3 57540 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations level of capital within the BHC, but just reallocate among its subsidiaries.522 In addition, the Commission recognizes that earnings will now have to retain in the SD and will no longer be available to be reallocated to fund other more profitable activities within the consolidated group or to be returned to shareholders. The Commission understands that capital is not additive, i.e., the sum of capital at individual subsidiary level may be more than the amount of capital required at the parent level for all its subsidiaries, due to the loss of netting benefits. TABLE 2—SD’S PARENT BHC’S COMMON EQUITY TIER 1 CAPITAL RATIO AS OF FIRST QUARTER 2020 Name of swap dealers Common equity tier 1 capital ratio of parent BHC SEC registered BD CITIGROUP ENERGY INC ........................................................ CREDIT SUISSE CAPITAL LLC ................................................ GOLDMAN SACHS FINANCIAL MARKETS LP ........................ GOLDMAN SACHS MITSUI MARINE DERIVATIVE PRODUCTS LP. ING CAPITAL MARKETS LLC ................................................... J ARON & COMPANY ................................................................ MERRILL LYNCH CAPITAL SERVICES INC ............................ MERRILL LYNCH COMMODITIES INC ..................................... MIZUHO CAPITAL MARKETS LLC ........................................... MACQUARIE ENERGY LLC ...................................................... MORGAN STANLEY CAPITAL GROUP INC ............................ MORGAN STANLEY CAPITAL SERVICES LLC ....................... MORGAN STANLEY CAPITAL PRODUCTS LLC ..................... NOMURA DERIVATIVE PRODUCTS INC ................................. NOMURA GLOBAL FINANCIAL PRODUCTS INC .................... SMBC CAPITAL MARKETS INC ................................................ Citigroup Inc. 11.1% 523 ............................................................. Credit Suisse 12.1% 524 ............................................................. Goldman Sachs 12.3% 525 ......................................................... Goldman Sachs 12.3% .............................................................. N Y Y N ING Group 13.97% 526 ............................................................... Goldman Sachs 12.3% .............................................................. Bank of America 10.8% 527 ........................................................ Bank of America 10.8% ............................................................. Mizuho Financial Group 11.65% 528 .......................................... Macquarie Bank 12.2% 529 ........................................................ Morgan Stanley 15.3% 530 ......................................................... Morgan Stanley 15.3% .............................................................. Morgan Stanley 15.3% .............................................................. Nomura Holdings 18.06% 531 ..................................................... Nomura Holdings 18.06% .......................................................... SMFG 15.55% 532 ...................................................................... N N N N N N N N N N Y N As discussed above, the Commission expects these SDs would use models to calculate market risk and credit risk charges. Their parents BHCs most likely are already using their risk models to calculate capital for the positions of these wholly owned subsidiaries (including uncleared swaps) to measure the credit and market risk exposures of these positions. 4. U.S. SDs That Are Not Part of BHCs The Commission estimates that there are approximately 8 U.S. SDs not part of BHCs or financial holding companies that comply with Basel III capital requirements. These SDs currently do not have any capital requirement. However, these SDs are part of groups that are already subject to the CFTC’s or the SEC’s net capital requirements. These SDs’ consolidated group has excess net capital ranging from $32 million to $1.3 billion.533 As it is possible for the consolidated entity to keep the same level of capital within the group, by reallocating it among subsidiaries, the additional cost of complying with the Commission’s capital requirement may not be too burdensome. However, for those SDs or their consolidated groups that currently have smaller amount of excess net capital, they might need to raise additional capital and thus might incur significant cost to comply with the Commission’s capital requirement. However, given the complexities of the final rule, the compliance cost to some SDs might be significant, particularly for certain business models. TABLE 3—CURRENT CAPITAL REQUIREMENT (EXCESS NET CAPITAL) AT THE SD OR ITS PARENT LEVEL Excess net capital at entity or its parent level Name of swap dealers jbell on DSKJLSW7X2PROD with RULES3 BTIG LLC ........................................................................................................................................................... GAIN GTX LLC .................................................................................................................................................. 522 For purposes of this analysis, the Commission is only using CET1 as a comparison since this represents the majority of eligible capital under the approach. The Commission expects firms to use permitted subordinated debt to comprise the remaining amount of capital. 523 https://www.citigroup.com/citi/investor/data/ p200423a.pdf?ieNocache=743. 524 https://www.credit-suisse.com/about-us-news/ en/articles/media-releases/1q20-financial-report202005.html. 525 https://www.goldmansachs.com/investorrelations/financials/current/other-information/1qpillar3-2020.pdf. 526 https://www.ing.com/web/file?uuid=e0fcbfe7f4a7-4746-af3b-b112c5e9b302&owner=b03bc017e0db-4b5d-abbf-003b12934429&contentid= 49857&elementid=2138555. 527 https://mms.businesswire.com/media/ 20200415005331/en/785157/1/Q1_2020_Bank_of_ VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 America_Financial_Results_Press_ Release.pdf?download=1. 528 https://www.mizuho-fg.com/investors/ financial/basel/capital/data2003/pdf/fg_fy01.pdf. 529 https://www.macquarie.com/assets/macq/ investor/regulatory-disclosures/2020/MBL-Basel-IIIPillar-3-capital-disclosures-032020.pdf. 530 https://www.morganstanley.com/about-us-ir/ shareholder/1q2020.pdf. 531 https://www.nomuraholdings.com/company/ group/holdings/pdf/basel_201912.pdf. 532 https://www.smfg.co.jp/english/investor/ library/basel_3/2020/2020_fg_e_cc1.pdf. 533 Selected FCM Financial Data as of April 30, 2020. 534 At December 31, 2019, BTIG LLC’s net capital was $85,412,256 which was $85,162,256 in excess of its minimum requirement. PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 534 85,162,256 535 32,628,137 SEC Registered BD Y N 535 GAIN GTX LLC is a wholly owned subsidiary of GAIN Capital Holdings, Inc., a global provider of online trading services. GAIN Capital Group LLC (a CFTC registered FCM and RFD) is also subsidiary of GAIN Capital Holdings, Inc. and has excess net capital of 14,821,951. 536 Excess net capital of INTL FCSTONE FINANCIAL INC (FCM and BD) as of Apr. 30, 2020. 537 Excess net capital of Jefferies LLC, parent of Jefferies Derivative Products LLC, Jefferies Financial Products LLC, and Jefferies Financial Services LLC. 538 Excess net capital at Cantor Fitzgerald & CO. (FCM and Broker-Dealer), which is owned by Cantor Fitzgerald Securities (94% ownership). 539 Excess net capital of E D & F MAN CAPITAL MARKETS INC (FCM and BD) as of Apr. 30, 2020. 540 At December 31, 2018, excess net capital was $1 .09 billion for Citadel Securities LLC, a registered BD. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 57541 TABLE 3—CURRENT CAPITAL REQUIREMENT (EXCESS NET CAPITAL) AT THE SD OR ITS PARENT LEVEL—Continued Excess net capital at entity or its parent level Name of swap dealers INTL FCSTONE MARKETS LLC ...................................................................................................................... JEFFERIES FINANCIAL PRODUCTS LLC ...................................................................................................... JEFFERIES FINANCIAL SERVICES INC ......................................................................................................... CANTOR FITZGERALD SECURITIES ............................................................................................................. ED&F MAN DERIVATIVE PRODUCTS INC ..................................................................................................... CITADEL SECURITIES SWAP DEALER LLC .................................................................................................. jbell on DSKJLSW7X2PROD with RULES3 5. Non-Financial/Commercial SDs The capital rule would require NonFinancial/Commercial SDs to maintain tangible net worth in an amount equal to or in excess of the minimum capital level that is, max ($20 million plus market risk charges and credit risk charges, 8% of risk margin, RFA requirement). Currently, there is no capital requirement for commercial SDs. The Commission estimates that currently three to four SD would be in this category, and believes that their tangible net worth greatly exceeds the Commission’s requirement. Although these SDs may not need to raise additional capital, the cost of complying with the final rule might still be significant, particularly if these SDs choose to develop models for capital purposes. 6. Non-U.S. SDs Not Subject to a Prudential Regulator The Commission is allowing a ‘‘substituted compliance’’ program for capital requirements for SDs that are: (1) Not organized under the laws of the U.S., and (2) not domiciled in the U.S. The Commission estimates that there are about 24 non-U.S. provisionally registered SDs not subject to U.S. prudential regulators that would be eligible to apply for substituted compliance. The Commission would permit these non-U.S. SDs (or regulatory authorities in the non-U.S. SD’s home country jurisdictions) to petition the Commission to satisfy the Commission’s capital requirements through a program of substituted compliance with the SD’s home country capital requirements. These SDs are domiciled in U.K., Germany, France, Japan, Mexico, Singapore, and Australia; which are members of Basel Committee on Banking Supervision and have adopted Basel III risk-based capital.541 Thus, the Commission expects that these SDs or their parents may not need to raise significant additional capital to comply with the Commission’s capital requirements. However, these SDs may 541 https://www.bis.org/bcbs/publ/d338.pdf. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 incur significant cost to obtain approval for substituted compliance. ii. Margin vs. Capital The Commission’s capital rule also requires an SD to include the initial margin for all swaps that would otherwise fall below the $50 million initial margin threshold amount or the $500,000 minimum transfer amount, as defined in regulation 23.151, for purposes of computing the uncleared swap initial margin amount. As such, the uncleared swap initial margin amount would be the amount that an SD would have to collect from a counterparty, assuming that the exclusions and exemptions for collecting initial margin for uncleared swaps set forth in regulations 23.150– 161 would not apply, and also assuming that the thresholds under which initial margin would not need to be exchanged would not apply. Accordingly, swaps that are not subject to the Commission’s margin requirements such as those executed prior to the compliance date for margin requirements (‘‘legacy swaps’’), inter-affiliate swaps, and swaps with counterparties that would qualify for the exception or exemption under section 2(h)(7)(A) would have to be taken into account in determining the capital requirement. The Commission believes that it would be appropriate to require an SD to maintain capital for uncollateralized swap exposures to counterparties to cover the ‘‘residual’’ risk of a counterparty’s uncleared swaps positions. The Commission’s approach regarding including uncollateralized swap exposures in the SD’s capital requirements is consistent with the approach adopted by the prudential regulators in setting capital requirements for SDs subject to their jurisdiction and is consistent with the approach proposed by the SEC for SBSDs. The Commission provides certain exemptions from initial margin requirements for uncleared trades between affiliates. However, interaffiliate swaps would require capital to PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 536 72,247,715 537 1,334,356,732 1,334,356,732 538 365,105,535 539 95,389,978 540 1,090,000,000 SEC Registered BD Y N N N N N be held against them. The Commission understands that SDs may have different organizational structures due to various reasons. These reasons include, among others, centralized risk management for consolidation of balance-sheet, assetliability and liquidity risk management; taxation benefits; funds transfer pricing; merger and acquisition; trading centers; and subsidiaries in different jurisdictions. An arms-length swap may be offset by swap transaction with an affiliated SD because of any of the reasons listed above and possibly others. Centralization of risk within different entities of a firm in the same jurisdiction provides risk reduction benefits somewhat similar to the CCP and is encouraged. Both parties to a swap transaction may be required to hold capital even if they both are part of the same parent institution. In that sense, there may be double (or more) counting of capital at the parent level for a given outward facing swap based on the legal structure of the entity. This may lead to an uneven playing field between SDs if for a given swap, different swap dealers are required to hold different amount of capital based on the number of interaffiliate trades that they execute for the same client facing trade. iii. Model vs. Table The capital rule allows an SD to apply to the Commission or an RFA of which it is a member for approval to use internal models when calculating its market risk exposure and credit risk exposure. The capital rule also allows an FCM that is also an SD to apply in writing to the Commission or an RFA of which it is a member for approval to compute deductions for market risk and credit risk using internal models in lieu of the standardized deductions otherwise required. As discussed above, there are approximately 108 SDs and no MSPs provisionally registered with the Commission. Of these, the Commission estimates that approximately 55 SDs and no MSPs would be subject to the Commission’s capital rules as they are E:\FR\FM\15SER3.SGM 15SER3 57542 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 not subject to those of a prudential regulator. The Commission further estimates conservatively that most of these SDs would seek to obtain Commission approval to use models for computing their market and credit risk capital charges. These entities would incur cost to develop, maintain, document, audit models, and seek model approval. The possibility of using models to calculate credit risk and market risk charges may allow SDs to more efficiently deploy capital in other parts of its operations, because models could reduce capital charges and thereby could make additional capital available. This reduced capital requirement due to model use could improve returns of SDs and make them more competitive. However, if models developed for capital purposes deviate significantly from models used for pricing and risk management, and regulatory capital deviates significantly from economic capital, this could reduce the discussed benefits of capital rule. Although the Commission expects that SDs would use models for calculating market risk and credit risk charges, it is possible that some entities, particularly potential new entrants, may not have the risk management capabilities of which the models are an integral part, and, therefore, have to rely on the standardized haircut approach. The benefit of the standardized haircut approach for measuring market risk is its inherent simplicity. Therefore, this approach may improve customer protections and reduce systemic risk. In addition, a standardized haircut approach may reduce costs for the SD related to the risk of failing to observe or correct a problem with the use of models that could adversely impact the firm’s financial conditions, because the use of models would require the allocation by the SD of additional firm resources and personnel. Conversely, if the standardized haircuts are too conservative and netting benefits are very limited, they could make conducting swap business too costly, preventing or impairing the ability of the firms to engage in swaps, increasing transaction costs, reducing liquidity, and reducing the availability of swaps for risk mitigation by end users. iv. Other Considerations The capital rule requirements should reduce the risk of a failure of any major market participant in the swap market, which in turn reduces the possibility of a general market failure, and thus promotes confidence for market participants to transact in swaps for investment and hedging purposes. The VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 capital requirements are designed to promote confidence in SDs among customers, counterparties, and the entities that provide financing to SDs, thereby, lessen the potential that these market participants may seek to rapidly withdraw assets and financing from SDs during a time of market stress. This heightened confidence is expected to increase swap transactions and promote competition among dealers. A more competitive swap market may promote a more efficient capital allocation. However, to the extent that costs associated with the rules are high, they may negatively affect competition within the swap markets. This may, for example, lead smaller dealers or entities for whom dealing is not a core business to exit the market because compliance with the minimum capital and reporting requirements is too costly. These same costs may result in increased barriers of entry, as they may prevent new dealers from entering the market. The combination of these two events may lead to a concentration of SD in the market, which could lead to market inefficiencies. The capital rule could have a substantial impact on domestic and international commerce and the relative competitive position of SDs operating under different requirements of various jurisdictions. Specifically, SDs subject to a particular regulatory regime may be advantaged or disadvantaged if corresponding requirements in other regimes are substantially more or less stringent. This could affect the ability of U.S. SDs to compete in the domestic and global markets and, the ability of non-U.S. SDs to compete in U.S. markets. Substantial differences between the U.S. and foreign jurisdictions in the costs of complying with these requirements for swaps between U.S. and foreign jurisdictions could reduce cross-border capital flows and hinder the ability of global firms to efficiently allocate capital among legal entities to meet the demands of their customers/counterparties. The willingness of end users to trade with an SD dealer will depend on their evaluation of the counterparty credit risks of trading with that particular SD compared to alternative SDs, and their ability to negotiate favorable price and other terms. The capital and risk management requirements would in general reduce the likelihood of SDs’ defaulting or failing, and therefore may increase the willingness of end users to trade with more SDs that have strong capital reserves. End users of covered swaps are mostly made up of sophisticated participants such as hedge fund, asset management, other financial PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 firms, and large commercial corporations. Many of these entities trade substantial volume of swaps and are relatively well-positioned to negotiate price and other terms with competing dealers. To the extent that the capital rule results in increased competition, participants should be able to take advantage of this increased competition and negotiate improved terms. On the other hand, SDs may pass on additional capital, operational and compliance costs resulting from the final rule to end users in the form of higher fees or wider spreads. Thus end users may experience increased cost of using swaps for hedging and investing purposes. In addition, benefits may arise when SDs consolidate with other affiliated SDs, FCMs, and/or BDs. This may yield efficiencies for clients conducting business in swaps, including netting benefits, reduced number of account relationships, and reduced number of governing agreements. These potential benefits, however, may be offset by reduced competition from a smaller number of competing SDs. Further, the capital rule will permit conducting swap business in an entity jointly registered as an FCM, or SBSD, or broker-dealer, which may offer the potential for these firms to offer portfolio margining for a variety of positions. From a holding company’s perspective, aggregating swap business in a single entity, could help simplify and streamline risk management, allow more efficient use of capital, as well as operational efficiencies, and avoid the need for multiple netting and other agreements. The rules may create the potential for regulatory arbitrage to the extent that they differ from corresponding rules other regulators adopt. Also, to the extent that the requirements are overly stringent, they may prevent or discourage new entrants into swap markets and thereby may either increase spreads and trading costs or even reduce the availability of swaps. In these cases, end users would face higher cost or be forced to use less effective financial instruments to meet their business needs. List of Subjects 17 CFR Part 1 Brokers, Commodity futures, Reporting and recordkeeping requirements. 17 CFR Part 23 Capital and margin requirements, Major swap participants, Swap dealers, Swaps. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 17 CFR Part 140 Authority delegations (Government agencies). For the reasons stated in the Preamble, the Commodity Futures Trading Commission amends 17 CFR parts 1, 23, and 140 as follows: PART 1—GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT 1. The authority citation for part 1 continues to read as follows: ■ Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a–1, 7a–2, 7b, 7b–3, 8, 9, 10a, 12, 12a, 12c, 13a, 13a–1, 16, 16a, 19, 21, 23, and 24 (2012). 2. Amend § 1.10 by: a. Revising the paragraph (f)(1) introductory text; and ■ b. Revising paragraph (h) The revisions read as follows: ■ ■ § 1.12 Maintenance of minimum financial requirements by futures commission merchants and introducing brokers. § 1.10 Financial reports of futures commission merchants and introducing brokers. jbell on DSKJLSW7X2PROD with RULES3 * * * * * (f) * * * (1) In the event a registrant finds that it cannot file its Form 1–FR, or, in accordance with paragraph (h) of this section, its Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934, Part II, Part IIA, or Part IIC (FOCUS report), for any period within the time specified in paragraphs (b)(1)(i) or (b)(2)(i) of this section without substantial undue hardship, it may request approval for an extension of time, as follows: * * * * * (h) Filing option available to a futures commission merchant or an introducing broker that is also a securities broker or dealer. Any applicant or registrant which is registered with the Securities and Exchange Commission as a securities broker or dealer, a securitybased swap dealer, or a major securitybased market participant may comply with the requirements of this section by filing (in accordance with paragraphs (a), (b), (c), and (j) of this section) a copy, as applicable, of its Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934, Part II, Part IIA, Part IIC, or Part II CSE (FOCUS Report), in lieu of Form 1–FR; Provided, however, That all information which is required to be furnished on and submitted with Form 1–FR is provided with such FOCUS Report; and Provided, further, That a certified FOCUS Report filed by an introducing broker or applicant for registration as an introducing broker in VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 lieu of a certified Form 1–FR–IB must be filed according to National Futures Association rules, either in paper form or electronically, in accordance with procedures established by the National Futures Association, and if filed electronically, a paper copy of such filing with the original manually signed certification must be maintained by such introducing broker or applicant in accordance with § 1.31. * * * * * ■ 3. Amend § 1.12 by: ■ a. Revising paragraph (a) introductory text; ■ b. Revising paragraphs (a)(1), (b)(3) and (b)(4); and ■ c. Adding paragraph (b)(5). The revisions and additions read as follows: (a) Each person registered as a futures commission merchant or who files an application for registration as a futures commission merchant, and each person registered as an introducing broker or who files an application for registration as an introducing broker (except for an introducing broker or applicant for registration as an introducing broker operating pursuant to, or who has filed concurrently with its application for registration, a guarantee agreement and who is not also a securities broker or dealer), who knows or should have known that its adjusted net capital at any time is less than the minimum required by § 1.17 or by the capital rule of any self-regulatory organization to which such person is subject, or the minimum net capital requirements of the Securities and Exchange Commission if the applicant or registrant is registered with the Securities and Exchange Commission, must: (1) Give notice, as set forth in paragraph (n) of this section that the applicant’s or registrant’s capital is below the applicable minimum requirement. Such notice must be given immediately after the applicant or registrant knows or should have known that its adjusted net capital or net capital, as applicable, is less than minimum required amount; and * * * * * (b) * * * (3) 150 percent of the amount of adjusted net capital required by a registered futures association of which it is a member, unless such amount has been determined by a margin-based capital computation set forth in the rules of the registered futures PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 57543 association, and such amount meets or exceeds the amount of adjusted net capital required under the margin-based capital computation set forth in § 1.17(a)(1)(i)(B), in which case the required percentage is 110 percent; (4) For securities brokers or dealers, the amount of net capital specified in Rule 17a–11(b) of the Securities and Exchange Commission (17 CFR 240.17a–11(b)); or (5) For security-based swap dealers or major security-based swap participants, the amount of net capital specified in Rule 18a–8(b) of the Securities and Exchange Commission (17 CFR 240.18a–8(b)), must file notice to that effect, as soon as possible and no later than twenty-four (24) hours of such event. * * * * * ■ 4. Amend § 1.16 by revising paragraphs (f)(1)(i)(B) and (f)(1)(ii)(B) to read as follows: § 1.16 Qualifications and reports of accountants. * * * * * (f)(1) * * * (i) * * * (B) A futures commission merchant that is registered with the Securities and Exchange Commission as a securities broker or dealer may file with its designated self-regulatory organization a copy of any application that the registrant has filed with its designated examining authority, pursuant to § 240.17a–5(m) of this title, for an extension of time to file annual reports. The registrant must also promptly file with the designated self-regulatory organization and the Commission copies of any notice it receives from its designated examining authority to approve or deny the requested extension of time. Upon receipt by the designated self-regulatory organization and the Commission of copies of any such notice of approval, the requested extension of time referenced in the notice shall be deemed approved under this paragraph (f)(1)(i). * * * * * (ii) * * * (B) An introducing broker that is registered with the Securities and Exchange Commission as a securities broker or dealer may file with the National Futures Association copies of any application that the registrant has filed with its designated examining authority, pursuant to § 240.17a–5(m) of this title, for an extension of time to file annual reports. The registrant must also file promptly with the National Futures Association copies of any notice it receives from its designated examining E:\FR\FM\15SER3.SGM 15SER3 57544 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations authority to approve or deny the requested extension of time. Upon the receipt by the National Futures Association of a copy of any such notice of approval, the requested extension of time referenced in the notice shall be deemed approved under this paragraph (f)(1)(ii). * * * * * ■ 5. Amend § 1.17 by: ■ a. Revising paragraphs (a)(1)(i)(A) and (B); ■ b. Adding paragraph (a)(1)(ii); ■ c. Revising paragraphs (b)(9) and (10) and adding paragraph (b)(11) ; ■ d. Revising paragraph (c)(1)(i); ■ e. Revising paragraph (c)(2)(i); ■ f. Revising paragraphs (c)(2)(ii)(B) and (D) and adding paragraph (c)(2)(ii)(G); ■ g. Adding paragraphs (c)(5)(iii), (iv), (xv), and (xvi); ■ h. Revising paragraphs (c)(5)(viii), (x), (ix) and (xiv); ■ i. Revising paragraph (c)(6)(i) and (iv)(A), and adding paragraph (c)(6)(v); and ■ j. Revising paragraph (g)(1). The revisions and additions read as follows: jbell on DSKJLSW7X2PROD with RULES3 § 1.17 Minimum financial requirements for futures commission merchants and introducing brokers. (a)(1)(i) * * * (A) $1,000,000, Provided, however, that if the futures commission merchant also is a swap dealer, the minimum amount shall be $20,000,000; (B) The futures commission merchant’s risk-based capital requirement, computed as the sum of: (1) Eight percent of the total risk margin requirement (as defined in § 1.17(b)(8) of this section) for positions carried by the futures commission merchant in customer accounts and noncustomer accounts; and (2) For a futures commission merchant that is also a registered swap dealer, two percent of the total uncleared swap margin, as that term is defined in paragraph (b)(11) of this section. * * * * * (ii) A futures commission merchant that is registered as a swap dealer and has received approval to use internal models to compute market risk and credit risk charges for uncleared swaps must maintain net capital equal to or in excess of $100 million and adjusted net capital equal to or in excess of $20 million. * * * * * (b) * * * (9) Cleared over the counter derivative positions means a swap cleared by a derivatives clearing organization or a VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 clearing organization exempted by the Commission from registering as a derivatives clearing organization, and further includes positions cleared by any organization permitted to clear such positions under the laws of the relevant jurisdiction. (10) Cleared over the counter customer means any person for whom the futures commission merchant carries on its books one or more accounts for the cleared over the counter derivative positions of such person, and such account or accounts are not proprietary accounts as defined in § 1.3 of this part. (11) Uncleared swap margin: This term means the amount of initial margin, computed in accordance with § 23.154 of this chapter, that a duallyregistered futures commission merchant and swap dealer would be required to collect from each counterparty for each outstanding swap position of the duallyregistered futures commission merchant and swap dealer. A dually-registered futures commission merchant and swap dealer must include all swap positions in the calculation of the uncleared swap margin amount, including swaps that are exempt or excluded from the scope of the Commission’s margin regulations for uncleared swaps pursuant to § 23.150 of this chapter, exempt foreign exchange swaps or foreign exchange forwards, or netting set of swaps or foreign exchange swaps, for each counterparty, as if the counterparty was an unaffiliated swap dealer. Furthermore, in computing the uncleared swap margin amount, a dually-registered futures commission merchant and swap dealer may not exclude the initial margin threshold amount or the minimum transfer amount as such terms are defined in § 23.151 of this chapter. (c) * * * (1) * * * (i) Unrealized profits shall be added and unrealized losses shall be deducted in the accounts of the applicant or registrant, including unrealized profits and losses on fixed price commitments, uncleared swaps, uncleared securitybased swaps, and forward contracts; * * * * * (2) * * * (i) Exclude any unsecured commodity futures, options, cleared swaps, or other Commission regulated account containing a ledger balance and open trades, the combination of which liquidates to a deficit or containing a debit ledger balance only: Provided, however, deficits or debit ledger balances in unsecured customers’, noncustomers’, and proprietary PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 accounts, which are the subject of calls for margin or other required deposits may be included in current assets until the close of business on the business day following the date on which such deficit or debit ledger balance originated providing that the account had timely satisfied, through the deposit of new funds, the previous day’s debit or deficits, if any, in its entirety. (ii) * * * (B)(1) Interest receivable, floor brokerage receivable, commissions receivable from other brokers or dealers (other than syndicate profits), mutual fund concessions receivable and management fees receivable from registered investment companies and commodity pools that are not outstanding more than thirty (30) days from the date they are due; (2) Dividends receivable that are not outstanding more than thirty (30) days from the payable date; and (3) Commissions or fees receivable, including from other brokers or dealers, resulting from swap transactions that are not outstanding more than sixty (60) days from the month end accrual date provided they are billed promptly after the close of the month of their inception; * * * * * (D) Receivables from registered futures commission merchants or brokers, resulting from commodity futures, options, cleared swaps, foreign futures or foreign options transactions, except those specifically excluded under paragraph (c)(2)(i) of this section; * * * * * (G) Receivables from third-party custodians that maintain the futures commission merchant’s initial margin deposits associated with uncleared swap and security-based swap transactions pursuant to the margin rules of the Commission, the Securities and Exchange Commission, a prudential regulator, as defined in section 1a(39) of the Act, or a foreign jurisdiction that has received a Comparability Determination under § 23.160 of this chapter. * * * * * (5) * * * (iii) Swaps: (A) Uncleared swaps that are creditdefault swaps referencing broad-based securities indices.(1) Short positions (selling protection). In the case of an uncleared short credit default swap that references a broad-based securities index, deducting the percentage of the notional amount based upon the current basis point spread of the credit default swap and the maturity of the credit default swap in accordance with the following table: E:\FR\FM\15SER3.SGM 15SER3 57545 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations TABLE TO § 1.17(C)(5)(III)(A)(1)—MARKET RISK CHARGES FOR UNCLEARED CREDIT DEFAULT SWAPS Basis point spread (%) Length of time to maturity of CDS contract 100 or less jbell on DSKJLSW7X2PROD with RULES3 Less than 12 months ............................... 12 months but less than 24 months ........ 24 months but less than 36 months ........ 36 months but less than 48 months ........ 48 months but less than 60 months ........ 60 months but less than 72 months ........ 72 months but less than 84 months ........ 84 months but less than 120 months ...... 120 months and longer ............................ 0.67 1.00 1.33 2.00 2.67 3.67 4.67 5.67 6.67 (2) Long positions (purchasing protection). In the case of an uncleared swap that is a long credit default swap referencing a broad-based security index, deducting 50 percent of the deduction that would be required by paragraph (c)(5)(iii)(A)(1) of this section if the swap was a short credit default swap, each such deduction not to exceed the current market value of the long position. (3) Long and short positions. (i) Long and short uncleared credit default swaps referencing the same broad-based security index. In the case of uncleared swaps that are long and short credit default swaps referencing the same broad-based security index, have the same credit events which would trigger payment by the seller of protection, have the same basket of obligations which would determine the amount of payment by the seller of protection upon the occurrence of a credit event, that are in the same or adjacent spread category and have a maturity date within three months of the other maturity category, deducting the percentage of the notional amounts specified in the higher maturity category under paragraph (c)(5)(iii)(A)(1) or (c)(5)(iii)(A)(2) of this section on the excess of the long or short position. (ii) Long basket of obligors and uncleared long credit default swap referencing a broad-based securities index. In the case of an uncleared swap that is a long credit default swap referencing a broad-based security index and the futures commission merchant is long a basket of debt securities comprising all of the components of the security index, deducting 50 percent of the amount specified in § 240.15c3– 1(c)(2)(vi) of this title for the component of securities, provided the futures commission merchant can deliver the component securities to satisfy the obligation of the futures commission merchant on the credit default swap. (iii) Short basket of obligors and uncleared short credit default swap VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 101–300 301–400 1.33 2.33 3.33 4.00 4.67 5.67 6.67 10.00 13.33 3.33 5.00 6.67 8.33 10.00 11.67 13.33 15.00 16.67 referencing a broad-based securities index. In the case of an uncleared swap that is a short credit default swap referencing a broad-based security index and the futures commission merchant is short a basket of debt securities comprising all of the components of the security index, deducting the amount specified in § 240.15c3–1(c)(2)(vi) of this title for the component securities. (B) Interest rate swaps. In the case of an uncleared interest rate swap, deducting the percentage deduction specified in § 240.15c3–1(c)(2)(vi)(A) of this title based on the maturity of the interest rate swap, provided that the percentage deduction must be no less than one eighth of 1 percent of the amount of a long position that is netted against a short position in the case of an uncleared interest rate swap with a maturity of three months or more; (C) All other uncleared swaps. (1) In the case of any uncleared swap that is not a credit default swap or interest rate swap, deducting the amount calculated by multiplying the notional value of the uncleared swap by: (i) The percentage specified in § 240.15c3–1 of this title applicable to the reference asset if § 240.15c3–1 of this title specifies a percentage deduction for the type of asset and this section does not specify a percentage deduction; (ii) Six percent in the case of a currency swap that references euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs, and twenty percent in the case of currency swaps that reference any other foreign currencies; or (iii) In the case of over-the-counter swap transactions involving commodities, 20 percent of the market value of the amount of the underlying commodities. (D) Netting of Swap Market Risk Charges. The deductions under paragraphs (c)(5)(iii)(B) and (C) of this section may be reduced by an amount equal to any reduction recognized for a PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 401–500 5.00 6.67 8.33 10.00 11.67 13.33 15.00 16.67 18.33 501–699 6.67 8.33 10.00 11.67 13.33 15.00 16.67 18.33 20.00 700 or more 10.00 11.67 13.33 15.00 16.67 18.33 20.00 26.67 33.33 comparable long or short position in the reference asset or interest rate under this section or in § 240.15c3–1 of this title. (iv) Security-based Swaps: In the case of security-based swaps as defined in section 3(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)), the percentage as specified in § 240.15c3–1 of this title. * * * * * (viii) In the case of a futures commission merchant, for undermargined customer accounts, the amount of funds required in each such account to meet maintenance margin requirements of the applicable board of trade or if there are no such maintenance margin requirements, clearing organization margin requirements applicable to such positions, after application of calls for margin or other required deposits which are outstanding no more than one business day. If there are no such maintenance margin requirements or clearing organization margin requirements, then the amount of funds required to provide margin equal to the amount necessary, after application of calls for margin or other required deposits outstanding no more than one business day, to restore original margin when the original margin has been depleted by 50 percent or more: Provided, to the extent a deficit is excluded from current assets in accordance with paragraph (c)(2)(i) of this section such amount shall not also be deducted under this paragraph. In the event that an owner of a customer account has deposited an asset other than cash to margin, guarantee or secure his account, the value attributable to such asset for purposes of this subparagraph shall be the lesser of: (A) The value attributable to the asset pursuant to the margin rules of the applicable board of trade, or (B) The market value of the asset after application of the percentage deductions specified in paragraph (c)(5) of this section; E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57546 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (ix) In the case of a futures commission merchant, for undermargined noncustomer and omnibus accounts the amount of funds required in each such account to meet maintenance margin requirements of the applicable board of trade or if there are no such maintenance margin requirements, clearing organization margin requirements applicable to such positions, after application of calls for margin or other required deposits which are outstanding no more than one business day. If there are no such maintenance margin requirements or clearing organization margin requirements, then the amount of funds required to provide margin equal to the amount necessary after application of calls for margin or other required deposits outstanding no more than one business day to restore original margin when the original margin has been depleted by 50 percent or more: Provided, to the extent a deficit is excluded from current assets in accordance with paragraph (c)(2)(i) of this section such amount shall not also be deducted under this paragraph. In the event that an owner of a noncustomer or omnibus account has deposited an asset other than cash to margin, guarantee or secure his account the value attributable to such asset for purposes of this paragraph shall be the lesser of the value attributable to such asset pursuant to the margin rules of the applicable board of trade, or the market value of such asset after application of the percentage deductions specified in paragraph (c)(5) of this section; (x) In the case of open futures contracts, cleared swaps, and granted (sold) commodity options held in proprietary accounts carried by the applicant or registrant which are not covered by a position held by the applicant or registrant or which are not the result of a ‘‘changer trade’’ made in accordance with the rules of a contract market: (A) For an applicant or registrant which is a clearing member of a clearing organization for the positions cleared by such member, the applicable margin requirement of the applicable clearing organization; (B) For an applicant or registrant which is a member of a self-regulatory organization, 150 percent of the applicable maintenance margin requirement of the applicable board of trade, or clearing organization, whichever is greater; (C) For all other applicants or registrants, 200 percent of the applicable maintenance margin requirements of the applicable board of trade or clearing organization, whichever is greater; or VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 (D) For open contracts or granted (sold) commodity options for which there are no applicable maintenance margin requirements, 200 percent of the applicable initial margin requirement: Provided, the equity in any such proprietary account shall reduce the deduction required by this paragraph (c)(5)(x) if such equity is not otherwise includable in adjusted net capital; * * * * * (xiv) For securities brokers and dealers, all other deductions specified in § 240.15c3–1 of this title; (xv) In the case of a futures commission merchant that is also a registered swap dealer, the amount of funds required from each swap counterparty and security-based swap counterparty to meet initial margin requirements of the Commission or Securities and Exchange Commission, as applicable, after application of calls for margin or other required deposits which are outstanding within the required time frame to collect margin or other required deposits; (xvi) In the case of a futures commission merchant that is also a registered swap dealer, the amount of initial margin calculated pursuant to § 23.154 of this chapter for the account of a swap counterparty that is subject to a margin exception or exemption under § 23.150 of this chapter, less any margin posted on such account, and the amount of initial margin calculated pursuant to § 240.18a–3(c)(1)(i)(B) of this title for the account of a security-based swap counterparty that is subject to a margin exception or exemption under the rules of the Securities and Exchange Commission, less any margin posted on such account. (6)(i) Election of alternative capital deductions that have received approval of Securities and Exchange Commission pursuant to § 240.15c3–1(a)(7) of this title. Any futures commission merchant that is also registered with the Securities and Exchange Commission as a securities broker or dealer, and who also satisfies the other requirements of this paragraph (c)(6), may elect to compute its adjusted net capital using the alternative capital deductions that, under § 240.15c3–1(a)(7) of this title, the Securities and Exchange Commission has approved by written order in lieu of the deductions that would otherwise be required under this section. * * * * * (iv) * * * (A) Information that the futures commission merchant files on a monthly basis with its designated examining authority or the Securities and Exchange Commission, whether by PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 way of schedules to its FOCUS reports or by other filings, in satisfaction of § 240.17a–5(a)(5) of this title; * * * * * (v) Election of alternative market risk and credit risk capital deductions for a futures commission merchant that is registered as a swap dealer and has received approval of the Commission or a registered futures association for which the futures commission merchant is a member. For purposes of this paragraph (c)(6)(v) only, all references to futures commission merchant means a futures commission merchant that is also registered as a swap dealer. (A) A futures commission merchant may apply in writing to the Commission or a registered futures association of which it is a member for approval to compute deductions for market risk and credit risk using internal models in lieu of the standardized deductions otherwise required under this section; Provided however, that the Commission must issue a determination that the registered futures association’s model requirements and review process are comparable to the Commission’s requirements and review process in order for the registered futures association’s model approval to be accepted as an alternative means of compliance with this section. The futures commission merchant must file the application in accordance with instructions approved by the Commission and specified on the website of the registered futures association. (B) A futures commission merchant’s application must include the information set forth in Appendix A to Subpart E of Part 23 and the market risk and credit risk charges must be computed in accordance with § 23.102 of this chapter. (C) The Commission or registered futures association upon obtaining the Commission’s determination that its requirements and model approval process are comparable to the Commission’s requirements and process, may approve or deny the application, in whole or in part, or approve or deny an amendment to the application, in whole or in part, subject to any conditions or limitations the Commission or registered futures association may require, if the Commission or registered futures association finds the approval to be appropriate in the public interest, after determining, among other things, whether the applicant has met the requirements of § 23.102 of this chapter. * * * * * E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (g)(1) The Commission may by order restrict, for a period of up to twenty business days, any withdrawal by a futures commission merchant of equity capital, or any unsecured advance or loan to a stockholder, partner, limited liability company member, sole proprietor, employee or affiliate if the Commission, based on the facts and information available, concludes that any such withdrawal, advance or loan may be detrimental to the financial integrity of the futures commission merchant, or may unduly jeopardize its ability to meet customer obligations or other liabilities that may cause a significant impact on the markets. * * * * * 6. Amend § 1.65 by revising paragraph (b) introductory text, paragraphs (d) and (e) to read as follows: ■ § 1.65 Notice of bulk transfers and disclosure obligations to customers. jbell on DSKJLSW7X2PROD with RULES3 * * * * * (b) Notice to the Commission. Each futures commission merchant or introducing broker shall file with the Commission, at least ten business days in advance of the transfer, notice of any transfer of customer accounts carried or introduced by such futures commission merchant or introducing broker that is not initiated at the request of the customer, where the transfer involves the lesser of: * * * * * (d) The notice required by paragraph (b) of this section shall be considered filed when submitted to the Director of the Division of Swap Dealer and Intermediary Oversight, in electronic form using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission. (e) In the event that the notice required by paragraph (b) of this section cannot be filed with the Commission at least ten days prior to the account transfer, 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 accept a lesser time period for such notification at the Director’s or designee’s discretion. In any event, however, the transferee futures commission merchant or introducing broker shall file such notice as soon as practicable and no later than the day of the transfer. Such notice shall include a brief statement explaining the VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 circumstances necessitating the delay in filing. * * * * * PART 23—SWAP DEALERS AND MAJOR SWAP PARTICIPANTS 7. The authority citation for part 23 continues 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. 8. Add section 23.100 to subpart E to read as follows: ■ § 23.100 Definitions applicable to capital requirements. For purposes of §§ 23.101 through 23.106 of subpart E, the following terms are defined as follows: Actual daily net trading profit and loss. This term is used in assessing the performance of a swap dealer’s VaR measure and refers to changes in the swap dealer’s portfolio value that would have occurred were end-of-day positions to remain unchanged (therefore, excluding fees, commissions, reserves, net interest income, and intraday trading). Advanced approaches Boardregulated institution. The term shall have the meaning ascribed to it in 12 CFR part 217. BHC equivalent risk-weighted assets. This term means the risk-weighted assets of a swap dealer that elects to meet the capital requirements in § 23.101(a)(1)(i) calculated as follows: (1) If the swap dealer is not approved to use internal models to calculate credit risk exposure under § 23.102, it shall calculate its credit risk-weighted assets using the bank holding company regulations in subpart D of 12 CFR part 217, as if the swap dealer itself were a bank holding company, with the swap dealer permitted to calculate its exposure amount for OTC derivative contracts using either the current exposure method or the standardized approach for counterparty credit risk, without regard to the status of any affiliate of the swap dealer as an advanced approaches Board-regulated institution; (2) If the swap dealer is approved to use internal models to calculate credit risk exposure under § 23.102, it shall calculate its credit risk-weighted assets using the bank holding company regulations in subpart E of 12 CFR part 217, as if the swap dealer itself were a bank holding company, with the swap dealer permitted to calculate its exposure amount for OTC derivative contracts using either the internal models methodology or the standardized approach for counterparty PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 57547 credit risk, without regard to the status of any affiliate of the swap dealer as an advanced approaches Board-regulated institution; (3) If the swap dealer is not approved to use internal models to calculate market risk exposure under § 23.102, it shall compute a market risk capital charge for the positions that the swap dealer holds in its proprietary accounts using the applicable standardized market risk charges set forth in § 240.18a–1 of this title and § 1.17 of this chapter for such positions, and multiplying that amount by a factor of 12.5; (4) If the swap dealer is approved to use internal models to calculate market risk exposure under § 23.102, it shall calculate its market risk-weighted assets using subpart F of 12 CFR part 217; Provided, however, that the swap dealer may elect to apply either the provisions of such sections that are applicable to advanced approaches Board-regulated institutions or those that are applicable to Board-regulated institutions that are not advanced approaches Boardregulated institutions. Credit risk. This term refers to the risk that the counterparty to an uncleared swap transaction could default before the final settlement of the transaction’s cash flows. Credit risk exposure requirement. This term refers to the amount that the swap dealer (other than a swap dealer subject to the minimum capital requirements of § 23.101(a)(1)(i)) is required to compute under § 23.102 if approved to use internal credit risk models, or to compute under § 23.103 if not approved to use internal credit risk models. Exempt foreign exchange swaps and foreign exchange forwards are those foreign exchange swaps and foreign exchange forwards that were exempted from the definition of a swap by the U.S. Department of the Treasury. Market risk exposure. This term means the risk of loss in a position or portfolio of positions resulting from movements in market prices and other factors. Market risk exposure is the sum of: (1) General market risks including changes in the market value of a particular assets that result from broad market movements, such as a changes in market interest rates, foreign exchange rates, equity prices, and commodity prices; (2) Specific risk, which includes risks that affect the market value of a specific instrument, such as the credit risk of the issuer of the particular instrument, but do not materially alter broad market conditions; E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57548 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (3) Incremental risk, which means the risk of loss on a position that could result from the failure of an obligor to make timely payments of principal and interest; and (4) Comprehensive risk, which is the measure of all material price risks of one or more portfolios of correlation trading positions. Market risk exposure requirement. This term refers to the amount that the swap dealer (other than a swap dealer subject to the minimum capital requirements of § 23.101(a)(1)(i)) is required to compute under § 23.102 if approved to use internal market risk models, or § 23.103 if not approved to use internal market risk models. OTC derivative contract. This term shall have the meaning ascribed to it in 12 CFR part 217. Predominantly engaged in nonfinancial activities. A swap dealer is predominantly engaged in non-financial activities if: (1) The swap dealer’s consolidated annual gross financial revenues, or if the swap dealer is a wholly owned subsidiary, then the swap dealer’s consolidated parent’s annual gross financial revenues, in either of its two most recently completed fiscal years represents less than 15 percent of the swap dealer’s consolidated gross revenue in that fiscal year (‘‘15% revenue test’’), and (2) the consolidated total financial assets of the swap dealer, or if the swap dealer is wholly owned subsidiary, the consolidated total financial assets of the swap dealer’s parent, at the end of its two most recently completed fiscal years represents less than 15 percent of the swap dealer’s consolidated total assets as of the end of the fiscal year (‘‘15% asset test’’). For purpose of computing the 15% revenue test or the 15% asset test, a swap dealer’s activities or swap dealer’s parent’s activities shall be deemed financial activities if such activities are defined as financial activities under 12 CFR 242.3 and Appendix A to 12 CFR 242, including lending, investing for others, safeguarding money or securities for others, providing financial or investment advisory services, underwriting or making markets in securities, providing securities brokerage services, and engaging as principal in investing and trading activities; Provided, however, a swap dealer may exclude from its financial activities accounts receivable resulting from non-financial activities. Prudential regulator. This term has the same meaning as set forth in section 1a(39) of the Act, and includes the Board of Governors of the Federal Reserve System, the Office of the VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Federal Housing Finance Agency, as applicable to a swap dealer or major swap participant. Regulatory capital. This term shall mean: (1) With respect to the capital requirement under § 23.101(a)(1)(i), the amount of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital maintained by a covered SD, computed in accordance with § 23.101(a)(1)(i); (2) With respect to the capital requirement under § 23.101(a)(1)(ii), the amount of tentative net capital and net capital maintained by a covered SD, computed in accordance with § 23.101(a)(1)(ii); (3) With respect to the capital requirement under § 23.101(a)(2)(i), the amount of tangible net worth as defined in this section and maintained by a covered SD; and (4) With respect to the capital requirement under 23.101(b), the amount of tangible net worth as defined in this section and maintained by a major swap participant. Regulatory capital requirement. This term refers to each of the capital requirements that § 23.101 applies to a swap dealer or major swap participant. Tangible net worth. This term means the net worth of a swap dealer or major swap participant as determined in accordance with generally accepted accounting principles in the United States, excluding goodwill and other intangible assets. In determining net worth, all long and short positions in swaps, security-based swaps and related positions must be marked to their market value. A swap dealer or major swap participant must include in its computation of tangible net worth all liabilities or obligations of a subsidiary or affiliate that the swap dealer or major swap participant guarantees, endorses, or assumes either directly or indirectly. Uncleared swap margin. This term means the amount of initial margin, computed in accordance with § 23.154, that a swap dealer would be required to collect from each counterparty for each outstanding swap position of the swap dealer. A swap dealer must include all swap positions in the calculation of the uncleared swap margin amount, including swaps that are exempt or excluded from the scope of the Commission’s margin regulations for uncleared swaps pursuant to § 23.150, exempt foreign exchange swaps or foreign exchange forwards, or netting set of swaps or foreign exchange swaps, for each counterparty, as if that PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 counterparty was an unaffiliated swap dealer. Furthermore, in computing the uncleared swap margin amount, a swap dealer may not exclude the initial margin threshold amount or minimum transfer amount as such terms are defined in § 23.151. ■ 9. Add section 23.101 to subpart E to read as follows: § 23.101 Minimum financial requirements for swap dealers and major swap participants. (a)(1) Except as provided in paragraphs (a)(2) through (a)(5) of this section, each swap dealer must elect to be subject to the minimum capital requirements set forth in either paragraphs (a)(1)(i) or (a)(1)(ii) of this section: (i) A swap dealer that elects to meet the capital requirements in this paragraph (a)(1)(i) must at all times maintain regulatory capital that meets the following: (A) $20 million of common equity tier 1 capital, as defined under the bank holding company regulations in 12 CFR 217.20, as if the swap dealer itself were a bank holding company subject to 12 CFR part 217; (B) An aggregate of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital, all as defined under the bank holding company regulations in 12 CFR 217.20, equal to or greater than eight percent of the swap dealer’s BHC equivalent risk-weighted assets; provided, however, that the swap dealer must maintain a minimum of common equity tier 1 capital equal to six point five percent of its BHC equivalent riskweighted assets; provided further, that any capital that is subordinated debt under 12 CFR 217.20 and that is included in the swap dealer’s capital for purposes of this paragraph (a)(1)(i)(B) must qualify as subordinated debt under § 240.18a–1d of this title; (C) An aggregate of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital, all as defined under the bank holding company regulations in 12 CFR 217.20, equal to or greater than eight percent of the amount of uncleared swap margin, as that term is defined in § 23.100 of this part, for each uncleared swap position open on the books of the swap dealer, computed on a counterparty by counterparty basis pursuant to § 23.154 of this part; and (D) The amount of capital required by a registered futures association of which the swap dealer is a member. (ii)(A) A swap dealer that elects to meet the capital requirements in this paragraph (a)(1)(ii) must at all times maintain net capital, as defined and computed in accordance with E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations § 240.18a–1 of this title as if the swap dealer were a security-based swap dealer registered with the Securities and Exchange Commission and subject to § 240.18a–1 of this title, that equals or exceeds the greater of: (1) $20 million; provided however, that if the swap dealer is approved under § 23.102 of this part to use internal models to compute market risk capital charges or credit risk capital charges it must maintain tentative net capital, as defined and computed in accordance with § 240.18a–1 of this title as if the swap dealer were a securitybased swap dealer registered with the Securities and Exchange Commission and subject to § 240.18a–1 of this title, of not less than $100 million and net capital of $20 million; (2) Two percent of the uncleared swap margin, as defined in § 23.100 of this part; or (3) The amount of capital required by a registered futures association of which the swap dealer is a member. (B) A swap dealer that uses internal models to compute market risk for its proprietary positions under § 240.18a– 1(d) of this title must calculate the total market risk as the sum of the VaR measure, stressed VaR measure, specific risk measure, comprehensive risk measure, and incremental risk measure of the portfolio of proprietary positions in accordance with § 23.102 of this part and Appendix A to Subpart E of Part 23; and (C) A swap dealer may recognize as a current asset, receivables from thirdparty custodians that maintain the swap dealer’s initial margin deposits associated with uncleared swap and security-based swap transactions pursuant to the margin rules of the Commission, the Securities and Exchange Commission, a prudential regulator, as defined in section 1a(39) of the Act, or a foreign jurisdiction that has received a margin Comparability Determination under § 23.160 of this chapter. (2)(i) A swap dealer that is ‘‘predominantly engaged in nonfinancial activities’’ as defined in § 23.100 of this part may elect to meet the minimum capital requirements in this paragraph (a)(2) in lieu of the capital requirements in paragraph (a)(1) of this section. (ii) A swap dealer that satisfies the requirements of paragraph (a)(2)(i) of this section and elects to meet the requirements of this paragraph (a)(2) must maintain tangible net worth, as defined in § 23.100 of this part, equal to or in excess of the greatest of the following: VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 (A) $20 million plus the amount of the swap dealer’s market risk exposure requirement (as defined in § 23.100 of this part) and its credit risk exposure requirement (as defined in § 23.100 of this part) associated with the swap dealer’s swap and related hedge positions that are part of the swap dealer’s swap dealing activities. The swap dealer shall compute its market risk exposure requirement and credit risk exposure requirement for its swap positions in accordance with § 23.102 of this part if the swap dealer has obtained approval to use internal capital models. The swap dealer shall compute its market risk exposure requirement and credit risk exposure requirement in accordance with the standardized approach of paragraphs (b)(1) and (c)(1) of § 23.103 of this part if it has not been approved to use internal capital models; (B) Eight percent of the amount of uncleared swap margin, as that term is defined in § 23.100 of this part, for each uncleared swap positions open on the books of the swap dealer, computed on a counterparty by counterparty basis pursuant to § 23.154 of this part; or (C) The amount of capital required by a registered futures association of which the swap dealer is a member. (3) A swap dealer that is subject to minimum capital requirements established by the rules or regulations of a prudential regulator pursuant to section 4s(e) of the Act is not subject to the regulatory capital requirements set forth in paragraph (a)(1) or (2) of this section. (4) A swap dealer that is a futures commission merchant is subject to the minimum capital requirements of § 1.17 of this title, and is not subject to the regulatory capital requirements set forth in paragraph (a)(1) or (2) of this section. (5) A swap dealer that is organized and domiciled outside of the United States, including a swap dealer that is an affiliate of a person organized and domiciled in the United States, may satisfy its requirements for capital adequacy under paragraphs (a)(1) or (2) of this section by substituted compliance with the capital adequacy requirement of its home country jurisdiction. In order to qualify for substituted compliance, a swap dealer’s home country jurisdiction must receive from the Commission a Capital Comparability Determination under § 23.106 of this part. A swap dealer that is a registered futures commission merchant may not apply for a Capital Comparability Determination and must comply with the minimum capital requirements set forth in § 1.17 of this chapter. PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 57549 (6) A swap dealer that elects to meet the capital requirements of paragraph (a)(1)(i), (a)(1)(ii), or (a)(2) of this section may not subsequently change its election without the prior written approval of the Commission. A swap dealer that wishes to change its election must submit a written request to the Commission and must provide any additional information and documentation requested by the Commission. (b)(1) Every major swap participant for which there is not a prudential regulator must at all time have and maintain positive tangible net worth. (2) Notwithstanding paragraph (b)(1) of this section, each major swap participant for which there is no prudential regulator must meet the minimum capital requirements established by a registered futures association of which the major swap participant is a member. (3) Notwithstanding paragraphs (b)(1) and (2) of this section, a major swap participant that is a futures commission merchant is subject to the minimum capital requirements of § 1.17 of this chapter, and is not subject to the regulatory capital requirements set forth in paragraph (b)(1) and (2) of this section. (4) A major swap participant that is organized and domiciled outside of the United States, including a major swap participant that is an affiliate of a person organized and domiciled in the United States, may satisfy its requirements for capital adequacy under paragraphs (b)(1) and (2) of this section by substituted compliance with the capital adequacy requirement of its home country jurisdiction. In order to qualify for substituted compliance, a major swap participant’s home country jurisdiction must receive from the Commission a Capital Comparability Determination under § 23.106 of this part. A major swap participant that is a registered futures commission merchant may not apply for a Capital Comparability Determination and must comply with the minimum capital requirements set forth in § 1.17 of this chapter. (c)(1) Before any applicant may be registered as a swap dealer or major swap participant, the applicant must demonstrate to the satisfaction of a registered futures association of which it is a member, or applying for membership, one of the following: (i) That the applicant complies with the applicable regulatory capital requirements in paragraphs (a)(1), (a)(2), (b)(1), or (b)(2) of this section; E:\FR\FM\15SER3.SGM 15SER3 57550 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (ii) That the applicant is a futures commission merchant that complies with § 1.17 of this chapter; (iii) That the applicant is subject to minimum capital requirements established by the rules or regulations of a prudential regulator under paragraph (a)(3) of this section; (iv) That the applicant is organized and domiciled in a non-U.S. jurisdiction and is regulated in a jurisdiction for which the Commission has issued a Capital Comparability Determination under § 23.106 of this part, and the nonU.S. person has obtained confirmation from the Commission that it may rely upon the Commission’s Comparability Determination under § 23.106 of this part. (2) Each swap dealer and major swap participant subject to the minimum capital requirements set forth in paragraphs (a) and (b) of this section must be in compliance with such requirements at all times, and must be able to demonstrate such compliance to the satisfaction of the Commission and to the registered futures association of which the swap dealer or major swap participant is a member. ■ 10. Add section 23.102 to subpart E to read as follows: jbell on DSKJLSW7X2PROD with RULES3 § 23.102 Calculation of market risk exposure requirement and credit risk exposure requirement using internal models (a) A swap dealer may apply to the Commission or to a registered futures association of which the swap dealer is a member to obtain approval to use internal models under terms and conditions required by the Commission or the registered futures association and by these regulations, when calculating the swap dealer’s market risk exposure and credit risk exposure under §§ 23.101(a)(1)(i)(B), 23.101(a)(1)(ii)(A), or 23.101(a)(2)(ii)(A); Provided however, that the Commission must issue a determination that the registered futures association’s model requirements and review process are comparable to the Commission’s requirements and review process in order for the registered futures association’s model approval to be accepted as an alternative means of compliance with this section. (b) The swap dealer’s application to use internal models to compute market risk exposure and credit risk exposure must be in writing and must be filed with the Commission and with a registered futures association of which the swap dealer is a member. The swap dealer must file the application in accordance with instructions established by the Commission and the registered futures association. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 (c) A swap dealer’s application must include the following: (1) In the case of a swap dealer subject to the minimum capital requirements in § 23.101(a)(1)(i) applying to use internal models to compute market risk exposure, the information required under subpart F of 12 CFR part 217, as if the swap dealer were itself a bank holding company subject to 12 CFR part 217. (2) In the case of a swap dealer subject to the minimum capital requirements in § 23.101(a)(1)(i) applying to use internal models to compute credit risk exposure, the information required under subpart E of 12 CFR part 217 in order to calculate credit risk-weighted assets in accordance with sections 217.131 through 217.155 of that subpart, as if the swap dealer were itself a bank holding company subject to 12 CFR part 217. (3) In the case of a swap dealer subject to the minimum capital requirements in § 23.101(a)(ii) or § 23.101(a)(2), the information set forth in Appendix A to Subpart E of Part 23. (d) The Commission, or registered futures association upon obtaining the Commission’s determination that its requirements and model approval process are comparable to the Commission’s requirements and process, may approve or deny the application, or approve or deny an amendment to the application, in whole or in part, subject to any conditions or limitations the Commission or registered futures association may require, if the Commission or registered futures association finds the approval to be appropriate in the public interest, after determining, among other things, whether the applicant has met the requirements of this section. A swap dealer that has received Commission or registered futures association approval to compute market risk exposure requirements and credit risk exposure requirements pursuant to internal models must compute such charges in accordance with Appendix A to Subpart E of Part 23. (e) A swap dealer must cease using internal models to compute its market risk exposure requirement and credit risk exposure requirement, upon the occurrence of any of the following: (1) The swap dealer has materially changed a mathematical model described in the application or materially changed its internal risk management control system without first submitting amendments identifying such changes and obtaining the approval of the Commission or the registered futures association for such changes; PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 (2) The Commission or the registered futures association of which the swap dealer is a member determines that the internal models are no longer sufficient for purposes of the capital calculations of the swap dealer as a result of changes in the operations of the swap dealer; (3) The swap dealer fails to come into compliance with its requirements under this section, after having received from the Director of the Commission’s Division of Swap Dealer and Intermediary Oversight, or from the registered futures association of which the swap dealer is a member, written notification that the swap dealer is not in compliance with its requirements, and must come into compliance by a date specified in the notice; or (4) The Commission by written order finds that permitting the swap dealer to continue to use the internal models is no longer appropriate. (f)(1) Notwithstanding paragraphs (a) through (d) of this section, a swap dealer may use internal market risk or credit risk models upon the submission to the Commission and the registered futures association of which the swap dealer is a member a certification, signed by the Chief Executive Officer, Chief Financial Officer, or other appropriate official with knowledge of the swap dealer’s capital requirements and the capital models, that such models are in substantial compliance with Commission’s model requirements and have been approved for use in computing capital by the swap dealer, or an affiliate of the swap dealer, by the Securities and Exchange Commission, a prudential regulator (as defined in § 1.3 of this chapter), a foreign regulatory authority in a jurisdiction that the Commission has found to be eligible for substituted compliance under § 23.106, or a foreign regulatory authority whose capital adequacy requirements are consistent with the capital requirements issued by the Basel Committee on Banking Supervision. A swap dealer also must file an application containing the information required under paragraph (c) of this section with the Commission with its certification. A swap dealer may use such models pending the subsequent approval or denial of the swap dealer’s capital model application by the Commission or the registered futures association of which the swap dealer is a member. (2) A swap dealer shall revise the certification required under paragraph (f)(1) of this section to address any material changes or revisions to the models, or to reflect any regulatory restrictions placed on the models since the certification was submitted. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (3) A swap dealer shall cease using capital models subject to the certification under paragraph (f)(1) of this section if the regulatory authority that previously approved the models for use by the swap dealer, or by the swap dealer’s affiliate, has withdrawn its approval and the Commission or a registered futures association has not approved the models. ■ 11. Add section 23.103 to subpart E to read as follows: jbell on DSKJLSW7X2PROD with RULES3 § 23.103 Calculation of market risk exposure requirement and credit risk requirement when models are not approved. (a) Non-model approach. A swap dealer that: (1) Does not compute its regulatory capital requirements under § 23.101(a)(1)(i), and (2) Either: (A) has not received approval from the Commission or from a registered futures association of which the swap dealer is a member to compute its market risk exposure requirement and/ or credit risk exposure requirement pursuant to internal models under § 23.102, or (B) has had its approval to compute its market risk exposure requirement and/or credit risk exposure requirement pursuant to internal models under § 23.102 revoked by the Commission or registered futures association must compute its market risk exposure requirement and/or credit risk exposure requirement pursuant to paragraphs (b) and/or (c) of this section. (b) Market risk exposure requirements. (1) A swap dealer that computes its regulatory capital under § 23.101(a)(1)(ii) or (a)(2) shall compute a market risk capital charge for the positions that the swap dealer holds in its proprietary accounts using the applicable standardized market risk charges set forth in § 240.18a–1 of this title and § 1.17 of this chapter for such positions. (2) In computing its net capital under § 23.101(a)(1)(ii), a swap dealer shall deduct from its tentative net capital the sum of the market risk capital charges computed under paragraph (b)(1) of this section. (3) In computing its minimum capital requirement under § 23.101(a)(2), a swap dealer must add the amount of the market risk capital charge computed under this section to the $20 million minimum capital requirement. (c) Credit risk charges. (1) A swap dealer that computes regulatory capital under § 23.101(a)(1)(ii) shall compute counterparty credit risk charges using the applicable standardized credit risk VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 charges set forth in § 240.18a–1 of this title and § 1.17 of this chapter for such positions. (2) In computing its net capital under § 23.101(a)(1)(ii), a swap dealer shall reduce its tentative net capital by the sum of the counterparty credit risk charges computed under paragraph (c)(1) of this section. (3) In computing its minimum capital requirement under § 23.101(a)(2), a swap dealer must add the amount of the credit risk charge computed under this section to the $20 million minimum capital requirement. ■ 12. Add section 23.104 to subpart E to read as follows: § 23.104 Equity Withdrawal Restrictions. (a) Equity withdrawal restrictions. The capital of a swap dealer, including the capital of any affiliate or subsidiary whose liabilities or obligations are guaranteed, endorsed, or assumed by the swap dealer may not be withdrawn by action of the swap dealer or its equity holders, or by redemption of shares of stock by the swap dealer or by such affiliates or subsidiaries, or through the payment of dividends or any similar distribution, nor may any unsecured advance or loan be made to an equity holder or employee if, after giving effect thereto and to any other such withdrawals, advances, or loans which are scheduled to occur within six months following such withdrawal, advance or loan, the swap dealer’s regulatory capital is less than 120 percent of the minimum regulatory capital required under § 23.101 of this part. The equity withdrawal restrictions, however, do not preclude a swap dealer from making required tax payments or from paying reasonable compensation to equity holders. The Commission may, upon application by the swap dealer, grant relief from this paragraph (a) if the Commission deems such relief to be in the public interest. (b) Temporary equity withdrawal restrictions by Commission order. (1) The Commission may by order restrict, for a period of up to twenty business days, any withdrawal by a swap dealer of capital or any unsecured loan or advance to a stockholder, partner, member, employee or affiliate under such terms and conditions as the Commission deems appropriate in the public interest if the Commission, based on the information available, concludes that such withdrawal, loan or advance may be detrimental to the financial integrity of the swap dealer, or may unduly jeopardize the swap dealer’s ability to meet its financial obligations to counterparties or to pay other liabilities which may cause a significant PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 57551 impact on the markets or expose the counterparties and creditors of the swap dealer to loss. (2) An order temporarily prohibiting the withdrawal of capital shall be rescinded if the Commission determines that the restriction on capital withdrawal should not remain in effect. A hearing on an order temporarily prohibiting withdrawal of capital will be held within two business days from the date of the request in writing by the swap dealer. ■ 13. Add section 23.105 to subpart E to read as follows: § 23.105 Financial recordkeeping, reporting and notification requirements for swap dealers and major swap participants. (a) Scope. (1) Except as provided in paragraphs (a)(2) and (a)(3) of this section, a swap dealer or major swap participant must comply with the applicable requirements set forth in paragraphs (b) through (p) of this section. (2) The requirements in paragraphs (b) through (o) of this section do not apply to any swap dealer or major swap participant that is subject to the capital requirements of a prudential regulator. (3) The requirements in paragraph (p) of this section do not apply to any swap dealer or major swap participant that is subject to the capital requirements of the Commission. (b) Current books and records. A swap dealer or major swap participant shall prepare and keep current ledgers or other similar records which show or summarize, with appropriate references to supporting documents, each transaction affecting its asset, liability, income, expense, and capital accounts, and in which all its asset, liability, and capital accounts are classified in accordance with U.S. generally accepted accounting principles, and as otherwise may be necessary for the capital calculations required under § 23.101 of this part: Provided, however, that a swap dealer or major swap participant that is not otherwise required to prepare financial statements in accordance with U.S. generally accepted accounting principles, may prepare and keep records required by this section in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board. Such records must be maintained in accordance with § 1.31 of this chapter. (c) Notices. (1) A swap dealer or major swap participant who knows or should have known that its regulatory capital at any time is less than the minimum required by § 23.101 of this part, must: E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57552 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (i) Provide immediate written notice to the Commission and to the registered futures association of which it is a member that the swap dealer’s or major swap participant’s regulatory capital is less than that required by § 23.101 of this part; and (ii) Provide together with such notice, documentation in such form as necessary to adequately reflect the swap dealer’s or major swap participant’s regulatory capital condition as of any date such person’s regulatory capital is less than the minimum required. The swap dealer or major swap participant must provide similar documentation for other days as the Commission or registered futures association may request. (2) A swap dealer or major swap participant who knows or should have known that its regulatory capital at any time is less than 120 percent of its minimum regulatory capital requirement as determined under § 23.101 of this part, must provide written notice to the Commission and to the registered futures association of which it is a member to that effect within 24 hours of such event. (3) If a swap dealer or major swap participant at any time fails to make or to keep current the books and records required by these regulations, such swap dealer or major swap participant must, on the same day such event occurs, provide written notice to the Commission and to the registered futures association of which it is a member of such fact, specifying the books and records which have not been made or which are not current, and within 48 hours after giving such notice file a written report stating what steps have been and are being taken to correct the situation. (4) A swap dealer or major swap participant must provide written notice to the Commission and to the registered futures association of which it is a member of a substantial reduction in capital as compared to that last reported in a financial report filed with the Commission pursuant to this section. The notice shall be provided if the swap dealer or major swap participant experiences a 30 percent or more decrease in the amount of capital that the swap dealer or major swap participant holds in excess of its regulatory capital requirement as computed under § 23.101 of this part. (5) A swap dealer or major swap participant must provide written notice to the Commission and to the registered futures association of which it is a member two business days prior to the withdrawal of capital by action of the equity holders of the swap dealer or VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 major swap participant where the withdrawal exceeds 30 percent of the swap dealer’s or major swap participant’s excess regulatory capital as computed under § 23.101 of this part. (6) A swap dealer or major swap participant that is registered with the Securities and Exchange Commission as a security-based swap dealer or as a major security-based swap participant and files a notice with the Securities and Exchange Commission under 17 CFR 240.18a–8 or 17 CFR 240.17a–11, as applicable, must file a copy of such notice with the Commission and with the registered futures association of which it is a member at the time the security-based swap dealer or major security-based swap participant files the notice with the Securities and Exchange Commission. (7) A swap dealer or major swap participant must submit a written notice to the Commission and to the registered futures association of which it is a member within 24 hours of the occurrence of any of the following events: (i) A single counterparty, or group of counterparties that are under common ownership or control, fails to post initial margin or pay variation margin to the swap dealer or major swap participant for swap positions in compliance with § 23.152 and § 23.153 of this part and security-based swap positions in compliance with 17 CFR 240.18a– 3(c)(1)(ii) and 17 CFR 240.18a– 3(c)(2)(ii), and such initial margin and variation margin, in the aggregate, is equal to or greater than 25 percent of the swap dealer’s minimum capital requirement or 25 percent of the major swap participant’s tangible net worth; (ii) Counterparties fail to post initial margin or pay variation margin to the swap dealer or major swap participant for swap positions in compliance with § 23.152 and § 23.153 of this part and security-based swap positions in compliance with 17 CFR 240.18a– 3(c)(1)(ii) and 17 CFR 240.18a–3(c)(2)(ii) in an amount that, in the aggregate, exceeds 50 percent of the swap dealer’s minimum capital requirement or 50 percent of the major swap participant’s tangible net worth; (iii) A swap dealer or major swap participant fails to post initial margin or pay variation margin to a single counterparty or group of counterparties under common ownership and control for swap positions in compliance with § 23.152 and § 23.153 of this part and security-based swap positions in compliance with 17 CFR 240.18a– 3(c)(1)(ii) and 17 CFR 240.18a– 3(c)(2)(ii), and such initial margin and variation margin, in the aggregate, PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 exceeds 25 percent of the swap dealer’s minimum capital requirement or 25 percent of the major swap participant’s tangible net worth; or (iv) A swap dealer or major swap participant fails to post initial margin or pay variation margin to counterparties for swap positions in compliance with § 23.152 and § 23.153 of this part and security-based swap positions in compliance with 17 CFR 240.18a– 3(c)(1)(ii) and 17 CFR 240.18a–3(c)(2)(ii) in an amount that, in the aggregate, exceeds 50 percent of the swap dealer’s s minimum capital requirement or 50 percent of the major swap participants tangible net worth. (d) Unaudited financial reports. (1) A swap dealer or major swap participant shall file with the Commission and with a registered futures association of which it is a member monthly financial reports meeting the requirements in paragraph (d)(2) of this section as of the close of business each month; Provided, however, that a swap dealer or major swap participant who is subject to the minimum capital requirements of § 23.101(a)(2) or (b), respectively, may file quarterly financial reports meeting the requirements of paragraph (d)(2) of this section as of the close of business each quarter end. Such financial reports must be filed no later than 17 business days after the date for which the report is made. (2) The financial reports required by this section must be prepared in the English language and be denominated in United States dollars. The financial reports shall include a statement of financial condition, a statement of income/loss, a statement of changes in liabilities subordinated to the claims of general creditors, a statement of changes in ownership equity, a statement demonstrating compliance with and calculation of the applicable regulatory capital requirement under § 23.101, and such further material information as may be necessary to make the required statements not misleading. The monthly report and schedules must be prepared in accordance with generally accepted accounting principles as established in the United States; Provided, however, that a swap dealer or major swap participant that is not otherwise required to prepare financial statements in accordance with U.S. generally accepted accounting principles, may prepare the monthly report and schedules required by this section in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board. (3) A swap dealer or major swap participant that is also registered with E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations the Securities and Exchange Commission as a broker or dealer, security-based swap dealer, or a major security-based swap participant and files a monthly Form X–17A–5 FOCUS Report Part II with the Securities and Exchange Commission pursuant to 17 CFR 240.18a–7 or 17 CFR 240.17a–5, as applicable, may file such Form X–17A– 5 FOCUS Report Part II with the Commission and with the registered futures association in lieu of the financial reports required under paragraphs (d)(1) and (2) of the section. The swap dealer or major swap participant must file the form with the Commission and registered futures association when it files the Form X– 17A–5 FOCUS Report Part II with the Securities and Exchange Commission, provided, however, that the swap dealer or major swap participant must file the Form X–17A–5 FOCUS Report Part II with the Commission and registered futures association no later than 17 business days after the end of each month. (4) A swap dealer or major swap participant that is also registered with the Commission as a futures commission merchant may file a Form 1–FR–FCM in lieu of the monthly financial reports required under paragraphs (d)(1) and (2) of the section. (e) Annual audited financial report. (1) A swap dealer or major swap participant shall file with the Commission and with a registered futures association of which it is a member an annual financial report as of the close of its fiscal year, certified in accordance with paragraph (e)(2) of this section, and including the information specified in paragraph (e)(3) of this section no later than 60 days after the close of the swap dealer’s or major swap participant’s fiscal year-end: Provided, however, that a swap dealer or major swap participant who is subject to the minimum capital requirements of § 23.101(a)(2) or (b), respectively, of this part may file an annual financial report no later than 90 days after the close of the swap dealer’s and major swap participant’s fiscal year-end. (2) The annual financial report shall be audited and reported upon with an opinion expressed by an independent certified public accountant or independent licensed accountant that is in good standing in the accountant’s home jurisdiction. (3) The annual financial reports shall be prepared in accordance with generally accepted accounting principles as established in the United States, be prepared in the English language, and denominated in United States dollars: Provided, however, that a VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 swap dealer or major swap participant that does not otherwise prepare financial statements in accordance with U.S. generally accepted accounting principles, may prepare the annual financial report required by this section in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board. (4) The annual financial report must include the following: (i) A statement of financial condition as of the date for which the report is made; (ii) Statements of income (loss), cash flows, changes in ownership equity for the period between the date of the most recent certified statement of financial condition filed with the Commission and registered futures association and the date for which the report is made, and changes in liabilities subordinated to claims of general creditors; (iii) Appropriate footnote disclosures; (iv) A statement demonstrating the swap dealer’s or major swap participant’s compliance with and calculation of the applicable regulatory capital requirement under § 23.101 of this part; (v) A reconciliation of any material differences from the unaudited financial report prepared as of the swap dealer’s or major swap participant’s year-end date under paragraph (d) of this section and the swap dealer’s or major swap participant’s annual financial report prepared under this paragraph (e); and (vi) Such further material information as may be necessary to make the required statements not misleading. (5) A swap dealer or major swap participant that is also registered with the Securities and Exchange Commission as a broker or dealer, security-based swap dealer, or a major security-based swap participant and files an annual financial report with the Securities and Exchange Commission pursuant to 17 CFR 240.18a–7 or 17 CFR 240.17a–5, as applicable, may file such annual financial report with the Commission and the registered futures association in lieu of the annual financial report required under this paragraph (e). The swap dealer or major swap participant must file its annual financial report with the Commission and the registered futures association at the same time that it files the annual financial report with the Securities and Exchange Commission, provided that the annual financial report is filed with the Commission and registered futures association no later than 60 days from the swap dealer’s or major swap participant’s fiscal year-end date. PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 57553 (6) A swap dealer or major swap participant that is also registered with the Commission as a futures commission merchant may file an audited Form 1–FR–FCM in lieu of the annual financial report required under this paragraph (e). (f) Oath or affirmation. Attached to each unaudited and audited financial report must be an oath or affirmation that to the best knowledge and belief of the individual making such oath or affirmation the information contained in the financial report is true and correct. The individual making such oath or affirmation must be: If the swap dealer or major swap participant is a sole proprietorship, the proprietor; if a partnership, any general partner; if a corporation, the duly authorized officer; and, if a limited liability company or limited liability partnership, the chief executive officer, the chief financial officer, the manager, the managing member, or those members vested with the management authority for the limited liability company or limited liability partnership. (g) Change of fiscal year-end. A swap dealer or major swap participant may not change the date of its fiscal year-end from that used in its most recent annual financial report filed under paragraph (e) of this section unless the swap dealer or major swap participant has requested and received written approval for the change from a registered futures association of which it is a member. (h) Additional information requirements. From time to time the Commission or a registered futures association, may, by written notice, require any swap dealer or major swap participant to file financial or operational information on a daily basis or at such other times as may be specified by the Commission or registered futures association. Such information must be furnished in accordance with the requirements included in the written Commission or registered futures association notice. (i) Public disclosure and nonpublic treatment of reports. (1) A swap dealer or major swap participant must no less than six months after the date of the most recent annual audited financial report make publicly available on its website the following unaudited information: (i) The statement of financial condition; and (ii) A statement disclosing the amount of the swap dealer’s or major swap participant’s regulatory capital as of the end of the quarter and the amount of its minimum regulatory capital requirement, computed in accordance with § 23.101. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57554 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations (2) A swap dealer or major swap participant must no less than annually make publicly available on its website the following information: (i) The statement of financial condition from the swap dealer or major swap participant’s audited annual financial report including applicable footnotes; and (ii) A statement disclosing the amount of the swap dealer’s or major swap participant’s regulatory capital as of the fiscal year end and its minimum regulatory capital requirement, computed in accordance with § 23.101. (3) Financial information required to be made publicly available pursuant to paragraph (i)(2) of this section must be posted within 10 business days after the firm is required to file with the Commission the reports required under paragraph (e)(1). (4) Financial information required to be made publicly available pursuant to paragraph (i)(1) of this section must be posted within 30 calendar days of the date of the statements required under paragraph (d)(1). (5) Financial information required to be filed with the Commission pursuant to this section, and not otherwise publicly available, will be treated as exempt from mandatory public disclosure for purposes of the Freedom of Information Act and the Government in the Sunshine Act and parts 145 and 147 of this chapter; Provided, however, that all information that is exempt from mandatory public disclosure will be available for official use by any official or employee of the United States or any State, by the National Futures Association and by any other person to whom the Commission believes disclosure of such information is in the public interest. (j) Extension of time to file financial reports. A swap dealer or major swap participant may file a request with the registered futures association of which it is a member for an extension of time to file a monthly unaudited financial report or an annual audited financial report required under paragraphs (d) and (e) of this section. Such request will be approved, conditionally or unconditionally, or disapproved by the registered futures association. (k) Additional reporting requirements for swap dealers approved to use models to calculate market risk and credit risk for computing capital requirements. (1) A swap dealer that has received approval or filed an application for provisional approval under § 23.102(d) from the Commission, or from a registered futures association of which the swap dealer is a member, to use internal models to compute its VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 market risk exposure requirement and credit risk exposure requirement in computing its regulatory capital under § 23.101 must file with the Commission and with the registered futures association of which the swap dealer is a member the following information within 17 business days of the end of each month: (i) For each product for which the swap dealer calculates a deduction for market risk other than in accordance with a model approved or for which an application of provisional approval has been filed pursuant to § 23.102(d), the product category and the amount of the deduction for market risk; (ii) A graph reflecting, for each business line, the daily intra-month VaR; (iii) The aggregate VaR for the swap dealer; (iv) For each product for which the swap dealer uses scenario analysis, the product category and the deduction for market risk; (v) Credit risk information on swap, mixed swap and security-based swap exposures including: (A) Overall current exposure; (B) Current exposure (including commitments) listed by counterparty for the 15 largest exposures; (C) The 10 largest commitments listed by counterparty; (D) The swap dealer’s maximum potential exposure listed by counterparty for the 15 largest exposures; (E) The swap dealer’s aggregate maximum potential exposure; (F) A summary report reflecting the swap dealer’s current and maximum potential exposures by credit rating category; and (G) A summary report reflecting the swap dealer’s current exposure for each of the top ten countries to which the swap dealer is exposed (by residence of the main operating group of the counterparty). (2) A swap dealer that has received approval or filed an application of provisional approval under § 23.102(d) from the Commission or from a registered futures association of which the swap dealer is a member to use internal models to compute its market risk exposure requirement and credit risk exposure requirement in computing its regulatory capital under § 23.101 must file with the Commission and with the registered futures association of which the swap dealer is member the following information within 17 business days of the end of each calendar quarter: (i) A report identifying the number of business days for which the actual daily PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 net trading loss exceeded the corresponding daily VaR; and (ii) The results of back-testing of all internal models used to compute allowable capital, including VaR, and credit risk models, indicating the number of back-testing exceptions. (l) Additional position and counterparty reporting requirements. A swap dealer or major swap participant must provide on a monthly basis to the Commission and to the registered futures association of which the swap dealer or major swap participant is a member the specific information required in Appendix B to Subpart E of this part. (m) Margin reporting. A swap dealer or major swap participant must file with the Commission and with the registered futures association of which the swap dealer or major swap participant is a member the following information as of the end of each month within 17 business days of the end of each month: (1) The name and address of each custodian holding initial margin or variation margin collected by the swap dealer or major swap participant for uncleared swap transactions pursuant to §§ 23.152 and 23.153; (2) The amount of initial margin and variation margin collected by the swap dealer or major swap participant that is held by each custodian listed in paragraph (m)(1) of this section; (3) The aggregate amount of initial margin that the swap dealer or major swap participant is required to collect from swap counterparties pursuant to § 23.152(a); (4) The name and address of each custodian holding initial margin or variation margin posted by the swap dealer or major swap participant for uncleared swap transaction pursuant to §§ 23.152 and 23.153; (5) The amount of initial margin and variation margin posted by the swap dealer or major swap participant that is held by each custodian listed in paragraph (m)(4) of this section; and (6) The aggregate amount of initial margin that the swap dealer or majors swap participant is required to post to its swap counterparties pursuant to § 23.152(b). (n) Electronic filing. All filings of financial reports, notices and other information required to be submitted to the Commission or registered futures association under paragraphs (b) through (m) of this section must be filed in electronic form using a form of user authentication assigned in accordance with procedures established by or approved by the Commission or registered futures association, and otherwise in accordance with E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations instructions issued by or approved by the Commission or registered futures association. A swap dealer or major swap participant must provide the Commission or registered futures association with the means necessary to read and to process the information contained in such report. Any such electronic submission must clearly indicate the swap dealer or major swap participant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. In the case of a financial report required under paragraphs (d), (e), or (h) of this section and filed via electronic transmission in accordance with procedures established by or approved by the Commission or registered futures association, such transmission must be accompanied by the user authentication assigned to the authorized signer under such procedures, and the use of such user authentication will constitute and become a substitute for the manual signature of the authorized signer for the purpose of making the oath or affirmation referred to in paragraph (f) of this section. (o) Comparability determination for certain financial reporting. A swap dealer or major swap participant that is subject to the monthly financial reporting requirements of paragraph (d) of this section and the annual financial reporting requirements of paragraph (e) of this section may petition the Commission for a Capital Comparability Determination under § 23.106 to file monthly financial reports and/or annual financial reports prepared in accordance with the rules a foreign regulatory authority in lieu of the requirements contained in this section. (p) Quarterly financial reporting and notification provisions for swap dealers and major swap participants that are subject to the capital requirements of a prudential regulator. (1) Scope. A swap dealer or major swap participant that is subject to the capital requirements of a prudential regulator must comply with the requirements of this paragraph. (2) Financial report and position information. A swap dealer or major swap participant that is subject to the capital requirements of a prudential regulator shall file on a quarterly basis with the Commission the financial reports and specific position information set forth in Appendix C to subpart E of this part. The swap dealer or major swap participant must file Appendix B to subpart E of this part with the Commission within 30 VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 calendar days of the date of the end of the swap dealer’s or major swap participant’s fiscal quarter. (3) Notices. A swap dealer or major swap participant that is subject to the capital requirements of a prudential regulator must comply with the following written notice provisions: (i) A swap dealer or major swap participant that files a notice of adjustment of its reported capital category with the Federal Reserve Board, the Office of the Comptroller of the Currency, or the Federal Deposit Insurance Corporation, or files a similar notice with its home country supervisor(s), must give written notice of this fact that same day by transmitting a copy of the notice of the adjustment of reported capital category, or the similar notice provided to its home country supervisor(s), to the Commission and with a registered futures association of which it is a member. (ii) A swap dealer or major swap participant must provide immediate written notice to the Commission and with a registered futures association of which it is a member that the swap dealer’s or major swap participant’s regulatory capital is less than the applicable minimum capital requirements set forth in 12 CFR 217.10, 12 CFR 3.10, or 12 CFR 324.10, or the minimum capital requirements established by its home country supervisor(s). (iii) If a swap dealer or major swap participant at any time fails to make or to keep current the books and records necessary to produce reports required under paragraph (p)(2) of this section, such swap dealer or major swap participant must, on the same day such event occurs, provide written notice to the Commission and with a registered futures association of which it is a member of such fact, specifying the books and records which have not been made or which are not current, and within 48 hours after giving such notice file a written report stating what steps have been and are being taken to correct the situation. (4) Additional information. From time to time the Commission may, by written notice, require a swap dealer or major swap participant that is subject to the capital rules of a prudential regulator to file financial or operational information on a daily basis or at such other times as may be specified by the Commission. Such information must be furnished in accordance with the requirements included in the written Commission notice. (5) Oath or affirmation. Attached to each financial report, must be an oath or PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 57555 affirmation that to the best knowledge and belief of the individual making such oath or affirmation the information contained in the filing is true and correct. The individual making such oath or affirmation must be: If the swap dealer or major swap participant is a sole proprietorship, the proprietor; if a partnership, any general partner; if a corporation, the duly authorized officer; and, if a limited liability company or limited liability partnership, the chief executive officer, the chief financial officer, the manager, the managing member, or those members vested with the management authority for the limited liability company or limited liability partnership. (6) Electronic filing. All filings of financial reports, notices, and other information made pursuant to this paragraph (p) must be submitted to the Commission in electronic form using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission. Each swap dealer and major swap participant must provide the Commission with the means necessary to read and to process the information contained in such report. Any such electronic submission must clearly indicate the swap dealer or major swap participant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. In the case of a financial report required under this paragraph (p) and filed via electronic transmission in accordance with procedures established by or approved by the Commission, such transmission must be accompanied by the user authentication assigned to the authorized signer under such procedures, and the use of such user authentication will constitute and become a substitute for the manual signature of the authorized signer for the purpose of making the oath or affirmation referred to in paragraph (p)(5) of this paragraph. Every notice or report required to be transmitted to the Commission pursuant to this paragraph (p) must also be filed with the Securities and Exchange Commission if the swap dealer or major swap participant also is registered with the Securities and Exchange Commission. (7) A swap dealer or major swap participant that is subject to rules of a prudential regulator and is also registered with the Securities and Exchange Commission as a securitybased swap dealer or a major security- E:\FR\FM\15SER3.SGM 15SER3 57556 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations based swap participant and files a quarterly Form X–17A–5 FOCUS Report Part IIC with the Securities and Exchange Commission pursuant to 17 CFR 240.18a–7, may file such Form X– 17A–5 FOCUS Report Part IIC with the Commission in lieu of the financial reports required under paragraphs (p)(2) of this section. The swap dealer or major swap participant must file the form with the Commission when it files the Form X–17A–5 FOCUS Report Part IIC with the Securities and Exchange Commission, provided, however, that the swap dealer or major swap participant must file the Form X–17A– 5 FOCUS Report Part IIC with the Commission no later than 30 calendar days from the date the report is made. ■ 14. Add section 23.106 to subpart E to read as follows: jbell on DSKJLSW7X2PROD with RULES3 § 23.106 Substituted compliance for swap dealer’s and major swap participant’s capital and financial reporting. (a)(1) Eligibility requirements. The following persons may, either individually or collectively, request a Capital Comparability Determination with respect to the Commission’s capital adequacy and financial reporting requirements for swap dealers or major swap participants: (i) A swap dealer or major swap participant that is eligible for substituted compliance under § 23.101 or a trade association or other similar group on behalf of its members who are swap dealers or major swap participants; or (ii) A foreign regulatory authority that has direct supervisory authority over one or more swap dealers or major swap participants that are eligible for substituted compliance under § 23.101, and such foreign regulatory authority is responsible for administering the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements over the swap dealer or major swap participant. (2) Submission requirements. A person requesting a Capital Comparability Determination must electronically submit to the Commission: (i) A description of the objectives of the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements over entities that are subject to the Commission’s capital adequacy and financial reporting requirements in this part; (ii) A description (including specific legal and regulatory provisions) of how the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements address the elements of the Commission’s capital adequacy and VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 financial reporting requirements for swap dealers and major swap participants, including, at a minimum, the methodologies for establishing and calculating capital adequacy requirements and whether such methodologies comport with any international standards, including Basel-based capital requirements for banking institutions; and (iii) A description of the ability of the relevant foreign regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements. Such description should discuss the powers of the foreign regulatory authority or authorities to supervise, investigate, and discipline entities for compliance with capital adequacy and financial reporting requirements, and the ongoing efforts of the regulatory authority or authorities to detect and deter violations, and ensure compliance with capital adequacy and financial reporting requirements. The description should address how foreign authorities and foreign laws and regulations address situations where a swap dealer or major swap participant is unable to comply with the foreign jurisdictions capital adequacy or financial reporting requirements. (iv) Upon request, such other information and documentation that the Commission deems necessary to evaluate the comparability of the capital adequacy and financial reporting requirements of the foreign jurisdiction. (v) All supplied documents shall be provided in English, or provided translated to the English language, with currency amounts stated in or converted to USD (conversions to be noted with applicable date). (3) Standard of Review. The Commission will issue a Capital Comparability Determination to the extent that it determines that some or all of the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements and related financial recordkeeping and reporting requirements for swap dealing financial intermediaries are comparable to the Commission’s corresponding capital adequacy and financial recordkeeping and reporting requirements. In determining whether the requirements are comparable, the Commission may consider all relevant factors, including: (i) The scope and objectives of the foreign jurisdiction’s capital adequacy and financial reporting requirements; (ii) Whether the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements achieve comparable outcomes to the Commission’s corresponding capital PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 adequacy and financial reporting requirements for swap dealers and major swap participants; (iii) The ability of the relevant regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s capital adequacy and financial reporting requirements; and (iv) Any other facts or circumstances the Commission deems relevant. (4) Reliance. (i) A swap dealer or major swap participant that is subject to the supervision of a foreign jurisdiction that has received a Capital Comparability Determination from the Commission must file a notice of its intent to comply with the capital adequacy and financial reporting requirements of the foreign jurisdiction with the Commission. (ii) Any swap dealer or major swap participant that has filed the notice set forth in paragraph (a)(4)(i) of this section and has received confirmation from the Commission that it may comply with a foreign jurisdiction’s capital adequacy and financial reporting requirements will be deemed to be in compliance with the Commission’s corresponding capital adequacy and financial reporting requirements. Accordingly, if a swap dealer or major swap participant has failed to comply with the foreign jurisdiction’s capital adequacy and financial reporting requirements, the Commission may initiate an action for a violation of the Commission’s corresponding requirements. All swap dealers and major swap participants, regardless of whether they rely on a Capital Comparability Determination, remain subject to the Commission’s examination and enforcement authority. (5) Conditions. In issuing a Capital Comparability Determination, the Commission may impose any terms and conditions it deems appropriate, including certain capital adequacy and financial reporting requirements on swap dealers or major swap participants. The violation of such terms and conditions may constitute a violation of the Commission’s capital adequacy or financial reporting requirements and/or result in the modification or revocation of the Capital Comparability Determination. (6) Modifications. The Commission reserves the right to further condition, modify, suspend or terminate or otherwise restrict a Capital Comparability Determination in the Commission’s discretion. 15. Add Appendix A to subpart E of part 23 to read as follows: ■ E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 Appendix A to Subpart E of Part 23— Application for Internal Models To Compute Market Risk Exposure Requirement and Credit Risk Exposure Requirement (a) A swap dealer that is requesting the approval of the Commission or the approval of a registered futures association of which the swap dealer is a member to use internal models to compute its market risk exposure requirement and credit risk exposure requirement under § 23.102 must include the following information as part of its application: (1) An executive summary of the information within its application and, if applicable, an identification of the ultimate holding company of the swap dealer; (2) A list of the categories of positions that the swap dealer holds in its proprietary accounts and a brief description of the methods that the swap dealer will use to calculate deductions for market risk and credit risk on those categories of positions; (3) A description of the mathematical models used by the swap dealer under this Appendix A to compute the VaR of the swap dealer’s positions; the stressed VaR of the swap dealer’s positions; the specific risk of the swap dealer’s positions subject to specific risk; comprehensive risk of the swap dealer’s positions; and the incremental risk of the swap dealer’s positions, and deductions for credit risk exposure. The description should encompass the creation, use, and maintenance of the mathematical models; a description of the swap dealer’s internal risk management controls over the models, including a description of each category of persons who may input data into the models; if a mathematical model incorporates empirical correlations across risk categories, a description of the process for measuring correlations; a description of the back-testing procedures the swap dealer will use to backtest the mathematical models; a description of how each mathematical model satisfies the applicable qualitative and quantitative requirements set forth in this Appendix A and a statement describing the extent to which each mathematical model used to compute deductions for market risk exposures and credit risk exposures will be used as part of the risk analyses and reports presented to senior management; (4) If the swap dealer is applying to the Commission for approval or a registered futures association to use scenario analysis to calculate deductions for market risk for certain positions, a list of those types of positions, a description of how those deductions will be calculated using scenario analysis, and an explanation of why each scenario analysis is appropriate to calculate deductions for market risk on those types of positions; (5) A description of how the swap dealer will calculate current exposure; (6) A description of how the swap dealer will determine internal credit ratings of counterparties and internal credit riskweights of counterparties, if applicable; (7) For each instance in which a mathematical model to be used by the swap dealer to calculate a deduction for market VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 risk exposure or to calculate maximum potential exposure for a particular product or counterparty differs from the mathematical model used by the swap dealer’s ultimate holding company or the swap dealer’s affiliates (if applicable) to calculate an allowance for market risk exposure or to calculate maximum potential exposure for that same product or counterparty, a description of the difference(s) between the mathematical models; (8) A description of the swap dealer’s process of re-estimating, re-evaluating, and updating internal models to ensure continued applicability and relevance; and (9) Sample risk reports that are provided to management at the swap dealer who are responsible for managing the swap dealer’s risk. (b) The application of the swap dealer shall be supplemented by other information relating to the internal risk management control system, mathematical models, and financial position of the swap dealer that the Commission or a registered futures association may request to complete its review of the application. (c) A person who files an application with the Commission pursuant to this appendix for which it seeks confidential treatment may clearly mark each page or segregable portion of each page with the words ‘‘Confidential Treatment Requested.’’ All information submitted in connection with the application will be accorded confidential treatment by the Commission, to the extent permitted by law. (d) If any of the information filed with the Commission or a registered futures association as part of the application of the swap dealer is found to be or becomes inaccurate before the Commission or a registered futures association approves the application, the swap dealer must notify the Commission or the registered futures association promptly and provide the Commission or the registered futures association with a description of the circumstances in which the information was found to be or has become inaccurate along with updated, accurate information. (e) The Commission or the registered futures association may approve the application or an amendment to the application, in whole or in part, subject to any conditions or limitations the Commission or the registered futures association may require if the Commission or the registered futures association finds the approval to be appropriate in the public interest, after determining, among other things, whether the swap dealer has met all the requirements of this Appendix A. (f) A swap dealer shall amend its application under this Appendix A and submit the amendment to the Commission and the registered futures association for approval before it may materially change a mathematical model used to calculate market risk exposure requirements or credit risk exposure requirements or before it may materially change its internal risk management control system with respect to such model. (g) As a condition for a swap dealer to use internal models to compute deductions for PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 57557 market risk exposure and credit risk exposure under this Appendix A, the swap dealer agrees that: (1) It will notify the Commission and the registered futures association 45 days before it ceases to use internal models to compute deductions for market risk exposure and credit risk exposure under this Appendix A; and (2) The Commission or the registered futures association may determine that the notice will become effective after a shorter or longer period of time if the swap dealer consents or if the Commission determines that a shorter or longer period of time is appropriate in the public interest. (h) The Commission or the registered futures association may by written order revoke a swap dealer’s approval to use internal models to compute market risk exposures and credit risk exposures on certain credit exposures arising from transactions in derivatives instruments if the Commission or the registered futures association finds that such approval is no longer appropriate in the public interest. In making its finding, the Commission or the registered futures association will consider the compliance history of the swap dealer related to its use of models and the swap dealer’s compliance with its internal risk management controls. If the Commission or the registered futures association withdraws all or part of a swap dealer’s approval to use internal models, the swap dealer shall compute market risk exposure requirements and credit risk exposure requirements in accordance with § 23.103. (i) VaR models. A value-at-risk (‘‘VaR’’) model must meet the following minimum requirements in order to be approved: (1) Qualitative requirements. (i) The VaR model used to calculate market risk exposure or credit risk exposure for a position must be integrated into the daily internal risk management system of the swap dealer; (ii) The VaR model must be reviewed both periodically and annually. The periodic review may be conducted by personnel of the swap dealer that are independent from the personnel that perform the VaR model calculations. The annual review must be conducted by a qualified third party service. The review must include: (A) An evaluation of the conceptual soundness of, and empirical support for, the internal models; (B) An ongoing monitoring process that includes verification of processes and the comparison of the swap dealer’s model outputs with relevant internal and external data sources or estimation techniques; and (C) An outcomes analysis process that includes back-testing. This process must include a comparison of the changes in the swap dealer’s portfolio value that would have occurred were end-of-day positions to remain unchanged (therefore, excluding fees, commissions, reserves, net interest income, and intraday trading) with VaR-based measures during a sample period not used in model development. (iii) For purposes of computing market risk, the swap dealer must determine the appropriate multiplication factor as follows: (A) Beginning three months after the swap dealer begins using the VaR model to E:\FR\FM\15SER3.SGM 15SER3 57558 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations calculate the market risk exposure, the swap dealer must conduct monthly back-testing of the model by comparing its actual daily net trading profit or loss with the corresponding VaR measure generated by the VaR model, using a 99 percent, one-tailed confidence level with price changes equivalent to a one business-day movement in rates and prices, for each of the past 250 business days, or other period as may be appropriate for the first year of its use; (B) On the last business day of each quarter, the swap dealer must identify the number of back-testing exceptions of the VaR model using actual daily net trading profit and loss, as that term is defined in §§ 23.100. An exception has occurred when for a business day the actual net trading loss, if any, exceeds the corresponding VaR measure. The counting period shall be for the prior 250 business days except that during the first year of use of the model another appropriate period may be used; and (C) The swap dealer must use the multiplication factor indicated in Table 1 of this Appendix A in determining its market risk until it obtains the next quarter’s backtesting results; TABLE 1—MULTIPLICATION FACTOR BASED ON THE NUMBER OF BACKTESTING EXCEPTIONS OF THE VAR MODEL Number of exceptions Multiplication factor jbell on DSKJLSW7X2PROD with RULES3 4 or fewer ............................. 5 ............................................ 6 ............................................ 7 ............................................ 8 ............................................ 9 ............................................ 10 or more ............................ 3.00 3.40 3.50 3.65 3.75 3.85 4.00 (iv) For purposes of computing the credit equivalent amount of the swap dealer’s exposures to a counterparty, the swap dealer must determine the appropriate multiplication factor as follows: (A) Beginning three months after it begins using the VaR model to calculate maximum potential exposure, the swap dealer must conduct back-testing of the model by comparing, for at least 80 counterparties (or the actual number of counterparties if the swap dealer does not have 80 counterparties) with widely varying types and sizes of positions with the firm, the ten business day change in its current exposure to the counterparty based on its positions held at the beginning of the ten-business day period with the corresponding ten-business day maximum potential exposure for the counterparty generated by the VaR model; (B) As of the last business day of each quarter, the swap dealer must identify the number of back-testing exceptions of the VaR model, that is, the number of ten-business day periods in the past 250 business days, or other period as may be appropriate for the first year of its use, for which the change in current exposure to a counterparty, assuming the portfolio remains static for the tenbusiness day period, exceeds the VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 corresponding maximum potential exposure; and (C) The swap dealer will propose, as part of its application, a schedule of multiplication factors, which must be approved by the Commission, or a registered futures association of which the swap dealer is a member, based on the number of backtesting exceptions of the VaR model. The swap dealer must use the multiplication factor indicated in the approved schedule in determining the credit equivalent amount of its exposures to a counterparty until it obtains the next quarter’s back-testing results, unless the Commission or the registered futures association determines, based on, among other relevant factors, a review of the swap dealer’s internal risk management control system, including a review of the VaR model, that a different adjustment or other action is appropriate. (2) Quantitative requirements. (i) For purposes of determining market risk exposure, the VaR model must use a 99 percent, one-tailed confidence level with price changes equivalent to a ten businessday movement in rates and prices; (ii) For purposes of determining maximum potential exposure, the VaR model must use a 99 percent, one-tailed confidence level with price changes equivalent to a one-year movement in rates and prices; or based on a review of the swap dealer’s procedures for managing collateral and if the collateral is marked to market daily and the swap dealer has the ability to call for additional collateral daily, the Commission, or the registered futures association of which the swap dealer is a member, may approve a time horizon of not less than ten business days; (iii) The VaR model must use an effective historical observation period of at least one year. The swap dealer must consider the effects of market stress in its construction of the model. Historical data sets must be updated at least monthly and reassessed whenever market prices or volatilities change significantly or portfolio composition warrant; and (iv) The VaR model must take into account and incorporate all significant, identifiable market risk factors applicable to positions in the accounts of the swap dealer, including: (A) Risks arising from the non-linear price characteristics of derivatives and the sensitivity of the fair value of those positions to changes in the volatility of the derivatives’ underlying rates, prices, or other material risk factors. A swap dealer with a large or complex portfolio with non-linear derivatives (such as options or positions with embedded optionality) must measure the volatility of these positions at different maturities and/or strike prices, where material; (B) Empirical correlations within and across risk factors provided that the swap dealer validates and demonstrates the reasonableness of its process for measuring correlations, if the VaR-based measure does not incorporate empirical correlations across risk categories, the swap dealer must add the separate measures from its internal models used to calculate the VaR-based measure for the appropriate risk categories (interest rate risk, credit spread risk, equity price risk, foreign exchange rate risk, and/or commodity PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 price risk) to determine its aggregate VaRbased measure, or, alternatively, risk factors sufficient to cover all the market risk inherent in the positions in the proprietary or other trading accounts of the swap dealer, including interest rate risk, equity price risk, foreign exchange risk, and commodity price risk; and (C) Spread risk, where applicable, and segments of the yield curve sufficient to capture differences in volatility and imperfect correlation of rates along the yield curve for securities and derivatives that are sensitive to different interest rates. For material positions in major currencies and markets, modeling techniques must incorporate enough segments of the yield curve—in no case less than six—to capture differences in volatility and less than perfect correlation of rates along the yield curve. (j) Stressed VaR-based Measure. A stressed VaR model must meet the following minimum requirements in order to be approved: (1) Requirements for stressed VaR-based measure. (i) A swap dealer must calculate a stressed VaR-based measure for its positions using the same model(s) used to calculate the VaR-based measure under paragraph (i) of this appendix, subject to the same confidence level and holding period applicable to the VaR-based measure, but with model inputs calibrated to historical data from a continuous 12-month period that reflects a period of significant financial stress appropriate to the swap dealer’s current portfolio. (ii) The stressed VaR-based measure must be calculated at least weekly and be no less than the swap dealer’s VaR-based measure. (iii) A swap dealer must have policies and procedures that describe how it determines the period of significant financial stress used to calculate the swap dealer’s stressed VaRbased measure under this appendix and must be able to provide empirical support for the period used. The swap dealer must obtain the prior approval of the Commission, or a registered futures association of which the swap dealer is a member, if the swap dealer makes any material changes to these policies and procedures. The policies and procedures must address: (A) How the swap dealer links the period of significant financial stress used to calculate the stressed VaR-based measure to the composition and directional bias of its current portfolio; and (B) The swap dealer’s process for selecting, reviewing, and updating the period of significant financial stress used to calculate the stressed VaR-based measure and for monitoring the appropriateness of the period to the swap dealer’s current portfolio. (iv) Nothing in this appendix prevents the Commission or the registered futures association of which the swap dealer is a member from requiring a swap dealer to use a different period of significant financial stress in the calculation of the stressed VaRbased measure. (k) Specific Risk. A specific risk model must meet the following minimum requirements in order to be approved: (1) General requirement. A swap dealer must use one of the methods in this E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations paragraph (k) to measure the specific risk for each of its debt, equity, and securitization positions with specific risk. (2) Modeled specific risk. A swap dealer may use models to measure the specific risk of its proprietary positions. A swap dealer must use models to measure the specific risk of correlation trading positions that are modeled under paragraph (m) of this appendix. (i) Requirements for specific risk modeling. (A) If a swap dealer uses internal models to measure the specific risk of a portfolio, the internal models must: (1) Explain the historical price variation in the portfolio; (2) Be responsive to changes in market conditions; (3) Be robust to an adverse environment, including signaling rising risk in an adverse environment; and (4) Capture all material components of specific risk for the debt and equity positions in the portfolio. Specifically, the internal models must: (i) Capture name-related basis risk; (ii) Capture event risk and idiosyncratic risk; and (iii) Capture and demonstrate sensitivity to material differences between positions that are similar but not identical and to changes in portfolio composition and concentrations. (B) If a swap dealer calculates an incremental risk measure for a portfolio of debt or equity positions under paragraph (l) of this appendix, the swap dealer is not required to capture default and credit migration risks in its internal models used to measure the specific risk of those portfolios. (C) A swap dealer shall validate a specific risk model through back-testing. (ii) Specific risk fully modeled for one or more portfolios. If the swap dealer’s VaRbased measure captures all material aspects of specific risk for one or more of its portfolios of debt, equity, or correlation trading positions, the swap dealer has no specific risk add-on for those portfolios. (3) Specific risk not modeled. (i) If the swap dealer’s VaR-based measure does not capture all material aspects of specific risk for a portfolio of debt, equity, or correlation trading positions, the swap dealer must calculate a specific-risk add-on for the portfolio under the standardized measurement method as described in 12 CFR 217.210. (ii) A swap dealer must calculate a specific risk add-on under the standardized measurement method as described in 12 CFR 217.200 for all of its securitization positions that are not modeled under this paragraph (k). (l) Incremental Risk. An incremental risk model must meet the following minimum requirements in order to be approved: (1) General requirement. A swap dealer that measures the specific risk of a portfolio of debt positions under paragraph (k) of this appendix using internal models must calculate at least weekly an incremental risk measure for that portfolio according to the requirements in this appendix. The incremental risk measure is the swap dealer’s measure of potential losses due to incremental risk over a one-year time horizon VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. With the prior approval of the Commission or a registered futures association of which the swap dealer is a member, a swap dealer may choose to include portfolios of equity positions in its incremental risk model, provided that it consistently includes such equity positions in a manner that is consistent with how the swap dealer internally measures and manages the incremental risk of such positions at the portfolio level. If equity positions are included in the model, for modeling purposes default is considered to have occurred upon the default of any debt of the issuer of the equity position. A swap dealer may not include correlation trading positions or securitization positions in its incremental risk measure. (2) Requirements for incremental risk modeling. For purposes of calculating the incremental risk measure, the incremental risk model must: (i) Measure incremental risk over a oneyear time horizon and at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. (A) A constant level of risk assumption means that the swap dealer rebalances, or rolls over, the swap dealer’s trading positions at the beginning of each liquidity horizon over the one-year horizon in a manner that maintains the swap dealer’s initial risk level. The swap dealer must determine the frequency of rebalancing in a manner consistent with the liquidity horizons of the positions in the portfolio. The liquidity horizon of a position or set of positions is the time required for a swap dealer to reduce its exposure to, or hedge all of its material risks of, the position(s) in a stressed market. The liquidity horizon for a position or set of positions may not be less than the shorter of three months or the contractual maturity of the position. (B) A constant position assumption means that the swap dealer maintains the same set of positions throughout the one-year horizon. If a swap dealer uses this assumption, it must do so consistently across all portfolios. (C) A swap dealer’s selection of a constant position or a constant risk assumption must be consistent between the swap dealer’s incremental risk model and its comprehensive risk model described in paragraph (m) of this appendix, if applicable. (D) A swap dealer’s treatment of liquidity horizons must be consistent between the swap dealer’s incremental risk model and its comprehensive risk model described in paragraph (m) of this appendix, if applicable. (ii) Recognize the impact of correlations between default and migration events among obligors. (iii) Reflect the effect of issuer and market concentrations, as well as concentrations that can arise within and across product classes during stressed conditions. (iv) Reflect netting only of long and short positions that reference the same financial instrument. (v) Reflect any material mismatch between a position and its hedge. PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 57559 (vi) Recognize the effect that liquidity horizons have on dynamic hedging strategies. In such cases, a swap dealer must: (A) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions; (B) Demonstrate that including rebalancing results in a more appropriate risk measurement; (C) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and (D) Capture in the incremental risk model any residual risks arising from such hedging strategies. (vii) Reflect the nonlinear impact of options and other positions with material nonlinear behavior with respect to default and migration changes. (viii) Maintain consistency with the swap dealer’s internal risk management methodologies for identifying, measuring, and managing risk. (m) Comprehensive Risk. A comprehensive risk model must meet the following minimum requirements in order to be approved: (1) General requirement. (i) Subject to the prior approval of the Commission or a registered futures association of which the swap dealer is a member, a swap dealer may use the method in this paragraph to measure comprehensive risk, that is, all price risk, for one or more portfolios of correlation trading positions. (ii) A swap dealer that measures the price risk of a portfolio of correlation trading positions using internal models must calculate at least weekly a comprehensive risk measure that captures all price risk according to the requirements of this paragraph (m). The comprehensive risk measure is either: (A) The sum of: (1) The swap dealer’s modeled measure of all price risk determined according to the requirements in paragraph (m)(2) of this appendix; and (2) A surcharge for the swap dealer’s modeled correlation trading positions equal to the total specific risk add-on for such positions as calculated under paragraph (k) of this appendix multiplied by 8.0 percent; or (B) With approval of the Commission, or the registered futures association of which the swap dealer is a member, and provided the swap dealer has met the requirements of this paragraph (m) for a period of at least one year and can demonstrate the effectiveness of the model through the results of ongoing model validation efforts including robust benchmarking, the greater of: (1) The swap dealer’s modeled measure of all price risk determined according to the requirements in paragraph (b) of this appendix; or (2) The total specific risk add-on that would apply to the swap dealer’s modeled correlation trading positions as calculated under paragraph (k) of this appendix multiplied by 8.0 percent. (2) Requirements for modeling all price risk. If a swap dealer uses an internal model to measure the price risk of a portfolio of correlation trading positions: (i) The internal model must measure comprehensive risk over a one-year time E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 57560 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations horizon at a one-tail, 99.9 percent confidence level, either under the assumption of a constant level of risk, or under the assumption of constant positions. (ii) The model must capture all material price risk, including but not limited to the following: (A) The risks associated with the contractual structure of cash flows of the position, its issuer, and its underlying exposures; (B) Credit spread risk, including nonlinear price risks; (C) The volatility of implied correlations, including nonlinear price risks such as the cross-effect between spreads and correlations; (D) Basis risk; (E) Recovery rate volatility as it relates to the propensity for recovery rates to affect tranche prices; and (F) To the extent the comprehensive risk measure incorporates the benefits of dynamic hedging, the static nature of the hedge over the liquidity horizon must be recognized. In such cases, a swap dealer must: (1) Choose to model the rebalancing of the hedge consistently over the relevant set of trading positions; (2) Demonstrate that including rebalancing results in a more appropriate risk measurement; (3) Demonstrate that the market for the hedge is sufficiently liquid to permit rebalancing during periods of stress; and (4) Capture in the comprehensive risk model any residual risks arising from such hedging strategies; (iii) The swap dealer must use market data that are relevant in representing the risk profile of the swap dealer’s correlation trading positions in order to ensure that the swap dealer fully captures the material risks of the correlation trading positions in its comprehensive risk measure in accordance with this appendix; and (iv) The swap dealer must be able to demonstrate that its model is an appropriate representation of comprehensive risk in light of the historical price variation of its correlation trading positions. (3) Requirements for stress testing. (i) A swap dealer must at least weekly apply specific, supervisory stress scenarios to its portfolio of correlation trading positions that capture changes in: (A) Default rates; (B) Recovery rates; (C) Credit spreads; (D) Correlations of underlying exposures; and (E) Correlations of a correlation trading position and its hedge. (ii) Other requirements. (A) A swap dealer must retain and make available to the Commission and to the registered futures association of which the swap dealer is a member the results and all assumptions and parameters of the supervisory stress testing, including comparisons with the capital VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 requirements generated by the swap dealer’s comprehensive risk model. (B) A swap dealer must report promptly to the Commission and to the registered futures association of which it is a member any instances where the stress tests indicate any material deficiencies in the comprehensive risk model. (n) Securitization Exposures. (1) To use the simplified supervisory formula approach (SSFA) to determine the specific riskweighting factor for a securitization position, a swap dealer must have data that enables it to assign accurately the parameters described in paragraph (n)(2) of this appendix. Data used to assign the parameters described in paragraph (n)(2) of this appendix must be the most currently available data; if the contracts governing the underlying exposures of the securitization require payments on a monthly or quarterly basis, the data used to assign the parameters described in paragraph (n)(2) of this appendix must be no more than 91 calendar days old. A swap dealer that does not have the appropriate data to assign the parameters described in paragraph (n)(2) of this appendix must assign a specific riskweighting of 100 percent to the position. (2) SSFA parameters. To calculate the specific risk-weighting factor for a securitization position using the SSFA, a swap dealer must have accurate information on the five inputs to the SSFA calculation described in paragraphs (n)(2)(i) through (n)(2)(v) of this appendix. (i) KG is the weighted-average (with unpaid principal used as the weight for each exposure) total capital requirement of the underlying exposures calculated for a swap dealer’s credit risk. KG is expressed as a decimal value between zero and one (that is, an average risk weight of 100 percent presents a value of KG equal to 0.08). (ii) Parameter W is expressed as a decimal value between zero and one. Parameter W is the ratio of the sum of the dollar amounts of any underlying exposures of the securitization that meet any of the criteria as set forth in paragraphs (n)(2)(ii)(A) through (F) of this appendix to the balance, measured in dollars, of underlying exposures: (A) Ninety days or more past due; (B) Subject to a bankruptcy or insolvency proceeding; (C) In the process of foreclosure; (D) Held as real estate owned; (E) Has contractually deferred payments for 90 days or more, other than principal or interest payments deferred on; (1) Federally-guaranteed student loans, in accordance with the terms of those guarantee programs; or (2) Consumer loans, including nonfederally guaranteed student loans, provided that such payments are deferred pursuant to provisions included in the contract at the time funds are disbursed that provide for period(s) of deferral that are not initiated based on changes in the creditworthiness of the borrower; or (F) Is in default. PO 00000 Frm 00100 Fmt 4701 Sfmt 4700 (iii) Parameter A is the attachment point for the position, which represents the threshold at which credit losses will first be allocated to the position. Except as provided in 12 CFR 217.210(b)(2)(vii)(D) for nth to default derivatives, parameter A equals the ratio of the current dollar amount of underlying exposures that are subordinated to the position of the swap dealer to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the position that contains the swap dealer’s securitization exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a decimal value between zero and one. (iv) Parameter D is the detachment point for the position, which represents the threshold at which credit losses of principal allocated to the position would result in a total loss of principal. Except as provided in 12 CFR 210(b)(2)(vii)(D) for nth-to-default credit derivatives, parameter D equals parameter A plus the ratio of the current dollar amount of the securitization positions that are pari passu with the position (that is, have equal seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a decimal value between zero and one. (v) A supervisory calibration parameter, p, is equal to 0.5 for securitization positions that are not resecuritization positions and equal to 1.5 for resecuritization positions. (3) Mechanics of the SSFA. KG and W are used to calculate KA, the augmented value of KG, which reflects the observed credit quality of the underlying exposures. KA is defined in paragraph (n)(4) of this appendix. The values of parameters A and D, relative to KA determine the specific risk-weighting factor assigned to a securitization position, or portion of a position, as appropriate, is the larger of the specific risk-weighting factor determined in accordance with this paragraph (n)(3), paragraph (n)(4) of this appendix, and a specific risk-weighting factor of 1.6 percent. (i) When the detachment point, parameter D, for a securitization position is less than or equal to KA, the position must be assigned a specific risk-weighting factor of 100 percent. (ii) When the attachment point, parameter A, for a securitization position is greater than or equal to KA, the swap dealer must calculate the specific risk-weighting factor in accordance with paragraph (n)(4) of this appendix. (iii) When A is less than KA and D is greater than KA, the specific risk-weighting factor is a weighted-average of 1.00 and KSSFA calculated under paragraphs (n)(3)(iii)(A) and (3)(iii)(B) of this appendix. For the purpose of this calculation: (A) The weight assigned to 1.00 equals E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 control procedures; or computing the swap dealer’s deductions for market and credit risk in accordance with §§ 23.102 as appropriate. If the Commission or registered futures association finds it is necessary or appropriate in the public interest, the Commission or registered futures association may impose additional conditions on the swap dealer, if: (1) The swap dealer is required to provide notice to the Commission or the registered futures association that the swap dealer’s regulatory capital is less than $100 million; (2) The swap dealer fails to meet the reporting requirements set forth in § 23.105; (3) Any event specified in § 23.105 occurs; (4) There is a material deficiency in the internal risk management control system or in the mathematical models used to price PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 securities or to calculate deductions for market and credit risk or allowances for market and credit risk, as applicable, of the swap dealer; (5) The swap dealer fails to comply with this Appendix A; or (6) The Commission finds that imposition of other conditions is necessary or appropriate in the public interest. 16. Add Appendix B to Subpart E of Part 23 to read as follows: ■ Appendix B to Subpart E of Part 23— Swap Dealer and Major Swap Participant Position Information BILLING CODE 6351–01–P E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.014</GPH> jbell on DSKJLSW7X2PROD with RULES3 (iii) The specific risk-weighting factor for the position (expressed as a percent) is equal to KSSFA × 100. (o) Additional conditions. As a condition for the swap dealer to use this Appendix A to calculate certain of its capital charges, the Commission, or registered futures association of which the swap dealer is a member, may impose additional conditions on the swap dealer, which may include, but are not limited to restricting the swap dealer’s business on a product-specific, categoryspecific, or general basis; submitting to the Commission or the registered futures association a plan to increase the swap dealer’s regulatory capital; filing more frequent reports with the Commission or the registered futures association; modifying the swap dealer’s internal risk management 57561 VerDate Sep<11>2014 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00102 Fmt 4701 Sfmt 4725 E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.015</GPH> jbell on DSKJLSW7X2PROD with RULES3 57562 VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00103 Fmt 4701 Sfmt 4725 E:\FR\FM\15SER3.SGM 15SER3 57563 ER15SE20.016</GPH> jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations VerDate Sep<11>2014 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00104 Fmt 4701 Sfmt 4725 E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.017</GPH> jbell on DSKJLSW7X2PROD with RULES3 57564 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations jbell on DSKJLSW7X2PROD with RULES3 VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 Appendix C to Subpart E of Part 23— Financial Reports and Specific Position Information for Swap Dealers and Major Swap Participants Subject to the Capital Requirements of a Prudential Regulator PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.018</GPH> 17. Add Appendix C to Subpart E of Part 23 to read as follows: ■ 57565 VerDate Sep<11>2014 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00106 Fmt 4701 Sfmt 4725 E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.019</GPH> jbell on DSKJLSW7X2PROD with RULES3 57566 VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00107 Fmt 4701 Sfmt 4725 E:\FR\FM\15SER3.SGM 15SER3 57567 ER15SE20.020</GPH> jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations VerDate Sep<11>2014 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00108 Fmt 4701 Sfmt 4725 E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.021</GPH> jbell on DSKJLSW7X2PROD with RULES3 57568 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations 57569 VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 PO 00000 Frm 00109 Fmt 4701 Sfmt 4700 E:\FR\FM\15SER3.SGM 15SER3 ER15SE20.022</GPH> jbell on DSKJLSW7X2PROD with RULES3 BILLING CODE 6351–01–C 57570 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations PART 140—ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION 18. The authority citation for part 140 continues to read as follows: ■ Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and 16(b). 19. In § 140.91, redesignate paragraphs (a)(11) and (12) as paragraphs (a)(12) and (13), and add a new paragraph (a)(11) to read as follows: ■ § 140.91 Delegation of authority to the Director of the Division of Clearing and Risk and to the Director of the Division of Swap Dealer and Intermediary Oversight. (a) * * * (11) All functions reserved to the Commission in § 23.100–106 of this chapter, except for those related to the revocation of a swap dealer’s or major swap participant’s approval to use internal models to compute capital requirements under § 23.102 of this chapter, those related to the Commission’s order under § 23.104 of this chapter, and the issuance of Capital Comparability Determinations under § 23.106 of this chapter. * * * * * Issued in Washington, DC, on July 24, 2020, by the Commission. Robert Sidman, Deputy Secretary of the Commission. Note: The following appendices will not appear in the Code of Federal Regulations. Appendices to Capital Requirements of Swap Dealers and Major Swap Participants—Commission Voting Summary, Chairman’s Statement, and Commissioners’ Statements Appendix 1—Commission Voting Summary On this matter, Chairman Tarbert and Commissioners Quintenz and Stump voted in the affirmative. Commissioners Behnam and Berkovitz voted in the negative. jbell on DSKJLSW7X2PROD with RULES3 Appendix 2—Supporting Statement of Chairman Heath P. Tarbert Today marks 10 years and a day since the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’) was signed into law. Much has changed during the past decade—our derivatives markets today are faster, increasingly digital, and more deeply connected to the global economy than they were in 2010. Yet amidst these changes, there has been at least one constant: The absence of capital requirements for swap dealers and major swap participants for which the CFTC is responsible.1 As a 1 The CFTC does not have jurisdiction to establish capital requirements for swap dealers subject to the jurisdiction of a federal banking regulator as identified in Section 1a(39) of the CEA, 7 U.S.C. 1(a)(39) (2018). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 response to the credit crisis of 2008, Section 731 of the Dodd-Frank Act amended the Commodity Exchange Act (‘‘CEA’’), providing that the CFTC ‘‘shall adopt’’ capital and financial reporting requirements for these entities.2 It is high time to fulfill this mandate and close the book on our DoddFrank Act responsibilities.3 After all, ‘‘late’’ is always better than ‘‘too late.’’ There is another compelling reason to finalize a capital rule that is more than a decade in the making: 4 Certainty. One of our strategic goals as an agency is to enhance the regulatory experience for market participants at home and abroad.5 Certainty is the bedrock of this goal. Our swap dealers cannot effectively plan for compliance without clarity from us about what their capital obligations will look like. Today we lift this cloud of uncertainty by finalizing a capital rule that carefully accounts for the differences among our swap dealers. The final capital rule is designed to enhance customer protection and reduce systemic risk in the financial system. Capital requirements are the ultimate backstop, ensuring that customers are protected and the financial system remains sound in the event that all other measures fail. While our uncleared margin rules have effectively absorbed the shocks of recent pandemicdriven volatility,6 a capital regime will provide further assurances that our markets and their participants can weather new storms. Determining Capital The final capital rule requires swap dealers and major swap participants to maintain a level of minimum capital based on one of three basic approaches. Each approach incorporates minimum amounts of capital based on various criteria, including a $20 million floor, a level of capital required by the National Futures Association, and the amount of margin on uncleared swap 2 See Section 4s(e) and 4s(f)(2) of the CEA, 7 U.S.C. 6s(e), 6s(f)(2) (2018). 3 Section 731 of the Dodd-Frank Act also required the CFTC to establish initial and variation margin requirements for uncleared swaps, which are being implemented on a phased schedule that currently extends to all but the smallest swap market participants. See Statement of Chairman Heath P. Tarbert in Support of Extending the Phase 5 Initial Margin Compliance Deadline (May 28, 2020), https://www.cftc.gov/PressRoom/ SpeechesTestimony/tarbertstatement052820c. 4 The capital rule was first proposed in 2011 and re-proposed in 2016. See Capital Requirements of Swap Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011); see also Capital Requirements of Swap Dealers and Major Swap Participants, 81 FR 91252 (Dec. 16, 2016). The comment period was re-opened in December 2019, allowing the Commission to glean additional insights from market participants prior to presenting today’s final rule. See Capital Requirements of Swap Dealers and Major Swap Participants, 84 FR 69664 (Dec. 16, 2019). 5 See CFTC Strategic Plan 2020–2024, at 4 (discussing Strategic Goal 3), https://www.cftc.gov/ media/3871/CFTC2020_2024StrategicPlan/ download. 6 Heath Tarbert, Volatility Ain’t What it Used to Be, Wall Street Journal (Mar. 23, 2020), https:// www.wsj.com/articles/volatility-aint-what-it-usedto-be-11585004897. PO 00000 Frm 00110 Fmt 4701 Sfmt 4700 transactions. The three basic approaches will be the focus of my remarks because they are effectively tailored to the distinctive type of swap dealer involved. Regulatory Flexibility Our derivatives markets are vibrant in large part because of the diversity of swap dealers and other market participants. Of the 108 provisionally registered swap dealers, 56 will be subject to the capital requirements. Of those, four are futures commission merchants that are dually registered with the SEC as broker-dealers and 12 are non-bank subsidiaries of bank holding companies. Others are non-banks that deal in financial swaps involving interest rates, foreign currency, credit, and the like; still more are primarily engaged in agricultural and energy businesses; and several are subject to the laws and regulations of other countries. The final capital rule applies to entities with a variety of business structures, asset profiles, and risk levels. For example, a swap dealer primarily involved in the energy business is fundamentally different from a large bank involved in financial swaps. A ‘‘one-size-fits-all’’ approach would be incompatible with the rich gradations in our derivatives markets. As a result, the final capital requirements offer regulatory flexibility by accounting for key differences among covered entities. This flexible approach is designed to enhance the regulatory experience for our market participants 7 while safeguarding the markets, as more fully discussed below. 1. Capital Requirements for FCM Swap Dealers The CFTC has longstanding capital requirements for Futures Commission Merchants (‘‘FCMs’’) to ensure customer funds are protected in the event of an FCM failure.8 The final rule preserves existing FCM capital rules for swap dealers that are also registered as FCMs, but makes a few key adjustments to better address risk and customer protection associated with dealing in swaps. The final rule requires FCM swap dealers to maintain minimum capital equal to or greater than the sum of: (i) The current FCM risk margin amount of 8% of customer and noncustomer cleared futures, cleared foreign futures, and cleared swaps positions; and (ii) 2% of the total margin amount associated with uncleared swaps. Security-based swaps are excluded from both margin amounts. In addition, the final rule increases the $1 million minimum capital ‘‘floor’’ for FCMs to $20 million for FCM swap dealers. These changes reflect sound policy. In particular, excluding security-based swaps comports with the CFTC’s longstanding respect for the SEC’s jurisdiction over those products. Moreover, excluding cleared swaps from the 2% risk margin amount brings our capital requirements in line with the lower credit risk posed by cleared products. This approach is also consistent with the CFTC’s net capital requirement for Registered 7 See 8 See E:\FR\FM\15SER3.SGM CFTC Strategic Plan, supra note 5, at 4. Regulation 1.17, 17 CFR 1.17 (2019). 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations Foreign Exchange Dealers,9 as well as the SEC’s capital rules for broker dealers.10 jbell on DSKJLSW7X2PROD with RULES3 2. Capital Requirements for Non-FCM Swap Dealers Well-crafted rules must account for the differences among our market participants. For swap dealers that are not FCMs, the final rule provides three methods of determining minimum capital that respond to their different business models, risk profiles, and capital structures.11 a. The Net Liquid Assets Approach Some swap dealers have responsibility for customer funds, such as those that are dually registered with the SEC as broker dealers. For these swap dealers, capital requirements can advance customer protection where all else has failed, by providing a ‘‘cushion’’ for orderly liquidation.12 An effective cushion requires liquidity, which can be analogized to the readily available cash in one’s wallet. Consistent with this analogy, swap dealers may select the Net Liquid Assets approach in the final rule—requiring them to maintain 2% of the margin amount associated with uncleared swaps—which we believe is sufficient to protect customer funds in the event of a liquidation. The Net Liquid Assets approach is not only about customer protection: It also facilitates sensible harmonization with SEC capital requirements for dual registrants. In doing so, the Net Liquid Assets approach supports the CFTC’s strategic goal of improving the regulatory experience for market participants.13 b. The Bank-Based Approach Banks are the backbone of our financial system, and are subject to a specific statutory regime managed by the Federal Reserve Board and other federal banking regulators. Banks—and by extension their non-bank swap dealer subsidiaries—naturally raise greater systemic risk concerns than other types of swap dealers. While the cash in one’s wallet is the appropriate analogy when thinking about capital as a measure of customer protection, the central role banks play in our financial system requires us to consider a much bigger picture. For banks, capital must facilitate safety and soundness, ensuring that they act prudently.14 The personal finance analogy for assessing bank capital, therefore, is not just cash-in-wallet, but also savings accounts, checking accounts, retirement funds, and other assets. This broad view of bank capital as a window into solvency is designed to reduce overall risk in the financial system, 9 See Section 2(c)(2)(C) of the CEA, 7 U.S.C. 2(c)(2)(C) (2018), and Regulation 5.7(a), 17 CFR 5.7(a) (2019). 10 See SEC Rule 240.15c3–1, 17 CFR 240.15C3–1 (2019). 11 See Regulation 23.101. 12 Former SEC Commissioner Dan Gallagher, ‘‘The Philosophies of Capital Requirements’’ (speech in Washington, DC, Jan. 15, 2014) at 1, https://www.sec.gov/news/speech/2014spch011514dmg. 13 See CFTC Strategic Plan, supra note 5 at 4 (discussing Strategic Goal 3). 14 See Gallagher, supra note 12, at 1. VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 advancing a strategic goal of the CFTC.15 As stated in the agency’s 2020–2024 Strategic Plan, ‘‘[t]aking steps to avoid systemic risk will not only protect market participants, but increase confidence in the soundness of U.S. derivatives markets.’’ 16 Our bank-based capital approach is designed to meet this goal. Accordingly, swap dealers selecting the Bank-Based Approach may satisfy their capital requirements by retaining (i) 8% of risk-weighted assets (‘‘RWA’’), composed of at least 6.5% of tier 1 common equity (‘‘CET1’’), and (ii) 8% of their uncleared swap margin amount. Requiring at least 6.5% of a swap dealer’s RWA to be composed of CET1—the highest-quality regulatory capital—addresses potential systemic risk by ensuring that available capital can immediately stem losses, avoiding financial contagion. Second, the requirement that swap dealers electing the Bank-Based Approach must retain 8% of margin for uncleared swaps reflects the uniquely critical role they play in the financial system. c. The Tangible Net Worth Approach Finally, some swap dealers are not financial entities, but rather commercial businesses engaged in the agriculture and energy sectors. These swap dealers help American families put food on the table and gas in the car. Unlike financial entities, their balance sheets often contain significant physical assets, such as oil refineries, grain warehouses, and even railroad rolling stock. Net worth—inclusive of physical assets—is the appropriate measure to assess minimum capital for these commercial entities. In extending our analogy, capital for these swap dealers must be inclusive not just of cash or retirement account holdings, but one’s house and car—the assets that could be pledged as collateral in borrowing. The final capital rule recognizes that commercial entities are fundamentally different from other swap dealers. This is reflected in the Tangible Net Worth (‘‘TNW’’) approach, which sets minimum capital at 8% of the margin amount for uncleared swaps. Eligibility for the TNW approach is determined at the consolidated parent level, which allows a financial subsidiary of a commercial entity that is registered as a swap dealer to elect the approach. 3. Market and Credit Risk Models In addition to capital requirements, today’s final rule makes important adjustments to the requirements that swap dealers must satisfy to rely on internal market and credit risk models rather than the standardized models provided in Regulation 1.17. Like minimum capital requirements, market and credit risk models will be most effective when they reflect a swap dealer’s unique business and risk profile. In addition, internal models specific to a swap dealer’s portfolio can provide a more nuanced view of risk than standardized models. That said, the final rule provides a certification process for swap dealers relying 15 See CFTC Strategic Plan, supra note 5, at 5 (discussing Strategic Goal 1, which is to strengthen the resilience and integrity of our derivatives markets while fostering their vibrancy). 16 Id. PO 00000 Frm 00111 Fmt 4701 Sfmt 4700 57571 on internal market and credit risk models, ensuring flexibility while retaining oversight through the National Futures Association. Permitting swap dealers to rely on bespoke models that best account for their particular situations is good governance and enhances the regulatory experience.17 At the same time, by subjecting those models to objective validation by the National Futures Association (and potentially other domestic and foreign regulators), there is a check on that flexibility. Further, this approach makes the CFTC’s model approval process more closely aligned with the SEC and federal banking regulators.18 Allowing swap dealers to rely on internal risk models is also an appropriate instance of principles-based regulation,19 as prescriptive requirements that do not account for differences among firms simply cannot measure risk as accurately as internal models that account for key differences among swap dealers. 4. Financial Reporting Today’s final rule also adopts financial reporting, recordkeeping, and notification requirements for swap dealers and major swap participants. These requirements include the obligation to provide financial statements and reports to the CFTC and the National Futures Association. Most importantly, covered entities must alert us when there is undercapitalization, a books and records problem, and/or a specified triggering event, such as the failure to post required margin. The rule also includes public reporting requirements for those swap dealers not subject to the jurisdiction of a banking regulator. These reporting requirements should serve as early warning systems for systemic risk, allowing the CFTC to react quickly to emerging threats to financial stability. At the same time, the reporting requirements are designed to harmonize, as appropriate, with existing financial reporting requirements for FCMs, bank swap dealers, and SEC-registered entities. The final rule also eliminates weekly position reporting, which does not materially advance our ability to monitor systemic risk. In short, balance is the touchstone of the financial reporting rules, allowing us to achieve greater insight into potential systemic risk without placing undue burdens on market participants. 5. Substituted Compliance Last, our final rule today accounts for nonU.S. domiciled swap dealers by allowing them to petition the CFTC for substituted compliance in satisfaction of their capital and financial reporting requirements. These swap dealers may seek a comparability determination based on the capital and 17 See CFTC Strategic Plan, supra note 5, at 7. market and credit risk model approval process in the final rule is similar to the requirements established by the Federal Reserve Board for bank holding companies, as well as the SEC’s requirements for security-based swap dealers. 19 For a discussion of the circumstances in which to apply principles vs. rules, see Heath P. Tarbert, Rules for Principles and Principles for Rules: Tools for Crafting Sound Financial Regulation, 10 Harvard Business Law Review (2020). 18 The E:\FR\FM\15SER3.SGM 15SER3 57572 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations financial reporting rules of their home jurisdictions, provided certain conditions are met. In providing this option, the final rule supports international comity while enhancing the regulatory experience for market participants abroad.20 Conclusion Today we mark a decade and a day following the enactment of the Dodd-Frank Act by completing the CFTC’s required rulemakings under Section 731. The final capital rule is flexible and tailored, to accommodate the wide array of swap dealers that touch every corner of our markets. The final rule is also long on customer protection and systemic risk mitigation, advancing the CFTC’s mission of promoting the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation. After 10 years of hard work by CFTC staff, I am pleased to support the final rule and the long-awaited certainty it brings to our markets. Given the current economic crisis the world faces in light of the continuing COVID–19 pandemic, we are fortunate to have a final rule that has come late, but not too late. jbell on DSKJLSW7X2PROD with RULES3 Appendix 3—Supporting Statement of Commissioner Brian D. Quintenz Ten years and one day ago, the Dodd-Frank Act Wall Street Reform and Consumer Protection Act was enacted. I am proud to vote for today’s final rule which, in my view, is the capstone of the Commodity Futures Trading Commission’s (CFTC or Commission) work to appropriately calibrate the post-crisis reforms. Capital ensures that firms are able to continue to operate during times of economic and financial stress by providing an adequate cushion to protect them from losses. Just as important as the safety and soundness of individual firms, capital is designed to give the marketplace confidence that any given firm has a high probability of surviving the next crisis. But, capital requirements also create important incentives that drive market behavior. The cost of capital may be the most determinative factor in a firm’s decision to remain, or become, a swap dealer (SD), or to continue to provide clearing services to clients, in the case of a futures commission merchant (FCM). If capital costs are too expensive, firms will restrict certain business activities, end unprofitable business lines, or, in some cases, exit the swaps or futures markets altogether. As a result, over time, the swaps and futures markets will become less liquid, less accessible to end users, more heavily concentrated, and less competitive. These are not the hallmarks of a healthy financial system. This is why I have always regarded the finalization of capital requirements for SDs and FCMs to be the most consequential rulemaking of the postcrisis reforms. I believe the final capital regulations for SDs and FCMs adopted today establish minimum capital requirements that will ensure the safety and soundness of these firms for years to come, through periods of 20 See CFTC Strategic Plan, supra note 5, at 4 (discussing Strategic Goal 3). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 economic growth and stability and through periods of market contraction and extreme volatility. They are appropriately calibrated to the true risks posed by an SD’s or FCM’s business and ensure these firms have the capital necessary to support their active participation in the markets and servicing of clients. They are also largely harmonized with the capital approaches of the prudential regulators and the Securities and Exchange Commission (SEC), which should reduce unnecessary burdens and facilitate compliance. No rule is perfect. I expect there will be aspects of this rule that need to be revised or recalibrated in the future—and I specifically discuss some areas below which I would like to see revisited. Nevertheless, it is a common saying that you cannot build a great house without a solid foundation. I am confident that today’s capital regulations provide that foundation and will support vibrant, healthy derivatives markets, with future Commissions able to build upon this progress in the years to come. I would like to highlight a few aspects of the final rule below. The risk margin amount. We heard from many commenters that, of all the alternatives, the proposed eight percent risk margin amount would act not as a capital floor as intended, but rather as the primary driver of firms’ capital requirements and as a potential binding constraint on their businesses. The final rule appropriately recalibrates the scope of products included in this calculation, while also adopting a risk margin amount percentage that is appropriately tailored to the capital approach elected by the firm. Specifically, the final rule maintains the existing minimum capital requirements for standalone FCMs, with those firms continuing to maintain minimum capital equal to or greater than 8% of the risk margin amount for customer futures and cleared swaps. For FCM–SDs, the final rule establishes a minimum capital requirement equal to or greater than (i) 8% of the risk margin amount for customer futures and cleared swaps, plus (ii) 2% of the risk margin amount for the FCM–SD’s uncleared swaps. For non-FCM SDs that elect the Net Liquid Assets Approach, the Final Rule requires the firm to maintain minimum capital equal to or greater than 2% of the SD’s uncleared swap margin. For non-FCM SDs electing either the Bank-Based Approach or the Tentative Net Worth Approach, the final rule establishes a minimum capital requirement equal to or greater than 8% of the firm’s uncleared swap margin. For the reasons discussed below, I believe each of these adjustments from the proposal represents an improvement that more precisely tailors the capital requirements of a firm to its particular business and its selected capital approach. I support the removal of a firm’s cleared and uncleared security-based swaps (SBS) from the risk margin amount calculation. It is appropriate that the Commission maintain its historical approach and establish minimum capital requirements for registrants that are based upon products within the CFTC’s jurisdiction. I am also very pleased that proprietary cleared futures and swaps were removed from the risk margin amount. PO 00000 Frm 00112 Fmt 4701 Sfmt 4700 FCMs, FCM–SDs, and SDs electing the Net Liquid Assets Approach are all subject to rigorous market and credit risk capital charges on these proprietary cleared positions. I believe these capital charges adequately account for the risk of these positions and there is no reason to account for them yet again in the firm’s minimum capital requirement. Moreover, for SDs that elect one of the other capital approaches, I also believe it is appropriate to exclude proprietary cleared positions given that the SD’s credit exposure on such positions is limited to either a clearing organization or to the FCM that carries the SD’s account. Finally, I also support the reduced 2% risk margin multiplier amount on uncleared swap margin for FCMs, FCM–SDs, and SDs electing the Net Liquid Assets Approach, while maintaining the 8% multiplier for other types of standalone SDs. Under the FCM capital rules and the Net Liquid Assets Capital Approach for standalone SDs, the types of capital that may be used to meet a firm’s minimum capital requirement are significantly more conservative than the types of capital that may be used under the Bank-Based Capital Approach and the Tangible Net Worth Capital Approach. The Net Liquid Assets Approach is liquidityfocused and generally requires the firm to hold at least one dollar of highly liquid assets for each dollar of the firm’s liabilities. As a result, when computing what qualifies as eligible capital under this approach, firms must subtract all illiquid assets, such as fixed assets and intangible assets. In contrast, the other capital approaches focus on the solvency of the firm and require the firms to maintain positive balance sheet equity. Under these approaches, firms are not required to subtract illiquid assets or fixed assets from their balance sheet equity. Given the significantly more restrictive standard for qualifying eligible capital under the Net Liquid Assets Approach, I think it is appropriate to lower the risk margin multiplier to 2% in order to minimize competitive disparities across the other two capital approaches. The final rule also expresses the Commission’s ongoing commitment to monitor, and if necessary, adjust, the risk margin percentage. This should only be done, however, with a wealth of data and a highly robust economic analysis. With the benefit of the financial reporting the Commission will soon receive from SDs, the Commission may be able to further refine this metric to promote consistency across the possible SD capital approaches. Bank-based capital approach. In response to commenters, the final rule now permits firms to use a combination of common equity tier 1, additional tier 1, and tier 2 capital to meet its minimum capital requirements under both the 8% of risk-weighted assets and 8% of uncleared swap margin alternatives. In particular, with respect to the 8% of uncleared swap margin alternative, the rule does not limit the amounts of additional tier 1 or tier 2 capital the firm can use to meet the requirement. Because of this additional flexibility, the final rule requires firms electing this approach to satisfy all of the four possible minimum capital alternatives. E:\FR\FM\15SER3.SGM 15SER3 jbell on DSKJLSW7X2PROD with RULES3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations The Commission will need to closely observe the impact of this change to ensure it does not create any competitive disadvantages for firms electing this approach. I anticipate that if additional data and analysis shows this outcome creates unintended consequences, the Commission will take action to address them. Model approval process. I am also pleased with the model approval process established in the final rule, which allows the Commission to realize the benefits of the NFA’s considerable expertise and resources. Once the Commission, or the Director of the Division of Swap Dealer and Intermediary Oversight (DSIO) pursuant to delegated authority, makes a determination that the NFA’s model review process is comparable to the Commission’s process, the NFA’s approval of a model will satisfy the Commission’s model approval requirement. In addition, for a firm utilizing a model that has already been approved by its relevant regulator, the final rule provides a process whereby, upon making certain representations, the firm can continue to use the model pending approval by the Commission or NFA. These steps help ensure that firms seeking to use models will be able to do so by the rule’s compliance date. Areas for further improvement. As I noted above, no rule is perfect. I would like to briefly highlight three areas not addressed in this final rule that I hope the Commission will address in the future. Standardized market risk capital charges. First, this final rule does not adjust any of the standardized market risk charges under Regulation 1.17. I believe that many of these standardized charges are too high given the liquidity and actual risks of the product. For example, the final rule applies a 20% notional standardized market risk charge on uncleared foreign exchange non-deliverable forwards. In contrast, the Commission’s uncleared margin rules apply a 6% notional charge on these products for purposes of the standardized initial margin calculation. I hope that in the future the Commission can work with the SEC to recalibrate and update these charges to better reflect the risks of the underlying products. Alternative forms of collateral. Second, I hope that with the benefit of experience and information received from financial reporting, the Commission will consider modifying its rules to recognize alternative forms of collateral, such as letters of credit or liens, provided by commercial end users that are exempt from clearing and margin requirements when computing credit risk charges. Alternative collateral arrangements are frequently used by SDs in commodity derivatives transactions with end users to create ‘‘right way’’ risk and can be effective means of managing the credit risk of certain derivatives transactions. I think it would be beneficial for the Commission’s capital regime to recognize, as appropriate, the riskreducing nature of these arrangements. Net liquid assets approach. Third, I am also interested in continuing to explore commenters’ suggestion that firms electing the Net Liquid Assets Approach be required to maintain tentative net capital in excess of the risk margin amount, as opposed to the VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 current net capital requirement. I continue to have concerns that in periods of high volatility, the procyclicality of increasing margin requirements may cause unnecessary stress on these firms, as their capital charges for positions increase at the same time as their minimum capital requirement. I am interested in looking at possible adjustments that could be made to address this issue. In closing, I believe the capital regime adopted today strikes the necessary balance between capital levels that protect firms from losses on certain products, and levels that allow firms to earn an economic benefit from servicing their customers’ risk management needs through those products. There is a direct tradeoff between the amount of capital regulators require firms to hold to ensure firms’ resilience and viability, and the amount of available capital firms have to deploy in financial markets to support the market’s ongoing liquidity and health. The capital standards adopted today protect the safety and soundness of firms, while ensuring they can continue to service their clients and make markets. I would also like to thank DSIO, in particular Tom Smith, for their thoughtfulness and tireless dedication to getting this rule right. It has truly been a pleasure to work with and learn from you throughout this process. Appendix 4—Dissenting Statement of Commissioner Rostin Behnam I respectfully dissent from the Commodity Futures Trading Commission’s (the ‘‘Commission’’ or ‘‘CFTC’’) rulemaking today regarding Capital Requirements of Swap Dealers and Major Swap Participants (the ‘‘Final Capital Rule’’). Ten Years of Dodd-Frank Yesterday marked ten years since Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act.1 Congress passed Dodd-Frank as a targeted legislative response to the 2008 financial crisis and the near obsolescence of the U.S. financial regulatory framework. The Great Recession wreaked havoc on Main Street Americans and the global economy. Undercapitalization was at the heart of the 2008 crisis, and the swift response to require financial institutions to hold additional capital mitigated both the blunt economic shock we endured this past March, and the substantial weight we continue to shoulder as a result of the Covid-19 pandemic. Section 731 of the Dodd-Frank Act 2 requires the CFTC to establish capital rules for all registered Swap Dealers (‘‘SDs’’) and Major Swap Participants (‘‘MSPs’’) that are not banks, as well as associated financial recordkeeping and reporting requirements. The capital requirements in Section 731, which established Section 4s(e) of the Commodity Exchange Act (‘‘the Act’’), are clear: ‘‘. . . [t]o offset the greater risk to the swap dealer or major swap participant and the financial system arising from the use of 1 See The Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203 124 Stat. 1376 (2010) (the ‘‘Dodd-Frank Act’’). 2 Id.at section 731(e), 124 Stat. at 1704–6. PO 00000 Frm 00113 Fmt 4701 Sfmt 4700 57573 swaps that are not cleared,’’ the Commission’s capital requirements shall ‘‘help ensure the safety and soundness of the swap dealer or major swap participant’’ and ‘‘be appropriate to the risk associated with the non-cleared swaps held as a swap dealer or major swap participant.’’ 3 There can be no doubt that Congress intended to impose significant new requirements that would contribute to the protection from another financial crisis. Congress’s 2010 response largely incorporated the international financial reform initiatives for over-the-counter derivatives laid out at the 2009 G20 Pittsburgh Summit aimed at improving transparency, mitigating systemic risk, and protecting against market abuse.4 One of the core initiatives in the G20 statement was the imposition of higher capital requirements. Paragraph 16 of the statement provides the purpose the G20 leaders agreed to aim for: ‘‘To make sure our regulatory system for banks and other financial firms reins in the excesses that led to the crisis.’’ 5 Paragraph 17 then lays out what the G20 leaders agreed to do to rein in the excesses, and the first item is this: ‘‘We committed to act together to raise capital standards.’’ 6 The G20 leaders said unequivocally that, for over-the-counter derivatives markets, ‘‘[n]on-centrally cleared contracts should be subject to higher capital requirements.’’ 7 Congress had this same goal in mind when enacting the Dodd-Frank Act a decade ago.8 Three and a Half Years of the Capital Proposal In 2016, the Commission issued a bipartisan proposal to implement capital requirements as directed by Congress through Section 731 of the Dodd-Frank Act.9 The Commission now jumps from a proposal issued in 2016 to a significantly different final rule nearly four years later, without any intervening reproposal to provide interested market participants clear proposed capital requirements to meaningfully comment upon. In so doing, the Commission undermines the spirit of the Dodd-Frank Act and violates the letter of the Administrative Procedure Act (‘‘APA’’).10 The preamble to the Final Capital Rule asserts that all of the actions taken today are 3 Section 4s(e)(3) of the Commodity Exchange Act (‘‘the Act’’), 7 U.S.C. 6s(e)(3). 4 G20, Leaders’ Statement, The Pittsburgh Summit (Sept. 24–25, 2009), available at https:// www.oecd.org/g20/summits/pittsburgh/. 5 Id. at 2. 6 Id. 7 Id. at 9. 8 See Statement of Sen. Christopher Dodd, Cong. Rec., Vol. 156, Issue 104, S5828, S5832 (July 14, 2010) (‘‘Derivatives are vitally important if utilized properly in terms of wealth creation and growing an economy. But what was once a way for companies to hedge against sudden price shocks has become a profit center in and of itself, and it can be a dangerous one as well, when dealers and other large market participants don’t hold enough capital to back up their risky bets and regulators don’t have information about where the risks lie.’’). 9 Capital Requirements of Swap Dealers and Major Swap Participants, 81 FR 91252 (proposed Dec. 16, 2016) (the ‘‘2016 Proposal’’). 10 5 U.S.C. 551 et seq. E:\FR\FM\15SER3.SGM 15SER3 57574 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations a ‘‘logical outgrowth’’ from the 2016 Proposal.11 The preamble even goes a step further, arguing that ‘‘modifications described in the 2019 Capital Reopening, including a discussion and specific inclusion of potential rule language, were logical outgrowths’’ of the 2016 Proposal.12 This simply cannot be true if the requirement that a final rule is a logical outgrowth of an agency’s proposed rule is to have any meaning at all.13 The changes in the Final Capital Rule to the amount of capital that a futures commission merchant SD (FCM–SD) must maintain are illustrative of the point. The 2016 Proposal would have required an FCM– SD to maintain regulatory capital equal to or greater than 8% of the initial margin associated with the FCM–SD’s proprietary cleared and uncleared futures, foreign futures, swap, and security-based swap positions. In 2019, the Commission reopened the comment period on the 2016 Proposal.14 In the Federal Register release announcing the 2019 reopening, the Commission sought additional public input based on an initial review of comments received from the 2016 Proposal on myriad alternatives, seeking comment ‘‘on all aspects of the proposed risk margin amount, including comments regarding the possible increase or decrease of the risk margin percentage in coordination with the inclusion or exclusion of certain products in order to establish the most optimal capital requirement.’’ 15 This, in many respects, is a blank check. Not only does it allow for any conceivable percentage of risk margin, it simultaneously opens up multiple combinations of inputs. The Commission now states that any of the possible outcomes along this sliding scale would have been a logical outgrowth. It is the equivalent of saying that the Final Capital Rule is a logical outgrowth because it imposes any capital requirements at all, and that simply cannot be the case under the legal intent and plain reading of the principle of logical outgrowth. A Final Capital Rule (and Five Years of Review) Where did the Commission end up? The Commission decides today to set the multiplier for the uncleared swaps of FCM– SDs at 2%, rather than the 8% originally proposed. The Commission also is modifying the final rule from the proposal to remove security-based swaps, proprietary futures, foreign futures, and cleared swaps from the risk margin amount calculation. These are significant changes from the 2016 proposal, and they are just one of the possible 11 Final Capital Rule at 1.B. Capital Requirements for Swap Dealers and Major Swap Participants, 84 FR 69664 (Dec. 19, 2019). 13 See Small Refiner Lead Phase-Down Task Force v. United States Envtl. Prot. Agency, 705 F.2d 506, 548–49 (D.C. Cir. 1983) (‘‘Agency notice must describe the range of alternatives being considered with reasonable specificity. Otherwise, interested parties will not know what to comment on, and notice will not lead to better-informed agency decisionmaking.’’). 14 84 FR 69664. 15 Id. at 69668. jbell on DSKJLSW7X2PROD with RULES3 12 Id.; VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 outcomes suggested in the reopening of the comment period. I am not sure if 2% is the appropriate landing spot to insulate our markets from outsize risk. And based on the preamble to this Final Capital Rule, I do not think the Commission is certain either. The preamble states that the Commission does not have the data to determine whether or not 2% is the optimal or even adequate percentage.16 Instead, the Commission chooses 2% with the intent that ‘‘the Commission’s decision to modify the final rule by removing cleared and uncleared security-based swaps, as well as proprietary futures, foreign futures, and cleared swaps positions from the risk margin amount calculation, and to set the multiplier at 2% should mitigate many of the commenters’ concerns that the proposed 8% risk margin amount calculation was over inclusive of the types of positions included in the calculation and was set at a percentage that was too high.’’ 17 Due to this lack of data, the Commission will need to conduct a 5year post implementation review ‘‘to assess whether the minimum capital requirements for FCM–SDs are adequately calibrated to ensure their safety and soundness.’’ 18 And I applaud the Commission for including this critical regulatory component of the capital regime’s implementation. However, this information is exactly the type of data that the Commission would have benefited from during the notice and comment process. By failing to issue a reproposal in 2019, allowing just a few additional months of concrete, data driven deliberation, which could have clearly stated a specific approach, we lost the opportunity to find out whether the minimum capital requirements that we selected are adequately calibrated to ensure safety and soundness. Because of the lack of clarity in the reopening of the comment period, we again received more general comments that 8% was too high. In justifying the selection of 2%, the preamble states that ‘‘2% should mitigate many of the commenters’ concerns that the proposed 8% risk margin amount calculation was over inclusive of the types of positions included in the calculation and was set at a percentage that was too high.’’ 19 Because we did not provide a clear alternative, we again received comments on 8% rather than comments on 2%, or on some alternative. Ultimately, this lack of information gathering impacts the CFTC and results in a Final Capital Rule that has not benefited from fulsome public comment. However, the impacts on our market participants are greater. They have been denied the ability to comment meaningfully. This is particularly true of the cost benefit analysis. Broadly asking stakeholders to comment on any variation results in a situation where no one had an opportunity to comment on anything approximating what the Commission has 16 Final Capital Rule at II.B.2.b. (‘‘The Commission does not have the benefit of . . . comprehensive data regarding the multiplier for the uncleared swaps risk margin amount at this time.’’) 17 Id. 18 Id. 19 Id. PO 00000 Frm 00114 Fmt 4701 Sfmt 4700 done in its Final Capital Rule. As a result, this rule ultimately derived from a process that is, in many respects, equivalent to not soliciting comments from the public and market participants at all.20 I note that, less than a month ago, the Commission voted to withdraw the Regulation Automated Trading proposal (‘‘Regulation AT’’),21 the most recent iteration of which had been issued in November 2016, a couple of weeks before the 2016 Proposal.22 At the same time that Regulation AT was withdrawn, the Commission issued a rebranded Electronic Trading Risk Principles proposal intended to ‘‘accomplish a similar goal’’ to the original Regulation AT.23 Following the logic set forth today for the Final Capital Rule, the Commission could have simply issued a final rule for Electronic Trading Risk Principles last month, arguing that it was merely a logical outgrowth of the latest iteration of Regulation AT. While I disagreed with last month’s policy decision, procedurally the Commission did the right thing under the APA. We should have followed the same procedure for capital, and issued a reproposal.24 If we had done so last December, we could have received meaningful comments from market participants on a clearly stated reproposal, and we could well have been in position to finalize a stronger, more carefully considered Final Capital Rule today that addresses current market conditions in a manner that is more data driven. Conclusion Before I conclude, I would like to thank staff from the Division of Swap Dealer and Intermediary Oversight for their excellent work on this highly technical and complex rulemaking, and willingness to answer my questions and take feedback. While I would have liked to stand with my fellow Commissioners today, I cannot justify it under these circumstances. I truly wish that I could support today’s Commission action as we mark the tenth anniversary of the Dodd-Frank Act this week. To reiterate sentiments made in my first speech as a CFTC Commissioner,25 capital is a 20 See Texas v. United States EPA, 389 F.Supp. 3d. 497, 505 (S.D. Tex. 2019) (‘‘The APA does not envision requiring interested parties to parse through such vague references like tea leaves to discern an agency’s regulatory intent regarding such significant changes to a final rule’’). 21 Press Release Number 8188–20, CFTC, CFTC Approves Two Final Rules and Two Proposed Rules at June 25 Open Meeting (June 25, 2020), https:// www.cftc.gov/PressRoom/PressReleases/8188-20. 22 Regulation Automated Trading, 81 FR 85333 (proposed Nov. 25, 2016). 23 Electronic Trading Risk Principles (proposed Jun. 25, 2020), at I.B. 24 Statement of Dissent of Commissioner Rostin Behnam, Capital Requirements of Swap Dealers and Major Swap Participants (Dec. 10, 2019), available at https://www.cftc.gov/PressRoom/Speeches Testimony/behnamstatement121019. 25 See Rostin Behnam, Commissioner, CFTC, The Dodd-Frank Inflection Point: Building on Derivatives Reform, Remarks of CFTC Commissioner Rostin Behnam at the Georgetown Center for Financial Markets and Policy (Nov. 14, 2017), https://www.cftc.gov/PressRoom/ SpeechesTestimony/opabehnam. E:\FR\FM\15SER3.SGM 15SER3 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations cornerstone financial crisis reform 26 that is critical to protecting our financial institutions and our financial system as a whole from systemic risk and contagion. But it is also critical to protection from unintended consequences if capital (and margin) levels are applied and set without due regard to the uniqueness of our financial markets and market participants. I appreciate that in moving forward, we must fulfill our directive to establish capital standards appropriately, and in consideration of other activities engaged in by SDs and MSPs such that we ensure that we do not penalize commercial end-users who need choices and benefit from competition in our markets. At the same time, we must heed Congressional intent without any compromise, regardless of what we think is best, remaining cognizant of the impact that capital requirements have on market stability, and follow APA rulemaking requirements when we do so. Shortly before the Commission voted on the reopening in December, 2019, Chairman Tarbert gave remarks about transparency 27, making many very powerful and important points about the incredible importance of being mindful—as regulators—of ‘‘. . . not only what we do, but how we do it.’’ 28 The Chairman ended that particular statement with a wonderful quote from Aristotle. Among many profound lessons from the Greek philosopher, he is also sometimes credited with the statement that ‘‘[p]atience is bitter, but its fruit is sweet.’’ In that vein, I simply wish the Commission had devoted a little bit more time to how we fulfill this foundational Dodd-Frank requirement. The road has been long, far too long in many respects. But, unsure of what deadlines we are racing to meet at this point, or targets we are aiming to hit, I feel strongly the Commission and our markets, would have stood on sturdier ground, and perhaps even have landed at the same conclusion voted on today, if we had practiced a little patience. Appendix 5—Dissenting Statement of Commissioner Dan M. Berkovitz jbell on DSKJLSW7X2PROD with RULES3 Today, for the first time, the Commission adopts capital requirements for non-bank swap dealers (‘‘Final Rule’’). This is the last major swap dealer regulation required under the Dodd-Frank Act. The Dodd-Frank Act specified that the swap dealer capital requirement ‘‘shall—(i) help ensure the safety and soundness of the swap dealer or major swap participant; and (ii) be appropriate for the risk associated with the non-cleared swaps held as a swap dealer or major swap participant.’’ 1 Unfortunately, there is no rational basis to conclude that the minimum capital 26 G20, Leaders’ Statement, Framework for Strong, Sustainable and Balanced Growth, The Pittsburgh Summit (September 24–25 2009), https:// www.g20.utoronto.ca/2009/2009communique 0925.html (‘‘We committed to act together to raise capital standards . . .’’). 27 Heath P. Tarbert, Chairman, CFTC, Statement of Chairman Heath P. Tarbert Before the December 10, 2019 Open Meeting (Dec. 10, 2019), https:// www.cftc.gov/PressRoom/SpeechesTestimony/ tarbertstatement121019. 28 Id. 1 CEA section 4s(e)(3)(A). VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 requirements in the Final Rule meet those standards and serve their intended purpose. The Final Rule is not based on quantitative analysis of data or the appropriate level of capital for the risks presented by a swap dealer. Rather, it appears to be designed with the objective of ensuring that most dealers will not need to raise more capital. In its consideration of costs and benefits, the Commission concludes that, depending on the type of swap dealer, ‘‘the likelihood of . . . needing to raise additional capital due to this rule might be low,’’ ‘‘may not be significant,’’ or ‘‘that their tangible net worth greatly exceeds the Commission’s requirement.’’ 2 For this reason, I dissent. No Rational Basis To Conclude That Minimum Capital Levels Are Appropriate The Final Rule permits swap dealers, depending on their characteristics, to select one of three different approaches to calculate their minimum capital requirements. The approaches are identified as the: (1) ‘‘Net Liquid Assets Capital Approach,’’ (2) ‘‘BankBased Capital Approach,’’ and (3) ‘‘Tangible Net Worth Capital Approach.’’ The first two approaches are based on existing CFTC, Securities and Exchange Commission (‘‘SEC’’), and Federal Reserve capital requirements for futures commission merchants (‘‘FCMs’’), securities brokerdealers (‘‘BDs’’), and banks. The third approach is designed to accommodate commercial swap dealers whose capital is normally in the form of physical assets. These methods are based on existing holistic, all-enterprise capital approaches that take into account a broad spectrum of risks. They are not necessarily suited to the swap dealers subject to the CFTC capital requirements, which are mostly stand-alone legal entities for swap dealing. Accordingly, it is not clear that these methodologies will generate capital requirements that are ‘‘appropriate for the risk associated with the non-cleared swaps held as a swap dealer or major swap participant.’’ 3 However, using those precedents has some advantages in that it allows the different types of swap dealers to manage capital using known structures. While these historical approaches were not specifically designed to be able to meet the statutory standard, it may be possible to achieve the intended outcome using these structures if the specific methods, limits, and other factors had been developed based on the swap dealer specific standard. Unfortunately, this did not happen. In December 2016, the Commission issued a re-proposal of the previously proposed capital regulations (‘‘2016 Re-Proposal’’) 4 that contained minimum capital requirements in each approach that were largely based on existing levels for FCM capital requirements. The 2016 Re-Proposal 2 Final Capital Rule release, Cost Benefit Considerations, Attachment A. The analysis also notes that a few non-bank financial swap dealers ‘‘might need to raise additional capital and thus might incur significant cost to comply with the Commission’s capital requirement.’’ 3 CEA section 4s(e)(3)(A). 4 Proposed Rule, Capital Requirements of Swap Dealers and Major Swap Participants, 81 FR 91252 (Dec. 16, 2016). PO 00000 Frm 00115 Fmt 4701 Sfmt 4700 57575 included cleared and uncleared swaps and uncleared security-based swaps in the calculation of the minimum requirements. Commenters objected that the 2016 ReProposal was too costly and burdensome. At the end of last year the Commission, by a 3– 2 vote, issued a second re-proposal (‘‘2019 Second Re-Proposal’’) consisting of over 140 mostly open-ended questions designed to invite comments supporting reduced minimum capital requirements or otherwise lower the costs for swap dealers to comply.5 Not surprisingly, the Final Rule adopts numerous provisions that are weaker than the 2016 Re-Proposal. The preamble to the Final Rule identifies ‘‘lower capital charges,’’ ‘‘harmonization,’’ and consistency with ‘‘historical’’ precedent as rationales for these provisions. While the Commission makes conclusory statements that the rule helps ‘‘ensure the safety and soundness’’ of the swap dealers, there is little or no analysis supporting these assertions. Similarly, there is no analysis as to how or why these capital levels are ‘‘appropriate for the risk associated with the non-cleared swaps held as a swap dealer or major swap participant.’’ The capital requirements for duallyregistered FCM/BDs that are also swap dealers illustrate how this approach leads to arbitrary results from a risk-based perspective. Under the 2016 Re-Proposal, in addition to capital required to be held for non-swap activity, the FCM/BD swap dealer would be required to hold capital equal to a minimum of 8% of initial margin for uncleared swaps, security-based swaps, and certain futures positions of the swap dealer. As explained in the 2016 Re-Proposal, the 8% multiplier level is drawn from the Commission’s experience with its risk-based capital requirements for FCMs.6 Based on comments received on the prior proposals, and on the desire to ‘‘harmonize’’ with the SEC, the Final Rule lowers the capital add-on multiplier level to 2%, and only applies the multiplier to uncleared swaps initial margin.7 Security-based swaps are not included in the calculation based on the rationale that only swaps are within the CFTC’s jurisdiction. If the entity is also registered with the SEC and the SEC’s capital requirements are greater than the CFTC’s, then the entity can use the SEC’s requirement with no add-on for uncleared swaps. The Commission makes these changes not based on any analysis of the risk to the registrant, 5 For a more in-depth discussion of the procedural and substantive problems inherent in the 2019 Second Re-Proposal, see Dissenting Statement of Commissioner Dan M. Berkovitz, ‘‘Proposed’’ Rule and ‘‘Request for Additional Comment’’ on Capital Requirements of Swap Dealers and Major Swap Participants (Dec. 10, 2019), available at https://www.cftc.gov/PressRoom/ SpeechesTestimony/berkovitzstatment121019b. 6 See 17 CFR 1.17(a)(1)(i)(B). 7 While the Final Capital Rule selectively picks the 2% level purportedly to ‘‘harmonize’’ with the SEC’s security-based swap dealer capital rule, the final rule uses different formulas and positions for the calculation. Furthermore, the SEC’s rule has a built-in increase in the multiplier from 2% to 8% over time. The CFTC Final Capital Rule expressly choses to deviate from that SEC approach and has no such increases. E:\FR\FM\15SER3.SGM 15SER3 57576 Federal Register / Vol. 85, No. 179 / Tuesday, September 15, 2020 / Rules and Regulations but because this approach ‘‘maintains a consistency with the long-standing historical approach that the Commission and SEC have followed with respect to dually-registered FCM/BDs.’’ 8 The following example shows how this approach can result in an arbitrary outcome from a risk perspective. Under the Final Rule, if the amount of uncleared swap margin for an FCM that is not a BD is $1 billion, multiplying that amount by 2% yields a minimum capital add-on of $20 million. Similarly, under the SEC’s capital rule, for a securities-based swap dealer that is not an FCM with $1 billion of required margin for uncleared security-based swaps, a 2% add-on would be $20 million.9 Now, let’s consider the add-on for a dually-registered FCM/BD. Each of the CFTC and SEC capital rules individually require that the minimum capital requirements include capital based on either the uncleared swap positions or the uncleared security-based swap positions, respectively, but not the aggregate of both types of positions. A dually-registered firm with the same aggregate risk margin amount of $1 billion, but split half to swaps and half to security-based swaps, would be required to reserve $10 million ($500 million * 2%). Thus, the dually-registered firm with a total initial margin requirement of $1 billion held for a portfolio split evenly between swaps and security-based swaps would be required to reserve only half the capital required for the same amount of initial margin held for a 8 Final Rule release, section II.C.2. it is acknowledged that this example is somewhat simplified from the calculations and absolute minimum amounts specified in both the CFTC and SEC capital rules, the example illustrates a possible outcome of the rules. jbell on DSKJLSW7X2PROD with RULES3 9 While VerDate Sep<11>2014 19:50 Sep 14, 2020 Jkt 250001 portfolio that was either all swaps or all security-based swaps. For such duallyregistered firms, the amount of capital required to be held may ultimately be based on irrelevant and arbitrary considerations of ‘‘historical precedent’’ and agency jurisdiction rather than swap risk-based calculations. Financial Data and Monitoring Capital Sufficiency The capital requirements for swap dealers are one of the most complex and highly technical areas in our regulations. The swap dealers subject to the CFTC capital requirements vary significantly and include (i) very large FCMs and/or BDs registered with the CFTC and the SEC; (ii) U.S. and foreign affiliates of banking organizations; (iii) large commercial enterprises and affiliates thereof; and (iv) other financial companies that are not affiliated with banks. Each grouping has unique capital structures. Furthermore, there was little available quantitative financial accounting data for the swap activities of these entities to calibrate the appropriate levels of capital. Given this complex and technical backdrop, the Final Rule notes in several places that the Commission will gather and analyze the new financial reporting data now required under the rule and may reassess components of the rule to determine whether it needs to be amended to be better fit for purpose. I strongly support that effort and will follow this monitoring and analysis closely. Substituted Compliance for Capital Requirements Under the Final Rule, swap dealers organized and domiciled outside of the United States, including many subsidiaries of PO 00000 Frm 00116 Fmt 4701 Sfmt 9990 U.S. firms, can satisfy the capital requirements by complying with the capital requirements of the country of their domicile if the Commission grants substituted compliance. The methods and standards for such a determination are similar to those to be established in the final cross-border swap regulations scheduled for consideration by the Commission tomorrow. Unfortunately, those methods and standards are substantively weaker than the standards currently used by the Commission and may result in outsourcing swap dealer capital oversight to other jurisdictions where not appropriate. Conclusion Notwithstanding my dissent, I want to once again acknowledge the complexity and highly technical nature of the capital requirements. Given these difficulties, I would like to recognize the hard-working staff of the CFTC for their efforts in fashioning the Final Rule. Some of you spent many a late night addressing comments and questions and revising the rule release. While I cannot support the outcome, I nonetheless appreciate and thank you for the dedication you bring to your work here at the CFTC. Unfortunately, the rule the Commission will be adopting today is simply an affirmation of the status quo. This is not what Congress intended when it directed the CFTC to adopt capital requirements ‘‘appropriate for the risk’’ presented by uncleared swap activities of swap dealers. For this reason, I dissent. [FR Doc. 2020–16492 Filed 9–14–20; 8:45 am] BILLING CODE 6351–01–P E:\FR\FM\15SER3.SGM 15SER3

Agencies

Commodity Futures Trading Commission

[Federal Register Volume 85, Number 179 (Tuesday, September 15, 2020)]
[Rules and Regulations]
[Pages 57462-57576]
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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 23, and 140

RIN 3038-AD54


Capital Requirements of Swap Dealers and Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is adopting new regulations imposing minimum capital 
requirements and financial reporting requirements on swap dealers 
(``SDs'') and major swap participants (``MSPs'') that are not subject 
to a prudential regulator. The Commission is also amending existing 
capital requirements for futures commission merchants (``FCMs'') to 
provide specific capital deductions for market risk and credit risk for 
swaps and security-based swaps entered into by an FCM. The Commission 
is further adopting amendments to its regulations to permit certain 
entities dually-registered with the Securities and Exchange Commission 
(``SEC'') to file an SEC Financial and Operational Combined Uniform 
Single Report in lieu of CFTC financial reports, to require certain 
Commission registrants to file notices of certain defined events, and 
to require notices of bulk transfers to be filed with the Commission 
electronically and within a defined period of time.

DATES: 
    Effective date: November 16, 2020.
    Compliance date: October 6, 2021

FOR FURTHER INFORMATION CONTACT: Joshua Sterling, Director, 202-418-
6056, [email protected]; Thomas Smith, Deputy Director, 202-418-5495, 
[email protected]; Joshua Beale, Associate Director, 202-418-5446, 
[email protected]; Jennifer Bauer, Special Counsel, 202-418-5472, 
[email protected]; Rafael Martinez, Senior Financial Risk Analyst, 202-
418-5462, [email protected], Division of Swap Dealer and Intermediary 
Oversight; Paul Schlichting, Assistant General Counsel, Office of the 
General Counsel, 202-418-5884, [email protected]; Lihong McPhail, 
Research Economist and Head of Academic Outreach, 202-418-5722, 
[email protected], Office of the Chief Economist; Commodity Futures 
Trading Commission, Three Lafayette Centre, 1155 21st Street NW, 
Washington, DC 20581; or Mark Bretscher, Special Counsel, 312-596-0598, 
[email protected]; Division of Swap Dealer and Intermediary 
Oversight, Commodity Futures Trading Commission, 525 West Monroe 
Street, Suite 1100, Chicago, IL 60661.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Introduction
    A. Background and Statutory Authority
    B. Proposed Rulemakings and Reopening of the Comment Period
    C. Consultation With U.S. Securities and Exchange Commission and 
Prudential Regulators
II. Final Regulations and Amendments to Existing Regulations
    A. Capital Framework for FCMs, Covered SDs, and Covered MSPs
    B. Capital Requirements for Stand-Alone FCMs and FCM-SDs
    1. Introduction to General Capital Requirements for Stand-Alone 
FCMs and FCM-SDs
    2. Minimum Capital Requirement for Stand-Alone FCMs and FCM-SDs
    a. Minimum Fixed-Dollar Amount of Net Capital
    b. Minimum Capital Requirement Based on 8% Risk Margin Amount
    3. Stand-Alone FCM and FCM-SD Calculation of Net Capital and 
Adjusted Net Capital
    a. Stand-Alone FCM and FCM-SD Standardized Market Risk Capital 
Charges
    b. FCM and FCM-SD Standardized Counterparty Credit Risk Capital 
Charges
    c. Model-Based Market Risk and Counterparty Credit Risk Capital 
Charges
    (i) FCMs That Are SEC-Registered ANC Firms
    (ii) Market Risk and Credit Risk Capital Models for FCM-SDs That 
Are Not SEC-Registered BDs
    C. Capital Requirements for Swap Dealers and Major Swap 
Participants
    1. Introduction to Covered SD and Covered MSP Capital 
Requirements
    2. Capital Requirement for Covered SDs Electing the Net Liquid 
Assets Capital Approach
    a. Computation of Minimum Capital Requirement
    b. Computation of Net Capital To Meet Minimum Capital 
Requirement
    (i) Swap Dealers Not Approved To Use Internal Capital Models
    (ii) Swap Dealers Approved To Use Internal Capital Models
    3. Capital Requirement for Covered SDs Electing the Bank-Based 
Capital Approach
    a. Computation of Minimum Capital Requirement
    4. Capital Requirement for Covered SDs Electing the Tangible Net 
Worth Capital Approach
    5. Capital Requirements for Covered MSP
    6. Requirements for Market Risk and Credit Risk Models
    a. VaR Models
    b. Stressed VaR Models
    c. Specific Risk Models
    d. Incremental Risk Models
    e. Comprehensive Risk Models
    f. Credit Risk Models
    7. Model Approval Process for Covered SDs and FCM-SDs
    8. Liquidity Requirements for Covered SDs and FCM-SDs
    9. Equity Withdrawal Restrictions for Covered SDs and Covered 
MSPs
    10. Leverage Ratio Requirements for Covered SDs
    D. Swap Dealer and Major Swap Participant Financial 
Recordkeeping, Reporting and Notification Requirements
    1. Routine Financial Reporting and Recordkeeping Requirements
    2. Swap Dealer and Major Swap Participant Notice Requirements
    3. Swap Dealers and Major Swap Participants Subject to the 
Capital Rules of a Prudential Regulator
    4. Public Disclosures
    5. Electronic Filing Requirements for Financial Reports and 
Regulatory Notices
    6. Swap Dealer and Major Swap Participant Reporting of Position 
Information
    7. Reporting Requirements for Swap Dealers and Major Swap 
Participants Approved To Use Internal Capital Models
    8. Weekly Position and Margin Reporting
    E. Comparability Determinations for Eligible Covered SDs and 
Covered MSPs
    F. Additional Amendments to Existing Regulations
    1. Financial Reporting Requirements for FCMs or IBs That Are 
Also Registered SBSDs
    2. Amendments to the FCM and IB Notice Provisions in Regulation 
1.12
    3. FCM and IB Unsecured Receivables From Swap Transactions
    4. Amendments to FCM and IB Notice and Disclosure Requirements 
for Bulk Transfers
    5. Conforming Amendments to Delegated Authority Provisions in 
Regulation 140.91
    G. Effective Date and Compliance Date
III. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    1. Background
    2. New Information Collection Requirements and Related Burden 
Estimates
    i. FOCUS Report
    ii. Notice of Failure To Maintain Minimum Financial Requirements
    iii. Requests for Extensions of Time To File Financial 
Statements
    iv. Capital Requirements Elections
    v. Application for Use of Models
    vi. Equity Withdrawal Requirements
    vii. Financial Recordkeeping, Reporting and Notification 
Requirements for SDs and MSPs
    viii. Capital Comparability Determinations
IV. Cost Benefit Considerations
    A. Background
    B. Regulatory Capital
    C. General Summary of Rulemaking
    D. Baseline
    E. Overview of Approaches
    1. Bank-Based Capital Approach
    2. Net Liquid Assets Approach
    3. Alternative Net Capital (``ANC'')

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    4. Tangible Net Worth
    5. Substituted Compliance
    F. Entities
    1. Bank Subsidiaries
    2. SD/BD (Without Models)
    3. SD/BD/OTC Derivatives Dealers (Without Models)
    4. FCM-SD (Without Models)
    5. ANC Firms (SD/BD and/or FCMs That Use Models)
    6. Stand-Alone SD (With and Without Models)
    7. Non-Financial SD (With and Without Models)
    8. MSP
    9. Substituted Compliance
    G. Liquidity Requirements
    H. Equity Withdrawal Restrictions
    I. Reporting and Recordkeeping Requirements
    J. Section 15(a) Factors
    1. Protection of Market Participants and the Public
    2. Efficiency, Competitiveness, and Financial Integrity of Swaps 
Markets
    3. Price Discovery
    4. Sound Risk Management Practices
    5. Other Public Interest Considerations
    K. Attachment A to Cost Benefit Considerations

I. Introduction

A. Background and Statutory Authority

    The Commission is adopting capital and financial reporting 
requirements for SDs and MSPs, and is amending existing capital rules 
for FCMs to provide explicit capital requirements for proprietary 
positions in swaps and security-based swaps that are not cleared by a 
clearing organization. The adoption of the capital requirements for SDs 
and MSPs completes the Congressional mandate directing the Commission 
to adopt rules imposing both capital requirements on SDs and MSPs that 
are not subject to a prudential regulator, and imposing initial and 
variation margin on uncleared swaps entered into by SDs and MSPs that 
are not subject to a prudential regulator.\1\
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    \1\ The term ``prudential regulator'' is defined for purposes of 
the section 4s(e) capital and margin requirements to mean the Board 
of Governors of the Federal Reserve System (``Federal Reserve 
Board''); the Office of the Comptroller of the Currency (``OCC''); 
the Federal Deposit Insurance Corporation (``FDIC''); the Farm 
Credit Administration; and the Federal Housing Finance Agency. See 
section 1a(39) of CEA (7 U.S.C. 1 et. seq.).
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    Title VII of the Dodd-Frank Act established a new regulatory 
framework for swap and security-based swap transactions.\2\ The 
legislation was enacted, among other reasons, to reduce risk, increase 
transparency, and promote market integrity within the financial system, 
including by: (i) Providing for the registration and comprehensive 
regulation of SDs, security-based swap dealers (``SBSDs''), MSPs and 
major security-based swap participants (``MSBSPs''); (ii) imposing 
clearing and trade execution requirements on swaps and security-based 
swaps, subject to certain exceptions; (iii) creating rigorous 
recordkeeping and real-time reporting regimes; and (iv) enhancing the 
rulemaking and enforcement authorities of the Commissions with respect 
to, among others, all registered entities and intermediaries subject to 
the Commission's oversight. The Dodd-Frank Act further established a 
jurisdictional boundary by authorizing the Commission to regulate 
``swaps,'' and granting the SEC authority to regulate ``security-based 
swaps.'' \3\ Sections 721 and 761 of the Dodd-Frank Act also added 
definitions of the terms ``swap dealer,'' ``security-based swap 
dealer,'' ``major swap participant,'' and ``major security-based swap 
participant'' to the CEA and Exchange Act.\4\
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    \2\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at https://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
    \3\ The term ``swap'' is defined in section 1a(47) of the CEA (7 
U.S.C. 1a(47)) and Commission regulation Sec.  1.3 (17 CFR 1.3). The 
term ``security-based swap'' is defined in section 3(a)(68) of the 
Exchange Act (15 U.S.C. 78c(a)(68)). Commission regulations referred 
to in this release are found at 17 CFR chapter I (2019), and are 
accessible on the Commission's website at https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
    \4\ See CEA sections 1a(33) and (49) (7 U.S.C. 1a(33) and (49)) 
for the definition of the terms ``major swap participant'' and 
``swap dealer,'' respectively; See Exchange Act section 3(a)(67) and 
(71) (15 U.S.C. 3(a)(67) and (71)) for the definition of the terms 
``major security-based swap participant'' and ``security-based swap 
dealer,'' respectively.
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    An additional provision of the new swap regulatory framework, 
section 731 of the Dodd-Frank Act, amended the CEA \5\ by adding 
section 4s, which requires an entity meeting the definition of an SD or 
an MSP to register with the Commission.\6\ Section 4s authorizes the 
Commission to adopt rules requiring such SDs and MSPs to maintain daily 
trading records of their swaps and all related records (including 
related cash or forward transactions) and recorded communications.\7\ 
Section 4s further requires each SD or MSP to conform with the business 
conduct standards prescribed by the Commission that relate to: (i) 
Fraud, manipulation, and other abusive practices involving swaps; (ii) 
diligent supervision of the business of the SD or MSP; (iii) adherence 
to applicable position limits; and (iv) such other matters as the 
Commission determines appropriate.\8\
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    \5\ 7 U.S.C. 1 et seq.
    \6\ 7 U.S.C. 6s(a).
    \7\ 7 U.S.C. 6s(g).
    \8\ 7 U.S.C. 6s(h).
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    Section 4s(e) also addresses minimum capital requirements for SDs 
and MSPs, and imposes initial and variation margin obligations on swaps 
entered into by SDs and MSPs that are not cleared by a registered 
derivatives clearing organization.\9\ Section 4s(e) applies a 
bifurcated approach with respect to capital and margin by requiring 
each SD and MSP subject to regulation by a prudential regulator to meet 
the minimum capital and margin requirements adopted by the applicable 
prudential regulator, and requiring each SD and MSP not subject to 
regulation by a prudential regulator to meet the minimum capital and 
margin requirements adopted by the Commission.\10\ Therefore, the 
Commission's authority to impose capital and margin requirements 
extends to SDs and MSPs that are non-banking entities that are not 
subject to a prudential regulator, including non-banking subsidiaries 
of bank holding companies regulated by the Federal Reserve Board. SDs 
and MSPs subject to the Commission's capital and margin requirements 
are referred to in this document as ``covered SDs'' and ``covered 
MSPs,'' respectively. SDs and MSPs subject to the margin and capital 
requirements of a prudential regulator are referred to in this document 
as ``bank SDs'' and ``bank MSPs,'' respectively.
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    \9\ 7 U.S.C. 6s(e).
    \10\ 7 U.S.C. 6s(e)(1).
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    The Commission previously adopted rules imposing margin 
requirements for uncleared swap transactions entered into by covered 
SDs and covered MSPs as required by section 4s(e).\11\ The prudential 
regulators also adopted rules imposing margin requirements for 
uncleared swap and security-based swap transactions entered into by 
bank SDs or bank MSPs.\12\ The prudential regulators further adopted 
capital requirements applicable to bank SDs

[[Page 57464]]

and bank MSPs that incorporate swap and security-based swap 
transactions into the capital framework.\13\
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    \11\ The Commission adopted final rules on December 18, 2015 
imposing initial and variation margin requirements on covered SDs 
and covered MSPs for swap transactions that are not cleared by a 
registered derivatives clearing organization (``DCO''). See, Margin 
Requirements for Uncleared Swaps for Swap Dealers and Major Swap 
Participants, 81 FR 636 (Jan. 6, 2016). The margin rules, which 
became effective on April 1, 2016, are codified in part 23 of the 
Commission's regulations (17 CFR 23.150-23.159, 23.161). In May 
2016, the Commission amended the margin rules to add Commission 
regulation Sec.  23.160, providing rules on the cross-border 
application of the margin rules. See Margin Requirements for 
Uncleared Swaps for Swap Dealers and Major Swap Participants--Cross-
Border Application of the Margin Requirements, 81 FR 34818 (May 31, 
2016).
    \12\ 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).
    \13\ The prudential regulators have adopted capital rules 
addressing capital requirements for swap and security-based swap 
transactions. In this regard, the Federal Reserve Board and OCC have 
adopted revised capital rules to incorporate Basel III capital 
adequacy requirements. See, Regulatory Capital Rules: Regulatory 
Capital, Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule, 78 FR 62018 (Oct. 11, 2013).
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    Furthermore, section 764 of the Dodd-Frank Act added section 15F to 
the Exchange Act to address capital and margin requirements associated 
with security-based swaps. Section 15F(e)(1)(B) directs the SEC to 
adopt capital and margin requirements for SBSDs and MSBSPs that do not 
have a prudential regulator (``nonbank SBSDs'' and ``nonbank MSBSPs''). 
The SEC adopted final capital rules for nonbank SBSDs and nonbank 
MSBSPs, as well as final margin rules for security-based swaps entered 
into by nonbank SBSDs and nonbank MSBSPs, in June 2019.\14\
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    \14\ Capital, Margin, and Segregation Requirements for Security-
Based Swap Dealers and Major Security-Based Swap Participants and 
Capital and Segregation Requirements for Broker-Dealers, Exchange 
Act Release No. 86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019) 
(``2019 SEC Final Capital Rule''). The compliance date for these 
rules is October 6, 2021.
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    In addition to the new capital authority over covered SDs and 
covered MSPs, the Commission also has separate statutory authority to 
adopt rules imposing minimum capital requirements on FCMs.\15\ The 
Commission expects that certain FCMs will engage in a level of swap 
dealing activity that will require their registration as SDs with the 
Commission. Such FCMs that are dually-registered as SDs (``FCM-SDs'') 
will be subject to the Commission's long-standing FCM capital rules. In 
addition, other FCMs may engage in a level of swap dealing activity 
that is less than what is required to register as an SD; FCMs may 
engage in swaps and security-based swaps as part of their business to, 
for example, hedge financial and commercial risks (``stand-alone 
FCMs''). Although the general capital treatment of unsecured market 
gains as non-current assets and the capital charges for inventory and 
fixed price commitments have been applied as applicable to the market 
and credit risk of swap positions for FCMs, to now explicitly address 
both the market and credit risk of these positions for FCM-SDs and 
stand-alone FCMs, the Commission is adopting rules to specifically 
incorporate uncleared swaps and security-based swaps into the existing 
FCM capital framework by defining specific market risk charges and 
credit risk charges for such transactions. The Commission's FCM 
regulations are consistent with its authority under section 4f(b) of 
the CEA, which authorizes the Commission to impose minimum financial 
requirements, including capital requirements, on FCMs. This authority 
extends to establishing capital requirements with respect to all of an 
FCM's activities, including activities involving swaps and security-
based swaps.\16\ Under the Commission's final rules, an FCM-SD and a 
stand-alone FCM are subject to the FCM capital requirements set forth 
in regulation 1.17.
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    \15\ Section 4f(b) of the CEA (7 U.S.C. 6f(b)) authorizes the 
Commission to establish minimum financial requirements for FCMs. The 
Commission previously adopted minimum capital requirements for FCMs, 
which are set forth in Commission regulation Sec.  1.17 (17 CFR 
1.17).
    \16\ Section 4s(e)(3)(B) (7 U.S.C. 6s(e)(3)(B)) of the CEA 
provides that the nothing in section 4s shall limit, or be construed 
to limit, the authority of the Commission to set financial 
responsibility rules for an FCM.
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    The Commission also is adopting financial reporting and 
recordkeeping requirements for SDs and MSPs. Section 4s(f)(2) of the 
CEA directs the Commission to adopt rules governing financial condition 
reporting and recordkeeping for SDs and MSPs, and section 4s(f)(1)(A) 
requires each registered SD and MSP to make such reports as are 
required by Commission rule or regulation regarding the SD's or MSP's 
financial condition.\17\ The Commission also is adopting record 
retention and inspection requirements consistent with the provisions of 
section 4s(f)(1)(B).\18\
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    \17\ See 7 U.S.C. 6s(f)(1) and (2).
    \18\ The Commission previously finalized certain record 
retention requirements for SDs and MSPs regarding their swap 
activities. See, Swap Dealer and Major Swap Participant 
Recordkeeping, Reporting, and Duties Rules; Futures Commission 
Merchant and Introducing Broker Conflicts of Interest Rules; and 
Chief Compliance Officer Rules for Swap Dealers, Major Swap 
Participants, and Futures Commission Merchants, 76 FR 20128 (Apr. 3, 
2012).
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    The final reporting requirements require covered SDs and covered 
MSPs to file periodic unaudited financial statements and an annual 
audited financial report with the Commission and with the registered 
futures association (``RFA'') of which they are a member.\19\ The final 
regulations further require covered SDs and covered MSPs to file 
certain regulatory notices with the Commission and with the RFA of 
which they are a member. The notices are comparable to the existing FCM 
notices, and are intended to alert the Commission and RFA to scenarios 
that may indicate potential financial or operational issues, including 
instances of undercapitalization and failure to maintain current books 
and records. Covered SDs and covered MSPs are also required to file 
notice if certain triggering events regarding the failure to post or 
collect initial or variation margin with swap counterparties occur.
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    \19\ Section 3 of the CEA states that a purpose of the CEA is to 
establish a system of effective self-regulation under the oversight 
of the Commission. Consistent with the self-regulatory concept 
established under section 3, section 17 of the CEA provides a 
process whereby an association of persons may register with the 
Commission as an RFA. Currently, the National Futures Association 
(``NFA'') is the only RFA under section 17 of the CEA.
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    The Commission also is adopting a program for non-U.S. domiciled 
covered SDs or covered MSPs to petition the Commission for a program of 
substituted compliance. Non-U.S. domiciled covered SDs or covered MSPs 
may seek a determination from the Commission that they operate in a 
jurisdiction that has comparable capital adequacy and financial 
reporting objectives and goals as set forth by the Commission in the 
final regulations. Non-U.S. domiciled covered SDs or MSPs that operate 
in a jurisdiction that the Commission has determined meets the capital 
adequacy and financial reporting objectives of the CEA and the 
Commission's regulations may meet some or all of their capital and 
financial reporting requirements by complying with their home country 
jurisdiction requirements.
    The Commission is also adopting several amendments to existing 
regulations as part of the proposed capital and financial recordkeeping 
and reporting requirements. The Commission is amending regulation 1.12 
to require an FCM or an introducing broker (``IB'') that is subject to 
the capital rules of both the Commission and the SEC to file a notice 
with the Commission if the FCM or IB fails to meet the SEC's minimum 
capital requirement. The Commission is also adopting amendments to 
regulation 1.12 to require an FCM or an IB that is also registered with 
the SEC as an SBSD or an MSBSP to file a notice if the SBSD's or 
MSBSP's net capital falls below the ``early warning level'' established 
in the rules of the SEC.\20\ The Commission is also adopting amendments 
to the bulk

[[Page 57465]]

transfer provisions of regulation 1.65 by expanding from 5 to 10 days 
the advance notice that an FCM or an IB must provide to the Commission 
prior to the transfer. The Commission is further revising the bulk 
transfer rules to provide that the notice of the bulk transfer must be 
filed with the Commission electronically, and delegating the authority 
to accept delivery of such notice in a period shorter than 10 days to 
the Director of the Division of Swap Dealer and Intermediary Oversight, 
provided that the notice must be provided as soon as practicable and in 
no event later than the day of the transfer.
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    \20\ The SEC requires each SBSD for which there is no prudential 
regulator to provide notice within 24 hours if the SBSD's net 
capital or tentative net capital (as applicable) falls below 120% of 
the SBSD's minimum net capital or tentative net capital requirement. 
An MSBSP is required to provide notice within 24 hours if its 
tangible net worth falls below $20 million. See 17 CFR 240.18-8(b).
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    The Commission also proposed specific quantitative liquidity 
requirements for certain SDs. As discussed in section II.C.8. below, 
the Commission has determined to defer consideration of the proposed 
liquidity requirements at this time. Accordingly, the Commission is not 
adopting the proposed liquidity requirements in this final rulemaking. 
SDs will continue to be subject to the existing risk management program 
requirements, including the liquidity requirements, set forth in 
regulation 23.600.
    The Commission intends to monitor the impact of the capital and 
financial reporting requirements being adopted today using data 
received from covered SDs and covered MSPs once they are subject to 
these capital and financial reporting requirements. Information that 
the Commission will receive and observe includes data regarding the 
level of capital that the covered SDs and covered MSPs are required to 
maintain, the level of capital actually maintained, the liquidity that 
the firms maintain, the leverage the firms employ, and the scale and 
types of swaps and other transactions that they are engaged in. The 
Commission also will continue to consult with the prudential regulators 
and the SEC to assess the capital adequacy of SDs, MSPs, SBSDs, and 
MSBSPs. The Commission will monitor the data resulting from the 
adoption of today's rules and general market events and consider 
modifications to the capital and financial reporting requirements in 
light of this information. The Commission also will monitor the 
information that it receives to assess the adequacy of the liquidity of 
SDs and, if appropriate, will consider proposing additional liquidity 
requirements as necessary.

B. Proposed Rulemakings and Reopening of the Comment Period

    The Commission initially proposed capital and financial reporting 
requirements for covered SDs and covered MSPs in 2011.\21\ The 
Commission received comments from a broad spectrum of market 
participants, industry representatives, and other interested parties. 
The commenters addressed numerous topics including the permissible use 
of models for computing market risk and credit risk capital charges and 
the need for harmonization of the Commission's capital and financial 
reporting requirements for covered SDs with the capital and financial 
reporting rules of the prudential regulators for bank SDs and with the 
rules of the SEC for nonbank SBSDs. Commenters particularly emphasized 
a need for the harmonization of regulatory requirements for covered SDs 
that also are registered with the SEC as SBSDs.
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    \21\ See Capital Requirements of Swap Dealers and Major Swap 
Participants, 76 FR 27802 (May 12, 2011) (the ``2011 Capital 
Proposal'').
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    Shortly after the Commission issued the 2011 Capital Proposal, the 
Basel Committee on Banking Supervision (``BCBS'') and the International 
Organization of Securities Commissions, in consultation with the 
Committee on Payment and Settlement Systems and the Committee on Global 
Financial Systems, formed a working group (the ``WGMR'') to develop 
internationally harmonized standards for margin requirements for 
uncleared swaps. Representatives of more than 20 regulatory authorities 
participated in the WGMR including the Commission, the SEC, Federal 
Reserve Board, OCC, FDIC, and the Federal Reserve Bank of New York. The 
Commission elected to defer consideration of the SD and MSP capital and 
financial reporting rules until the WGMR had completed its work and the 
Commission had adopted margin requirements for uncleared swap 
transactions. As noted above, the Commission subsequently adopted final 
margin requirements for uncleared swaps in December 2015, and the 
compliance period for the final rules is being phased-in through 
2021.\22\
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    \22\ See 81 FR 636 (Jan. 6, 2016) and Commission regulation 
Sec.  23.161 (17 CFR 23.161)). The Commission also has proposed to 
extend the compliance date for the final phase-in period to 
September 1, 2022. See Margin Requirements for Uncleared Swaps for 
Swap Dealers and Major Swap Participants, 85 FR 41463 (July 10, 
2020).
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    In 2016, in consideration of the substantial amount of time that 
had passed since the 2011 Capital Proposal, the Commission re-proposed 
the capital and financial reporting rules for SDs and MSPs to provide 
commenters with an opportunity to provide further comment in 
recognition of the significant developments in the swaps marketplace 
since the 2011 Capital Proposal.\23\ These marketplace developments 
included more than 100 entities provisionally registering with the 
Commission as SDs, the Commission adopting final margin rules for 
uncleared swaps, the prudential regulators adopting final capital and 
margin rules for swap and security-based swap transactions, and the SEC 
proposing capital, margin, segregation and financial reporting 
requirements for SBSDs and MSBSPs.
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    \23\ Capital Requirements of Swap Dealers and Major Swap 
Participants, 81 FR 91252 (Dec. 16, 2016) (the ``2016 Capital 
Proposal'' or the ``Proposal''). The comment letters for the 2016 
Capital Proposal are available at: https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769 (the public comment file). 
Commenters included financial services associations, agricultural 
associations, energy associations, insurance associations, banks, 
brokerage firms, investment managers, insurance companies, pension 
funds, commercial end users, law firms, public interest 
organizations, and other members of the public.
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    The Commission again received comments from a broad spectrum of 
market participants and other interested parties. The commenters raised 
several issues with regards to the 2016 Capital Proposal, including the 
appropriateness of basing a capital requirement on initial margin 
requirements, the appropriateness of a liquidity requirement for 
covered SDs, the use of models to compute market risk and credit risk 
capital charges, and the need for harmonization of the Commission's 
rules with the rules of the prudential regulators and the SEC. 
Commenters also requested that the Commission provide an additional 
opportunity for public comment on the 2016 Capital Proposal once the 
SEC finalized its capital, margin, and financial reporting requirements 
for SBSDs and MSBSPs. The commenters noted the particular necessity for 
an opportunity to provide further comment on the 2016 Capital Proposal 
as the Commission's Proposal would permit a covered SD to compute its 
capital as if it were a SBSD subject to the SEC's SBSD capital 
requirements. The commenters noted that the SEC had received many 
substantial comments on its proposed nonbank SBSD and nonbank MSBSP 
capital requirements. The commenters further stated that they would 
need to review the SEC's final capital, margin and financial reporting 
rules, including the SEC's response to the many comments on its 
proposal, in order to provide full comments on the 2016 Capital 
Proposal.
    The Commission ultimately reopened the comment period for the 2016 
Capital Proposal.\24\ The 2019 Capital Reopening

[[Page 57466]]

was published after the SEC had adopted final capital, margin, 
segregation, and financial reporting requirements for SBSD and MSBSPs. 
Accordingly, the 2019 Capital Reopening provided interested parties 
with an additional opportunity to provide comments on the 2016 Capital 
Proposal after the SEC finalized its capital and financial reporting 
rules.
---------------------------------------------------------------------------

    \24\ See Capital Requirements of Swap Dealers and Major Swap 
Participants, 84 FR 69664 (Dec. 16, 2019) (the ``2019 Capital 
Reopening''). The comment letters for the 2019 Capital Reopening are 
available at: https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769 (the public comment file). Commenters 
included financial services associations, agricultural associations, 
energy associations, insurance associations, banks, brokerage firms, 
investment managers, insurance companies, pension funds, commercial 
end users, law firms, public interest organizations, and other 
members of the public.
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    One commenter stated that the Commission could not finalize the 
2016 Capital Proposal due to the lack of cost benefit analysis related 
to additional questions contained in the 2019 Capital Reopening and was 
unable to fully assess the potential modifications to the proposed 
rules without re-proposal.\25\ The commenter further argued that the 
2019 Capital Reopening contained only questions and requests for 
comment with no specific rule text or accompanying explanation, 
including evaluation of costs and benefits as the commenter believed 
required. As a result of this, the commenter posited any final 
rulemaking following the 2019 Capital Reopening failed to provide 
adequate notice of identifiable regulatory outcomes to commenters and 
therefore, would not satisfy APA considerations for notice and comment 
rulemaking.\26\ The Commission disagrees. The 2019 Capital Reopening 
provided an additional opportunity for commenters to address aspects of 
the 2016 Capital Proposal in light of the SEC's final capital rule for 
SBSDs and MSBSPs, which was itself incorporated by reference into the 
2016 Capital Proposal.
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    \25\ See Letter From Dennis M. Kelleher, President and CEO, 
Better Markets Inc. (March 3, 2020) (Better Markets 3/3/2020 
Letter).
    \26\ Id. at page 7.
---------------------------------------------------------------------------

    In 2016, the Commission re-proposed the SD Capital rules for a 
second time.\27\ In that release, the Commission specifically noted 
that it had considered the comments from the 2011 proposal in 
developing the 2016 Capital Proposal.\28\ The 2016 Capital Proposal 
again proposed complementary financial reporting rules and recognized 
the expected use of models. Further, the Commission stated at the time 
that it had also considered capital rules adopted by the prudential 
regulators and capital rules proposed by the SEC for security-based 
swap dealers and major security-based swap participants.\29\ As such, 
the Commission specifically said that it had to a great extent drawn 
upon the SEC capital rules in developing the proposed capital 
requirements.\30\ The 2019 Capital Reopening did not change the 2016 
proposed framework, which has largely remained intact since the 
original proposal in 2011--such as, what method an entity could use to 
calculate its required capital and the various capital minimums 
dependent upon the characteristics of the registered entity, while 
seeking to maintain comparability to the other capital regimes of the 
Prudential Regulators and the SEC, as statutorily required. The 2019 
Capital Reopening sought to specifically respond to commenters who had 
asked for an additional opportunity to comment on the 2016 Capital 
Proposal following the finalization of capital rules for SBSDs by the 
SEC. It gave commenters the opportunity to provide their views on 
whether certain items should be included or how the process should 
account for them.\31\ Each of the areas addressed in the 2019 Capital 
Reopening signaled potential modifications that the Commission was 
considering in light of comments received, including modifications 
adopted by the SEC.\32\ Modifications in the final rule, including a 
discussion and specific inclusion of various approaches, are therefore 
the logical outgrowth of the 2016 Capital Proposal.
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    \27\ 81 FR 91252 (Dec. 16, 2016).
    \28\ Id. at 91254.
    \29\ Id. In this regard, Section 4s(e)(3)(D) of the CEA provides 
that the CFTC, SEC, and prudential regulators shall, to the maximum 
extent practicable, establish and maintain comparable minimum 
capital requirements for SDs and MSPs.
    \30\ Id.
    \31\ See 84 FR 69665.
    \32\ Id.
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    In addition, the 2016 Capital Proposal included a comprehensive 
cost benefit consideration section, addressing the Section 15(a) 
factors in detail. The cost-benefit analysis discussed an elective 
approach utilizing similar tailored minimums depending on the 
characteristics of the registered entity--a net liquid asset approach 
incorporating the traditional FCM and SEC registered broker or dealer 
(``BD'') capital framework, a bank-based approach incorporating again 
the risk-weighted assets framework from banking rules, and again a 
tangible net worth approach for certain eligible firms. The 2016 
Capital Proposal again proposed complementary financial reporting rules 
and recognized the expected use of models. The public was asked to 
comment on all aspects of the proposal, and several comments were 
received in response. A more fulsome discussion is in the Cost-Benefit 
Consideration section of this document; however, as noted above, the 
potential modifications described in the 2019 Capital Reopening, 
including a discussion and specific inclusion of potential rule 
language, were logical outgrowths of the 2016 Capital Proposal.

C. Consultation With U.S. Securities and Exchange Commission and 
Prudential Regulators

    The Dodd-Frank Act amended the CEA and the Exchange Act to require 
the Commission, SEC, and prudential regulators to coordinate and 
develop comparable capital requirements for SDs and SBSDs, and for MSPs 
and MSBSPs. Section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D), in 
conjunction with section 15F(e)(3)(D) of the Exchange Act (15 U.S.C. 
78o-10(e)(3)(D)), provides that, to the maximum extent practicable, the 
Commission, SEC and the prudential regulators shall establish and 
maintain comparable minimum capital requirements for SDs and SBSDs, and 
for MSPs and MSBSPs. Further, section 4s(e)(3)(D) and section 
15F(e)(3)(D) provide that staff of the CFTC, SEC, and prudential 
regulators shall meet periodically, but no less frequently than 
annually, to consult on minimum capital requirements. Consistent with 
this Congressional mandate, the respective staffs of the Commission, 
SEC, and the prudential regulators have regularly shared drafts of 
proposed and final rulemakings with staffs of the other agencies for 
review and comment before taking final action with respect to the 
proposed or final rulemakings. Consistent with this approach, the 
Commission provided the SEC and prudential regulators with drafts of 
the final rules for review and comment, and the final rulemaking 
reflects comments received from the SEC and prudential regulators.

II. Final Regulations and Amendments to Existing Regulations

A. Capital Framework for FCMs, Covered SDs, and Covered MSPs

    FCMs are subject to existing capital requirements set forth in 
regulation 1.17. The Commission is amending regulation 1.17 to 
establish capital requirements explicitly for swap and security-based 
swap transactions entered into by FCMs. The Commission is also amending 
regulation 1.17 to require an FCM-SD to comply with the amended FCM 
capital requirements. A discussion of the amendments to

[[Page 57467]]

regulation 1.17 for FCMs and FCM-SDs is contained in section II.B. of 
this release.
    The Commission is also adopting final capital rules for covered SDs 
that are not FCM-SDs, and is adopting final capital rules for covered 
MSPs. The Commission is adopting a flexible approach that allows 
covered SDs to elect one of three alternative capital frameworks for 
establishing their minimum capital requirements and for computing their 
regulatory capital. The three alternative approaches draw to a great 
extent on the existing CFTC capital requirements for FCMs contained in 
regulation 1.17, as well as the SEC's capital requirements for BDs and 
nonbank SBSDs, and the prudential regulators' capital requirements for 
bank SDs. Specifically, the Commission's final capital rules, depending 
on the characteristics of a covered SD, permit such SD to elect: (i) A 
capital requirement consistent with the SEC's final capital 
requirements for SBSDs, as well as the existing CFTC capital rules for 
FCMs and the existing SEC capital rules for BDs (the ``Net Liquid 
Assets Capital Approach''); (ii) a capital requirement consistent with 
the prudential regulators' capital requirements for bank SDs, and that 
is based on existing Federal Reserve Board capital requirements for 
bank holding companies (the ``Bank-Based Capital Approach''); or (iii) 
a capital requirement based on the covered SD's tangible net worth, 
provided that the covered SD or its parent entity is predominantly 
engaged in non-financial activities as defined in the rule (the 
``Tangible Net Worth Capital Approach''). Each of the approaches is 
discussed in section II. below.
    With respect to covered MSPs, the Commission is adopting a minimum 
regulatory capital requirement based upon the tangible net worth of the 
MSP. While there currently are no provisionally-registered MSPs or 
entities pending registration as MSPs, the Commission is adopting final 
capital requirements in the event that entities seek registration in 
the future. A capital requirement based upon the tangible net worth of 
the MSP is consistent with the approach adopted by the SEC for nonbank 
MSBSPs, as discussed in section II.C.5. of this release.
    Broadly speaking, in developing the proposed capital requirements, 
the Commission strived to advance the statutory goal of helping to 
protect the safety and soundness of covered SDs and covered MSPs, while 
also taking into account the diverse nature of the entities registered 
as SDs, and the existing capital regimes that apply to covered SDs and/
or their financial group. In this regard, as of June 30, 2020, there 
were 108 provisionally registered SDs. Fifty-two of the provisionally 
registered SDs are bank SDs, subject to a prudential regulator. The 
remaining 56 SDs are covered SDs, subject to the Commission's capital 
rules. While each of the 56 covered SDs is registered with the 
Commission as a result of their swap dealing activities, the SDs 
represent a broad range of business activities and a diverse population 
of swap counterparties. Several of the covered SDs are primarily 
engaged in commodity-focused swap transactions with commercial 
counterparties, while other covered SDs are focused primarily with 
financial related swaps, including interest rate, foreign currency, and 
credit default swaps, and have a broad range of swaps counterparties 
that includes both commercial and financial counterparties.
    The 56 covered SDs subject to the Commission's capital requirements 
are associated with 21 corporate families, with several families having 
more than 1 provisionally-registered covered SD. Many of these 
corporate families are part of U.S. bank or foreign bank holding 
companies that offer global financial services and are subject to 
prudential capital regulation, including BCBS-based capital 
requirements that may extend to some of the provisionally-registered 
covered SDs. The alternative capital approaches adopted by the 
Commission are intended to mitigate potential competitive disadvantages 
and unnecessary costs that might otherwise arise if the Commission were 
to impose a single capital approach in light of the existing different 
operating and corporate structures of the covered SDs. The Commission 
further believes that the flexibility of the capital approaches will 
potentially benefit market participants by providing a tailored capital 
regime that encourages SDs that are not part of global financial firms 
to continue to provide liquidity in the swaps market, particularly to 
smaller financial or commercial end users that do not have 
relationships with the large financial SDs.
    As mentioned above, FCM-SDs are subject to the FCM capital 
requirements set forth in regulation 1.17. Covered SDs that are not 
FCM-SDs and covered MSPs that are not FCM-MSPs are subject to the final 
capital requirements set forth in regulation 23.101. Regulation 23.101 
details the minimum capital requirements for each of the three capital 
approaches for covered SDs and the eligibility criteria (as 
applicable), and further defines the capital computations for each 
approach, including various market risk and credit risk capital 
charges. Regulation 23.101 also defines the minimum capital 
requirements for covered MSPs and defines the capital computation for 
covered MSPs. Each of these capital approaches is discussed below.

B. Capital Requirements for Stand-Alone FCMs and FCM-SDs

1. Introduction to General Capital Requirements for Stand-Alone FCMs 
and FCM-SDs
    The capital requirements for FCMs are set forth in regulation 1.17 
and require each FCM to maintain a minimum level of ``liquid assets'' 
in excess of the firm's liabilities to provide resources for the FCM to 
meet its financial obligations as a market intermediary in the 
regulated futures and cleared swaps markets. As a market intermediary, 
an FCM provides services to its customers and the marketplace, 
including, in the event of a customer default, guaranteeing the 
financial performance of each customer to clearing organizations that 
clear the customers' futures and cleared swap transactions. To ensure 
that an FCM is capable of meeting its financial obligations, regulation 
1.17 requires an FCM to hold at all times more than one dollar of 
highly liquid assets for each dollar of liabilities (e.g., money owed 
to customers, counterparties and creditors), excluding certain 
subordinated debt.\33\ The FCM capital requirements also are intended 
to ensure that an FCM maintains a sufficient level of liquid assets in 
excess of its liabilities in order to effectively and efficiently wind-
down its operations by transferring customer positions and funds to 
other FCMs in the event that the FCM voluntarily or involuntarily 
ceases operations.
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    \33\ Commission regulation Sec.  1.17(h) (17 CFR 1.17(h)) 
permits an FCM to exclude certain qualifying subordinated debt from 
its liabilities in computing its net capital. In order to qualify, 
the person lending cash to the FCM must subordinate its claim 
against the FCM to all other creditors of the FCM in addition to 
agreeing to other conditions, including potential restrictions 
associated with scheduled repayments of the debt.
---------------------------------------------------------------------------

    The FCM capital requirement contains two components. The first 
component is a minimum level of ``adjusted net capital'' that an FCM is 
required to maintain at any given time. The minimum adjusted net 
capital requirement is generally the greater of the following: (i) A 
fixed-dollar amount; (ii) an amount computed based upon the clearing 
organization margin imposed on customer and noncustomer futures, 
foreign futures, and cleared swap

[[Page 57468]]

positions carried by the FCM; (iii) the amount of net capital required 
by the SEC for FCMs that are dually-registered as BDs (``FCM/BDs''); 
or, (iv) the amount of adjusted net capital required by an RFA of which 
the FCM is a member.\34\
---------------------------------------------------------------------------

    \34\ See Commission regulation Sec.  1.17(a)(1)(i) (17 CFR 
1.17(a)(1)(i)).
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    The second component of the FCM capital requirement is the amount 
of adjusted net capital that an FCM actually maintains based upon the 
assets and liabilities of the firm. In determining its adjusted net 
capital, an FCM is first required to compute its net worth under 
generally accepted accounting principles (``GAAP'') as adopted in the 
United States, and then is required to apply certain rule-based 
adjustments to reduce its net worth to the extent it contains illiquid 
assets such as fixed assets and unsecured receivables. The resulting 
calculation reflects the FCM's ``net capital.'' The FCM is then 
required to apply certain rule-based capital charges or haircuts to 
reflect market risk associated with its liquid assets. The resulting 
calculation reflects the FCM's ``adjusted net capital.'' The 
calculation of adjusted net capital in this manner is intended, as 
noted above, to ensure that the FCM holds at least one dollar of highly 
liquid assets to meet each dollar of liabilities, excluding certain 
qualifying subordinated liabilities.
    The Commission proposed several amendments to regulation 1.17 in 
recognition that the current capital requirements do not explicitly 
reflect FCMs transacting in uncleared swap or security-based swap 
transactions, or engaging in swap dealing activities. The Commission 
also proposed to require FCM-SDs to comply with the FCM capital 
requirements.\35\ The Commission proposed to require FCM-SDs to comply 
with regulation 1.17 due to the Commission's experience regulating FCMs 
and its belief that the FCM capital requirements, with its emphasis on 
liquidity, are well-designed to ensure that an FCM will be able to 
continue to perform its critical functions in the futures and cleared 
swaps marketplace. As noted above, FCMs are market intermediaries that 
provide customers with access to the futures and cleared swaps markets. 
As market intermediaries, FCMs play a central role in the daily 
settlement process at derivatives clearing organizations by paying or 
collecting their customers' initial and variation margin obligations. 
FCMs also guarantee their customers' financial performance to each DCO, 
and contribute to DCO guarantee funds. FCMs also provide numerous 
services for their customers, including providing confirmations of each 
transaction and periodic account statements. Based on its experience 
with FCMs, the Commission believes that the FCM capital rule, which is 
a liquidity-based capital rule, is appropriate for FCM-SDs.
---------------------------------------------------------------------------

    \35\ Section 4s(e)(3)(B)(i) of the CEA (7 U.S.C. 6s(e)(3)(B)(i)) 
states that nothing in section 4s(e) imposing capital and margin 
requirement on SDs and MSPs limits, or shall be construed to limit, 
the authority of the Commission to set financial responsibility 
rules for FCMs pursuant to section 4f(a).
---------------------------------------------------------------------------

2. Minimum Capital Requirement for FCMs and FCM-SDs
a. Minimum Fixed-Dollar Amount of Net Capital
    Regulation 1.17(a)(1)(i) requires an FCM to maintain a minimum 
amount of adjusted net capital that is equal to or greater than the 
highest of: (i) $1 million; (ii) for an FCM that engages in off-
exchange foreign currency transactions with retail forex customers,\36\ 
$20 million, plus 5% percent of the FCM's liabilities to the retail 
forex customers that exceed $10 million; (iii) 8% percent of the sum of 
the risk margin of futures, options on futures, foreign futures, and 
swap positions cleared by a clearing organization and carried by the 
FCM in customer and noncustomer accounts; (iv) the amount of adjusted 
net capital required by the RFA of which the FCM is a member; and (v) 
for an FCM that is also registered with the SEC as a BD, the amount of 
net capital required by the rules of the SEC.\37\
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    \36\ Commission regulation Sec.  5.1(k) (17 CFR 5.1(k)) defines 
the term ``retail forex customer'' as a person, other than an 
eligible contract participant as defined in section 1a(18) of the 
CEA, acting on its own behalf in any account agreement, contract or 
transaction described in section 2(c)(2)(B) or 2(c)(2)(C) of the CEA 
(7 U.S.C. 2(c)(2)(B) or 2(c)(2)(C)).
    \37\ See Commission regulation Sec.  1.17(a)(1)(i) (17 CFR 
1.17(a)(1)(i)).
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    The term ``risk margin'' is defined in regulation 1.17(b)(8) as the 
level of maintenance margin or performance bond required for the 
customer or noncustomer positions by the applicable exchanges or 
clearing organizations, and, where margin or performance bond is 
required only for accounts at the clearing organization, for purposes 
of the FCM's risk-based capital calculations applying the same margin 
or performance bond requirements to customer and noncustomer positions 
in accounts carried by the FCM, subject to the following: (i) Risk 
margin does not include the equity component of short or long option 
positions maintained in an account; (ii) the maintenance margin or 
performance bond requirement associated with a long option position may 
be excluded from risk margin to the extent that the value of such long 
option position does not reduce the total risk maintenance or 
performance bond requirement of the account that holds the long option 
position; (iii) the risk margin for an account carried by an FCM which 
is not a member of the exchange or the clearing organization that 
requires collection of such margin should be calculated as if the FCM 
were such a member; and (iv) if an FCM does not possess sufficient 
information to determine what portion of an account's total margin 
requirement represents risk margin, all of the margin required by the 
exchange or the clearing organization that requires collection of such 
margin for that account, shall be treated as risk margin.\38\
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    \38\ Commission regulation Sec.  1.17(b)(8) (17 CFR 1.17(b)(8)).
---------------------------------------------------------------------------

    The Commission proposed amending regulation 1.17(a)(1)(i)(A) to 
increase the minimum fixed-dollar amount of adjusted net capital from 
$1 million to $20 million for FCM-SDs. The Commission did not propose 
to amend the required minimum fixed-dollar amount of adjusted net 
capital for stand-alone FCMs that may engage in swap activities at a 
level that does not require registration as an SD, as the Commission 
believed that the existing minimum fixed-dollar amount of required 
adjusted net capital was properly calibrated for such firms.
    The Commission believes that the proposed higher minimum dollar 
amount of adjusted net capital for FCM-SDs is appropriate given the 
enhanced risk that an FCM-SD assumes in engaging in swap dealing 
activities, while also continuing to carry futures and cleared swaps 
customers.\39\ As noted above, FCMs act primarily as market 
intermediaries for futures and cleared swaps customers and typically do 
not use their balance sheet to facilitate customer transactions. Absent 
a customer default, an FCM does not take on market risk of its 
customers' positions in performing this market intermediary function. 
FCMs that are FCM-SDs, however, are engaging in swap dealing 
activities. As dealers, FCM-SDs use their balance sheet to facilitate 
customer transactions as they are counterparties on swap positions in 
addition to performing market intermediary functions for their 
customers. Dealing activities present additional risks to FCM-SDs. As 
dealers, an FCM-SD is potentially exposed to market risks on uncleared

[[Page 57469]]

swap positions, and is exposed to counterparty credit risk from swap 
counterparties. FCM-SDs also may be required to post initial margin and 
pay variation margin to swap counterparties on a daily basis for their 
proprietary uncleared swap positions. The proposed increase in the 
fixed-dollar amount of the minimum adjusted net capital was intended to 
address the potential increase in risks posed to FCM-SDs from dealing 
activities, including the impact that dealing may have on the liquidity 
of FCM-SDs. The proposed increase in the minimum capital requirement 
also was intended to otherwise help ensure the safety and soundness of 
the FCM-SD, as the insolvency of an FCM-SD could have potential adverse 
consequences to the efficient operation of the market, particularly as 
the insolvency impacts the futures and cleared swaps customers of the 
FCM-SD. The Commission further noted that the proposed $20 million 
minimum adjusted net capital requirement was consistent with the $20 
million minimum dollar amount of adjusted net capital imposed by 
Congress and the Commission on retail foreign exchange dealers 
(``RFEDs'') or FCMs that enter into off-exchange foreign currency 
transactions with retail persons under section 2(c)(2)(C) of the CEA 
and regulation 5.7(a).
---------------------------------------------------------------------------

    \39\ 2016 Capital Proposal, 81 FR 91252.
---------------------------------------------------------------------------

    The Commission also proposed amending regulation 1.17(a)(1)(ii) to 
require an FCM-SD that receives approval from the Commission or from an 
RFA of which it is a member to use internal market risk or credit risk 
models to compute capital charges in lieu of the standardized capital 
charges or deductions to maintain net capital equal to or in excess of 
$100 million, and adjusted net capital equal to or in excess of $20 
million. The requirement to maintain a minimum $100 million fixed-
dollar amount of net capital was intended to address the issue that 
while models are more risk sensitive and generally result in 
substantially lower market risk and credit risk capital charges than 
standardized charges, models may not capture all risks, including 
extreme market losses (i.e., tail risk) or liquidity concerns. The 
requirement for an FCM-SD that is approved to use capital models to 
maintain a minimum of $100 million of net capital and $20 million of 
adjusted net capital is consistent with the SEC's final capital rule 
for SBSDs that are not registered BDs (``stand-alone SBSDs'') and that 
are approved to use internal models to compute market risk and credit 
risk capital charges. These entities are required to maintain fixed-
dollar tentative net capital of $100 million and fixed-dollar net 
capital of $20 million.\40\
---------------------------------------------------------------------------

    \40\ See SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)).
---------------------------------------------------------------------------

    The Commission did not receive comment on the proposed $20 million 
fixed-dollar amount of adjusted net capital required of FCM-SDs. The 
Commission received a comment stating that the proposed $100 million 
net capital requirement for FCM-SDs that have approval to use internal 
models to compute market risk or credit risk capital charges in lieu of 
the standardized capital charges would create an unnecessary barrier to 
entry.\41\
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    \41\ See Letter from Joanna Mallers, FIA Principal Traders Group 
(May 24, 2017) (FIA-PTG 5/24/2017 Letter).
---------------------------------------------------------------------------

    The Commission has considered the proposed amendments of the 
minimum fixed-dollar amount of net capital and adjusted net capital 
that FCM-SDs would be required to maintain and is adopting the 
amendments as proposed.\42\ As noted above, FCMs play a central role as 
market intermediaries for futures and cleared swaps transactions, 
including guaranteeing each customer's financial performance to 
clearing organizations or carrying FCMs. An adequate level of capital 
is necessary to ensure that FCMs meet their financial obligations, 
which in turn promotes customer protection and helps ensure the cleared 
futures and cleared swaps markets operate efficiently. The increase in 
adjusted net capital for FCM-SDs to $20 million is also necessary to 
address the additional risk that is inherent in an SD's dealing 
activities. As a dealer, an FCM-SD uses its balance sheet to facilitate 
customer swap transactions, is a counterparty in swap transactions, and 
is obligated to post and collect initial margin and settle variation 
margin with swap counterparties. Furthermore, the final requirement for 
an FCM-SD to maintain a minimum of $20 million of adjusted net capital 
is consistent with the Commission's required minimum adjusted net 
capital of $20 million for RFEDs, and is consistent with the SEC's 
final minimum capital requirements for SBSDs.
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    \42\ The 2019 SEC Final Capital Rule requires BDs that use 
internal models to compute market risk and credit risk capital 
charges in lieu of standardized capital charges to maintain $5 
billion of net capital and $1 billion of adjusted net capital. FCM/
SDs that also are registered with the SEC as BDs are required to 
comply with the SEC's capital requirements in meeting the 
Commission's minimum capital requirement.
---------------------------------------------------------------------------

    With respect to the comment that a $100 million minimum net capital 
requirement for FCM-SD's seeking approval to use capital models may act 
as a barrier to entry, the Commission notes that the regulation was 
designed to account for the fact that model-based market risk and 
credit risk capital charges, while more risk sensitive than 
standardized capital charges, tend to be substantially lower than 
standardized charges. The $100 million of net capital is intended to 
address potential model errors and tail risk and other factors that may 
not be fully or accurately captured in the models. The Commission 
further notes that currently the only FCM-SDs provisionally registered 
are four BD/FCMs that are subject to substantially higher minimum 
capital requirements under SEC and CFTC rules as discussed in section 
II.B.3.c.(i). below. Accordingly, no provisionally-registered FCM-SD 
will be subject to the $100 million minimum net capital requirement 
based on the current list of provisionally registered SDs.
b. Minimum Capital Requirement Based on 8% Risk Margin Amount
    Another component of the minimum capital requirements in regulation 
1.17 provides that each FCM must maintain adjusted net capital equal to 
or greater than 8% of the risk margin amount associated with the 
futures, foreign futures, and cleared swaps positions carried by the 
FCM in customer and noncustomer accounts.\43\ As discussed in section 
II.B.2.a. above, the term ``risk margin'' for an account generally 
means the level of maintenance margin or performance bond required for 
customer and noncustomer positions by the applicable exchanges or 
clearing organizations.\44\ Clearing organizations generally set 
initial margin requirements for futures, foreign futures, and cleared 
swap positons at a level to cover one-day market moves with a 99% level 
of confidence.\45\
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    \43\ A noncustomer account is an account that an FCM carries for 
persons that generally are officers or employees of the FCM (i.e., 
the persons are not customers of the FCM and the account is not the 
proprietary account of the FCM). See Commission regulation Sec.  
1.17(b)(4) (17 CFR 1.17(b)(4)).
    \44\ See Commission regulation Sec.  1.17(b)(8) (17 CFR 
1.17(b)(8)).
    \45\ See, for example, Commission regulation Sec.  39.13(g) (17 
CFR 39.13(g)) which provides that a derivatives clearing 
organization must set margin for futures and swaps on agricultural 
commodities, energy commodities, and metals using a one-tailed 99% 
confidence interval with a minimum one-day liquidation period, and 
must set margin for all other swaps using a one-tailed 99% 
confidence interval with a minimum five-day liquidation period.
---------------------------------------------------------------------------

    In computing the 8% risk margin amount, an FCM is required to 
compute risk margin on the positions of each customer on a customer-by-
customer basis, and multiply the resulting aggregate risk margin amount 
by 8%. The 8% risk margin amount is a risk

[[Page 57470]]

sensitive calculation in that an FCM's minimum capital requirement is 
tied to the level of exchange or clearing organization margin 
associated with each customer's and noncustomer's account. Accordingly, 
an FCM's minimum capital requirement increases or decreases as the 
aggregate of its customer and noncustomer risk margin increases or 
decreases. The 8% risk margin amount is also a volume-based metric as 
it requires an FCM to compute the risk margin amount on each individual 
customer and noncustomer account, with no offsets between accounts to 
reflect offsetting positions or to reflect margin collected on the 
accounts. As a volume-based metric, an FCM's minimum capital 
requirement increases or decreases based upon the aggregate amount of 
risk margin required of each customer and noncustomer account carried 
by the FCM.
    The Commission proposed amending the minimum capital requirement in 
regulation 1.17(a)(1)(i)(B) by expanding the types of positions that an 
FCM-SD must include in the 8% risk margin amount calculation. The 
Commission did not propose to expand the types of positions that must 
be included in the risk margin amount calculation for stand-alone FCMs. 
An FCM that is not an FCM-SD must continue to calculate the 8% risk 
margin amount based upon the customer and noncustomer futures, foreign 
futures, and cleared swap positions carried by the FCM.\46\
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    \46\ A commenter noted an ambiguity in the 2016 Capital Proposal 
in that the Commission stated in the preamble that the proposed 
increases in the minimum capital requirements would be applicable 
only to FCM-SDs and not to stand-alone FCMs, but that the proposed 
rule text in Commission regulation Sec.  1.17 did not clearly draw 
that distinction. See Letter from Walt Lukken, Futures Industry 
Association, March 3, 2020 (FIA 3/3/2020 Letter). The Commission 
confirms that the proposed increases in the minimum capital 
requirements were only applicable to FCM-SDs, and has modified the 
final rule text to clarify this point.
---------------------------------------------------------------------------

    Regulation 1.17(a)(1)(i)(B) currently requires an FCM, as noted 
above, to include the risk margin associated with the futures, foreign 
futures, and cleared swap positions carried in customer and noncustomer 
accounts in the 8% risk margin amount calculation. The 2016 Capital 
Proposal expanded the list of products that an FCM-SD must include in 
the 8% risk margin amount calculation to further include the cleared 
security-based swap positions carried for customers and noncustomers, 
as well as the FCM-SD's proprietary cleared swaps and proprietary 
cleared security-based swap positions. The positions in the risk margin 
amount calculation was proposed to be further extended to include the 
FCM-SD's uncleared swap and uncleared security-based swap positions.
    The Proposal required an FCM-SD to include all swaps and security-
based swaps in the risk margin amount calculation, including swaps that 
are excluded from the Commission's margin rules for uncleared swaps and 
any security-based swaps that the SEC excluded from its margin rules. 
Specifically, the proposal provided that an FCM-SD must include in its 
computation of the risk margin amount each outstanding uncleared swap, 
including swaps exempt from the scope of the Commission's uncleared 
swaps margin rules by regulation 23.150 (``TRIPRA Exemption),\47\ 
legacy swaps, foreign exchange swaps as the term is defined in 
regulation 23.151, or netting set of swaps or foreign exchange swaps, 
for each counterparty, as if the counterparty were an unaffiliated SD. 
The Proposal further required an FCM-SD to include the initial margin 
for all uncleared swaps that would otherwise fall below the $50 million 
initial margin threshold amount or the $500,000 minimum transfer 
amount, as defined in regulation 23.151, for purposes of computing the 
uncleared swap margin amount.\48\
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    \47\ Title III of the Terrorism Risk Insurance Program 
Reauthorization Act of 2015 amended sections 731 and 764 of the 
Dodd-Frank Act to provide that the Commission's margin requirements 
shall not apply to a swap in which a counterparty: (i) Qualifies for 
an exception under section 2(h)(7)(A) of the CEA; (ii) qualifies for 
an exemption issued under section 4(c)(1) of the CEA for cooperative 
entities as defined in such exemption; and (iii) satisfies the 
criteria in section in section 2(h)(7)(D) of the CEA. See Public Law 
114-1, 129 Stat. 3.
    \48\ 2016 Capital Proposal, 81 FR 91252 at 91258.
---------------------------------------------------------------------------

    The Commission received comments on various aspects of the proposed 
8% risk margin amount calculation for FCM-SDs. Commenters to the 2016 
Capital Proposal and the 2019 Capital Reopening objected to including 
cleared and uncleared security-based swaps in the 8% risk margin amount 
calculation for FCM-SDs.\49\ Commenters stated that the Commission 
should not include security-based swaps in the 8% risk margin amount 
calculation as security-based swaps are products regulated by the SEC, 
and that including SEC-regulated products in the Commission's minimum 
capital requirement is inconsistent with long-standing CFTC and SEC 
capital requirements for FCMs and BDs.\50\
---------------------------------------------------------------------------

    \49\ See FIA 3/3/2020 Letter; Letter from Briget Polichene, 
Institute of International Bankers, Scott O'Malia, International 
Swaps and Derivatives Association, and Kenneth Bentsen, Jr., 
Securities Industry and Financial Markets Association (March 3, 
2020) (IIB/ISDA/SIFMA 3/3/2020 Letter).
    \50\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    A commenter noted that a dually-registered FCM/BD is generally 
required to maintain adjusted net capital equal to the greater of (i) 
8% of the margin required for futures, foreign futures, and cleared 
swaps carried by the FCM for customers and noncustomers, or (ii) 2% of 
the debit items calculated in respect of the BD's customer securities 
positions.\51\ The commenter further stated that the approach of 
setting separate, as opposed to aggregate, requirements for Commission 
and SEC regulated products allows the agency that Congress selected to 
regulate a given product to determine the appropriate balance between 
robust capital cushions and robust market liquidity.\52\
---------------------------------------------------------------------------

    \51\ Id.
    \52\ Id.
---------------------------------------------------------------------------

    The commenter further noted that the 2019 SEC Final Capital Rule 
continued this historical approach as the SEC elected to include in its 
minimum capital requirement the initial margin associated only with 
customer and noncustomer cleared security-based swaps and the SBSD's 
uncleared security-based swaps.\53\ The SEC's final rule did not 
incorporate initial margin associated with customer cleared swap 
positions or uncleared swap positions, or otherwise include positions 
that are not subject to the SEC's jurisdiction.
---------------------------------------------------------------------------

    \53\ Id.
---------------------------------------------------------------------------

    One commenter stated that FX forwards and swaps should be excluded 
from the 8% risk margin amount calculation as Congress gave the United 
States Treasury Department the authority over these products.\54\
---------------------------------------------------------------------------

    \54\ See Letter from Joanna Mallers, FIA Principal Traders Group 
(March 3, 2020) (FIA-PTG 3/3/2020 Letter).
---------------------------------------------------------------------------

    The Commission has considered the proposal and the comments 
received, and is adopting a minimum capital requirement based upon a 
percentage of the risk margin amount. The Commission is modifying the 
final rule, however, to exclude cleared security-based swap and 
uncleared security-based swap positions from the risk margin amount 
calculation. The Commission acknowledges that in setting minimum 
capital requirements for FCMs, including FCMs that are dually-
registered as FCM/BDs, it has historically considered only the futures 
related activities of an FCM. In this regard, the Commission's initial 
minimum capital requirement was based upon a percentage of futures 
customer and noncustomer funds held by an FCM, and was subsequently

[[Page 57471]]

amended to be based upon a percentage of the risk margin associated 
with futures and cleared swaps customer and noncustomer positions 
carried by an FCM.\55\ The Commission has not historically required an 
FCM/BD to maintain a level of minimum capital necessary to meet the 
aggregate of the CFTC's minimum requirement and the SEC's minimum 
requirement, which is based on the FCM/BD's securities activities.
---------------------------------------------------------------------------

    \55\ See Minimum Financial and Related Reporting Requirements 
for Futures Commission Merchants and Introducing Brokers, 69 FR 
49784 (Aug. 12, 2004).
---------------------------------------------------------------------------

    The Commission believes that the overall adequacy of the minimum 
capital requirement at an FCM-SD should be based upon the activities of 
the FCM-SD in CFTC-regulated markets. This allows the Commission to 
monitor the adequacy of the minimum capital requirements based upon its 
expertise and experience with Commission-regulated products and 
markets. In addition, an FCM-SD that is also registered as a BD would 
continue to be subject to the minimum capital requirements established 
by the SEC for BDs in addition to the minimum capital requirements 
established by the Commission for FCM-SDs. The Commission's current 
capital rule requires an FCM/BD to maintain a minimum level of capital 
that is greater than the higher of the CFTC minimum requirement for 
FCMs or the SEC minimum requirement for BDs.\56\ Therefore, an FCM-SD 
that is registered as a BD will have to maintain minimum capital in an 
amount based upon the greater of the CFTC or SEC minimum requirement. 
This would help ensure the safety and soundness of the FCM-SD by 
providing readily available financial resources to address operational, 
legal, compliance, or other risks, and, if necessary, by providing 
financial resources to assist with the orderly liquidation of the FCM-
SD in the event of its insolvency.
---------------------------------------------------------------------------

    \56\ See Commission regulation Sec.  1.17(a)(1)(i)(D) (17 CFR 
1.17(a)(1)(i)(D)).
---------------------------------------------------------------------------

    Commenters also stated that the Commission's proposed inclusion of 
the proprietary futures and proprietary cleared swap positions in an 
FCM-SD's 8% risk margin amount calculation would duplicate existing 
capital charges required under regulation 1.17.\57\ The commenters 
noted that regulation 1.17(c)(5)(x) currently requires an FCM to take a 
capital charge in an amount equal to 100% or 150% of the margin 
required by a clearing organization for proprietary futures and cleared 
swap positions \58\ in computing its adjusted net capital.\59\ Another 
commenter stated that including margin associated with proprietary 
cleared swaps in the 8% risk margin amount was not necessary as 
proprietary cleared positions present minimal credit risk to an FCM-SD 
as the only credit exposure is to a clearing organization or 
broker.\60\ The proprietary futures and cleared swaps capital charge 
also would apply to FCM-SDs under the Commission's Proposal, as FCM-SDs 
are required to comply with regulation 1.17. One commenter also stated 
that the SEC in its final rules requires a BD or SBSD to take a 
standardized capital charge for cleared security-based swaps equal to 
100% of the margin required by a clearing agency, and does not impose a 
150% charge for positions held by non-clearing BDs or SBSDs.\61\ The 
commenter stated that if the Commission adopts this capital charge, it 
should do so in a manner that is consistent with the SEC's final rule.
---------------------------------------------------------------------------

    \57\ See FIA 3/3/2020 Letter.
    \58\ Commission regulation Sec.  1.17(c)(5)(x) (17 CFR 
1.17(c)(5)(x)) currently requires an FCM that is a clearing member 
of a clearing organization to take a capital charge equal to 100% of 
the margin required by the clearing organization for the cleared 
positions. FCMs that are not clearing members are required to take a 
capital charge equal to 150% of the maintenance margin required by 
the applicable clearing organization for the cleared positions.
    \59\ See Letter from Stephen Berger, Citadel Securities (May 15, 
2017) (Citadel 5/15/2017 Letter); Letter from Mary Kay Scucci, 
Securities Industry and Financial Markets Association (May 15, 2017) 
(SIFMA 5/15/2017 Letter); Letter from Walter Lukken, Futures 
Industry Association (May 15, 2017) (FIA 5/15/2017 Letter); FIA-PTG 
5/24/2017 Letter; FIA 3/3/2020 Letter; FIA-PTG 3/3/2020 Letter.
    \60\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \61\ See IIB/ISDA/SIFMA 3/3/2020 Letter. See also, SEC rule 
15c3-1(c)(2)(vi)(O) (17 CFR 240.15c3-1(c)(2)(vi)(O)) which provides 
that capital charge for a proprietary cleared security-based swaps 
is the margin amount of the clearing agency or, if the security-
based swap references an equity security, the broker or dealer may 
take a deduction using the method specified in rule 15c3-1a (17 CFR 
240.15c3-1a).
---------------------------------------------------------------------------

    The Commission has reconsidered the Proposal and the comments 
received and is modifying final regulation 1.17(a)(1)(i)(B) to not 
include proprietary futures, foreign futures, and proprietary cleared 
swaps from the risk margin amount calculation. The Commission believes 
that the requirement for an FCM-SD to take a capital charge equal to 
100% or 150% of the required initial margin or required maintenance 
margin, as applicable, on its proprietary cleared positions adequately 
accounts for the risk associated with those positions, as it reflects 
the potential market risk presented by the positions as determined by a 
clearing organization or broker and further recognizes that the initial 
margin posted with the clearing organization or broker is no longer 
available for use in the FCM-SD's business and, thus, warrants at least 
a 100% capital charge. The market risk capital charge imposed on 
proprietary futures and cleared swaps for FCM-SDs approved to use 
capital models for market risk would be model-based and not the margin 
imposed by a clearing organization. Since a market risk charge would 
reduce the FCM-SD's capital, the Commission believes that it is 
appropriate to exclude the proprietary cleared positions from the 8% 
risk margin amount calculation.
    The Commission believes that under such circumstances it is not 
necessary to impose an additional capital requirement in the form of an 
increase in the minimum capital requirement equal to 8% of the margin 
associated with the FCM-SD's proprietary cleared futures, foreign 
futures, and swaps positions. In this regard, the Commission notes that 
an FCM-SD's credit exposure is limited on cleared positions to either a 
clearing organization or to an FCM that carries the FCM-SD's account 
(or in the case of foreign futures, a foreign broker that carries the 
FCM-SD's account). The credit exposure on such cleared positions is 
limited as clearing organizations and FCMs/foreign brokers are 
regulated entities that are generally subject to financial 
requirements, including capital, margining, and financial reporting 
requirements. Clearing organizations and FCMs/foreign brokers are also 
subject to regulations regarding the holding of customer funds to 
ensure that such funds are used solely for the benefit of the customer 
and not for the benefit of other customers or of the clearing 
organization or FCM/foreign broker.\62\ Furthermore, as noted above, an 
FCM-SD will be required to maintain a level of net capital that is 
sufficient to cover the market risk charges associated with the 
proprietary cleared futures, foreign futures, and cleared swap 
positions.
---------------------------------------------------------------------------

    \62\ See, e.g., Commission regulations Sec. Sec.  1.20, 1.22, 
and 39.15 (17 CFR 1.20, 1.22 and 39.15).
---------------------------------------------------------------------------

    The Commission is also modifying the final regulation to set the 
risk margin amount multiplier for uncleared swaps at 2% of the 
``uncleared swap margin'' amount required on such positions. The term 
``uncleared swap margin'' is defined in regulation 1.17(b)(11) to mean 
the amount of initial margin that the FCM-SD would compute on each 
uncleared swap position pursuant to the calculation requirements of 
regulation 23.154. The FCM-SD must include all uncleared swap positions 
in the

[[Page 57472]]

calculation of the uncleared swap margin amount, including uncleared 
swaps that are exempt from the scope of the Commission's margin 
regulations for uncleared swaps pursuant to regulation 23.150, exempt 
foreign exchange swaps or foreign exchange forwards, or netting set of 
swaps or foreign exchange swaps, for each counterparty, as if the 
counterparty was an unaffiliated swap dealer. Furthermore, in computing 
the uncleared swap margin amount, an FCM-SD may not reduce the 
uncleared swap margin amount to reflect the initial margin threshold 
amount or the minimum transfer amount as such terms are defined in 
regulation 23.151.\63\
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    \63\ The Commission is modifying the definition of the term 
``uncleared swap margin'' in final paragraph (b)(11) of Commission 
regulation 1.17 (17 CFR 1.17(b)(11)) to align the wording of the 
regulation to be consistent with the definition of the term 
``uncleared swap margin'' in regulation 23.100 for SDs that are not 
also registered FCMs.
---------------------------------------------------------------------------

    The Commission is modifying the risk margin amount multiplier in 
recognition that the Commission's margin requirements generally impose 
a higher margin requirement on uncleared swap positions relative to 
cleared swaps and futures positions. Minimum initial margin 
requirements for cleared futures and swap transactions are generally 
set by clearing organizations. In this regard, the FCM minimum capital 
requirement of 8% of the risk margin amount on futures and cleared 
swaps is based upon margin calculations using clearing organization 
models that require a 99% one-tailed confidence interval over a minimum 
liquidation period of one day for futures, agricultural swaps, energy 
swaps, and metal swaps, and a minimum liquidation period of five days 
for all other swaps, including financial swaps such as interest rate 
swaps.\64\ In contrast, initial margin for uncleared swaps is required 
to be calculated at a 99% one-tailed confidence interval over minimum 
liquidation period of 10 business days (or the maturity of the swap if 
shorter).\65\ The greater margin period of risk for uncleared swaps 
generally requires a higher level of initial margin, which would 
increase the FCM-SD's minimum capital requirement for uncleared swaps 
relative to cleared transactions. The modification of the final rule to 
set the risk margin amount multiplier at 2% for uncleared swap 
positions is appropriate given the generally higher initial margin 
requirements imposed on such positions under the Commission's 
regulations relative to cleared positions. In addition, as noted above, 
FCM-SD's will also be required to take market risk charges for each of 
its proprietary positions, including uncleared swaps, in computing its 
adjusted net capital.
---------------------------------------------------------------------------

    \64\ See Commission regulation Sec.  39.13(g) (17 CFR 39.13(g)).
    \65\ See Commission regulation Sec.  23.154(b)(2) (17 CFR 
23.154(b)(2)).
---------------------------------------------------------------------------

    As noted by a commenter, the 8% risk margin amount was proposed in 
2003, and subsequently adopted in 2004, based upon an analysis and 
comparison of the then existing FCM capital regime that was based on a 
percentage of the customer funds held by an FCM, with a minimum capital 
requirement based upon risk margin associated with the customer 
positions carried by the FCM.\66\ Staff also had the benefit of 
observing data of the actual performance of the two capital regimes for 
an extended period of time as each FCM was required to calculate its 
minimum capital requirement based on customer funds and its capital 
requirement based on a percentage of its risk margin amount for 
approximately two years as part of a pilot program.\67\
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    \66\ See Minimum Financial and Related Reporting Requirements 
for Futures Commission Merchants and Introducing Brokers, 68 FR 
40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004). See also, CFTC 
Division of Trading and Markets, Review of Standard Portfolio 
Analysis of Risk Margining System Implemented by the Chicago 
Mercantile Exchange, Board of Trade Clearing Corporation, and the 
Chicago Board of Trade (Apr. 2001) (``T&M 2001 Report''). See IIB/
ISDA/SIFMA 3/3/2020 Letter.
    \67\ See T&M 2001 Report.
---------------------------------------------------------------------------

    The Commission does not have the benefit of similar comprehensive 
data regarding the multiplier for the uncleared swaps risk margin 
amount at this time. However, the Commission's decision to modify the 
final rule by removing cleared and uncleared security-based swaps, as 
well as proprietary futures, foreign futures, and cleared swaps 
positions from the risk margin amount calculation, and to set the 
multiplier at 2% should mitigate many of the commenters' concerns that 
the proposed 8% risk margin amount calculation was over inclusive of 
the types of positions included in the calculation and was set at a 
percentage that was too high.
    The modification to remove proprietary futures, foreign futures, 
cleared swap, and cleared and uncleared security-based swap positions 
from the risk margin amount calculation also mitigates concerns raised 
by commenters that the capital rule ``double counts'' positions by 
requiring an FCM-SD to include such positions in its minimum capital 
requirement while also requiring the FCM-SD to take market risk and 
credit risk charges in computing its adjusted net capital. The 
modifications to the final rule also more closely aligns the 
Commission's minimum capital requirement for FCM-SDs with the approach 
adopted by the SEC for setting minimum capital requirements for BDs 
that are SBSDs and stand-alone SBSDs.
    The Commission will review within five years of the effective date 
of this rule, the impact that the 2% risk margin amount has on the 
level of minimum capital required of FCM-SDs after the compliance date 
of the rules. The Commission will use the financial statements and 
other information that it will receive from FCM-SDs under existing FCM 
financial reporting requirements to assess whether the minimum capital 
requirements for FCM-SDs are adequately calibrated to ensure their 
safety and soundness. The information that the Commission will receive 
will allow it to determine if it would be appropriate to propose 
amending the minimum capital requirement by, among other things, 
increasing or decreasing the risk margin amount multiplier.
3. Stand-Alone FCM and FCM-SD Calculation of Net Capital and Adjusted 
Net Capital
    As previously noted, the second component of the FCM and FCM-SD 
capital requirement is the computation of the firm's adjusted net 
capital based upon the assets and liabilities of the firm. Regulation 
1.17(c)(5) defines the term ``adjusted net capital'' as an FCM's 
``current assets'' (i.e., current, liquid assets excluding, however, 
most unsecured receivables), less all of the FCM's liabilities (except 
certain qualifying subordinated debt). An FCM is further required to 
impose certain prescribed capital deductions (``capital charges'' or 
``haircuts'') from the current market value of the FCM's proprietary 
positions (e.g., futures, securities, debt instruments, money market 
instruments, and commodities) in computing its adjusted net capital to 
reflect potential market risk associated with the firm's proprietary 
positions, as well as to provide a capital cushion against other 
potential risks, including liquidity, legal, and operational risk.
    Regulation 1.17(c)(5) establishes specific standardized capital 
charges for market risk for an FCM's proprietary positions in physical 
inventory, forward contracts, fixed price commitments, and securities. 
Regulation 1.17(c)(5), however, did not explicitly address market risk 
capital charges for uncleared swap or security-based swap positions. 
While FCMs have not historically engaged in a significant level of 
swaps or security-based swap transactions, the Commission has required 
FCMs to use the standardized market risk capital charges specified in 
regulation

[[Page 57473]]

1.17(c)(5)(ii), or the standardized market risk capital charges 
established by SEC rule 15c3-1 (17 CFR 240.15c3-1) (``SEC rule 15c3-
1'') for dually-registered FCM-BDs, to compute market risk capital 
charges for uncleared swap and security-based swap positions.\68\
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    \68\ For example, existing Commission regulation Sec.  
1.17(c)(5)(ii)(C) (17 CFR 1.17(c)(5)(ii)(C)) imposes a market risk 
capital charge on inventory positions held by an FCM equal to 20% of 
the market value of the inventory, and Sec.  1.17(c)(5)(ii)(G) (17 
CFR 1.17(c)(5)(ii)(G)) imposes the same market risk capital charge 
of 20% on the value of fixed price commitments and forward 
contracts. FCMs holding agricultural swaps or energy swaps have been 
required to take a market risk capital charge equal to 20% of the 
notional value of the swap under the application of either of these 
two provisions.
---------------------------------------------------------------------------

    The Commission proposed amendments to regulation 1.17(c)(5) to more 
explicitly provide for specific standardized market risk capital 
charges for an FCM's or FCM-SD's proprietary positions in uncleared 
swaps and security-based swaps.\69\ The Proposal further provided that 
an FCM or FCM-SD that obtained approval to use internal market risk 
capital models could use such models in lieu of the standardized market 
risk charges. In order to use capital models, an FCM-BD must have 
obtained SEC approval to use capital models. These dually-registered 
FCM-BDs are referred to as ``Alternative Net Capital Firms'' (``ANC 
Firms''), and are subject to enhanced minimum capital requirements as 
discussed below. An FCM which is not a BD, but also is registered as an 
SBSD would also be subject to the approval of both the Commission and 
the SEC to use models, but with lesser applicable fixed dollar net 
capital and adjusted net capital thresholds. The proposed standardized 
market risk charges and model-based charges are also discussed below.
---------------------------------------------------------------------------

    \69\ 2016 Capital Proposal, 81 FR 91252 at 91266-67.
---------------------------------------------------------------------------

a. Stand-Alone FCM and FCM-SD Standardized Market Risk Capital Charges
    FCMs currently are required to take standardized market risk 
charges for proprietary positions in computing their adjusted net 
capital under regulation 1.17. The current standardized market risk 
charges are aligned with the SEC's market risk capital charges for BDs, 
and reflect the two agencies' long-standing efforts of maintaining a 
uniform capital rule for FCMs and BDs as most FCMs are dually-
registered as BDs. In this regard, regulation 1.17 requires FCMs that 
hold positions in securities and securities-related products, such as 
U.S. Government securities, equity securities and options, municipal 
securities, commercial paper, and certificates of deposit, to take 
market risk capital charges on such positions in the manner and amount 
specified by SEC rule 15c3-1 and rule 15c3-1a (17 CFR 240.15c3-1a) 
(``SEC rule 15c3-1a''). FCMs that hold positions in commodities, 
including foreign currency and physical commodities, are required to 
take market risk capital charges set forth in Commission regulation 
1.17(c)(5). For example, regulation 1.17(c)(5) requires an FCM to take 
a capital charge equal to 0% to 20% of the market value of inventory 
depending on whether the FCM's inventory position is adequately offset 
(or ``covered'') by proprietary futures positions.\70\ The standardized 
Commission and SEC market risk capital charges are generally computed 
based upon the market value of the position multiplied by a percentage 
factor set forth in the rule or regulation.
---------------------------------------------------------------------------

    \70\ See Commission regulation Sec.  1.17(j) (17 CFR 1.17(j)) 
for the definition of the term ``cover.''
---------------------------------------------------------------------------

    Regulation 1.17 and SEC rules, however, did not provide explicit 
market risk capital charges for swaps or security-based swaps. To the 
extent an FCM engages in uncleared swap or security-based swap 
transactions, the FCM is required to take a market risk capital charge 
based upon the standardized capital charges contained in SEC rules 
15c3-1, 15c3-1a, or Commission regulation 1.17(c)(5) that are 
applicable to proprietary positions in securities, inventory, foreign 
currency, fixed price commitments, or forward contracts. For example, 
an energy swap is treated as a fixed price commitment under regulation 
1.17(c)(5), and an FCM is required to take a market risk capital charge 
equal to 20 percent of the notional value of the swap.\71\ The purpose 
of the market risk capital charge is to require an FCM, in computing 
its adjusted net capital, to reserve a minimum level of capital to 
cover potential future losses in the value of the swap.
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    \71\ For example, swaps with a reference asset of a physical 
commodity are subject to a capital charge equal to 20% of the 
notional value of the contract (See Commission regulation Sec.  
1.17(c)(5)(ii)(G) (17 CFR 1.17(c)(5)(ii)(G)).
---------------------------------------------------------------------------

    The 2016 Capital Proposal proposed amending the standardized market 
risk capital charges to explicitly reflect uncleared swap and security-
based swap positions. The Commission proposed to amend regulation 
1.17(c)(5)(iii) to provide a schedule of standardized market risk 
capital charges for positions in uncleared credit default swaps, 
interest rate swaps, foreign exchange swaps, commodity swaps, and all 
other uncleared swaps.\72\ The Commission also proposed that an FCM or 
an FCM-SD must take the applicable standardized capital charge in SEC 
rule 15c3-1, as such rule was proposed to be amended, for proprietary 
positions in uncleared security-based swaps, including uncleared 
security-based credit default swaps and equity swaps.\73\
---------------------------------------------------------------------------

    \72\ See 2016 Capital Proposal, 81 FR 91252 at 91266-67.
    \73\ The SEC proposed amending rules 15c3-1 and 15c3-1b to 
establish standardized capital charges for security-based swaps and 
swaps that would apply to stand-alone BDs and BDs that are also 
registered SBSDs. 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) (``SEC 2012 Proposed Capital Rule'').
---------------------------------------------------------------------------

    Credit default swaps are generally defined by the reference asset 
or entity, the notional amount, the duration of the contract, and 
credit events. The Commission proposed standardized market risk capital 
charges for credit default swaps using maturity grids. The ``maturity 
grid'' was based on a ``maturity grid'' approach that was proposed and 
subsequently adopted by the SEC for credit default swaps and security-
credit default swaps.\74\ Market risk capital charges for uncleared 
credit default swaps were proposed to be based on two variables under 
the 2016 Capital Proposal: (i) The length of time to maturity of the 
credit default swap; and (ii) the amount of the current offered basis 
point spread on the uncleared credit default swap. The standardized 
market risk charge for an unhedged short position in a credit default 
swap was the applicable percentage specified in the grid. The deduction 
for an unhedged long position was 50% of the applicable deduction 
specified in the grid.\75\
---------------------------------------------------------------------------

    \74\ SEC rule 15c3-1(c)(2)(vi)(P)(1) (17 CFR 240.15c3-
1(c)(2)(vi)(P)(1)).
    \75\ See proposed paragraph (c)(5)(iii)(A) of Commission 
regulation Sec.  1.17; 2016 Capital Proposal, 81 FR 91252 at 91307.
---------------------------------------------------------------------------

    The 2016 Capital Proposal also permitted an FCM to net long and 
short positions where the uncleared credit default swaps reference the 
same entity or obligation, reference the same credit events that would 
trigger payment by the seller of the protection, reference the same 
basket of obligations that would determine the amount of payment by the 
seller of protection upon the occurrence of a credit event, and are in 
the same or adjacent maturity and spread categories (as long as the 
long and short positions each have maturities within three months of 
the other maturity category). In this case, the FCM was required to 
take the specified market risk percentage deduction only

[[Page 57474]]

on the notional amount of the excess long or short position.\76\
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    \76\ See 2016 Capital Proposal, 81 FR 91252 at 91267.
---------------------------------------------------------------------------

    For uncleared interest rate swaps, the Commission proposed a 
standardized market risk capital charge approach that required 
multiplying the notional amount of the swap by a stated percent.\77\ 
The percentage that applied to the notional amount was determined by 
referencing the standardized haircuts in SEC rule 15c3-1(c)(2)(vi)(A) 
for U.S. government securities with comparable maturities to the 
interest rate swaps maturities, and would range from 0% (for interest 
rate swaps with a remaining time to maturity of less than 3 months) to 
6% (for interest rate swaps with a remaining time to maturity of 25 
years or more). The 2016 Capital Proposal further provided that an FCM 
may net certain long and short uncleared interest rate swaps to reduce 
the net notional amount of the interest rate swaps subject to the 
market risk capital charge. The net amount of the long and short 
interest rate swaps was determined based upon the existing SEC netting 
schedule for government securities, which is based upon the time to 
maturity of the interest rate swaps. For example, long and short 
interest rate swaps with maturity dates ranging between 3 years to less 
than 5 years are subject to market risk capital charge equal to 3% on 
the net long or short interest rate swap position.
---------------------------------------------------------------------------

    \77\ Id.
---------------------------------------------------------------------------

    The Proposal further provided that the market risk capital charge 
for interest rate swaps must not be less than 0.5% of the amount of the 
long position that was netted against a short position, notwithstanding 
that the netting provisions contained in SEC rule 15c3-1 does not 
impose a market risk capital charge on U.S. government securities with 
less than 3 months to maturity.\78\ The 0.5% floor on the total amount 
of the long interest rate swaps netted against the short interest rate 
swaps was designed to account for potential differences between the 
movement of interest rates on U.S. government securities and interest 
rates upon which swap payments are based.
---------------------------------------------------------------------------

    \78\ The SEC proposed minimum standardized market risk charge of 
1% of the net notional value of the interest rate swaps for SBSDs 
and 0.5% for BDs. See SEC Proposed Capital Rule, 77 FR 70214 at 
70345; Proposed rule 18a-1b(b)(2)(C) for SBSDs and proposed rule 
15c3-1b(2)(ii)(C).
---------------------------------------------------------------------------

    The Commission also proposed specific market risk capital charges 
for foreign currency swaps, commodity swaps, security-based swaps, and 
all other uncleared swaps. The Proposal requires FCM and FCM-SDs to 
take a market risk capital charge for foreign currencies swaps that is 
consistent with the standardized market risk charges for foreign 
currency positions and foreign currency forwards contained in 
regulation 1.17(c)(5). Specifically, the Commission proposed market 
risk charges equal to 6% of the notional value of a foreign currency 
swap that references euros, British pounds, Canadian dollars, Japanese 
yen, or Swiss francs. Foreign currency swaps that reference any other 
currency are subject to a market risk capital charge equal to 20% of 
the notional value of the respective swap.
    With respect to swaps referencing a physical commodity, the 
Proposal required FCM and FCM-SDs to take a market risk capital charge 
equal to 20% of the market value of the relevant commodity underlying a 
commodity swap. Consistent with the foreign currency and interest rate 
swaps, the proposed commodity swap market risk capital charge was based 
upon the existing capital charges for physical commodities set forth in 
regulation 1.17(c)(5). The Proposal further required an FCM or FCM-SD 
to take the market risk capital charges specified in SEC rules for 
security-based swaps, which would include equity swaps, and for any 
swap that has a reference asset that is subject to specific SEC market 
risk capital charges and is not otherwise subject to a Commission 
imposed capital charge.
    Commenters objected to the proposed standardized market risk 
capital charges as being too punitive and not tailored to the risk 
posed by the relevant portfolios of positions.\79\ Specifically, 
commenters noted that the proposed standardized market risk charges for 
interest rate swaps are substantially higher than the capital charges 
based on clearing house maintenance margin requirements for cleared 
interest rate futures contracts.\80\ One commenter provided a sample 
matched book portfolio of interest rate swaps demonstrating that an FCM 
would have substantially higher capital charges under the proposed 
standardized approach as compared to the model approach or as compared 
to clearing house maintenance margin requirements.\81\ These commenters 
indicated that the excessive capital requirements derived from the 
proposed standardized market risk capital charges would particularly 
impact small to mid-sized SDs that are not approved or otherwise do not 
use internal market risk capital models.\82\
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    \79\ See SIFMA 5/15/2017 Letter; Letter from Michael Sharp, 
Jefferies Group LLC (May 12, 2017) (Jefferies 5/12/2017 Letter).
    \80\ SIFMA and Jefferies each estimated that the proposed 
standardized market risk charges for uncleared interest rate swaps 
would be substantially higher than the clearing house margin 
requirements. See Id.
    \81\ See Jefferies 5/12/2017 Letter.
    \82\ See proposed Commission regulation Sec.  23.101(a)(1), 2016 
Capital Proposal, 81 FR 91252 at 91310-11. See SIFMA 5/15/2017 
Letter; Letter from Ryan Hayden, ED&F Man Derivative Products, Inc./
INTL FCStone Markets, LLC (March 3, 2020) (ED&F Man/INTL FCStone 3/
3/2020 Letter); IIB/ISDA/SIFMA 3/3/2020 Letter; FIA 3/3/2020 Letter; 
Letter from Alexander Lange, ABN AMRO Securities (USA) LLC; Michael 
Bando, ING Capital Markets LLC; Adam Hopkins, Mizuho Capital Markets 
LLC; David Moser, Nomura Holding America Inc. (January 29, 2018) 
(ABN/ING/Mizuho/Nomura 1/29/2018 Letter).
---------------------------------------------------------------------------

    Commenters also requested that the Commission reconsider the 
standardized capital charge on currency swaps.\83\ The commenters noted 
that an FCM or FCM-SD would have to take a market risk capital charge 
equal to 20% of the notional amount of an uncleared foreign currency 
non-deliverable forward contract, while the standardized (or grid-
based) initial margin requirements on such a contact is 6% of the 
notional amount.\84\ One commenter recommended that the final rule 
align the capital charge with the volatility and liquidity conditions 
of the relevant currency pair.\85\ Another commenter stated that the 
standardized capital charge is too high for a product that is highly 
liquid and recommended that the capital charge be aligned with the 
standardized initial margin requirement of 6% under the uncleared 
margin rules.\86\
---------------------------------------------------------------------------

    \83\ Letter from Stephen John Berger, Citadel Securities, March 
3, 2020 (Citadel 3/3/2020 Letter); FIA-PTG 3/3/2020 Letter.
    \84\ IIB/ISDA/SIFMA 3/3/2020 Letter; Citadel 3/3/2020 Letter.
    \85\ Citadel 3/3/2020 Letter.
    \86\ FIA-PTG 3/3/2020 Letter.
---------------------------------------------------------------------------

    Another commenter stated that a covered SD that enters into a swap 
with uncleared swap contracts containing a flip-clause should require a 
charge for required margin on such contract plus market risk.\87\
---------------------------------------------------------------------------

    \87\ Letter from William Harrington (3/3/2020) (Harrington 3/3/
2020 Letter).
---------------------------------------------------------------------------

    The Commission acknowledged in the 2019 Capital Reopening that the 
proposed standardized market risk charges would impact FCMs, FCM-SDs, 
and covered SDs that do not have approval to use internal market risk 
capital models, which are more likely to be smaller to mid-sized firms 
that may not be part of a financial group that has the approval of the 
SEC, a prudential regulator, or a foreign regulator to use internal 
capital models. The Commission further believed that establishing a 
more appropriate market risk capital charge for uncleared interest

[[Page 57475]]

rates swaps, in particular, given the relatively high market risk 
capital charge would benefit market participants by encouraging smaller 
to mid-sized FCMs, FCM-SDs, and covered SDs to remain in the market or 
to enter the market. Accordingly, the Commission requested further 
comment on the proposed standardized market risk charge for uncleared 
interest rate swaps. The Commission also noted that the SEC's final 
capital rule for BDs and SBSDs imposed a minimum capital requirement 
for uncleared interest rate swaps equal to \1/8\ of one percent 
(0.125%) and only applicable to the matched long position that is 
netted against a short position in the case of a uncleared interest 
rate swap with a maturity of three months or more.\88\
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    \88\ See 2019 SEC Final Capital Rule, rule 18a-
1b(b)(2)(ii)(A)(3) (17 CFR 240.18a-1b(b)(2)(ii)(A)(3) for SBSDs and 
rule 15c3-1b(b)(2)(ii)(A)(3) (17 CFR 240.15c3-1b(b)(2)(ii)(A)(3)) 
for BDs.
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    The Commission has considered the comments and is adopting the 
proposed standardized market risk charges for uncleared swaps and 
uncleared security-based swaps as proposed, with several modifications 
that are discussed below. The standardized market risk capital charges 
being adopted are generally based on existing Commission and SEC 
standardized market risk charges for positions in foreign currencies, 
commodities, U.S. treasuries, equities and other instruments, which, in 
the Commission's long experience, have generally proven to be effective 
and appropriately calibrated to address potential market risk in the 
positions. The Commission believes at this time that this approach, in 
conjunction with other charges discussed herein, appropriately accounts 
for the wide variety of possible uncleared swap transactions that FCMs, 
FCM-SDs, and covered SDs may engage in, including bespoke swap 
transactions involving flip-clauses or other unique features. Overtime, 
the Commission may consider adjusting these charges as a result of 
experience with their impacts on required capital in these firms and as 
market developments may warrant.
    In response to several commenters, the Commission recognizes that 
standardized market risk charges are not as risk sensitive as market 
risk models, and generally result in higher market risk capital charges 
than internal models. The Commission notes, however, the lower capital 
charges for firm's approved to use market risk model is one of the 
reasons that model approved firms are subject to the higher minimum 
capital requirements. As noted in section II.B.2.a. above, FCM-SDs that 
are approved to use internal market risk models are required to 
maintain net capital of at least $100 million and adjusted net capital 
of $20 million, while FCM-SDs that are not approved to use internal 
market risk models are required to maintain $20 million of adjusted net 
capital, but are not subject to the $100 million dollar net capital 
requirement. The imposition of $100 million net capital requirement is 
to provide protection for potential model errors or the failure of the 
models to address all applicable risks. The Commission believes that it 
is appropriate to require FCM-SDs that do not use internal models and 
therefore have a lower capital requirement to be subject to the higher 
standardized market risk capital charges. The approach is also 
consistent with the approach adopted by both the Commission and SEC 
with respect to ANC Firms that have been approved to use internal 
capital models and, which under the 2019 SEC Final Capital Rule, are 
subject to a minimum capital requirement of $5 billion of tentative net 
capital and $1 billion of net capital.\89\
---------------------------------------------------------------------------

    \89\ SEC rule 15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)).
---------------------------------------------------------------------------

    In addition, the Commission believes that FCM-SDs will seek 
approval to use model-based market risk charges. There currently are 
four FCM-SDs provisionally-registered with the Commission. Each of the 
FCM-SDs is an ANC Firm that is approved to use market risk capital 
models and, which under the 2019 SEC Final Capital Rule, is subject to 
the SEC's minimum capital requirement of $5 billion of tentative net 
capital and $1 billion of net capital. In order to effectively compete 
with the existing FCM-SDs and other covered SDs, any new FCM-SD 
registrant would need to obtain model approval.
    The Commission is also modifying the final regulation by reducing 
the minimum capital charge for a portfolio of interest rate swaps to 
align with the SEC's final capital requirement for BD's and SBSD's 
using standardized capital charges. In reviewing the comments, the 
Commission realizes that the standardized market risk charges for 
interest rate swaps that it proposed in its 2016 Capital Proposal was 
too high relative to the market risk of the positions. The Proposal's 
imposition of a minimum market risk capital charge of .5% of the 
notional amount of the matched long interest rate swaps has been shown 
by commenters to be poorly calibrated to the market risk of the 
positions. Therefore, under the final regulation, an FCM-SD or FCM is 
required to take a capital charge of at least \1/8\ of one percent 
(0.125%) of the matched long interest rate swap positions that is 
netted against a short interest rate swap positions with a maturity of 
three months or more. The Commission believes that in making this 
change, the overall effect on the amount of capital held by an FCM or 
an FCM-SD will not have a substantial adverse impact on the safety and 
soundness of these entities. The Commission, however, will monitor the 
standardized capital charges and refine the percentages as it obtains 
experience with the level of interest rate swaps transactions entered 
into by stand-alone FCMs and FCM-SDs and magnitude of the market risk 
charges on such positions.
    The Commission is also making a technical modification to the final 
capital rule for credit default swaps. As noted in the 2019 Capital 
Reopening, the 2019 SEC Final Capital Rule includes the same 
standardized capital charges for credit default swaps for BDs and SBSDs 
as proposed by the Commission for FCMs, FCM-SDs, and covered SDs. There 
is a slight difference between the Commission's Proposal and the SEC's 
final rule, however, in applying the capital charges based upon the 
time to maturity. Specifically, the maturity grids differ by one month, 
and there are some slight changes to the rule text. The Commissions is 
modifying the time to maturity grids and the wording in the final rule 
to align with the SEC's final rule to avoid having dually-registered 
entities being subject to slightly different regulatory requirements 
with respect to market risk charges for credit default swaps. The 
Commission believes that this modification will have no material impact 
on its capital requirements.
    The Commission is also modifying the final rule to provide that an 
FCM or FCM-SD may reduce market risk charges for uncleared swap 
positions, other than credit default swaps which as proposed provided 
for netting, to account for comparable offsetting positions.\90\ The 
Commission noted in the 2019 Capital Reopening that the SEC adopted a 
netting proviso applicable to both BDs and SBSDs, permitting a 
reduction of the resulting market risk capital charge by an amount 
equal to any reduction recognized for comparable long or short 
positions in the reference asset or interest rate under

[[Page 57476]]

regulation 1.17 or SEC rule 15c3-1.\91\ For example, an FCM or FCM-SD 
that is required to take market risk charges on equal and opposite legs 
of a portfolio of foreign currency swaps is permitted to net the market 
risk charges on the long and short positions to the extent that the 
positions are comparable.
---------------------------------------------------------------------------

    \90\ See paragraph (c)(5)(iii)(D) of Commission regulation Sec.  
1.17, as amended (17 CFR 1.17(c)(5)(iii)(D)).
    \91\ SEC rule 15c3-1b(b)(2)(ii)(B) (17 CFR 240.15c3-
1b(b)(2)(ii)(B)) for BDs and rule 18a-1b(b)(2)(ii)(B) (17 CFR 
240.18a-1b(b)(2)(ii)(B)) for SBSDs.
---------------------------------------------------------------------------

    The Commission stated in the 2019 Capital Reopening that it 
intended to maintain consistency with the 2019 SEC Final Capital Rule 
with respect to the applicability of the standardized market risk 
charges for uncleared currency and commodity swaps, and requested 
comment on including the same netting proviso to regulation 
1.17(c)(5)(iii).\92\ Commenters to the 2019 Capital Reopening generally 
supported the netting provision.\93\ One commenter stated that such an 
approach would be consistent with common and current risk management 
practices and would allow non-financial SDs to be more responsive to 
customer needs.\94\
---------------------------------------------------------------------------

    \92\ See 2019 Capital Reopening, 84 FR 69664 at 69672.
    \93\ See Citadel 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 
Letter; Letter from Alexander Holtan, Commercial Energy Working 
Group (March 3, 2020) (CEWG 3/3/2020 Letter); Letter from Sebastian 
Crapanzano and Soo-Mi Lee, Morgan Stanley (March 3, 2020) (MS 3/3/
2020 Letter).
    \94\ See Citadel 3/3/2020 Letter page 5.
---------------------------------------------------------------------------

    The Commission believes that it is appropriate that an FCM or an 
FCM-SD be permitted to net offsetting swap positions in computing the 
market risk on the portfolio of swap positions in an identical fashion 
as the SEC has adopted for BDs and SBSDs. Otherwise, the capital rule 
would require individual capital charges on each swap position without 
any consideration of the actual risk of the positions. Such an approach 
would discourage FCMs or FCM-SDs from hedging their exposures and from 
participating in the swaps market. The ability to net offsetting 
positions in computing market risk is also a fundamental approach that 
has been adopted by other regulators including the SEC, prudential 
regulators, and others. Therefore the Commission is adopting the 
netting provision as set forth at regulation 1.17(c)(5)(iii)(D).
    FCMs currently are required by regulation 1.17(c)(5)(x) to take 
standardized capital charges on proprietary cleared futures and cleared 
swap positions. The capital charge is equal to 100% of the margin 
requirement imposed by the clearing organization on the positions if 
the FCM is a clearing member of such clearing organization. For FCMs 
that are not clearing members of the clearing organization that clears 
the positions, the capital charge is equal to 150% of the applicable 
maintenance margin requirement of the applicable board of trade or 
clearing organization, whichever is greater. FCM-SDs also are subject 
to these capital charges as such firms must comply with the FCM capital 
requirements set forth in regulation 1.17.
    Several commenters requested that the Commission eliminate the 
requirement for an FCM to take capital charges equal to 150% of the 
margin for proprietary futures or cleared swap positions. One commenter 
stated that there is no justification for a higher capital charge as 
market risk is independent of whether the firm is or is not a clearing 
firm.\95\ This commenter also noted that the SEC's final capital rules 
for SBSDs impose a capital requirement for proprietary cleared 
positions equal to 100% of the required clearing organization margin, 
and do not require a non-clearing SBSD to take a higher capital charge 
of 150% of required margin.\96\ Another commenter stated that there is 
no justification for assessing covered SDs that are non-clearing 
members the higher 150% charge and imposing such a requirement is 
placing the SDs at an unnecessary competitive disadvantage. The 
commenter recommended that all SDs should be able to take a 
standardized market risk charge equal to the clearing organizations' 
margin requirement.\97\
---------------------------------------------------------------------------

    \95\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \96\ Id.
    \97\ See FIA-PTG 3/3/2020 Letter.
---------------------------------------------------------------------------

    The Commission has considered the Proposal and comments and is not 
revising regulation 1.17(c)(5)(x). The capital requirement for FCMs to 
take a capital charge for cleared proprietary positions has been in 
place for many years. The higher capital charge for non-clearing FCMs 
takes into consideration that such firms are not subject to heightened 
capital and other requirements that are imposed by clearing 
organizations on clearing members. FCM clearing members also are 
required to post guarantee fund contributions to clearing organizations 
to support their financial obligations, and are subject to clearing 
organization assessment authority in the event that a shortfall results 
from the default of a fellow clearing member. The higher capital charge 
for non-clearing FCMs and FCM-SDs is intended to ensure that such firms 
retain an appropriate level of capital and liquid resources to meet 
their financial obligations, including to their carrying FCMs and 
ultimately to clearing organizations, and the Commission believes that 
the 150% capital charge is appropriate to help ensure the safety and 
soundness of the FCM or FCM-SD.
b. FCM and FCM-SD Standardized Counterparty Credit Risk Capital Charges
    FCMs currently are required to take standardized capital charges to 
reflect counterparty credit risk associated with uncleared swap and 
security-based swap positions. The Commission's capital rule requires 
an FCM that holds swap or security-based swap positions to mark the 
positions to their respective fair market values in their financial 
records.\98\ Swap and security-based swap positions that have mark-to-
market losses result in the FCM recognizing variation margin payables 
to swap and security-based swap counterparties. Such losses reduce the 
FCM's capital either by the payment of variation margin or the 
recognition of a liability. Swap and security-based swap positions that 
have mark-to-market gains result in the FCM recognizing variation 
margin receivables from the swap and security-based swap 
counterparties. The variation margin receivables, however, are subject 
to a 100% counterparty credit risk capital charge unless the 
receivables are secured by readily marketable collateral.\99\
---------------------------------------------------------------------------

    \98\ Commission regulation Sec.  1.17(c)(1) (17 CFR 1.17(c)(1)).
    \99\ See Commission regulation Sec.  1.17(c)(1) and (2) (17 CFR 
1.17(c)(1) and (2)), which defines the term ``net capital'' and 
requires an FCM to include unrealized gains and losses in the 
computation of net capital, and further provides that an FCM must 
generally exclude unsecured receivables (including unsecured 
receivables from swap and security-based swap counterparties).
---------------------------------------------------------------------------

    The Commission proposed to retain the 100% counterparty credit risk 
charges for unsecured receivables from swap and security-based swap 
counterparties in the Proposal, and further proposed extending this 
treatment to FCM-SDs. The Proposal further imposed the 100% 
counterparty credit risk treatment applied to all swap and security-
based swap counterparties of the FCM or FCM-SD, including commercial 
end users, that are exempt from the requirement to exchange variation 
margin.\100\ The FCM or FCM-SD also would be required to take a 100% 
capital charge on unsecured receivables resulting from transactions 
that are exempt from the margin requirements, including legacy swap and 
security-based swap transactions and foreign exchange forward and swap

[[Page 57477]]

transactions, as well as any receivables from counterparties that are 
subject to a $500,000 minimum transfer amount.\101\
---------------------------------------------------------------------------

    \100\ See Commission regulation Sec.  23.150 (17 CFR 23.150).
    \101\ Commission regulation Sec.  23.153 (17 CFR 23.153), 
provides that a covered SD is not required to collect or post 
variation margin with a particular swaps counterparty until the 
combined initial and variation margin required to be exchanged with 
the counterparty exceeds $500,000.
---------------------------------------------------------------------------

    The Commission proposed the 100% capital charge on unsecured 
receivables from swap and security-based swap counterparties as it is 
was consistent with the Commission's general approach of requiring an 
FCM to exclude unsecured receivables from its adjusted net capital. As 
noted above, the Commission's capital rule focuses on the liquidity of 
the FCM and unsecured receivables do not reflect a liquid asset to the 
FCM that it may use in order to meet its own financial obligations.
    The Proposal effectively required an FCM or FCM-SD that did not 
have approval to use models to compute counterparty credit risk to take 
a 100% capital charge for unsecured receivables due from swap and 
security-based swap counterparties. This would include counterparties 
that are not obligated to exchange variation margin with the FCM or 
FCM-SD, including commercial end users, affiliates, and counterparties 
engaging foreign exchange swaps as the term is defined in regulation 
23.151.
    FCM-SDs are also subject to the Commission's margin rules for 
uncleared swap transactions and may be directly or indirectly subject 
to the SEC's margin rules for uncleared security-based swaps. Under the 
Commission's margin rules, an FCM-SD is generally required to post 
initial margin for uncleared swap transactions entered into with other 
SDs or financial end users with a third-party custodian and may post 
initial margin with the custodian for security-based swaps. Stand-alone 
FCMs that engage in swaps and security-based swaps also may be 
obligated or elect to post initial margin for such transactions with a 
third-party custodian in accordance with the Commission's or the SEC's 
respective uncleared swap and security-based swap margin rules. Such 
deposits would generally be treated under the Commission's capital rule 
as an unsecured receivable from the third-party custodian, and subject 
to a 100% capital charge.
    The Commission proposed to amend regulation 1.17(c)(2)(ii)(G) to 
permit an FCM or an FCM-SD to include initial margin funds it deposited 
with third-party custodians for uncleared swaps and uncleared security-
based swaps in its capital computation, provided that the margin is 
held in accordance with the requirements established by the applicable 
Commission or SEC margin rules.\102\ The Commission proposed to permit 
FCMs and FCM-SDs to include initial margin posted with third-party 
custodians as capital in recognition that the Commission's capital 
rules require an FCM-SD or stand-alone FCM to post initial margin for 
their uncleared swap transactions with third-party custodians to ensure 
that the FCM-SD or FCM meets its financial obligations to swap 
counterparties. The Commission also believes that the FCM-SD has 
minimal credit risk from the third-party custodian as the Commission's 
margin regulations require that the FCM-SD enter into a custodial 
agreement with the third-party custodian that prohibits the custodian 
from rehypothecating, repledging, reusing, or otherwise transferring 
(including though repurchase agreements) the collateral held by the 
custodian.\103\ The custodial agreement also must be a legal, valid, 
binding, and enforceable agreement under the laws of all relevant 
jurisdictions including in the event of a bankruptcy, insolvency, or 
similar proceeding.\104\
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    \102\ See 2016 Capital Proposal, 81 FR 91252 at 91306-07, 
proposed paragraph (c)(2)(ii)(G) of Commission regulation Sec.  
1.17.
    \103\ See Commission regulation Sec.  23.157 (17 CFR 23.157).
    \104\ Id.
---------------------------------------------------------------------------

    The Commission is adopting the amendment to regulation 
1.17(c)(2)(ii)(G) to permit FCMs and FCM-SDs to recognize margin posted 
with a third-party custodian for swap and security-based swap 
transactions as a current asset in computing their adjusted net 
capital. In order to qualify as a current asset, the initial margin 
must be deposited by the FCM or FCM-SD with a third-party custodian in 
accordance with the requirements specified in the Commission's 
uncleared swap margin rules set forth in regulations 23.150 through 
23.161, or the SEC's uncleared security-based swap margin rules. The 
Commission is modifying the final regulation to clarify that initial 
margin posted by an FCM or FCM-SD with third-party custodians for 
uncleared swaps or uncleared security-based swaps entered into with 
bank SDs subject to the margin rules of a prudential regulator and 
entered into with foreign registered SDs that operate in a jurisdiction 
that has received a margin Comparability Determination by the 
Commission under regulation 23.160 also may be recognized as a current 
asset in computing adjusted net capital.
    The Commission also proposed to require an FCM-SD to take a capital 
charge to reflect undermargined uncleared swap positions with a 
counterparty.\105\ A capital charge for undermargined positions 
protects the FCM-SD by ensuring that it maintains capital to cover 
potential future credit exposure to swap counterparties, which is 
consistent with the statutory objective of ensuring the safety and 
soundness of the FCM-SD. The proposed undermargined capital charge 
further provided that an FCM-SD could reduce the amount of the capital 
charge by any amount owed by the FCM-SD to the counterparty resulting 
from uncleared swap transactions. The undermargined capital charge for 
uncleared swap positions is consistent with existing Commission 
undermargined capital charges for customer and noncustomer futures, 
foreign futures, and cleared swap accounts carried by an FCM.\106\ The 
Commission did not receive comments on the proposed capital charges, 
and is adopting the undermargined capital charges with modifications as 
discussed below.
---------------------------------------------------------------------------

    \105\ Proposed paragraph (c)(5)(xv) of Commission regulation 
Sec.  1.17 did not specifically impose undermargined capital charges 
for security-based swaps. See 2016 Capital Proposal, 81 FR 91252 at 
91308. Such charges, however, are applicable to an FCM-SD under 
Commission regulation Sec.  1.17(b)(1) (17 CFR 1.17(b)(1)), which 
provides that an FCM (including an FCM-SD) that has an asset or 
liability defined in the capital rules of the SEC shall treat such 
assets or liabilities for capital purposes in accordance with the 
rules of the SEC, provided that the Commission did not define a 
specific capital treatment in regulation 1.17.
    \106\ See Commission regulation Sec.  1.17(c)(5)(viii) and (ix) 
for undermargined capital charges for customer and noncustomer 
futures, foreign futures, and cleared swap accounts.
---------------------------------------------------------------------------

    The Commission is modifying final paragraph (c)(5)(xv) of 
regulation 1.17 by adopting two separate paragraphs. Final regulation 
1.17(c)(5)(xv) requires an FCM-SD to take a capital charge in an amount 
necessary for a swap counterparty or security-based swap counterparty 
to meet its respective Commission margin requirement for uncleared swap 
positions and the SEC margin requirement for uncleared security-based 
swap transactions to the SD. The final regulation would apply only to 
uncleared swaps and uncleared security-based swaps that are subject to 
the Commission's or SECs' margin requirements under applicable 
regulations. The final regulation further provides that the FCM-SD may 
reduce the amount of the undermargined charge to reflect calls for 
margin issued by the FCM-SD to the counterparty that are outstanding 
within the respective time frames established in the margin rules of 
the Commission and SEC, as applicable, to collect margin from a 
counterparty. This provision replaces

[[Page 57478]]

the proposed language in regulation 1.17(c)(5)(xv) that would have 
permitted a covered SD to reduce the undermargined capital charge by 
any amount owed by the counterparty to the SD. The modified provision 
more accurately reflects the process of an SD calling for outstanding 
margin and is consistent with the undermargined capital charges for an 
FCM carrying customer and noncustomer accounts and the undermargined 
capital charge adopted by the SEC for SBSDs.
    Final regulation 1.17(c)(5)(xvi) requires an FCM-SD to take a 
capital charge for uncleared swaps and uncleared security-based swaps 
that are exempt or excluded from the Commission's or SEC's margin 
requirements, such as commercial end users and transactions entered 
into prior to the compliance date of the margin regulations (i.e., 
legacy swaps). In this regard, swaps entered into prior to the Phase 6 
uncleared margin compliance date or with excluded counterparties for 
which no margin has been collected are treated no differently than 
other uncollateralized exposures under the Commission's rules. Such 
treatment for capital purposes of these counterparty exposures is 
consistent with the capital rules of both the SEC and prudential 
regulators as applied to their respective registrants.\107\ The final 
regulation further provides that the FCM-SD may reduce the amount of 
the undermargined capital charge by any funds deposited by the 
counterparty to margin its swaps or security-based swap positions. 
These deposits would include funds deposited by the counterparty and 
held by third-party custodians or held by the FCM directly.
---------------------------------------------------------------------------

    \107\ See, e.g., SEC rule 18a-1(c)(1)(viii) (17 CFR 240.18a-
1(c)(1)(viii)).
---------------------------------------------------------------------------

    The Commission also modified the final rule text to clarify that 
the undermargined swap capital charges in regulation 1.17(c)(5)(xv) and 
(xvi) are applicable only to FCM-SDs and not FCMs, as FCM-SDs are 
subject to the Commission's margin requirements for uncleared swap 
transactions. Stand-alone FCMs, however, are not directly subject to 
the Commission's uncleared swap margin requirements as they are not 
SDs. Final regulations 1.17(c)(5)(xv) and (xvi) also have been modified 
to align the regulatory text more closely with the comparable SEC rule 
text requiring SBSDs to take capital charges for undermargined 
uncleared security-based swap and uncleared swaps positions from 
counterparties.\108\ As noted above, the final regulation is designed 
to help ensure the safety and soundness of the FCM-SD by requiring the 
firm to reserve capital in the event a counterparty defaults on its 
swaps and security-based positions that are undermargined.
---------------------------------------------------------------------------

    \108\ See SEC rule 18a-1(c)(viii) (17 CFR 240.18a-
1(c)(1)(viii)).
---------------------------------------------------------------------------

    The Commission also requested comment on whether FCM-SD's or 
covered SD's should be permitted to recognize alternative forms of 
collateral (e.g., letters of credit and liens) provided by commercial 
end-users that are exempt from clearing and from the uncleared margin 
requirements in computing the FCM-SD's or SD's counterparty credit risk 
charges for uncleared swap transactions.\109\ Several commenters 
supported such alternative or non-financial collateral. One commenter 
stated that alternative forms of collateral, such as parent guarantees, 
letters of credit, or liens on assets are frequently used by SDs as 
credit risk mitigants when non-financial end-users do not post cash 
collateral on uncleared derivatives.\110\ The commenter stated that 
allowing FCM-SDs to recognize alternative forms of collateral in 
computing credit risk charges is consistent with Congressional intent 
that FCM-SD capital requirements should not be punitive to end-users. 
This commenter further stated that permitting FCM-SDs to recognize non-
cash collateral as a credit risk mitigant is consistent with the 
prudential regulators' final rule on the standardized approach to 
counterparty credit risk (``SA-CCR''), which provides that banks may 
take into account non-cash collateral in computing credit risk charges 
for OTC derivatives. Another commenter stated that non-cash collateral 
allows for the value of the commercial market participant's assets 
making it an effective method for satisfying credit requirements 
without unnecessarily setting aside capital from a productive use.\111\ 
One commenter also stated that the Commission could require FCM-SD's to 
appropriately haircut non-cash collateral to address the general 
illiquid nature of non-cash collateral.\112\
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    \109\ See 2019 Capital Reopening, at 69681.
    \110\ See CEWG 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter; Shell 
3/3/2020 Letter.
    \111\ See NCGA/NGSA 3/3/2020 Letter.
    \112\ See Shell 3/3/2020 Letter.
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    The Commission has considered the comments and is not modifying the 
credit risk charges to recognize non-cash collateral. Margin provides 
an FCM-SD or a covered SD with protection from a potential counterparty 
default. In a default situation, non-financial collateral may not be 
immediately available, or the collateral may be available but may take 
time to liquidate. This may exacerbate potential losses to the FCM-SD 
or covered SD or expose such firms to additional risk by, for example, 
leaving them exposed to the market risk of cash market positions that 
were being hedged by the swap. While the Commission is not modifying 
the final rules to reflect non-cash collateral, it will continue to 
monitor and assess FCM-SD's and covered SD's acceptance of non-cash 
collateral from commercial end-users and consider possible revisions to 
its rules after it gains further experience with the capital condition 
of such firms.
c. Model-Based Market Risk and Counterparty Credit Risk Capital Charges
(i) FCMs That Are SEC-Registered ANC Firms
    Commission regulation 1.17(c)(6) permits an FCM that is dually-
registered with the SEC as a BD to use internal models to compute 
market risk and credit risk capital charges in lieu of standardized 
capital charges in computing its adjusted net capital under Commission 
regulation 1.17 provided that the SEC has approved the FCM/BD's use of 
such models for computing net capital under SEC rule 15c3-1. The SEC 
has approved certain FCM/BDs to use internal models to compute market 
risk capital charges for proprietary positions in securities, debt 
instruments, futures, security-based swaps and swaps in lieu of 
standardized capital charges contained in SEC rules 15c3-1 or 15c3-1b. 
The SEC also has approved the use of internal models to compute credit 
risk charges associated with exposures from swap and security-based 
swap counterparties in lieu of the standardized 100% unsecured 
receivable capital charges. As noted in section II.B.3. above, these 
FCM/BDs are referred to as ANC Firms. Five FCMs currently are ANC 
Firms, with four of the firms also provisionally-registered SDs.
    Regulation 1.17(c)(6) requires an ANC Firm to file a notice with 
the Commission in order to use the SEC's approved capital models. The 
notice must include the SEC's approval order and other information, 
including: (i) A list of the categories of positions that the ANC Firm 
holds in its proprietary accounts, and, for each such category, a 
description of the methods that the ANC Firm will use to calculate its 
deductions for market risk and credit risk, and also, if calculated 
separately, deductions for specific risk; (ii) a description of the 
value at risk (VaR) models to be used for its market risk and credit 
risk

[[Page 57479]]

deductions, and an overview of the integration of the models into the 
internal risk management control system of the ANC Firm; (iii) a 
description of how the ANC Firm will calculate current exposure and 
maximum potential exposure for its deductions for credit risk; (iv) a 
description of how the futures commission merchant will determine 
internal credit ratings of counterparties and internal credit risk 
weights of counterparties, if applicable; and (v) a description of the 
estimated effect of the alternative market risk and credit risk 
deductions on the amounts reported by the ANC Firm as net capital and 
adjusted net capital. Further qualitative and quantitative requirements 
for such market risk and credit risk models are discussed in section 
II.C.6. of this release.
    ANC Firms also are subject to heightened SEC capital requirements 
as a condition of using the capital models. The 2019 SEC Final Capital 
rule requires an ANC Firm, including an FCM that is dually-registered 
as an ANC Firm, to maintain tentative net capital of at least $5 
billion and net capital of not less than the greatest of $1 billion or 
the sum of (i) 2% of the risk margin amount associated with customer 
cleared security-based swaps and uncleared security-based swaps and 
(ii) the aggregate indebtedness of the ANC Firm or 2% of the aggregate 
debit items computed in accordance with the Formula for Determination 
of Reserve Requirements for Brokers and Dealers (Exhibit A to rule 
15c3-3).\113\ The 2019 SEC Final Capital rule also requires an ANC Firm 
to provide the SEC, and CFTC if dually-registered as an FCM, with a 
written notice if its tentative net capital falls below $6 
billion.\114\
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    \113\ See 2019 SEC Final Capital Rule, 84 FR 43872 at 43874; 17 
CFR 240.15c3-1(a)(7). All ANC firms currently use the 2% aggregate 
debit item financial ratio (the ``alternative standard'') under rule 
15c3-1(a)(1)(ii).
    \114\ Id.
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    The Commission proposed to retain the above notice and filing 
process to permit ANC Firms that register as FCMs or FCM-SDs to use the 
SEC-approved internal capital models in lieu of the standardized market 
risk and credit risk capital charges in computing their adjusted net 
capital under regulation 1.17. Currently, only four of the 56 
provisionally-registered covered SDs are FCMs, and each of the FCM-SDs 
is an ANC Firm with capital model approval from the SEC. Accordingly, 
such FCM-SDs will be required to maintain tentative net capital of no 
less than $5 billion and net capital of no less than $1 billion upon 
the compliance date of the 2019 SEC Final Capital Rule.\115\ The 
Commission is electing to retain regulation 1.17(c)(6) to permit ANC 
Firms to engage in swap and security-based swap transactions under the 
existing regulatory structure, including the SEC's revised minimum 
capital requirements, as it believes that the minimum capital 
requirements are adequately designed to help ensure the safety and 
soundness of the FCM-SD.
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    \115\ The Commission's term ``net capital'' is equivalent to the 
SEC's term ``tentative net capital'' and the Commission's term 
``adjusted net capital'' is equivalent to the SEC's term ``net 
capital.'' The term ``tentative net capital'' is generally defined 
as an entity's assets less liabilities (excluding certain qualifying 
subordinated debt), and ``net capital'' as tentative net capital 
less certain capital deductions such as market risk and credit risk 
deductions. See 17 CFR 240.18a-1.
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(ii) Market Risk and Credit Risk Capital Models for FCM-SDs That Are 
Not SEC-Registered BDs
    The Commission proposed amending regulation 1.17(c)(6) to permit 
FCM-SDs that are not SEC registered BDs to apply to the Commission, or 
an RFA of which the FCM-SD is a member, for approval to use internal 
market risk or credit risk models in lieu of the standardized capital 
charges. If an FCM or covered SD is also a registered BD, it may only 
use market risk and credit risk capital models if the SEC has approved 
such firm to use such models and the firm meets the capital 
requirements of an ANC Firm. Therefore, the Commission's proposal to 
extend the use of capital models to FCM-SDs is only applicable to FCM-
SDs that are not registered with the SEC as BDs. The purpose of the 
amendment proposed in regulation 1.17(c)(6) was to provide FCM-SDs that 
were not dually-registered as BDs with the ability to use internal 
capital models in lieu of the standardized capital charges and to 
establish a mechanism for the FCM-SDs to obtain approval for such 
models. FCM-SDs that may also be registered as SBSDs or OTC Derivatives 
Dealers but not BDs would also be able to use this provision with 
respect to the use of models; however, they would separately need to 
obtain the SEC's approval to use models as registered SBSDs and OTC 
Derivatives Dealers. While currently the only FCMs that are 
provisionally-registered as SDs are the four ANC Firms, the Commission 
believed that other stand-alone FCMs may register as SDs and that the 
regulations should provide an opportunity for such firms to use capital 
models to compute market and credit risk.
    Proposed regulation 1.17(c)(6)(v) required an FCM-SD to apply in 
writing, and further required that the market risk and credit risk 
models contain specified qualitative and quantitative requirements 
proposed to be established by the Commission in new regulation 23.102 
and Appendix A to regulation 23.102.\116\ The qualitative and 
quantitative requirements for the FCM-SD's models are comparable to the 
existing SEC model requirements for ANC Firms and non-BD SBSDs, and the 
Commission's proposed model requirements for covered SDs. The 
qualitative and quantitative requirements for the capital models are 
discussed in detail in section II.C.6. of this release.
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    \116\ Please note that due to changes in Federal Register 
publication requirements, the appendix that had been referred to as 
Appendix A to section 23.102 in previous documents is being 
published in this final rule as Appendix A to Subpart E of Part 23.
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    The Commission also proposed enhanced fixed-dollar minimum capital 
requirements as a condition for an FCM-SD to obtain capital model 
approval. Specifically, the Commission proposed that FCM-SDs must 
maintain net capital of no less than $100 million and adjusted net 
capital of no less than $20 million in order to use capital models. The 
$100 million net capital requirement was in recognition that model-
based capital charges are generally substantially lower than the 
Commission's standardized capital charges, and that models may not 
fully capture all risks at all times.\117\ The minimum fixed-dollar 
capital requirement is also consistent with the Commission's proposed 
minimum fixed-dollar capital requirement for covered SDs, and is 
consistent with the SEC's minimum fixed-dollar capital requirement for 
OTC derivative dealers and non-BD SBSDs.\118\
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    \117\ See section II.B.2.a. above for a discussion of the fixed-
dollar minimum capital requirements for FCM-SDs.
    \118\ See sections II.C.2.a. and II.C.3.a. of this release for a 
discussion of the Commission's minimum capital requirements for 
covered SDs. See SEC rule 15c3-1(a)(5) (17 CFR 240.15c3-1(a)(5)) for 
minimum capital requirements for OTC Derivative Dealers that are not 
SBSDs and rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)) for SBSDs that 
are not BDs, other than OTC Derivatives Dealers.
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    The proposed $100 minimum fixed-dollar amount of net capital for 
FCM/SDs, however, is not consistent with the SEC's current approach for 
ANC Firms or SBSDs/ANC Firms approved to use internal models. As noted 
above, ANC Firms are subject to minimum fixed-dollar tentative net 
capital requirement of $5 billion, and a minimum fixed-dollar net 
capital requirement of $1 billion. The Commission stated in the 
Proposal that it believed that FCM/SDs that are not BDs do not raise 
the same types of risks as ANC Firms that would

[[Page 57480]]

warrant a $5 billion minimum tentative net capital requirement. The 
Commission noted that ANC firms represent the largest BDs and are 
engaged in significant brokerage businesses including providing 
customer financing for securities transactions, engaging in repurchase 
transactions and other activities. FCMs generally have limited 
proprietary futures trading and operate primarily as market 
intermediaries for customers trading futures and foreign futures 
transactions. In this capacity, FCMs receive and hold customer funds in 
segregated accounts that are used to satisfy the customers' financial 
obligations to clearing organizations. Even in their capacity as SDs, 
the margin regulations mitigate the risks to and from the FCM as they 
generally are required to exchange variation margin on swaps on a daily 
basis with all other SDs and financial end users, and to post and 
collect initial margin with counterparties that are SDs and financial 
end users.
    The Commission did not receive specific comments on the use of 
models by FCM-SDs that are not ANC Firms. The Commission has considered 
the issue and is adopting the proposed amendment to regulation 
1.17(c)(6) to provide a model approval process for FCM-SDs that are not 
BDs substantially as proposed, but with a modification to not adopt the 
proposed liquidity requirement and also to comport with the final model 
process requirements for covered SDs.\119\ While the four FCM-SDs 
provisionally-registered with the Commission are ANC Firms and already 
approved to use models, the Commission believes that other, non-BD FCM-
SDs have the potential to enhance market liquidity in certain sections 
of the swaps market, particularly with smaller counterparties and less 
frequently traded products. The Commission believes that it is 
important to provide an opportunity for such firms to potentially enter 
the market and service counterparties that may not have significant 
choice in selecting SDs. For example, FCM-SDs may be more willing to 
make markets in commodity swaps to agricultural firms and smaller 
commercial end users such as farmers and ranchers that might not 
otherwise be able to use such markets to manage risks in their 
businesses or might have to pay higher fees to engage in swaps if the 
number of SDs was limited. The Commission further believes that given 
the nature of the business operations of FCM-SDs, the proposed minimum 
capital requirement of $100 million of adjusted net capital is 
consistent with the objective of section 4s(e) of the CEA of helping to 
ensure the safety and soundness of the FCM-SD.
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    \119\ Commission regulation Sec.  1.17(c)(6) (17 CFR 1.17(c)(6)) 
provides that an FCM-SD may apply for model approval with the 
Commission or with an RFA of which it is a member. See section 
II.C.7. below for a discussion of model approvals, including the 
Commission's standards and process for reviewing and approving 
capital models, and the process that the Commission will use in 
determining whether NFA's approval of an FCM-SD's capital models may 
serve as an alternative means of complying with the Commission's 
model approval requirement.
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C. Capital Requirements for Swap Dealers and Major Swap Participants

1. Introduction to Covered SD and Covered MSP Capital Requirements
    The Commission is adopting final capital requirements for covered 
SDs and covered MSPs in order to help ensure the safety and soundness 
of the SDs and MSPs by requiring such firms to maintain a minimum level 
of financial resources that is based upon the level of margin 
associated with the uncleared swaps entered into by the firms. The 
appropriate setting of minimum capital requirements will help ensure 
that covered SDs and covered MSPs are able to meet their respective 
financial obligations to swap and security-based swap counterparties, 
and to creditors generally. The ability of the covered SDs and covered 
MSPs to meet their financial obligations will provide for a more 
efficient and effective swaps marketplace for participants by reducing 
the potential for covered SDs or covered MSPs to default on their 
obligations to swap and security-based swap counterparties.
    There are currently 56 covered SDs subject to the Commission's 
capital requirements. As noted in section II.A. above, these 56 covered 
SDs represent a diverse group of corporate entities, ranging from 
subsidiaries of major global financial and banking institutions to 
entities that are primarily engaged in physical commodities such as 
agriculture and energy. The Commission also understands that these 56 
covered SDs have a significant level of diversity in swap 
counterparties, ranging from financial end users to commercial 
enterprises.
    The Commission is providing flexibility to address the diversity of 
the business models of the covered SDs by permitting each SD that is 
not also a registered FCM to elect one of two possible capital 
alternatives.\120\ The first alternative is the Net Liquid Assets 
Capital Approach, which is based on the liquidity-based capital rule 
for FCMs in regulation 1.17, as well as the liquidity-based capital 
requirements imposed on BDs and SBSDs by the SEC. The second 
alternative is the Bank-Based Capital Approach, which is based on the 
capital requirements established by the Federal Reserve Board for bank 
holding companies and is generally consistent with the prudential 
regulators' capital rules applicable to bank SDs. The flexibility 
provided by the Commission's covered SD capital rules is consistent 
with the Congressional mandate in the Dodd-Frank Act directing the 
Commission, SEC, and prudential regulators to adopt, to the maximum 
extent practicable, comparable minimum capital requirements for SDs and 
SBSDs.\121\
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    \120\ SDs that are FCM-SDs are required to comply with the FCM 
capital requirements contained in Commission regulation Sec.  1.17 
(17 CFR 1.17), as amended by this final rulemaking. See section 
II.B. above for a further discussion.
    \121\ See section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D)) 
and section 15F(e)(3)(D)(ii) of the Exchange Act (15 U.S.C. 78o-
10(e)(3)(D)(ii)).
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    The Commission's final rule further allows certain eligible covered 
SDs to elect to compute their regulatory capital under the Tangible Net 
Worth Capital Approach. The Tangible Net Worth Capital Approach 
requires a covered SD to maintain a tangible net worth, computed in 
accordance with GAAP, equal to or greater than the highest of: (i) $20 
million, plus the market risk and credit risk exposures associated with 
its swap and related hedge positions that are part of the covered SD's 
dealing activities; (ii) 8% uncleared swap margin associated with the 
covered SD's swaps positions; and (iii) the amount of capital required 
by an RFA of which the covered SD is a member.
    To use the Tangible Net Worth Capital Approach, a covered SD must 
be predominantly engaged in non-financial activities, or be part of a 
corporate parent entity that is predominantly engaged in non-financial 
activities. The Commission is adopting the Tangible Net Worth Capital 
Approach as it would be available only for covered SDs that, either 
directly or at their corporate parent level, are primarily involved in 
non-financial, commercial activities. As the Commission has previously 
noted, financial firms generally present a higher level of systemic 
risk to the financial system than commercial firms as the profitability 
and viability of financial firms are more tightly linked to the health 
of the financial system than commercial firms.\122\
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    \122\ See 2016 Capital Proposal, 81 FR 91252 at 91255.
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    The Commission's final capital requirements for covered MSPs 
require such firms to maintain a positive

[[Page 57481]]

tangible net worth. The final MSP capital requirements are discussed in 
section II.C.5. below.
2. Capital Requirement for Covered SDs Electing the Net Liquid Assets 
Capital Approach
a. Computation of Minimum Capital Requirement
    The Commission's capital requirements for covered SDs electing the 
Net Liquid Assets Capital Approach generally incorporate by reference 
the SEC's capital requirements contained in rule 18a-1 for SBSDs that 
are not also registered as BDs.\123\ The capital requirements are set 
forth in regulation 23.101, and are comprised of two components. The 
first component of the capital rule requires a covered SD to compute 
the minimum amount of capital that the SD is required to hold at any 
given point in time. The second component of the capital rules requires 
a covered SD to compute, based upon its balance sheet and certain 
adjustments including market risk and credit risk capital charges to 
its swaps, security-based swaps, and other proprietary positions, the 
actual amount of capital that the covered SD maintains. The covered 
SD's actual capital must be equal to or greater than its minimum 
capital requirement at all times in order for the covered SD to be in 
compliance with the rules.
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    \123\ Rule 18a-1 (17 CFR 240.18a-1) (``rule 18a-1'') also 
applies to SBSDs that are OTC derivatives dealers, as that term is 
defined in SEC Rule 3b-12 (17 CFR 240.3b-12).
---------------------------------------------------------------------------

    The 2016 Capital Proposal required a covered SD electing the Net 
Liquid Assets Capital Approach to maintain a minimum level of net 
capital \124\ equal to or greater than the highest of the following 
criteria:
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    \124\ As noted above, covered SDs electing the Net Liquid Assets 
Capital Approach are subject to the SEC's capital requirements for 
SBSDs set forth in SEC rule 18a-1, which has been incorporated into 
the Commission's rules by reference. The Commission and SEC use 
different terms to express capital requirements. The Commission's 
term ``net capital'' is equivalent to the SEC's term ``tentative net 
capital'' and the Commission's term ``adjusted net capital'' is 
equivalent to the SEC's term ``net capital.'' The term ``tentative 
net capital'' is generally defined as an entity's assets less 
liabilities (excluding certain qualifying subordinated debt), and 
``net capital'' as tentative net capital less certain capital 
deductions such as market risk and credit risk deductions. See 17 
CFR 240.18a-1. This document will use the SEC defined terms for 
purposes of the discussion of the Net Liquid Assets Capital 
Approach.
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    (1) $20 million; or
    (2) Net capital equal to or greater than 8% of the sum of:
    (a) The amount of ``uncleared swap margin'' (as that term was 
proposed to be defined in regulation 23.100) \125\ for each uncleared 
swap position open on the books of the covered SD, computed on a 
counterparty-by-counterparty basis pursuant to Commission regulation 
23.154 (17 CFR 23.154);
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    \125\ The term ``uncleared swap margin'' is defined in 
Commission regulation Sec.  23.100 to mean the amount of initial 
margin that a swap dealer would be required to collect from each 
swap counterparty pursuant to the margin rules for uncleared swap 
transactions (Commission regulation Sec.  23.154 (17 CFR 23.154)). 
The term ``uncleared swap margin'' includes all uncleared swaps that 
an SD is required to collect margin for under the margin 
regulations, and also includes all uncleared swaps that are exempt 
or excluded from the margin requirements including swaps with 
commercial end users, swaps entered into prior to the respective 
compliance dates of the Commission's margin requirements set forth 
in Commission regulation Sec.  23.161 (17 CFR 23.161) (i.e., legacy 
swaps), and excluded swaps with an affiliated entity.
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    (b) The amount of initial margin required for each uncleared 
security-based swap position open on the books of the covered SD, 
computed on a counterparty-by-counterparty basis pursuant to SEC Rule 
18a-3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)), without regard for 
any amounts that may be excluded or exempted under the SEC's rules;
    (c) The amount of ``risk margin requirement'' (as that term is 
defined in Commission regulation 1.17(b)(8) (17 CFR 1.17(b)(8))) for 
the covered SD's cleared futures, foreign futures, and swaps positions 
open on the books of the covered SD; and
    (d) The amount of initial margin required by a clearing 
organization for proprietary cleared security-based swaps positions 
open on the books of the covered SD; or
    (3) The capital required by the RFA of which the covered SD is a 
member.\126\ The 2016 Capital Proposal also required a covered SD that 
received approval from the Commission, or from an RFA of which the 
covered SD was a member, to use internal models to compute market risk 
and credit risk capital charges for its swaps, security-based swaps, 
and other proprietary positions when computing its capital, as 
described in section II.C.2.a. of this release, to maintain a minimum 
level of tentative net capital equal to $100 million.
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    \126\ See 2016 Capital Proposal, 81 FR 91252 at 91260-61.
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Fixed-Dollar Capital Requirement for Net Liquid Assets Capital Approach
    The first criterion under the Net Liquid Assets Capital Approach 
required a covered SD to maintain a minimum of $20 million of net 
capital and, if the covered SD was approved to use market risk or 
credit risk models, $100 million of tentative net capital and $20 
million of net capital.\127\ The Commission requested comment in the 
2016 Capital Proposal on the appropriateness of the fixed-dollar 
capital requirements of $100 million of tentative net capital and $20 
million of net capital.\128\ The Commission received one comment 
regarding the proposed requirement that covered SDs must maintain a 
minimum of $20 million of net capital, and a minimum of $100 million of 
tentative net capital and $20 million of net capital if approved to use 
market risk or credit risk models.\129\ The commenter stated that the 
requirement that SDs using internal models must have $100 million in 
tentative net capital would create an unnecessary barrier to 
entry.\130\ The Commission recognizes the commenter's concern but 
believes that covered SDs must maintain a minimum of $100 million of 
tentative net capital if approved to use models in order to provide an 
appropriate buffer of capital to protect against model errors and to 
protect against the models not recognizing all types of risk, such as 
operational risk, compliance risk, legal risk, and liquidity risk. 
Models will result in substantially lower market risk charges than the 
standardized market risk charges, which will allow a covered SD to 
engage in more of the transactions than they otherwise would be able to 
enter into at the same level of capital. In order to protect against 
model errors, the Commission believes that it is necessary to have an 
enhanced minimum capital requirement.
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    \127\ See 2016 Capital Proposal, 81 FR 91252 at 91261.
    \128\ See 2016 Capital Proposal, 81 FR 91252 at 91262.
    \129\ See FIA-PTG 5/24/2017 Letter.
    \130\ Id. at 3-4.
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    The Commission has considered the Proposal further and is adopting 
the requirements as proposed. The Commission believes, given the role 
that covered SDs play in the financial markets by engaging in swap 
dealing activities, it is appropriate to require all covered SDs to 
maintain a minimum level of net capital, stated as an absolute fixed-
dollar amount, that does not fluctuate with the level of the firms' 
dealing activities to help ensure the safety and soundness of the 
covered SDs. The $20 million minimum net capital requirement also is 
consistent with the minimum regulatory capital requirements adopted for 
covered SDs that elect the Bank-Based Capital Approach or the Tangible 
Net Worth Capital Approach, as discussed in sections II.C.3. and 
II.C.4., respectively, of this release. Furthermore, the $20

[[Page 57482]]

million minimum net capital requirement for covered SDs that elect the 
Net Liquid Assets Capital Approach is consistent with the minimum 
capital requirements adopted by the SEC for SBSDs.\131\ In addition, 
the requirement for a covered SD to maintain a minimum of $100 million 
of tentative net capital if approved to use models is consistent with 
the SEC minimum capital requirement for stand-alone SBSDs approved to 
use capital models.\132\
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    \131\ See SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(1)).
    \132\ See SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)).
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Risk Margin Amount Calculation Under Net Liquid Assets Capital Approach
    The second criterion under the proposed Net Liquid Assets Capital 
Approach required a covered SD to maintain a minimum level of net 
capital equal to or greater than 8% of the sum of: (i) The amount of 
``uncleared swap margin'' (as that term was proposed to be defined in 
regulation 23.100) for each uncleared swap position open on the books 
of the covered SD, computed on a counterparty-by-counterparty basis 
pursuant to Commission regulation 23.154; (ii) the amount of initial 
margin required for each uncleared security-based swap position open on 
the books of the covered SD, computed on a counterparty-by-counterparty 
basis pursuant to SEC rule 18a-3(c)(1)(i)(B) without regard to any 
initial margin exemptions or exclusions that the rules of the SEC may 
provide to such security-based swap positons; (iii) the amount of 
``risk margin'' (as defined in Commission regulation 1.17(b)(8)) 
required by a clearing organization for the covered SD's futures, 
swaps, and foreign futures positions that are open on the books of the 
covered SD; and (iv) the amount of initial margin required by a 
clearing organization for security-based swaps that are open on the 
books of the covered SD.\133\ The proposed 8% risk margin amount 
required a covered SD to include all swaps and security-based swaps in 
its computation of the margin for uncleared swaps and security-based 
swaps subject to the 8% risk margin amount calculation, including any 
swaps positions that are not included in the margin requirements under 
Commission regulations 23.150 through 23.161, and any security-based 
swaps positions that are exempt or excluded from the SEC's margin 
requirements in rule 18a-3(c)(1)(i)(B).
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    \133\ See paragraph (a)(1)(ii)(A)(1) of proposed Commission 
regulation Sec.  23.101. See 2016 Capital Proposal, 81 FR 91252 at 
91310.
---------------------------------------------------------------------------

    The proposed 8% risk margin amount was based on the Commission's 
minimum capital requirements for FCMs, which includes a requirement 
that each FCM must maintain a level of adjusted net capital that is 
equal to or greater than 8% of the risk margin amount associated with 
the futures, foreign futures, and cleared swap positions carried in 
customer and noncustomer accounts.\134\ This requirement was intended 
to ensure that a covered SD electing the Net Liquid Assets Capital 
Approach maintains a minimum level of capital that is proportionate to 
all risks associated with the SD's operations and activities. The 
Commission believed that the proposed 8% risk margin amount was an 
appropriate approach as the minimum capital requirement was correlated 
with the ``risk'' of the SD's futures, foreign futures, swaps, and 
security-based swaps positions as measured by the margin required on 
the positions. Specifically, a covered SD's minimum capital requirement 
would increase or decrease in proportion to the number, size, 
complexity, and market risk inherent in the SD's derivatives 
business.\135\
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    \134\ See section II.B. above for a discussion of the minimum 
capital requirements for FCMs.
    \135\ See 2016 Capital Proposal, 81 FR 91252 at 91258.
---------------------------------------------------------------------------

    The proposed 8% risk margin amount also was consistent with the 
proposed minimum capital requirements for covered SDs that elect the 
Bank-Based Capital Approach, as discussed in section II.C.3. below, and 
was consistent with the capital requirements of the Tangible Net Worth 
Capital Approach, discussed in section II.C.4. below. The proposed 8% 
risk margin amount also was comparable with the SEC's capital 
requirements for SBSDs, with the exception that the SEC's proposal 
required a SBSD to include a significantly more limited set of 
positions in the 8% risk margin amount calculation. Specifically, a 
SBSD's risk margin amount would include only customer cleared security-
based swaps and uncleared security-based swaps.\136\
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    \136\ See SEC 2012 Proposed Capital Rule, 77 FR 70214 at 70223. 
The SEC modified the capital requirement in the final rule to 
require a SBSD to maintain net capital in excess of 2% of the risk 
margin amount, with the possibility of the SEC increasing the 
percentage amount to 4% or less after the third anniversary of the 
rule's compliance date, and then to 8% or less after the fifth 
anniversary of the rule's compliance date. The rule further provides 
that the SEC will only raise the 2% risk margin amount multiplier 
after publishing a notice of the potential change. See rule 18a-
1(a)(1) (17 CFR 240.18a-1(a)(1)).
---------------------------------------------------------------------------

    The Commission received numerous comments regarding the proposed 8% 
risk margin amount in response to the 2016 Capital Proposal. One 
commenter strongly supported the 8% risk margin amount threshold on a 
comprehensive basis.\137\ The commenter noted a concern that basing 
capital requirements on internal models could be manipulated, and that 
a floor based on 8% of initial margin of a covered SDs positions was 
appropriate as a counterbalance to ensure that internal modelling does 
not reduce loss absorbency.\138\
---------------------------------------------------------------------------

    \137\ See Letter from Marcus Stanley, Americans for Financial 
Reform (May 15, 2017) (AFR 5/15/2017 Letter).
    \138\ Id.
---------------------------------------------------------------------------

    Commenters, however, raised concerns with the proposed 8% risk 
margin amount.\139\ Commenters stated that the proposed 8% risk margin 
amount has a limited relationship to the actual risk of the covered 
SD's swaps, SBS, futures, and foreign futures positions.\140\ 
Commenters noted that the 8% risk margin amount is computed on a 
counterparty-by-counterparty basis and not on the aggregate of all of 
the covered SD's positions across all counterparties, which may 
overstate the covered SD's risk by not taking into account offsetting 
positions across multiple counterparties, including hedging 
positions.\141\ A commenter also noted that the 8% risk margin amount 
did not reflect the actual risk of a covered SD's proprietary cleared 
swap, cleared security-based swaps, futures, and foreign futures 
positions, as the risk margin amount is required to be computed on a 
clearing organization-by-clearing organization basis and, therefore, 
does not recognize hedging and risk-reducing portfolio margin across 
multiple clearing organizations.\142\
---------------------------------------------------------------------------

    \139\ See, e.g., SIFMA 5/15/2017 Letter; FIA 5/15/2017 Letter; 
Citadel 5/15/2017 Letter); Letter from William Dunaway, INTL FCStone 
Markets, LLC (May 15, 2017) (IFM 5/15/2017 Letter); Letter from 
Sebastien Crapanzano and Soo-Mi Lee, Morgan Stanley (May 15, 2017) 
(MS 5/15/2017 Letter); Letter from Christine Stevenson, BP Energy 
Company (May 15, 2017) (BPE 5/15/2017 Letter); Letter from Steven 
Kennedy, International Swaps and Derivatives Association (May 15, 
2017) (ISDA 5/15/2017 Letter); Letter from the Japanese Bankers 
Association (March 14, 2017) (JBA 3/14/2017 Letter); and, FIA-PTG 5/
24/2017 Letter.
    \140\ Id.
    \141\ See, e.g., ISDA 5/15/2017 Letter; JBA 3/14/2017 Letter; 
SIFMA 5/15/2017 Letter.
    \142\ See FIA-PTG 5/24/2017 Letter.
---------------------------------------------------------------------------

    Commenters further noted that the Net Liquid Assets Capital 
Approach double counts the risks of various positions held by a covered 
SD.\143\ The commenters stated that the 8% risk

[[Page 57483]]

margin amount requires a covered SD to hold net capital equal to or in 
excess of the 8% risk margin amount, while also requiring the covered 
SD to reduce the amount of capital it actually holds by the amount of 
market risk and credit risk charges associated with the covered SD's 
positions.\144\ The commenters noted that including these positions in 
the 8% risk margin amount effectively results in both an increase in 
the amount of capital that a covered SD is required to hold to meet its 
minimum requirement and a decrease to the amount of capital the covered 
SD actually maintains due to the market risk and credit risk charges.
---------------------------------------------------------------------------

    \143\ See SIFMA 5/15/2017 Letter; ISDA 5/15/2017 Letter; FIA 5/
15/2017 Letter; FIA-PTG 5/24/2017 Letter; JBA 3/14/2017 Letter; 
Letter from Sunhil Cutinho, CME Group, Inc. (May 15, 2017) (CME 5/
15/2017 Letter); and Citadel 5/15/2017 Letter.
    \144\ Id. See also IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    Several commenters also generally stated that the 8% risk margin 
amount was both too high of a percentage and over-inclusive of the 
various types of business activities engaged in by covered SDs.\145\ 
One commenter suggested that the Commission consider limiting the 8% 
risk margin amount solely to uncleared swaps subject to the 
Commission's uncleared margin rules,\146\ and another commenter 
requested the Commission to reconsider the application of the 8% risk 
margin threshold to cleared swaps.\147\
---------------------------------------------------------------------------

    \145\ Id.
    \146\ See IFM 5/15/2017 Letter.
    \147\ See ISDA 5/15/2017 Letter.
---------------------------------------------------------------------------

    Several commenters also stated that if the Commission were to 
retain the 8% risk margin amount as a component of the minimum capital 
requirement for covered SDs, that the Commission adjust the 8% to a 
lower multiplier, such as 2%, for a period of time to allow the 
Commission to gather empirical data in order to determine an 
appropriate level.\148\
---------------------------------------------------------------------------

    \148\ See SIFMA 5/15/2017 Letter; MS 5/15/2017 Letter.
---------------------------------------------------------------------------

    The Commission acknowledged in the 2019 Capital Reopening the 
receipt of a significant number of comments concerning the proposed 8% 
risk margin amount and the potential impact that it may have on driving 
a covered SD's minimum capital requirement, and, consequently, the 
funding and business activities of the covered SD. The 2019 Capital 
Reopening invited interested parties to comment on all aspects of the 
proposed 8% risk margin amount. The Commission also requested comment 
and supporting data on the quantification of the potential minimum 
capital requirements required of covered SDs electing the Net Liquid 
Assets Capital Approach as a result of the proposed 8% risk margin 
amount threshold. The Commission further requested comment and 
supporting data on how the amount of potential minimum capital based 
upon the 8% risk margin requirement compared with the amount of capital 
currently maintained by entities that are provisionally registered as 
covered SDs, and how such amounts compared with the amounts of capital 
required of SBSDs under the 2019 SEC Final Capital Rule.\149\
---------------------------------------------------------------------------

    \149\ See 2019 Capital Reopening, 84 FR 69664 at 69668-69 (Dec. 
19, 2019).
---------------------------------------------------------------------------

    The 2019 Capital Reopening also requested comment and supporting 
data on whether the proposed 8% risk margin amount should be modified 
for covered SDs electing the Net Liquid Assets Capital Approach to a 
lower percentage requirement, such as 4%, or to another percentage, and 
requested that commenters state why the suggested percentage was an 
appropriate percentage properly calibrated to the inherent risk of a 
covered SD and the activities that it engages in.\150\ The Commission 
further requested commenters to quantify the difference in the amount 
of capital that would be required of a covered SD pursuant to the 
proposed 8% risk margin amount and 4%, or any other suggested lower 
percentage, of risk margin amount, and to the extent possible to model 
the impact of different percentages of risk margin on the minimum 
capital requirements for an actual or hypothetical portfolio of 
positions.\151\
---------------------------------------------------------------------------

    \150\ Id.
    \151\ Id.
---------------------------------------------------------------------------

    The 2019 Capital Reopening also requested comment on whether the 
proposed 8% risk margin amount should be harmonized with the approach 
adopted by the SEC for SBSDs in the 2019 SEC Final Capital Rule.\152\ 
Specifically, the Commission requested comment on whether the proposed 
regulation should be revised to lower the risk margin amount percentage 
from 8% to 2%, and whether the regulation should be further modified to 
authorize the Commission by order to increase the risk margin amount 
percentage in stages from 2% to 4% or less, and from 4% to 8% or less 
based upon the Commission's future experience with covered SD capital 
levels after the implementation of the final regulations.\153\
---------------------------------------------------------------------------

    \152\ Id.
    \153\ Id.
---------------------------------------------------------------------------

    The Commission received several comments in response to the 2019 
Capital Reopening addressing the 8% risk margin amount. One commenter 
stated that the Commission should eliminate the 8% risk margin amount 
requirement for covered SDs from the Net Liquid Assets Capital 
Approach.\154\ This commenter stated that while the Commission based 
the 8% risk margin amount on an existing requirement of an FCM to 
maintain adjusted net capital in excess of 8% of the risk margin amount 
for futures, foreign futures, and cleared swap positions carried by the 
FCM in customer and noncustomer (i.e., affiliates) accounts, there are 
fundamental differences between the business activities of FCMs and 
covered SDs that makes the application of the 8% risk margin amount 
requirement to covered SDs illogical.\155\ This commenter further 
stated that the 8% risk margin amount is not necessary to ensure that 
covered SDs maintain appropriate capital levels, noting that market 
risk and credit risk charges will apply to all of the covered SD's 
derivatives positions under the proposed Net Liquid Assets Capital 
Approach, and noting that other applicable regulatory authorities do 
not impose a requirement similar to the 8% risk margin amount, which 
indicates that it is not necessary for a robust capital framework.\156\
---------------------------------------------------------------------------

    \154\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \155\ Id.
    \156\ Id. The commenter noted that the capital rules of the 
prudential regulators rely on setting a minimum capital requirement 
based on the risk-weighted assets of prudentially-regulated 
institutions, including bank SDs, without any 8% risk margin amount 
add-on. The commenter stated that the Commission did not articulate 
a rationale for departing from the approaches of other regulators, 
and that the CEA requires the Commission, SEC, and prudential 
regulators to maintain comparable minimum capital requirements to 
the maximum extent practicable.
---------------------------------------------------------------------------

    The commenter also stated that the 8% risk margin requirement would 
discourage covered SDs from hedging market risk.\157\ This commenter 
noted that a covered SD enters into swaps and other derivatives 
transactions as a counterparty, which exposes the derivative positions 
to market risk. The commenter further noted that the covered SD may 
hedge this market risk by entering into offsetting positions with other 
counterparties. The commenter stated that instead of recognizing the 
risk-mitigating effects of entering into hedged positions, the Proposal 
penalizes the covered SD by requiring the initial margin of both the 
original and hedge positions to be subject to the 8% risk margin 
amount, which increases costs to the covered SD and discourages risk 
management.\158\
---------------------------------------------------------------------------

    \157\ Id.
    \158\ Id.
---------------------------------------------------------------------------

    Commenters also stated that the 8% risk margin amount fails to 
recognize the risk-reducing effects resulting from

[[Page 57484]]

the collection of initial margin.\159\ One commenter noted that the 
proposed 8% risk margin amount would impose the same minimum capital 
requirement on a covered SD regardless of whether the SD collected 
initial margin from the counterparty.\160\ Another commenter stated 
that the 8% risk margin amount would be improved through the 
recognition of initial margin that is collected by the covered SD and 
held by an independent custodian as required by the Commission's margin 
rules.\161\ The commenter stated that the collection of initial margin 
reduces the potential credit risk exposure that a covered SD has from a 
counterparty, which should be reflected in the minimum capital 
requirements.\162\
---------------------------------------------------------------------------

    \159\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
    \160\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \161\ See MS 3/3/2020 Letter.
    \162\ Id.
---------------------------------------------------------------------------

    One commenter stated that the 8% risk margin amount would impose 
significant and expensive operational burdens on covered SDs.\163\ The 
commenter noted that proposed 8% risk margin amount requires a covered 
SD to include positions in the calculation that are not subject to the 
Commission's uncleared swap margin rules. The commenter stated that the 
requirement to include positions, such as certain foreign currency 
forwards and foreign currency swaps, legacy swaps and other swaps and 
security-based swaps that are excluded from the Commission's or SEC's 
uncleared margin rules in the 8% risk margin amount calculation will 
potentially require a covered SD to obtain approval from NFA to use a 
model to compute initial margin for these positions in order to avoid 
having to include the initial margin requirements based upon the 
standardized table in the Commission's margin rules. The commenter 
further noted that notwithstanding the burden and potential costs 
associated with obtaining model approval for these positions that are 
otherwise exempt from uncleared margin requirements, there is a burden 
and cost associated with computing margin for swaps and security-based 
swaps that are not subject to the Commission's or SEC's margin 
requirements. The commenter also noted that the traditional 8% risk 
margin amount under the FCM capital rules does not present the same 
challenges and costs as the traditional FCM rule applies only to 
cleared customer and noncustomer transactions where clearing 
organizations provide the relevant initial margin requirements.\164\
---------------------------------------------------------------------------

    \163\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \164\ Id.
---------------------------------------------------------------------------

    This commenter also stated that the proposed 8% risk margin amount 
could make it difficult for covered SDs and other market participants 
to enter into swaps that facilitate the transition from interbank 
offered rates (``IBORs'') to other risk-free rates.\165\ The commenter 
stated that the Commission has previously recognized that market 
participants may seek to transition swap or other portfolios that 
reference IBORs to an alternative reference rate by means of a basis 
swap that swaps the entire IBOR basis of a portfolio with an 
alternative reference rate basis.\166\ The commenter note that the 
basis swaps and other similar transactions serve to reduce risk, both 
to covered SDs and to their counterparties. The transactions, however, 
may also increase the aggregate gross notional amount of a covered SD's 
swaps as well as the initial margin that a covered SD is required to 
collect, and that absent a revision in the final rule, the transactions 
may also increase the minimum capital requirement under the 8% risk 
margin amount.\167\
---------------------------------------------------------------------------

    \165\ Id.
    \166\ See Letter No. 19-28 (Dec. 17, 2019); Letter No. 19-27 
(Dec. 17, 2019); Letter 19-26 (Dec. 17, 2019).
    \167\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    The commenter also stated that the 8% risk margin amount would 
exacerbate the impacts resulting from the current limited availability 
of portfolio margining.\168\ The commenter noted that under current 
Commission and SEC margin rules, a dually-registered SD/SBSD is 
required to compute initial margin separately for uncleared swaps and 
security-based swaps with a single counterparty, which prevents the SD/
SBSD from recognizing the risk-reducing impacts of offsetting swaps and 
security-based swap positions. The commenter stated the Commission was 
distorting the minimum capital requirement by establishing an 8% risk 
margin amount that scaled up with the initial margin requirements and 
not the actual risk of the positions viewed from a portfolio 
basis.\169\
---------------------------------------------------------------------------

    \168\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \169\ Id.
---------------------------------------------------------------------------

    Several commenters stated that certain elements of the 8% risk 
margin amount calculation should be revised if the Commission were to 
adopt it as part of a covered SD's minimum capital requirements. 
Commenters stated that the Commission should revise the 8% risk margin 
amount contained in the Net Liquid Assets Capital Approach to eliminate 
the ``double-counting'' of a covered SD's positions.\170\ These 
commenters noted that under the proposed Net Liquid Assets Capital 
Approach, a covered SD is required to maintain capital equal to 8% of 
the risk margin amount computed on the covered SD's futures, foreign 
futures, cleared and uncleared swaps, and cleared and uncleared 
security-based swaps positions. The covered SD is also required to 
subtract the amount of the market risk and credit risk associated with 
its proprietary positions in futures, foreign futures, cleared and 
uncleared swaps, and cleared and uncleared security-based swaps in 
determining the amount of capital that the covered SD has in order to 
meet the minimum capital requirement. The commenters stated that the 
proposed Net Liquid Assets Capital Approach double counts a covered 
SD's proprietary positions as the approach both reduces the covered 
SD's net capital (through the proposed market and credit risk charges) 
and increases the covered SD's minimum capital requirement (through the 
proposed 8% risk margin amount). The commenters stated that the Net 
Liquid Assets Capital Approach's double-counting overstates the risk 
that swaps present to the covered SD, and places the covered SD at a 
competitive disadvantage relative to covered SDs that elect the Bank-
Based Capital Approach, which does not double-count a covered SD's 
proprietary positions.\171\
---------------------------------------------------------------------------

    \170\ See FIA-PTG 3/3/2020 Letter.
    \171\ Supra fn 143. See also IIB/ISDA/SIFMA 3/3/2020 Letter. As 
discussed further in section II.C.3.a. below, under the Bank-Based 
Capital Approach, a covered SD is required to maintain a minimum 
amount of regulatory capital that is equal to or in excess of the 
greater of 8% of (i) the risk margin amount or (ii) the SD's risk-
weighted assets. A covered SD that elects the Bank-Based Capital 
Approach is not required to deduct the market risk or credit risk 
associated with its proprietary positions in computing its 
regulatory capital necessary to meet the above to minimum standards.
---------------------------------------------------------------------------

    Commenters stated that the Commission should address the ``double-
counting'' issue by revising the final Net Liquid Assets Capital 
Approach to impose the 8% risk margin amount as a capital requirement 
prior to the imposition of proprietary market and credit risk 
charges.\172\ Under this approach, a covered SD electing the Net Liquid 
Assets Capital Approach would be required to maintain minimum tentative 
net capital equal to or greater than 8% of the risk margin amount.
---------------------------------------------------------------------------

    \172\ Id.
---------------------------------------------------------------------------

    Commenters also stated that the Commission should reduce the 
multiplier if it adopts the 8% risk margin amount.\173\ Commenters 
noted

[[Page 57485]]

that the 8% risk margin amount was based upon the Commission's capital 
requirements for FCMs, which imposes an obligation on FCMs to maintain 
adjusted net capital of at least 8% of the margin required on customer 
and noncustomer futures, foreign futures, and cleared swaps 
positions.\174\ One commenter stated that there is no evidence to 
support a conclusion that an 8% calibration is appropriate in the 
context of non-cleared swaps markets, with fundamentally different 
regulatory standards and risk management principles than FCM's 
customers and noncustomer clearing activities.\175\
---------------------------------------------------------------------------

    \173\ Id.
    \174\ See Commission regulation Sec.  1.17(a)(1)(i) (17 CFR 
1.17(a)(1)(i)).
    \175\ See MS 3/3/2020 Letter. The commenter further noted, for 
instance, that SDs act as counterparties to market participants, and 
not as financial guarantors of their customers.
---------------------------------------------------------------------------

    Another commenter stated that the FCM capital requirement based on 
8% of customer and noncustomer margin was never intended to apply 
broadly to the uncleared swaps market.\176\ This commenter stated that 
data collected almost two decades ago in the context of futures 
positions does not provide a logical foundation for the adoption of the 
8% risk margin requirement, as it does not reflect appropriately the 
risks faced by covered SDs on their positions, particularly their 
uncleared positions, which are subject to higher margin requirements 
based on a 10-day liquidation horizon as opposed to a 1-day horizon 
common for futures.
---------------------------------------------------------------------------

    \176\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    The commenter also stated that if the Commission did not modify the 
8% risk margin amount requirement to reflect the ``double-counting'' 
discussed above, then reducing the 8% risk margin amount multiplier 
would be necessary to prevent competitive disparities. The commenter 
also stated that based on data it had compiled, an 8% multiplier for 
the risk margin amount would be high for covered SDs that elect the Net 
Liquid Assets Capital Approach.\177\
---------------------------------------------------------------------------

    \177\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    Such a requirement would dramatically increase the amount of 
capital required to support the derivatives activities well beyond any 
current capital requirements applicable to such SDs.\178\ Further, this 
same higher required capital would occur on covered SDs regardless of 
the elected approach under the Commission's proposed framework or 
relative to capital requirements for bank SDs on portfolios of similar 
positions.\179\
---------------------------------------------------------------------------

    \178\ Id.
    \179\ Id.
---------------------------------------------------------------------------

    Commenters also explicitly stated that if the Commission adopts a 
minimum capital requirement based upon the initial margin of a covered 
SD's proprietary positions, the multiplier should be reduced from 8% to 
2%.\180\ The commenters further stated that a 2% risk margin amount 
would be consistent with the 2019 SEC Final Capital Rule. One of the 
commenters also stated that consistency with the SEC's 2% calibration 
is particularly important for dually-registered SD/SBSDs, otherwise the 
Commission would be setting the risk margin multiplier for security-
based swaps, which effectively undermines the SEC's capital approach to 
SBSDs that are also covered SDs.\181\
---------------------------------------------------------------------------

    \180\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter; 
FIA-PTG 3/3/2020 Letter.
    \181\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    Commenters also stated that the Commission should exclude 
proprietary futures, cleared swaps and cleared security-based swaps 
from the calculation if the Commission adopts the 8% risk margin 
amount.\182\ One commenter stated that including proprietary futures, 
cleared swaps and cleared security-based swaps in the 8% risk margin 
amount fails to recognize the limited risks and leverage associated 
with proprietary cleared positions. Unlike customer cleared positions 
or proprietary uncleared swaps and security-based swaps, proprietary 
positions present minimal credit risk as the covered SD's only exposure 
is to clearing organizations. The commenter further noted that 
centrally cleared transactions present limited leverage since the 
initial margin associated with such transactions is not reused, but 
maintained at the clearing organization or custodian. The commenter 
further stated that the proposed 8% risk margin amount would treat 
proprietary cleared positions no differently from uncleared swaps, 
thereby eliminating the incentive to clear transactions and subjecting 
product types that present markedly different risks to the same capital 
treatment.\183\ Another commenter stated that including a covered SD's 
cleared futures, swap and security-based swap positions in the 8% risk 
margin amount fails to recognize the risk mitigating nature of 
centralized clearing.\184\
---------------------------------------------------------------------------

    \182\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter; 
FIA-PTG 3/3/2020 Letter.
    \183\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
    \184\ See FIA-PTG 3/3/2020 Letter.
---------------------------------------------------------------------------

    The Commission has considered the comments on the 8% risk margin 
amount and continues to believe that a minimum capital requirement 
based on initial margin is an appropriate component of a covered SD's 
minimum capital requirement under the Net Liquid Assets Capital 
Approach. The Commission acknowledges commenters' views that the risk 
margin amount could more precisely measure portfolio-related risks if 
it were to recognize the risk mitigating effects of margin collateral 
received from counterparties or if it was computed on a total portfolio 
basis as opposed to being computed on a counterparty-by-counterparty 
basis. However, the intent of the risk margin amount requirement was to 
establish a method of developing a minimum amount of capital for a 
covered SD to meet all of its obligations as a SD to market 
participants, and to cover potential operational risk, legal risk, and 
liquidity risk, and not just the risks of its trading portfolio.
    The Commission believes that the risk margin amount is a minimum 
capital requirement that provides a floor based on a measure of the 
risk of the positions, the volume of positions, the number of 
counterparties and the complexity of operations of the covered SD. 
Initial margin reflects the degree of risk associated with the 
positions, with lower risk positions having lower initial margin 
requirements and higher risk positions having higher initial margin 
requirements. Therefore, the amount of the minimum capital required of 
a covered SD under the risk margin amount calculation is directly 
related to the volume, size, complexity and risk of the covered SD's 
positions, however, the minimum capital requirement is intended to 
cover a multitude of potential risks faced by the SD. This concept is 
generally consistent with the FCM capital rule, which bases the minimum 
capital requirement on margin associated with customer and noncustomer 
futures, foreign futures and cleared swaps transactions, but is 
intended to address the general risks of operating an FCM such as 
operational, legal, liquidity and other risks in addition to risks 
arising from carrying customer accounts. Therefore, the Commission 
believes that it is appropriate to set a minimum capital requirement 
for covered SDs that is a floor that reflects the risk margin 
associated with the SD's uncleared swap positions.
    The Commission, however, is modifying the final rule in response to 
its reconsideration of the issues and the comments received. The 
Commission is modifying the proposed risk margin amount by removing 
cleared and uncleared security-based swap positions from the 
calculation. As noted in section II.B.2.b. above, the Commission 
believes that a registrants' minimum capital requirements should be 
based upon the transactions that are within

[[Page 57486]]

the Commission's jurisdiction and not the jurisdiction of another 
regulatory agency. This allows the Commission to set minimum capital 
requirements for registrants, including covered SDs, based upon markets 
and products that the Commission regulates and for which it has 
expertise.
    Modifying the proposed risk margin amount by removing security-
based swaps also maintains a consistency with the long-standing 
historical approach that the Commission and SEC have followed with 
respect to dually-registered FCM/BDs. Under the existing FCM/BD capital 
rules, the Commission sets minimum capital requirements for FCMs based 
upon the firm's futures and cleared swaps activities, and the SEC sets 
the minimum capital requirements based upon the firm's securities 
activities.\185\ As noted by commenters above, the proposed inclusion 
of security-based swap positions in the Commission's minimum capital 
requirement for dually-registered SD/SBSDs not only goes against this 
historical approach, it also effectively overrides the SEC's decision 
regarding the appropriate level of capital that should be imposed on 
SBSDs with respect to SEC-regulated security-based swap products, 
particularly if the Commission's and SEC's multiplier are different. In 
addition, the Commission notes that security-based swaps have only been 
excluded from the risk margin amount, which establishes the minimum 
capital requirement. To the extent that a covered SD engages in 
security-based swaps or other proprietary transactions, including 
equities, foreign currencies, physical commodities, futures, and swaps, 
the covered SD is required to reflect these transactions in its capital 
in the form of market risk and, as appropriate, credit risk charges, 
and the SD is required to hold capital in an amount sufficient to cover 
such charges. The exclusion of the security-based swaps from the risk 
margin amount addresses commenters concern that the proposed Net Liquid 
Assets Capital Approach ``double counts'' the covered SD's security-
based swap positions in the capital computation by including such 
positions in the both the computation of net capital and in the 
calculation of the minimum capital requirement. The Commission also 
notes that to the extent a covered SD is also a registered SBSD, it 
will be subject to a minimum capital requirement established by the 
SEC, which requires the SBSD to maintain minimum net capital equal to 
the greater of $20 million or 2% of the risk margin amount associated 
with the SBSD's uncleared security-based swaps and customer cleared 
security-based swaps. Therefore, to the extent a covered SD that is 
dually-registered as a SBSD engages in a substantial amount of 
security-based swaps such that its SEC minimum capital requirement is 
greater than the CFTC minimum capital requirement, the SD would have to 
maintain compliance with the higher SEC minimum capital requirement in 
order to comply with the SEC rules.
---------------------------------------------------------------------------

    \185\ See Commission regulation Sec.  1.17(a)(1)(i) (17 CFR 
1.17(a)(1)(i)) and SEC rule 15c3-1.
---------------------------------------------------------------------------

    The Commission is also modifying the proposed risk margin amount 
calculation to exclude proprietary futures, foreign futures, and 
cleared swap transactions. The Commission believes that it is 
appropriate to revise the proposed risk margin amount to exclude 
proprietary cleared positions from the minimum capital requirement as 
the covered SD's credit exposure is limited on such positions to either 
a clearing organization or to an FCM that carries the SD's account (or 
in the case of foreign futures, a foreign broker that carries the SD's 
account). The credit exposure on such cleared positions is limited 
relative to swap counterparties as clearing organizations and FCM/
foreign brokers are regulated entities that are generally subject to 
financial requirements, including capital, margining, and financial 
reporting requirements. Clearing organizations and FCM/foreign brokers 
are also subject to regulations regarding the holding of customer funds 
to ensure that such funds are used solely for the benefit of the 
customer and not for the benefit of other customers or of the clearing 
organization or FCM/foreign broker.\186\ The clearing of the positions 
also ensures that the potential default by the SD is reduced as it is 
obligated to post initial margin with an FCM/foreign broker or clearing 
organization, and to settle open positions on a daily basis. Therefore, 
any default on the part of the SD is promptly identified by the FCM/
foreign broker or clearing organization and steps are taken to mitigate 
the potential losses resulting from the default. These types of 
restrictions on the holding of customer funds by FCMs, foreign brokers, 
and clearing organizations and the clearing organizations' daily 
margining processes mitigate the risk associated with the covered SD's 
cleared futures, foreign futures, and cleared swaps transactions. 
Furthermore, while the cleared proprietary positions are being excluded 
from the minimum capital requirement based upon the risk margin amount, 
the positions are reflected in the covered SD's capital in the form of 
market risk and credit risk charges and the covered SD is required to 
hold capital sufficient to cover those charges.
---------------------------------------------------------------------------

    \186\ See, e.g., Commission regulations Sec. Sec.  1.20, 1.22 
and 39.15 (17 CFR 1.20, 1.22 and 39.15).
---------------------------------------------------------------------------

    The Commission is also modifying the proposed 8% risk margin amount 
for covered SDs electing the Net Liquid Assets Capital Approach by 
setting the multiplier at 2%. The Commission has reviewed the proposed 
capital requirements and has considered the comments received and 
believes that it is appropriate to modify the risk margin amount 
multiplier in the Net Liquid Assets Capital Approach, and to retain the 
8% risk margin amount multiplier in the Bank-Based Capital Approach and 
the Tangible Net Worth Capital Approach. Therefore, under the final 
regulation, a covered SD that elects the Net Liquid Assets Capital 
Approach must maintain a minimum level of net capital that is equal to 
or greater than 2% of the initial margin of its uncleared swaps, 
computed on a counterparty-by-counterparty basis.
    The Commission believes that modifying the risk margin amount 
multiplier under the Net Liquid Assets Capital Approach is appropriate 
due to (i) differences in the assets that comprise regulatory capital 
under the Net Liquid Assets Capital Approach relative the Bank-Based 
Capital Approach and the Tangible Net Worth Capital Approach, and (ii) 
differences in how the minimum capital requirement is applied under the 
Net Liquid Assets Capital Approach relative the Bank-Based Capital 
Approach and the Tangible Net Worth Capital Approach. As previously 
discussed, the Net Liquid Assets Capital Approach is a liquidity-based 
capital approach that requires a covered SD to hold at least one dollar 
of highly liquid assets for each dollar of the firm's liabilities 
(excluding qualifying subordinated debt). With respect to the assets 
that comprise net capital under the Net Liquid Assets Capital Approach, 
a SD is required to calculate its net worth in accordance with U.S. 
GAAP, and subtract all illiquid assets, such as fixed assets and 
intangible assets, and deduct all of the firm's liabilities (except 
certain qualifying subordinated debt) to determine its tentative net 
capital. The SD then deducts market risk charges on all of its 
proprietary positions, including uncleared swap and security-based swap 
positions, and credit risk charges on its exposures to counterparties 
on its derivative positions, to determine its net capital.
    In contrast to the liquidity-based approach of the Net Liquid 
Assets

[[Page 57487]]

Capital Approach, the Bank-Based Capital Approach and the Tangible Net 
Worth Capital Approach are more properly viewed as solvency-based 
capital requirements that require a covered SD to maintain positive 
balance sheet equity. Under the Bank-Based Capital Approach and 
Tangible Net Worth Capital Approach, a covered SD is not required to 
deduct fixed assets or other illiquid assets from its balance sheet 
equity.\187\ A covered SD is also not required to deduct market risk 
and credit risk charges from its balance sheet equity. Therefore, the 
capital that is available and that may be used to meet the minimum 
capital requirement is substantially more conservative under the Net 
Liquid Assets Capital Approach than it is under the Bank-Based Capital 
Approach and the Tangible Net Worth Capital Approach.
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    \187\ SDs electing the Tangible Net Worth Capital Approach are 
required to deduct intangible assets.
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    In addition to what assets qualify as capital, the risk margin 
amount requirement is applied in a more conservative manner to covered 
SDs under the Net Liquid Assets Capital Approach than it is under the 
Bank-Based Capital Approach and the Tangible Net Worth Capital 
Approach. Under the proposed Net Liquid Assets Capital Approach, a 
covered SD was required to maintain a level of net capital (as defined 
above) that equaled or exceeded 8% of the risk margin amount. Covered 
SDs electing the proposed Bank-Based Capital Approach or Tangible Net 
Worth Capital Approach were required to maintain balance sheet equity 
(without deductions for fixed assets and market risk and credit risk 
charges) that equaled or exceeded 8% of the risk margin amount. 
Therefore, covered SDs electing the Bank-Based Capital Approach or 
Tangible Net Worth Capital Approach may have substantially more assets 
that qualify as capital to meet the proposed 8% risk margin amount 
requirement.
    The Commission recognizes that the differences in the capital 
approaches discussed above may provide a competitive advantage to 
covered SDs electing the Bank-Based Capital Approach and Tangible Net 
Worth Capital Approach due to the ability of such SDs to include fixed 
assets and not have to deduct market and credit risk charges. To 
address this potential competitive disadvantage, the Commission is 
modifying the regulation by setting the risk margin amount multiplier 
at 2% under the Net Liquid Assets Capital Approach. Given the 
differences in the operation of the respective capital approaches as 
discussed above, the Commission believes that setting the risk margin 
amount multiplier at 2% for covered SDs electing the Net Liquid Assets 
Capital approach imposes a minimum capital requirement that is more 
equivalent to the 8% risk margin amount requirement for Bank-Based 
Capital Approach and Tangible Net Worth Capital Approach SDs. Setting 
the risk margin amount at 2% also mitigates commenters' concern that 
the Net Liquid Assets Capital Approach results in ``double counting'' 
of positions in the capital computation.
    The Commission proposed an 8% risk margin amount multiplier based 
upon its experience with FCM capital requirements, which requires each 
FCM to maintain a minimum capital requirement based upon 8% of the risk 
margin on the futures, foreign futures, and cleared swap positions 
carried in customer and noncustomer accounts. As noted by a commenter, 
the 8% risk margin amount was proposed in 2003 and adopted in 2004 
based upon an analysis and comparison of the capital regime in effect 
at the time, which was based on a percentage of the customer funds held 
by an FCM, with a minimum capital requirement based upon risk margin 
associated with the customer positions carried by the FCM.\188\ Staff 
also had the benefit of observing data of the actual performance of the 
two capital regimes for an extended period of time as each FCM was 
required to calculate its minimum capital requirement based on customer 
funds and its capital requirement based on a percentage of its risk 
margin amount for approximately three years as part of a pilot 
program.\189\
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    \188\ See Minimum Financial and Related Reporting Requirements 
for Futures Commission Merchants and Introducing Brokers, 68 FR 
40835 (July 9, 2003) (``2003 Proposed Risk-based Capital 
Rulemaking''). The final rule is available at 69 FR 49784 (Aug. 12, 
2004). See also, IIB/ISDA/SIFMA 3/3/2020 Letter.
    \189\ See 2003 Proposed Risk-based Capital Rulemaking, 68 FR 
40835 at 40839.
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    The Commission does not have sufficient data to perform a 
quantitative analysis of the optimal level to set the multiplier for 
the risk margin amount at this time. However, the Commission's decision 
to modify the final rule by removing cleared and uncleared security-
based swaps, as well as proprietary futures, foreign futures, and 
cleared swaps positions from the risk margin amount calculation and to 
set the multiplier at 2% should mitigate many of the commenters' 
concerns that the proposed 8% risk margin amount calculation was over 
inclusive of the types of positions included in the calculation and was 
set at a percentage that was too high. In addition, as the commenters 
noted, the FCM capital requirement of 8% of the risk margin on futures, 
foreign futures and cleared swaps is based upon margin calculations 
using clearing organization models that require the clearing 
organization to use a 99% one-tailed confidence interval over a minimum 
liquidation period of one day for futures, agricultural swaps, energy 
swaps, and metal swaps of one day, and a minimum liquidation period of 
five days for all other swaps.\190\ In contrast, initial margin for 
uncleared swaps is required to be calculated at a 99% one-tailed 
confidence interval over minimum liquidation period of 10 business days 
(or the maturity of the swap if shorter).\191\ The greater minimum 
holding period for uncleared swaps generally requires a higher level of 
initial margin, which would increase the covered SD's minimum capital 
requirement relative to cleared transactions.
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    \190\ See Commission regulation Sec.  39.13(g) (17 CFR 
39.13(g)).
    \191\ See Commission regulation Sec.  23.154(b)(2) (17 CFR 
23.154(b)(2)).
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    Also, the Commission's final approach is consistent with the 
Congressional mandate to adopt capital requirements that are to the 
maximum extent practicable, comparable with the SEC and prudential 
regulators' capital requirements. The SEC's final rules require a SBSD 
to maintain net capital (not tentative net capital) that is equal to or 
greater than 2% of the risk margin amount calculated on its customer 
cleared security-based swaps and uncleared security-based swaps. 
Therefore, the Commission's final regulation is comparable with the 
SEC's final rule for SBSDs.\192\
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    \192\ Under the Commission's final rule, a covered SD will be 
required to maintain a minimum level of adjusted net capital equal 
to or greater than 2% of the risk margin associated with the SD's 
proprietary uncleared swap transactions. Under the SEC's final rule, 
a stand-alone SBSD will be required to maintain a minimum level of 
net capital equal to or greater than 2% of the sum of the SBSD's 
customer cleared security-based swaps and uncleared security-based 
swaps. Covered SDs that clear customer swaps would be required to 
register as an FCM and will be subject to the FCM-SD capital 
requirements discussed in section II.B. above, which includes a 
minimum capital requirement of 8% of the risk margin amount 
associated with the FCM-SD's cleared customer futures, foreign 
futures, and cleared swap positions.
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    The Commission believes it will be necessary to monitor and 
evaluate whether the numerical percentage is effective in achieving the 
statutory requirement for capital. Therefore, unlike the SEC, the 
Commission is not committing to a predetermined upward ratcheting 
percentage, but will

[[Page 57488]]

continually monitor and evaluate, which provides the Commission more 
flexibility in making fact-based assessments about the efficacy of the 
final rule in the future.
    The Commission will monitor the impact that the 2% risk margin 
amount has on the level of minimum capital required of covered SDs 
electing the Net Liquid Assets Capital Approach after the compliance 
date of the rules. The Commission intends to use the financial 
statements and other information that it will receive from covered SDs 
under the financial reporting requirements discussed in section II.D. 
below to continually monitor the minimum capital requirements under the 
final rule, ensuring the Commission's capital requirements are 
adequately calibrated to protect the safety and soundness of the 
covered SDs. The information that the Commission will receive will 
allow it to determine if it would be appropriate to propose amending 
the minimum capital requirements by, among other things, increasing or 
decreasing the risk margin amount multiplier.
    The Commission also has considered the comments that the minimum 
capital requirement should be revised to require a covered SD to 
maintain tentative net capital in excess of the risk margin amount as 
opposed to the proposed net capital requirement. The Commission is not 
modifying the final rule to reflect these comments. While the 
Commission acknowledges that a covered SD electing the Net Liquid 
Assets Capital Approach is required to both include its uncleared swaps 
in the 2% risk margin amount calculation in order to establish its 
minimum capital requirement and to take capital charges for market risk 
and credit risk on the uncleared swaps in computing the amount of 
capital the covered SD holds, the Commission does not believe that it 
would be appropriate to revise the final rule at this time to only 
apply to tentative net capital. If the Commission were to revise the 
final regulation consistent with the comments, then a covered SD would 
be subject only to the minimum fixed-dollar net capital requirement of 
$20 million (and those approved to use capital models, a tentative net 
capital requirement of $100 million). Including the uncleared swaps in 
establishing a minimum capital requirement is intended to provide a 
floor of net capital that each SD following the Net Liquid Assets 
Capital Approach is required to maintain to cover all risks to the 
firm, including market, credit, operation, liquidity, and legal risk.
    With respect to commenters' concerns that the proposed risk margin 
amount would exacerbate the impact of a covered SD's inability to 
portfolio margin uncleared swaps and uncleared security-based swaps 
with a counterparty in a single account, the Commission recognizes the 
capital and margin efficiencies that portfolio margining provides to 
covered SDs and counterparties. The Commission also recognizes that the 
inability of a covered SD that is dually-registered with the SEC as a 
SBSD to portfolio margin uncleared swaps and uncleared security-based 
swaps impacts the SD's ability to compete with bank SDs that may margin 
uncleared swaps and security-based swaps in a single account, subject 
to the rules of the applicable prudential regulator. Under the Dodd-
Frank Act framework, the Commission has the authority to establish 
margin requirements for swaps and the SEC has the authority to 
establish margin requirements for security-based swaps. Therefore, the 
respective Commissions need to take coordinated action in order for a 
dually-registered covered SD and SBSD to margin uncleared swaps and 
security-based swaps with a counterparty in a single account. The 
Commission will consult with the SEC regarding portfolio margining and, 
as part of such consultation, address capital issues.
    With respect to comments that the risk margin amount may make it 
difficult for covered SDs and other market participants to enter into 
swaps that facilitate the transition from interbank offered rates to 
other risk-free rates, the Commission invites market participants that 
may be impacted by the capital rule to seek guidance from Commission 
staff. As noted above, Commission staff has provided no-action relief, 
including margin relief, to facilitate a covered SD's transition of 
open swaps with an interbank offered rate to other rates.
Minimum Capital Requirement of a Registered Futures Association Under 
Net Liquid Assets Capital Approach
    The third criterion of the proposed Net Liquid Assets Capital 
Approach required a covered SD to maintain net capital that was equal 
to or greater than the amount of net capital required by an RFA of 
which the covered SD was a member. As noted in the 2016 Capital 
Proposal, the proposed minimum capital requirement based on membership 
requirements of an RFA is consistent with section 17(p)(2) of the CEA 
and current regulation 1.17 for FCMs and IBs.\193\
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    \193\ See Commission regulations Sec. Sec.  1.17(a)(1)(i)(C) and 
170.16 (17 CFR 1.17(a)(1)(i)(C) and 170.16).
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    Section 17(p)(2) of the CEA provides, in relevant part, that an RFA 
must adopt rules establishing minimum capital and other financial 
requirements applicable to the RFA's members for which such 
requirements are imposed by the Commission.\194\ Section 17(p)(2) 
further requires an RFA to implement a program to audit and enforce its 
members' compliance with such capital and other financial requirements. 
As noted above, the NFA currently is the only RFA, and each SD is 
required to be a member of NFA.\195\
---------------------------------------------------------------------------

    \194\ See section 17(p)(2) of the CEA (7 U.S.C. 21(p)(2)), which 
requires RFAs to adopt rules establishing minimum capital and other 
financial requirements applicable to its members for which such 
requirements are imposed by the Commission, provided that such 
requirements may not be less stringent than the requirements imposed 
by the CEA or by Commission regulations.
    \195\ Commission regulation Sec.  170.16 (17 CFR 170.16) 
provides, in relevant part, that each person registered as an SD 
must become and remain a member of at least one futures association 
that is registered with the Commission under section 17 of the CEA 
and provides for the membership of SDs. NFA is currently the only 
RFA and accepts SD members.
---------------------------------------------------------------------------

    The 2016 Capital Proposal noted that NFA is required by section 17 
of the CEA to adopt SD capital rules once the Commission imposes 
capital requirements on SDs, and that NFA's capital rules must be at 
least as stringent as the Commission's capital requirements on covered 
SDs.\196\ The Commission's proposed Net Liquid Assets Capital Approach 
incorporated the NFA minimum capital requirement into the Commission's 
capital rule, which would make a violation of the NFA's rule also a 
violation of the Commission's rule in a manner that is consistent with 
the current FCM capital rules.\197\
---------------------------------------------------------------------------

    \196\ See 2016 Capital Proposal, 81 FR 91252 at 91259 and 
footnote 87 at 91269.
    \197\ Commission regulation Sec.  1.17(a)(1)(i)(C) (17 CFR 
1.17(a)(1)(i)(C)) currently incorporates NFA's minimum capital 
requirement for an FCM into the Commission's minimum capital 
requirement by providing that each person registered as an FCM must 
maintain adjusted net capital required by an RFA of which the FCM is 
a member.
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    The Commission received several comments regarding the proposed 
requirement that a covered SD must meet the capital rules adopted by 
the NFA. Several commenters stated that any future NFA capital rules 
for covered SDs should be subject to public comment.\198\ One commenter 
also stated that creating, revising and implementing

[[Page 57489]]

systems, controls, processes, reporting and related internal mechanisms 
requires ample notice of uninterrupted requirements that could be 
jeopardized by an inconsistent NFA capital requirement.\199\ To address 
this issue, the commenter requested that the Commission require NFA to 
establish a public comment period to solicit feedback on any covered SD 
capital requirements prior to mandating compliance with such 
requirements.\200\
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    \198\ ED&F Man/INTL FCStone 3/3/2020 Letter; Letter from Scott 
Earnest, Shell Trading Risk Management LLC (March 2, 2020) (Shell 3/
3/2020 Letter).
    \199\ ED&F Man/INTL FCStone 3/3/2020 Letter.
    \200\ Id.
---------------------------------------------------------------------------

    Another commenter stated that the Commission's efforts to obtain 
public input pursuant to the 2016 Capital Proposal and the 2019 Capital 
Reopening may be nullified if the NFA adopts capital rules that are 
different from the Commission's final rules.\201\ The commenter 
requested that the Commission require NFA to adopt capital rules that 
closely mirror the Commission's final capital rules, or, at the least, 
require NFA to conduct a rigorous notice and comment process prior to 
finalizing its capital rules.\202\
---------------------------------------------------------------------------

    \201\ See Shell 3/3/2020 Letter.
    \202\ Id.
---------------------------------------------------------------------------

    The Commission appreciates the commenters concerns regarding the 
need for conformity between its final capital rules governing covered 
SDs and those that may be adopted by NFA as an RFA in the future. The 
Commission believes, however, that the concerns are largely mitigated 
by the existing statutory and Commission regulatory requirements as 
well as the internal governance structure of NFA, which was established 
to comply with these requirements. Section 17(j) of the CEA, for 
example, requires NFA to file with the Commission any change in or 
addition to its rules. Any such change or addition is effective within 
10 days of submission unless NFA requests, or the Commission notifies 
NFA of its intent to subject the filing to, a review and approval 
process.\203\ To the extent NFA plans to adopt significant new rules, 
it typically has worked very closely with Commission staff to ensure, 
among other things, consistency with existing Commission regulations. 
The current capital and financial requirements applicable to FCMs and 
IBs, are essentially the same under both Commission regulations and NFA 
rules.\204\
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    \203\ See section 17(j) of the CEA (7 U.S.C. 21(j)).
    \204\ Cf. Commission regulation Sec.  1.17 (17 CFR 1.17) with 
NFA Financial Requirements.
---------------------------------------------------------------------------

    Further, the statutory and Commission regulatory requirements and 
NFA's governance structure ensure that SDs are represented and given a 
voice in the potential adoption of NFA rules, including capital and 
financial reporting rules, that may impact them. Specifically, section 
17(b)(5) of the CEA and regulation 170.3 require generally that the 
rules of an RFA assure fair representation of its members in the 
adoption of any rule, in the selection of its officers, directors, and 
in other aspects of its administration.\205\ In this regard, NFA's 
Articles of Incorporation require that its Board of Directors include 5 
elected representatives of registered (or provisionally-registered) 
SDs, registered (or provisionally registered) major swap participants 
and registered RFEDs. Of these representatives, at least 2 must be SDs 
that are Large Financial Institutions \206\ (as of June 30 of the prior 
calendar year) and at least 2 others must be representatives of SDs, 
MSPs or RFEDs that are not Large Financial Institutions.\207\
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    \205\ 7 U.S.C. 21(b)(5) and Commission regulation Sec.  170.3 
(17 CFR 1.17). See also, section 17(b)(11) of the CEA (7 U.S.C. 
21(b)(11)) which requires that an RFA provide for meaningful 
representation on the governing board of such association of a 
diversity of membership interests and provides that no less than 20 
percent of the regular voting members of the board be comprised of 
qualified nonmembers of or persons not regulated by such 
association.
    \206\ The term ``Large Financial Institution'' is defined in 
Article XVIII(n) of NFA's Articles of Incorporation as ``a Swap 
Dealer included in a well defined, publicly available and 
independent list of financial institutions that the Board of 
Directors identifies by resolution from time to time.''
    \207\ Article XVII, Section 2A(d) of NFA Articles of 
Incorporation. Article VIII, Section 3(c)(iv) requires that NFA's 
Executive Committee composition include 13 Directors, 2 of whom 
represent SDs, MSPs or RFEDs.
---------------------------------------------------------------------------

    In light of NFA's governance structure, the Commission's review 
process with respect to new NFA rules and the typically close 
interaction between Commission and NFA staff with regard to NFA's 
adoption of new rules, the Commission believes that an additional 
mandatory public comment period for NFA capital rules would be 
unnecessary. Accordingly, the Commission is adopting the third 
criterion that a covered SD electing the Net Liquid Assets Capital 
Approach must maintain capital in an amount equal to or in excess of an 
amount of capital, if any, imposed by an RFA of which the covered SD is 
a member.
b. Computation of Net Capital To Meet Minimum Capital Requirement
    The second component of the proposed Net Liquid Assets Capital 
Approach required a covered SD to compute the amount of ``tentative net 
capital'' and ``net capital'' that the SD maintains in order to satisfy 
its minimum capital requirement. Proposed regulation 23.101(a)(1)(ii) 
required each covered SD electing the Net Liquid Assets Capital 
Approach to compute its tentative net capital and net capital in 
accordance with the SEC's computation of tentative net capital and net 
capital for nonbank SBSDs under Rule 18a-1 as if the covered SD was a 
nonbank SBSD, subject to several adjustments.\208\
---------------------------------------------------------------------------

    \208\ See 2016 Capital Proposal, 81 FR 91252 at 91260-61.
---------------------------------------------------------------------------

    The Net Liquid Assets Capital Approach and the SEC capital approach 
for SBSDs are based on the existing FCM and BD capital rules and place 
an emphasis on liquidity of the entity. The FCM and BD capital rules 
are liquidity-based capital requirements that generally require a firm 
to maintain at all times at least $1 dollar of highly liquid assets to 
cover each dollar of its unsubordinated liabilities, which is generally 
money owed to customers, counterparties and creditors.
    A covered SD electing the Net Liquid Assets Capital Approach will 
compute net capital by first determining its net worth under U.S. GAAP, 
which generally reflects the firm's total assets less its total 
liabilities. The covered SD would then adjust its net worth by 
deducting certain assets such as unsecured receivables and 
undermargined counterparty accounts. The covered SD would also be able 
to add back to its net worth certain qualifying subordinated 
liabilities. The result of these adjustments would be the covered SD's 
``tentative net capital.''
    The covered SD will then compute its ``net capital'' by deducting 
from ``tentative net capital'' prescribed capital charges from the 
mark-to-market value of its proprietary swap, security-based swap, 
equities, and commodity positions. The prescribed capital charges for 
the covered SD's proprietary positions are the existing standardized 
capital charges set forth in Commission regulation 1.17 for FCMs and 
SEC rule 15c3-1 for BDs. The Proposal also provided that a covered SD 
could seek approval from the Commission or an RFA to use internal 
models to compute market risk and credit risk capital charges in lieu 
of the standardized capital charges. The application and approval 
process for market risk and credit risk capital models is discussed in 
section II.C.7. below.
(i) Swap Dealers Not Approved To Use Internal Capital Models
    The 2016 Capital Proposal required a covered SD electing the Net 
Liquid Assets Capital Approach to apply, in computing its net capital, 
standardized market risk and credit risk capital

[[Page 57490]]

charges set forth in SEC Rule 18a-1, and the appendices thereto, for 
positions in swaps, security-based swaps, and other proprietary 
positions, if the covered SD had not obtained Commission or RFA 
approval to use internal models. The standardized market risk charges 
under SEC rule 18a-1 are rules-based capital charges that require a 
covered SD to compute market risk capital charges for swaps, security-
based swaps, and other positions by multiplying the notional amount or 
fair market value of the positions by a specified percentage set forth 
in SEC rule 18a-1.\209\ The resulting market risk charges would be 
deducted from the covered SD's tentative net capital to arrive at the 
firm's net capital.
---------------------------------------------------------------------------

    \209\ See, e.g., SEC rule 18a-1.
---------------------------------------------------------------------------

    Standardized credit risk charges under SEC Rule 18a-1 generally 
provide that unsecured receivables are subject to a 100 percent credit 
risk capital charge (i.e., the covered SD would have to deduct 100 
percent of any unsecured receivable balance, including receivables from 
swap and security-based swap counterparties for unpaid variation margin 
or mark-to-market gains, from tentative net capital in computing net 
capital).\210\ Accordingly, under the proposed standardized credit risk 
charges, covered SDs were required to deduct any unsecured receivables 
arising from not collecting variation margin from any counterparty, 
including counterparties that are exempt or excepted from having to pay 
and collect variation margin with the covered SD. Therefore, covered 
SDs would have to take a capital charge for any exposures arising from 
unpaid variation margin to any counterparties, including commercial end 
users and counterparties excluded from or exempt from the requirement 
to exchange variation margin with the covered SD.
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    \210\ See 2019 SEC Final Capital Rule, 84 FR 43872 at 44053.
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    The Commission proposed several adjustments that a covered SD 
electing the Net Liquid Assets Capital Approach could make to the 
standardized credit risk capital charges set forth in SEC rule 18a-1. 
In this regard, the Commission proposed that a covered SD, in computing 
its regulatory capital, may recognize unsecured receivables from third-
party custodians as a current asset in computing its regulatory 
capital, where the receivable represents the amount of initial margin 
that the covered SD posted with the third-party custodian for uncleared 
swaps or uncleared security-based swaps pursuant to the margin rules of 
the Commission or SEC, as applicable.\211\ Absent this modification of 
the application of Rule 18a-1, a covered SD would have to take a 100% 
capital charge for the receivables from the third party 
custodians.\212\ The Commission proposed this modification to rule 18a-
1 to take into account that covered SDs are required to post initial 
margin for all swaps with SD counterparties and with all financial end 
users with material swaps exposure under the uncleared swap margin 
rules, while the SEC's final rules do not require a SBSD to post 
initial margin for security-based swaps with other SBSDs or with 
financial end users.\213\
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    \211\ See paragraph (a)(1)(ii)(A)(4) of proposed Commission 
regulation Sec.  23.101; 2016 Capital Proposal, 81 FR 91252 at 
91310.
    \212\ The 2019 SEC Final Capital Rule provides interpretive 
guidance stating that a BD or a stand-alone SBSD does not have to 
take a capital charge for initial margin for swaps and security-
based swaps that is posted with a third-party custodian if: (i) The 
initial margin requirement is funded pursuant to a fully-executed 
written loan agreement with an affiliate of the stand-alone BD or 
SBSD; (ii) the loan agreement provides that the lender waives re-
payment of the loan until the initial margin is returned to the 
stand-alone BD or SBSD; and (iii) the liability of the stand-alone 
BD or SBSD to the lender can be fully satisfied by delivering the 
collateral serving as the initial margin to the lender. See 2019 SEC 
Final Capital Rule, 84 FR 43872 at 43887.
    \213\ Commission regulation Sec.  23.152 (17 CFR 23.152).
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    The Commission received a comment on the proposed adjustment to 
permit covered SDs to recognize receivables from third-party custodians 
as a current asset in computing their net capital under SEC rule 18a-
1.\214\ The commenter stated that it supported the proposed adjustment, 
but noted that the rule was too restrictive by recognizing initial 
margin held by third-party custodian pursuant to the Commission's rules 
and the rules of the SEC. The commenter noted that covered SDs may 
enter into uncleared swap or security-based swap transactions with SDs 
that are subject to the margin rules of a prudential regulator, or a SD 
that operates in a foreign jurisdiction that has received a margin 
comparability determination from the Commission. The commenter stated 
that in order to avoid creating unwarranted disparities depending on 
the parties with which a covered SD trades, the Commission should 
expand the adjustment to allow an SD to recognize IM posted in 
accordance with the margin rules of a prudential regulator or foreign 
jurisdiction for which the Commission has made a comparability 
determination.\215\
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    \214\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \215\ Id.
---------------------------------------------------------------------------

    The Commission has considered the comment and is modifying the 
final regulation to allow a covered SD electing the Net Liquid Assets 
Capital Approach to recognize initial margin for uncleared swaps and 
security-based swaps deposited with third-party custodians as a current 
asset in computing its net capital. The covered SD must deposit the 
initial margin with a third-party custodian in accordance with the 
applicable rules of the Commission, SEC, prudential regulators, or a 
foreign jurisdiction that has obtained a margin comparability 
determination from the Commission. The modification of the final 
regulation is consistent with the original intent of the proposed 
regulation, which was to permit covered SDs to recognize initial margin 
posted with third-party custodians pursuant to the new margin framework 
which requires a SD to both post and collect initial margin with a swap 
dealer counterparty or with a financial end user with material swaps 
exposure.\216\ The modification more fully and accurately reflects the 
types of counterparties that a covered SD may transact with, and the 
regulations that may govern such uncleared swap and security-based swap 
transactions.
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    \216\ The term ``material swaps exposure'' is defined by 
Commission regulation 23.150 (17 CFR 23.150) to mean that the entity 
and its margin affiliates have an average daily aggregate notional 
amount of uncleared swaps, uncleared security-based swaps, foreign 
exchange forwards, and foreign exchange swaps with all 
counterparties for June, July and August of the previous calendar 
year that exceeds $8 billion.
---------------------------------------------------------------------------

    The Commission also proposed to permit a covered SD that elects the 
Net Liquid Assets Capital Approach to exclude a capital charge 
contained in proposed SEC rule 18a-1(c)(viii). Applying SEC proposed 
rule 18a-1(c)(viii) would require a covered SD to take a capital charge 
to the extent that standardized market risk charges computed on a 
portfolio of customer security-based swaps exceeded the clearinghouse 
margin associated with such cleared security-based swaps 
positions.\217\ The SEC did not include this capital charge in its 
final rules, and the Commission is deleting the exception from this 
capital charge in final regulation 23.101(a)(1)(ii) as it is no longer 
necessary.
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    \217\ See SEC 2012 Proposed Capital Rule, 77 FR 70214 at 70335. 
The SEC also requested comment on proposed rule text that extended 
the capital charge to cleared swaps in addition to cleared SBS. See 
Capital, Margin, and Segregation Requirements for Security-Based 
Swap Dealers and Major Security-Based Swap Participants and Capital 
Requirements for Broker-Dealers, 83 FR 53007 (Oct. 19, 2018).

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[[Page 57491]]

(ii) Swap Dealers Approved To Use Internal Capital Models
    The 2016 Capital Proposal permitted a covered SD electing the Net 
Liquid Assets Capital Approach to seek Commission or RFA approval to 
use internal models to compute market risk and credit risk capital 
charges on its swaps, security-based swaps and other proprietary 
positions in lieu of the standardized deductions contained in the SEC 
Rule 18a-1.\218\ In order to be considered for approval, the SD's 
models must meet the qualitative and quantitative requirements set 
forth in proposed regulation 23.102 and Appendix A to regulation 
23.102.
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    \218\ The Commission proposed that a covered SD's market risk 
models must calculate the total market risk for its proprietary 
positions under SEC rule 18a-1(d) (17 CFR 240.18a-1(d)) as the sum 
of the VaR measure, stressed VaR measure, specific risk measure, 
comprehensive risk measure, and incremental risk measure of the 
portfolio of proprietary positions in accordance with proposed 
Commission regulation Sec.  23.102 and proposed Appendix A of 
regulation Sec.  23.102. See paragraph (a)(1)(ii)(A)(2) of proposed 
Commission regulation Sec.  23.101; 2016 Capital Proposal, 81 FR 
91252 at 91310.
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    The Commission noted in the 2016 Capital Proposal that the Federal 
Reserve Board had adopted quantitative and qualitative requirements for 
internal models used by bank holding companies to compute market risk 
and credit risk capital charges.\219\ In developing the proposed market 
risk and credit risk requirements for covered SDs, including the 
proposed quantitative and qualitative internal model requirements, the 
Commission incorporated the market risk and credit risk model 
requirements adopted by the Federal Reserve Board.\220\ The 
Commission's proposed model requirements are also comparable to the 
SEC's model requirements for SBSDs and for BDs.\221\ The model 
requirements and the process for obtaining Commission or RFA review is 
set forth in section II.C.7. of this release.
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    \219\ See 2016 Capital Proposal, 81 FR 91252 at 91258; See, 12 
CFR 217, subparts E and F.
    \220\ See 2016 Capital Proposal, 81 FR 91252 at 91258.
    \221\ See 2016 Capital Proposal, 81 FR 91252 at 91278.
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    The Commission's 2016 Capital Proposal required a covered SD 
electing the Net Liquid Assets Capital Approach to compute its credit 
risk charges as if the covered SD were a SBSD subject to SEC rule 18a-
1.\222\ The SEC 2012 Proposed Capital Rule limited the use of credit 
risk models to transactions with commercial end users.\223\ The 
Commission, however, believed that a covered SD should be able to use 
credit risk models to compute capital charges for uncleared swap and 
security-based swap transactions with all counterparties, and not just 
commercial end users. In this regard, the Commission proposed that 
covered SDs that elect the Net Liquid Assets Capital Approach or the 
Bank-Based Capital Approach, and FCM-SDs could use models to compute 
credit risk charges for swap and security-based swaps counterparties. 
Therefore, the Commission proposed to add paragraph (a)(1)(ii)(A)(3) to 
regulation 23.101 to allow a covered SD electing the Net Liquid Assets 
Capital Approach to use credit risk models to compute credit risk 
charges for uncollected variation margin and initial margin from swap 
and security-based swap counterparties.
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    \222\ See 2016 Capital Proposal, 81 FR 91252 at 91310; Proposed 
regulation 23.101(a)(1)(ii).
    \223\ See SEC 2012 Proposed Capital Rule, 77 FR 70214 (Nov. 23, 
2012) at 70245-46.
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    In its final rule adopting capital requirement for SBSDs, the SEC 
modified its rule 18a-1 from the proposal to permit SBSDs approved to 
use credit risk models to use such models to compute credit risk 
capital charges from all classes of swap and security-based swap 
counterparties and not just commercial end users.\224\ Therefore, the 
Commission has modified the final regulation 23.101 by deleting 
paragraph (a)(1)(ii)(A)(3) as the provision is no longer necessary as 
the SEC and CFTC rules are aligned in that a covered SD may use an 
approved model to compute counterparty credit risk charges for swap and 
security-based swap transactions with all counterparties.
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    \224\ See 2019 SEC Final Capital Rule, 84 FR 43872 at 43902-93.
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3. Capital Requirement for Covered SDs Electing the Bank-Based Capital 
Approach
a. Computation of Minimum Capital Requirement
    The 2016 Capital Proposal provided covered SDs with an option of 
electing the Bank-Based Capital Approach, which is based on the Federal 
Reserve Board's capital requirements for bank holding companies.\225\ 
The Federal Reserve Board's bank holding company capital requirements 
are consistent with the bank capital framework adopted by the 
BCBS.\226\ The BCBS framework is an internationally-recognized 
framework for setting capital requirements for banks and bank holding 
companies, and was developed to provide prudential standards to help 
ensure the safety and soundness of bank and bank holding companies. The 
Bank-Based Capital Approach also offers a covered SD that is part of 
bank holding company structure with potential efficiencies as the 
covered SD may maintain financial accounting records in a manner that 
provides for the efficient consolidation of the SD into the financial 
reporting requirements of the bank-holding company.
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    \225\ See paragraph (a)(1)(i) of proposed Commission regulation 
Sec.  23.101, 2016 Capital Proposal, 81 FR 91252 at 91310.
    \226\ BCBS is the primary global standard-setter for the 
prudential regulation of banks and provides a forum for cooperation 
on banking supervisory matters. Institutions represented on the BCBS 
include the Federal Reserve Board, the European Central Bank, 
Deutsche Bundesbank, Bank of France, Bank of England, Bank of Japan, 
and Bank of Canada.
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    The Commission's Bank-Based Capital Approach was set forth in 
proposed regulation 23.101(a)(1)(i), and required a covered SD to 
maintain a minimum level of regulatory capital that is equal to or in 
excess of the greatest of the following four criteria:
    (1) $20 million of common equity tier 1 capital, as defined under 
the bank holding company regulations in 12 CFR 217.20, as if the SD 
itself were a bank holding company subject to 12 CFR part 217; \227\
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    \227\ Common equity tier 1 capital is defined in 12 CFR 217.20 
of the Federal Reserve Board's rules. Common equity tier 1 capital 
generally represents the sum of a bank holding company's common 
stock instruments and any related surpluses, retained earnings, and 
accumulated other comprehensive income.
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    (2) common equity tier 1 capital, as defined under the bank holding 
company regulations in 12 CFR part 217.20, equal to or greater than 8% 
of the SD's risk-weighted assets computed under the bank holding 
company regulations in 12 CFR part 217 as if the SD were a bank holding 
company subject to 12 CFR part 217;
    (3) common equity tier 1 capital, as defined under 12 CFR 217.20, 
equal to or greater than 8 percent of the sum of:
    (a) The amount of ``uncleared swap margin'' (as that term is 
defined in proposed regulation 23.100) for each uncleared swap position 
open on the books of the SD, computed on a counterparty by counterparty 
basis pursuant to regulation 23.154;
    (b) the amount of initial margin that would be required for each 
uncleared security-based swap position open on the books of the SD, 
computed on a counterparty-by-counterparty basis pursuant to proposed 
SEC Rule 18a-3(c)(1)(i)(B), without regard to any initial margin 
exemptions or exclusions that the rules of the SEC may provide to such 
security-based swap positions; and
    (c) the amount of initial margin required by a clearing 
organization for cleared proprietary futures, foreign

[[Page 57492]]

futures, swaps, and security-based swap positions open on the books of 
the SD; or
    (4) the capital required by an RFA of which each SD is a member. 
Commenters generally supported the proposed Bank-Based Capital Approach 
as it represents an internationally recognized capital regime for 
establishing capital that is designed to promote the safety and 
soundness of banking institutions under standards issued by the BCBS. 
One commenter stated that the Bank-Based Capital Approach is a 
significant and necessary pillar in the Commission's proposed 
regulatory framework as it fosters greater comparability of covered SDs 
with bank SDs, provides a risk-sensitive capital methodology for 
covered SD business models that are not adequately captured in 
traditional net capital calculations, and provides covered SD 
subsidiaries of bank holding companies with potential risk management 
and operational synergies.\228\ Another commenter supported the Bank-
Based Capital Approach noting that the Commission's proposal of 
offering distinct capital approaches recognizes that covered SDs have a 
wide range of business models, many of which do not fit easily within 
other proposed capital frameworks.\229\ This commenter further stated 
that covered SDs that are not dually-registered as SBSDs or FCMs 
generally do not maintain custody of customer assets nor are they 
subject to insolvency regimes premised on liquidation and the return of 
customer assets and, therefore, it makes sense for the Commission not 
to apply the Net Liquid Assets Capital Approach or FCM approach which 
are premised on the customer profile and insolvency regime applicable 
to SBSDs and FCMs, respectively.\230\
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    \228\ See MS 3/3/2020 Letter.
    \229\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \230\ Id.
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Fixed-Dollar Minimum Capital Requirement Under Bank-Based Capital 
Approach
    The first criterion under the Commission's Proposal required 
covered SDs electing the Bank-Based Capital Approach to maintain a 
minimum of $20 million of common equity tier 1 capital. The Commission 
believed that given the role that a SD performs in the financial 
markets by engaging in swap dealing activities that it was appropriate 
to require each SD to maintain a minimum level of capital, stated as an 
absolute dollar amount, that does not fluctuate with the level of the 
firm's dealing activities to help ensure the safety and soundness of 
the SD.
    The proposed $20 million of minimum capital also was consistent 
with the minimum regulatory capital requirements proposed by the 
Commission for SDs that elect the Net Liquid Assets Capital Approach or 
the Tangible Net Worth Capital Approach as discussed in sections 
II.C.2.a. and II.C.4., respectively, of this release. The proposed $20 
million minimum capital requirement also was consistent with the net 
capital requirements adopted by the SEC for SBSDs, and was consistent 
with the current minimum net capital requirements for OTC derivatives 
dealers registered with the SEC.\231\ The Commission did not receive 
comment on the proposed $20 million dollar minimum capital requirement, 
and is adopting the requirement as proposed.
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    \231\ The SEC capital requirements for SBSDs impose a minimum 
net capital requirement of $20 million for SBSDs that are not 
approved to use internal capital models and a $100 million dollar 
tentative net capital and $20 million net capital requirement for 
SBSDs that are approved to use internal capital models See 2019 SEC 
Final Capital Rule, 84 FR 43872 at 43884. SEC rule 15c3-1(a)(5) (17 
CFR 240.15c3-1(a)(5)) currently requires an OTC derivatives dealer 
that has obtained approval to use capital models to maintain a 
minimum of $100 million of tentative net capital and $20 million of 
net capital. See 2019 SEC Final Capital Rule, 84 FR 43872 at 44042, 
44052.
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Minimum Capital Based on Risk-Weighted Assets Under Bank-Based Capital 
Approach
    The second criterion of the minimum capital requirement for covered 
SDs electing the Bank-Based Capital Approach required a covered SD to 
maintain common equity tier 1 capital equal to or greater than 8% of 
the covered SD's risk-weighted assets computed under the bank holding 
company regulations in 12 CFR part 217 as if the covered SD was a bank 
holding company. In effect, this provision of proposed regulation 
23.101(a)(1)(i) imposed a capital approach on a covered SD that is 
generally consistent with the capital approach that the Federal Reserve 
Board imposes on bank holding companies.\232\ For purposes of the 2016 
Capital Proposal, as is also the case for the Federal Reserve Board's 
minimum ratio requirement, the assets and off-balance sheet 
transactions or exposures of the bank holding company would be weighted 
relative to their respective risk.\233\ Thus, under the 2016 Capital 
Proposal, the greater the perceived risk of the assets and the off-
balance sheet items, the greater the weighting for the risk and the 
greater the amount of capital necessary to cover 8% of the risk-
weighted assets.\234\ The Commission believed it was important to 
include this criterion in its minimum capital requirements so that a 
covered SD maintained a level of common equity tier 1 capital that was 
comparable to the level that the SD would maintain if it were subject 
to the capital rules of the Federal Reserve Board.
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    \232\ As discussed further below, the Commission's Proposal 
differed from the rules of the Federal Reserve Board in that the 
Commission's Proposal would require a covered SD to adjust its risk-
weighted assets calculation by including the market risk capital 
charges computed in accordance with Commission regulation Sec.  1.17 
(17 CFR 1.17) if the covered SD had not obtained approval from the 
Commission or from an RFA to use internal market risk models.
    \233\ See 12 CFR 217 subparts D, E, and F.
    \234\ Large, complex banks also must make further adjustments to 
these risk-weighted assets, calculated pursuant to approved models, 
for the additional capital they must hold to reflect the market risk 
of their trading assets See 12 CFR 217 subpart F. The market risk 
requirements generally apply to Federal Reserve Board-regulated 
institutions with aggregate trading assets and trading liabilities 
equal to 10 percent or more of total assets or one billion dollars 
or more.
---------------------------------------------------------------------------

    Proposed paragraph (a)(1)(i) of regulation 23.101 required a 
covered SD electing the Bank-Based Capital Approach to compute its 
risk-weighted assets in accordance with the Federal Reserve Board's 
capital requirements contained in 12 CFR part 217. The Proposal 
included two general approaches to computing risk-weighted assets under 
12 CFR part 217. The first approach was for covered SDs that did not 
have Commission or RFA approval to calculate their risk-weighted assets 
using internal market risk or credit risk models. Proposed regulation 
23.103 required these covered SDs to use a standardized, or rules-
based, approach to computing their risk-weighted assets. Under the 
standardized approach, the covered SDs would use the credit risk 
charges from the Federal Reserve Board's standardized approach under 
subpart D of 12 CFR 217 and the standardized market risk charges for 
FCMs set forth in regulation 1.17.\235\ As discussed in section 
II.B.3.a. above, regulation 1.17 contains the standardized market risk 
capital charges that have been imposed on FCMs for many years and is 
being amended by this rulemaking to reflect explicit

[[Page 57493]]

standardized capital charges for swap and security-based swap positions 
that are aligned with the SEC's standardized market risk capital 
charges. Generally, market risk charges are computed under regulation 
1.17 by multiplying the notional value or market value of the position 
or asset by a fixed percentage set forth in the regulation.\236\ The 
market risk charges are then multiplied by a factor of 12.5 and added 
to the total risk-weighted assets of the SD.\237\
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    \235\ The Federal Reserve Board's standardized approach under 
subpart D of 12 CFR 217 applies only to credit risk charges; the 
Federal Reserve Board has not adopted standardized market risk 
charges. Bank and bank holding companies that are subject to market 
risk charges are required to use internal models and, accordingly, 
subpart D of 12 CFR 217 does not include a standardized approach for 
computing market risk charges. To address this issue, the Commission 
proposed that a covered SD that had not obtained Commission or RFA 
approval to use internal market risk models must apply the 
standardized market risk capital charges contained in Commission 
regulation Sec.  1.17 (17 CFR 1.17) in computing its total risk-
weighted assets.
    \236\ For example, U.S. Treasuries are subject to capital 
charges of between zero and six percent depending on the time to 
maturity of each treasury instrument, and readily marketable equity 
securities are subject to a 15 percent capital charge. See 
Commission regulation Sec.  1.17(c)(5)(v) (17 CFR 1.17(c)(5)(v)), 
which references SEC rule 15c3-1(c)(2)(vi) (17 CFR 240.15c3-
1(c)(2)(vi)). SEC rule 15c3-1(c)(2)(vi)(A)(1) (17 CFR 240.15c3-
1(c)(2)(vi)(A)(1)) provides that a BD shall take a capital charge on 
U.S. Treasuries of between zero and six percent of the fair market 
value of the instrument depending upon the time to maturity. SEC 
rule 15c3-1(c)(2)(vi)(J) (17 CFR 240.15c3-1(c)(2)(vi)(J)) provides a 
capital charge for equities equal to 15 percent of the fair market 
value of the securities.
    \237\ The 12.5 multiplication factor is necessary to ensure that 
the SD maintains a level of common equity tier 1 capital to cover 
the full amount of the market risk charge. Since the SD is required 
to maintain common equity tier 1 capital equal to or in excess of 8% 
of the risk-weighted assets, the market risk charge is multiplied by 
12.5, which effectively requires the SD to hold common equity tier 1 
capital in an amount equal to the full amount of the market risk 
charge. This approach is consistent with the Federal Reserve Board's 
approach to bank holding companies.
---------------------------------------------------------------------------

    The second approach to computing risk-weighted assets permitted 
covered SDs that have Commission or RFA approval to use internal market 
risk and credit risk models to use such models to calculate their risk-
weighted assets. The models would have to meet the qualitative and 
quantitative requirements set forth in proposed regulation 23.102 and 
Appendix A to regulation 23.102 in order to be approved. The 
qualitative and quantitative requirements were based on the Federal 
Reserve Board's qualitative and quantitative requirements for capital 
models in 12 CFR part 217.\238\ The proposed qualitative and 
quantitative requirements for the models, and the proposed model 
submission process, are discussed in section II.C.7. of this release.
---------------------------------------------------------------------------

    \238\ Federal Reserve Board model-based capital charges for 
credit risk and market risk are set forth in 12 CFR part 217 
subparts E and F, respectively.
---------------------------------------------------------------------------

    The Commission acknowledged in the 2016 Capital Proposal that 
limiting a covered SD's ability to use only common equity tier 1 
capital to meet its minimum capital requirement based upon 8% of its 
risk-weighted assets was a departure from the Federal Reserve Board's 
requirements, which allow a bank holding company to meet its minimum 
capital requirements with a combination of common equity tier 1 
capital, additional tier 1 capital, and tier 2 capital.\239\ The 
Commission stated in the 2016 Capital Proposal that it was proposing 
the stricter standard as common equity tier 1 capital is a more 
conservative form of capital than additional tier 1 or tier 2 capital, 
particularly as it relates to the permanence of the capital and its 
availability to absorb unexpected losses.\240\ The Commission also 
proposed the stricter common equity tier 1 requirement as it did not 
propose to include in the SD's minimum capital requirement certain of 
the prudential regulators' capital add-ons, including the capital 
conservation buffer and the countercyclical capital buffer.\241\
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    \239\ Under the Federal Reserve Board's rules, a bank holding 
company's total capital must equal or exceed at least 8% of its 
risk-weighted assets. In addition, at least six percent of the bank 
holding company's capital must be in the form of tier 1 capital, and 
at least 4.5 percent of the tier 1 capital must qualify as common 
equity tier 1 capital. The remaining two percent of capital may be 
comprised of tier 2 capital. Tier 1 capital includes common equity 
tier 1 capital and further includes such instruments as preferred 
stock. Tier 2 capital includes certain types of instruments that 
include both debt and equity characteristics (e.g., certain 
perpetual preferred stock instruments and subordinated term debt 
instruments). See 12 CFR 217.10.
    \240\ See 2016 Capital Proposal, 81 FR 91252 at 91259-60.
    \241\ See 12 CFR 217.11. The capital conservation buffer and the 
countercyclical capital buffer represent capital ``add-ons'' to the 
bank capital requirements and are intended to require entities 
subject to the rules to have certain levels of capital in order to 
make capital distributions and discretionary bonuses.
---------------------------------------------------------------------------

    The Commission received comments regarding the proposed limitation 
of the type of capital that a covered SD may use under the Bank-Based 
Capital Approach in satisfying its 8% of risk-weighted assets to common 
equity tier 1 capital ratio requirement. One commenter supported the 
proposed limitation noting that the more conservative common equity 
tier 1 capital is appropriate given the Commission's Proposal does not 
include all of the capital add-ons and supervisory safeguards that are 
set forth in the prudential regulators' capital framework.\242\
---------------------------------------------------------------------------

    \242\ See AFR 5/15/2017 Letter.
---------------------------------------------------------------------------

    Other commenters stated that the proposed minimum capital 
requirement of common equity tier 1 capital equal to or greater than 8% 
of risk-weighted assets would impose a capital requirement on covered 
SDs that is materially higher and more restrictive than the prudential 
regulators' capital requirement for banks and bank holding 
companies.\243\ These commenters noted that the prudential regulators' 
minimum capital requirements provide that an entity is ``adequately 
capitalized'' if its common equity tier 1 capital is equal to or 
greater than 4.5% of the SD's risk-weighted assets, and is ``well 
capitalized'' if its common equity tier 1 capital is at least 6.5% of 
its risk-weighted assets.\244\ These commenters further stated that the 
Commission's proposed ``early warning capital requirement'' would 
effectively require SDs to maintain common equity tier 1 capital equal 
to at least 9.6% (120% x 8%) of risk-weighted assets as entities 
subject to the ``early warning capital requirements'' generally ensure 
that their regulatory capital exceeds such requirements.\245\ Another 
commenter stated that the Proposal may make it difficult for covered 
SDs subject to the Commission's capital rule to compete with bank SDs 
subject to the capital rules of a prudential regulator, and more 
generally would deviate from the more tailored risk-based approach 
taken by the prudential regulators.\246\
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    \243\ See ISDA 5/15/2017 Letter; MS 5/15/2017 Letter; SIFMA 5/
15/2017 Letter.
    \244\ Id.
    \245\ Id. The 2016 Capital Proposal required each covered SD 
subject to the Bank-Based Capital Approach, the Net Liquid Assets 
Capital Approach, or the Tangible Net Worth Capital Approach to 
provide written notification to the Commission within 24 hours of 
the covered SD's regulatory capital falling below 120 percent of the 
SD's minimum requirement. This proposed notice provision, which is 
consistent with current FCM requirements in Commission regulation 
Sec.  1.12 (17 CFR 1.12), is generally referred to as the ``early 
warning capital requirement.'' The proposed ``early warning capital 
requirement'' for SDs was included in paragraph (c)(2) of proposed 
Commission regulation Sec.  23.105. See 2016 Capital Proposal, 81 FR 
91252 at 91318.
    \246\ See JBA 3/14/2017 Letter.
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    In addition, a commenter requested that the Commission revise its 
Bank-Based Capital Approach to recognize subordinated debt as capital 
in meeting the 8% of risk-weighted assets capital ratio.\247\ This 
commenter noted that prudential regulators' capital requirements permit 
a bank or a bank holding company to recognize certain subordinated debt 
as capital in meeting the 8% of risk-weighted assets capital ratio 
requirement.\248\
---------------------------------------------------------------------------

    \247\ See SIFMA 5/15/2017 Letter.
    \248\ Id.
---------------------------------------------------------------------------

    The Commission requested additional comment in the 2019 Capital 
Reopening on whether the proposed minimum capital requirement based 
upon a covered SD's common equity tier 1 capital was appropriate.\249\ 
The Commission also requested comment on whether a covered SD should be 
able to

[[Page 57494]]

use additional tier 1 and tier 2 capital, including subordinated debt, 
in addition to common equity tier 1 capital in meeting the 8% of its 
risk-weighted assets requirement.\250\
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    \249\ See 2016 Capital Proposal, 81 FR 91252 at 91260.
    \250\ Id.
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Common Equity Tier 1 Capital
    The Commission received comments in response to the 2019 Capital 
Reopening generally supporting the minimum capital requirement based on 
a percentage of the covered SD's risk-weighted assets, including the 
requirement for covered SDs electing the Bank-Based Capital Approach to 
maintain common equity tier 1 capital equal to a specific percentage of 
the risk-weighted assets. Commenters, however, stated that the proposed 
requirement that a covered SD maintain only common equity tier 1 
capital in excess of 8% of its risk-weighted assets was not consistent 
with prudential regulators' requirements and was higher than the 
comparable requirements imposed by the Federal Reserve Board for bank 
holding companies.\251\ These commenters noted that the prudential 
regulators requirements permit banks to use a combination of common 
equity tier 1 capital, additional tier 1 capital, and tier 2 capital in 
meeting their regulatory capital requirements.\252\
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    \251\ See, e.g., MS 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 
Letter.
    \252\ Id.
---------------------------------------------------------------------------

    Several commenters further noted, consistent with comments received 
from the 2016 Capital Proposal, that the Commission was effectively 
imposing a requirement for a covered SD electing the Bank-Based Capital 
Approach to maintain common equity tier 1 capital in excess of 9.6 
percent of the SD's risk-weighted assets due to the proposed ``early 
warning capital requirements'' that requires a covered SD to notify the 
Commission if its regulatory capital falls below 120 percent of its 
minimum requirement.\253\ Commenters further stated that the resulting 
9.6% common equity tier 1 capital requirement is not consistent with 
any bank-based capital methodology.\254\
---------------------------------------------------------------------------

    \253\ Id.
    \254\ See MS 3/3/2020 Letter.
---------------------------------------------------------------------------

    Commenters suggested that the Commission align the proposed 8% 
common equity tier 1 capital requirement with the Federal Depository 
Insurance Corporation's prompt corrective action (``PCA'') framework, 
which is calibrated based on the U.S. Basel III risk-weighted average 
framework.\255\ Under the PCA framework, a bank is deemed ``adequately 
capitalized'' if it maintains common equity tier 1 capital of at least 
4.5 percent of the bank's risk-weighted assets, and is deemed ``well 
capitalized'' if it maintains common equity tier 1 capital of at least 
6.5 percent of the bank's risk-weighted assets.\256\ Commenters 
recommended revising the final regulations to provide that a covered SD 
that elects the Bank-Based Capital Approach must maintain common equity 
tier 1 capital at a level that is not less than 4.5 percent of the SD's 
risk-weighted assets, and must maintain common equity tier 1 capital in 
excess of 6.5 percent of the SD's risk-weighted assets in computing the 
``early warning capital requirement'' under proposed regulation 
23.105(c)(2).\257\ Another commenter suggested that the Commission 
adopt a risk-weighted asset ratio that is tiered based on the size and 
complexity of the covered SD's business (e.g., a 4.5% common equity 
tier 1 requirement with the tier 2 capital being eligible for the 
remaining 3.5%).\258\
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    \255\ Id.
    \256\ See 12 CFR 208.43(b) for the Federal Reserve Board's 
capital measures and capital levels that are used for determining 
the supervisory actions for insured depository institutions that are 
not adequately capitalized.
    \257\ See IIB/ISDA/SIFMA 3/3/2020 Letter. MS 3/3/2020 Letter at 
8.
    \258\ See Shell 3/3/2020 Letter.
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    The Commission has considered the proposed requirement for a 
covered SD electing the Bank-Based Capital Approach to maintain common 
equity tier 1 capital equal to or in excess of 8% of the SD's risk-
weighted assets, and has considered the comments that have been 
received. The Commission is adopting the requirement as a component of 
the final capital rule for covered SDs electing the Bank-Based Capital 
Approach, subject to the following modifications. The Commission is 
retaining the minimum requirement for a covered SD to maintain capital 
at a level equal to or in excess of 8% of the SD's risk-weighted 
assets. The Commission is modifying the final regulation, however, to 
require that at least 6.5% of the minimum 8% capital requirement must 
be common equity tier 1 capital, with the remaining 1.5% to be 
comprised of common equity tier 1 capital, additional tier 1 capital, 
or tier 2 capital, as defined by the Federal Reserve Board in 12 CFR 
217.20. The Commission is further modifying the final rule to provide 
that any capital that is in the form of subordinated debt must meet the 
conditions adopted by the SEC for qualifying subordinated debt for 
SBSDs set forth in rule 18a-1d (17 CFR 240.18a-1d). In addition, a 
covered SD may use additional tier 1 and tier 2 capital (including 
qualifying subordinated debt) to meet the early warning capital 
requirement above the 6.5% of common equity tier 1 capital.
    The Commission is adopting these modifications as it believes that 
it establishes an appropriate balance between ensuring that a covered 
SD maintains an appropriate level of permanent capital in the form of 
common equity tier 1 capital and permitting an SD to use other forms of 
capital formation, including qualifying subordinated debt. As noted 
below, the subordinated debt qualifications require the lender to 
subordinate their claims against the covered SD to the claims of all 
other creditors, which is comparable to the position of holders of 
common equity capital. The subordinated debt regulations further place 
restrictions on the ability of the SD to repay the subordinated debt if 
it would adversely impact the capital of the SD.\259\ In addition, 
final regulation 23.104 imposes limitations on the withdrawal of equity 
from a covered SD by actions of its shareholders, including paying 
dividends and similar distributions, if such distributions would result 
in the SD holding less than 120% of its minimum capital 
requirement.\260\ These additional regulatory requirements effectively 
ensure that the capital, including capital provided in the form of 
subordinated debt, is retained in the covered SD ensuring its safety 
and soundness.
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    \259\ See, e.g., SEC rule 18a-1d(b)(7) (17 CFR 240.18a-1(b)(7)) 
which suspends a SBSD's obligation to make a scheduled payment on a 
subordinated loan agreement if, after giving effect to the payment 
obligation (and to any other payment obligations under other 
subordinated debt agreements that are scheduled to be paid on or 
before the payment date of the subordinated loan agreement in 
question), the SBSD's net capital would fall below 120 percent of 
the SBSD's minimum net capital or tentative net capital requirement, 
as applicable.
    \260\ See final Commission regulation Sec.  23.104.
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    The final rule is also consistent with the Commission's capital 
rules for FCMs, the SEC's rules for BDs and SBSDs, and the prudential 
regulators' rules for banks and bank holding companies, all of which 
recognize certain qualifying subordinated debt as capital.\261\ The 
final regulations also impose identical terms and conditions on 
qualifying subordinated debt under the Bank-Based Capital Approach and 
the Net Liquid Assets Capital Approach as covered SDs electing either 
approach

[[Page 57495]]

are subject to the subordinated debt provision of SEC rule 18a-1d.\262\
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    \261\ See, e.g., Commission regulation Sec.  1.17(h) (17 CFR 
1.17), SEC rules 15c3-1d and 18a-1d (17 CFR 240.15c3-1d and 17 CFR 
240.18a-1d), and Federal Reserve Board rule 217.20 (12 CFR 217.20) 
for rules governing subordinated debt as capital for FCMs, BDS and 
SBDS, and banks and bank holding companies, respectively.
    \262\ A covered SD that elects the Net Liquid Assets Capital 
Approach is permitted under SEC rule 18a-1 (17 CFR 240.18a-1) to 
recognize subordinated debt that meets the qualification standards 
in SEC rule 18a-1d (17 CFR 240.18a-1d) in meeting its minimum 
capital requirements.
---------------------------------------------------------------------------

    The SEC's qualification conditions in Rule 18a-1d require that the 
loan agreement must: (i) Be in writing and have a minimum term of at 
least one year; (ii) be a valid and binding obligation enforceable in 
accordance with its terms against the SD and the lender; and (iii) 
effectively subordinate any right of the lender to receive any payment 
with respect to the loan agreement to the prior payment in full of all 
claims of all present and future creditors of the covered SD arising 
out of any matter occurring prior to the date on which the related 
payment obligation matures, except for claims which are the subject of 
subordinated loan agreements that rank on the same priority as, or 
junior to, the claim of the lender under the subordinated loan 
agreement. Rule 18a-1d also contains conditions intended to ensure that 
the SBSD does not make payments on subordinated loans if such payments 
would reduce the SBSD's net capital below 120% of its minimum capital 
requirement. These terms and conditions effectively result in the 
subordinated debt having the characteristics of common equity as the 
issuances of the subordinated loan rank just above common equity 
holders in the event of the insolvency of the covered SD. Therefore, 
the Commission believes that it is appropriate to recognize 
subordinated debt that meets the conditions of SEC rule 18a-1d to 
qualify as tier 2 capital under the Commission's final regulation.
Calculation of Risk-Weighted Assets
    As noted above, the Proposal required a covered SD electing the 
Bank-Based Capital Approach to compute its risk-weighted assets in 
accordance with the Federal Reserve Board's capital requirements 
contained in 12 CFR part 217. Covered SDs using the standardized 
approach were required to use the credit risk charges from the Federal 
Reserve Board's standardized approach under subpart D 12 CFR part 217. 
Covered SDs using internal capital models were required to use models 
that met the qualitative and quantitative requirements set forth in 
proposed regulation 23.102 and Appendix A to regulation 23.102. The 
qualitative and quantitative requirements set forth in regulation 
23.102 and Appendix A were based on the Federal Reserve Board's 
qualitative and quantitative requirements for capital models in 12 CFR 
part 217. Federal Reserve Board model-based capital charges for credit 
risk and market risk are set forth in 12 CFR part 217 subparts E and F, 
respectively.
    Commenters noted that the Federal Reserve's capital approach is 
currently undergoing significant transformation as it implements the 
revised Basel III framework adopted in 2017.\263\ One commenter stated 
that the Federal Reserve Board's implementation of certain fundamental 
aspects of the Basel III framework, including approaches for credit, 
market, and operational risks remain pending, and further noted that 
the BCBS is also making further revisions to the credit valuation 
adjustment risk framework to further align it with other capital 
requirements.\264\ Another commenter stated that there are significant 
ongoing efforts to revise specific credit risk and market risk 
methodologies, which will likely require at least two, and potentially 
several, years to reach finalization.\265\ The commenters stated that 
it is essential that the Commission adopt a Bank-Based Capital Approach 
that provides covered SDs with certainty of application despite these 
and other future changes to the bank capital framework.\266\ The 
commenters stated that given the ongoing revisions to the banking 
regulators' capital requirements, the Commission should revise its 
rules to incorporate the Federal Reserve Board's rules by reference 
instead of setting forth explicit capital model provisions and 
quantitative and qualitative capital requirements in Appendix A of 
regulation 23.102.
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    \263\ IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
    \264\ IIB/ISDA/SIFMA 3/3/2020 Letter.
    \265\ MS 3/3/2020 Letter.
    \266\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
---------------------------------------------------------------------------

    The commenters also specifically stated that given the current 
unsettled nature of the prudential regulators' requirements, covered 
SDs electing the Bank-Based Capital Approach that are approved to use 
internal market risk and credit risk models should be permitted to 
choose whether or not to apply the Federal Reserve Board's provisions 
for advanced approaches for Federal Reserve Board-regulated 
institutions.\267\ The Commenter further stated that covered SDs should 
also be permitted to compute their credit risk-weighted assets using 
the current exposure method (``CEM''), the internal models method 
(``IMM''), or SA-CCR with certain modifications.\268\
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    \267\ Id.
    \268\ Id. The CEM, IMM, and SA-CCR approaches for computing 
credit risk are set forth in the Federal Reserve Board's capital 
rules for bank holding companies, 12 CFR part 217.
---------------------------------------------------------------------------

    The Commission has considered the Proposal and the comments 
requesting flexibility in adopting the Bank-Based Capital Approach. The 
Commission understands that some critical elements of Basel III are 
still being revised and adoption by the Federal Reserve Board is an 
ongoing process that may span several years, which makes incorporating 
specific market risk and credit risk components of the Federal Reserve 
Board's rules into Appendix A of regulation 23.102 difficult. In this 
process the Federal Reserve Board also may allow for alternative 
calculation methods, some transitionally and some permanently, which 
further makes specific incorporation of bank capital requirements into 
Appendix A challenging.
    The Commission does not want to introduce conflicting deadlines, 
contradictory guidance, or cause firms to incur duplicative model 
implementation costs during this implementation process. Thus, the 
Commission is modifying the final rules to incorporate the Federal 
Reserve Board's market risk and credits requirements by referencing the 
applicable sections of the Federal Reserve Board's regulations in 12 
CFR part 217 instead of incorporating specific market risk and credit 
risk requirements contained in 12 CFR part 217 into Appendix A of 
regulation 23.102. This modification of the rule text will provide 
legal certainty to the covered SDs that future changes to the relevant 
market risk and credit risk requirements in 12 CFR part 217 will be 
appropriately incorporated into the Commission's capital requirements 
without further Commission action, such as a rulemaking. The Commission 
will retain Appendix A of regulation 23.102 as it will be applicable to 
covered SDs electing the Net Liquid Assets Capital Approach or the 
Tangible Net Worth Capital Approach to compute market risk and credit 
risk capital charges.
    The Commission is also modifying the final rule to provide that 
where the Federal Reserve Board's rules allow for alternative 
calculation methods, the Commission's final rule also allows for the 
same alternatives. For example, commenters noted that subpart D of 12 
CFR part 217 currently provides that bank holding companies may compute 
standardized credit risk charges for OTC

[[Page 57496]]

derivative transactions using either the CEM or SA-CCR calculation 
methods. The Commission's final rule permits covered SDs to elect to 
use either method, recognizing that both CEM and SA-CCR are part of the 
BCBS international capital framework and have been adopted by the 
prudential regulators.
    Furthermore, the choice of calculation method elected by a covered 
SD does not have to be the same as the calculation method the covered 
SD's banking parent or affiliate elects to use or is required to use 
under the Federal Reserve Board's rules. For example, a covered SD may 
elect to use the CEM method notwithstanding that its banking affiliate 
uses the SA-CCR method. However, a covered SD must address these 
differences in its model application, particularly if it relies upon or 
uses model documentation provided by a banking affiliate to prudential 
regulators as part of a model approval or oversight process by the 
prudential regulators. The covered SD also must inform the Commission 
or NFA if another regulator has denied its or its affiliate's use of an 
alternative calculation.
    In choosing an alternative calculation the non-bank SD must adopt 
the entirety of the alternative. The Commission understands that some 
alternatives may include charges or deductions for risks not otherwise 
part of market and credit risk models described in this rule (e.g., 
operational risk), however, the Commission is not prepared to accept 
partial application of alternative calculation methods or to compensate 
this inclusion by reducing other charges calculated per this rule 
outside of the market and credit risk models.
    The Commission is implementing the above revisions to the final 
rules by modifying regulation 23.100 to include a definition of the 
term ``BHC equivalent risk-weighted assets'' that defines the method 
that a covered SD that elects the Bank-Based Capital Approach uses to 
compute market risk and credit risk using either models or standardized 
charges in computing its regulatory capital. Under the BHC equivalent 
risk-weighted assets definition, a covered SD that is not approved to 
use models would compute market risk in accordance with the 
standardized charges in Commission regulation 1.17 and SEC rule 18a-1, 
and would compute credit risk charges in accordance with the 
standardized charges using the bank holding company regulations in 
subpart D of 12 CFR part 217. Covered SDs approved to use models would 
compute market risk in accordance with the bank holding company 
requirements set forth in subpart F of 12 CFR part 217, and would 
compute credit risk charges in accordance with the bank holding company 
requirements in subpart E of 12 CFR part 217. The Commission also is 
modifying regulation 23.103 to remove the calculation of market and 
credit risk under the Bank-Based Capital Approach as it is now 
contained in revised regulation 23.100, and modifying definitions in 
regulation 23.100 to define the terms ``advanced approaches Board-
regulated institution'' and ``OTC derivative contract'' to effect the 
above revisions to the rule text.
    Commenters also requested that the Commission modify the final 
rules by providing an adjustment to the Federal Reserve Board's SA-CCR 
credit risk calculation when the SD applies SA-CCR in computing its 
capital.\269\ One commenter stated that the Federal Reserve Board's SA-
CCR rules set a ``supervisory factor'' for energy derivatives of 
between 18%, for oil and natural gas transactions, and 40%, for 
electricity transactions.\270\ The commenter represented that when 
adopting the calibrations, the Federal Reserve Board calibrated the 
supervisory factors to spot prices rather than forward prices. The 
commenter stated that SDs active in the oil, natural gas, and 
electricity markets are heavily concentrated in forward markets, which 
have very different volatilities and credit risk profiles than those of 
spot markets.
---------------------------------------------------------------------------

    \269\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
    \270\ See MS 3/3/2020 Letter.
---------------------------------------------------------------------------

    The Commission is not modifying the final regulations to reset the 
supervisory factors adopted by the Federal Reserve Board for derivative 
transactions. This is an issue that the Commission will assess during 
the implementation of the rule.
Minimum Capital Requirement Based on Risk Margin Amount Under Bank-
Based Capital Approach
    The third criterion comprising the minimum capital requirement 
under the proposed Bank-Based Capital Approach required a covered SD to 
maintain common equity tier 1 capital equal to or in excess of 8% of 
the sum of: (i) The covered SD's uncleared swap margin requirements for 
uncleared swaps transactions; (ii) the initial margin that would be 
required for each uncleared security-based swap transaction pursuant to 
SEC's proposed Rule 18a-3(c)(1)(i)(B), without regard for any amounts 
of security-based swaps that may be exempted or excluded under the 
SEC's proposal; (iii) the risk margin required on the covered SD's 
cleared futures, foreign futures, and swaps positions; and (iv) the 
amount of initial margin required by a clearing organization that 
clears the covered SD's proprietary security-based swaps.\271\
---------------------------------------------------------------------------

    \271\ See 2016 Capital Proposal, 81 FR 91252 at 91258-59.
---------------------------------------------------------------------------

    This requirement was intended to ensure that a covered SD electing 
the Bank-Based Capital Approach maintains a minimum level of capital 
that is comprehensive with respect to all of the SD's operations and 
activities. The Commission believed that the proposed 8% risk margin 
amount was an appropriate approach as the minimum capital requirement 
was correlated with the ``risk'' of the covered SD's futures, foreign 
futures, swaps, and security-based swaps positions as measured by the 
margin required on the positions. Specifically, a covered SD's minimum 
capital requirement would increase or decrease in proportion to the 
number, size, complexity and all risks inherent in the SD's customer, 
client, and proprietary derivatives business.\272\
---------------------------------------------------------------------------

    \272\ See 2016 Capital Proposal, 81 FR 91252 at 91258.
---------------------------------------------------------------------------

    Commenters generally raised the same concerns regarding the 8% risk 
margin amount as discussed in detail in section II.C.2.a. above for the 
covered SDs electing the Net Liquid Assets Capital Approach. 
Specifically, commenters stated the 8% risk margin amount is too high a 
percentage and includes too many types of derivatives products. 
Commenters also stated that the risk margin amount is not a good 
measure of the risk of the positions to the covered SD.
    One commenter also stated that the Commission should not adopt the 
8% risk margin amount for covered SDs electing the Bank-Based Capital 
Approach. One commenter stated that prudential regulators do not have a 
minimum capital requirement based on a bank SD's risk margin 
amount.\273\
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    \273\ IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    One commenter stated that if the Commission adopted the risk margin 
amount, the Commission should modify the final regulation to permit 
covered SDs electing the Bank-Based Capital Approach to include 
additional tier 1 capital and tier 2 capital in addition to common 
equity tier 1 capital in meeting the risk margin amount.\274\
---------------------------------------------------------------------------

    \274\ Id.
---------------------------------------------------------------------------

    The Commission has considered the proposed risk margin amount 
requirement for covered SDs electing the Bank-Based Capital Approach 
and has considered the comments received, and is adopting the 
requirement with

[[Page 57497]]

several modifications. The final regulation will require a covered SD 
electing the Bank-Based Capital Approach to maintain a combination of 
common equity tier 1 capital, additional tier 1 capital, and tier 2 
capital in an amount equal to or greater than 8% of the covered SD's 
uncleared swap margin. The term ``uncleared swap margin'' is defined in 
regulation 23.100, and means the amount of initial margin computed in 
accordance with the Commission's uncleared margin rules (regulation 
23.154; 17 CFR 23.154) that a SD would be required to collect from each 
counterparty for each outstanding swap position of the SD, including 
all swap positions that are excluded or exempt from the uncleared 
margin rules under regulation 23.150 (17 CFR 23.150), legacy swap 
positions, exempt foreign exchange swaps or foreign exchange forwards.
    As discussed in section II.C.2.a. above, the Commission believes 
that a minimum capital requirement based on initial margin is an 
appropriate component of a covered SD's minimum capital requirement. 
The intent of the risk margin amount requirement was to ensure that a 
covered SD has a sufficient level of capital to meet its obligations as 
a SD, and to cover potential operational risk, legal risk, and other 
risks, and not just the risks of its trading portfolio. The Commission 
believes that the risk margin amount is a minimum capital requirement 
that provides a floor based on a measure of the risk of the swap 
positions, the volume of positions, the number of counterparties and 
the complexity of operations of the covered SD. The risk margin amount 
is based on the initial margin that is computed on the proprietary 
positions held by the covered SD. Initial margin reflects the degree of 
risk associated with the positions, with lower risk positions having 
lower initial margin requirements and higher risk positions having 
higher initial margin requirements. Therefore, the Commission believes 
that because the risk margin amount calculation is directly related to 
the volume, size, complexity and risk of the covered SD's uncleared 
swap positions, it serves as a good proxy for inherent risk in the SD's 
positions, operations, and other risks, and is used to calibrate the 
amount of the minimum capital required of a covered SD.
    The Commission, however, is not modifying the regulation by 
lowering the risk margin amount multiplier from 8% to 2% or to a 
different percentage. As discussed in section II.C.2.a. above, the 
minimum capital requirement based upon the risk margin amount is 
applied in a different manner in the Bank-Based Capital Approach as 
compared with the Net Liquid Assets Capital Approach. Under the Bank-
Based Capital Approach, a covered SD is required to maintain balance 
sheet equity in excess of 8% of the risk margin on uncleared swap 
positions. This approach is a less conservative approach than the Net 
Liquid Assets Capital Approach, which requires a covered SD to maintain 
current, liquid assets, less market risk and credit risk capital 
charges on proprietary positions including swaps and security-based 
swaps, in excess of 2% of the risk margin amount on uncleared swaps. 
Due to the different approaches, the Commission believes that it is 
appropriate to set the risk margin amount multiplier at 8% under the 
Bank-Based Capital Approach to help ensure that the minimum capital 
requirement ensures the safety and soundness of the covered SD.
    The Commission also believes that many of the commenters' concerns 
are mitigated by the modifications that the Commission is making to the 
final regulation. Consistent with its approach for FCM-SDs and Net 
Liquid Assets Capital Approach, the Commission is modifying the final 
regulation to exclude cleared and uncleared security-based swap 
positions, and proprietary futures, foreign futures, and cleared swap 
positions from the risk margin amount calculation.
    In addition, as noted above, the Commission will monitor the risk 
margin amount after the compliance date of the regulations to assess 
whether adjustments are necessary to the regulations to ensure the 
safety and soundness of the covered SD. The Commission will use the 
information that it obtains from financial reports submitted by covered 
SDs and from the Commission's and NFA's ongoing oversight of the SDs to 
continually monitor and evaluate the adequacy of the minimum capital 
requirements.
Minimum Capital Requirement of a Registered Futures Association Under 
Bank-Based Capital Approach
    The fourth criterion of the proposed minimum capital requirements 
required a covered SD to maintain the minimum level of capital required 
by an RFA of which the covered SD is a member. As noted above, the 
proposed minimum capital requirement based on membership requirements 
of an RFA is consistent with current FCM capital requirements under 
regulation 1.17, and reflects Commission regulations that require each 
covered SD to be a member of an RFA.\275\ As further noted above, the 
Proposal is also consistent with section 17(p)(2) of the CEA, which 
provides, in relevant part, that an RFA must adopt rules establishing 
minimum capital and other financial requirements applicable to the 
RFA's members for which such requirements are imposed by the 
Commission.\276\ The Proposal recognizes that the NFA, as the only RFA, 
would be required by section 17 of the CEA to adopt capital rules for 
covered SDs once the Commission imposes capital requirements on covered 
SDs, and would incorporate the NFA minimum capital requirements into 
the Commission's regulation.
---------------------------------------------------------------------------

    \275\ See Commission regulations Sec. Sec.  1.17(a)(1)(i)(C) and 
170.16 (17 CFR 1.17(a)(1)(i)(C) and 170.16).
    \276\ See section 17(p)(2) of the CEA, which requires RFAs to 
adopt rules establishing minimum capital and other financial 
requirements applicable to its members for which such requirements 
are imposed by the Commission, provided that such requirements may 
not be less stringent than the requirements imposed by the CEA or by 
Commission regulations.
---------------------------------------------------------------------------

    The Commission received general comments regarding the proposed 
requirement that a covered SD must meet the capital rules adopted by 
the NFA. Several commenters stated that any future NFA capital rules 
for covered SDs should be subject to public comment.\277\ Another 
commenter stated that the Commission's efforts to obtain public input 
pursuant to the 2016 Capital Proposal and the 2019 Capital Reopening 
may be nullified if the NFA adopts capital rules that are different 
from the Commission's final rules, and requested that the Commission 
require NFA to adopt capital rules that closely mirror the Commission's 
final capital rules, or, at the least, require NFA to conduct a 
rigorous notice and comment process prior to finalizing its capital 
rules.\278\
---------------------------------------------------------------------------

    \277\ ED&F Man/INTL FCStone 3/3/2020 Letter; Shell 3/2/2020 
Letter.
    \278\ See Shell 3/2/2020 Letter.
---------------------------------------------------------------------------

    As discussed in section II.C.2.a. above, the Commission believes 
that commenters' concerns are largely mitigated by the existing 
statutory and Commission regulatory requirements as well as the 
internal governance structure of NFA, which was established to comply 
with these requirements. Section 17(j) of the CEA requires NFA to file 
with the Commission any change in or addition to its rules. Any such 
change or addition is effective within 10 days of submission unless NFA 
requests, or the Commission notifies NFA of its intent to subject the 
filing to, a review and approval process.\279\ Further, NFA's 
governance structure ensures that SDs are represented in the

[[Page 57498]]

potential adoption of NFA rules, including capital and financial 
reporting rules, that may impact them. As noted in section II.C.2.a. 
above, section 17(b)(5) of the CEA and regulation 170.3 require 
generally that the rules of an RFA assure fair representation of its 
members in the adoption of any rule, in the selection of its officers, 
directors, and in other aspects of its administration.\280\ Therefore, 
the Commission is adopting this component of the minimum capital 
requirements of the Bank-Based Capital Approach as proposed.
---------------------------------------------------------------------------

    \279\ See section 17(j) of the CEA (7 U.S.C. 21(j)).
    \280\ 7 U.S.C. 21(b)(5) and Commission regulation Sec.  170.3 
(17 CFR 1.17). See also, section 17(b)(11) of the CEA (7 U.S.C. 
21(b)(11)) which requires that an RFA provide for meaningful 
representation on the governing board of such association of a 
diversity of membership interests and provides that no less than 20 
percent of the regular voting members of[the board be comprised of 
qualified nonmembers of or persons not regulated by such 
association.
---------------------------------------------------------------------------

Final Minimum Capital Requirement for Covered SDs Electing the Bank-
Based Capital Approach
    As noted above, the Commission proposed that a covered SD electing 
the Bank-Based Capital Approach must maintain common equity tier 1 
capital equal to or greater than the greatest of (i) $20 million, (ii) 
8% of the covered SD's risk margin amount, (iii) 8% of the covered SD's 
risk-weighted assets, or (iv) the amount of capital required by an RFA. 
Also as noted above, the Commission is modifying the final regulation 
to permit a covered SD to hold common equity tier 1, additional tier 1, 
and tier 2 capital to meet the 8% of the risk margin amount and to meet 
the 8% of risk weighted assets. Therefore, the Commission is modifying 
the final minimum capital requirement to require a covered SD to 
satisfy each of the four minimum capital requirements. This 
modification is intended to align the final rule with the original 
proposal, which required a covered SD to hold a sufficient amount of 
common equity tier 1 capital to meet each of the four minimum capital 
requirements. Under the final rule, the covered swap dealer will 
continue to have to meet each of the four criteria, but may use capital 
other than common equity tier 1 capital to meet such requirements 
consistent with the rule.
4. Capital Requirement for Covered SDs Electing the Tangible Net Worth 
Capital Approach
    The Commission proposed to permit covered SDs that are 
``predominantly engaged in non-financial activities,'' as defined 
below, to elect a capital requirement based on the SD's tangible net 
worth (the ``Tangible Net Worth Capital Approach'').\281\ The term 
``tangible net worth'' was proposed to be defined as the net worth of a 
covered SD, as determined in accordance with U.S. GAAP, excluding 
goodwill and other intangible assets.\282\ The 2016 Capital Proposal 
further required a covered SD, in computing its tangible net worth, to 
include all liabilities or obligations of a subsidiary or affiliate 
that the covered SD guaranteed, endorsed, or assumed either directly or 
indirectly to ensure that the tangible net worth of the covered SD 
reflects the full extent of the covered SD's potential financial 
obligations.\283\ The proposed definition further provided that in 
determining net worth, all long and short positions in swaps, security-
based swaps, and related positions must be marked to their respective 
market values to ensure that the tangible net worth reflected the 
current market value of the covered SD's swap and security-based swap 
positions, including any accrued losses on such positions.\284\
---------------------------------------------------------------------------

    \281\ See proposed Commission regulation Sec.  23.101(a)(2)(ii), 
2016 Capital Proposal, 81 FR 91252 at 91311.
    \282\ See proposed Commission regulation Sec.  23.100, 2016 
Capital Proposal, 81 FR 91252 at 91309-10.
    \283\ See proposed definition of ``tangible net worth'' in 
Commission regulation Sec.  23.100, 2016 Capital Proposal, 81 FR 
91252 at 91310.
    \284\ Id.
---------------------------------------------------------------------------

    The Commission further proposed that a covered SD eligible for the 
Tangible Net Worth Capital Approach must maintain tangible net worth in 
an amount equal to or in excess of the greatest of:
    (1) $20 million plus the amount of the covered SD's market risk 
exposure requirement and credit risk exposure requirement associated 
with the covered SD's swap and related hedge positions that are part of 
the covered SD's swap dealing activities;
    (2) 8% of the sum of:
    (a) The amount of uncleared swap margin (as that term was defined 
in regulation 23.100) for each uncleared swap position open on the 
books of the covered SD, computed on a counterparty by counterparty 
basis pursuant to regulation 23.154 without regard to any initial 
margin exemptions or thresholds that the Commission's margin rules may 
provide;
    (b) the amount of initial margin that would be required for each 
uncleared security-based swap position open on the books of the covered 
SD, computed on a counterparty by counterparty basis pursuant to 17 CFR 
240.18a-3(c)(1)(i)(B) without regard to any initial margin exemptions 
or exclusions that the rules of the SEC may provide to such security-
based swap positions; and
    (c) the amount of initial margin required by clearing organizations 
for cleared proprietary futures, foreign futures, swaps and security-
based swaps positions open on the books of the covered SD; or
    (3) The amount of net capital required by the registered futures 
association of which the covered SD is a member.
    The 2016 Capital Proposal further provided that a covered SD could 
use internal models to compute market risk and credit risk capital 
charges provided that the models were approved by the Commission or an 
RFA.\285\ A covered SD that did not obtain Commission or RFA approval 
to use internal models was required to compute standardized market risk 
and credit risk charges for its proprietary swaps, security-based 
swaps, or other financial positions in accordance with the FCM 
standardized market risk and credit risk capital charges set forth 
under regulation 1.17, as proposed to be amended.\286\
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    \285\ See proposed Commission regulation Sec.  23.102(a), 2016 
Capital Proposal, 81 FR 91252 at 91311.
    \286\ See section II.B.3.a above for a discussion of the 
standardized market risk and credit risk capital charges for FCMs 
and FCM-SDs.
---------------------------------------------------------------------------

    The Commission also proposed that to be eligible to use the 
Tangible Net Worth Capital Approach, a covered SD's financial 
activities must be de minimis in relation to its overall financial and 
non-financial activities. Specifically, the 2016 Capital Proposal 
provided that the covered SD must be ``predominantly engaged in non-
financial activities.'' The term ``predominantly engaged in non-
financial activities'' was proposed to be defined by referencing the 
definition of the term ``financial activities'' under the Federal 
Reserve Board's regulations establishing criteria for determining if a 
nonbank financial company is ``predominantly engaged in financial 
activities'' and therefore, subject to Federal Reserve Board 
oversight.\287\
---------------------------------------------------------------------------

    \287\ See 12 CFR 242.3.
---------------------------------------------------------------------------

    Title I of the Dodd-Frank Act established the Financial Stability 
Oversight Council (``FSOC''), which, among other authorities and 
duties, may subject a nonbank financial company to supervision by the 
Federal Reserve Board and consolidated prudential standards if the FSOC 
determines that material financial distress at the nonbank financial 
company, or the nature, scope, size, scale, concentration, 
interconnectedness, or mix of the company's activities, could pose a 
threat to the financial stability of the U.S. Title I of the Dodd-Frank 
Act defines a ``nonbank financial company'' to include both a U.S. 
nonbank financial

[[Page 57499]]

company and foreign nonbank financial company that, among other things, 
are ``predominantly engaged in financial activities.'' For purposes of 
Title 1 of the Dodd-Frank Act, a company is considered to be 
``predominantly engaged'' in financial activities if either (i) the 
annual gross revenue derived by the company and all of its subsidiaries 
from financial activities, as well as from the ownership or control of 
an insured depository institution, represented 85 percent or more of 
the consolidated annual gross revenues of the company; or (ii) the 
consolidated assets of the company and all of its subsidiaries related 
to financial activities, as well as related to the ownership or control 
of an insured depository institution, represent 85 percent or more of 
the consolidated assets of the company.
    The Commission proposed to adopt this Federal Reserve Board 
standard to distinguish covered SDs that are predominantly engaged in 
financial activities from covered SDs that are predominantly engaged in 
non-financial activities. The Commission, however, modified the test 
for purposes of the eligibility of the Tangible Net Worth Capital 
Approach to provide that a covered SD would be considered 
``predominantly engaged in non-financial activities'' if: (i) The 
consolidated annual gross financial revenues of the covered SD in 
either of its two most recently completed fiscal years represented less 
than 15 percent of the consolidated gross revenue in that fiscal year 
(``15% Revenue Test''); and (ii) the consolidated total financial 
assets of the covered SD at the end of its two most recently completed 
fiscal years represented less than 15 percent of the consolidated total 
assets as of the end of the fiscal year (``15% Asset Test'').
    The 2016 Capital Proposal also proposed to define the financial 
activities covered by the 15% Revenue Test and 15% Asset Test by 
reference to the listed financial activities set forth in Appendix A of 
12 CFR part 242, which covers an extensive range of financial 
activities and services.\288\ The financial activities set forth in 
Appendix A of 12 CFR part 242 include, among other things: (i) Lending, 
exchanging, transferring, investing for others, or safeguarding money 
or securities; (ii) insuring, guaranteeing, or indemnifying against 
loss or harm, damage or death in any state; (iii) providing financial, 
investment, or economic advisory services; (iv) issuing or selling 
interests in a pool; (v) underwriting, dealing in, or making a market 
in securities; and (vi) engaging as principal in the investment and 
trading of certain financial instruments. The Commission, however, 
proposed to explicitly provide that accounts receivable from non-
financial activities, which may meet the definition of financial 
activities under 12 CFR part 242, may be excluded by the covered SD 
from the computation of its financial activities.\289\ The Commission 
stated that the purpose of providing this exclusion was to prevent the 
covered SD's non-financial activities from becoming part of the 
computation of the covered SD's financial activities merely on the 
basis that the non-financial activities result in the covered SD 
recognizing receivables.
---------------------------------------------------------------------------

    \288\ See definition of ``predominantly engaged in non-financial 
activities'' in proposed Commission regulation Sec.  23.100, 2016 
Capital Proposal, 81 FR 91252 at 91309.
    \289\ Id.
---------------------------------------------------------------------------

    The Commission proposed the Tangible Net Worth Capital Approach in 
recognition that certain entities that engage predominantly in non-
financial activities may currently or in the future meet the statutory 
and regulatory definition of the term ``swap dealer'' and, therefore, 
will be required to register as such with the Commission.\290\ The 
Commission stated that while these entities may meet the definition of 
a ``swap dealer'' they may also be primarily commercial entities 
engaged predominantly in non-financial activities.\291\ The Commission 
further recognized that covered SDs that are primarily engaged in 
commercial activities differ from financial entities in various ways, 
including the composition of their respective balance sheets (e.g., the 
types of assets they hold), the types of transactions they enter into, 
and the types of market participants and swap counterparties that they 
deal with. Because of these differences, the Commission stated that 
application of the Bank-Based Capital Approach or the Net Liquid Assets 
Capital Approach could result in inappropriate capital requirements 
that would not be proportionate to the risk taken by such covered SDs, 
and proposed to permit these covered SDs to have an option of electing 
the Tangible Net Worth Capital Approach.\292\ The Commission, however, 
modified the standards established by the Federal Reserve Board as it 
believed that covered SDs that engage in anything more than a de 
minimis level of financial activities must be subject to either the Net 
Liquid Assets Capital Approach or the Bank-Based Capital Approach in 
order for the Commission's regulations to achieve the Congressional 
mandate that the SD capital requirements ensure the safety and 
soundness of the SD.
---------------------------------------------------------------------------

    \290\ The term ``swap dealer'' is defined by section 1a(49) of 
the CEA and Commission regulation Sec.  1.3 (17 CFR 1.3). Regulation 
1.3 provides that an entity may apply to limit its designation as an 
SD to specified categories of swaps or specified activities in 
connection with swaps.
    \291\ See 2016 Capital Proposal, 81 FR 91252 at 91255.
    \292\ Furthermore, as an SD, the firm is subject to the 
Commission's final swaps margin requirements.
---------------------------------------------------------------------------

    The Commission received comments generally supporting the proposed 
Tangible Net Worth Capital Approach, but also stating that the 
qualifying criteria were overly narrow and entity specific.\293\ 
Commenters generally noted that a parent entity that is ``predominantly 
engaged in non-financial activities'' as defined by the regulation 
would not be permitted in any practical way to establish a covered SD 
subsidiary that would qualify to use the Tangible Net Worth Capital 
Approach as the swaps activity of the SD subsidiary would be considered 
financial activities.\294\ Another commenter stated that commercial 
firms often establish subsidiaries to perform centralized risk 
management operations for the full commercial enterprise, including 
entering into swap transactions, and that such subsidiaries should have 
the ability to elect a Tangible Net Worth Capital Approach.\295\ 
Commenters further noted that the proposed Tangible Net Worth Capital 
Approach would discriminate against corporate entities that are 
predominantly engaged in non-financial activities but elect to maintain 
their swap dealing activities in separate legal entities.\296\ Several 
commenters suggested that the Commission should address these concerns 
by modifying the Proposal to permit a covered SD to elect the Tangible 
Net Worth Capital Approach if the SD or its parent meets the qualifying 
criteria of ``predominantly engaged in non-financial activities.'' 
\297\
---------------------------------------------------------------------------

    \293\ See, e.g., Letter from Phillip Lookadoo, and Jeremy 
Weinstein, International Energy Credit Association (May 15, 2017) 
(IECA 5/15/2017 Letter); Letter from Scott Earnest, Shell Trading 
Risk Management LLC (May 15, 2017) (Shell 5/15/2017 Letter); Letter 
from David McIndoe, Commercial Energy Working Group (May 15, 2017) 
(CEWG 5/15/2017 Letter); and Letter from Michael P. LeSage, Cargill 
Risk Management, a unit of Cargill, Inc. (May 15, 2017) (Cargill 5/
15/2017 Letter).
    \294\ See IECA 5/15/2017 Letter; Shell 5/15/2017 Letter; CEWG 5/
15/2017 Letter.
    \295\ See Letter from National Corn Growers Association and 
National Gas Supply Association, (May 15, 2017) (NCGA/NGSA 5/15/2017 
Letter).
    \296\ See, e.g., Shell 5/15/2017 Letter.
    \297\ See IECA 5/15/2017 Letter; CEWG 5/15/2017 Letter; NCGA/
NGSA 5/15/2017 Letter.
---------------------------------------------------------------------------

    In reopening the comment period in 2019, the Commission requested 
further

[[Page 57500]]

comment on the Tangible Net Worth Capital Approach based upon issues 
raised in the 2016 Capital Proposal.\298\ The Commission requested 
comment on whether a covered SD that does not meet the ``predominantly 
engaged in non-financial activities'' standard should be eligible to 
use the Tangible Net Worth Capital Approach if its parent entity, or 
the ultimate parent of its consolidated ownership group, satisfies the 
qualifying standards.\299\ The Commission further requested comment on 
whether a covered SD that relies on a parent entity to satisfy the 
``predominantly engaged in non-financial activities'' criteria should 
be required to obtain parent guarantees, or some other form of 
financial support, for its swaps obligations.\300\
---------------------------------------------------------------------------

    \298\ See 2019 Capital Reopening, 84 FR 69664 at 69674-75.
    \299\ Id.
    \300\ Id.
---------------------------------------------------------------------------

    The Commission also requested comment in the 2019 Capital Reopening 
on whether a covered SD that was primarily engaged in commodity swaps 
should be permitted to use the Tangible Net Worth Capital Approach 
notwithstanding that its parent entity does not meet the 
``predominantly engaged in non-financial activities'' requirements 
(i.e., the parent is primarily engaged in financial activities).\301\ 
Finally, the Commission requested comment regarding modifications that 
commenters believed the Commission should consider to the 15% Asset 
Test and/or the 15% Revenue Test, and requested that commenters explain 
why such modifications were necessary to achieve the purpose and 
objective of the Tangible Net Worth Capital Approach.\302\
---------------------------------------------------------------------------

    \301\ Id.
    \302\ Id.
---------------------------------------------------------------------------

    The Commission received comments in response to the 2019 Capital 
Reopening, and the commenters continued to generally support a Tangible 
Net Worth Capital Approach.\303\ Several commenters, however, continued 
to express the concern that the eligibility criteria, as expressed in 
the 15% Asset Test and the 15% Revenue Test, are not broad enough and 
should be expanded to provide more covered SDs with the ability to 
elect the Tangible Net Worth Capital Approach.\304\ One commenter 
stated that the Commission should revise the qualifications to permit 
more covered SDs to elect the Tangible Net Worth Capital Approach, 
which the commenter viewed as a more suitable approach than the Bank-
Based Capital Approach and the Net Liquid Assets Capital Approach.\305\
---------------------------------------------------------------------------

    \303\ See, e.g., IIB/SIFMA/ISDA 3/3/2020 Letter; MS 3/3/2020 
Letter; CEWG 3/3/2020 Letter; Letter from Jennifer Fordham, National 
Corn Growers Association/Natural Gas Supply Association (March 3, 
2020) (NCGA/NGSA 3/3/2020 Letter); ED&F Man/INTL FCStone 3/3/2020 
Letter; and Shell 3/3/2020 Letter.
    \304\ See, e.g., Shell 3/3/2020 Letter; CEWG 3/3/2020 Letter; MS 
3/3/2020 Letter; IIB/SIFMA/ISDA 3/3/2020 Letter; NCGA/NGSA 3/3/2020 
Letter.
    \305\ See NCGA/NGSA 3/3/2020 Letter. The NCGA/NGSA suggested 
that the Commission base the eligibility of the Tangible Net Worth 
Capital Approach based on the definition of the term ``financial 
entity'' contained in section 2(h)(7)(C)(i)(VIII) of the CEA (7 
U.S.C. 2(h)(7)(C)(i)(VIII)).
---------------------------------------------------------------------------

    Other commenters stated that the Commission should revise the 
eligibility criteria for the Tangible Net Worth Capital Approach to 
provide that a covered SD may use such capital approach if it is part 
of a holding company or corporate structure that is itself 
``predominantly engaged in non-financial activities'' and satisfies the 
15% Asset Test and the 15% Revenue Test.\306\ Several of these 
commenters noted that parent entities that are non-financial entities 
often ``ring-fence'' financial activities (including swap dealing 
activities and treasury functions) in affiliates that are stand-alone 
legal entities, and that the Commission's Proposal effectively prevents 
such stand-alone entities from being eligible for the Tangible Net 
Worth Capital Approach as they are not ``predominantly engaged in non-
financial activities.'' \307\ A commenter stated that centralizing 
financial functions into a single subsidiary provides efficiencies for 
some holding companies that are primarily involved in non-financial 
businesses, such as energy production or agriculture, and that the 
Commission's rules should be corporate-structure neutral.\308\ An 
additional commenter stated that the ultimate parent level is the 
proper level at which to determine whether a corporate enterprise, and 
its subsidiaries, is predominantly engaged in non-financial 
activity.\309\ Another commenter stated that a covered SD that 
otherwise qualifies for and elects the Tangible Net Worth Capital 
Approach should not be required to obtain a parent guarantee for 
obligations arising from its swaps activities.\310\
---------------------------------------------------------------------------

    \306\ See Shell 3/3/2020 Letter; CEWG 3/3/2020 Letter; NCGA/NGSA 
3/3/2020 Letter.
    \307\ See Shell 5/15/2017 Letter; NCGA/NGSA 3/3/2020 Letter.
    \308\ See NCGA/NGSA 3/3/2020 Letter.
    \309\ See CEWG 3/3/2020 Letter.
    \310\ See Shell 3/3/2020 Letter.
---------------------------------------------------------------------------

    The Commission also received comments that the eligibility criteria 
for the Tangible Net Worth Capital Approach should be modified to 
permit a covered SD to use such approach if the SD's swap dealing 
activity is focused on agricultural and exempt swap transactions (a 
``commodity-focused covered SD''), even if the covered SD is part of a 
financial holding company or a corporate parent that provides general 
financial services.\311\ Two entities submitted a joint comment stating 
that the Commission's capital rules should recognize unique issues of 
small, commodity-focused covered SDs by expanding the eligibility 
criteria for the Tangible Net Worth Capital Approach to include smaller 
covered SDs with portfolios predominantly centered around 
counterparties that qualify for the hedging end user exception under 
section 2(h)(7) of the CEA.\312\ The joint comment stated that smaller 
commodity-focused covered SDs do not present the type of 
interconnectedness and systemic risk to the broader financial markets 
in comparison to other covered SDs, in part due to (i) relatively lower 
trading volumes (i.e., market impact); and (ii) the non-financial and 
hedging nature of their customer base.\313\ The joint commenters 
further stated that a significant percentage of the customer base and 
trading activities of smaller commodity-focused covered SDs may qualify 
for the hedging end user exception under section 2(h)(7) of the CEA, 
entering into swap transactions for the purpose of hedging physical 
commodity risk. The commenters claim that as a result of the end user 
exception from clearing and margin, smaller commodity-focused covered 
SDs may not collateralize these relationships fully or the extent they 
would otherwise be required when dealing with financial entities or 
financial end users, and that they would be required to internalize 
capital charges for all uncollateralized exposures, placing burdensome 
costs on these SDs, their market presence, and ultimately commercial 
end user customers.\314\ The commenters suggest that the Commission 
should modify the final rule by adopting an additional qualifying test 
for smaller commodity-

[[Page 57501]]

focused covered SDs with portfolios predominantly centered on 
counterparties that are commercial end users.\315\
---------------------------------------------------------------------------

    \311\ See ED&F Man/INTL FCStone 3/3/2020 Letter; MS 3/3/2020 
Letter; CEWG 3/3/2020 Letter.
    \312\ See ED&F Man/INTL FCStone 3/3/2020 Letter.
    \313\ Id. To demonstrate the nature of their customer base as 
commercial end users, and the relative size of their trading 
activities, the two commenters represent that as of March 3, 2020, 
the two firms have not come into scope for complying with the 
Commission's margin requirement for uncleared swap transactions.
    \314\ Id.
    \315\ Id.
---------------------------------------------------------------------------

    One commenter stated that it agreed with comments filed in response 
to the 2016 Capital Proposal, which supported an expansion of the 
eligibility for the Tangible Net Worth Capital Approach to covered SDs 
that provide access to physical hedging markets.\316\ Commenters also 
suggested that the Commission should modify the ``predominantly engaged 
in non-financial activities'' criteria by, for instance, providing that 
covered SDs whose swaps notional amounts are at least 85 percent 
concentrated in commodity reference assets (e.g., agricultural and 
exempt commodities) are eligible for the Tangible Net Worth Capital 
Approach.\317\
---------------------------------------------------------------------------

    \316\ See ED&F Man/INTL FCStone 3/3/2020 Letter (citing Letter 
from Christine Stevenson, BP Energy Company (May 15, 2017), Letter 
from William Dunaway, INTL FCStone Inc. (May 15, 2017), and Shell 5/
15/2017 Letter).
    \317\ See MS 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 Letter; 
CEWG 3/3/2020 Letter.
---------------------------------------------------------------------------

    Commenters also suggest modifications to the 15% Assets Test and 
15% Revenue Test. One commenter stated the respective tests should 
consider the assets and revenue derived from trading and investing in 
physical commodities to be non-financial in nature.\318\ This commenter 
further suggested that all hedges of commercial risk should be 
considered non-financial in nature as the activity is more indicative 
of an entity being a commercial end user rather than an entity engaged 
in activity that is financial.\319\ Another commenter stated that the 
Commission should exclude financial hedges of physical commodity, 
interest rate, or other corporate risks from being considered 
``financial activities'' for purposes of the 15% Assets Test and the 
15% Revenue Test.\320\ This commenter asserted that the use of 
financial derivatives to manage commercial risk is common for non-
financial entities and is not indicative of an entity being engaged in 
financial activity.\321\ The commenter further stated that the 
Commission should consider assets and revenue derived from trading and 
investing in physical commodities to be non-financial in nature as 
including such activity as ``financial in nature'' under the Federal 
Reserve Board's definition of that term, was not because such activity 
is financial, but because certain banks need the ability to transact in 
physical commodity markets to support their financial derivatives 
activity.\322\
---------------------------------------------------------------------------

    \318\ See Shell 3/3/2020 Letter. See also, CEWG 3/3/2020 Letter 
representing that the inclusion by the Federal Reserve Board of 
trading and investing in physical commodities in the definition of 
activities that are ``financial in nature'' was because certain 
banks need the ability to transact in physical commodity markets to 
support their derivatives activity.
    \319\ Id.
    \320\ See CEWG 3/3/2020 Letter.
    \321\ Id.
    \322\ Id.
---------------------------------------------------------------------------

    The Commission has considered the comments received on the proposed 
Tangible Net Worth Capital Approach and is adopting the regulations as 
proposed, subject to the following modifications. The Commission is 
modifying the definition of the term ``predominantly engaged in non-
financial activities'' in regulation 23.100 to effectively extend the 
eligibility of the Tangible Net Worth Capital Approach to covered SDs 
that are subsidiaries of parent entities that are commercial 
enterprises. Specifically, the definition in regulation 23.100 is 
modified to provide that a swap dealer is predominantly engaged in non-
financial activities if: (1) The swap dealer's consolidated annual 
gross financial revenues, or if the swap dealer is a wholly owned 
subsidiary, then the swap dealer's consolidated parent's annual gross 
financial revenues, in either of its two most recently completed fiscal 
years represents less than 15 percent of the swap dealer's consolidated 
gross revenue in that fiscal year, and (2) the consolidated total 
financial assets of the swap dealer, or if the swap dealer is wholly 
owned subsidiary, the consolidated total financial assets of the swap 
dealer's ultimate parent, at the end of its two most recently completed 
fiscal years represents less than 15 percent of the swap dealer's 
consolidated total assets as of the end of the fiscal year. The 
modifications to the definition of the term ``predominantly engaged in 
non-financial activities'' will permit a covered SD that either 
directly satisfies the 15% Asset Test and the 15% Revenue Test, or is a 
subsidiary of an ultimate parent entity that satisfies the 15% Asset 
Test and the 15% Revenue Test, to elect the Tangible Net Worth Capital 
Approach.
    The Commission is adopting this modification as it recognizes that 
certain corporate entities that are predominantly engaged in 
nonfinancial activities establish separate legal entities to operate as 
financial affiliates to act on behalf of itself and the other 
affiliates of the corporate enterprise. The Commission believes that by 
allowing the ultimate consolidated parent entity to conduct the test it 
provides a better indication as to whether the overall entity is 
commercial in nature or financial in nature, and whether the covered SD 
should be viewed as a commercial SD or financial SD. The Commission 
does not believe that covered SDs that are separately established 
subsidiaries of commercial entities should be precluded from electing 
the Tangible Net Worth Capital Approach as it was not the intent of the 
Proposal to prohibit a commercial enterprise from establishing 
financial subsidiaries that otherwise meet the definition of a swap 
dealer due to their support of the activities of their parent entity, 
affiliates, and their respective commercial customers from electing a 
Tangible Net Worth Capital Approach.
    The Commission is not modifying the final rule to require a covered 
SD that is eligible to elect the Tangible Net Worth Capital Approach as 
a result of its parent satisfying the ``predominantly engaged in non-
financial activities'' standard to obtain any specific financial 
support or guarantees from its parent. The test to determine whether a 
SD can elect the Tangible Net Worth Capital Approach at the ultimate 
parent level is only to determine whether the consolidated entity is 
commercial in nature; however, the final Tangible Net Worth Capital 
Approach requires the covered SD to maintain its own regulatory capital 
in the form of tangible net worth equal to or greater than $20 million 
plus the amount of market risk charges and credit risk charges 
associated with the covered SD's swaps and related hedge positions that 
are part of the its swap dealing activities. In addition, the covered 
SD is required to reflect its positions in swaps, security-based swaps, 
and related positions at fair market value, which ensures that all 
market-to-market losses are deducted from the SD's tangible net worth. 
The tangible net worth is intended to ensure that a covered SD has an 
appropriate level of financial resources available to directly meet its 
obligations as they arise, which will ensure the safety and soundness 
of the covered SD. Furthermore, covered SDs electing the Tangible Net 
Worth Capital Approach are subject to the risk management requirements 
of Commission regulation 23.600, which requires the SD, among other 
things, to assess its liquidity resources and outlays on a daily basis, 
including margin obligations, to ensure that it has both the financial 
resources and liquidity to meet its financial obligations to swap 
counterparties.
    The Commission also is not modifying the final regulation to allow 
commodity-focused covered SDs that are direct or indirect subsidiaries 
of global financial holding companies to

[[Page 57502]]

elect the Tangible Net Worth Capital Approach. As noted above, the 
Commission proposed the Tangible Net Worth Capital Approach in 
recognition that not all covered SDs would be financial firms and able 
to satisfy the Net Liquid Assets Capital Approach or the Bank-Based 
Capital Approach due to the measurement of illiquid assets necessary to 
commercial activities. The Commission limited the availability of the 
Tangible Net Worth Capital Approach to covered SDs that are not 
predominantly engaged in financial activities. Further, as discussed 
above, the Commission believes that it is appropriate to extend the 
Tangible Net Worth Capital Approach to accommodate covered SDs that are 
direct or indirect subsidiaries of holding companies or corporate 
parent entities that are not predominantly engaged in financial 
activities, in order to allow such holding companies or corporate 
parent entities to establish separate SD subsidiaries to provide 
financial services for the corporate group, including engaging in swaps 
on behalf of the corporate group. In such situations, the covered SD is 
established to act on behalf of the commercial parent entity by, for 
example, entering into swaps with commercial end users that are seeking 
to manage their commercial risks with swaps, and to offset the risks 
incurred by its commercial affiliates by entering into swaps with 
counterparties, including other SDs or financial end users.
    Covered SDs that are subsidiaries of financial holding companies or 
corporate entities, however, present different issues. While the 
covered SD may engage in commodity-focused swaps and may also engage in 
trading of physical commodities, it is doing so as a subsidiary of a 
financial parent entity. The Commission has generally perceived greater 
risk from global financial entities than it does from commercial 
enterprises, and, for this reason does not believe that it would be 
appropriate to extend the more limited capital treatment of the 
Tangible Net Worth Capital Approach to such covered SDs. Therefore, the 
Commission is adopting the Tangible Net Worth Capital Approach as 
proposed, without requiring parent guarantee and subject to the limited 
modification to eligibility discussed above, in order to be neutral as 
to the overall corporate structure employed by commercial entities.
5. Capital Requirements for Covered MSPs
    The Commission proposed to establish a minimum capital requirement 
for covered MSPs as directed by section 4s(e) of the CEA.\323\ An MSP 
is defined as a person that is not a swap dealer and that: (i) 
Maintains a substantial position in swaps, excluding positions held to 
hedge or mitigate commercial risk; (ii) has outstanding swaps that 
create ``substantial counterparty exposures that could have serious 
adverse effects on the financial stability of the U.S. banking system 
or financial markets;'' or (iii) is a financial entity that is highly 
leveraged, is not subject to capital requirements of a prudential 
regulator, and has a substantial position in swaps, including positions 
used to hedge and mitigate commercial risk.\324\
---------------------------------------------------------------------------

    \323\ See 2016 Capital Proposal, 81 FR 91252 at 91264-65. There 
currently are no MSPs provisionally registered with the Commission.
    \324\ See Commission regulation Sec.  1.3 (17 CFR 1.3). There 
currently are no MSPs provisionally registered with the Commission.
---------------------------------------------------------------------------

    Proposed regulation 23.101(a)(2)(ii) required a covered MSP to 
maintain the greater of (i) positive tangible net worth, or (ii) the 
amount of capital required by the RFA of which the covered MSP was a 
member. The term ``tangible net worth'' was proposed to be defined as 
the net worth of a covered MSP as determined in accordance with US 
GAAP, excluding goodwill and other intangible assets. The Proposal 
further required a covered MSP in computing its tangible net worth to 
include all liabilities or obligations of a subsidiary or affiliate 
that the covered MSP guarantees, endorses, or assumes, either directly 
or indirectly, to ensure that the tangible net worth reflects the full 
extent of the covered MSP's potential financial obligations. The 
proposed definition further provided that in determining net worth, all 
long and short positions in swaps, security-based swaps and related 
positions must be marked to their market value to ensure that the 
tangible net worth reflects the current market value of the covered 
MSP's swaps and security-based swaps, including any accrued losses on 
such positions.
    A positive tangible net worth standard was proposed for MSPs, 
rather than an alternative approach, including the Net Liquid Assets 
Capital Approach, Bank-Based Capital Approach, or Tangible Net Worth 
Capital Approach, as the Commission anticipated that entities that 
register as MSPs may be engaging in a range of business activities that 
are different from, and broader than, the activities of covered SDs. In 
addition, covered MSPs are expected to use swaps for different purposes 
(e.g., hedging or investing) than covered SDs, which generally engage 
in swaps as a dealing activity. Covered MSP's also may engage in 
commercial activities that require the holding of a substantial amount 
of fixed assets or engage in financial activities that are beyond swap 
dealing activities, which results in the holding of assets that are not 
consistent with the general Net Liquid Assets Capital Approach or the 
Bank-Based Capital Approach, such as fixed assets or intangible assets.
    The 2016 Capital Proposal also considered the impact of the final 
margin rules for uncleared swap transactions in developing the proposed 
positive tangible net worth requirement for covered MSPs. Covered MSPs 
subject to the Commission's margin regulations are required to post and 
collect initial margin and variation margin with SDs, other MSPs, and 
financial end users (subject to certain thresholds and minimum transfer 
amounts).\325\ The exchanging of variation margin and the exchange of 
initial margin by covered MSPs and certain of their counterparties 
would substantially reduce the uncollateralized exposures that the 
covered MSPs and the counterparties have to each other, which mitigates 
the possibility that covered MSPs could destabilize the financial 
markets or present systemic risk. Lastly, the Commission's proposed 
covered MSP capital standards are comparable with the SEC's capital 
standards for MSBSPs subject to the SEC's capital requirements, and are 
intended to require a covered MSP to maintain a sufficient level of 
assets to meet its obligations to counterparties and creditors and to 
help ensure the safety and soundness of the covered MSP.\326\
---------------------------------------------------------------------------

    \325\ See 17 CFR part 23, subpart E (Capital and Margin 
Requirements for Swap Dealers and Major Swap Participants).
    \326\ See 17 CFR 240.18a-2.
---------------------------------------------------------------------------

    The Commission requested additional comment on the proposed capital 
requirements for covered MSPs in the 2016 Capital Proposal. 
Specifically, the Commission requested comment on whether the positive 
tangible net worth capital requirement was an appropriate standard for 
MSPs; whether the Net Liquid Assets Capital Approach or the Bank-Based 
Capital Approach would be a more appropriate method for establishing 
capital requirements for covered MSPs; and whether other capital 
approaches should be considered for covered MSPs.\327\ The Commission 
further requested comment on whether the positive tangible net worth 
capital requirement should include a minimum fixed-dollar amount 
requirement, for example, equal to $20 million or some other amount, 
and

[[Page 57503]]

whether the positive tangible net worth capital requirements should 
include a requirement for a covered MSP to maintain positive tangible 
net worth in an amount in excess of the market risk and credit risk 
charges on the covered MSP's swap and security-based swap 
positions.\328\ The Commission did not receive comments addressing 
these issues.
---------------------------------------------------------------------------

    \327\ See 2016 Capital Proposal, 81 FR 91252 at 91264-25.
    \328\ Id.
---------------------------------------------------------------------------

    The Commission has considered the proposed capital requirements for 
covered MSPs, and is adopting the capital requirements as proposed. The 
Commission believes that it is appropriate to impose a capital 
requirement on a covered MSP that requires such entity to maintain the 
greater of (i) positive tangible net worth, or (ii) the amount of 
capital required by an RFA of which the covered MSP is a member. The 
Commission also recognizes that the positive tangible net worth capital 
requirement is a less rigorous requirement than the Net Liquid Assets 
Capital Approach or the Bank-Based Capital Approach. The Commission 
believes, however, that the positive tangible net worth capital 
requirement is appropriate to help ensure the safety and soundness of 
the covered MSP.
    Under the final rule as adopted, a covered MSP is required to 
maintain the greater of (i) positive tangible net worth, or (ii) the 
minimum amount of capital required by an RFA of which the covered MSP 
is a member.\329\ The final rule further requires a covered MSP to mark 
its swaps, security-based swaps and related positions to their market 
values in computing its tangible net worth, and to include in its 
liabilities obligations of a subsidiary or affiliate that the covered 
MSP guarantees, endorses, or assumes either directly or indirectly, to 
ensure that the tangible net worth of the covered MSP reflects the 
extent of such potential financial obligations.\330\
---------------------------------------------------------------------------

    \329\ See paragraph (a)(2) of Commission regulation Sec.  
23.101, as adopted.
    \330\ See definition of the term ``tangible net worth'' in 
Commission regulation Sec.  23.100, as adopted.
---------------------------------------------------------------------------

    As noted above, there are no MSPs currently provisionally-
registered with the Commission, and only two firms have ever 
provisionally-registered as MSPs. Therefore, the Commission has limited 
experience with MSPs and such experience does not provide reliable 
information or data on how such firms may be structured or operate in 
future. This lack of information and data makes establishing a more 
tailored capital requirement beyond the positive tangible net worth 
requirement challenging. Accordingly, the Commission will monitor any 
future developments with MSPs and assess the appropriateness of the 
positive tangible net worth capital requirement to such firms to 
ensuring the safety and soundness of the MSPs. The Commission will 
consider any rule amendments that may be necessary based upon the 
information and data that it will receive from any registered MSP. In 
addition, the final capital rule provides that an MSP must also 
maintain a level of capital as established by the RFA of which it is a 
member. This provision is consistent with section 17 of the CEA, which 
provides that an RFA must establish minimum capital requirements for 
members that are at least as stringent as applicable capital 
requirements adopted by the Commission. This provision authorizes NFA, 
as the only RFA, to adopt capital requirements for its member MSPs that 
are higher than the Commission's MSP capital requirement. This provides 
an additional level of assurance that the Commission or NFA can adjust, 
if necessary, capital requirements relative to the business activities 
of any MSPs that the Commission in the future believes present systemic 
risk.
6. Requirements for Market Risk and Credit Risk Models
    The Commission's Proposal recognized that internal market risk and 
credit risk capital models, including value-at-risk (``VaR'') models, 
can provide a more effective means of measuring economic risk from 
complex trading strategies involving swaps, security-based swaps, and 
other proprietary positions than the standardized market risk and 
credit risk charges set forth in regulation 1.17. In order to use 
internal capital models to compute its capital, the covered SD or FCM-
SD must obtain the approval of the Commission or an RFA of which it was 
a member.
    In developing the specific proposed market risk and credit risk 
models requirements, including the proposed quantitative and 
qualitative requirements of the models discussed below, the Commission 
incorporated the market risk and credit risk model requirements adopted 
by the Federal Reserve Board for bank holding companies, including the 
value at risk (``VaR''), stressed VaR, specific risk, incremental risk, 
and comprehensive risk qualitative and quantitative standards and 
requirements. The Commission's proposed qualitative and quantitative 
requirements for capital models also are comparable to the SEC's 
existing capital model requirements for ANC Firms and the capital model 
requirements adopted for SBSDs.
a. VaR Models
    Proposed regulation 23.102 required that a VaR model's quantitative 
criteria include the use of a VaR-based measure that incorporates a 99 
percent, one-tailed confidence interval.\331\ The VaR-based measure 
must be based on a price shock equivalent to a ten business-day 
movement in rates or prices. Price changes estimated using shorter time 
periods must be adjusted to the ten-business-day standard. The minimum 
effective historical observation period for deriving the rate or price 
changes is one year, and data sets must be updated at least quarterly 
or more frequently if market conditions warrant. The Commission noted 
that for many types of positions it would be appropriate for a covered 
SD or FCM-SD to update its data positions more frequently than 
quarterly. In all cases, a covered SD or FCM-SD must have the 
capability to update its data sets more frequently than quarterly in 
anticipation of market conditions that require such updating.
---------------------------------------------------------------------------

    \331\ 2016 Capital Proposal, 81 FR 91252, 91269-72.
---------------------------------------------------------------------------

    The covered SD or FCM-SD also would not need to employ a single 
internal capital model to calculate its VaR-based measure. A covered SD 
or FCM-SD may use any generally accepted approach, such as variance-
covariance models, historical simulations, or Monte Carlo simulations, 
based on the nature and size of the positions the model covers. The 
internal capital model must use risk factors sufficient to measure the 
market and credit risk inherent in all positions. The risk factors must 
address the risks including interest rate risk, credit spread risk, 
equity price risk, foreign exchange risk, and commodity price risk. For 
material positions in the major currencies and markets, modeling 
techniques must incorporate enough segments of the yield curve--in no 
case less than six--to capture differences in volatility and less than 
perfect correlation of rates along the yield curve.
    The internal capital model may incorporate empirical correlations 
within and across risk categories, provided that the covered SD or FCM-
SD validates and demonstrates the reasonableness of its process for 
measuring correlations. If the internal capital model does not 
incorporate empirical correlations across risk categories, the covered 
SD or FCM-SD must add the separate measures from its internal capital 
models for the

[[Page 57504]]

appropriate risk categories as listed above to determine its aggregate 
VaR-based measure of capital.
    The VaR-based measure must include the risks arising from the 
nonlinear price characteristics of options positions or positions with 
embedded optionality and the sensitivity of the fair value of the 
positions to changes in the volatility of the underlying rates, prices 
or other material factors. A covered SD or FCM-SD with a large or 
complex options portfolio must measure the volatility of options 
positions or positions with embedded optionality by different 
maturities and/or strike prices, where material.
    The internal capital model also must be subject to backtesting 
requirements that must be calculated no less than quarterly. A covered 
SD or FCM-SD must compare its daily VaR-based measure for each of the 
preceding 250 business days against its actual daily trading profit or 
loss, which includes realized and unrealized gains and losses on 
portfolio positions as well as fee income and commissions associated 
with its activities. If the quarterly back-testing shows that the 
covered SD's or FCM-SD's daily net trading loss exceeded its 
corresponding daily VaR-based measure, a back-testing exception has 
occurred. If a covered SD or FC-SD experiences more than four back-
testing exceptions over the preceding 250 business days, it is 
generally required to apply a multiplication factor in excess of three 
when it calculates its VaR-based capital requirements.
    The qualitative requirements proposed would specify, among other 
things, that: (i) Each VaR model must be integrated into the covered 
SD's or FCM-SD's daily internal risk management system; (ii) each VaR 
model must be reviewed periodically by the firm's internal audit staff 
and annually by a third party service provider; and (iii) the VaR 
measure computed by the model must be multiplied by a factor of at 
least three but potentially a greater amount if there are exceptions to 
the measure resulting from quarterly backtesting results.
    A covered SD or FCM-SD would also be subject to on-going 
supervision by staff of the Commission and RFA with respect to its 
internal risk management, including its use of VaR models.
b. Stressed VaR Models
    The Commission proposed that covered SDs or FCM-SDs approved to use 
VaR models to compute market risk deductions also must include a 
stressed VaR component in the calculation. The stressed VaR measure 
supplements the VaR measure, as the VaR measure's inherent limitations 
produced an inadequate amount of capital to withstand the losses 
sustained by many financial institutions in the financial crisis of 
2007-2008.\332\ The stressed VaR measure also should contribute to a 
more appropriate measure of the risks of a covered SD's or an FCM-SD's 
positions as stressed VaR is intended to account for more volatile and 
extreme price changes.
---------------------------------------------------------------------------

    \332\ See Revisions to the Basel II market risk framework, 
published by the Basel Committee on Banking Supervision for an 
explanation of the implementation of the stressed VaR requirement.
---------------------------------------------------------------------------

    The 2016 Capital Proposal required a covered SD or FCM-SD to use 
the same model that it uses to compute its VaR measure for its stressed 
VaR measure. The model inputs however would be calibrated to reflect 
historical data from a continuous 12-month period that reflects a 
period of significant financial stress appropriate to the covered SD's 
or FCM-SD's portfolio. The stressed VaR measure must be calculated at 
least weekly and be no less than the VaR measure. The Commission 
further noted that it expected that the stressed VaR measure would be 
substantially greater than the VaR measure.
    The Commission also required that the stress tests take into 
account concentration risk, illiquidity under stressed market 
conditions, and other risks arising from the covered SD's or FCM-SD's 
activities that may not be captured adequately in the covered SD's or 
FCM-SD's internal VaR models. For example, it may be appropriate for 
the covered SD or FCM-SD to include in its stress testing large price 
movements, one-way markets, nonlinear or deep out-of-the-money 
products, jumps-to-default, and significant changes in correlation. 
Relevant types of concentration risk include concentration by name, 
industry, sector, country, and market.
    The Proposal also provided that a covered SD or FCM-SD must 
maintain policies and procedures that describe how it determines the 
period of significant financial stress used to compute its stressed VaR 
measure and be able to provide empirical support for the period used. 
These policies and procedures must address: (i) How the covered SD or 
FCM-SD links the period of significant financial stress used to 
calculate the stressed VaR-based measure to the composition and 
directional bias of the covered SD's or FCM-SD's portfolio; and (ii) 
the covered SD's or FCM-SD's process for selecting, reviewing, and 
updating the period of significant financial stress used to calculate 
the stressed VaR measure and for monitoring the appropriateness of the 
12-month period in light of the covered SD's or FCM-SD's current 
portfolio. Before making material changes to these policies and 
procedures, a covered SD or FCM-SD must obtain approval from the 
Commission or RFA. The Commission or the RFA also may require a covered 
SD or FCM-SD to use a different period of stress to compute its 
stressed VaR measure.
c. Specific Risk Models
    The Commission proposed to allow covered SDs or FCM-SDs to model 
their specific risk. Under the Proposal, the specific risk model must 
be able to demonstrate the historical price variation in the portfolio, 
be responsive to changes in market conditions, be robust to an adverse 
environment, and capture all material aspects of specific risk for its 
positions. The Proposal required that a covered SD's or FCM-SD's models 
capture event risk (such as the risk of loss on equity or hybrid equity 
positions as a result of a financial event, such as the announcement or 
occurrence of a company merger, acquisition, spin-off, or dissolution) 
and idiosyncratic risk, and capture and demonstrate sensitivity to 
material differences between positions that are similar but not 
identical, and to changes in portfolio composition and concentrations. 
If a covered SD or FCM-SD calculates an incremental risk measure for a 
portfolio of debt or equity positions under paragraph (I) of proposed 
23.102 Appendix A, the covered SD or FCM-SD is not required to capture 
default and credit migration risks in its internal models used to 
measure the specific risk of these portfolios.
    The Commission noted in the Proposal that it understood that not 
all debt, equity, or securitization positions (for example, certain 
interest rate swaps) have specific risk. Therefore, the Commission 
proposed that there would be no specific risk capital requirement for 
positions without specific risk. A covered SD or FCM-SD, however, must 
have clear policies and procedures for determining whether a position 
has specific risk.
    The Commission also stated in the Proposal that it believed that a 
covered SD or FCM-SD should develop and implement VaR-based models for 
both market risk and specific risk. A covered SD's or FCM-SD's use of 
different approaches to model specific risk and general market risk 
(for example, the use of different models) would be reviewed to ensure 
that the overall capital requirement for market risk is

[[Page 57505]]

commensurate with the risks of the covered SD's or FCM-SD's positions.
d. Incremental Risk Models
    The Commission proposed an incremental risk requirement for covered 
SDs or FCM-SDs that measures the specific risk of a portfolio of debt 
positions using internal models. Incremental risk consists of the 
default risk and credit migration risk of a position. Default risk 
means the risk of loss on a position that could result from the failure 
of an obligor to make timely payments of principal or interest on its 
debt obligation, and the risk of loss that could result from 
bankruptcy, insolvency, or similar proceeding. Credit migration risk 
means the price risk that arises from significant changes in the 
underlying credit quality of the position. A covered SD or FCM-SD also 
may include portfolios of equity positions in the incremental risk 
model with the prior permission from the Commission or RFA, provided 
that the covered SD or FCM-SD consistently includes such equity 
positions in how it internally measures and manages the incremental 
risk for such positions at the portfolio level. Default is assumed to 
occur with respect to an equity position that is included in its 
incremental risk model upon the default of any debt of the issuer of 
the equity position.
e. Comprehensive Risk Models
    The 2016 Capital Proposal required a covered SD or FCM-SD to 
compute all material price risks of one or more portfolios of 
correlation trading positions using an internal model. The Commission 
required the model to measure all price risk consistent with a one-year 
time horizon at a one-tail, 99.9 percent confidence level, under the 
assumption either of a constant level of risk or of constant positions. 
The Commission stated that it expected that the covered SD or FCM-SD 
remains consistent in its choice of constant level or risk or 
positions, once it makes a selection. Also, the covered SD's or FCM-
SD's choice of a liquidity horizon must be consistent between its 
calculation of its comprehensive and incremental risk.
    The Commission also required a covered SD's or FCM-SD's 
comprehensive risk model to capture all material price risk, including, 
but not limited to: (i) The risk associated with the contractual 
structure of cash flows of each position, its issuer, and its 
underlying exposures (for example, the risk arising from multiple 
defaults, including the ordering of defaults in tranched products); 
(ii) credit spread risk, including nonlinear price risks; (iii) 
volatility of implied correlations, including nonlinear price risks 
such as the cross-effect between spreads and correlations; (iv) basis 
risks; (v) recovery rate volatility as it relates to the propensity for 
recovery rates to affect tranche prices; and (vi) to the extent that 
the comprehensive risk measure incorporates benefits from dynamic 
hedging, the static nature of the hedge over the liquidity horizon. The 
Commission noted that additional risks that are not explicitly 
discussed but are a material source of price risk must be included in 
the comprehensive risk measure.
    The Commission also required a covered SD or FCM-SD to have 
sufficient market data to ensure that it fully captures the material 
price risks of the correlation trading positions in its comprehensive 
risk measure. Moreover, a covered SD or FCM-SD must be able to 
demonstrate that its model is an appropriate representation of 
comprehensive risk in light of the historical price variation of its 
correlation trading positions. A covered SD or FCM-SD also would be 
required to inform the Commission and RFA if the covered SD or FCM-SD 
plans to extend the use of a model that has been approved to an 
additional business line or product type.
    The Proposal required that the comprehensive risk measure must be 
calculated at least weekly. In addition, a covered SD or FCM-SD must at 
least weekly apply to its portfolio of correlation trading positions a 
set of specific stressed scenarios that capture changes in default 
rates, recovery rates, and credit spreads, and various correlations. A 
covered SD or FCM-SD must retain and make available to the Commission 
and the RFA the results of the stress testing, including comparisons 
with capital generated by the covered SD's or FCM-SD's comprehensive 
risk model. A covered SD or FCM-SD must promptly report to the 
Commission or the RFA any instances where the stress tests indicate any 
material deficiencies in the comprehensive risk model.
f. Credit Risk Models
    The 2016 Capital Proposal required covered SDs or FCM-SDs seeking 
to obtain Commission or RFA approval to use internal models to compute 
credit risk to submit credit risk models that satisfy the quantitative 
and qualitative requirements set forth in Appendix A to proposed 
regulation 23.102. With respect to uncleared derivatives contracts, a 
covered SD or FCM-SD would need to determine an exposure charge for 
each counterparty to its uncleared derivatives positions. The exposure 
charge for a counterparty that is insolvent, in a bankruptcy 
proceeding, or in default of an obligation on its senior debt, is the 
net replacement value of the uncleared derivatives contracts with the 
counterparty (i.e., the net amount of uncollateralized current exposure 
to the counterparty). The counterparty exposure charge for all other 
counterparties is the credit equivalent amount of the covered SD's or 
FCM-SD's exposure to the counterparty multiplied by an applicable 
credit risk-weight factor multiplied by 8%. The credit equivalent 
amount is the sum of the covered SD's or FCM-SD's (i) maximum potential 
exposure (``MPE'') multiplied by a backtesting determined factor; and 
(ii) current exposure to the counterparty. The MPE amount is a charge 
to address potential future exposure and is calculated using the VaR 
model as applied to the counterparty's positions after giving effect to 
a netting agreement, taking into account collateral received, and 
taking into account the current replacement value of the counterparty's 
positions.
    The Commission in its margin requirements (see Commission 
regulations 23.150 through 23.161) set forth the requirements for 
eligible collateral for uncleared swaps. In order to account for 
collateral in its VaR model for the credit risk charges, the Commission 
stated that it expected a covered SD or FCM-SD to account only for the 
collateral that complies with Commission regulation 23.156 and is held 
in accordance with regulation 23.157 for uncleared swaps that are 
subject to the Commission's margin rules. A covered SD or FCM-SD would 
be able to take into consideration in its VaR calculation collateral 
that does not comply with regulation 23.156 and is not held in 
accordance with regulation 23.157, for uncleared swaps that are not 
subject to the Commission's margin rules.
    The Commission proposed to allow covered SDs or FCM-SDs to use 
internal methodologies to determine the appropriate credit risk-weights 
to apply to counterparties, if it has received the Commission's or the 
RFA's approval. A higher percentage credit risk-weight factor would 
result in a larger counterparty exposure charge amount. The Commission 
stated that it expected that the counterparty credit risk-weight should 
be based on an assessment of the creditworthiness of the counterparty.
    The Commission stated that its proposed approach to calculating 
credit risk charges is appropriate given that its requirements are 
based on a method of

[[Page 57506]]

computing capital charges for credit risk exposures in the 
international capital standards for banking institutions. Since credit 
risk is the risk that a counterparty could not meet its obligations on 
an OTC derivatives contract in accordance with agreed terms (such as 
failing to pay), the considerations that inform a covered SD's or FCM-
SD's assessment of a counterparty's credit risk should be broadly 
similar across the various relationships that may arise between the 
dealer and the counterparty. Therefore, the Commission believes that 
its approach is a reasonable model, as the SEC also uses a similar 
approach for its ANC BDs and SBSDs using models.
    The Commission also proposed that covered SDs or FCM-SDs that are 
subject to the Bank-Based Capital Approach requirement could also 
request Commission or RFA approval to use the Federal Reserve Board's 
internal ratings-based and advanced measurement model approaches to 
compute risk-weighted assets for the credit exposures listed in subpart 
E of 12 CFR 217. The covered SD or FCM-SD would have to include such 
exposures in its application to the Commission and RFA, and explain how 
its proposed models are consistent with the Federal Reserve Board's 
model criteria in subpart E of 12 CFR 217.
    The Commission received several comments concerning the use of 
internal capital models. One commenter expressed a strong concern 
regarding the 2016 Capital Proposal's potential heavy reliance on the 
use of internal models.\333\ The commenter stated that a reliance on 
internal models can permit regulated entities to manipulate risk 
controls to increase their own profits at the cost of increasing risks 
to the public. The commenter pointed out that analysis of the financial 
crisis experience evidenced manipulation of models to reduce capital 
charges. While the commenter acknowledged post-crisis refinements to 
internal model requirements, both in technique and governance, it 
argued that resource limitations at regulators, as well as continuing 
pressure from industry, may limit regulators' ability to prevent 
weakening standards and model misuse. The commenter thus advocated for 
strong limitations and floors to counterbalance the use of internal 
models.\334\
---------------------------------------------------------------------------

    \333\ See AFR 5/15/17 Letter.
    \334\ Id.
---------------------------------------------------------------------------

    The Commission appreciates the commenter's concerns regarding 
models generally, and the need for the Commission to maintain strong 
limitations and floors. In this regard, the Commission is providing 
that only capital models that satisfy specified quantitative and 
qualitative requirements set forth in the regulations will be approved 
for use by covered SDs. Such requirements are consistent with the 
standards established by the BCBS and SEC for banking institutions and 
BDs, respectively. In addition, the Commission plans to work with NFA 
to establish a comprehensive ongoing examination program over the 
capital models used by covered SDs, which will be designed to identify 
and address issues with model performance through such means as back-
testing results. These steps should assist with mitigating concerns 
regarding model performance.
    Other commenters generally supported the Commission's Proposal to 
permit internal capital models in lieu of standardized market and 
credit risk capital charges.\335\ Another commenter stated that it 
strongly supports permitting SDs the flexibility to use internal 
models, when appropriate.\336\
---------------------------------------------------------------------------

    \335\ See, e.g., ISDA 5/15/17 Letter; SIFMA 5/15/17 Letter; MS 
5/15/17 Letter.
    \336\ See IFM 5/15/17 Letter.
---------------------------------------------------------------------------

    Two commenters stated that the detailed quantitative and 
qualitative requirements for market risk and credit risk models set 
forth in Appendix A of proposed regulation 23.102 do not reflect the 
requirements of all of the models that a bank or bank holding company 
may use for market risk and credit calculations under the capital rules 
of the Federal Reserve Board.\337\ One of the commenters stated that 
the prudential regulators have undertaken an extensive effort to revise 
U.S. Basel III risk-weighted asset standards, which has includes 
significant ongoing efforts to revise specific credit risk and market 
risk methodologies that will require several years to finalize.\338\ 
One of the commenters stated that the differences between the Federal 
Reserve Board rules and the requirements of Appendix A would require a 
covered SD electing the Bank-Based Capital Approach to submit a model 
application that contains more information than the information 
required by the Federal Reserve Board.\339\ The commenters also state 
that the calculations of market risk and credit risk under some of the 
Federal Reserve Board rules differ from the calculation requirements 
under proposed Appendix A of regulation 23.102. The commenters 
recommended that the Commission modify proposed regulation 23.102 and 
appendix A to allow a Bank-Based Capital Approach to use models 
approved to calculate market risk and credit risk exposures if the 
model satisfies the relevant Federal Reserve Board requirements for 
market risk and credit risk models, as appropriate. The commenters also 
recommended that the Commission permit a covered SD that has obtained 
approval to use credit risk models to calculate its credit risk 
exposure using the Federal Reserve Board's advance approaches capital 
framework, contained in subpart E of 12 CFR part 217, and further 
permit a covered SD that has obtained approval to use market risk 
models to calculate its market risk using the Federal Reserve Board's 
rules contained in subpart F of 12 CFR part 217. The commenters stated 
that the above modifications would allow covered SDs electing the Bank-
Based Capital Approach to calculate market risk and credit risk 
consistently with how bank SDs and many foreign SDs calculate their 
exposures for capital purposes.
---------------------------------------------------------------------------

    \337\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter.
    \338\ Id.
    \339\ IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    The Commission recognizes that the Federal Reserve Board's capital 
rules are continuing to evolve and will evolve further in the future as 
global banking regulators continue to harmonize capital requirements 
under the Basel capital framework. The Commission proposed the Bank-
Based Capital Approach in recognition that it reflected a global 
banking capital regime that was designed for safety and soundness. The 
proposed approach also provided covered SDs that are non-bank 
subsidiaries of bank holding companies the ability to use capital 
models approved by prudential regulators for their bank affiliates.
    The Commission understands that model requirements set forth in 
proposed Appendix A of regulation 23.102 do not reflect fully the 
market risk and credit risk options available at this time to banking 
organizations under the rules of the Federal Reserve Board. The 
Commission also understands that each of the market risk and credit 
risk options under the Federal Reserve Board's rules are, and will 
continue to be, based on Basel capital requirements, and thus 
appropriate for calculating market risk or credit risk for covered SDs. 
Therefore, the Commission is modifying regulation 23.102 to both 
clarify and expand the market risk and credit risk models that may be 
used by a covered SD such that the requirement aligns with requirements 
of the Federal Reserve Board. Specifically, the Commission is modifying 
paragraph (c) of regulation 23.102 to provide that a covered SD's 
application for market risk models must include the information

[[Page 57507]]

specified in Federal Reserve Board's rules contained in subpart F of 12 
CFR part 217, and the information required under subpart E of 12 CFR 
part 217 for credit risk models. The Commission believes that the 
modifications are appropriate in that they provide model requirements 
that are identical to the Federal Reserve Board's requirements and, by 
incorporating the Federal Reserve Board's rules by reference, address 
concerns raised regarding the ongoing revisions to the rules as Basel 
enhancements continue to be adopted.
7. Model Approval Process for Covered SDs and FCM-SDs
    The Commission's Proposal required each covered SD and FCM-SD to 
submit an application for approval to use internal capital models to 
compute market risk or credit risk capital charges to the Commission 
and to the RFA of which the SD or FCM-SD was a member.\340\ The 
Proposal provided that a covered SD's or FCM-SD's application must be 
in writing and must be filed with the Commission and with an RFA in 
accordance with applicable filing requirements. Proposed Appendix A to 
regulation 23.102 required the application to include: (i) A list of 
categories of positions that the covered SD or FCM-SD holds in its 
proprietary accounts and a brief description of the methods the covered 
SD or FCM-SD would use to calculate market risk and credit risk 
charges; (ii) a description of the mathematical models to be used to 
price positions and to compute market risk and credit risk; (iii) a 
description of how the covered SD or FCM-SD would calculate current 
exposure and potential future exposure for its credit risk charges, and 
(iv) a description of how the covered SD or FCM-SD would determine 
internal credit risk-weights of counterparties, if applicable. The 
Commission or RFA also may require a covered SD or FCM-SD to supplement 
its application with additional information necessary for a proper 
evaluation.\341\
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    \340\ See 2016 Capital Proposal, 81 FR 91252 at 91269-70. FCMs 
and FCM-SDs that also are registered BDs would have to obtain SEC 
approval as an ANC Firm in order to use market risk and credit risk 
models in lieu of taking standardized capital charges. See 
Commission regulation Sec.  1.17(c)(6)(i), as adopted.
    \341\ See 2016 Capital Proposal, 81 FR 91252 at 91269-70.
---------------------------------------------------------------------------

    The Proposal also provided that the Commission or RFA could deny 
the application or approve the application, subject to any conditions 
or limitations that the Commission or RFA may require, if such denial 
or approval is found to be in the public interest. In making a public 
interest determination, the Commission will consider whether the 
applicant's models meet the quantitative and qualitative requirements, 
and assess the governance structure regarding the development, 
operation, and ongoing monitoring of the models. The Commission will 
further assess the qualification of personnel with the responsibility 
for operating the models and the personnel with responsibility for 
supervising the daily operations and reporting to senior management. 
The Commission's assessment is intended to determine that the use of 
capital models does not impair the overall safety and soundness of the 
covered SD or FCM-SD. The Commission also will consider the potential 
benefits that models provide by more appropriately reflecting market 
and credit risk as compared to standardized capital charges, which 
encourages FCM-SDs and covered SDs to provide markets to market 
participants and provides for a more efficient use of FCM-SD and 
covered SD capital.
    A covered SD or FCM-SD also would be required to cease using the 
models if: (i) The models are altered or revised materially, or if the 
SD's or FCM-SD's internal risk management is materially changed, and 
such changes have not been submitted to the Commission and RFA for 
approval; (ii) the Commission or RFA determines that the models are no 
longer sufficient or adequate to compute market or credit risk charges; 
(iii) the SD or FCM-SD fails to comply with the regulations governing 
the use of models; or (iv) the Commission by written order finds that 
permitting the SD or FCM-SD to continue to use the internal models is 
no longer appropriate.
    The Commission requested comment in the 2016 Capital Proposal on 
all aspects of the proposed model review process, including the 
viability of the proposed model review process given the number of 
provisionally-registered covered SDs, the number of capital models that 
may be required to be approved for each provisionally-registered 
covered SD, and the complexity of the models that may be submitted for 
approval.\342\ The Commission also requested comment on whether the 
regulation should include a process for the automatic approval or 
temporary approval of capital models that had been reviewed and 
approved by a prudential regulator or an appropriate foreign 
regulator.\343\
---------------------------------------------------------------------------

    \342\ See 2016 Capital Proposal, 81 FR 91252 at 91272-73.
    \343\ Id.
---------------------------------------------------------------------------

    Commenters generally stated that it was necessary for the 
Commission to develop an efficient approach for the review and approval 
of internal models and noted that covered SDs or FCM-SDs that did not 
have model approval at the compliance date would be at a significant 
competitive disadvantage relative to covered SDs and FCM-SDs that had 
the approval to use models at the compliance date. In this connection, 
one commenter stated that in no event should a covered SD be required 
to use the proposed standardized capital charges while awaiting model 
approval at the compliance date.\344\ Another commenter requested that 
the Commission clarify that no covered SD would be required to use the 
proposed standardized capital charges while awaiting model 
approval.\345\
---------------------------------------------------------------------------

    \344\ See ISDA 5/15/17 Letter.
    \345\ See IFM 5/15/17 Letter.
---------------------------------------------------------------------------

    Other commenters suggested various approaches that the Commission 
should adopt to ensure that covered SDs and FCM-SDs have the ability to 
use capital models at the compliance date. One commenter stated that 
capital models should be deemed ``provisionally approved'' while under 
review by the Commission or NFA at the compliance date.\346\ Several 
commenters stated that the Commission should automatically approve 
market risk models and credit risk models of covered SDs or FCM-SDs 
that have already been approved by a prudential regulator, the SEC, or 
certain foreign regulators.\347\ One commenter stated that Commission's 
final rule should provide for the recognition of internal capital 
models used throughout corporate families if such models have been 
approved by a prudential regulator, the SEC, or a foreign regulator in 
a jurisdiction that has adopted the Basel capital requirements, 
provided that the relevant regulatory authority has ongoing periodic 
assessment power with regard to the model and provides the CFTC and the 
NFA with appropriate information.\348\
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    \346\ See ISDA 5/15/17 Letter.
    \347\ See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter. See 
also, ABN/ING/Mizuho/Nomura 1/29/2018 Letter.
    \348\ See ISDA 5/15/17 Letter.
---------------------------------------------------------------------------

    The Commission invited interested persons to provide additional 
comment on the model approval process in the 2019 Capital Reopening. 
Commenters generally reiterated their views that the Commission needed 
to adopt an efficient and effective model review process that 
recognizes the complexity of the undertaking, and ensures that all 
covered SDs and FCM-SDs that want to use models have authorization to 
use such models at the compliance date in

[[Page 57508]]

order to avoid competitive disadvantages for firms not permitted to use 
models.\349\ One commenter stated that the failure to create and 
implement a flexible capital model approval process and timeline 
creates a competitive disadvantage for smaller covered SDs (including 
smaller commodity-focused covered SDs) relative to bank and bank 
holding company-affiliate SDs.\350\ The commenter noted that many 
larger SDs currently operate with approved models, and noted that 
smaller SDs do not have off-the-shelf or pre-approved internal models 
that can be used or leveraged for capital compliance purposes, and 
anticipate significant expense and resource will be necessary for the 
development of counterparty credit risk and market risk model 
procedures, processes, and systems.\351\ One commenter stated that 
firms submitting models for the first time must be provided with 
sufficient time to complete the approval process.\352\
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    \349\ See, e.g., NCGA/NGSA 3/3/2020 Letter; CEWG 3/3/2020 
Letter; FIA-PTG 3/3/2020 Letter.
    \350\ See ED&F Man/INTL FCStone 3/3/2020 Letter.
    \351\ Id.
    \352\ See FIA-PTG 3/3/2020 letter.
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    Another commenter stated that commodity-focused covered SDs should 
be subject to models that focus on risks associated with the physical 
commodity market, and the capital model should not need to account for 
non-applicable risks.\353\ The commenter requested that the Commission 
confirm that a commodity-focused covered SD's capital model needs only 
to account for the positions and risks relevant to the applicable 
business and does not need to address every risk and requirement set 
forth in proposed Appendix A to regulation 23.102.\354\
---------------------------------------------------------------------------

    \353\ See CEWG 3/3/2020 Letter.
    \354\ Id.
---------------------------------------------------------------------------

    Commenters also expressed the view that the Commission should 
provide automatic model approval or provisional model approval to SDs 
and FCM-SDs that use models that have been reviewed and approved by the 
SEC, a prudential regulator, or a qualified foreign regulator. One 
commenter also stated that the Commission should provide provisional 
approval for models submitted by covered SDs in good faith, subject to 
further review and approval if necessary.\355\
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    \355\ See NCGA/NGSA 3/3/2020 Letter. The NCGA/NGSA also stated 
that the Commission's capital rules should allow for the use of 
unencumbered cash to be considered part of a covered SD's capital 
base even when the cash is swept into a corporate omnibus account 
and held overnight at a financial institution. The Commission 
acknowledges that under the proposed Tangible Net Worth Capital 
Approach, unencumbered cash deposits, including cash transferred to 
an affiliate, would be considered a tangible asset and part of the 
capital base. See also, CEWG 3/3/2020 Letter.
---------------------------------------------------------------------------

    NFA expressed its willingness to undertake the review of covered 
SDs and covered FCM-SDs capital models for compliance with the 
regulatory requirements.\356\ NFA noted that it currently has a team 
with significant model experience that has been focusing on the review, 
approval, and ongoing monitoring of covered SD's initial margin models 
for uncleared swaps. NFA stated that it would leverage the experience 
it has gained in reviewing and approving initial margin models, and 
would allocate similar resources to the review of covered SDs' internal 
capital models for compliance with the Commission's requirements.
---------------------------------------------------------------------------

    \356\ See Letter from Carol Wooding, National Futures 
Association (March 2, 2020) (NFA 3/2/2020 Letter).
---------------------------------------------------------------------------

    NFA also commented, however, that the capital model review process 
will be significantly more complex than the process conducted for 
initial margin models. The additional complexity is attributable in 
part to the lack of an industry-wide, standardized internal capital 
model and the fact that each covered SD may have several models under 
the proposed capital rules to address various aspects of market risk 
(e.g., VaR models and stressed VaR models). The review process is 
further challenged in that the Commission did not propose a multi-year 
compliance schedule that would allow capital models to be phased-in 
over a sufficiently long period of time comparable to the now six-year 
phase-in schedule for initial margin requirements for uncleared 
swaps.\357\
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    \357\ Id. The Commission's margin rules for uncleared swap 
transactions are subject to a phase-in period that extended from 
September 1, 2016 to September 1, 2021. See Commission regulation 
Sec.  23.161 (17 CFR 23.161).
---------------------------------------------------------------------------

    NFA estimated that as many as 51 covered SDs (from 21 corporate 
families) could be subject to the Commission's capital rules and may 
seek model review and approval prior to the compliance date. NFA also 
commented that it would need to build systems and processes to receive 
the requisite model information from covered SDs and FCM-SDs, and that 
its review would need to occur over a period of time given the 
complexity of the market and credit risk models. To address these 
concerns, NFA suggested several modifications that the Commission could 
make to the process of reviewing and approving capital models. 
Specifically, NFA suggested that a covered SD electing a Bank-Based 
Capital Approach that uses the internal market and credit risk capital 
models previously reviewed by a prudential regulator for an affiliated 
SD (e.g., a bank holding company) be permitted to use such models 
without a formal review or approval of the covered SD's capital models 
prior to the compliance date. NFA also stated that the Commission 
should consider implementing a similar process for covered SDs that use 
internal market risk and credit risk models that have been reviewed or 
approved for the covered SD's use or for use by an affiliate of the 
covered SD by a foreign regulator in a jurisdiction that has 
implemented the Basel III capital standards. NFA stated that for 
covered SDs or covered FCM-SDs that are permitted to use capital models 
without a pre-compliance date review and approval as outlined above, it 
would review the SDs' or FCM-SDs' overall capital compliance, including 
their use of models after the compliance date through NFA's examination 
process and ongoing compliance monitoring program.
    NFA commented that if the above framework is implemented, it will 
work with the Commission to develop a pre-compliance date model review 
and approval process, including appropriate information gathering and 
certification requirements for covered SDs with models that have not 
been reviewed by a prudential or qualified foreign regulator, as well 
as an appropriate post-compliance date model review and monitoring 
process. NFA stated that it is committed post compliance date to 
monitor the overall governance and use of market and credit risk models 
by all covered SDs that are subject to a model pre-approval process or 
post-compliance model review including, at a minimum, assessing model 
performance test results and monitoring for compliance with the 
Commission's SD capital rules.
    NFA further estimated that if the above framework is adopted that 
as many as 12 covered SDs that are provisionally-registered may require 
immediate capital model review. These 12 covered SDs have not obtained 
direct regulatory approval to use capital models and are not part of 
corporate families that have obtained any other regulatory approval to 
use capital models. NFA also estimated that it will take approximately 
15 months to review and approve capital models for these 12 covered 
SDs.
    NFA also recommended a modification to the final rule language. NFA 
stated that to make the post-compliance date framework effective, since 
NFA will not formally approve a

[[Page 57509]]

covered SD's use of market and credit risk models previously reviewed 
by a prudential regulator a qualified foreign regulator, it believed 
that it is important that the Commission and/or NFA reserve the 
authority to require that a covered SD cease at any time using internal 
models if the covered SD is not in compliance with the Commission's 
capital requirements. To address this issue, NFA recommended that the 
Commission modify regulation 23.102(e) to clarify the Commission's and 
NFA's authority to rescind a covered SD's use of models that were not 
formally ``approved'' prior to the requirements compliance date.\358\
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    \358\ NFA noted that proposed Appendix A to Commission 
regulation Sec.  23.102, which provides that the Commission or an 
RFA may revoke a covered SD's internal market and credit risk 
models. NFA stated that this provision of Appendix A should be 
modified to clarify that the Commission or an RFA may revoke a 
covered SD's ability to use internal market and credit risk models 
that have been approved by a prudential regulator or qualified 
foreign regulator. See NFA 3/2/2020 Letter.
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    The Commission has considered the Proposal and the comments 
received, and is adopting the model approval process as proposed with 
several modifications discussed below. The Commission recognizes the 
substantial resources that are necessary in order to effectively and 
efficiently review and approve capital models submitted by covered SDs, 
and further recognizes that Commission staff would not be able to 
perform such reviews in a reasonable period of time. Therefore, final 
regulations 1.17(c)(6)(v) and 23.102 provides two alternative 
approaches for FCM-SDs and covered SDs, respectively. An FCM-SD or a 
covered SD may submit an application to the Commission for approval to 
use internal models to compute market risk and credit risk capital 
charges in lieu of standardized charges. In the alternative, an FCM-SD 
or a covered SD may submit an application to NFA (as an RFA) to use 
internal models provided that the Commission has made a determination 
that NFA's process to approve internal models is consistent with the 
Commission's approval process and NFA's approval would be accepted as 
an alternative means of compliance with the Commission's model 
requirements and approval as contained in Regulation 23.102.\359\
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    \359\ At this time, NFA is the only RFA.
---------------------------------------------------------------------------

    In this release, the Commission is setting forth a process for 
determining whether the NFA's standard and process for reviewing and 
approving an FCM-SD's and a covered SD's capital models is comparable 
to those of the Commission's. As part of the Commission's assessment, 
the Commission will perform a review of the NFA's FCM-SD and covered SD 
capital requirements for consistency with the Commission's 
requirements. The Commission also will assess the sufficiency of the 
NFA's planned model review process and procedures to ensure that such 
processes and procedures are adequate for providing NFA with an 
appropriate basis for determining whether an FCM-SD's or a covered SD's 
capital models satisfy the NFA's model requirements. Based on these 
assessments, the Commission will issue a determination that the NFA's 
approval of an FCM-SD's or a covered SD's capital models may serve as 
an alternative means of complying with the Commission's model approval 
requirement. The Commission is delegating authority to issue the 
determination to the Director of the Division of Swap Dealer and 
Intermediary Oversight under the revisions to regulation 140.91.
    Due to limited Commission resources, the Commission anticipates 
that FCM-SDs and covered SDs will seek model approval from the NFA in 
order to help ensure a timely review. As noted in its comment letter, 
NFA has devoted substantial efforts to obtain the personnel and other 
resources necessary to perform the review, approval, and ongoing 
assessment of FCM-SDs' and covered SDs' models to calculate initial 
margin for uncleared swaps, and plans to leverage these resources and 
experience in its review and assessment of capital models.
    In addition, as noted in section II.B.2. above, NFA is required by 
section 17(p) of the CEA to adopt capital requirements for SDs that are 
at least as stringent as the Commission's capital requirements for 
covered SDs. In this regard, the Commission has approved NFA Compliance 
Rule 2-49, which incorporates the Commission's part 23 rules into NFA's 
rules. Therefore, the capital and financial reporting requirements set 
forth in this final rulemaking will become NFA requirements 60 days 
after the publication of this Federal Register release (the effective 
date). The NFA SD capital requirements will include the options for 
market risk and credit risk models and will require SDs to obtain NFA 
approval to use such models under the NFA SD capital rules.\360\
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    \360\ The Commission also revised paragraph (c) of Appendix A of 
final regulation 23.102 to provide that a covered SD that files a 
model application with the Commission may request confidential 
treatment under the Freedom of Information Act. Paragraph (c) of 
Appendix A does not apply to applications filed with the NFA, which 
is not subject to the Freedom of Information Act.
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    The Commission further acknowledges that the model review process 
will require a period of time that will prevent the Commission or NFA 
from reviewing and approving models for all covered SDs that seek model 
approval prior to the compliance date of the regulations. The 
Commission also recognizes that a process that results in some covered 
SDs receiving approval to use capital models while the capital models 
of other covered SDs are under review at the compliance date solely due 
to the inability of the Commission or NFA to complete the necessary 
review would place the non-model covered SDs at a substantial 
competitive disadvantage.
    To address this issue, the Commission is modifying regulation 
23.102 by providing a new paragraph (f) to provide that a covered SD 
may use capital models after filing an application for model approval 
with the Commission, and pending approval by the Commission or the NFA, 
provided that the covered SD submits a certification to the Commission 
and to NFA certifying that the models have been approved for use by the 
covered SD, or an affiliate of the covered SD, by the SEC, a prudential 
regulator, a foreign regulatory authority in a jurisdiction that the 
Commission has found to be eligible for substituted compliance under 
Commission regulation 23.106, or a foreign regulatory authority whose 
capital adequacy requirements are consistent with the BCBS bank capital 
requirements. The certification must be signed by the covered SD's 
Chief Executive Officer, Chief Financial Officer, or other appropriate 
official with knowledge of the covered SD's capital requirements and 
the capital models, and must include a representation that the models 
are in substantial compliance with Commission's model requirements.
    The final rule further requires a covered SD to revise its 
certification to address any material changes or revisions to the 
models, or to reflect any regulatory restrictions placed on the models 
by the regulatory authority that approved the models. The covered SD is 
also required to cease using the models if the regulatory authority 
that previously approved the models for use by the SD, or by the SD's 
affiliate, withdraws its approval prior to the Commission or NFA 
approving the models.
    To clarify, the covered SD is not required to submit a model 
application to NFA with its certification. NFA will

[[Page 57510]]

obtain any necessary documentation and model information as part of its 
ongoing examination and monitoring of the covered SD, including the 
information necessary to approve the models of the covered SD.
    The covered SD will be subject to the Commission's and NFA's 
supervision and ongoing monitoring pending the Commission's or NFA's 
final determination to approve or not approve the application. This 
supervision and monitoring will include the review of the models 
performance and compliance with Commission requirements through 
examination and review of periodic reports, including back-testing 
results.
    The Commission is not, however, adopting a process to permit FCM-
SDs to use capital models pending the Commission's or NFA's approval. 
FCM-SDs must have approval in order to use capital models. The 
Commission is making this distinction as FCM-SDs carry customer and 
noncustomer funds, and act as intermediaries in the futures markets by 
performing daily settlement cycles on behalf of customers and 
noncustomers, and guaranteeing their customers' and noncustomers' 
financial performance to clearing organizations and other FCMs. As 
noted above, capital models have the potential to substantially reduce 
the market risk and credit risk capital charges that an FCM must take 
relative to the standardized charges. The Commission believes that 
given the important role that FCMs perform in the futures markets, and 
in order to provide greater protection to customers and their funds, 
that FCM-SDs must have model approval prior to using such models to 
compute their adjusted net capital. Furthermore, the Commission notes 
that currently the only FCM-SDs provisionally-registered with the 
Commission are four ANC Firms that have existing approvals to use 
capital models and may continue to use such models after the compliance 
date of these rules.
    The 2016 Capital Proposal also included proposed amendments to the 
Commission's delegation of authority to the Director of the Division of 
Swap Dealer and Intermediary Oversight contained in regulation 140.91. 
The proposed amendments delegated to the Director the authority of the 
Commission to approve capital models submitted to the Commission under 
regulation 23.102 and Appendix A. The authority to revoke a previously 
approved model was not delegated to the Director. The Commission did 
not receive comments on the proposed amendments to the delegation of 
authority under regulation 140.91 and, for the reasons discussed in the 
2016 Capital Proposal, is adopting the amendments substantially as 
proposed.
8. Liquidity Requirements for Covered SDs and FCM-SDs
    The 2016 Capital Proposal required FCM-SDs and covered SDs electing 
the Bank-Based Capital Approach or the Net Liquid Assets Capital 
Approach to satisfy specific liquidity requirements.\361\ The 2016 
Capital Proposal did not proposed liquidity requirements for covered 
SDs electing the Tangible Net Work Capital Approach, covered MSPs, bank 
SDs, or bank MSPs.
---------------------------------------------------------------------------

    \361\ See 2016 Capital Proposal, 81 FR 91252 at 91273-75.
---------------------------------------------------------------------------

    Proposed regulation 23.104(a)(1) required covered SD electing the 
Bank-Based Capital Approach to meet the liquidity requirements 
established by the Federal Reserve Board for banking entities. 
Specifically, proposed regulation 23.104(a)(1) required covered SDs to 
comply with the liquidity coverage ratio requirements set forth in 12 
CFR part 249, and apply such requirements as if the covered SD were a 
bank holding company subject to 12 CFR part 249.\362\ The proposed 
liquidity coverage ratio required the SD to maintain each day an amount 
of high quality liquid assets (``HQLAs''), as defined in 12 CFR 249.20, 
that is no less than 100 percent of the SDs total net cash outflows 
over a prospective 30 calendar-day period (the ``HQLA Proposal'').\363\
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    \362\ Id.
    \363\ See 12 CFR 249.10. Federal Reserve Board rules require a 
regulated institution to maintain a liquidity coverage ratio of HQLA 
to net cash outflows that is equal to or greater than 1.0 on each 
business day.
---------------------------------------------------------------------------

    The Commission proposed several adjustments to the liquidity 
coverage ratio to better reflect the business of an SD. For example, 
the Commission proposed to permit a covered SD to consider cash 
deposits that are readily available to meet the general obligations of 
the SD as a level 1 liquid asset in computing its liquidity coverage 
ratio.\364\ The Commission also proposed modifying the liquidity 
coverage ratio so that covered SDs organized and domiciled outside of 
the U.S. could recognize certain foreign deposited assets in computing 
its liquidity coverage ratio. Finally, the Commission's Proposal 
required a covered SD to maintain a contingency funding plan component, 
as well as, certain internal senior management notifications and 
approvals.\365\
---------------------------------------------------------------------------

    \364\ See proposed Commission regulation Sec.  23.104(a)(1); 
2016 Capital Proposal, 81 FR 91252 at 91317.
    \365\ See proposed Commission regulation Sec.  23.104; 2016 
Capital Proposal, 81 FR 91252 at 91317-18.
---------------------------------------------------------------------------

    Proposed regulation 23.104(b) required covered SDs electing the Net 
Liquid Assets Capital Approach and FCM-SDs to adopt a liquidity stress 
test requirement that addressed the types of liquidity outflows 
experienced by SEC-registered BDs that are ANC Firms in times of stress 
(the ``LST Proposal''). Under the Commission's proposed LST Proposal, a 
covered SD or FCM-SD would be required to perform a liquidity stress 
test at least monthly that took into account certain assumed conditions 
lasting for 30 consecutive days. The results of the liquidity stress 
test would be reviewed by senior management periodically. The covered 
SD or FCM-SD also would be required to have a contingency funding plan 
to address potential liquidity issues.
    In proposing these requirements, the Commission intended to address 
the potential risk that a covered SD or FCM-SD may not be able to meet 
both expected and unexpected current and future cash flow and 
collateral needs as a result of adverse events impacting the covered 
SD's or FCM-SD's daily operations or financial condition. Further, the 
proposed liquidity requirements were consistent with those that had 
been proposed at the time for SBSDs by the SEC and the existing 
liquidity requirements adopted by the Federal Reserve Board for bank 
holding companies.\366\
---------------------------------------------------------------------------

    \366\ See SEC proposed rule 18a-1(f), 77 FR 70213 (Nov. 23, 
2012), and 12 CFR part 249.
---------------------------------------------------------------------------

    The Commission received comments on the proposed HQLA Proposal and 
the LST Proposal. One commenter suggested that covered SDs should be 
able to elect either the HQLA Proposal or the LST Proposal, without 
regard to the SD's chosen capital approach.\367\ Another commenter 
stated that the requirements of the HQLA Proposal and the LST Proposal 
should be revised to be more similar to each other given that both 
approaches have the comparable regulatory objective of helping to 
ensure that a covered SD or FCM-SD has sufficient access to liquidity 
to meet its obligations during periods of expected and unexpected 
market activity.\368\ The commenter specifically noted that the LST 
Proposal's definition of liquidity reserves is materially narrower than 
the HQLA Proposal's definition of HQLA, and that the Commission should 
expand the definition under the LST Proposal to match the definition 
under the HQLA

[[Page 57511]]

Proposal so as to recognize the full range of assets that are actually 
available to a firm to support its liquidity needs.\369\
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    \367\ See, e.g., MS 5/15/17 Letter.
    \368\ See SIFMA 5/15/17 Letter.
    \369\ Id.
---------------------------------------------------------------------------

    Commenters also raised the concept of a third alternative, which 
would be the application of a more qualitative than quantitative 
requirement applicable to covered SDs that are subsidiaries of bank 
holding companies and already subject to comprehensive overall 
liquidity risk management program requirements at a parent level.
    The Commission requested additional comments regarding the proposed 
liquidity requirements in the 2019 Capital Reopening. The Commission 
requested specific comment on whether it was necessary for the proposed 
SD capital rules to include additional liquidity requirements given 
that the Commission had previously adopted a risk management program 
set forth in regulation 23.600 for both bank SDs and covered SDs that 
includes liquidity requirements.
    The Commission received comments in response to the 2019 Capital 
Reopening. Several commenters suggested that the Commission defer 
adopting separate and distinct quantitative liquidity requirements as 
part of the SD capital rule given that the SD risk management program 
adopted by the Commission in regulation 23.600 requires a covered SD to 
assess liquidity risk.\370\ One commenter stated that the Commission 
should not adopt the proposed specific liquidity requirement as SDs 
have a diversity of business models, making standard quantitative 
liquidity requirements difficult to apply across SDs. The commenter 
further stated that the Commission should instead rely on the 
qualitative liquidity requirements in regulation 23.600, and evaluate 
the sufficiency of the liquidity program based on the specific business 
and associated risks of the covered SD.\371\ The commenter noted that 
regulation 23.600 is tailored specifically to address liquidity needs 
associated with posting margin and performing on swap transactions. In 
this regard, the commenter stated that a covered SD is required under 
regulation 23.600 to measure liquidity needs on a daily basis, assess 
procedures to liquidate non-cash collateral in a timely manner without 
significant effect on price, and apply appropriate collateral haircuts 
that accurately reflect market risk and credit risk, as well as 
requiring a covered SD to establish and enforce a system of risk 
management policies and procedures to monitor and manage market and 
credit risk associated with its dealing activities. The commenter 
further stated that the requirements of regulation 23.600 achieve the 
objective of ensuring SD liquidity in a flexible manner, without 
imposing a separate and standardized quantitative approach for firms 
that have different operations.
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    \370\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter; 
Shell 3/3/2020 Letter.
    \371\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    One commenter noted that many covered SDs engage in multiple 
business lines, not just swap dealing, which may be subject to separate 
regulatory frameworks which address liquidity risk. For example, a 
dual-registered BD/SD would be subject to either the Net Liquid Assets 
Capital Approach or the FCM approach if the SD is also a registered 
FCM, which is a liquidity-based capital requirement that requires the 
entity to take net capital deductions for nonmarketable or otherwise 
illiquid assets.\372\ In addition, this commenter noted that a 
quantitative standard applicable at a covered SD level may trap liquid 
assets within the covered SD and make such assets unavailable at the 
SD's holding company level.\373\ The commenter stated that this may 
make the holding company and other affiliates of the covered SD less 
resilient by removing the flexibility to liquidate assets held at the 
covered SD and deploy the cash where and when it is needed most.\374\
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    \372\ See IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter; 
Shell 3/3/2020 Letter.
    \373\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \374\ Id.
---------------------------------------------------------------------------

    Commenters also noted that many of the covered SDs are directly or 
indirectly already subject to various forms of quantitative liquidity 
requirements due to their status as subsidiaries of large U.S. bank 
holding companies. One commenter stated that liquidity coverage ratios 
and Federal Reserve regulation YY-mandated internal liquidity stress 
testing programs apply and operate on a consolidated basis across large 
U.S. bank holding companies, ensuring that liquidity risks arising in 
covered SDs are addressed in consolidated liquidity requirements. This 
commenter further noted that U.S. bank holding companies subject to 
Recovery and Resolution Planning requirements are required to consider 
funding and liquidity requirements of SDs that are ``material operating 
entities'', which may result in a requirement to preposition liquidity 
and funding in a covered SD.
    The Commission has considered the comments received and assessed 
the additional proposed liquidity requirements and has determined to 
defer the adoption of final rules at this time. As noted by the 
Commission in the 2019 Capital Reopening and by many of the commenters, 
regulation 23.600 currently imposes liquidity requirements on covered 
SDs. Regulation 23.600 requires each SD to establish, document, 
maintain, and enforce a system of written risk management policy and 
procedures designed to monitor and manage the risk associated with the 
covered SD's swaps activities. A covered SD' risk management policies 
and procedures must take into account market, credit, foreign currency, 
legal, operational, settlement, and any other applicable risks in 
addition to liquidity risk. With respect to liquidity risk, the risk 
management policies and procedures must, at a minimum, monitor and/or 
manage the daily measurement of liquidity needs and include an 
assessment of the procedures to liquidate non-cash collateral in a 
timely manner and without significant effect on the price realized for 
the non-cash collateral.
    Moreover, staff's review of covered SDs' risk exposure reports has 
revealed that there is a wide disparity in how covered SDs establish 
their liquidity risk management policies and procedures, and assess 
their liquidity needs. This disparity is in part due to the variety of 
provisionally-registered SDs under the Commission's jurisdiction. Some 
covered SDs are subsidiaries of much larger parent organizations, many 
of which are banking entities, that are subject to sophisticated 
liquidity risk management policies and procedures at both the parent 
and subsidiary levels. Other covered SDs are not part of a large bank 
holding company or financial organization and have different, less 
sophisticated liquidity policies and procedures that are more suited to 
the type of swaps activities that they engage in with counterparties. 
Given the diversity of the provisionally-registered SDs, the Commission 
believes that it is not advisable to impose a single, mandated method 
of measuring liquidity needs at a covered SD, and the Commission has 
determined to defer the adoption of detailed quantitative liquidity 
requirements at this time. Commission staff will monitor covered SDs' 
liquidity as part of its ongoing monitoring of the financial reporting 
submitted by covered SDs and will reassess the appropriateness of 
recommending to the Commission additional liquidity risk management 
requirements that are a supplement to, enhancement of, or replacement 
of, the

[[Page 57512]]

current liquidity risk management requirements in regulation 23.600. 
Such additional liquidity requirements would be based upon the 
Commission staff's assessment and experience with actual liquidity 
practices and procedures used by covered SDs and would be tailored to 
address any potential deficiencies or lapses in liquidity risk 
management.
9. Equity Withdrawal Restrictions for Covered SDs and Covered MSPs
    The 2016 Capital Proposal proposed to prohibit certain withdrawals 
of equity capital from covered SDs.\375\ The restrictions were based 
upon existing equity withdrawal restrictions for FCMs set forth in 
regulation 1.17(e). The Proposal generally provided that the capital of 
a covered SD, or any subsidiary or affiliate of the covered SD that has 
any of its liabilities or obligations guaranteed by the covered SD, may 
not be withdrawn by action of the covered SD or by its equity holders 
if the withdrawal, and any other similar transactions scheduled to 
occur within the succeeding six months, would result in the covered SD 
holding less than 120 percent of the minimum regulatory capital that 
the covered SD is required to hold pursuant to proposed regulation 
23.101. The Proposal also included an exception permitting the covered 
SD to pay required tax payments and reasonable compensation to equity 
holders of the SD.
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    \375\ See 2016 Capital Proposal, 81 FR 91252 at 91275.
---------------------------------------------------------------------------

    In addition to the equity withdrawal restrictions, proposed 
regulation 23.104(d) authorized the Commission to issue an order to 
restrict for up to 20 business days the withdrawal of capital from a 
covered SD, or to prohibit the covered SD from making an unsecured loan 
or advance to any stockholder, partner, member, employee or affiliate 
of the covered SD. The Proposal further authorized the Commission to 
issue an order restricting or prohibiting the withdrawal of capital if, 
based upon the information available, the Commission concludes that the 
withdrawal, loan or advance may be detrimental to the financial 
integrity of the covered SD, or may unduly jeopardize the covered SD's 
ability to meet its financial obligations to counterparties or to pay 
other liabilities which may cause a significant impact on the markets 
or expose the counterparties and creditors of the covered SD to 
loss.\376\
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    \376\ Id. The Proposal further provided that the covered SD may 
request a hearing on the order, which must be held within two 
business days of the date of the written request by the covered SD.
---------------------------------------------------------------------------

    As noted in the Proposal, the proposed equity withdrawal 
restrictions discussed above are consistent with existing equity 
withdrawal restrictions imposed on FCMs and BDs, and with equity 
withdrawal restrictions adopted by the SEC for SBSDs.\377\ In addition, 
the grant of authority to the Commission to issue an order temporarily 
restricting certain unsecured loans or advances is consistent with the 
existing Commission authority under regulation 1.17(g)(1) for FCMs and 
with the SEC's authority over BDs and SBSDs.\378\ Further, the 
Commission proposed to make the existing language of 1.17(g)(1) as 
applicable to FCMs more consistent with same language contained in 
final SEC equity withdrawal restrictions for BDs and SBSDs, and 
received no comments thereon.
---------------------------------------------------------------------------

    \377\ Equity withdrawal restrictions for FCMs are set forth in 
Commission regulation Sec.  1.17(e) (17 CFR 1.17(e)), and for BDs 
are set forth in SEC rule 15c3-1(e)(2) (17 CFR 240.15c3-1(e)(2)). 
SEC equity withdrawal restrictions for SBSDs are contained in SEC 
rule 18a-1(h)(2) (17 CFR 240.18a-1(h)(2)).
    \378\ See SEC rule 15c3-1(e)(3) (17 CFR 240.15c3-1(e)(3)) for 
BDs and rule 18a-1(h)(3) (17 CFR 240.18a-1(h)(3)) for SBSDs.
---------------------------------------------------------------------------

    The Commission did not receive comments on the proposed equity 
withdrawal requirements. The Commission has considered the Proposal and 
for the reasons set out in the 2016 Proposal is adopting them with a 
minor modification. The equity withdrawal restrictions were proposed in 
paragraphs (c) and (d) of regulation 23.104. The Commission is 
redesignating paragraphs (c) and (d) of regulation 23.104 as paragraphs 
(a) and (b) in the final rule to reflect the removal of the proposed 
liquidity requirements in proposed regulation 23.104(a) and (b) as 
discussed above. The Commission is further adopting the amendment to 
1.17(g)(1) as proposed to make the language of the FCM equity 
withdrawal order restriction consistent with the same language as 
effective for BDs and SBSDs, and now regulation 23.104 for SDs.
10. Leverage Ratio Requirements for Covered SDs
    The Commission requested comment in the 2019 Capital Reopening as 
to whether it would be appropriate for the Commission, at a future date 
after notice and comment, to revise the covered SD capital requirements 
by adopting a leverage ratio for SDs in lieu of the proposed percentage 
of the risk margin amount, if adopted as final. The Commission also 
requested comment on the cost, if any, in terms of additional required 
capital that a leverage ratio requirement would impose on a covered SD 
relative to the Net Liquid Assets Capital Approach, Bank-Based Capital 
Approach, and Tangible Net Worth Capital Approach, and how the adoption 
of a leverage ratio requirement would affect the efficiency, 
competitiveness, integrity, safety and soundness, and price discovery 
of the swap markets.\379\
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    \379\ See 2019 Capital Reopening, 84 FR 69664 at 69669.
---------------------------------------------------------------------------

    Commenters generally opposed the adoption of a leverage ratio. One 
commenter stated that while leverage ratios have been argued to serve 
as effective backstops to guard against miscalculations of market risk 
or credit risk, leverage ratios are very blunt instruments that create 
perverse incentives.\380\ This commenter noted that a leverage ratio 
would discourage a covered SD from maintaining a reserve of safer, 
lower-yielding, securities and cash positions, despite the liquidity 
and safety and soundness benefits of such instruments.\381\ The 
Commission is not adopting a leverage ratio as part of its capital 
requirements at this time.
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    \380\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
    \381\ Id.
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D. Swap Dealer and Major Swap Participant Financial Recordkeeping, 
Reporting and Notification Requirements.

    Section 4s(f) of the CEA requires SDs and MSPs to make any reports 
regarding transactions and positions, as well as any reports regarding 
financial condition, that the Commission adopts by rule or 
regulation.\382\ Consistent with section 4s(f), the Commission proposed 
new regulation 23.105, which require SDs and MSPs to satisfy current 
books and records requirements, ``early warning'' and other 
notification filing requirements, and periodic and annual financial 
report filing requirements with the Commission and with any RFA of 
which the SDs and MSPs are members.
---------------------------------------------------------------------------

    \382\ 7 U.S.C. 6s(f).
---------------------------------------------------------------------------

    The notice and financial reporting requirements proposed by the 
Commission differentiate covered SDs and covered MSPs from bank SDs and 
bank MSPs.\383\ For covered SDs and covered MSPs, the Commission 
proposed a financial reporting, notification and recordkeeping approach 
that was modelled after the existing reporting regimes followed by FCMs 
and BDs, and that was proposed by the SEC for SBSDs. Where applicable, 
the Commission proposed flexibility for foreign-domiciled SDs and MSPs 
recognizing that a significant number of these SDs and MSPs would 
likely be subject to existing financial

[[Page 57513]]

reporting requirements. For bank SDs and bank MSPs, the Commission 
proposed more limited requirements as the financial condition of these 
entities will be predominantly supervised by the applicable prudential 
regulator and subject to its capital and financial reporting 
requirements.
---------------------------------------------------------------------------

    \383\ See proposed Commission regulation Sec.  23.105(a)(2); 
2016 Capital Proposal, 81 FR 91252 at 91318.
---------------------------------------------------------------------------

    The recordkeeping, reporting and notification requirements in the 
2016 Capital Proposal were intended to facilitate effective oversight 
over the Commission's capital requirements and improve internal risk 
management, via requiring robust internal procedures for creating and 
retaining records central to the conduct of business as an SD or 
MSP.\384\ The 2016 Capital Proposal proposed to require covered SDs and 
covered MSPs to, among other things: (i) Maintain current ledgers and 
other similar records summarizing transactions affecting their assets, 
liabilities, income, and expenses; (ii) file notices of certain events 
with the Commission, including notices of failing to comply with the 
applicable minimum capital requirements; (iii) file monthly unaudited 
and annual audited financial statements with the Commission; and (iv) 
provide the Commission with additional information as requested.\385\ 
The Proposal also required bank SDs and bank MSPs to file certain 
information with the Commission. Such information included: (i) 
Quarterly statements of financial condition, regulatory capital 
computations, and aggregate swaps position information; (ii) notice 
filings, including notice of a failure to maintain the minimum 
applicable capital requirement; and (iii) additional information as 
requested by the Commission.\386\
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    \384\ See 2016 Capital Proposal, 81 FR 91252 at 91295.
    \385\ See Proposed Commission regulation Sec.  23.105; 2016 
Capital Proposal, 81 FR at 91252 at 91318-22.
    \386\ Id.
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    The Commission received several detailed comments regarding the 
2016 proposed financial reporting, notification and recordkeeping 
requirements. Several commenters noted the importance of harmonizing 
the Commission's financial reporting and notification requirements with 
the requirements of other regulators, namely the SEC and the prudential 
regulators.\387\ Commenters generally supported the Commission's 
approach of permitting non-U.S. SDs and MSPs to use International 
Financial Reporting Standards (``IFRS'') in lieu of U.S. GAAP in the 
preparation of required financial statements, but some asked that the 
Commission remove the foreign domicile requirement to use IFRS.\388\ 
Several commenters to the Proposal also expressed concern that the 60-
day timeline for annual certified financial statement reporting was not 
practical for many large non-financial companies as they are typically 
permitted to provide audited financial statements within 90 days of the 
end of their fiscal year.\389\ Other commenters expressed concern for 
the weekly position reporting requirements.\390\ Several covered SDs 
that are subsidiaries of non-financial public companies requested that 
the posting period for public disclosures be extended or eliminated 
altogether, noting that additional time would be necessary to allow for 
internal and external auditors to review the information.\391\
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    \387\ See SIFMA 5/15/17 Letter.
    \388\ See, e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter.
    \389\ See, e.g., Shell 5/15/17 Letter; Cargill 5/15/17 Letter.
    \390\ See MS 5/15/17 Letter at 9; SIFMA 5/15/17 Letter at 29.
    \391\ See Shell 5/15/17 Letter; NCGA/NGSA 5/15/2017 Letter; and 
CEWG 5/15/2017 Letter.
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    In the 2019 Capital Reopening, the Commission asked several 
additional questions in response to these comments. The Commission 
specifically asked whether the IFRS requirement should be expanded to 
include a broader set of eligible covered SDs and whether the annual 
audit reporting timelines for certain covered SDs should be lengthened 
to 90 days.\392\ The Commission also asked whether it should harmonize 
certain requirements, including the public disclosure timelines of bank 
SDs, with the finalized reporting, notification and recordkeeping 
requirements of SBSDs adopted by the SEC.\393\
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    \392\ See 2019 Capital Reopening, 84 FR 69664 at 69678 (Dec. 19, 
2019).
    \393\ Id. See also, Recordkeeping and Reporting Requirements for 
Security-Based Swap Dealers, Major Security-Based Swap Participants, 
and Broker-Dealers, 84 FR 68550 (Dec. 16, 2019).
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    The Commission received several comments in response to the 
questions.\394\ Certain commenters stated that the Commission should 
permit non-U.S. covered SDs and U.S. covered SDs that are subsidiaries 
of non-U.S. parent companies to use IFRS, one stating that there would 
be no material difference in its financial statements if they were 
produced under IFRS versus GAAP.\395\ Several commenters did not 
believe that the Commission should adopt the weekly margin position 
reporting requirements, citing that information required under the 
reporting is duplicative of information received or proposed to be 
received under the Commission proposed part 45 data requirements.\396\ 
Several commenters also stated that the Commission should harmonize 
public disclosure requirements with those adopted by the SEC for stand-
alone SBSDs.\397\ One commenter stressed that the Commission should not 
adopt any financial reporting requirements for bank SDs, and that 
covered SDs following the Bank-Based Capital Approach should be 
subjected to the same reporting timeline (45 days after quarter end) as 
a bank.\398\
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    \394\ Shell Trading 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter; 
IIB/ISDA/SIFMA 3/3/2020 Letter.
    \395\ See Shell 3/3/2020 Letter at 3: CEWG 3/3/2020 Letter at 5-
6; NCGA/NGSA 3/3/2020 at 6-7; IIB/ISDA/SIFMA 3/3/2020 Letter at 52.
    \396\ See NCGA/NGSA 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 
Letter at 53.
    \397\ See CEWG 3/3/2020 Letter at 6; IIB/ISDA/SIFMA 3/3/2020 
Letter.
    \398\ See IIB/ISDA/SIFMA 3/3/2020 Letter at 50-51.
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    After considering those comments and in light of the final 
financial reporting, notification and recordkeeping requirements for 
MSBSP and SBSDs adopted by the SEC,\399\ the Commission is adopting the 
recordkeeping, notice and financial reporting requirements as proposed 
with the following modifications.
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    \399\ Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers, 84 FR 68550 (Dec. 16, 2019).
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1. Routine Financial Reporting and Recordkeeping Requirements
    Proposed regulation 23.105(b) required a covered SD or a covered 
MSP to prepare current ledgers or other similar records showing or 
summarizing each transaction affecting its asset, liability, income, 
expense, and capital accounts.\400\ The accounts must be classified in 
accordance with U.S. GAAP provided, however, that if the covered SD or 
covered MSP is organized under the laws of a foreign jurisdiction and 
is not otherwise required to prepare its records or financial 
statements in accordance with U.S. GAAP, the SD or MSP may prepare the 
required records in accordance with IFRS issued by the International 
Accounting Standards Board.\401\ The Commission also proposed to 
require covered SDs and covered MSPs to file periodic financial

[[Page 57514]]

reports with the Commission and with the SDs' or MSPs' RFA.\402\ In 
proposed regulation 23.105(d)(2) and (e)(3), the monthly unaudited and 
annual audited financial statements must also be prepared in accordance 
with U.S. GAAP, provided, however, that the Commission proposed to 
permit covered SDs or covered MSPs that are organized and domiciled 
outside of the U.S., and otherwise are not required to prepare 
financial statements in accordance with U.S. GAAP, to prepare the 
financial statements in accordance with IFRS or another local 
accounting standard, after requesting approval by the Commission, which 
is discussed below, in lieu of U.S. GAAP.\403\
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    \400\ These proposed requirements are based upon existing FCM 
and BD financial recordkeeping and reporting requirements. 
Commission regulation Sec.  1.18 (17 CFR 1.18) requires each FCM to 
prepare and keep current ledgers or other similar records which show 
or summarize, with appropriate references to supporting documents, 
each transaction affecting its asset, liability, income, expense and 
capital accounts. SEC rule 17a-3 (17 CFR 240.17a-3) requires a BD to 
make and maintain comparable ledgers and other similar records 
reflecting its assets, liabilities, income and expenses.
    \401\ FCMs are required to classify accounts only in accordance 
with U.S. GAAP.
    \402\ As noted in the proposal, these periodic financial 
reporting requirements are consistent with existing requirements for 
FCMs and BDs. See Commission regulation Sec.  1.10 (17 CFR 1.10), 
which requires FCMs to submit unaudited monthly and audited annual 
financial reports to the Commission and to the FCMs' respective 
designated self-regulatory organization. SEC rule 17a-5 (17 CFR 
240.17a-5) directs BDs to file unaudited monthly reports and annual 
audited reports with the SEC.
    \403\ See proposed Commission regulations Sec. Sec.  
23.105(d)(2) and (e)(3), 2016 Capital Proposal, 81 FR at 91252 at 
91319. Commission regulation Sec.  1.10 (17 CFR 1.10) provides that 
FCMs must present its unaudited monthly reports and audited annual 
reports in accordance with U.S GAAP.
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    Commenters generally supported the Commission's approach of 
permitting non-U.S. covered SDs and covered MSPs to use IFRS in lieu of 
U.S. GAAP in the preparation of required financial statements. However, 
several commenters requested that the proposed regulation be modified 
to permit U.S.-based covered SDs that are subsidiaries of non-U.S. 
parent entities to prepare required financial statements in accordance 
with IFRS.\404\ These commenters stated that U.S. covered SDs that are 
subsidiaries of foreign-based holding companies may prepare their 
financial statements in accordance with IFRS as the subsidiary is 
consolidated with the parent in producing the parent's consolidated 
financial statements, and further stated that requiring U.S. GAAP 
financial statements in such situations would impose unnecessary costs 
on covered SDs without providing substantial enhancements to the 
regulatory objectives.\405\ Three commenters to the 2019 Capital 
Reopening stated that the Commission should permit non-U.S. covered SDs 
and U.S. covered SDs that are subsidiaries of non-U.S. parent companies 
to use IFRS, one stating that there would be no material difference in 
its financial statements if they were prepared in accordance with IFRS 
versus U.S. GAAP.\406\
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    \404\ See, e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter.
    \405\ Id.
    \406\ See Shell 3/3/2020 Letter at 3: CEWG 3/3/2020 Letter at 5-
6; NCGA/NGSA 3/3/2020 at 6-7; IIB/ISDA/SIFMA 3/3/2020 Letter at 52.
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    The Commission is adopting regulation 23.105(b), (d)(2) and (e)(3) 
as proposed with the exception of a modification to the eligibility 
requirement for the use of IFRS to address concerns raised by 
commenters. The Commission is generally comfortable with both U.S. GAAP 
and IFRS accounting standards for covered SDs and covered MSPs, 
especially as both standards continue to move towards greater 
convergence. However, the Commission's preference continues to be U.S. 
GAAP, and therefore, the Commission is requiring that covered SDs or 
covered MSPs that are not included in the exception described below, 
must prepare their financial statements in accordance with U.S. GAAP. 
In response to commenters, the Commission has removed the requirement 
that an eligible covered SD or covered MSP must be domiciled outside 
the U.S in order to be permitted to use IFRS. However, all covered SDs 
and covered MSPs that are also registered as FCMs or BDs must continue 
to prepare their financial statements in accordance with U.S. GAAP and 
are not eligible to use IFRS. The Commission notes that foreign 
domiciled covered SD or covered MSP may also apply under final 
regulation 23.106 for a Capital Comparability Determination and has 
retained language in regulation 23.105(o) to make clear that such a 
determination could consider different, yet comparable financial 
reporting requirements including the use of a local accounting standard 
other than U.S. GAAP or IFRS.
    The Commission proposed in regulation 23.105(d)(1) to require a 
covered SD or covered MSP to file a monthly unaudited financial report 
within 17 business days of the close of business each month, and 
proposed in regulation 23.105(e)(1) to require a covered SD or covered 
MSP to file an annual audited financial report within 60 days of the 
close of the SD's or MSP's fiscal year-end date. Proposed regulation 
23.105(e)(2) required the annual financial statements to be audited by 
a public accountant that is in good standing in the accountant's home 
country jurisdiction.\407\
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    \407\ The monthly unaudited and the annual audited financial 
reports must be prepared in the English language and denominated in 
U.S. dollars. The proposal also required that the monthly unaudited 
and annual audited financial reports include: (1) A statement of 
financial condition; (2) a statement of income or loss; (3) a 
statement of cash flows; (4) a statement of changes in ownership 
equity; (5) a statement of the applicable capital computation; and 
(6) any further materials that are necessary to make the required 
statements not misleading. Proposed Regulation 23.105(e)(4)(iii) 
would further require that the annual audited financial statements 
also include any necessary footnote disclosures. See 2016 Capital 
Proposal, 81 FR 91252 at 91320.
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    The 2019 Capital Reopening asked several questions regarding 
whether it would be appropriate to expand the 60-day annual audit 
reporting requirement.\408\ In response, the Commission received 
several comments advocating for extending the financial reporting 
timelines in general, not just the 60-day audit requirement. One 
commenter requested that the Commission permit covered SDs that elect 
to use the Bank-Based Capital Approach to submit quarterly reports, as 
opposed to monthly, and that such reports should be filed within 45 
days of the end of the quarter, as is currently required of banks and 
bank holding companies by regulations of prudential regulators.\409\ 
Another commenter supported the proposition that monthly financial 
reporting be eliminated for non-bank covered SDs.\410\ Other commenters 
supported an extension of the annual audited financial statement 
requirement from 60 to 90 days after the end of the covered SD's fiscal 
year.\411\
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    \408\ 2019 Capital Reopening at 69679.
    \409\ See IIB/ISDA/SIFMA 3/3/2020 Letter at 52.
    \410\ See NCGA/NGSA 3/3/2020 at 6.
    \411\ See NCGA/NGSA 3/3/2020 at 6.
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    As noted in the Proposal, the timing of the proposed financial 
reporting requirements is consistent with the existing requirements for 
FCMs, which is harmonized with that required of BDs and SBSDs by the 
SEC.\412\ Timely financial reporting is the Commission's primary method 
for routine monitoring for compliance with the Commission's capital 
rule across multiple registrants. The Commission does not expect this 
timing to be operationally challenging for non-commercial covered SDs, 
as many of these registrants already prepare financial reports within 
the organization on a routine basis. In addition, several of these 
firms are expected to be dually registered with the SEC as either a 
SBSD or BD, and will be subject to a monthly financial reporting 
requirement and 60-day reporting timeline for annual audited financial 
statements.\413\
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    \412\ See Commission regulation Sec.  1.10(b) (17 CFR 1.10(b)), 
and 17 CFR 240.17a-5, and 240.18a-7.
    \413\ See 17 CFR 240.18a-7(a)(1) and (c)(5).
---------------------------------------------------------------------------

    On the other hand, covered SDs eligible to use the Tangible Net 
Worth Capital Approach and who are not dually-registered with the SEC 
could engage in a wide variety of business

[[Page 57515]]

operations and may be closely held corporations, partnerships or 
subsidiaries thereof. These covered SDs may not be subject to routine 
reporting requirements and could require longer periods to perform 
year-end audit requirements based on the composition of their balance 
sheet and financial statements. Therefore, the Commission is modifying 
the timeline for commercial firms by moving the monthly unaudited 
requirement to a quarterly requirement, and expanding the annual audit 
timeline for these firms to 90 days. This expanded approach will only 
be available to covered SDs that elect the Tangible Net Worth Capital 
Approach under regulation 23.101(a)(2).
    The Commission notes that regardless of a covered SD's reporting 
timeline or elected approach, compliance with the Commission's capital 
rule is an ``at all times'' requirement. As such, covered SDs should 
routinely monitor their capital position and notify the Commission and 
its RFA of material changes in accordance notification requirements 
discussed herein. In this regard, regulation 23.105(h) provides that 
the Commission or RFA may, by written notice, require any covered SD or 
covered MSP to file financial or operational information to the 
Commission or RFA.\414\ Accordingly, covered SDs and covered MSPs 
eligible to file financial information on a quarterly basis in 
accordance with regulation 23.105(d), may be required by the Commission 
or RFA to furnish such information on a monthly or more frequent basis 
as provided by such notices under regulation 23.105(h). As such, 
covered SDs and covered MSPs should therefore maintain their books and 
records in a manner capable of furnishing such information upon request 
by the Commission or RFA under a written notice issued under regulation 
23.105(h) and to be able to demonstrate compliance with notification 
requirements under regulation 23.105(c). Therefore, the Commission is 
adopting the financial reporting process and timelines for covered SDs 
as proposed in regulation 23.105(d)(1), 23.105(e)(1), and 23.105(h) 
with the modifications discussed above for covered SDs and covered MSPs 
eligible to use the Tangible Net Worth Capital Approach and regarding 
furnishing additional reports as requested by the Commission or RFA.
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    \414\ As discussed in the 2016 Capital Proposal, the 
Commission's intention is to require all covered SDs and covered 
MSPs to file financial reports and notices required under regulation 
23.105 with both the Commission and the RFA. As noted, this is 
consistent with the existing approach under Commission regulations 
Sec. Sec.  1.10 and 1.12 (17 CFR 1.10 and 1.12) applicable to FCMs 
and IBs. Regulation 23.105(h) and elsewhere in regulations 
23.105(c), (d), and (e), have been modified to clarify such 
reporting requirements.
---------------------------------------------------------------------------

    The Commission also proposed in regulation 23.105(d)(3), (4) and 
(e)(5) to permit a covered SD or covered MSP that is registered with 
the Commission as an FCM or registered with the SEC as a BD to satisfy 
the Commission's SD or MSP financial statement reporting requirements 
by submitting a CFTC Form 1-FR-FCM or its applicable SEC Financial and 
Operational Combined Uniform Single (``FOCUS'') Report in lieu of the 
specific financial statements required under proposed regulation 
23.105.\415\ Similarly, the Commission proposed to permit covered SDs 
and covered MSPs dually registered with the SEC as either SBSDs or 
MSBSPs to comply with the Commission's financial reporting and 
notification requirements under regulation 23.105 by filing 
simultaneously with the Commission all applicable notices or reports 
required under the SEC's rules.\416\ This proposed framework is 
consistent with the Commission's long history of permitting SEC 
registrants to meet their financial statement filing obligations with 
the Commission by submitting a FOCUS Report in lieu of CFTC Form 1-FR-
FCM and reduces the burden on dually registered firms by not requiring 
two separate financial reporting requirements.
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    \415\ FCMs are required to file monthly unaudited and annual 
audited Forms 1-FR-FCM with the Commission and with their designated 
self-regulatory organization. The Forms 1-FR-FCM include, among 
other information, a statement of financial condition, a statement 
of income or loss, a statement of changes in ownership equity, a 
statement of liabilities subordinated to the claims of general 
creditors, a statement of the computation of regulatory minimum 
capital, and any further information as may be necessary to make the 
required statements not misleading. See Commission regulation Sec.  
1.10(d) (17 CFR 1.10(d)). SEC FOCUS Reports are required to contain, 
among other statements and information, a statement of financial 
condition, a statement of income or loss, a statement of changes in 
ownership equity, a statement of liabilities subordinated to the 
claims of general creditors, and a statement of the computation of 
regulatory minimum capital. See SEC rule 17a-5 (17 CFR 240.17a-5).
    \416\ See Commission regulation Sec.  23.105(c)(5) (17 CFR 
23.105(c)(5)) referencing proposed 17 CFR 240-18a-8 for notification 
requirements for SBSDs and MSBSPs. See Sec.  23.105(d)(3) and Sec.  
23.105(e)(5) (17 CFR 23.105(d)(3) and 23.105(e)(5)) referencing 
proposed 17 CFR 240.18a-7, for monthly and annual financial 
reporting requirements for SBSDs and MSBSPs.
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    The SEC finalized reporting requirements which require SBSDs and 
MSBSPs to file a FOCUS form X-17A-5 Part II, no longer requiring a 
separate FORM SBS as proposed.\417\ The Commission is not changing its 
approach permitting dual registrants the ability to file SEC forms in 
lieu of the financial reporting and notification requirements of the 
CFTC. Accordingly, regulation 23.105(d) and (e) have been modified to 
permit these dual registered covered SDs to file FOCUS reports as 
discussed in lieu of the Commission's financial reporting requirements.
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    \417\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers, 84 FR 68550 (December 16, 2019). See SEC rule 18a-7 
(17 CFR 240.18a-7), 84 FR 68550 at 68662-67; SEC rule 18a-10 (17 CFR 
240.18a-10), 84 FR 68550 at 68668-69.
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    The Commission has made further technical modifications to the 
general financial reporting requirements to align them with existing 
rules for FCMs and dually-registered SBSDs and BDs. The Commission is 
making these modifications to prevent different treatment between 
dually-registered SDs and stand-alone SDs. The Commission is modifying 
regulation 23.105(d) to remove the statement of cash flows, as this 
schedule is not necessary to assess the financial condition and safety 
and soundness of the covered SD, nor required of existing FCMs under 
regulation 1.10 or for BDs under 17 CFR 240.17a-5. For the same 
reasons, regulation 23.105(d) is also modified to include a statement 
of changes in liabilities subordinated to the claims of general 
creditors and references to the annual audited or certified financial 
report throughout regulation 23.105 have been renamed annual financial 
report. The Commission has also included references to SEC rule Sec.  
240.17a-5 to paragraphs (d)(3) and (e)(5) of regulation 23.105, as 
SBSDs and MSBSPs which are dually-registered BDs file financial reports 
in accordance with that rule.
    The Commission did not receive comments on the other aspects not 
discussed herein in regards to regulation 23.105(d) and (e) and is 
adopting such provisions substantially as proposed.
2. Swap Dealer and Major Swap Participant Notice Requirements
    The 2016 Capital Proposal required SDs and MSPs to file certain 
regulatory notices with the Commission and with the RFA of which the 
SDs or MSPs are members if certain defined events occurred.\418\ 
Certain of the notice provisions applied solely to covered SDs and 
covered MSPs, while other notice provisions applied solely to bank SDs 
and bank MSPs. The Commission also proposed notice provisions that 
applied to all registered SDs and MSPs. The proposed notice provisions 
were based on the existing notice provisions

[[Page 57516]]

applicable to FCMs, and are intended to require registrants to provide 
the Commission and RFA with notice of certain events that may indicate 
that the registrants are experiencing an actual or a potential adverse 
event, affecting their financial or operational condition.\419\ Upon 
filing of a notice, the Commission or an RFA would initiate an inquiry, 
including engaging directly with the SD or MSP as necessary, to assess 
if the notice is an indication of potential issues with the registrant 
regarding its ability to meet its obligations to customers, 
counterparties, clearing organizations, creditors, and the marketplace 
in general.
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    \418\ See 2016 Capital Proposal, 81 FR 91252 at 91277-78.
    \419\ See Commission regulation Sec.  1.12 (17 CFR 1.12), which 
requires FCMs to file notices with the Commission and with the FCMs' 
designated self-regulatory organizations of certain events, 
including a firm being undercapitalized or failing to maintain 
current books and records.
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    The Commission proposed in regulation 23.105(c) to require a 
covered SD or a covered MSP to provide the Commission and RFA with 
immediate written notice when the firm is: (i) Undercapitalized; (ii) 
fails to maintain capital at a level that is in excess of 120 percent 
of its minimum capital requirement; or (iii) fails to maintain current 
books and records. Proposed regulation 23.105(c) also required a 
covered SD or covered MSP, as applicable, to provide notice to the 
Commission and to an RFA within 24 hours of: (i) Failing to comply with 
the liquidity requirements under proposed regulation 23.104, (ii) 
experiencing a 30 percent reduction in capital as compared to the last 
reported capital in a financial report filed with the Commission, or 
(ii) failing to post or collect initial margin for uncleared swap and 
security-based swap transactions or exchange variation margin for 
uncleared swap or security-based swap transactions as required by the 
Commission's uncleared swaps margin rules or the SEC's uncleared 
security-based margin rules, respectively, if the total amount that has 
not been exchange is equal to or greater than: (1) 25 percent of the 
SD's or MSP's required capital under final regulation 23.101 calculated 
for a single counterparty or group of counterparties that are under 
common ownership or control; or (2) 50 percent of the SD's or MSP's 
required capital under final regulation 23.101 calculated for all of 
the SD's counterparties.\420\
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    \420\ See Commission regulations Sec. Sec.  23.152 and 23.153 
(17 CFR 23.152 and 23.153).
---------------------------------------------------------------------------

    Proposed regulation 23.105(c) also required a covered SD or covered 
MSP to provide the Commission and an RFA with a minimum two days 
advance notice of an intention to withdraw capital by an equity holder 
that would exceed 30 percent of the SD's or MSP's excess regulatory 
capital.\421\ Finally, the proposal required a covered SD or covered 
MSP that is dually-registered with the SEC as an SBSD or MSBSP to file 
with the Commission and with its RFA a copy of any notice that the SBSD 
or MSBSP is required to file with the SEC under SEC Rule 18a-8 (17 CFR 
240.18a-8). SEC Rule 18a-8 requires SBSDs and MSBSPs to provide written 
notice to the SEC for comparable reporting events as proposed by the 
Commission in regulation 23.105(c), including if a SBSD or MSBSP is 
undercapitalized or fails to maintain current books and records.\422\ 
The Commission proposed to require covered SDs and covered MSPs that 
are dually-registered with the SEC to file copies with the Commission 
of notices filed with the SEC under Rule 18a-8 to allow the Commission 
to be aware of any events that may indicate that the SD or MSP is 
unable to meet its operational or financial obligations on an ongoing 
basis.
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    \421\ The term `regulatory capital'' is defined in proposed 
Commission regulation Sec.  23.100 and means the relevant capital 
approach applicable to the SD under proposed Commission regulation 
Sec.  23.101. See 2016 Capital Proposal, 81 FR 91252 at 91309-11.
    \422\ See 17 CFR 240.18a-8.
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    The Commission did not receive comments on the proposed notice 
provisions in regulation 23.105(c). The Commission has considered the 
proposal, and is adopting the SD and MSP notice requirements as 
proposed, with a modification to eliminate the notice provision 
relating to liquidity requirements that the Commission did not adopt.
3. Swap Dealers and Major Swap Participants Subject to the Capital 
Rules of a Prudential Regulator
    The Commission proposed limited financial reporting for bank SDs 
and bank MSPs that are subject to the capital requirements of a 
prudential regulator, as these SDs and MSPs are already subject to 
existing financial reporting requirements by such prudential regulator. 
As such, the Commission did not propose to require a bank SD or bank 
MSP to file monthly unaudited or annual audited financial statements 
with the Commission or with the RFA of which the SD or MSP is a member. 
The Commission also did not propose to require such bank SDs or bank 
MSPs to file notifications contained in Regulation 23.105(c) with the 
Commission or with an RFA. The Commission did, however, propose to 
require bank SDs and bank MSPs to file quarterly unaudited financial 
reports. The Commission also proposed certain regulatory notices that 
bank SDs and bank MSPs must file with the Commission and with an RFA.
    Under the Proposal, bank SDs and bank MSPs were required to file 
financial reports and specific position and margin information with the 
Commission and with the RFA of which the SDs and MSPs are members 
within 17 business days of the end of each calendar quarter. The 
financial reports and specific position information that would be 
required under this requirement was set forth in a separate Appendix B 
to proposed Regulation 23.105(p). The information required on Appendix 
B was intended to be identical to that required by the SEC for SBSDs 
subject to the capital rules of a prudential regulator.\423\ These 
quarterly unaudited reports filed with the Commission were largely 
based on existing ``call reports'' that the bank SDs and bank MSPs are 
required to file with their respective prudential regulator.\424\
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    \423\ See 2016 Capital Proposal, 81 FR 91252 at 91279.
    \424\ See proposed Commission regulation Sec.  23.105(p) and 
Appendix B; 2016 Capital Proposal, 81 FR 91252 at 91321-22 and 
91329-32. See also, Consolidated Reports of Condition and Income for 
a Bank with Domestic and Foreign Offices (``call reports''); 12 
U.S.C. 324; 12 U.S.C. 1817; 12 U.S.C. 161; and 12 U.S.C. 1464. The 
proposed financial reporting requirement was consistent with the SEC 
proposed filing requirement for SBSDs that are subject to the 
capital rule of a prudential regulator. See proposed SEC rule 17 CFR 
240.18a-8. Specifically, the Commission proposed that the SDs and 
MSPs submit to the Commission Appendix B of proposed Commission 
regulation Sec.  23.105, which is largely based on the SEC's 
proposed Form SBS part 2 and part 5.
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    In addition, proposed regulation 23.105(p) required bank SDs and 
bank MSPs to file certain notices with the Commission and their RFA 
following the occurrence of certain events. Proposed regulation 23.105 
(p)(3)(i) required a bank SD or bank MSP to file a notice with the 
Commission and with an RFA if the SD or MSP filed a notice of change of 
its reported capital category with the Federal Reserve Board, the OCC, 
or the FDIC. Proposed regulation 23.105(p)(3) also required a bank SD 
that is a foreign bank to notify the Commission if the SD files a 
notice of a change in its capital category or a notice of falling below 
its minimum capital requirement with a prudential regulator or with its 
home country supervisor.\425\ Proposed regulation 23.105(p)(3) also 
required a bank SD or bank MSP to file notices in the event the SD or 
MSP fails to post or collect initial margin for uncleared swap 
transactions

[[Page 57517]]

or post or collect uncleared swap variation margin as required under 
the respective prudential regulators' rules subject to certain 
thresholds.\426\ Finally, proposed regulation 23.105(p) also included 
an identical oath and affirmation provisions and electronic filing 
requirements for bank SDs and bank MSPs as the Commission proposed 
under paragraphs (f) and (n) of regulation 23.105 for covered SDs and 
covered MSPs.
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    \425\ These notices are identical to those finalized for SBSDs 
by the SEC in 17 CFR 240.18a-8(c).
    \426\ These notices are identical to those required for SDs and 
MSPs subject to the capital rules of the Commission and proposed 
under 23.105(c). See 2016 Capital Proposal, 81 FR 91252 at 91318.
---------------------------------------------------------------------------

    The 2019 Capital Reopening noted that the SEC finalized its 
recordkeeping, reporting and notification requirements for SBSDs and 
MSBSPs, which include requiring SBSDs and MSBSPs subject to the capital 
rules of a prudential regulator to report quarterly unaudited financial 
information and provide notices of change in its capital category or 
falling below its minimum capital requirement with the a prudential 
regulator.\427\ The 2019 Capital Reopening asked whether it was 
appropriate to make specific changes to proposed regulation 23.105(p) 
Appendix B in this regard, and to make such schedule align with that 
finalized by the SEC under Form X-17a-5 FOCUS Part IIC.\428\
---------------------------------------------------------------------------

    \427\ See 17 CFR 240.18a-7(a)(2) and 240.18a-8(c).
    \428\ 2019 Capital Reopening, 84 FR 69664 at 69680.
---------------------------------------------------------------------------

    Several commenters noted that the 17 business day timeline for the 
quarterly unaudited financial reporting requirement for bank SDs and 
bank MSPs was inconsistent with existing banking requirements which 
permit between a 30-day or 45 calendar day timeline depending on size. 
In addition, the SEC amended their requirements for SBSDs subject to 
the capital rules of a prudential regulator to 30 calendar days, making 
slight adjustments to the schedules in order to make them more 
consistent with existing call reports.
    As noted previously, the Commission wishes to harmonize the 
reporting requirements for bank SDs and bank MSPs to the maximum extent 
practicable. The Commission is modifying final regulation 23.105(p) to 
require a 30 calendar day reporting timeline comparable to that 
required by SBSD subject to the capital rules of a prudential 
regulator. The Commission is also adopting the notification 
requirements relating to the notices of change in capital category or 
failing below its minimum capital requirement with a prudential 
regulator. The Commission, however, is not adopting the additional 
requirements relating to posting and collecting of initial and 
variation margin under certain thresholds as these notices are not 
required for SBSDs subject to the rules of a prudential regulator. The 
Commission further notes in this regard that bank SDs and bank MSPs are 
also not subject to the Commission's rules for uncleared margin. The 
Commission is making technical amendments to the Appendix B to align 
the schedule with that required of SBSD subject to the capital 
requirements of a prudential regulator under FORM x-17a-5 FOCUS Part 
IIC, which have been aligned primarily with FFIEC Form 031.
4. Public Disclosures
    The Commission proposed to require covered SDs and covered MSPs to 
provide public disclosure on their website of required financial 
reporting, including a statement of financial condition and of the 
amount of minimum regulatory capital required and the amount of 
regulatory capital of the SD or MSP no less than quarterly, with the 
same information provided from an audited financial statement no less 
than annually.\429\ The Commission also proposed to require bank SDs 
and bank MSPs to make publically available no less than quarterly 
similar financial information.\430\ In both instances, the proposed 
public disclosures were required to be posted to the SD's or MSP's 
website within ten business days after the SD or MSP is required to 
file the financial information with the Commission.
---------------------------------------------------------------------------

    \429\ See Proposed Commission regulation Sec.  23.105(i)(3); 
2016 Capital Proposal, 81 FR 91252 at 91320.
    \430\ See Proposed Commission regulation Sec.  23.105(p)(7); 
2016 Capital Proposal, 81 FR 91252 at 91322.
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    The Commission noted in the 2016 Capital Proposal that its approach 
was consistent with the financial reporting information the Commission 
had previously determined should not qualify as exempt from the Freedom 
of Information Act for FCMs.\431\ For bank SDs and bank MSPs, the 
Commission noted the Proposal was consistent with publically available 
information provided by bank entities in call reports.\432\
---------------------------------------------------------------------------

    \431\ See 2016 Capital Proposal, 81 FR 91252 at 91277.
    \432\ Id.
---------------------------------------------------------------------------

    Several covered SDs that are subsidiaries of public companies 
requested that the posting period on firm's website be extended from 
ten days to 20 days for the quarterly information, noting that 
additional timeframe would be necessary to allow for internal and 
external auditors to review the information.\433\ One commenter stated 
that public disclosure of financial reports will be onerous for 
commercial covered SDs, while others requested elimination of public 
disclosures by bank SDs.\434\
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    \433\ See Shell 5/15/17 Letter; NCGA/NGSA 5/15/2017 Letter; CEWG 
5/15/2017 Letter.
    \434\ See Shell 5/15/17 Letter; SIFMA 5/15/17 Letter; MS 5/15/17 
Letter.
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    In the 2019 Capital Reopening, the Commission asked questions 
regarding the practicality of moving the posting deadline from ten 
business days to 30 calendar days to be consistent with the final 
requirements adopted by the SEC for SBSDs. Further, the Commission 
asked whether it was appropriate to remove the public disclosure 
requirement for bank SDs and bank MSPs under the rationale that this 
information is already provided to the public on a timely basis as a 
result of separate disclosure requirements imposed by the prudential 
regulators.\435\ In response, commenters confirmed that a longer period 
for public disclosure would be preferred and that imposing an 
additional Commission requirement for bank SDs is duplicative and would 
override existing balances that were struck.\436\ One commenter 
suggested harmonizing the public disclosure requirement for stand-alone 
SDs with the biannual requirement required by the SEC for stand-alone 
SBSD.\437\ Another commenter recommended that an exemption be provided 
for commercial firms which meet a certain threshold of minimum 
capital.\438\
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    \435\ See 2019 Capital Reopening, 84 FR 69664 at 69680, 
questions 13-a and 13-b.
    \436\ See NCGA/NGSA 3/3/2020 Letter at 6; IIB/ISDA/SIFMA 3/3/
2020 Letter at 52.
    \437\ See Shell 3/3/2020 Letter at 4.
    \438\ See Cargill 3/3/2020 Letter at 3.
---------------------------------------------------------------------------

    The Commission believes that is best to harmonize public disclosure 
requirements to the maximum extent practicable with that required of 
SBSDs by the SEC. Thus, the Commission is not adopting public 
disclosure requirements for bank SDs and bank MSPs as these SDs and 
MSPs will already be providing public disclosures of key financial 
information as part of the ``call report'' process. Covered SDs and 
covered MSPs will be required to bi-annually make available on its 
website basic financial information 30 calendar days following when 
such information is filed with the Commission. This approach will 
harmonize the Commission's public disclosure requirements with those 
required of the stand-alone SBSDs under 17 CFR 240.18a-7(b). Therefore, 
the Commission is not adopting proposed regulation 23.105(p)(7)

[[Page 57518]]

regarding public disclosures requirements for bank SDs and bank MSPs. 
The Commission is adopting regulation 23.105(i) as proposed with 
modification to the timelines as discussed above.
5. Electronic Filing Requirements for Financial Reports and Regulatory 
Notices
    Proposed regulation 23.105(n) required all notifications and 
financial statement filings submitted to the Commission pursuant to 
regulation 23.105 to be filed in an electronic manner using a user 
authentication process approved by the Commission. Proposed regulation 
23.105(f) and (p) required each filing made pursuant to Regulation 
23.105 include an oath or affirmation signed by an appropriate SD or 
MSP personnel that the information provided in the filing was true and 
correct. The Commission notes that many SDs and MSPs are already 
familiar with the Commission approved WinJammer filing system 
maintained jointly by NFA and Chicago Mercantile Exchange. WinJammer 
currently allows Commission registrants that are authorized to use the 
electronic system to file financial reports and notices with the 
Commission and NFA simultaneously. The Commission views this system, as 
well as other future Commission approved systems, as the most effective 
way to ensure that the filings required under proposed regulation 
23.105 would be submitted promptly and directly to the Commission.
    One commenter to the 2016 Proposal asked that the Commission 
provide clarity with the requirements of the oath or affirmation.\439\ 
Another commenter, while generally supportive of the proposed 
requirements, encouraged the Commission to either adopt standard forms 
or mandate that the financial filings be accomplished in a form and 
manner prescribed by an RFA.\440\ This commenter further suggested that 
the Commission consider the SEC's final adopted forms as a starting 
point for the Commission's forms and encouraged the Commission to 
parallel any financial reporting requirements for prudentially 
regulated SDs and those relying on substituted compliance with the 
SEC's filing requirements for these firms.\441\
---------------------------------------------------------------------------

    \439\ SIFMA 5/15/17 Letter at 28.
    \440\ NFA 3/2/2020 Letter at 6, 7.
    \441\ Id.
---------------------------------------------------------------------------

    As with other requirements regarding financial reporting for SDs 
and MSPs, the Commission wishes to harmonize these rules to the maximum 
extent practicable with that adopted by the SEC. The Commission expects 
that those registrants that are dually-registered with the SEC as 
either BDs or SBSDs, including those that are also subject to the 
capital rules of a prudential regulator, would fully comply with the 
Commission's reporting requirements by filing forms adopted by the SEC. 
Accordingly, to ensure that bank SD or bank MSP duly registered with 
the SEC will not be subject to two separate filing requirements, the 
Commission is amending 23.105(p) by including a provision that a bank 
SD or bank MSP may file a Form X-17A-5 FOCUS Part IIC in lieu of the 
forms required under 23.105(p).
    The Commission wishes to add clarity that while it is adopting 
specific schedules in Appendix A and B with regard to swap position 
information, it is not adopting a standard form for the other routine 
monthly or annual filing requirements as discussed above.\442\ 
Nonetheless, the Commission may approve additional procedures developed 
by an RFA, which could include standard forms or procedures necessary 
to carry out the Commission's filing requirements. The Commission notes 
that an RFA is required to adopt minimum capital, segregation, and 
other financial requirements applicable to its members, in accordance 
with section 17(p)(2) of the CEA. In this regard, each self-regulatory 
organization, which includes an RFA, must have minimum financial and 
related reporting requirements that are the same as or more stringent 
than the Commission's requirements.\443\ The Commission is not 
modifying the proposed language related to the oath or affirmation that 
financial reports be true and correct. This language is identical to 
that required in regulation 1.10(d)(4) and that is required by the SEC 
in 240.17a-5(e)(2) and 240.18a-7(d)(1). In order to ensure that the 
oath and affirmation is harmonized with SEC for duly registered SBSDs, 
the Commission is modifying the application of the oath or affirmation 
to only apply to financial reports, and not to notice or other filings 
as proposed. For the same reasons, the Commission is modifying the 
language that for corporations, the oath and affirmation must be signed 
by the duly authorized officer. The Commission is adopting all other 
aspects of regulation 23.105(f) and (p) as proposed.
---------------------------------------------------------------------------

    \442\ Please note that due to changes in Federal Register 
publication requirements, the appendices that had been referred to 
as Appendix A to section 23.105 and Appendix B to section 23.105 in 
previous documents are being published in this final rule as 
Appendix B to Subpart E of Part 23 and Appendix C to Subpart E of 
Part 23, respectively.
    \443\ See also Commission regulation Sec.  1.52 (17 CFR 1.52).
---------------------------------------------------------------------------

6. Swap Dealer and Major Swap Participant Reporting of Position 
Information
    Proposed regulation 23.105(l) required each covered SD or covered 
MSP to file monthly swap and security-based swap position information 
with the Commission and with the RFA of which the SD or MSP is a 
member. This information was proposed to be reported using Appendix A 
to regulation 23.105, and was based upon the information proposed to be 
filed with the SEC by SBSDs.\444\ Accordingly, covered SDs or covered 
MSPs that are dually-registered as SBSDs would be subject to file the 
same position information with both regulators. In this regard, all 
covered SDs or covered MSPs were permitted under proposed 23.105(d)(3) 
to file SEC forms in lieu of the Commission's financial reporting 
requirements.
---------------------------------------------------------------------------

    \444\ See SEC proposed Form SBS part 4.
---------------------------------------------------------------------------

    The position information that was proposed in regulation 23.105(l) 
would include a covered SD's or covered MSP's: (i) Current net exposure 
by the top 15 counterparties, and all other counterparties combined; 
(ii) total exposure by the top 15 counterparties, and all others 
combined; and, (iii) the internal credit rating, gross replacement 
value, net replacement value, current net exposure, total exposure, and 
margin collected for the top 36 counterparties. The covered SD or 
covered MSP would also have to provide current exposure and net 
exposure by country for the top 10 countries. The Commission also 
proposed in 23.105(m) to require covered SDs and MSPs to file with the 
Commission information about their custodians that hold margin for 
uncleared swaps pursuant to regulations 23.152 and 23.153 and the 
aggregate amounts of margin held at such custodians, as well as, the 
aggregate amount required to be posted and collected pursuant to such 
rules. The Commission indicated this information will be necessary 
component of its financial surveillance program to monitor the 
financial condition and positions of SDs and MSPs.
    In the 2019 Capital Reopening, the Commission noted that a 
commenter had raised issue with the fact that the proposed appendices 
did not contain accompanying form instructions, despite having defined 
terms in both

[[Page 57519]]

column headings and rows.\445\ In this regard, the Commission asked 
whether it would be appropriate to incorporate by reference the form 
instructions published alongside of finalized SEC form X-17a-5 FOCUS 
Part II and IIC on the proposed appendices to regulation 23.105. 
Further, the Commission asked whether it was appropriate to modify the 
proposed Appendices to align certain column headings and rows to that 
finalized by the SEC in their aforementioned forms.
---------------------------------------------------------------------------

    \445\ See 2019 Capital Reopening, 84 FR 69664 at 69680 footnote 
121, citing to SIFMA 5/17/17 Letter.
---------------------------------------------------------------------------

    The Commission received one comment in support of adding the 
explanatory note incorporating by reference the form instructions 
published by the SEC.\446\ Therefore, the Commission is making 
technical modifications to the Appendix A to align the schedules with 
that required of SBSDs under Form X-17a-5 FOCUS Report Part II and 
incorporate by reference their form instructions. In this regard, the 
headings of Schedules 2, 3, and 4 of Appendix A have been modified to 
indicate that these will be required to be completed by Covered SDs 
authorized to use models. Much of the information on these schedules is 
required under regulation 23.105(k), and is consistent with that 
required by the SEC under their form schedules. In addition, Schedule 1 
of Appendix A contains general position information and utilizes 
identical column and row headings as the comparable SEC schedule and 
applies generally to all covered SDs. All other aspects of regulation 
23.105(l) and the incorporated Appendix A are being adopted as 
proposed. The Commission did not receive comment on the monthly 
custodian reporting in regulation 23.105(m) and is adopting as 
proposed.
---------------------------------------------------------------------------

    \446\ IIB/ISDA/SIFMA 3/3/2020 Letter at 50, fn. 108.
---------------------------------------------------------------------------

7. Reporting Requirements for Swap Dealers and Major Swap Participants 
Approved To Use Internal Capital Models
    The Commission proposed reporting requirements for covered SDs that 
have received approval from the Commission or from an RFA under 
proposed regulation 23.102(d) to use internal models to compute market 
risk capital charges or credit risk capital charges. The Commission's 
proposed requirements for the collection of model information are 
largely based on existing requirements for ANC Firms under regulation 
1.17 and the rules of the SEC, and on SEC rules for SBSDs and BDs.
    Regulation 23.105(k) required a covered SD to file, on a monthly 
basis, a listing of each product category for which the covered SD does 
not use an internal model to compute market risk deductions, and the 
amount of the market risk deduction; a graph reflecting, for each 
business line, the daily intra-month VaR; the aggregate VaR for the SD; 
for each product for which the SD uses scenario analysis, the product 
category and the deduction for market risk; and, credit risk 
information on swap, mixed swap, and security-based swap exposures, 
including: (A) Overall current exposure, (B) current exposure listed by 
counterparty; (C) the 10 largest commitments listed by counterparty, 
(D) the SD's maximum potential exposure listed by counterparty for the 
15 largest exposures; (E) the SD's aggregate maximum potential 
exposure, (F) a summary report reflecting the SD's current and maximum 
potential exposures by credit rating category, and (G) a summary report 
reflecting the SD's current exposure for each of the top 10 countries 
to which the SD is exposed.
    Regulation 23.105(k) also required each covered SD approved to use 
internal capital models to submit a report identifying the number of 
business days for which the actual daily net trading loss exceeded the 
corresponding daily VaR and the results of back-testing of all internal 
models used to compute allowable capital, including VaR, and credit 
risk models, indicating the number of back-testing exceptions. All of 
the information required to be submitted to the Commission or RFA under 
proposed regulation 23.105(k) would be required to be filed within 17 
days of the close of each month, with the exception of the report 
identifying the number of business days for which the actual daily net 
trading loss exceeded the corresponding daily VaR, which would be 
required on a quarterly basis.
    The Commission did not receive comment on the proposed reporting 
requirements for covered SDs and MSPs who have been approved to use 
models under regulation 23.102(d). The Commission also notes that such 
reporting requirements are identical to that finalized by the SEC for 
SBSDs and MSBSDs who have been approved to use models to calculate 
their market and credit risk charges under the SEC's rules. As such, 
the Commission is adopting regulation 23.105(k) with slight technical 
amendments to align such requirements with that finalized by the SEC.
8. Weekly Position and Margin Reporting
    The Commission proposed weekly reporting of position and margin 
information for the purposes of conducting risk surveillance of SDs and 
MSPs. This requirement would apply to SDs and MSPs subject to the 
capital and margin rules of either the Commission or a prudential 
regulator. Similar reporting is currently provided on a daily basis by 
DCOs for cleared swaps.\447\
---------------------------------------------------------------------------

    \447\ Commission regulation Sec.  39.19(c)(1) (17 CFR 
39.19(c)(1)).
---------------------------------------------------------------------------

    Proposed regulation 23.105(q)(1) would require SDs and MSPs to 
report position information, in a format specified by the Commission, 
(i) by counterparty, and (ii) for each counterparty, by the following 
asset classes--commodity, credit, equity, and foreign exchange or 
interest rate. Under the uncleared margin rules, these are asset 
classes within which margin offsets may be taken.\448\
---------------------------------------------------------------------------

    \448\ 17 CFR 23.154(b)(2)(v).
---------------------------------------------------------------------------

    Proposed regulation 23.105(q)(2) would require SDs and MSPs to 
report margin information, in a format specified by the Commission, 
showing: (i) The total initial margin posted by the SD or MSP with each 
counterparty; (ii) the total initial margin collected by the SD or MSP 
from each counterparty; and (iii) the net variation margin paid or 
collected over the previous week with each counterparty.
    Several commenters noted that the weekly position requirement was 
duplicative of information provided as part of the Commission's Part 45 
program.\449\ Other commenters noted ambiguities in the Commission's 
proposed requirements and indicated that any weekly reporting 
requirement would likely be very costly to implement.\450\
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    \449\ See ISDA 5/15/2017 Letter; Cargill 5/15/2017 Letter.
    \450\ See INTL FCStone 5/15/2017 Letter; CEWG 5/15/2017 Letter; 
BPE 5/15/2017 Letter; SIFMA 5/15/2017 Letter.
---------------------------------------------------------------------------

    As noted in the Proposal, the Commission currently uses positon and 
margin information filed by DCOs to identify and to take steps to 
mitigate the risks posed to the financial system by participants in 
cleared markets including DCOs, clearing members, and large 
traders.\451\ In addition, the Commission has collected specific 
transactional swap data as part of its Part 45 program and uses such 
data in various surveillance and oversight

[[Page 57520]]

functions.\452\ The Commission has recently proposed revisions to the 
Part 45 data collection, including several additional fields, such as 
initial and variation margin.\453\ Therefore, the Commission at this 
time believes that imposing an additional weekly position reporting 
requirement for SDs and MSPs would be duplicative of these efforts. The 
Commission will revisit the need for a separate weekly position and 
margin reporting requirement once the routine financial reporting 
requirements of SDs and MSPs are effective. Accordingly, the Commission 
is not adopting the weekly position and margin reporting requirements 
in proposed regulation 23.105(q) at this time.
---------------------------------------------------------------------------

    \451\ See 2016 Capital Proposal, 81 FR 91252 at 91279-80.
    \452\ See 85 FR 21578 at 21579, 21584.
    \453\ See 85 FR 21578 at 21649-51.
---------------------------------------------------------------------------

E. Comparability Determinations for Eligible Covered SDs and Covered 
MSPs

    The Commission proposed a substituted compliance framework that 
would permit covered SDs and covered MSPs that were organized and 
domiciled in a foreign jurisdiction to rely on compliance with their 
applicable home country regulator's capital and financial reporting 
requirements in lieu of meeting all or parts of the Commission's 
capital adequacy and financial reporting requirements.\454\ The 
availability of substituted compliance was conditioned upon the 
Commission issuing a determination that the relevant foreign 
jurisdiction's capital adequacy and financial reporting requirements 
are comparable with the Commission's corresponding capital adequacy and 
financial reporting requirements (i.e., a ``Capital Comparability 
Determination''). Furthermore, FCM-SDs and dually-registered FCM/MSPs 
(``FCM-MSPs'') were not eligible for substituted compliance as FCMs are 
required to comply with the capital and financial reporting 
requirements in part 1 of the Commission's regulations.\455\
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    \454\ See 2016 Capital Proposal, 81 FR 91252 at 91280-81.
    \455\ Two FCMs currently are organized and domiciled outside of 
the U.S., and neither is provisionally-registered as an SD or MSP. 
Accordingly, the Commission does not view the inability of an FCM-SD 
or an FCM-MSP to avail itself of substituted compliance to present 
any issues to registrants.
---------------------------------------------------------------------------

    The proposed Capital Comparability Determination framework 
established a standard of review for determining whether some or all of 
the relevant foreign jurisdiction's capital adequacy and financial 
reporting requirements are comparable with the Commission's 
corresponding capital adequacy and financial reporting requirements. 
This framework, as detailed below, is generally consistent with the 
approach adopted by the Commission in assessing substituted compliance 
of the margin rules for covered SDs engaging in cross-border uncleared 
swap transactions.
    Proposed regulation 23.106 provided that any eligible covered SD or 
covered MSP, and any foreign regulatory authority that has direct 
supervisory authority with respect to capital and financial reporting 
over one or more eligible covered SDs or covered MSPs, is permitted to 
request a Capital Comparability Determination. The Commission further 
proposed that eligible covered SDs and covered MSPs may coordinate with 
their home country regulators in order to simplify and streamline the 
process for obtaining a Capital Comparability Determination.\456\
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    \456\ The Commission also confirms that a trade association or 
similar organization may submit a Capital Comparability 
Determination on behalf of one or more eligible covered SDs or 
covered MSPs.
---------------------------------------------------------------------------

    Persons requesting a Capital Comparability Determination are 
required to submit to the Commission: (i) Copies of the relevant 
foreign jurisdiction's capital and financial reporting requirements 
(including English translations of any foreign language documents); 
(ii) descriptions of the objectives of the relevant capital and 
financial reporting requirements and how such requirements are 
comparable to, or different from, the Commission's capital and 
financial reporting requirements (e.g., the Net Liquid Assets Capital 
Approach and Bank-Based Capital Approach), international standards such 
as Basel bank capital requirements, if applicable; and, (iii) 
descriptions of how such requirements address the elements of the 
Commission's capital and financial reporting rules. A person requesting 
a Capital Comparability Determination is further required to identify 
the regulatory provisions that correspond to the Commission's capital 
and financial reporting requirements (and, if necessary, identify 
whether the foreign jurisdiction's capital requirements do not address 
a particular element). A person requesting the determination is also 
required to provide a description of the ability of the relevant 
foreign regulatory authority or authorities to supervise and enforce 
compliance with the applicable capital and financial reporting 
requirements, and to provide any other information and documentation 
the Commission deems appropriate.
    The proposal identified certain key factors that the Commission 
would consider in making a Capital Comparability Determination. 
Specifically, the Commission would consider: (i) The scope and 
objectives of the relevant foreign jurisdiction's capital requirements; 
(ii) how and whether the relevant foreign jurisdiction's capital 
adequacy requirements compare to international Basel capital standards 
for banking institutions or to other standards such as those used for 
securities brokers or dealers; (iii) whether the relevant foreign 
jurisdiction's capital requirements achieve comparable outcomes to the 
Commission's corresponding capital requirements; (iv) the ability of 
the relevant regulatory authority or authorities to supervise and 
enforce compliance with the relevant foreign jurisdiction's capital 
adequacy and financial reporting requirements; and (v) any other facts 
or circumstances the Commission deems relevant. The Commission further 
stated that a foreign capital regime may be deemed comparable in some, 
but not all, elements of the Commission's capital and financial 
reporting requirements.
    Proposed regulation 23.106 further provided that any covered SD or 
covered MSP that, in accordance with a Capital Comparability 
Determination, complies with a foreign jurisdiction's capital and 
financial reporting requirements, would be deemed in compliance with 
the Commission's corresponding capital adequacy and financial reporting 
requirements. Accordingly, the failure of such an SD or MSP to comply 
with the relevant foreign capital and financial reporting requirements 
may constitute a violation of the Commission's capital adequacy and 
financial reporting requirements. In addition, all covered SDs and 
covered MSPs relying on substituted compliance would remain subject to 
the Commission's examination and enforcement authority regardless of 
the Commission issuing a Capital Comparability Determination.
    The Commission also retained the authority to impose any terms and 
conditions it deems appropriate in issuing a Capital Comparability 
Determination and to further condition, modify, suspend, terminate or 
otherwise restrict any Capital Comparability Determination it had 
issued in its discretion. Such revisions or termination of the Capital 
Comparability Determination could result from, for example, changes in 
foreign laws or regulatory oversight. In this regard, the Capital 
Comparability Determinations issued by the Commission would require 
that the Commission be notified of any material changes to information 
submitted in support of a Capital

[[Page 57521]]

Comparability Determination, including, but not limited to, changes in 
the relevant foreign jurisdiction's supervisory or regulatory regime.
    Commenters generally supported the Commission's proposed 
substituted compliance framework.\457\ One commenter stated that less 
than full acceptance of foreign regulation by the Commission would 
result in substantially increased costs to non-U.S. covered SDs and to 
U.S. covered SDs with non-U.S. parent entities.\458\
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    \457\ See, e.g., ISDA 5/15/2017 Letter; SIFMA 5/15/2017 Letter; 
MS 5/15/2017 Letter; JBA 3/14/2017 Letter; Letter from Sarah Miller, 
Institute of International Bankers (May 15, 2017) (IIB 5/15/2017 
Letter); IIB/ISDA/SIFMA 3/3/2020 Letter; MS 3/3/2020 Letter; Letter 
from Atsushi Hirayama, International Bankers Association of Japan 
(February 27, 2020) (IBAJ 2/27/2020 Letter); and NFA 3/2/2020 
Letter.
    \458\ See SIFMA 5/15/2017 Letter.
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    Several commenters stated that the Commission should streamline or 
simplify the proposed substituted compliance process for certain non-
U.S. covered SDs. In this regard, one commenter requested that the 
Commission grant automatic qualification for substituted compliance 
with the Commission's capital rules for any non-U.S. covered SD that is 
subject to Basel-compliant home country capital requirements 
administered by a regulatory authority that is either in a G20 
jurisdiction or is a member of the BCBS or IOSCO.\459\ Another 
commenter requested that the Commission exempt non-US covered SDs from 
the substituted compliance approval process in cases where the covered 
SDs are subject to capital standards in their home countries that the 
Federal Reserve Board has determined in the context of foreign banking 
organizations to be consistent with the Basel III standards.\460\ One 
commenter stated that the Commission should clarify that a non-U.S. SD 
that qualifies for substituted compliance with the Commission's capital 
requirements can also meet any relevant Commission notification 
requirements in proposed regulation 23.105(c) by meeting comparable 
home country notice requirements.\461\
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    \459\ See IIB 5/15/2017 Letter.
    \460\ See JBA 3/14/2017 Letter.
    \461\ See IIB/ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    One commenter also requested that the Commission's assessment of 
the capital framework of a foreign jurisdiction be performed in a 
holistic manner, as opposed to narrowly focusing on a line-by-line 
comparison of regulatory requirements.\462\ In addition, one commenter 
stated that the Commission issue Capital Comparability Determinations 
well in advance of the compliance date, which will help alleviate 
potential issues with eligible covered SDs having to seek capital model 
approval.\463\
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    \462\ See IBAJ 2/27/2020 Letter.
    \463\ See NFA 3/2/2020 Letter.
---------------------------------------------------------------------------

    NFA also requested that the Commission revise proposed regulation 
23.106(a)(4), which provides that a covered SD that intends to comply 
with the capital adequacy and financial reporting requirements of a 
foreign jurisdiction that has received a Capital Comparability 
Determination to file a notice to that effect with NFA, and further 
requires NFA to confirm that the covered SD may comply with some or all 
of the requirements of the foreign jurisdiction in lieu of the 
Commission's requirements.\464\ NFA suggested that the requirement be 
revised to require that a non-U.S. covered SD make only a notice filing 
similar to the substituted compliance process for margin and entity-
level requirements.\465\
---------------------------------------------------------------------------

    \464\ Id.
    \465\ Id.
---------------------------------------------------------------------------

    The Commission has reviewed the proposed substituted compliance 
framework and considered the comments received and is adopting the 
framework with several modifications as discussed below. There 
currently are 24 non-U.S. covered SDs provisionally registered with the 
Commission. These 24 non-U.S. covered SDs are located in a total of 7 
foreign jurisdictions, with 12 SDs located in the United Kingdom. The 
Commission also understands that many, if not all, of the 24 non-U.S. 
covered SDs are subject to regulatory requirements in their respective 
home country jurisdictions, including capital and financial reporting 
requirements.
    The Commission's approach to substituted compliance is a 
principles-based, holistic approach that focuses on whether the foreign 
regulations are designed with the objective of ensuring overall safety 
and soundness of the non-U.S. covered SD in a manner that is comparable 
with the Commission's overall capital and financial reporting 
requirements and is not based on a line-by-line assessment or 
comparison of a foreign jurisdiction's regulatory requirements with the 
Commission's requirements. The Commission also will seek to address 
applications for Capital Comparability Determinations in as expeditious 
manner, which should provide adequate notice to market participants of 
its determination prior to the compliance date of these rules.
    The Commission is retaining the requirement in proposed regulation 
23.106(a)(2) that requires a person to submit a written request to 
Commission for a Capital Comparability Determination. The Commission is 
not revising the framework to permit certain non-U.S. covered SDs to 
satisfy their CFTC regulatory requirements through a process of 
automatic qualification of substituted compliance with the capital or 
financial reporting requirements of a foreign jurisdiction, including 
foreign jurisdictions that are compliant with Basel capital standards. 
The Commission believes that appropriate capital and financial 
reporting are fundamental to the Commission's statutory mandate of 
promoting the safety and soundness of covered SDs, and helping to 
ensure that such firms meet their financial obligations to swap 
counterparties. Accordingly, the Commission believes that a non-U.S. 
covered SD seeking to comply with the Commission's capital and 
financial reporting requirements must submit information that 
demonstrates how the foreign regulatory requirements achieve comparable 
outcomes to the Commission' requirements. The Commission believes that 
the proposal provides sufficient flexibility for persons seeking 
Capital Comparability Determinations in that it permits regulatory 
authorities as well as non-U.S. covered SDs to submit the required 
materials for the Commission's consideration.
    Proposed regulation 23.106(a)(1) provided that a covered SD, 
covered MSP, or a foreign regulatory authority that has direct 
supervisory authority over one or more covered SDs or covered MSPs that 
are eligible for substituted compliance may request a Capital 
Comparability Determination. The Commission is modifying regulation 
23.106(a)(1) by providing that a trade association or other similar 
group also may request a Capital Comparability Determination on behalf 
of its member covered SDs and covered MSPs. The purpose of this 
modification is to provide greater flexibility and efficiencies in the 
substituted compliance framework by allowing trade associations to 
request Capital Comparability Determinations for multiple covered SDs 
or covered MSPs that may be in a particular jurisdiction. This 
modification potentially allows the Commission to focus its limited 
resources on a smaller number of requests and will allow covered SDs 
and covered MSPs to reduce costs by not having to submit individual 
Capital Comparability Determination requests.
    The Commission also is modifying proposed regulation 23.106(a)(3), 
which provided that the Commission would consider all relevant factors 
in assessing whether a foreign jurisdiction's capital

[[Page 57522]]

and financial reporting requirements are comparable to the 
Commission's, including whether or how the foreign jurisdiction's 
capital adequacy requirements compare to the capital standards issued 
by the BCBS for banking institutions or to other standards used for 
securities brokers or dealers. The Commission is removing this specific 
reference to BCBS capital standards and to broker-dealer standards in 
the final rule. As noted above, the Commission's approach to 
substituted compliance is a principles-based, holistic approach that 
focuses on whether the foreign regulations are designed with the 
objective of ensuring overall safety and soundness of the non-U.S. 
covered SD or MSP in a manner that is comparable with the Commission's 
overall capital and financial reporting requirements. While a foreign 
jurisdiction's incorporation of BCBS standards or broker-dealer 
standards are approaches that the Commission would consider for 
substituted compliance, it was not the Commission's intent to limit the 
regulatory approaches, or to appear to limit the regulatory approaches, 
that it would deem acceptable for substituted compliance. To clarify 
the rule, and to avoid any potential confusion, the Commission is 
removing the references to BCBS and broker-dealer standards from the 
rule. This modification, however, does not represent any change in the 
Commission's stated approach to substituted compliance.
    Proposed regulation 23.106(a)(4) required a non-U.S. covered SD or 
a non-U.S. covered MSP to file with an RFA a notice of the SD's or 
MSP's intent to comply with the requirements of a foreign jurisdiction 
that had received a Capital Comparability Determination. Regulation 
23.106(a)(4) further provided that the RFA would determine the 
information that was necessary to be included in the notice and would 
provide a confirmation to the non-U.S. covered SD or non-U.S. MSP of 
its ability to meet the Commission's requirements through substituted 
compliance. The Commission is modifying the notice and confirmation 
provisions in final regulation 23.106(a)(4) to require a non-U.S. 
covered SD or non-U.S. covered MSP to file a notice of its intent to 
avail itself of a Capital Comparability Determination with the 
Commission. As the capital and financial reporting requirements are 
entity-level requirements, it is necessary for the Commission to assess 
whether each non-U.S. covered SD or non-U.S. covered MSP that files a 
notice of its intent to meet the Commission's capital and reporting 
requirements through substituted compliance satisfies any conditions 
set forth in the applicable Capital Comparability Determination issued 
to applicable foreign jurisdiction. Upon receipt of a notice, 
Commission staff will engage with the non-U.S. covered SD or non-U.S. 
covered MSP to determine the extent to which the foreign regulation 
that it is subject to is consistent with the Commission's Capital 
Comparability Determination. As part of the determination, the 
Commission will review the foreign jurisdiction's regulations, process, 
and/or procedures, as applicable, for assessing the ongoing financial 
condition of a covered SD or a covered MSP in determining whether it is 
appropriate to extend substituted compliance to the notice provisions 
contained in regulation 23.105(c).
    Regulation 23.106(a)(4) also provided that the failure of a non-
U.S. covered SD or non-non-U.S. covered MSP operating under substituted 
compliance to comply with the capital adequacy or financial reporting 
requirements of the relevant foreign jurisdiction may constitute a 
violation of the Commission's capital adequacy and financial reporting 
requirements. The Commission is modifying this provision in final 
regulation 23.106(a)(4)(ii) to explicitly provide that the Commission 
may initiate an action for a violation of the Commission's rules when a 
covered SD or covered MSP subject to a capital comparability 
determination has failed to comply with a foreign jurisdiction's 
corresponding capital adequacy and financial reporting requirements. 
This modification is intended to provide clarity to the final rule by 
providing that the Commission may initiate an action against a non-U.S. 
covered SD or non-U.S. covered MSP for failure to comply with the 
relevant Commission capital and financial reporting requirements when 
it violates the corresponding foreign jurisdiction's requirements.

F. Additional Amendments to Existing Regulations

1. Financial Reporting Requirements for FCMs or IBs That Are Also 
Registered SBSDs
    The Commission is amending regulation 1.10 to authorize dually-
registered FCM/SBSDs and IB/SBSDs to file SEC Financial and Operational 
Combined Uniform Single Report under the Securities Exchange Act of 
1934, Part II, Part IIA, or Part II C (``FOCUS Report''), as 
applicable, in in lieu of CFTC Form 1-FR-FCM or Form 1-FR-IB.
    Regulation 1.10 requires each FCM to file an unaudited monthly 
financial report with the Commission and with the FCM's designated 
self-regulatory organization (``DSRO'') within 17 business days of the 
close of each month.\466\ An FCM's monthly financial reports must be 
submitted on CFTC Form 1-FR-FCM. FCMs also are required to file an 
audited annual financial report with the Commission and with the firm's 
DSRO within 60 days of the end of the FCM's fiscal year end. An FCM's 
annual financial report may be submitted on Form 1-FR-FCM or, subject 
to certain conditions, presented in a manner consistent with U.S. 
GAAP.\467\
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    \466\ The term ``self-regulatory organization'' (``SRO'') is 
defined in Commission regulation Sec.  1.3 (17 CFR 1.3) as a 
contract market, a swap execution facility (all as further defined 
underSec.  1.3), or an RFA under section 17 of the CEA. The term 
``designated self-regulatory organization'' is also defined in 
Commission regulation Sec.  1.3 and generally means the SRO that has 
primary financial surveillance responsibilities over a registrant.
    \467\ See Commission regulation Sec.  1.10(d)(3) (17 CFR 
1.10(d)(3)).
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    Regulation 1.10 requires each IB to file with NFA an unaudited 
financial report on a semi-annual basis, and an audited annual 
financial report.\468\ The IB unaudited reports must be submitted on 
Form 1-FR-IB within 17 business days of the date of the report. IB 
annual reports may be filed on Form 1-FR-IB or, subject to certain 
conditions, presented in a manner consistent with U.S. GAAP. IB annual 
financial reports must be filed within 90 days of the IB's fiscal year 
end.\469\
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    \468\ See Commission regulation Sec.  1.10(b)(2)(i) (17 CFR 
1.10(b)(2)(i)). An IB is required to file its unaudited financial 
report as of the middle and the end of its fiscal year end.
    \469\ Commission regulation Sec.  1.10(b)(2)(ii)(A) (17 CFR 
1.10(b)(2)(ii)(A)).
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    Regulation 1.10(h) currently streamlines the financial reporting 
requirements imposed on FCMs and IBs that are dually-registered as BDs. 
Such dual-registrants are permitted to file with the Commission and 
with the firms' DSRO the SEC's FOCUS Reports, in lieu of a Form 1-FR-
FCM or Form 1-FR-IB. The 2016 Capital Proposal proposed amending 
regulation 1.10(h) to permit an FCM or IB that is dually-registered as 
a SBSD or MSBSP to file an SEC FOCUS Report in lieu of a CFTC Form 1-
FR-FCM or CFTC Form 1-FR-IB.\470\ The proposed amendment is consistent, 
as noted above, with the current provisions that authorize dually-
registered FCMs/BDs and IBs/BDs to file FOCUS Reports in lieu of the 
CFTC financial forms. Furthermore, the Commission's experience with

[[Page 57523]]

regulation 1.10(h) has been that the FOCUS Reports include information 
that is substantially comparable to the Forms 1-FR and provide the 
information necessary for the Commission to conduct financial 
surveillance of the registrants.
---------------------------------------------------------------------------

    \470\ See 2016 Capital Proposal, 81 FR 91252 at 91281-82.
---------------------------------------------------------------------------

    Regulations 1.10(f) and 1.16(f) also currently provide that a 
dually-registered FCM/BD or IB/BD may automatically obtain an extension 
of time to file its unaudited and audited financial reports required 
under regulation 1.10 by submitting a copy of the written approval for 
the extension issued by the BD's securities designated examining 
authority (``DEA'').\471\ The 2016 Capital Proposal proposed amending 
regulations 1.10(f) and 1.16 to provide that an FCM or IB that is also 
registered with the SEC as an SBSD or an MSBSP may obtain an automatic 
extension of time to file its unaudited or audited FOCUS Report with 
the Commission and with the firm's DSRO, as applicable, by submitting a 
copy of the SEC's or the DEA's approval of the extension request. The 
proposed amendment maintains the intent of the current regulations by 
retaining a consistent approach to the granting to dual registrants 
extensions of time to file financial reports. The Commission also 
proposed a technical amendment to regulation 1.16 to correct a cross 
reference to SEC rule 17a-5 (17 CFR 240.17a-5) for extensions of time 
to file audited financial statements.
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    \471\ Commission regulations Sec. Sec.  1.10(f) and 1.16(f) (17 
CFR 1.10(f) and 1.16(f)).
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    The Commission did not receive any comments related to the proposed 
amendments to the provisions of regulations 1.10 and 1.16 noted above. 
After further consideration and for the reasons stated in the 2016 
Capital Proposal, the Commission is adopting these amendments 
substantially as proposed.
2. Amendments to the FCM and IB Notice Provisions in Regulation 1.12
    Regulation 1.12 requires an FCM or IB to file a notice with the 
Commission and with the registrant's DSRO when certain prescribed 
events occur that trigger a notice filing requirement.\472\ Such events 
include the registrant: (i) Failing to maintain compliance with the 
Commission's capital requirements or the capital rules of a SRO; (ii) 
failing to hold sufficient funds in segregated or secured amount 
accounts to meet its regulatory requirements; (iii) failing to maintain 
current books and records; and (iv) experiencing a significant 
reduction in capital from the previous month-end.
---------------------------------------------------------------------------

    \472\ Commission regulation Sec.  1.12 (17 CFR 1.12).
---------------------------------------------------------------------------

    The Commission proposed amending regulation 1.12(a) to require an 
FCM or IB that is a dual registrant with the SEC to file a notice if 
the FCM or IB fails to meet any applicable SEC's minimum capital 
requirements. The Commission stated that such notice is appropriate as 
it provides Commission staff with the opportunity to assess the 
potential impact of the dually-registered FCM's or IB's failure to meet 
SEC minimum capital requirements on the respective firm's CFTC 
regulated activities, and to initiate discussions with the SEC 
regarding the capital deficiency.\473\
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    \473\ See 2016 Capital Proposal, 81 FR 91252 at 91282.
---------------------------------------------------------------------------

    Commission regulation 1.12(b) requires an FCM or IB to file notice 
with the Commission and with the firm's DSRO if a firm's adjusted net 
capital falls below the applicable ``early warning level'' set forth in 
the regulation.\474\ The Commission proposed amending regulation 
1.12(b) to require an FCM or IB that is also registered with the SEC as 
a SBSD or a MSBSP to file a notice if the SBSD's or MSBSP's capital 
falls below the ``early warning level'' established in the rules of the 
SEC. The proposal was intended to provide additional information to the 
Commission in its efforts to monitor the financial condition of its 
registrants.
---------------------------------------------------------------------------

    \474\ If an FCM's or IB's adjusted net capital falls below a 
certain threshold, such as 120 percent of its minimum adjusted net 
capital requirement, the firm is deemed to be maintaining adjusted 
net capital at a level below its ``early warning level.''
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    The Commission did not receive any comments related to the above 
proposed amendments to regulation 1.12. For the reasons stated in the 
2016 Capital Proposal, the Commission is adopting the amendments as 
proposed.
3. FCM and IB Unsecured Receivables From Swap Transactions
    Regulation 1.17 provides that an FCM or IB, in computing its net 
capital, must exclude unsecured receivables except for certain 
specified unsecured receivables, including interest receivable, floor 
broker receivable, commissions receivable from other brokers or 
dealers, mutual fund concessions receivable and management receivable 
from registered investment companies and commodity pools. The 
regulation further provides that an FCM or IB must exclude these 
otherwise permitted unsecured receivables from current assets in 
computing its net capital if the receivable is outstanding longer than 
30 days from the payable date.\475\ The operation of the regulation 
effectively allowed an FCM or IB to reflect commissions due from FCMs 
that carried customer accounts introduced by the FCM or IB as a current 
asset in computing its net capital, as the FCMs generally paid these 
commissions within 30 days from the payable date.
---------------------------------------------------------------------------

    \475\ Commission regulation Sec.  1.17(c)(2)(ii) (17 CFR 
1.17(c)(2)(ii)).
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    The Commission proposed to amend regulation 1.17(c)(2)(ii)(B) to 
codify several staff no-action letters that provided that staff would 
not recommend an enforcement action against an IB that reflect certain 
commissions receivable balances from swap transactions that are 
outstanding no more than 60 days from the month-end accrual date as 
current assets in computing its net capital, provided that the 
commissions are promptly billed.\476\ The staff no-action letters were 
issued to accommodate the long-standing commission billing practices in 
the swaps market that differed from the futures markets. Commissions 
for swaps transactions are often billed and paid in a process that 
exceeds 30 days. The final rule adopted by the Commission would allow 
both FCMs and IBs to recognize unsecured commissions receivable 
resulting from swap transactions in computing their net capital, 
provided that the unsecured receivables are not outstanding more than 
60 days from the month end accrual date and the commissions are billed 
promptly after the close of the month.
---------------------------------------------------------------------------

    \476\ See 2016 Capital Proposal, 81 FR 91252 at 91282.
---------------------------------------------------------------------------

    The Commission also proposed amending regulation 1.17(c)(2)(ii)(B) 
by adding a new provision that allows FCMs and IBs to recognize 
dividends receivable that are not outstanding more than 30 days. This 
proposed amendment was to further align the Commission's capital rules 
with the SEC's capital, which specifically addressed the capital 
treatment of dividends.
    The Commission received no comments on the proposed amendments to 
regulation 1.17(c)(2)(ii)(B). After considering the issue, and for the 
reasons stated in the 2016 Capital Proposal, the Commission has 
determined to adopt the amendments to regulation 1.17(c)(2)(ii)(B) as 
proposed.
4. Amendments to FCM and IB Notice and Disclosure Requirements for Bulk 
Transfers
    Regulation 1.65 provides that an FCM or IB must obtain a customer's 
specific consent prior to transferring the customer's account to 
another FCM or

[[Page 57524]]

IB, except if the account is transferred at the customer's 
request.\477\ Regulation 1.65 further provides that an FCM or IB may 
transfer a customer's account without the customer's specific consent 
if the FCM's or IB's account agreement with the customer contains a 
valid consent by the customer to a prospective transfer of the account; 
the customer is provided with written notice of, and a reasonable 
opportunity to object to, the transfer; and, the customer has not 
objected to the transfer or given other instructions as to the 
disposition of the account. The written notice provided to the 
customers is required to contain certain prescribed information 
including, the reason for the transfer, a statement that the customer 
is not required to accept the proposed transfer and may direct that the 
account be liquidated or transferred to an FCM or IB of the customer's 
choosing, and a clear statement of how the customer is to provide 
notice that it does not consent to the proposed transfer.\478\
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    \477\ Commission regulation Sec.  1.65(a)(1) (17 CFR 
1.65(a)(1)).
    \478\ Commission regulation Sec.  1.65(a)(2) (17 CFR 
1.65(a)(2)).
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    An FCM or IB is also required to file with the Commission notice of 
a transfer of customer accounts at least five business days prior to 
the transfer if the transfer involves more than 25 percent of the FCM's 
or IB's total accounts (or 50 percent if the FCM or IB has less than 
100 accounts).\479\ The notice must be submitted to the Commission by 
mail, addressed to the Deputy Director, Compliance and Registration 
Section, Division of Swap Dealer and Intermediary Oversight.\480\ 
Finally, the notice must be filed with the Commission as soon as 
practicable and no later than the day of the transfer if the FCM or IB 
cannot file the notice at least five business days prior to the 
transfer.\481\ The FCM or IB is required to file a brief statement 
explaining the circumstances necessitating the delay in filing.
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    \479\ Commission regulation Sec.  1.65(b) (17 CFR 1.65(b)).
    \480\ Commission regulation Sec.  1.65(d) (17 CFR 1.65(d)).
    \481\ Commission regulation Sec.  1.65(e) (17 CFR 1.65(e)).
---------------------------------------------------------------------------

    The Commission proposed to amend regulation 1.65 noting that it had 
found that five days' notice, when given, often is not a sufficient 
amount of time to allow the Commission to effectively monitor the bulk 
transfer of customer accounts.\482\ Specifically, the Commission 
proposed to amend regulation 1.65(b) to require that the notice of a 
bulk transfer of customer accounts must be filed with the Commission at 
least ten business days in advance of a transfer. The Commission noted 
that the bulk transfers of customer accounts are generally planned well 
in advance such that the FCM or IB should be able to provide the 
Commission ten days advance notice of such a transfer. The Commission 
also proposed to amend regulation 1.65(d) to require the notice to be 
filed by the FCM or IB electronically, which is consistent with the 
filing requirements of other notices and financial forms filed by FCMs 
or IBs with the Commission. The Commission noted that the electronic 
system to file such notices already exists and has been used by FCMs 
and IBs for many years. Accordingly, the Commission believed that the 
proposed electronic filing of notices of bulk transfers would not 
result in any additional costs either to the Commission or to FCMs and 
IBs.
---------------------------------------------------------------------------

    \482\ See 2016 Capital Proposal, 81 FR 91252 at 91282.
---------------------------------------------------------------------------

    The Commission also proposed to amend regulation 1.65(d) to provide 
that the notices shall be considered filed with the Commission when 
submitted to the Director of the Division of Swap Dealer and 
Intermediary Oversight. The Commission proposed to require the notices 
of bulk transfer to be addressed to the Director of the Division of 
Swap Dealer and Intermediary Oversight to reflect organizational 
changes since the rule was last revised, and to ensure that such 
notices are reviewed promptly upon receipt.
    The Commission further proposed to amend regulation 1.65(e) to 
delegate to the Director of the Division of Swap Dealer and 
Intermediary Oversight the authority to accept a lesser time period for 
the notification provided for in regulation 1.65(b). However, the 
notice must be filed as soon as practicable and in no event later than 
the day of the transfer. This provision is deemed necessary as certain 
transfers may be performed under exigent circumstances where 10 days 
advance notice is not possible, such as situations where the FCM or IB 
becomes insolvent and is required to terminate its business.
    The Commission did not receive any comments regarding the proposed 
amendments to the bulk transfer provisions of regulation 1.65. The 
Commission has considered the proposed amendments and, for the reasons 
stated in the 2016 Capital Proposal, has determined to adopt the 
amendments as proposed.
5. Conforming Amendments to Delegated Authority Provisions in 
Regulation 140.91
    Commission regulations 1.10, 1.12, and 1.17 reserve certain 
functions to the Commission, the greater part of which the Commission 
has delegated to the Director of the Division of Swap Dealer and 
Intermediary Oversight through the provisions of regulation 
140.91.\483\ The Commission proposed to amend regulation 140.91 to 
provide similar delegations with respect to functions reserved to the 
Commission in part 23.
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    \483\ Commission regulation Sec.  140.91 (17 CFR 140.91).
---------------------------------------------------------------------------

    Regulation 23.101(c), as adopted, requires a covered SD or covered 
MSP to be in compliance with the minimum regulatory capital 
requirements at all times and to be able to demonstrate such compliance 
to the Commission at any time. Regulation 23.103(d), as adopted, 
requires a covered SD or covered MSP, upon request, to provide the 
Commission with additional information regarding its internal models 
used to compute its market risk exposure requirement and OTC 
derivatives credit risk requirement. Regulation 23.105(a)(2), as 
adopted, requires a covered SD or covered MSP to provide the Commission 
with immediate notification if the SD or MSP fails to maintain 
compliance with the minimum regulatory capital requirements, and 
further authorizes the Commission to request financial condition 
reporting and other financial information from the covered SD or 
covered MSP. Regulation 23.105(d), as adopted, authorizes the 
Commission to direct a bank SD or bank MSP that is subject to capital 
rules established by a prudential regulator, or has been designated a 
systemically important financial institution by the Financial Stability 
Oversight Council and is subject to capital requirements imposed by the 
Board of Governors of the Federal Reserve System, to file with the 
Commission copies of its capital computations for any periods of time 
specified by the Commission.
    The Commission proposed to amend regulation 140.91 to delegate to 
the Director of the Division of Swap Dealer and Intermediary Oversight, 
or the Director's designee, the authority reserved to the Commission 
under regulations 23.101(c), 23.103(d), and 23.105(a)(2) and (d).\484\ 
The Commission did not receive any comments regarding the proposed 
amendments to regulation 140.91 to delegate the functions noted above 
to DSIO staff and has determined

[[Page 57525]]

to adopt the amendments substantially as proposed. The delegation of 
such functions to staff of the Division of Swap Dealer and Intermediary 
Oversight is necessary for the effective oversight of SDs and MSPs 
compliance with minimum financial and related reporting requirements. 
The delegation of authority is also comparable to the authorities 
currently delegated to staff under regulation 140.91 regarding the 
supervision of FCMs compliance with minimum financial requirements.
---------------------------------------------------------------------------

    \484\ See 2016 Capital Proposal, 81 FR 91252 at 91282-83.
---------------------------------------------------------------------------

G. Effective Date and Compliance Date

    The proposed amendments and new regulations adopted by the 
Commission shall be effective 60 days after publication in the Federal 
Register. Several commenters requested that timeline for implementation 
be extended to allow for approval of capital models.\485\ Specific 
concerns included comments that the implementation timeline should not 
create competitive disparities between SDs utilizing models approved by 
other regulators and SDs seeking model approval for the first time from 
the Commission and NFA.\486\ Another commenter stated SDs that did not 
have model approval at the compliance date would be at a significant 
competitive disadvantage relative to covered SDs and FCM-SDs that had 
the approval to use models at the compliance date because such SDs 
would be required to use the proposed standardized capital charges 
while awaiting model approval at the compliance date.\487\ Several 
commenters further stated that the Commission should automatically 
approve market risk models and credit risk models of covered SDs or 
FCM-SDs that have already been approved by a prudential regulator, the 
SEC, or certain foreign regulators.\488\ In view of these concerns, the 
Commission is extending the compliance date for the amended regulations 
and the new regulations until October 6, 2021. Additionally, the 
Commission has provided for the ability of SDs to use capital models 
pending Commission/NFA approval, provided the SD files the 
certification required under Commission regulation 23.102(f) and the 
model has been approved by the SEC, prudential regulators, or qualified 
foreign regulators. Further, the Commission has provided for a 
substituted compliance program. By setting the compliance date as 
October 6, 2021, the Commission has addressed commenters' concerns by 
allowing SDs a sufficient period of time to develop policies, 
procedures, and systems, to implement new financial reporting regimes 
and to develop capital models, as applicable, to meet the new 
regulatory requirements while also maintaining consistency with the 
SEC's compliance date for rules imposing capital, margin, segregation, 
and financial reporting obligations for SBSDs, and amending existing 
rules for BDs. The coordination of the compliance date will assist 
dually-registered entities with meeting their CFTC and SEC regulatory 
requirements.
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    \485\ See Citadel 5/15/2017 Letter; SIFMA 5/15/2017 Letter; FIA 
5/15/2017 Letter; FIA-PTG 5/24/2017 Letter.
    \486\ See Citadel 5/15/2017 Letter.
    \487\ See ISDA 5/15/17 Letter.
    \488\ See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter. See 
also, ABN/ING/Mizuho/Nomura 1/29/2018 Letter.
---------------------------------------------------------------------------

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RF Act'') requires that agencies 
consider whether the regulations they propose will have a significant 
economic impact on a substantial number of small entities.\489\ This 
rulemaking would affect the obligations of SDs, MSPs, FCMs, and IBs. 
The Commission has previously determined that SDs, MSPs, and FCMs are 
not small entities for purposes of the RF Act.\490\ Therefore, the 
requirements of the RF Act do not apply to those entities. The 
Commission has found it appropriate to consider whether IBs should be 
deemed small entities for purposes of the RF Act on a case-by-case 
basis, in the context of the particular Commission regulation at 
issue.\491\ As certain IBs may be small entities for purposes of the RF 
Act, the Commission considered whether this rulemaking would have a 
significant economic impact on such registrants.
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    \489\ 5 U.S.C. 601 et seq.
    \490\ See Policy Statement and Establishment of Definitions of 
``Small Entities'' for Purposes of the Regulatory Flexibility Act, 
47 FR 18618 (Apr. 30, 1982) (FCMs) and Registration of Swap Dealers 
and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (SDs 
and MSPs).
    \491\ See Introducing Brokers and Associated Persons of 
Introducing Brokers, Commodity Trading Advisors and Commodity Pool 
Operators; Registration and Other Regulatory Requirements, 48 FR 
35248, 35276 (Aug. 3, 1983).
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    Only a few of the regulations included in this rulemaking, the 
amendment of Commission regulations 1.10, 1.12, 1.16 and 1.17, will 
impact the obligations of IBs. These amendments will permit the filing 
and harmonization of financial reporting and notification rules as 
adopted by the SEC for dual registered SBSD and MSBSPs and accommodate 
common billing practices in the swap industry surrounding the 
collection of commission receivables. The Commission believes that 
these amendments will have a minimal effect on IBs, and are not 
expected to impose any new burdens or costs on them. The Commission 
does not, therefore, expect small entities to incur any additional 
costs as a result of this proposed rulemaking.
    Accordingly, for the reasons stated above, the Commission believes 
that this rulemaking will not have a significant economic impact on a 
substantial number of small entities. Therefore, the Chairman, on 
behalf of the Commission, hereby certifies, pursuant to 5 U.S.C. 
605(b), that the regulations being published today by this Federal 
Register release will not have a significant economic impact on a 
substantial number of small entities.

B. Paperwork Reduction Act

1. Background
    The Paperwork Reduction Act of 1995 (``PRA'') \492\ 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. The rule amendments adopted herein 
results in an amendment to existing collection of information 
``Regulations and Forms Pertaining to Financial Integrity of the Market 
Place; Margin Requirements for SDs/MSPs'' \493\ as discussed below. The 
responses to this collection of information are mandatory. 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 issued by the Office of Management and Budget (``OMB'').
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    \492\ 44 U.S.C. 3501 et seq.
    \493\ See OMB Control No. 3038-0024, https://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0024.
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    The Commission did not receive any comments regarding its PRA 
burden analysis in the preamble to the Proposal. The Commission is 
revising collection number 3038-0024 to reflect the adoption of 
amendments to Parts 1 and 23 of its regulations, as discussed below, 
with changes to reflect adjustments that were made to the final rules 
in response to comments on the Proposal. The Commission does not 
believe the rule amendments as adopted impose any other new collections 
of information that require approval of OMB under the PRA.

[[Page 57526]]

2. New Information Collection Requirements and Related Burden Estimates 
\494\
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    \494\ This discussion does not include information collection 
requirements that are included under other Commission regulations 
and related OMB control numbers.
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    Currently, there are approximately 108 SDs and no MSPs 
provisionally registered with the Commission that may be impacted by 
this rulemaking and, in particular, the collection of information 
contained herein and discussed below.
i. FOCUS Report
    The amendments to Commission regulation 1.10(h) allow an FCM or IB 
that is also an SEC-registered securities BD to file, subject to 
certain conditions, its FOCUS Form X-17a-5-Part II in lieu of its Form 
1-FR. Because these amendments provide an alternative to filing Form 1-
FR, the Commission believes that the amendments would not cause FCMs or 
IBs to incur any additional burden. Rather, to the extent that the rule 
provides an alternative to filing a Form 1-FR and is elected by FCMs or 
IBs, it is reasonable for the Commission to infer that the alternative 
is less burdensome to such FCMs and IBs.
    The amendments to Commission regulation 1.10(f) allow an FCM or IB 
that is dually-registered with the SEC as either a SBSD or MSBSP to 
request an extension of time to file its uncertified FOCUS Report. The 
Commission is unable to estimate with precision how many requests it 
would receive from registrants under Sec.  1.10(f) in relation to FOCUS 
Report annually. The Commission anticipates that it will receive one 
such request in the aggregate annually, and that preparing such a 
request will consume five burden hours, resulting in an annual increase 
in burden of five hours in the aggregate.
ii. Notice of Failure To Maintain Minimum Financial Requirements
    Commission regulations 1.12(a) and (b) currently require FCMs and 
IBs, to file notices if they know or should have known that certain 
specified minimum financial thresholds have been exceeded. The 
amendments to Commission regulation 1.12(a) and (b) add as an 
additional threshold for such notices certain financial requirements of 
the SEC if the applicant or registrant is registered with the SEC as an 
SBSD or MSBSD. The Commission is unable to estimate with precision how 
many additional notices it would receive from such entities as a result 
of the additional minimum threshold. In an attempt to provide 
conservative estimates, the Commission anticipates receiving 10 such 
notices in the aggregate annually, and that preparing such a notice 
will consume five burden hours, resulting in an annual increase in 
burden of 50 hours in the aggregate.
iii. Requests for Extensions of Time To File Financial Statements
    The amendments to Commission regulation 1.16(f) allow an FCM or IB 
that is registered with the SEC as an SBSD or MSBSP to request an 
extension of time to file its audited annual financial statements.\495\ 
The Commission is unable to estimate with precision how many of such 
requests it would receive from such entities. The Commission 
anticipates receiving one such request in the aggregate annually, and 
that preparing the request will consume five burden hours, resulting in 
an annual increase in burden of five hours in the aggregate.
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    \495\ The registrant would also be required to promptly file 
with the DSRO and the Commission copies of any notice it receives 
from its designated examining authority to approve or deny the 
requested extension of time.
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iv. Capital Requirement Elections
    Amended Commission regulation 23.101(a)(7) requires that certain 
SDs that wish to change their capital election submit a written request 
to the Commission and provide any additional information and 
documentation requested by the Commission. The Commission is unable to 
estimate with precision how many of such requests it would receive from 
such entities. The Commission anticipates that it would receive one 
such request in the aggregate annually, and that preparing such a 
request would consume five burden hours, resulting in an annual 
increase in burden of five hours in the aggregate.
v. Application for Use of Models
    Commission regulation 23.102(a) allow an SD to apply to the 
Commission or a RFA of which it is a member for approval to use 
internal models when calculating its market risk exposure and credit 
risk exposure under Commission regulations 23.101(a)(1)(i)(B), 
23.101(a)(1)(ii)(A), or 23.101(a)(2)(ii)(A), by sending to the 
Commission and such RFA an application, including the information set 
forth in Appendix A to Commission regulation 23.102 and meeting certain 
other requirements. Amended Commission regulation 1.17(c)(6)(v) 
relatedly allows an FCM that is also an SD to apply in writing to the 
Commission or an RFA of which it is a member for approval to compute 
deductions for market risk and credit risk using internal models in 
lieu of the standardized deductions otherwise required under Commission 
regulation 1.17.\496\
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    \496\ Note that the changes to Commission regulation Sec.  
1.17(c)(6)(i) (17 CFR 1.17(c)(6)(i)), which permit any dual 
registered FCM Broker-Dealer who has received approval by the SEC 
under Sec.  240.15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)) to use models 
to calculate its market and credit risk charges, do not add an 
additional collection of information and therefore are not 
considered in this analysis.
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    Appendices A and B to Commission regulation 23.102 contain further 
related information collection requirements, including that the SD: (i) 
Provide notice to the Commission and RFA and/or update its application 
and related materials for certain inaccuracies and amendments; (ii) 
notify the Commission or RFA before it ceases to use such internal 
models to compute deductions; (iii) if a VaR model is used, have an 
annual review of such model conducted by a qualified third party 
service, (iv) conduct stress-testing, retain and make available to the 
Commission and the RFA records of the results and all assumptions and 
parameters thereof, and notify the Commission and RFA promptly of 
instances where such tests indicate any material deficiencies in the 
comprehensive risk model; (v) demonstrate to the Commission or the RFA 
that certain additional conditions have been satisfied and retain and 
make available to the Commission or the RFA records related thereto; 
and (vi) comply with additional conditions that may be imposed on the 
SD by the Commission or the RFA.
    As discussed above, there are currently 108 SDs and 0 MSPs 
provisionally registered with the Commission. Of these, the Commission 
estimates that approximately 56 SDs and no MSPs would be subject to the 
Commission's capital rules as they are not subject to the capital rules 
of a prudential regulator. The Commission further estimates 
conservatively that 32 of these SDs would seek to obtain Commission 
approval to use models for computing their market and credit risk 
capital charges.
    The Commission staff estimates that an SD approved to use internal 
models would spend approximately 5,600 hours per year to review and 
update the models and approximately 640 hours per year to back-test the 
models for the aggregate of 6,240 annual burden hours for each SD. 
Consequently, Commission staff estimates that reviewing and backtesting 
the models for the 32 SDs will result in an aggregate annual hour 
burden of approximately 199,680 hours.

[[Page 57527]]

vi. Equity Withdrawal Requirements.
    Commission regulation 23.104 adds equity withdrawal restrictions on 
certain SDs. Commission regulation 23.104(a) allows an SD to apply in 
writing for relief from restrictions on certain equity withdrawals. 
Commission staff estimates that 28 of the 107 currently provisionally 
registered SDs would be subject to this regulation. Commission staff 
estimates that each of these 28 SDs would file approximately two 
notices annually with the Commission and that it would take 
approximately 30 minutes to file each of these notices. This results in 
an aggregate annual hour burden estimate of approximately 28 hours.
vii. Financial Recordkeeping, Reporting and Notification Requirements 
for SDs and MSPs
    Commission regulation 23.105 requires that each SD and MSP maintain 
certain specified records, report certain financial information and 
notify or request permission from the Commission under certain 
specified circumstances, in each case, as provided in the proposed 
regulation. For example, the regulation requires generally that SDs and 
MSPs maintain current books and records, provide notice to the 
Commission of regulatory capital deficiencies and related 
documentation, provide notice of certain other events specified in the 
rule, and file financial reports and related materials with the 
Commission (including the information in Appendix A and B to the 
regulation, as applicable). Regulation 23.105 also requires the SD or 
MSP to furnish information about its custodians that hold margin for 
uncleared swap transactions and the amounts of margin so held, and for 
SDs approved to use models (as discussed above), provide additional 
information regarding such models, as further described in regulation 
23.105(k).
    The Commission estimates that there are 28 SD firms which will be 
required to fulfill their financial reporting, recordkeeping and 
notification obligations under regulation 23.105(a)-23.105(n) because 
they are not subject to a prudential regulator, not already registered 
as an FCM, and not dually registered as a SBSD. The Commission expects 
these 28 firms will apply to use models. Commission staff estimates 
that the preparation of monthly and annual financial reports for these 
SDs, including the recordkeeping, related notification and preparation 
of the specific information required in Appendix A to 23.105, would 
impose an on-going burden of 250 hour per firm annually. The Commission 
further estimates it will cost each SD $300,000 to retain an 
independent public accountant to audit its financial statements each 
year. Thus, the total burden hours estimated for compliance with 
23.105(a)-23.105(n) for these 28 SD firms would be 7,000 hours 
annually.
    Regulation 23.105(p) and its accompanying Appendix B impose a 
quarterly financial reporting and notification obligations on SDs which 
are subject to a prudential regulator. The Commission expects that 
approximately 52 of the 108 currently provisionally registered SDs are 
subject to a prudential regulator. The Commission estimates that these 
reporting and notification requirements will impose a burden of 33 
hours on-going annually. This results in a total aggregate burden of 
1,716 hours annually.
viii. Capital Comparability Determinations
    Commission regulation 23.106 allows certain SDs, MSPs, and foreign 
regulatory authorities to request a Capital Comparability Determination 
with respect to capital adequacy and financial reporting requirements 
for SDs or MSPs, as discussed above. As part of this request, persons 
are required to submit to the Commission certain specified supporting 
information and further information, as requested by the Commission. 
Further, if such a determination was made by the Commission, an SD or 
MSP would be required to file a notice with the RFA of which it is a 
member of its intent to comply with the capital adequacy and financial 
reporting requirements of the foreign jurisdiction. Moreover, in 
issuing a Capital Comparability Determination, the Commission would be 
able to impose any terms and conditions it deems appropriate, including 
additional capital and financial reporting requirements.
    The Commission expects that 43 firms out of the 108 currently 
provisionally registered SDs would seek Capital Comparability 
Determinations. These 24 firms are located in five different 
jurisdictions, all of which appear to have adopted some level of Basel 
compliant capital rule or another capital rule that would apply to SDs. 
As such, Commission staff estimates that it will take approximately ten 
hours per firm annually to prepare and submit requests for Capital 
Comparability Determinations and otherwise comply with the requirements 
of proposed regulation 23.106, resulting in aggregate annual burden of 
240 hours.

IV. Cost Benefit Considerations

A. Background

    Section 15(a) of the CEA requires the Commission to consider the 
costs and benefits of its discretionary actions before promulgating a 
regulation under the CEA or issuing certain orders.\497\ 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. In this cost benefit section, the Commission discusses 
the costs and benefits resulting from its discretionary determinations 
with respect to the section 15(a) factors.\498\ In addition, in 
Attachment A to this section, the Commission, using available data, 
estimates the cost of the final rule to each type of SD or MSP.
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    \497\ 7 U.S.C. 19(a).
    \498\ The Commission notes that the costs and benefits in this 
rulemaking, and highlighted below, have informed the policy choices 
described throughout this release.
---------------------------------------------------------------------------

    This rulemaking implements the new statutory framework of Section 
4s(e) of the CEA, added by Section 731 of the Dodd-Frank Act, which 
requires the Commission to adopt capital requirements for SDs and MSPs 
that do not have a prudential regulator (i.e., ``covered swap 
entities'' or ``CSEs'') and amends Commission regulation 1.17 to impose 
specific market risk and credit risk capital charges for uncleared swap 
and security-based swap positions held by an FCM.\499\ Section 4s(e) of 
the CEA requires the Commission to adopt minimum capital requirements 
for CSEs that are designed to help ensure the CSE's safety and 
soundness and be appropriate for the risk associated with the uncleared 
swaps held by a CSE. In addition, section 4s(e)(2)(C) of the CEA, 
requires the Commission to set capital requirements for CSEs that 
account for the risks associated with the CSE's entire swaps portfolio 
and all other activities conducted by the CSE. Lastly, section 
4s(e)(3)(D) of the CEA provides that the Commission, the prudential 
regulators, and the SEC, must ``to the maximum extent practicable'' 
establish and maintain comparable capital rules. The rulemaking also 
includes certain financial reporting requirements related to an SDs and 
MSPs financial condition and capital requirements.
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    \499\ See section 4s(e)(2)(B).
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    In the following cost-benefit considerations, the Commission has

[[Page 57528]]

evaluated the costs and benefits of this rulemaking. In this section 
the Commission will: (i) Discuss the general benefits and costs of 
regulatory capital; (ii) summarize the rulemaking; (iii) describe the 
baseline for which the cost and benefits of this rulemaking were 
considered; (iv) provide an overview of the different capital 
approaches set out in this rulemaking and the rationale for each 
approach; (v) describe the costs and benefits to each type of SD and 
MSP under their corresponding capital approaches; (vi) discuss the 
reporting requirements; and (vii) an analyze the rulemaking as it 
relates to each of the 15(a) factors.
    Where reasonably feasible, the Commission has endeavored to 
estimate quantifiable costs and benefits. Where quantification is not 
feasible, the Commission identifies and describes costs and benefits 
qualitatively. The Commission acknowledges that it is limited in 
estimating the actual cost of its final capital rule. First, the 
initial and recurring costs for any particular registrant will depend 
on, among other things, its size, organizational structure, swap 
dealing activity, other business activities, modelling capacities, 
practices, and cost structure. In the 2016's proposal's cost-benefit 
considerations, the Commission estimated the cost of its capital 
proposal using SDR data on interest rate swaps for the purposes of 
extrapolating certain possible ranges regarding the possible cost of 
capital at Commission registered SDs. Interest rate swaps served as a 
proxy for all covered swap positions held by all covered SDs and then 
estimated the initial margin based on that portfolio. Interest rate 
swaps were selected because they represented a majority of the swaps 
notional reported to swap data repositories. The Commission did not 
receive any data or comments specifically addressing this analysis. 
Upon further review, the Commission has concluded that because this 
approach considered only one type of swap, the Commission does not 
believe that this estimate was helpful in understanding the range of 
possible cost outcomes that could have flowed from the proposal.
    In order for the Commission to be able to develop a credible 
estimate, it would need access to proprietary information for each swap 
dealer. Among some of the information that the Commission currently 
lacks and would be relevant are: (i) Position level data, sufficient to 
estimate risk margins; (ii) for the Bank-Based Capital Approach, data 
about the registrant's Risk-Weighted Assets (RWAs); and (iii) for the 
Net Liquid Assets Capital Approach and the tangible net worth approach, 
data about market risk and credit risk charges. For these reasons, the 
Commission has not quantified the costs of the rule in terms of the 
level of capital charges the rule may require. Instead, the Commission 
has attempted to quantify costs in terms of how implementation of the 
rule may affect registrants' capital requirements in comparison to 
their existing capital levels and other circumstances. As detailed in 
Attachment A, the Commission has compiled available capital data and 
considered whether additional capital would be required to meet the 
Commission's capital requirements.
    In considering the effects of the final rule and the resulting 
costs and benefits, the Commission acknowledges that the swaps markets 
have many types of market participants including SDs and their clients 
(who could be professional investors, public and non-public operating 
firms) and function internationally with: (i) Transactions that involve 
U.S. firms occurring across different international jurisdictions; (ii) 
some entities organized outside of the United States that are 
prospective Commission registrants; and (iii) some entities that 
typically operate both within and outside the United States. Where the 
Commission does not specifically refer to matters of location, the 
discussion of costs and benefits below refers to the effects of the 
amendments on all relevant swaps activities, whether based on their 
actual occurrence in the United States or on their connection with, or 
effect on U.S. commerce pursuant to, section 2(i) of the CEA.\500\
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    \500\ Pursuant to section 2(i) of the CEA, activities outside of 
the United States are not subject to the swap provisions of the CEA, 
including any rules prescribed or regulations promulgated 
thereunder, unless those activities either have a direct and 
significant connection with activities in, or effect on, commerce of 
the United States; or contravene any rule or regulation established 
to prevent evasion of a CEA provision enacted under the Dodd-Frank 
Act, Public Law 111-203, 124 Stat. 1376. 7 U.S.C. 2(i).
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B. Regulatory Capital

    Regulatory capital is designed to ensure that a firm will have 
enough capital, in times of financial stress, to cover the risk 
inherent of the activities in the firm. Regulatory capital's framework 
can be designed differently, but its primary purpose remains the same--
to meet this objective. Although a firm may mitigate its risks through 
other methods, including risk management techniques (e.g., netting, 
credit limits, margin), capital is viewed as the last line of defense 
of an entity, ensuring its viability in times of financial stress. In 
adopting this rulemaking, the Commission was cognizant of the purpose 
of capital and the potential trade-off between the costs of requiring 
additional capital and the Commission's statutory mandate of helping to 
ensure the safety and soundness of SDs and MSPs thereby promoting the 
stability of the U.S. financial system.

C. General Summary of Rulemaking

    The Commission designed this rulemaking on well-established 
existing capital regimes. The framework, which draws upon the 
principles and structures of bank-based capital, broker-dealer capital, 
and FCM capital, provides CSEs, operating under a current capital 
regime, with the ability to continue to comply with that regime, with 
minor adjustments to account for the inherent risk of swap dealing and 
to mitigate regulatory arbitrage. The Commission, in developing its 
capital framework, provides CSEs with the flexibility to continue 
operating under a similar capital framework, which should mitigate 
disruptions to the markets and mitigate the possibility of duplicative 
or even conflicting rules, while helping to ensure the safety and 
soundness of the CSE and the stability of the U.S. financial system.
    The final rule detail minimum capital requirements for different 
``types'' or ``categories'' of CSEs and further define the capital 
computations, including various market risk and credit risk charges, 
whether using models or a standardized rules-based or table-based 
approach, to determine whether a CSE satisfies the minimum capital 
requirements. The Commission's final rules permit SDs that are neither 
registered as FCMs nor subject to the capital rules of a prudential 
regulator to elect a capital requirement that is based on existing bank 
holding company (``BHC'') capital rules adopted by the Federal Reserve 
Board or a capital requirement that is based on the existing FCM/BD net 
capital rules. The Commission's final rule also permits certain SDs 
that meet defined conditions designed to ensure that they are 
``predominantly engaged in non-financial activities'' to compute their 
minimum regulatory capital based upon the firms' tangible net worth. 
Further, the Commission is allowing SDs to obtain approval from the 
Commission, or from an RFA of which the SDs are members, to use 
internal models to compute certain market risk and credit

[[Page 57529]]

risk capital charges when calculating their capital.\501\
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    \501\ Section 17 of the CEA sets forth the registration 
requirements for RFAs. RFAs are defined as self-regulatory 
organizations under Commission regulation Sec.  1.3 (17 CFR 1.3). 
The Commission recognizes that SDs that seek model approval from the 
Commission or from an RFA will be required to submit documentation 
addressing several capital models including value at risk, stressed 
value at risk, specific risk, comprehensive risk and incremental 
risk. To the extent that models are reviewed and approved by an RFA, 
additional costs may be incurred by the RFA which may be passed on 
to the SDs.
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    The Commission is also imposing certain restrictions on the 
withdrawal of capital from SDs if certain defined triggers are 
breached.
    The final rules also establish a program of ``substituted 
compliance'' that will allow a CSE that is organized and domiciled in a 
non-U.S. jurisdiction (``non-U.S. CSE'') (or an appropriate regulatory 
authority in the non-U.S. CSE's home country jurisdiction) to petition 
the Commission for a determination that the home country jurisdiction's 
capital and financial reporting requirements are comparable to the 
CFTC's capital and financial reporting requirements for such CSE, such 
that the CSE may satisfy its home country jurisdiction's capital and 
financial reporting requirements (subject to any conditions imposed by 
the Commission) in lieu of the Commission's capital and financial 
reporting requirements (i.e., ``Comparability Determination'').
    Consistent with section 4s(f), the Commission is requiring SDs and 
MSPs to satisfy current books and records requirements, ``early 
warning'' and other notification filing requirements, and periodic and 
annual financial report filing requirements with the Commission and 
with any RFA of which the SDs and MSPs are members.

D. Baseline

    In determining the costs and benefits of this rulemaking, the 
Commission's benchmark from which this rulemaking was evaluated was the 
market's status quo, i.e., the swap market as it exists today. As this 
final rule will implement capital and financial reporting on CSEs and 
recordkeeping requirements on SDs and MSPs, the Commission will discuss 
the incremental costs and benefits to each type or category of SD and 
MSP, as to their current capital and financial reporting and 
recordkeeping requirements. As each CSE or its parent holding company 
may be complying with current capital requirements, based on capital 
requirements that are a result of the entity or its parent entity 
registering with a financial agency, as a result of it being a 
financial intermediary (e.g., as an BD, FCM or BHC), the Commission has 
set different baselines for each type or category of entity. In the 
case that a CSE does not have current capital requirements, the 
Commission considered the full cost and benefit of its amendments on 
the entity. The following is a list of types or categories of 
registered entities and their corresponding capital regimes that the 
CSE currently complies with, if there is any, and their corresponding 
financial reporting and capital requirements. \502\ Therefore, the 
Commission is using the status quo or baseline to evaluate the costs 
and benefits of these final rules for the following types or categories 
of CSEs:
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    \502\ The baseline of this CBC doesn't include those SDs that 
are also registered with the SEC as Security-based Swap Dealers (SD-
SBSDs), as the SEC's rule will become effective at the same time as 
the Commission's Final rule. Therefore, unless SD-SBSDs are 
registered as another category of registered entities that impose 
capital requirements, this CBC will treat these entities as 
currently having no current capital requirements. However, the 
Commission recognizes that to the extent that the SEC's capital 
requirements for these dual registered SD-SBSDs require greater 
minimum capital than the Commission's Final Rule, the costs 
discussed below with be mitigated.
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SDs That Are Bank Subsidiaries
     Capital. Currently U.S. CSEs that are bank subsidiaries 
and are not a BD or an FCM are not subject to capital requirements; 
however, as part of a BHC or a subsidiary of a bank, the CSE's parent 
entity must comply with the prudential regulators' capital 
requirements. In addition, certain non-U.S. CSEs that are subsidiaries 
within a bank holding company and are not BDs or FCMs are currently 
complying with a foreign jurisdiction's capital, liquidity and 
financial reporting requirements and these CSEs are covered below, in 
the Substituted Compliance section.
     Reporting. These SDs do have reporting requirements, but 
not for the information that is requested in this rulemaking; however, 
a BHC must report the requested information to the Federal Reserve 
Board, which includes certain swap and security-based swap positions 
held at its SD subsidiary.
SDs That Are BDs (Including, OTC Derivatives Dealers) (With and Without 
Models)
     Capital. If a CSE is also registered as a BD with the SEC, 
the CSE is already meeting the SEC's BD capital requirements.
     The SEC currently imposes the Net Liquid Assets Capital 
Approach on BDs. However, the SEC has modified certain parts of this 
approach to address certain types of BDs (i.e., ANC Firms and OTC 
derivatives dealers). As discussed below, an ANC Firm is currently 
approved by the SEC to use capital models to calculate certain market 
and credit risk charges. In addition, OTC derivatives dealers may be 
approved by the SEC to use capital models provided that they maintain a 
minimum of $100 million in tentative net capital and at least $20 
million in net capital. Certain non-U.S. SDs are already complying with 
capital, liquidity and reporting requirements in other jurisdictions. 
Therefore, the Commission will cover these SDs in the Substituted 
Compliance section.
     Reporting. As a BD, these SDs must comply with the SEC's 
BD reporting requirements (the Commission's amended reporting 
requirements are based on the SEC reporting requirements).
SDs That are FCMs and not BDs (With and Without Models)
     Capital. For CSEs that are also registered with the 
Commission as FCMs, the Commission's Net Liquid Assets Capital Approach 
that is similar to the capital requirements of a registered BD.
     Reporting. As an FCM, these SDs must comply with the 
Commission's FCM reporting requirements (the Commission's amended 
reporting requirements are based on these).
SDs That Are BDs and/or FCMs (ANC Firms With Models and One Other SD)
     Capital. For CSEs that are also registered as BDs/FCMs 
(using approved models), a significant percentage of these SDs are 
currently using the ANC capital approach, as discussed below. There is 
currently one other SD that is not an ANC Firm, but meets the 
requirements set out above for SD/BDs and FCM-SDs.
     Reporting. As an ANC firm, these SDs must comply with the 
SEC's and the CFTC's ANC firm reporting requirements.
Stand-Alone SDs and Commercial SDs (With and Without Models)
     Capital. Currently a CSE that is a stand-alone SD has no 
capital requirements; however, certain non-US Stand-alone SDs are 
complying with a foreign jurisdiction's capital, liquidity and 
reporting requirements and, therefore, will be included in the 
Substituted Compliance benchmark below.
     Reporting. As CSEs, these entities have reporting 
requirements, but not for the information required requested in this 
rulemaking.

[[Page 57530]]

MSPs
     Capital. Although there are no MSPs at this time, it is 
possible that an MSP in the future may have existing capital 
requirements. For example, if a bank is determined to be an MSP or an 
insurance company, these entities may have existing capital 
requirements.
     Reporting. As MSPs, these entities have reporting 
requirements, but not for the information required in this rulemaking.
Substituted Compliance \503\
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    \503\ The Commission estimates that there are 24 SDs that may be 
eligible for substituted compliance under this rulemaking.
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     Capital. As discussed above, there are certain non-U.S. 
CSEs that comply with a foreign jurisdiction's capital and financial 
reporting requirements. Commission staff understands that generally 
these foreign capital requirements are either a bank-based capital 
regime or a dealer-based regime, which, as the Commission has been 
informed by these foreign regulators, are similar to the Net Liquid 
Assets Capital Approach.
     Reporting. The Commission understands that some of these 
non-U.S. CSEs are currently complying with a foreign jurisdiction's 
financial reporting requirements; however, these financial reporting 
requirements may not be the same as the Commission is requiring in this 
rulemaking.
Prudentially Regulated SDs \504\
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    \504\ The Commission notes that under section 4s(e) of the CEA, 
these SDs must comply with the prudential regulators' capital 
requirements, but must also comply with the Commission's reporting 
and recordkeeping requirements.
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     Reporting. These SDs comply with their applicable 
prudential regulator's reporting requirements.

E. Overview of Approaches

    In developing the capital approaches required herein, the 
Commission selected from well-established frameworks. As a result of 
the financial crisis and over the years after the crisis, each of the 
approaches has undergone significant analysis and changes.
    The Commission is providing certain CSEs with an option to choose 
between a Bank-Based Capital Approach (similar to the prudential 
regulators' capital approach) and a net Liquid Assets Capital Approach 
(similar to the SEC's and CFTC's capital approach). As detailed below, 
the Bank-Based Capital Approach is designed to require an SD to have 
enough equity, including common equity tier 1 capital (as defined 
above), to absorb losses in a time of stress, while the net liquid 
assets method is designed to require an SD to hold at all times more 
than one dollar of highly liquid assets for each dollar of 
unsubordinated liabilities.
    The following table summarizes the Commission's capital rules 
followed by a summary of each approach:
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    \505\ Under the final rule, 6.5% of RWA must be met using CET1, 
the remaining amount is permitted to be met with capital in the form 
of Tier 1 or Tier 2, provided that subordinated debt meets the 
conditions in Commission regulation 18a-1d (17 CFR 240.18a-1d). In 
addition, $20 million must be comprised of CET1, and 8% of total 
amount of swap dealer's initial margin on uncleared swaps must be 
comprised of CET1, Tier 1 or Tier 2 capital as defined under banking 
rules.

----------------------------------------------------------------------------------------------------------------
                                                                                           The greatest of the
              Approaches                     SD entities              Equity type               following:
----------------------------------------------------------------------------------------------------------------
Net Liquid Assets Capital, Regulation  SD-FCM.................  Net Liquid Assets        $20 million or $100
 1.17, FCM Approach.                                             (Assets- Liabilities-    million if approved to
                                                                 Market Risk- Credit      use capital models.
                                                                 Risk).                  8% of the total
                                                                                          customer and
                                                                                          noncustomer cleared
                                                                                          margin, plus an
                                                                                          additional 2% of the
                                                                                          total amount of a swap
                                                                                          dealer's initial
                                                                                          margin on uncleared
                                                                                          swaps.
                                                                                         RFA.
ANC, Regulation 1.17 and SEC Rule      SD-FCM-ANC Approved      Net Liquid Assets        $5 billion tentative
 15c3-1.                                Firm.                    (Assets- Liabilities-    net capital (not
                                                                 Market Risk- Credit      discounted).
                                                                 Risk).                  $6 billion early
                                                                                          warning net capital
                                                                                          (not discounted).
                                                                                         $1 billion Net
                                                                                          Discounted Assets.
                                                                                         8% of the total
                                                                                          customer and
                                                                                          noncustomer cleared
                                                                                          margin, plus an
                                                                                          additional 2% of the
                                                                                          total amount of a swap
                                                                                          dealer's initial
                                                                                          margin on uncleared
                                                                                          swaps.
                                                                                         RFA.
Net Liquid Assets Capital, SEC Rule    SD-BDs, SD-BDs (OTC      Net Liquid Assets        $20 million.
 15c3-1 or 18a-1.                       Derivatives Dealers),    (Assets- Liabilities-   2% of the total amount
                                        SD-Non-Bank              Market Risk- Credit      of a swap dealer's
                                        Subsidiaries of BHC,     Risk).                   initial margin on
                                        SD.                                               uncleared swaps.
                                                                                         RFA.
Bank-Based Capital...................  SD-Non-Bank              Common Tier 1 Equity,    $20 million.
                                        Subsidiaries of BHC,     Tier 1 or Tier 2,       8% of RWA.
                                        SD.                      subject to limits       8% of the total amount
                                                                 \505\.                   of a swap dealer's
                                                                                          initial margin on
                                                                                          uncleared swaps.
                                                                                         RFA.
Tangible Net Worth Capital Approach..  SDs-Non-financial        Basic Equity (Assets-    $20 million plus market
                                        Entities (15% test).     Liabilities- Goodwill).  and credit risk
                                                                                          charges.
                                                                                         8% of the total amount
                                                                                          of a swap dealer's
                                                                                          initial margin on
                                                                                          uncleared swaps.
                                                                                         RFA.
MSPs.................................  MSP....................  Equity.................  >=$0.
                                                                                         RFA.
----------------------------------------------------------------------------------------------------------------


[[Page 57531]]

1. Bank-Based Capital Approach
    Under the Bank-Based Capital Approach a CSE would need to maintain 
regulatory capital that meets the following:
     $20 million of common equity tier 1;
     Six point five percent (6.5%) of common equity tier 1 
capital equal to the sum of the following: (i) The amount of its risk-
weighted assets (``RWA''), which is the market risk capital charge 
under a VaR computation or a standardized formula table (Reg. 1.17); 
(ii) the amount of current counterparty credit risk (``CCR''), which is 
the sum of the default risk capital charge and a credit value 
adjustment (``CVA'') risk capital charge, which is under either a 
standardized formula table or a VaR method, provided that an additional 
one point five percent (1.5%) of capital may be met with common equity 
tier 1 capital, additional tier 1 capital, or tier 2 capital (including 
subordinated debt subject to the conditions in SEC rule 18a-1d;
     Eight percent (8%) of the total amount of a swap dealer's 
uncleared swap initial margin comprised of common equity tier 1, 
additional tier 1, or tier 2 capital; and
     The amount required by its RFA.
    As noted above, the Commission is requiring a $20 million fixed-
dollar floor, as this is the minimum amount of required capital under 
all approaches. The Commission is requiring this minimum level as it 
believes that this is the minimum amount of capital that should be 
required for a CSE, without regard to the volume of swaps the CSE 
engages in, to conduct its dealing activity. As noted above, this 
amount is based on the Commission's experience with other registered 
entities that are currently subject to capital requirements. The 
Commission is also adopting, an eight percent (8%) of uncleared swap 
initial margin requirement, as through its experience in supervising 
FCMs, it recognizes that this capital computation is a determinative 
condition in computing their required capital and requires an SD to 
maintain a higher level of capital as the operational and other risks 
associated with its dealing activity base increases, as measured by the 
initial margin requirements on the swaps positions. As discussed above, 
under the Bank-Based Capital Approach, the Commission is maintaining 
the 8% level of initial margin requirement. The Commission believes 
that the 8% level is properly calibrated for the Bank-Based Capital 
Approach method in determining capital. Unlike the Net Liquid Assets 
Capital Approach, which leaves higher quality assets in determining the 
required level of capital, the Bank-Based Capital Approach uses its 
entire balance sheet in determining the amount of required capital. As 
a result of including all of its assets (e.g., property, plant and 
equipment (``PP&E'')) in determining the capital requirement under the 
Bank-Based Capital Approach, the Commission believes that the 8% 
requirement is properly set, ensuring that the Commission meets its 
statutory requirements for harmonization. In addition, the Commission 
has determined to include only a SD's initial margin amount on its 
uncleared swaps in calculating its capital requirement under this prong 
of the Bank-Based Capital Approach. As discussed above in section 
II.C.3., the Commission did not include other instruments that require 
initial margin because it believes that these other instruments either 
do not contain the same level of risk to the SD as uncleared swaps 
(e.g., cleared swaps) or are not within the products or markets for 
which the Commission typically regulates. The Commission recognizes 
that by not including these margined instruments in the minimum 
calculation, it may be decreasing the amount of required capital; 
however, these instruments are not removed from the required amount of 
capital component, which includes these positions net of applied market 
and credit risk charges. The Commission believes this approach better 
harmonizes the minimum calculation across the different elective 
approaches under the Commission's framework and in comparison to other 
regulators (namely, the SEC and the Federal Reserve Board and OCC).
    In addition, the Commission has included a standardized table for 
market risk that is currently not part of the BCBS or prudential 
regulator capital framework. The Commission included the standardized 
table in calculating an SD's market risk charges to address SDs that do 
not use approved models in computing market risk charges. The 
Commission included the regulation 1.17 standardized market risk 
charges, as it believes these charges result in adequate capital 
computations for the level of market risk inherent in these financial 
instruments. In addition, the Commission is currently using these 
standardized charges in computing an FCM's market risk charges on the 
same financial instruments for an FCM's required capital.
2. Net Liquid Assets Capital Approach
    Under this approach, an SD is required to maintain minimum net 
capital equal to or exceeding the greatest of:
     $20 million; or
     Two percent (2%) of the total amount of a swap dealer's 
uncleared swap initial margin.
    Net capital is generally defined as an SD's current and liquid 
assets minus its liabilities (excluding certain qualifying subordinated 
debt), with the remainder discounted according to either a CFTC or RFA 
approved VaR-based model or a standardized rules-based approach set out 
in regulation 1.17.
    As noted and discussed above, under this approach, the Commission 
requires a $20 million fixed-dollar floor. In addition, the Commission 
is adopting, under this approach, a net liquid assets test that is 
designed to allow an SD to engage in activities that are part of its 
swaps business (e.g., holding risk inherent in swaps into its dealing 
inventory), but in a manner that places the SD in the position of 
holding at all times more than one dollar of highly liquid assets for 
each dollar of unsubordinated liabilities (e.g., money owed to 
customers, counterparties, and creditors). The Commission believes that 
the Net Liquid Assets Capital Approach, although structurally different 
than the Bank-Based Capital Approach, ensures the safety and soundness 
of the SD, while providing the same protections to the financial 
system.
    As discussed above, under the Net Liquid Assets Capital Approach, 
the Commission is changing the proposed 8% level of initial margin 
requirement to 2%. The Commission believes that, under this approach, 
the 2% level is properly calibrated in determining an SD's capital 
requirement. As discussed above in section II.C.1., as a concept an 8% 
risk margin amount capital minimum component was originally proposed by 
the Commission in 2003, and subsequently adopted in 2004, to apply to 
FCMs. At the time, the Commission justified this minimum amount 
component based on an analysis and comparison of the amount to then 
existing FCM capital regime, which used a percentage of the customer 
funds held by an FCM as the minimum.\506\

[[Page 57532]]

The Commission originally proposed to use this same concept and 
percentage for use in determining SD minimum capital as means to 
harmonize the SD approach with Commission's experience and familiarity 
with its use in the existing FCM approach. Yet, the Commission 
recognizes that the Commission's margin requirements for uncleared swap 
positions generally impose a higher initial margin requirement relative 
to cleared futures positions, which justify using a different 
multiplied in the Net Liquid Assets Capital Approach.
---------------------------------------------------------------------------

    \506\ See Minimum Financial and Related Reporting Requirements 
for Futures Commission Merchants and Introducing Brokers, 68 FR 
40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004). See also, CFTC 
Division of Trading and Markets, Review of Standard Portfolio 
Analysis of Risk Margining System Implemented by the Chicago 
Mercantile Exchange, Board of Trade Clearing Corporation, and the 
Chicago Board of Trade (Apr. 2001) (``T&M 2001 Report''). See, IIB/
ISDA/SIFMA 3/3/2020 Letter.
---------------------------------------------------------------------------

    Minimum initial margin requirements for cleared futures 
transactions are generally set by clearing organizations and typically 
have a different margin period of risk. In this regard, the FCM minimum 
capital requirement of 8% of the risk margin amount on futures is based 
upon margin calculations using clearing organization models that 
require a 99% one-tailed confidence interval over a minimum liquidation 
period of one day for futures.\507\ In contrast, initial margin for 
uncleared swaps is required to be calculated at a 99% one-tailed 
confidence interval over minimum liquidation period of 10 business days 
(or the maturity of the swap if shorter).\508\ The greater margin 
period of risk for uncleared swaps generally requires a higher level of 
initial margin, which when used in determining minimum capital results 
in a higher level of required capital relative to if cleared futures 
margin was alternative used. The modification of the final rule to set 
the risk margin amount multiplier at 2% for uncleared swap positions is 
therefore appropriate given the generally higher initial margin 
requirements imposed on such positions under the Commission's 
regulations relative to cleared positions.
---------------------------------------------------------------------------

    \507\ See Commission regulation Sec.  39.13(g) (17 CFR 
39.13(g)).
    \508\ See Commission regulation Sec.  23.154 (b)(2) (17 CFR 
23.154(b)(2)).
---------------------------------------------------------------------------

    As noted above, a 2% multiplier using uncleared swap margin is also 
justified under the Net Liquid Assets Capital Approach as compared to a 
8% multiplier in Bank-Based Capital Approach and Tangible Net Worth 
Approach because of differences in the composition of capital under the 
approaches. Bank-Based Capital Approach and Tangible Net Worth Capital 
Approach do not account for illiquid assets when determining the amount 
of capital, thereby including a much greater composition of assets as 
compared to that under the Net Liquid Assets Capital Approach. Applying 
a higher more comparable multiplier percentage under Net Liquid Assets 
Capital Approach would result in much more stringent capital 
requirement and could make competition among SDs utilizing this 
approach exponentially more difficult, especially for SDs which may be 
required to use this approach as a result of dual-registration with the 
SEC as either a BD or SBSD.
3. Alternative Net Capital (``ANC'')
    Under the ANC approach, an SD/BD or FCM would need to maintain its 
net capital in accordance with the following requirements:
     $1 billion net capital; \509\
---------------------------------------------------------------------------

    \509\ See SEC rule 15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)).
---------------------------------------------------------------------------

     $5 billion tentative net capital; \510\ and
---------------------------------------------------------------------------

    \510\ See Id.
---------------------------------------------------------------------------

     $6 billion early warning net capital.\511\
---------------------------------------------------------------------------

    \511\ See Id.
---------------------------------------------------------------------------

    An SD that is registered with the SEC as a BD and is approved by 
the SEC to use internal models to compute certain market risk and 
credit risk capital charges (an ``ANC Firm'') will be able to continue 
to use the ANC approach in calculating its SD capital; however, with 
enhancements to the minimum capital requirements as adopted by the SEC.
    An ANC Firm must maintain, at all times, tentative net capital, 
which is the net capital of an ANC Firm before deductions for market 
and credit risk, of $5 billion. In addition, an ANC Firm must maintain, 
at all times, early warning tentative net capital, which is the net 
capital of an ANC Firm before deductions for market and credit risk, of 
$6 billion. Lastly, an ANC Firm must maintain, at all times, $1 billion 
of net capital, which is net discounted assets (discounted by VaR 
models for market and credit risk).
    In adopting this approach, the Commission recognizes that ANC Firms 
are dual registrants with the Commission and SEC that offer a wide-
range of financial services and act as different types of 
intermediaries (e.g., BD, FCM, SD). As a result of the additional 
complexity and risk inherent in these entities, and the Commission's 
experience with these ANC Firms, the Commission is increasing their 
minimum capital requirements consistent with the SEC.
    The Commission expects that SDs that are ANC Firms will elect to 
use this capital approach for their swaps transactions. The Commission 
believes that since this approach has been in effect for more than 10 
years and it properly accounts for the inherent risk and complexity of 
these firms, including their swap dealing activities, that it is 
appropriate to permit ANC Firms to continue using this approach, but 
with some enhancements based on the Commission's experience. As 
discussed above, the Commission is increasing the minimum capital 
requirements for ANC Firms in a manner consistent with the SEC's 
increases for ANC Firms. The Commission believes that the increases are 
appropriate to reflect the potential increase in swaps activities that 
ANC Firms may engage in, particularly if affiliates move their swaps 
activities into the ANC Firms to more efficiently use the capital held 
by the ANC Firms.
4. Tangible Net Worth
    The Commission is adopting a Tangible Net Worth Capital Approach 
for both SDs and MSPs. With respect to SDs, the Commission is requiring 
an SD to maintain minimum net capital equal to or in excess of the 
greater of:
     $20 million plus market and credit risk charges;
     Eight percent (8%) of the total amount of a swap dealer's 
uncleared swap initial margin; or
     The amount required by its RFA.
    The term tangible net worth is defined to mean an SD's net worth as 
determined in accordance with generally accepted accounting principles 
in the United States, excluding goodwill and other intangible assets.
    As noted above, the Commission is adopting this approach as it 
recognizes that certain SD's that are primarily engaged in non-
financial activities may engage in a diverse range of business 
activities different from, and broader than, the dealing activities 
conducted by a financial entity. An SD, availing itself of this 
approach, must meet the Commission's 15% revenue test and 15% asset 
test as discussed in section II.C.4. to demonstrate that entity or its 
parent/consolidated entity is primarily engaged in non-financial 
activities.
    As discussed below, the Commission believes that the Tangible Net 
Worth Capital Approach meets statutory mandate, as it is designed to 
help ensure the safety and soundness of the SD, while calibrated to the 
inherent risk of the uncleared swaps held by the SD and the overall 
activity of the SD. As the Tangible Net Worth Capital Approach would 
only be available to SDs that are primarily engaged in non-financial 
activities, the Commission believes that this approach has proper 
controls to ensure that it is only able to be utilized by SDs which 
could not likely meet the other tests due to their unique position

[[Page 57533]]

in commercial markets as well as the swap dealing markets.
    With respect to MSPs, the Commission is requiring an MSP to 
maintain net tangible net worth in the amount equal to or in excess of 
the greater of the MSP's positive net worth or the amount of capital 
required by an RFA of which the MSP is a member. There are currently no 
MSPs and the only previously registered MSP were required to register 
as a result of their legacy swaps and not any current swap activity. 
The Commission believes that the capital requirements for MSPs are 
appropriate given that no entities are currently registered and the 
Commission is uncertain of the types of entities that may register in 
the future. As noted above, the Commission has taken this uncertainty 
into consideration by proposing to allow an RFA to establish an MSP's 
minimum capital requirements. Such RFA's are required under section 17 
of the CEA to establish capital requirements for all members that are 
subject to a Commission minimum capital requirement. Accordingly, RFAs 
may adjust their rules going forward depending on the nature of any 
entities that may seek to register as MSPs, and adopt minimum capital 
requirements as appropriate. Such RFA rules must be submitted to the 
Commission for review prior to the rules becoming effective.
    As discussed above, the Commission is maintaining the 8% level of 
initial margin requirement under the Tangible Net Worth Capital 
Approach. Similar to the discussion above in the Bank-Based Capital 
Approach, the Commission believes that the 8% level is properly 
calibrated. Unlike the Net Liquid Assets Capital Approach, which leaves 
higher quality assets in determining the required level of capital, the 
Tangible Net Worth Capital Approach uses a SD's entire balance sheet in 
determining the amount of required capital. As a result of including 
all assets, including illiquid assets (e.g., PP&E) in determining the 
capital requirements, the Commission believes that the 8% requirement 
is properly set, ensuring that the Commission meets its statutory 
requirements. For the same reasons discussed above with the other 
approaches, the Commission also decided to include only a SD's initial 
margin amount on its uncleared swaps in calculating its capital 
requirement under this prong.
5. Substituted Compliance
    As described above, the Commission is providing certain non-U.S. 
CSEs with the ability to petition the Commission for approval to comply 
with comparable foreign capital and financial reporting requirements in 
lieu of some or all of the Commission's requirements. The Commission 
recognizes that this may provide these CSEs with cost advantages by 
avoiding the costs of potentially duplicative or conflicting 
regulation.
    In limiting the scope of substituted compliance, the Commission 
does not believe it should make available substituted compliance to all 
CSEs. The Commission is adopting substituted compliance only to non-
U.S. CSEs, as it believes that it is necessary that its capital 
requirements apply to U.S. CSEs, as they are integral to the U.S. swaps 
market and critical in ensuring the stability of the U.S. financial 
system.
    Additionally, the Commission recognizes that substituted 
compliance, to the extent that it puts conditions on its comparability 
determination, may result in additional costs to these CSEs; however, 
the Commission believes that providing a substituted compliance regime 
that allows for conditions instead of an all-or-nothing approach will 
benefit these CSEs and provide for a more competitive swaps market. 
Moreover, to the extent that a non-U.S. CSE must comply with a foreign 
regime and the Commission does not find that regime comparable, the 
Commission recognizes that these non-U.S. CSE may be burdened with 
additional costs and subject to conflicting and/or duplicative costs.

F. Entities

    The following section discusses the related incremental costs and 
benefits of the rulemaking's capital approaches and reporting 
requirements on each type or category of SDs and MSPs. The Commission 
understands that certain SDs and MSPs organized and domiciled outside 
of the U.S. would be included in these types or categories of entities. 
These non-U.S. SDs and MSPs are discussed in the Substituted Compliance 
section below.
1. Bank Subsidiaries
    Currently, all U.S. CSEs that are subsidiaries in a BHC and are not 
a BD or FCM currently are not subject to capital requirements; \512\ 
however, their parent BHC complies with the Federal Reserve's capital 
requirements. Under the Federal Reserve Board's capital requirements, 
which are based on Basel III requirements, a BHC must maintain adequate 
capital for the entire consolidated entity.\513\ That is, all the 
assets and liabilities of the BHC's consolidated subsidiaries are 
consolidated into the holding company. The Federal Reserve Board's 
capital requirements are then imposed on the BHC, requiring the BHC to 
maintain capital levels according to those requirements.
---------------------------------------------------------------------------

    \512\ The Commission acknowledges that some subsidiaries in a 
BHC may be an insurance company and, therefore, may have capital 
requirements set by its insurance regulator. Such entities are 
outside the scope of the Commission's rulemaking as these entities 
are currently not registered with the CFTC as an SD or MSP. The 
Commission further acknowledges that there are some non-U.S. 
subsidiaries that are part of a bank and those subsidiaries and/or 
their parent may be subject to the capital regime of a foreign 
regulator. The Commission believes that in such a case, the capital 
regime that is likely to be applicable would be either the Basel 
III-based approach or a version of the net liquid assets approach.
    \513\ See Regulatory Capital Rules: Regulatory Capital, 
Implementation of Basel III, Capital Adequacy, Transition 
Provisions, Prompt Corrective Action, Standardized Approach for 
Risk-weighted Assets, Market Discipline and Disclosure Requirements, 
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital 
Rule; Final Rule, 78 FR 62018 (Oct. 11, 2013).
---------------------------------------------------------------------------

    As these CSEs are not currently required to be separately 
capitalized, the Commission understands that this may add incremental 
cost to the consolidated entity and/or the CSE as they may have to 
retain earnings or further capitalize the CSE to the required capital 
levels. However, the Commission recognizes that a consolidated entity 
may capitalize one of its subsidiaries in many different ways, 
including retaining earnings from the CSE or from within the 
consolidated group. Even with this requirement imposing capital on the 
subsidiaries, as noted above, the BHC must maintain capital levels in 
accordance with the Federal Reserve Board's capital requirements, which 
are calculated on a consolidated basis; therefore, incremental costs 
may be mitigated, as it may be possible for the consolidated entity to 
keep the same level of capital within the BHC, but reallocated among 
its subsidiaries.\514\ In addition, the Commission recognizes that 
earnings may now have to be retained in the CSE and may no longer be 
available to be reallocated to fund other more profitable activities 
within the consolidated group or to be returned to shareholders; 
however, the Commission believes that by providing these CSEs with the 
option of differing capital approaches, these CSEs will select the 
capital approach this is optimal for its operations, financial 
structure and which will reduce duplicative or conflicting rules and 
the administrative costs of calculating and maintaining additional sets 
of books and records.
---------------------------------------------------------------------------

    \514\ The Commission notes that the bank or an insurance company 
in a BHC must maintain certain capital and as such, may not be able 
available to capitalize the CSE.

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

[[Page 57534]]

    The Commission believes that although the capital approaches 
adopted herein may be structurally different, they each require a CSE 
to maintain adequate capital levels commensurate to its regulated swap 
dealing activities, which should help ensure the safety and soundness 
of the CSE and the stability of the U.S. financial system.
    In requiring capital for a bank subsidiary that is an SD, as 
discussed above, the SD may incur additional costs. As a result of the 
additional costs, some SDs may be put at a competitive disadvantage, 
when compared to those dealers with lesser capital requirements or with 
no capital requirements. As a result of this additional cost, some swap 
dealing activity may become too costly--becoming a low margin 
activity--and, therefore, some SDs may limit their dealing activity or 
exit the swaps market. Additional costs may also be passed on to 
customers in the form of higher prices; however, if these SDs are to 
remain competitive in the swaps market, they must compete by matching 
or beating prices of their competitors or provide other additional 
services to their customers. In addition, as most of the largest swap 
dealers are part of a BHC, these SDs are already incurring capital 
charges at the consolidated level, and, therefore, the incremental cost 
and the effect on competition and pricing of swaps may be mitigated. 
Because these SDs have the option to select the most optimal capital 
approach for them, they can control some of the burdens placed on them 
by the rules and thereby, mitigate the rulemaking's effect on pricing.
2. SD/BD (Without Models)
    An SD that is also a BD that does not use SEC/CFTC-approved models 
to calculate its market and credit risk charges has the option to use 
either the Bank-Based Capital Approach or the Net Liquid Assets Capital 
Approach, but with standardized capital charges for market risk and 
credit risk. The Commission recognizes that although it is giving an 
option to these SDs to comply with either approach, these SDs must 
still meet the SEC's BD capital requirement.
    The standardized capital charges impose significant capital 
requirements for uncleared swaps primarily in the form of rules-based 
market risk charges and credit risk charges. The Commission does not 
anticipate that many SD/BDs engaging in significant swaps activity will 
do so using the standardized capital charges for market and credit 
risk.
3. SD/BD/OTC Derivatives Dealers (Without Models)
    An SD that is registered with the SEC as an OTC derivatives dealer 
will have the option to comply with either the Bank-Based Capital 
Approach or the Net Liquid Assets Capital Approach. As OTC derivatives 
dealers, these SDs already comply with the SEC's net liquid assets 
capital requirements. OTC derivative dealers also may be approved by 
the SEC to use internal models to calculate market and credit risk 
charges in lieu of standardized, rules and table-based capital charges 
for swaps, security-based swaps and other financial instruments.
    The Commission believes that since SDs that are registered OTC 
derivatives dealers are already complying with the SEC's Net Liquid 
Assets Capital Approach, they will select this approach in meeting with 
the Commission SD's proposed capital requirements. The Commission 
believes that allowing these entities to continue using current capital 
requirements will reduce the possibility of duplicative or conflicting 
rules and administrative costs of calculating and maintaining 
additional sets of books and records. The Commission believes that this 
will result in only a small incremental cost to OTC derivative dealers.
    The Commission recognizes that OTC derivatives dealers already have 
received approval from the SEC to use models in computing their current 
capital requirements and, therefore, will not incur any additional 
costs in developing and implementing this model-based approach in 
computing capital charges.
4. FCM-SD (Without Models)
    An SD that is also registered with the Commission as an FCM that 
does not use models to calculate market and credit risk charges, must 
compute its capital in accordance with the standardized market and 
credit risk charges set forth in regulation 1.17. The Commission is 
amending certain provisions of regulation 1.17 to reduce the burden on 
an FCM engaging in swaps. The amendments align the FCM capital 
requirements with that of the Net Liquid Assets Capital Approach for 
SDs in regulation 23.101. In amending the requirements, the Commission 
believes that it is reducing the burden placed on SDs/FCMs, as the 
amount of capital on uncleared swaps would have been significantly 
higher under the current requirements and would have placed FCM-SDs at 
a competitive disadvantage. Specifically, regulation 1.17 currently 
does not allow an FCM to recognize collateral held at a third-party 
custodian as capital. Therefore, under regulation 1.17 an FCM-SD would 
have to take a 100 percent capital charge for margin posted with third-
party custodians even though the Commission's uncleared margin rules 
require initial margin to be held at a third-party custodian. This is 
true even though the custodian has no ability to rehypothecate the 
initial margin and the SD has the ability to retrieve the initial 
margin back from the custodian with no encumbrance. Therefore, the 
Commission believes that its amendments to regulation 1.17 to allow an 
FCM-SD to recognize margin posted with third-party custodians in 
accordance with the Commission's margin rules allows an FCM-SD to meet 
its minimum level of required capital while also requiring an FCM-SD to 
maintain adequate capital levels, when considering the amount of 
initial margin that the SD has at its disposal in the event of a 
counterparty default.
    As a result of the amendments, FCM-SDs should benefit from lower 
capital charges and should allow these FCM-SDs to continue to comply 
with one capital rule, which should mitigate some of the administrative 
costs and reduce the possibility of duplicative or conflicting rules. 
The Commission is not providing these SDs with an option to use the 
Bank-Based Capital Approach, as the Commission believes that this 
option is unnecessary and costly, and the current FCM capital approach 
reflects that the firm is not only a SD, but acts as an intermediary 
for customers on futures markets. The Commission has made amendments to 
account for FCM-SDs' swap activities and in allowing these FCMs to 
change their current capital method, the Commission believes that this 
would add an additional layer of complexity and costs to the FCMs, as 
the FCMs would have to change, modify or migrate all of their current 
systems to a new capital regime. In addition, the Commission believes 
that requiring the same capital regime, with beneficial amendments, is 
more appropriate in transitioning the Commission's capital requirements 
to these entities, as it should result in fewer burdens and a simple 
transition in implementing the Commission's amended capital 
requirements. Further, the Commission believes that this would simplify 
the Commission's ability to supervise these entities, as the Commission 
will be able to seamlessly transition from its current capital regime 
to these new requirements; however, the Commission recognizes that by 
not providing these

[[Page 57535]]

SDs with the option to use the Bank-Based Capital Approach it may be 
foreclosing the ability of these SDs to use a capital approach that may 
be more cost effective.
    The Commission recognizes that by amending regulation 1.17 capital 
charges it is reducing the burden currently placed on FCM-SDs' swaps 
activities, which may result in greater liquidity in the swaps market, 
as this activity will be less costly and may incentivize these entities 
to engage in more swap dealing activity.
    As a result of the amendments to regulation 1.17, these FCM-SDs may 
be able to realize some of the cost saving of the amendments when 
competing with other dealers for counterparties. This cost savings may 
also result in more efficient pricing for their counterparties. 
However, the Commission notes, as stated above, that as a result of the 
Commission's margin requirements for uncleared swaps these benefits may 
be limited.
5. ANC Firms (SD/BDs and/or FCMs That Use Models)
    An SD that is an ANC Firm (i.e., also a BD and/or FCM, with 
approval by the SEC/CFTC to use models in computing market risk and 
credit risk charges), will incur minimal additional capital charges, as 
a result of the amendments. The Commission is retaining this approach 
for these firms, but with an increase in the capital thresholds, as 
noted above. The Commission is making these amendments based on market 
experience in supervising ANC Firms, and in recognition that the 
amendments are consistent with the SEC's capital increases for ANC 
Firms. The Commission notes that the current ANC Firms are already 
maintaining more than the amended thresholds; however, by increasing 
these capital requirements the Commission recognizes that this may have 
an additional cost, as ANC Firms will now be required to maintain these 
capital levels, as under the current capital thresholds, these were 
held at their discretion.
    The Commission recognizes that ANC firms already have received 
approval from the to use models in computing their current capital 
requirements and, therefore, they will not incur any additional costs 
in developing and implementing this model-based approach in computing 
capital charges.
6. Stand-Alone SD (With and Without Models)
    A stand-alone SD is provided with an option to comply with either 
the Bank-Based Capital Approach or the Net Liquid Assets Capital 
Approach. In providing this option, the Commission, as discussed above, 
believes that both options provide adequate capital requirements and 
account for the financial activities of an SD. Therefore, the 
Commission believes that these SDs will benefit, as these SDs will have 
the ability to select the most optimal approach, based on their 
organizational and operational structure and the composition of their 
assets. In addition, this option will also reduce the possibility of 
duplicative or conflicting rules and administrative costs of 
calculating and maintaining additional sets of books and records.
    A stand-alone SD that does not use models must compute their market 
risk and credit risk charges in accordance with rules-based 
requirements and standardized tables. The Commission recognizes that 
under the Bank-Based Capital Approach, market risk charges are 
calculated with a prudential regulator's approved model; however, to 
allow stand-alone SDs to use the Bank-Based Capital Approach without a 
model, the Commission is incorporating regulation 1.17 market risk 
charges into the framework. In providing this alternative, the 
Commission is providing an option to those stand-alone SDs that do not 
have Commission-approved models. In doing so, the Commission is 
providing these SDs with a benefit, as they are still able to choose 
the most efficient capital approach. The Commission incorporated 
regulation 1.17 market risk charges, as amended, as it believes that 
this is a well-established method that properly accounts for market 
risk charges.
    However, the Commission recognizes that many of these entities are 
not currently subject to minimum capital requirements, and as such, 
will incur additional costs on all of their financial activities, 
including their swap activities, which may result in possible increases 
in costs and pricing. In addition, a stand-alone SD selecting to use 
models in computing its market and credit risk charges may incur 
additional costs in developing and implementing these models.
    The Commission recognizes that by requiring capital for SDs this 
may put these SDs at a competitive disadvantage, when compared to those 
dealers with a lesser capital requirement or with no additional capital 
requirements as a result of these rules. As a result of this additional 
cost, some swap activities may become too costly and, therefore, some 
SDs may limit their activity or exit the swaps market. This additional 
cost may in turn be passed on to customers in the form of higher 
prices; however, if these SDs are to remain competitive in the swaps 
market, they must compete by matching or beating prices of their 
competitors or provide other additional services to their customers. If 
an SD decides to limit its activity or withdraw from the swaps market, 
this may result in a reduced level of liquidity in the swaps market.
    In requiring minimum capital requirements, the Commission believes 
that it is complying with its statutory mandate, as these standards are 
calibrated to the level of risk in an SD and are designed to help 
ensure safety and soundness of the SD and the stability of the U.S. 
financial system. In addition, the Commission's proposal is modeled 
after two well-established capital regimes, which should help ensure 
safety and soundness of the SD and competition among all registered 
SDs.
7. Non-Financial SD (With and Without Models)
    An SD or an SD that has a parent that is predominantly engaged in 
non-financial activities, as defined in regulation 23.100 (85% non-
financial threshold), may use the Tangible Net Worth Capital Approach. 
This approach is designed after GAAP's tangible net worth computation 
and excludes intangibles and goodwill.\515\ The Commission is also 
requiring that the non-financial SD include in its capital requirement 
its market risk and credit risk charges.
---------------------------------------------------------------------------

    \515\ Under GAAP, tangible net equity is determined by 
subtracting a firm's liabilities from its tangible assets.
---------------------------------------------------------------------------

    The Commission believes that this approach, which is tailored to 
non-financial entities that are SDs or have a SD in its corporate 
family, provides these entities with the flexibility to meet an 
appropriate capital requirement, without requiring the firms to engage 
in costly restructuring of their operations and business. The 
Commission recognizes that these SDs deal in swaps, but the Commission 
also recognizes that these entities or their parent entity are 
primarily engaged in commercial activities and these SDs primarily 
transact with commercial clients. BCBS and the Commission did not fully 
consider this type of business model when developing the Bank-Based 
Capital Approach and the Net Liquid Assets Capital Approach. In 
allowing these entities to maintain their current structure, the 
Commission believes that its approach will allow for less disruption to 
these SDs and in the markets, as these SDs may serve smaller clients 
that would not otherwise be able to participate in the swaps market

[[Page 57536]]

without these SDs. However, the Commission, in helping to ensure the 
safety and soundness of these SDs, is requiring that these entities 
maintain a level of tangible net worth equal to or greater than the 
greatest of (i) $20 million plus the SD's market and credit risk 
charges, (ii) eight percent of its uncleared swaps initial margin 
amount or (iii) the amount of capital required by an RFA, as this would 
account for the SD's exposure (market and credit risk) to the swaps 
markets, without penalty to the SD's or the SD's parent's commercial 
activities.
    In developing this approach, the Commission also recognizes that 
the commercial activities of a commercial SD could affect the overall 
financial health of the SD. That is, in the event of a substantial loss 
emanating from its commercial activities, this loss may have a 
substantial negative affect on the SD, which may find itself in 
financial distress. As the Commission is not accounting for the risk in 
the commercial activities, it is possible that the amount and type of 
capital that a commercial SD is required to maintain may not be 
adequate to prevent the failure of the SD, which then will affect all 
of its swap counterparties. However, in tailoring this method to these 
commercial SDs, the Commission is taking a position that is consistent 
with the Commission's prior positions on commercial entities, as it 
believes these commercial entities and their corresponding activities 
present less default and systemic risk than a financial entity.\516\
---------------------------------------------------------------------------

    \516\ See e.g., 17 CFR 39.6.
---------------------------------------------------------------------------

    The Commission recognizes that these entities are not currently 
subject to minimum capital requirements, and as such, will incur 
additional costs due to the imposition of a capital requirement on all 
of their swap dealing activities, which may result in possible 
increases in pricing; however, as the Commission has developed its 
capital requirements to better account for activities in these 
commercial SDs, it believes that the additional cost should be 
mitigated by this approach.
    In addition, as the Commission expects that many of these SDs will 
use models in computing its market and credit risk charges, this may 
also result in additional costs in developing and implementing these 
models; however, this cost should be mitigated by the savings that may 
be realized by using such models.
8. MSP
    An MSP must maintain capital (i.e., tangible net worth) of the 
greater of positive tangible net worth or the amount of capital 
required by a RFA of which the MSP is a member. This approach is 
designed after GAAP's tangible net worth computation and excludes 
intangible assets and goodwill. Currently there are no MSPs. The 
Commission cannot determine if other entities will register in the 
future as MSPs, however, the Commission is required to adopt a capital 
requirement to address potential future registrants.
    In adopting the Tangible Net Worth Capital Approach for MSPs, the 
Commission is allowing these entities to continue their operations if 
they become registered as MSPs with little to no changes to the 
entities' structures. In providing for this, the Commission believes 
that these entities if they become registered as MSPs will incur 
minimal additional costs to comply with the proposed requirements.
    The Commission believes that the adopted capital requirements will 
help ensure the safety and soundness of MSPs, as these entities will 
typically be posting and collecting margin on all of their new 
uncleared swaps and, therefore, as these MSPs are registered only as a 
result of being an end user of swaps and not a swap dealer, the margin 
requirements satisfy most of the safety risk for these entities, which 
is on a $1 for $1 basis, than through more burdensome capital 
requirements. Therefore, the Commission is only requiring MSPs to 
maintain solvency, while noting that the entity may be subject to other 
capital requirements and hence required to comply with those capital 
requirements.
    As the Commission's capital requirements will result in minimal 
additional costs to these MSPs, there should be little to no effect on 
competition, as they are end users (i.e., price takers) and little to 
no incremental effect on pricing.
9. Substituted Compliance
    A non-U.S. CSE that is already complying with a comparable foreign 
jurisdiction's capital or financial reporting regime is provided with 
the ability to meet the Commission's capital requirements by meeting 
the foreign jurisdiction's capital requirements. In providing these 
CSEs with the ability to continue to comply with their current capital 
and financial reporting regimes the Commission believes that it is 
limiting the potential for conflicting and duplicate capital 
requirements. In addition, as each foreign jurisdiction must be 
determined to be of comparable effect, which mitigate the possible 
negative impacts on the U.S. financial system.
    The Commission further recognizes that non-U.S. CSEs that use 
conditional substituted compliance may incur additional costs; however, 
the Commission believes that conditional substituted compliance 
provides an offsetting benefit to these CSEs as it allows for a 
conditional substituted compliance determination instead of an all-or-
nothing approach, which may result in the Commission not recognizing a 
foreign jurisdictions capital requirements, resulting in more 
substantial additional cost, including possible conflicting and/or 
duplicative requirements.

G. Liquidity Requirements

    The Commission proposed to require FCM-SDs and covered SDs electing 
the Bank-Based Capital Approach or the Net Liquid Assets Capital 
Approach to satisfy specific liquidity requirements.\517\ The proposal 
required covered SD electing the Bank-Based Capital Approach to meet 
the liquidity coverage ratio requirements set forth in 12 CFR part 
249.\518\ In addition, the proposal required covered SDs electing the 
Net Liquid Assets Capital Approach and FCM-SDs to adopt a liquidity 
stress test requirement that was similar to those undertaken by SEC ANC 
Firms.\519\
---------------------------------------------------------------------------

    \517\ See 2016 Capital Proposal, 81 FR 91252 at 91273-75.
    \518\ Id.
    \519\ Id.
---------------------------------------------------------------------------

    The Commission proposed these requirements to address the potential 
risk that a covered SD or FCM-SD may not be able to meet both expected 
and unexpected current and future cash flows, including collateral 
needs. As noted above, the Commission is not adopting these 
requirements. Therefore, by not including these requirements, the 
Commission recognizes that it may be increasing risk to the financial 
system. The Commission realizes that it is possible for a firm to have 
enough capital, but not enough liquidity to continue its operations as 
an ongoing business. These requirements were intended to ensure that 
SDs would have enough liquid assets to meet liabilities, which would 
help it during a liquidity crisis--ensuring the short-term continuing 
operations of the SD. However, the Commission believes this increased 
risk to the financial system is mitigated by the Commission's 
regulation 23.600, which imposes liquidity requirements on covered SDs. 
Regulation 23.600 requires each SD to establish, document, maintain, 
and enforce a system of written risk management policy and procedures 
designed to monitor and manage the

[[Page 57537]]

risk associated with the covered SD's swaps activities, including 
liquidity risk. In addition, for those SDs that are part of a bank 
holding company, the bank holding company must comply with high quality 
liquid asset requirements, which should mitigate this increased risk at 
these SD. Finally, this risk is greatly reduced for firms electing the 
Net Liquid Assets Capital Approach, which already incorporates a 
liquidity component into its primary determination of the capital 
amount.
    In not adopting these requirements, the Commission believes that 
SDs will be provided with greater flexibility in meeting its current 
liquidity needs. This should allow SDs to allocate their funds in a 
more efficient manner, which may result in a greater return on capital, 
as they will no longer need to set aside funds in low-returning assets.

H. Equity Withdrawal Restrictions

    In the Final Rule, the Commission is prohibiting certain 
withdrawals of equity capital from covered SDs.\520\ The equity 
withdrawal restriction generally provides that the capital of a covered 
SD, or any subsidiary or affiliate of the covered SD that has any of 
its liabilities or obligations guaranteed by the covered SD, may not be 
withdrawn by action of the covered SD or by its equity holders if the 
withdrawal would result in the covered SD holding less than 120 percent 
of the minimum regulatory capital that the covered SD is required to 
hold pursuant to proposed regulation 23.101. As discussed above in 
section II. C. 9., the Commission adopted these requirements to ensure 
the safety and soundness of the covered SD and the integrity of the 
financial system, because the Commission believes that the withdrawal, 
loan or advance may be detrimental to the financial integrity of the 
covered SD. In addition, these transactions may unduly jeopardize the 
covered SD's ability to meet its financial obligations to 
counterparties or to pay other liabilities which may cause a 
significant impact on the markets or expose the counterparties and 
creditors of the covered SD to loss. However, the Commission notes that 
in adopting these requirements, the Commission may be limiting the 
consolidated entity's, including the covered SDs and their affiliates, 
financial flexibility. That is, these requirements may limit the 
ability of the consolidate entity to allocate capital, at a critical 
time, to an entity that may need funding or an entity with a greater 
rate of return. The Commission recognizes this, but, as stated above, 
believes that if it permitted this activity, it may cause significant 
impact on the financial system.
---------------------------------------------------------------------------

    \520\ See 23.104(a) and (b).
---------------------------------------------------------------------------

I. Reporting and Recordkeeping Requirements

    The recordkeeping, reporting and notification requirements set out 
in this rulemaking are intended to facilitate effective oversight and 
improve internal risk management, via requiring robust internal 
procedures for creating and retaining records central to the conduct of 
business as an SD or MSP. Requiring registered SDs and MSPs to comply 
with recordkeeping and reporting rules should help ensure more 
effective regulatory oversight. The amendments will help the Commission 
determine whether an SD or MSP is operating in compliance with the 
Commission's capital requirements and allow the Commission to assess 
the risks and exposures that these entities are managing.
    As detailed above in Section II.D., the Commission is requiring all 
SDs to file certain financial information pertaining to their capital 
requirements. Those SDs that are prudentially regulated are provided 
with the option to submit their financial information that is reported 
to their prudential regulator to the Commission. In addition, those SDs 
that are also FCMs may file their financial information pertaining to 
their capital requirements with the Commission, including notices, in 
the same manner as they currently report. For those SDs that are also 
registered with the SEC as a BD or a SBSD, these SDs may file the same 
financial information to the Commission, as they file with the SEC. In 
filing the required financial information with the Commission, these 
entities must file through the Winjammer electronic filing system. 
Alternatively, these same SDs have the option to report their financial 
information like stand-alone SDs, commercial SDs and MSPs report their 
financial information to the Commission. The Commission is providing 
this option, as the information reported to the Commission under this 
proposal and that is filed with the Commission or other financial 
regulatory agencies are similar, as the information provides the 
Commission with the ability to assess and monitor an SD's financial 
condition and whether the SD is currently meeting the Commission's 
capital requirements. In permitting these SDs to use their current 
required information, the Commission believes that this should mitigate 
some additional costs to prepare and report this information to the 
Commission. In addition, these SDs should already have developed 
policies, procedures and systems to aggregate, monitor, and track their 
swap dealing activities and risks. As such, this should also mitigate 
some of the costs incurred under the rulemaking.
    Those SDs and MSPs that are not subject to current capital 
requirements will have to develop and establish policies, procedures 
and systems to monitor, track, calculate and report the required 
information. In developing these policies, procedures and systems, 
these SDs will incur costs; however, as these entities are registered 
with the Commission as SDs, the Commission believes that they should 
already have developed policies, procedures and systems to aggregate, 
monitor, and track their swap activities and risks, as is required 
under the Commission's swap dealer framework. This should mitigate some 
of the burdens of the reporting and recordkeeping requirements. In 
addition, as the information that the Commission is requiring is based 
on GAAP or another accounting method, this information is already being 
prepared for other purposes and therefore, should again mitigate the 
costs in meeting these requirements.
    The Commission also believes that as a result of the reporting and 
recordkeeping requirements, SDs should be able to more effectively 
track their trading and risk exposure in swaps and other financial 
activities. To the extent that these SDs can better monitor and track 
their risks, this should help them better manage risk.
    As noted in the section F.9., the Commission is providing 
substituted compliance to certain non-U.S. CSEs. As discussed above and 
for the same reasons, the Commission believes that, in regards its 
reporting requirements, providing substitute compliance to these non-
U.S. CSEs it should reduce the possibility of additional costs and 
duplicative or conflicting requirements.

J. Section 15(a) Factors

    The following is a discussion of the cost and benefit 
considerations as it relates to the 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.
1. Protection of Market Participants and the Public
    The rules are intended to strengthen the swaps market by requiring 
all CSEs to maintain a minimum level of capital. These minimum capital 
requirements should enhance the loss absorbing

[[Page 57538]]

capacity of CSEs and reduce the probability of financial contagion in 
the event of a counterparty default or a financial crisis. In addition, 
capital functions as a risk management tool by limiting the amount of 
leverage that a CSE can incur. Financial reporting requirements for 
CSEs should help the Commission and investors monitor and assess the 
financial condition of these CSEs. As this rulemaking is designed to 
protect financial entities from default, this should have a direct 
benefit to the public, as the failure of these CSEs could result in a 
financial contagion, which could negatively impact the general public. 
On the other hand, the capital rules may require additional capital to 
be raised and will increase the cost of swaps for all market 
participants, as described above.
2. Efficiency, Competitiveness, and Financial Integrity of Swaps 
Markets
    The Commission seeks to promote efficiency and financial integrity 
of the swaps market, and where possible, mitigate undue competitive 
disparities. Most notably, the Commission aligned the regulations with 
that of the prudential regulators', SEC's and the Commission's current 
capital frameworks to the greatest extent possible. Doing so should 
promote greater operational efficiencies for those SDs that are part of 
a BHC or are also registered with the SEC as a BD or the Commission as 
an FCM, as they may be able to avoid creating duplicative compliance 
and operational infrastructures and instead, rely on the infrastructure 
supporting the other registered entities. In addition, this approach 
should also enhance efficiency and limit conflicting rules, as these 
entities can continue to operate under their current regimes. Moreover, 
the amendments permit CSEs to calculate credit and market risk charges 
under a standardized or model-based approach, which allows them to 
choose the methodology that is the most suitable for their asset 
composition.
    The Commission notes that the capital rule, like other requirements 
under the Dodd-Frank Act, could have a substantial impact on 
competition in the swaps market. As the Commission's capital rule will 
result in additional costs to certain CSEs that do not have current 
capital requirements, these CSEs may either limit their swap activities 
or withdraw from the swaps market. In this event, it is possible that 
this may result in less competition and increases in prices of swaps. 
Depending on the relative cost of the Commission's capital requirements 
compared with corresponding requirements under prudential regulators' 
regime, SEC's regime or in other jurisdictions, certain CSEs may have a 
competitive advantage or disadvantage; however, the Commission, in 
developing the capital rule, harmonized it with those of the prudential 
regulators and the SEC to the maximum extent practicable.
    As noted above, the Commission, recognizing that SDs are critical 
to the financial integrity of the financial markets, designed their 
capital requirements to help ensure the safety and soundness of these 
SDs. In doing so, this should protect an SD in the event of a default 
by its counterparty or a financial crisis, which the Commission 
determines should reduce the probability of financial contagion.
3. Price Discovery
    As noted above, the capital rule may have a negative effect on 
competition, as a result of increasing costs, which may result in some 
SDs limiting or withdrawing from the swaps markets. In that event, this 
negative effect on competition could result in a less liquid swaps 
market, which will have a negative effect on price discovery. However, 
as discussed above, most of the larger SDs or their parent entities are 
already subject to capital requirements that impose capital charges for 
their swap activities and, therefore, the rule's negative impact on 
competition, liquidity and price discovery should be limited, and in 
any event is outweighed by the increased benefit of the longer term 
safety and soundness of the entities that provide price discovery.
4. Sound Risk Management Practices
    A well-designed risk management system helps to identify, evaluate, 
address, and monitor the risks associated with a firm's business. As 
discussed above, capital plays an important risk management function 
and limits the amount of leverage an entity can incur. In addition, 
capital serves as the last line of defense in the event of a 
counterparty default or severe losses at a firm. The Commission's 
capital rule is developed from two well-established capital regimes. 
Therefore, the Commission's capital rule should promote increase risk 
management practices within a CSE. Moreover, the Commission believes 
that as a result of the reporting and recordkeeping requirements, SDs 
may more effectively track their trading and risk exposure in swaps and 
other financial activities. To the extent that these SDs can better 
monitor and track their risks, this should help them better manage risk 
within the entity.
5. Other Public Interest Considerations
    The Commission has not identified any additional public interest 
considerations related to the costs and benefits of the proposed rule.

K. Attachment A to Cost Benefit Considerations

i. Minimum Capital Requirement
    Due to data availability, the Commission's analysis is focused on 
cost arising from minimum capital requirements. As discussed above, 
this rulemaking would prescribe capital requirements for SDs and MSPs 
that are not subject to a prudential regulator, and amendments to 
existing capital rules for FCMs would prescribe capital requirement for 
FCMs that are also registered as SDs and increase capital requirement 
for FCMs to account for risk arising from their swaps and security-
based swaps. The Commission discusses cost at the entity level. The 
analysis below makes many assumptions that assume away complex details 
and the marginal cost resulting from the final rule would be much 
larger and proportionally larger for smaller entities. Please note that 
the true magnitude of cost is unknown.
    As of June 3, 2020, there are approximately 108 SDs and no MSPs 
provisionally registered with the Commission. The Commission estimates 
that out of the 108 provisionally registered SDs, 15 U.S. Prudential 
Regulated Registrants SDs are exempt from the Commission's capital 
requirement; 38 SDs which are Non-U.S. Registrants Overseen by the FRB 
are also exempt from the Commission's capital requirement. For the rest 
of the 56 provisionally registered SDs, 4 SDs are also registered with 
the Commission as FCMs, while the other 52 SDs are not FCMs.
    The cost benefit considerations noted in the 2016 Capital Proposal 
included an analysis of interest rate swap position data for the 
purposes of extrapolating certain possible ranges regarding the 
possible cost of capital at Commission registered SDs. The Commission 
noted at the time that this was because interest rate swaps represent a 
majority of the swaps notional reported to swap data repositories. The 
Commission received no comments specifically addressing this analysis 
and upon further review has concluded that utilizing Part 45 data for 
this exercise could be problematic; drawing conclusions of estimated 
capital costs from the one particular type of swap data does not 
adequately reflect the variety of SDs and their respective dealing 
books under the

[[Page 57539]]

Commission's jurisdiction. The Commission has updated other tables that 
were included to reflect current registrations. The quantitative data 
noted herein reflect data either reported on existing Commission 
filings from these registrants or is readily available to the public as 
part of the bank or financial holding company public disclosure 
process.
Discussing Capital Requirement Cost at Entity Level
    The Commission collects monthly financial and capital information 
from FCMs. There are currently four SDs that are also registered as 
FCMs. For the purpose of discussing cost of complying with these 
minimum capital requirements, the Commission further separates these 
SDs that are also FCMs into two categories: SDs that are also SEC 
registered ANC firms, and FCMs that are not ANC firms registered with 
the SEC.
1. SDs That Are FCMs and ANC Firms With the SEC

                 Table 1--Capital for SDs That Are Also FCMs and ANC Firms as of April 30, 2020
----------------------------------------------------------------------------------------------------------------
                                                            Adjusted net       Net capital         Excess net
      Name of swap dealers           Registered  as           capital          requirement          capital
----------------------------------------------------------------------------------------------------------------
CITIGROUP GLOBAL MARKETS INC...  FCM BD SD                  $9,448,443,343    $ 4,041,143,110     $5,407,300,233
GOLDMAN SACHS & CO.............  FCM BD SD                  19,731,764,252      4,116,348,831     15,615,415,421
JP MORGAN SECURITIES LLC.......  FCM BD SD                  23,422,668,118      5,808,368,054     17,614,300,064
MORGAN STANLEY & CO LLC........  FCM BD SD                  12,993,998,405      4,109,846,691      8,884,151,714
----------------------------------------------------------------------------------------------------------------
Source: FCM financial data as of April 30, 2020.

    The Commission estimates that four SDs are already registered as 
ANC BDs with the SEC. Under the 2019 SEC Final Capital Rule, ANC firms 
registered with the SEC are required to maintain a minimum of five 
billion dollars of tentative net capital and a minimum of one billion 
dollars of net capital. In addition, all ANC firms use models for risk 
charge computations. These minimum capital requirements for ANC firms 
by the SEC are much higher than the minimum capital requirements 
adopted by the Commission, thus are more likely the binding constraints 
for these firms. Based on financial information reported by these SDs 
in their monthly reports filed with the Commission, these four SDs 
maintain a significant amount of net capital in excess of SEC's 
requirement and the Commission's capital requirement. Therefore, the 
Commission expects that the likelihood of these entities needing to 
raise additional capital due to this rule might be low; however, there 
may be other significant costs for these entities to comply with this 
capital requirement. The true magnitude of these costs is hard to 
predict due to the complexities of these rules.
2. SDs That Are FCMs but Currently Are Not ANC Firms Registered With 
SEC
    There are currently no provisionally registered swap dealers which 
are registered as FCMs but not ANC firms registered with the SEC. As 
noted in the 2016 Proposal, there were four previously provisionally 
registered SDs in this category, but withdrew their registration. The 
Commission understands that a majority of these SDs engaged in forex 
dealing business exited swaps dealing as result of the adoption of 
other regulatory requirements, namely the uncleared margin rules. 
Accordingly, the Commission does not expect there to be any other type 
of FCM registered as a SD and thus is not further considering the costs 
of capital for these entities.
    For SDs that are not FCMs, the Commission prescribes the following 
minimum capital requirements depending on whether SDs are financial 
entities or commercial entities. Standardized approach to calculate 
credit and market risk may not be tailored to specific business models 
of SDs. Developing risk models for capital purposes and going through 
model approval process might be much more costly for SDs that currently 
do not have a formal model approval process in place. For the purpose 
of discussing the cost of complying with minimum capital requirement, 
the Commission separated stand-alone SDs into following categories.
3. Nonbank U.S. Subsidiaries of Bank Holding Companies (BHCs) or 
Financial Holding Companies Subject to Basel III Capital Regime
    These SDs currently do not have any capital requirement, and the 
capital requirement resulting from this final rule may increase cost to 
these SDs as it may have to raise capital to the required level. 
However, U.S. parents of the SDs in this category are currently subject 
to the Federal Reserve's capital requirements on a consolidated basis, 
including U.S. Basel III capital requirement and also are participants 
of the Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank 
Act Stress Test (DFAST). CCAR evaluates the capital planning process 
and capital adequacy of the largest U.S.-based BHCs, including the 
firms' planned capital actions. The Dodd-Frank Act stress tests are a 
forward-looking component to help assess whether firms have sufficient 
capital to absorb losses and have the ability to lend to households and 
businesses even in times of financial and economic stress. Similarly, 
other SDs in this category are subsidiaries of foreign BHCs or a 
foreign financial holding company (FHC), which already comply with 
Basel III risk-based capital requirements and having common equity tier 
1 capital ratio at consolidated level exceeding eight percent. The 
parent BHCs of these nonbank SDs, set out in the table below, are well 
capitalized due to these requirements, as indicated by their common 
equity tier 1 capital ratio at the consolidated level, which is much 
higher than eight percent.
    Therefore, assuming that these SDs would use the Bank-Based Capital 
Approach, the final rule requires common equity tier 1 capital, 
additional tier 1 capital, or tier 2 capital to be equal or greater 
than the minimum requirement, that is, max [$20mm, 8%* RWA,\521\ 8% * 
Risk Margin, RFA requirement] to be considered well-capitalized. 
Assuming risk margin based requirement is not the binding constraint, 
and CET1 qualified instruments are the same across jurisdictions, the 
additional CET1 capital required from the Commission's capital 
requirement may not be significant, as it may be possible for the 
consolidated entity to keep the same

[[Page 57540]]

level of capital within the BHC, but just reallocate among its 
subsidiaries.\522\ In addition, the Commission recognizes that earnings 
will now have to retain in the SD and will no longer be available to be 
reallocated to fund other more profitable activities within the 
consolidated group or to be returned to shareholders. The Commission 
understands that capital is not additive, i.e., the sum of capital at 
individual subsidiary level may be more than the amount of capital 
required at the parent level for all its subsidiaries, due to the loss 
of netting benefits.
---------------------------------------------------------------------------

    \521\ Under the final rule, 6.5% of RWA must be met using CET1, 
the remaining amount is permitted to be met with capital in the form 
of Tier 1 or Tier 2, provided that subordinated debt meets the 
conditions in Commission regulation 1.17(h) (17 CFR 1.17(h)).
    \522\ For purposes of this analysis, the Commission is only 
using CET1 as a comparison since this represents the majority of 
eligible capital under the approach. The Commission expects firms to 
use permitted subordinated debt to comprise the remaining amount of 
capital.
    \523\ https://www.citigroup.com/citi/investor/data/p200423a.pdf?ieNocache=743.
    \524\ https://www.credit-suisse.com/about-us-news/en/articles/media-releases/1q20-financial-report-202005.html.
    \525\ https://www.goldmansachs.com/investor-relations/financials/current/other-information/1q-pillar3-2020.pdf.
    \526\ https://www.ing.com/web/file?uuid=e0fcbfe7-f4a7-4746-af3b-b112c5e9b302&owner=b03bc017-e0db-4b5d-abbf-003b12934429&contentid=49857&elementid=2138555.
    \527\ https://mms.businesswire.com/media/20200415005331/en/785157/1/Q1_2020_Bank_of_America_Financial_Results_Press_Release.pdf?download=1.

   Table 2--SD's Parent BHC's Common Equity Tier 1 Capital Ratio as of
                           First Quarter 2020
------------------------------------------------------------------------
                                  Common equity tier 1
      Name of swap dealers          capital  ratio of    SEC  registered
                                       parent BHC               BD
------------------------------------------------------------------------
CITIGROUP ENERGY INC...........  Citigroup Inc. 11.1%                 N
                                  \523\.
CREDIT SUISSE CAPITAL LLC......  Credit Suisse 12.1%                  Y
                                  \524\.
GOLDMAN SACHS FINANCIAL MARKETS  Goldman Sachs 12.3%                  Y
 LP.                              \525\.
GOLDMAN SACHS MITSUI MARINE      Goldman Sachs 12.3%...               N
 DERIVATIVE PRODUCTS LP.
ING CAPITAL MARKETS LLC........  ING Group 13.97% \526\               N
J ARON & COMPANY...............  Goldman Sachs 12.3%...               N
MERRILL LYNCH CAPITAL SERVICES   Bank of America 10.8%                N
 INC.                             \527\.
MERRILL LYNCH COMMODITIES INC..  Bank of America 10.8%.               N
MIZUHO CAPITAL MARKETS LLC.....  Mizuho Financial Group               N
                                  11.65% \528\.
MACQUARIE ENERGY LLC...........  Macquarie Bank 12.2%                 N
                                  \529\.
MORGAN STANLEY CAPITAL GROUP     Morgan Stanley 15.3%                 N
 INC.                             \530\.
MORGAN STANLEY CAPITAL SERVICES  Morgan Stanley 15.3%..               N
 LLC.
MORGAN STANLEY CAPITAL PRODUCTS  Morgan Stanley 15.3%..               N
 LLC.
NOMURA DERIVATIVE PRODUCTS INC.  Nomura Holdings 18.06%               N
                                  \531\.
NOMURA GLOBAL FINANCIAL          Nomura Holdings 18.06%               Y
 PRODUCTS INC.
SMBC CAPITAL MARKETS INC.......  SMFG 15.55% \532\.....               N
------------------------------------------------------------------------

    As discussed above, the Commission expects these SDs would use 
models to calculate market risk and credit risk charges. Their parents 
BHCs most likely are already using their risk models to calculate 
capital for the positions of these wholly owned subsidiaries (including 
uncleared swaps) to measure the credit and market risk exposures of 
these positions.
---------------------------------------------------------------------------

    \528\ https://www.mizuho-fg.com/investors/financial/basel/capital/data2003/pdf/fg_fy01.pdf.
    \529\ https://www.macquarie.com/assets/macq/investor/regulatory-disclosures/2020/MBL-Basel-III-Pillar-3-capital-disclosures-032020.pdf.
    \530\ https://www.morganstanley.com/about-us-ir/shareholder/1q2020.pdf.
    \531\ https://www.nomuraholdings.com/company/group/holdings/pdf/basel_201912.pdf.
    \532\ https://www.smfg.co.jp/english/investor/library/basel_3/2020/2020_fg_e_cc1.pdf.
---------------------------------------------------------------------------

4. U.S. SDs That Are Not Part of BHCs
    The Commission estimates that there are approximately 8 U.S. SDs 
not part of BHCs or financial holding companies that comply with Basel 
III capital requirements. These SDs currently do not have any capital 
requirement. However, these SDs are part of groups that are already 
subject to the CFTC's or the SEC's net capital requirements. These SDs' 
consolidated group has excess net capital ranging from $32 million to 
$1.3 billion.\533\ As it is possible for the consolidated entity to 
keep the same level of capital within the group, by reallocating it 
among subsidiaries, the additional cost of complying with the 
Commission's capital requirement may not be too burdensome. However, 
for those SDs or their consolidated groups that currently have smaller 
amount of excess net capital, they might need to raise additional 
capital and thus might incur significant cost to comply with the 
Commission's capital requirement. However, given the complexities of 
the final rule, the compliance cost to some SDs might be significant, 
particularly for certain business models.
---------------------------------------------------------------------------

    \533\ Selected FCM Financial Data as of April 30, 2020.
    \534\ At December 31, 2019, BTIG LLC's net capital was 
$85,412,256 which was $85,162,256 in excess of its minimum 
requirement.
    \535\ GAIN GTX LLC is a wholly owned subsidiary of GAIN Capital 
Holdings, Inc., a global provider of online trading services. GAIN 
Capital Group LLC (a CFTC registered FCM and RFD) is also subsidiary 
of GAIN Capital Holdings, Inc. and has excess net capital of 
14,821,951.
    \536\ Excess net capital of INTL FCSTONE FINANCIAL INC (FCM and 
BD) as of Apr. 30, 2020.
    \537\ Excess net capital of Jefferies LLC, parent of Jefferies 
Derivative Products LLC, Jefferies Financial Products LLC, and 
Jefferies Financial Services LLC.
    \538\ Excess net capital at Cantor Fitzgerald & CO. (FCM and 
Broker-Dealer), which is owned by Cantor Fitzgerald Securities (94% 
ownership).
    \539\ Excess net capital of E D & F MAN CAPITAL MARKETS INC (FCM 
and BD) as of Apr. 30, 2020.
    \540\ At December 31, 2018, excess net capital was $1 .09 
billion for Citadel Securities LLC, a registered BD.

 Table 3--Current Capital Requirement (Excess Net Capital) at the SD or
                            Its Parent Level
------------------------------------------------------------------------
                                          Excess net
                                      capital at entity  SEC  Registered
        Name of swap dealers             or its parent          BD
                                            level
------------------------------------------------------------------------
BTIG LLC............................   \534\ 85,162,256               Y
GAIN GTX LLC........................   \535\ 32,628,137               N

[[Page 57541]]

 
INTL FCSTONE MARKETS LLC............   \536\ 72,247,715               Y
JEFFERIES FINANCIAL PRODUCTS LLC....              \537\               N
                                          1,334,356,732
JEFFERIES FINANCIAL SERVICES INC....      1,334,356,732               N
CANTOR FITZGERALD SECURITIES........  \538\ 365,105,535               N
ED&F MAN DERIVATIVE PRODUCTS INC....   \539\ 95,389,978               N
CITADEL SECURITIES SWAP DEALER LLC..              \540\               N
                                          1,090,000,000
------------------------------------------------------------------------

5. Non-Financial/Commercial SDs
    The capital rule would require Non-Financial/Commercial SDs to 
maintain tangible net worth in an amount equal to or in excess of the 
minimum capital level that is, max ($20 million plus market risk 
charges and credit risk charges, 8% of risk margin, RFA requirement). 
Currently, there is no capital requirement for commercial SDs. The 
Commission estimates that currently three to four SD would be in this 
category, and believes that their tangible net worth greatly exceeds 
the Commission's requirement. Although these SDs may not need to raise 
additional capital, the cost of complying with the final rule might 
still be significant, particularly if these SDs choose to develop 
models for capital purposes.
6. Non-U.S. SDs Not Subject to a Prudential Regulator
    The Commission is allowing a ``substituted compliance'' program for 
capital requirements for SDs that are: (1) Not organized under the laws 
of the U.S., and (2) not domiciled in the U.S. The Commission estimates 
that there are about 24 non-U.S. provisionally registered SDs not 
subject to U.S. prudential regulators that would be eligible to apply 
for substituted compliance. The Commission would permit these non-U.S. 
SDs (or regulatory authorities in the non-U.S. SD's home country 
jurisdictions) to petition the Commission to satisfy the Commission's 
capital requirements through a program of substituted compliance with 
the SD's home country capital requirements. These SDs are domiciled in 
U.K., Germany, France, Japan, Mexico, Singapore, and Australia; which 
are members of Basel Committee on Banking Supervision and have adopted 
Basel III risk-based capital.\541\ Thus, the Commission expects that 
these SDs or their parents may not need to raise significant additional 
capital to comply with the Commission's capital requirements. However, 
these SDs may incur significant cost to obtain approval for substituted 
compliance.
---------------------------------------------------------------------------

    \541\ https://www.bis.org/bcbs/publ/d338.pdf.
---------------------------------------------------------------------------

ii. Margin vs. Capital
    The Commission's capital rule also requires an SD to include the 
initial margin for all swaps that would otherwise fall below the $50 
million initial margin threshold amount or the $500,000 minimum 
transfer amount, as defined in regulation 23.151, for purposes of 
computing the uncleared swap initial margin amount. As such, the 
uncleared swap initial margin amount would be the amount that an SD 
would have to collect from a counterparty, assuming that the exclusions 
and exemptions for collecting initial margin for uncleared swaps set 
forth in regulations 23.150-161 would not apply, and also assuming that 
the thresholds under which initial margin would not need to be 
exchanged would not apply. Accordingly, swaps that are not subject to 
the Commission's margin requirements such as those executed prior to 
the compliance date for margin requirements (``legacy swaps''), inter-
affiliate swaps, and swaps with counterparties that would qualify for 
the exception or exemption under section 2(h)(7)(A) would have to be 
taken into account in determining the capital requirement.
    The Commission believes that it would be appropriate to require an 
SD to maintain capital for uncollateralized swap exposures to 
counterparties to cover the ``residual'' risk of a counterparty's 
uncleared swaps positions. The Commission's approach regarding 
including uncollateralized swap exposures in the SD's capital 
requirements is consistent with the approach adopted by the prudential 
regulators in setting capital requirements for SDs subject to their 
jurisdiction and is consistent with the approach proposed by the SEC 
for SBSDs.
    The Commission provides certain exemptions from initial margin 
requirements for uncleared trades between affiliates. However, inter-
affiliate swaps would require capital to be held against them. The 
Commission understands that SDs may have different organizational 
structures due to various reasons. These reasons include, among others, 
centralized risk management for consolidation of balance-sheet, asset-
liability and liquidity risk management; taxation benefits; funds 
transfer pricing; merger and acquisition; trading centers; and 
subsidiaries in different jurisdictions. An arms-length swap may be 
offset by swap transaction with an affiliated SD because of any of the 
reasons listed above and possibly others. Centralization of risk within 
different entities of a firm in the same jurisdiction provides risk 
reduction benefits somewhat similar to the CCP and is encouraged.
    Both parties to a swap transaction may be required to hold capital 
even if they both are part of the same parent institution. In that 
sense, there may be double (or more) counting of capital at the parent 
level for a given outward facing swap based on the legal structure of 
the entity. This may lead to an uneven playing field between SDs if for 
a given swap, different swap dealers are required to hold different 
amount of capital based on the number of inter-affiliate trades that 
they execute for the same client facing trade.
iii. Model vs. Table
    The capital rule allows an SD to apply to the Commission or an RFA 
of which it is a member for approval to use internal models when 
calculating its market risk exposure and credit risk exposure. The 
capital rule also allows an FCM that is also an SD to apply in writing 
to the Commission or an RFA of which it is a member for approval to 
compute deductions for market risk and credit risk using internal 
models in lieu of the standardized deductions otherwise required.
    As discussed above, there are approximately 108 SDs and no MSPs 
provisionally registered with the Commission. Of these, the Commission 
estimates that approximately 55 SDs and no MSPs would be subject to the 
Commission's capital rules as they are

[[Page 57542]]

not subject to those of a prudential regulator. The Commission further 
estimates conservatively that most of these SDs would seek to obtain 
Commission approval to use models for computing their market and credit 
risk capital charges. These entities would incur cost to develop, 
maintain, document, audit models, and seek model approval. The 
possibility of using models to calculate credit risk and market risk 
charges may allow SDs to more efficiently deploy capital in other parts 
of its operations, because models could reduce capital charges and 
thereby could make additional capital available. This reduced capital 
requirement due to model use could improve returns of SDs and make them 
more competitive. However, if models developed for capital purposes 
deviate significantly from models used for pricing and risk management, 
and regulatory capital deviates significantly from economic capital, 
this could reduce the discussed benefits of capital rule.
    Although the Commission expects that SDs would use models for 
calculating market risk and credit risk charges, it is possible that 
some entities, particularly potential new entrants, may not have the 
risk management capabilities of which the models are an integral part, 
and, therefore, have to rely on the standardized haircut approach. The 
benefit of the standardized haircut approach for measuring market risk 
is its inherent simplicity. Therefore, this approach may improve 
customer protections and reduce systemic risk. In addition, a 
standardized haircut approach may reduce costs for the SD related to 
the risk of failing to observe or correct a problem with the use of 
models that could adversely impact the firm's financial conditions, 
because the use of models would require the allocation by the SD of 
additional firm resources and personnel. Conversely, if the 
standardized haircuts are too conservative and netting benefits are 
very limited, they could make conducting swap business too costly, 
preventing or impairing the ability of the firms to engage in swaps, 
increasing transaction costs, reducing liquidity, and reducing the 
availability of swaps for risk mitigation by end users.
iv. Other Considerations
    The capital rule requirements should reduce the risk of a failure 
of any major market participant in the swap market, which in turn 
reduces the possibility of a general market failure, and thus promotes 
confidence for market participants to transact in swaps for investment 
and hedging purposes. The capital requirements are designed to promote 
confidence in SDs among customers, counterparties, and the entities 
that provide financing to SDs, thereby, lessen the potential that these 
market participants may seek to rapidly withdraw assets and financing 
from SDs during a time of market stress. This heightened confidence is 
expected to increase swap transactions and promote competition among 
dealers. A more competitive swap market may promote a more efficient 
capital allocation.
    However, to the extent that costs associated with the rules are 
high, they may negatively affect competition within the swap markets. 
This may, for example, lead smaller dealers or entities for whom 
dealing is not a core business to exit the market because compliance 
with the minimum capital and reporting requirements is too costly. 
These same costs may result in increased barriers of entry, as they may 
prevent new dealers from entering the market. The combination of these 
two events may lead to a concentration of SD in the market, which could 
lead to market inefficiencies.
    The capital rule could have a substantial impact on domestic and 
international commerce and the relative competitive position of SDs 
operating under different requirements of various jurisdictions. 
Specifically, SDs subject to a particular regulatory regime may be 
advantaged or disadvantaged if corresponding requirements in other 
regimes are substantially more or less stringent. This could affect the 
ability of U.S. SDs to compete in the domestic and global markets and, 
the ability of non-U.S. SDs to compete in U.S. markets. Substantial 
differences between the U.S. and foreign jurisdictions in the costs of 
complying with these requirements for swaps between U.S. and foreign 
jurisdictions could reduce cross-border capital flows and hinder the 
ability of global firms to efficiently allocate capital among legal 
entities to meet the demands of their customers/counterparties.
    The willingness of end users to trade with an SD dealer will depend 
on their evaluation of the counterparty credit risks of trading with 
that particular SD compared to alternative SDs, and their ability to 
negotiate favorable price and other terms. The capital and risk 
management requirements would in general reduce the likelihood of SDs' 
defaulting or failing, and therefore may increase the willingness of 
end users to trade with more SDs that have strong capital reserves. End 
users of covered swaps are mostly made up of sophisticated participants 
such as hedge fund, asset management, other financial firms, and large 
commercial corporations. Many of these entities trade substantial 
volume of swaps and are relatively well-positioned to negotiate price 
and other terms with competing dealers. To the extent that the capital 
rule results in increased competition, participants should be able to 
take advantage of this increased competition and negotiate improved 
terms. On the other hand, SDs may pass on additional capital, 
operational and compliance costs resulting from the final rule to end 
users in the form of higher fees or wider spreads. Thus end users may 
experience increased cost of using swaps for hedging and investing 
purposes.
    In addition, benefits may arise when SDs consolidate with other 
affiliated SDs, FCMs, and/or BDs. This may yield efficiencies for 
clients conducting business in swaps, including netting benefits, 
reduced number of account relationships, and reduced number of 
governing agreements. These potential benefits, however, may be offset 
by reduced competition from a smaller number of competing SDs. Further, 
the capital rule will permit conducting swap business in an entity 
jointly registered as an FCM, or SBSD, or broker-dealer, which may 
offer the potential for these firms to offer portfolio margining for a 
variety of positions. From a holding company's perspective, aggregating 
swap business in a single entity, could help simplify and streamline 
risk management, allow more efficient use of capital, as well as 
operational efficiencies, and avoid the need for multiple netting and 
other agreements.
    The rules may create the potential for regulatory arbitrage to the 
extent that they differ from corresponding rules other regulators 
adopt. Also, to the extent that the requirements are overly stringent, 
they may prevent or discourage new entrants into swap markets and 
thereby may either increase spreads and trading costs or even reduce 
the availability of swaps. In these cases, end users would face higher 
cost or be forced to use less effective financial instruments to meet 
their business needs.

List of Subjects

17 CFR Part 1

    Brokers, Commodity futures, Reporting and recordkeeping 
requirements.

17 CFR Part 23

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

[[Page 57543]]

17 CFR Part 140

    Authority delegations (Government agencies).

    For the reasons stated in the Preamble, the Commodity Futures 
Trading Commission amends 17 CFR parts 1, 23, and 140 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 
6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8, 9, 
10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 (2012).


0
2. Amend Sec.  1.10 by:
0
a. Revising the paragraph (f)(1) introductory text; and
0
b. Revising paragraph (h)
    The revisions read as follows:


Sec.  1.10  Financial reports of futures commission merchants and 
introducing brokers.

* * * * *
    (f) * * * (1) In the event a registrant finds that it cannot file 
its Form 1-FR, or, in accordance with paragraph (h) of this section, 
its Financial and Operational Combined Uniform Single Report under the 
Securities Exchange Act of 1934, Part II, Part IIA, or Part IIC (FOCUS 
report), for any period within the time specified in paragraphs 
(b)(1)(i) or (b)(2)(i) of this section without substantial undue 
hardship, it may request approval for an extension of time, as follows:
* * * * *
    (h) Filing option available to a futures commission merchant or an 
introducing broker that is also a securities broker or dealer. Any 
applicant or registrant which is registered with the Securities and 
Exchange Commission as a securities broker or dealer, a security-based 
swap dealer, or a major security-based market participant may comply 
with the requirements of this section by filing (in accordance with 
paragraphs (a), (b), (c), and (j) of this section) a copy, as 
applicable, of its Financial and Operational Combined Uniform Single 
Report under the Securities Exchange Act of 1934, Part II, Part IIA, 
Part IIC, or Part II CSE (FOCUS Report), in lieu of Form 1-FR; 
Provided, however, That all information which is required to be 
furnished on and submitted with Form 1-FR is provided with such FOCUS 
Report; and Provided, further, That a certified FOCUS Report filed by 
an introducing broker or applicant for registration as an introducing 
broker in lieu of a certified Form 1-FR-IB must be filed according to 
National Futures Association rules, either in paper form or 
electronically, in accordance with procedures established by the 
National Futures Association, and if filed electronically, a paper copy 
of such filing with the original manually signed certification must be 
maintained by such introducing broker or applicant in accordance with 
Sec.  1.31.
* * * * *

0
3. Amend Sec.  1.12 by:
0
a. Revising paragraph (a) introductory text;
0
b. Revising paragraphs (a)(1), (b)(3) and (b)(4); and
0
c. Adding paragraph (b)(5).
    The revisions and additions read as follows:


Sec.  1.12  Maintenance of minimum financial requirements by futures 
commission merchants and introducing brokers.

    (a) Each person registered as a futures commission merchant or who 
files an application for registration as a futures commission merchant, 
and each person registered as an introducing broker or who files an 
application for registration as an introducing broker (except for an 
introducing broker or applicant for registration as an introducing 
broker operating pursuant to, or who has filed concurrently with its 
application for registration, a guarantee agreement and who is not also 
a securities broker or dealer), who knows or should have known that its 
adjusted net capital at any time is less than the minimum required by 
Sec.  1.17 or by the capital rule of any self-regulatory organization 
to which such person is subject, or the minimum net capital 
requirements of the Securities and Exchange Commission if the applicant 
or registrant is registered with the Securities and Exchange 
Commission, must:
    (1) Give notice, as set forth in paragraph (n) of this section that 
the applicant's or registrant's capital is below the applicable minimum 
requirement. Such notice must be given immediately after the applicant 
or registrant knows or should have known that its adjusted net capital 
or net capital, as applicable, is less than minimum required amount; 
and
* * * * *
    (b) * * *
    (3) 150 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member, unless such 
amount has been determined by a margin-based capital computation set 
forth in the rules of the registered futures association, and such 
amount meets or exceeds the amount of adjusted net capital required 
under the margin-based capital computation set forth in Sec.  
1.17(a)(1)(i)(B), in which case the required percentage is 110 percent;
    (4) For securities brokers or dealers, the amount of net capital 
specified in Rule 17a-11(b) of the Securities and Exchange Commission 
(17 CFR 240.17a-11(b)); or
    (5) For security-based swap dealers or major security-based swap 
participants, the amount of net capital specified in Rule 18a-8(b) of 
the Securities and Exchange Commission (17 CFR 240.18a-8(b)), must file 
notice to that effect, as soon as possible and no later than twenty-
four (24) hours of such event.
* * * * *

0
4. Amend Sec.  1.16 by revising paragraphs (f)(1)(i)(B) and 
(f)(1)(ii)(B) to read as follows:


Sec.  1.16  Qualifications and reports of accountants.

* * * * *
    (f)(1) * * *
    (i) * * *
    (B) A futures commission merchant that is registered with the 
Securities and Exchange Commission as a securities broker or dealer may 
file with its designated self-regulatory organization a copy of any 
application that the registrant has filed with its designated examining 
authority, pursuant to Sec.  240.17a-5(m) of this title, for an 
extension of time to file annual reports. The registrant must also 
promptly file with the designated self-regulatory organization and the 
Commission copies of any notice it receives from its designated 
examining authority to approve or deny the requested extension of time. 
Upon receipt by the designated self-regulatory organization and the 
Commission of copies of any such notice of approval, the requested 
extension of time referenced in the notice shall be deemed approved 
under this paragraph (f)(1)(i).
* * * * *
    (ii) * * *
    (B) An introducing broker that is registered with the Securities 
and Exchange Commission as a securities broker or dealer may file with 
the National Futures Association copies of any application that the 
registrant has filed with its designated examining authority, pursuant 
to Sec.  240.17a-5(m) of this title, for an extension of time to file 
annual reports. The registrant must also file promptly with the 
National Futures Association copies of any notice it receives from its 
designated examining

[[Page 57544]]

authority to approve or deny the requested extension of time. Upon the 
receipt by the National Futures Association of a copy of any such 
notice of approval, the requested extension of time referenced in the 
notice shall be deemed approved under this paragraph (f)(1)(ii).
* * * * *

0
5. Amend Sec.  1.17 by:
0
a. Revising paragraphs (a)(1)(i)(A) and (B);
0
b. Adding paragraph (a)(1)(ii);
0
c. Revising paragraphs (b)(9) and (10) and adding paragraph (b)(11) ;
0
d. Revising paragraph (c)(1)(i);
0
e. Revising paragraph (c)(2)(i);
0
f. Revising paragraphs (c)(2)(ii)(B) and (D) and adding paragraph 
(c)(2)(ii)(G);
0
g. Adding paragraphs (c)(5)(iii), (iv), (xv), and (xvi);
0
h. Revising paragraphs (c)(5)(viii), (x), (ix) and (xiv);
0
i. Revising paragraph (c)(6)(i) and (iv)(A), and adding paragraph 
(c)(6)(v); and
0
j. Revising paragraph (g)(1).
    The revisions and additions read as follows:


Sec.  1.17   Minimum financial requirements for futures commission 
merchants and introducing brokers.

    (a)(1)(i) * * *
    (A) $1,000,000, Provided, however, that if the futures commission 
merchant also is a swap dealer, the minimum amount shall be 
$20,000,000;
    (B) The futures commission merchant's risk-based capital 
requirement, computed as the sum of:
    (1) Eight percent of the total risk margin requirement (as defined 
in Sec.  1.17(b)(8) of this section) for positions carried by the 
futures commission merchant in customer accounts and noncustomer 
accounts; and
    (2) For a futures commission merchant that is also a registered 
swap dealer, two percent of the total uncleared swap margin, as that 
term is defined in paragraph (b)(11) of this section.
* * * * *
    (ii) A futures commission merchant that is registered as a swap 
dealer and has received approval to use internal models to compute 
market risk and credit risk charges for uncleared swaps must maintain 
net capital equal to or in excess of $100 million and adjusted net 
capital equal to or in excess of $20 million.
* * * * *
    (b) * * *
    (9) Cleared over the counter derivative positions means a swap 
cleared by a derivatives clearing organization or a clearing 
organization exempted by the Commission from registering as a 
derivatives clearing organization, and further includes positions 
cleared by any organization permitted to clear such positions under the 
laws of the relevant jurisdiction.
    (10) Cleared over the counter customer means any person for whom 
the futures commission merchant carries on its books one or more 
accounts for the cleared over the counter derivative positions of such 
person, and such account or accounts are not proprietary accounts as 
defined in Sec.  1.3 of this part.
    (11) Uncleared swap margin: This term means the amount of initial 
margin, computed in accordance with Sec.  23.154 of this chapter, that 
a dually-registered futures commission merchant and swap dealer would 
be required to collect from each counterparty for each outstanding swap 
position of the dually-registered futures commission merchant and swap 
dealer. A dually-registered futures commission merchant and swap dealer 
must include all swap positions in the calculation of the uncleared 
swap margin amount, including swaps that are exempt or excluded from 
the scope of the Commission's margin regulations for uncleared swaps 
pursuant to Sec.  23.150 of this chapter, exempt foreign exchange swaps 
or foreign exchange forwards, or netting set of swaps or foreign 
exchange swaps, for each counterparty, as if the counterparty was an 
unaffiliated swap dealer. Furthermore, in computing the uncleared swap 
margin amount, a dually-registered futures commission merchant and swap 
dealer may not exclude the initial margin threshold amount or the 
minimum transfer amount as such terms are defined in Sec.  23.151 of 
this chapter.
    (c) * * *
    (1) * * *
    (i) Unrealized profits shall be added and unrealized losses shall 
be deducted in the accounts of the applicant or registrant, including 
unrealized profits and losses on fixed price commitments, uncleared 
swaps, uncleared security-based swaps, and forward contracts;
* * * * *
    (2) * * *
    (i) Exclude any unsecured commodity futures, options, cleared 
swaps, or other Commission regulated account containing a ledger 
balance and open trades, the combination of which liquidates to a 
deficit or containing a debit ledger balance only: Provided, however, 
deficits or debit ledger balances in unsecured customers', 
noncustomers', and proprietary accounts, which are the subject of calls 
for margin or other required deposits may be included in current assets 
until the close of business on the business day following the date on 
which such deficit or debit ledger balance originated providing that 
the account had timely satisfied, through the deposit of new funds, the 
previous day's debit or deficits, if any, in its entirety.
    (ii) * * *
    (B)(1) Interest receivable, floor brokerage receivable, commissions 
receivable from other brokers or dealers (other than syndicate 
profits), mutual fund concessions receivable and management fees 
receivable from registered investment companies and commodity pools 
that are not outstanding more than thirty (30) days from the date they 
are due;
    (2) Dividends receivable that are not outstanding more than thirty 
(30) days from the payable date; and
    (3) Commissions or fees receivable, including from other brokers or 
dealers, resulting from swap transactions that are not outstanding more 
than sixty (60) days from the month end accrual date provided they are 
billed promptly after the close of the month of their inception;
* * * * *
    (D) Receivables from registered futures commission merchants or 
brokers, resulting from commodity futures, options, cleared swaps, 
foreign futures or foreign options transactions, except those 
specifically excluded under paragraph (c)(2)(i) of this section;
* * * * *
    (G) Receivables from third-party custodians that maintain the 
futures commission merchant's initial margin deposits associated with 
uncleared swap and security-based swap transactions pursuant to the 
margin rules of the Commission, the Securities and Exchange Commission, 
a prudential regulator, as defined in section 1a(39) of the Act, or a 
foreign jurisdiction that has received a Comparability Determination 
under Sec.  23.160 of this chapter.
* * * * *
    (5) * * *
    (iii) Swaps:
    (A) Uncleared swaps that are credit-default swaps referencing 
broad-based securities indices.(1) Short positions (selling 
protection). In the case of an uncleared short credit default swap that 
references a broad-based securities index, deducting the percentage of 
the notional amount based upon the current basis point spread of the 
credit default swap and the maturity of the credit default swap in 
accordance with the following table:

[[Page 57545]]



                              Table to Sec.   1.17(c)(5)(iii)(A)(1)--Market Risk Charges for Uncleared Credit Default Swaps
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                              Basis point spread  (%)
       Length of time to maturity  of CDS contract       -----------------------------------------------------------------------------------------------
                                                            100 or less       101-300         301-400         401-500         501-699       700 or more
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12 months.....................................            0.67            1.33            3.33            5.00            6.67           10.00
12 months but less than 24 months.......................            1.00            2.33            5.00            6.67            8.33           11.67
24 months but less than 36 months.......................            1.33            3.33            6.67            8.33           10.00           13.33
36 months but less than 48 months.......................            2.00            4.00            8.33           10.00           11.67           15.00
48 months but less than 60 months.......................            2.67            4.67           10.00           11.67           13.33           16.67
60 months but less than 72 months.......................            3.67            5.67           11.67           13.33           15.00           18.33
72 months but less than 84 months.......................            4.67            6.67           13.33           15.00           16.67           20.00
84 months but less than 120 months......................            5.67           10.00           15.00           16.67           18.33           26.67
120 months and longer...................................            6.67           13.33           16.67           18.33           20.00           33.33
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (2) Long positions (purchasing protection). In the case of an 
uncleared swap that is a long credit default swap referencing a broad-
based security index, deducting 50 percent of the deduction that would 
be required by paragraph (c)(5)(iii)(A)(1) of this section if the swap 
was a short credit default swap, each such deduction not to exceed the 
current market value of the long position.
    (3) Long and short positions. (i) Long and short uncleared credit 
default swaps referencing the same broad-based security index. In the 
case of uncleared swaps that are long and short credit default swaps 
referencing the same broad-based security index, have the same credit 
events which would trigger payment by the seller of protection, have 
the same basket of obligations which would determine the amount of 
payment by the seller of protection upon the occurrence of a credit 
event, that are in the same or adjacent spread category and have a 
maturity date within three months of the other maturity category, 
deducting the percentage of the notional amounts specified in the 
higher maturity category under paragraph (c)(5)(iii)(A)(1) or 
(c)(5)(iii)(A)(2) of this section on the excess of the long or short 
position.
    (ii) Long basket of obligors and uncleared long credit default swap 
referencing a broad-based securities index. In the case of an uncleared 
swap that is a long credit default swap referencing a broad-based 
security index and the futures commission merchant is long a basket of 
debt securities comprising all of the components of the security index, 
deducting 50 percent of the amount specified in Sec.  240.15c3-
1(c)(2)(vi) of this title for the component of securities, provided the 
futures commission merchant can deliver the component securities to 
satisfy the obligation of the futures commission merchant on the credit 
default swap.
    (iii) Short basket of obligors and uncleared short credit default 
swap referencing a broad-based securities index. In the case of an 
uncleared swap that is a short credit default swap referencing a broad-
based security index and the futures commission merchant is short a 
basket of debt securities comprising all of the components of the 
security index, deducting the amount specified in Sec.  240.15c3-
1(c)(2)(vi) of this title for the component securities.
    (B) Interest rate swaps. In the case of an uncleared interest rate 
swap, deducting the percentage deduction specified in Sec.  240.15c3-
1(c)(2)(vi)(A) of this title based on the maturity of the interest rate 
swap, provided that the percentage deduction must be no less than one 
eighth of 1 percent of the amount of a long position that is netted 
against a short position in the case of an uncleared interest rate swap 
with a maturity of three months or more;
    (C) All other uncleared swaps. (1) In the case of any uncleared 
swap that is not a credit default swap or interest rate swap, deducting 
the amount calculated by multiplying the notional value of the 
uncleared swap by:
    (i) The percentage specified in Sec.  240.15c3-1 of this title 
applicable to the reference asset if Sec.  240.15c3-1 of this title 
specifies a percentage deduction for the type of asset and this section 
does not specify a percentage deduction;
    (ii) Six percent in the case of a currency swap that references 
euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs, 
and twenty percent in the case of currency swaps that reference any 
other foreign currencies; or
    (iii) In the case of over-the-counter swap transactions involving 
commodities, 20 percent of the market value of the amount of the 
underlying commodities.
    (D) Netting of Swap Market Risk Charges. The deductions under 
paragraphs (c)(5)(iii)(B) and (C) of this section may be reduced by an 
amount equal to any reduction recognized for a comparable long or short 
position in the reference asset or interest rate under this section or 
in Sec.  240.15c3-1 of this title.
    (iv) Security-based Swaps: In the case of security-based swaps as 
defined in section 3(a) of the Securities Exchange Act of 1934 (15 
U.S.C. 78c(a)), the percentage as specified in Sec.  240.15c3-1 of this 
title.
* * * * *
    (viii) In the case of a futures commission merchant, for 
undermargined customer accounts, the amount of funds required in each 
such account to meet maintenance margin requirements of the applicable 
board of trade or if there are no such maintenance margin requirements, 
clearing organization margin requirements applicable to such positions, 
after application of calls for margin or other required deposits which 
are outstanding no more than one business day. If there are no such 
maintenance margin requirements or clearing organization margin 
requirements, then the amount of funds required to provide margin equal 
to the amount necessary, after application of calls for margin or other 
required deposits outstanding no more than one business day, to restore 
original margin when the original margin has been depleted by 50 
percent or more: Provided, to the extent a deficit is excluded from 
current assets in accordance with paragraph (c)(2)(i) of this section 
such amount shall not also be deducted under this paragraph. In the 
event that an owner of a customer account has deposited an asset other 
than cash to margin, guarantee or secure his account, the value 
attributable to such asset for purposes of this subparagraph shall be 
the lesser of:
    (A) The value attributable to the asset pursuant to the margin 
rules of the applicable board of trade, or
    (B) The market value of the asset after application of the 
percentage deductions specified in paragraph (c)(5) of this section;

[[Page 57546]]

    (ix) In the case of a futures commission merchant, for 
undermargined noncustomer and omnibus accounts the amount of funds 
required in each such account to meet maintenance margin requirements 
of the applicable board of trade or if there are no such maintenance 
margin requirements, clearing organization margin requirements 
applicable to such positions, after application of calls for margin or 
other required deposits which are outstanding no more than one business 
day. If there are no such maintenance margin requirements or clearing 
organization margin requirements, then the amount of funds required to 
provide margin equal to the amount necessary after application of calls 
for margin or other required deposits outstanding no more than one 
business day to restore original margin when the original margin has 
been depleted by 50 percent or more: Provided, to the extent a deficit 
is excluded from current assets in accordance with paragraph (c)(2)(i) 
of this section such amount shall not also be deducted under this 
paragraph. In the event that an owner of a noncustomer or omnibus 
account has deposited an asset other than cash to margin, guarantee or 
secure his account the value attributable to such asset for purposes of 
this paragraph shall be the lesser of the value attributable to such 
asset pursuant to the margin rules of the applicable board of trade, or 
the market value of such asset after application of the percentage 
deductions specified in paragraph (c)(5) of this section;
    (x) In the case of open futures contracts, cleared swaps, and 
granted (sold) commodity options held in proprietary accounts carried 
by the applicant or registrant which are not covered by a position held 
by the applicant or registrant or which are not the result of a 
``changer trade'' made in accordance with the rules of a contract 
market:
    (A) For an applicant or registrant which is a clearing member of a 
clearing organization for the positions cleared by such member, the 
applicable margin requirement of the applicable clearing organization;
    (B) For an applicant or registrant which is a member of a self-
regulatory organization, 150 percent of the applicable maintenance 
margin requirement of the applicable board of trade, or clearing 
organization, whichever is greater;
    (C) For all other applicants or registrants, 200 percent of the 
applicable maintenance margin requirements of the applicable board of 
trade or clearing organization, whichever is greater; or
    (D) For open contracts or granted (sold) commodity options for 
which there are no applicable maintenance margin requirements, 200 
percent of the applicable initial margin requirement: Provided, the 
equity in any such proprietary account shall reduce the deduction 
required by this paragraph (c)(5)(x) if such equity is not otherwise 
includable in adjusted net capital;
* * * * *
    (xiv) For securities brokers and dealers, all other deductions 
specified in Sec.  240.15c3-1 of this title;
    (xv) In the case of a futures commission merchant that is also a 
registered swap dealer, the amount of funds required from each swap 
counterparty and security-based swap counterparty to meet initial 
margin requirements of the Commission or Securities and Exchange 
Commission, as applicable, after application of calls for margin or 
other required deposits which are outstanding within the required time 
frame to collect margin or other required deposits;
    (xvi) In the case of a futures commission merchant that is also a 
registered swap dealer, the amount of initial margin calculated 
pursuant to Sec.  23.154 of this chapter for the account of a swap 
counterparty that is subject to a margin exception or exemption under 
Sec.  23.150 of this chapter, less any margin posted on such account, 
and the amount of initial margin calculated pursuant to Sec.  240.18a-
3(c)(1)(i)(B) of this title for the account of a security-based swap 
counterparty that is subject to a margin exception or exemption under 
the rules of the Securities and Exchange Commission, less any margin 
posted on such account.
    (6)(i) Election of alternative capital deductions that have 
received approval of Securities and Exchange Commission pursuant to 
Sec.  240.15c3-1(a)(7) of this title. Any futures commission merchant 
that is also registered with the Securities and Exchange Commission as 
a securities broker or dealer, and who also satisfies the other 
requirements of this paragraph (c)(6), may elect to compute its 
adjusted net capital using the alternative capital deductions that, 
under Sec.  240.15c3-1(a)(7) of this title, the Securities and Exchange 
Commission has approved by written order in lieu of the deductions that 
would otherwise be required under this section.
* * * * *
    (iv) * * *
    (A) Information that the futures commission merchant files on a 
monthly basis with its designated examining authority or the Securities 
and Exchange Commission, whether by way of schedules to its FOCUS 
reports or by other filings, in satisfaction of Sec.  240.17a-5(a)(5) 
of this title;
* * * * *
    (v) Election of alternative market risk and credit risk capital 
deductions for a futures commission merchant that is registered as a 
swap dealer and has received approval of the Commission or a registered 
futures association for which the futures commission merchant is a 
member. For purposes of this paragraph (c)(6)(v) only, all references 
to futures commission merchant means a futures commission merchant that 
is also registered as a swap dealer.
    (A) A futures commission merchant may apply in writing to the 
Commission or a registered futures association of which it is a member 
for approval to compute deductions for market risk and credit risk 
using internal models in lieu of the standardized deductions otherwise 
required under this section; Provided however, that the Commission must 
issue a determination that the registered futures association's model 
requirements and review process are comparable to the Commission's 
requirements and review process in order for the registered futures 
association's model approval to be accepted as an alternative means of 
compliance with this section. The futures commission merchant must file 
the application in accordance with instructions approved by the 
Commission and specified on the website of the registered futures 
association.
    (B) A futures commission merchant's application must include the 
information set forth in Appendix A to Subpart E of Part 23 and the 
market risk and credit risk charges must be computed in accordance with 
Sec.  23.102 of this chapter.
    (C) The Commission or registered futures association upon obtaining 
the Commission's determination that its requirements and model approval 
process are comparable to the Commission's requirements and process, 
may approve or deny the application, in whole or in part, or approve or 
deny an amendment to the application, in whole or in part, subject to 
any conditions or limitations the Commission or registered futures 
association may require, if the Commission or registered futures 
association finds the approval to be appropriate in the public 
interest, after determining, among other things, whether the applicant 
has met the requirements of Sec.  23.102 of this chapter.
* * * * *

[[Page 57547]]

    (g)(1) The Commission may by order restrict, for a period of up to 
twenty business days, any withdrawal by a futures commission merchant 
of equity capital, or any unsecured advance or loan to a stockholder, 
partner, limited liability company member, sole proprietor, employee or 
affiliate if the Commission, based on the facts and information 
available, concludes that any such withdrawal, advance or loan may be 
detrimental to the financial integrity of the futures commission 
merchant, or may unduly jeopardize its ability to meet customer 
obligations or other liabilities that may cause a significant impact on 
the markets.
* * * * *

0
6. Amend Sec.  1.65 by revising paragraph (b) introductory text, 
paragraphs (d) and (e) to read as follows:


Sec.  1.65   Notice of bulk transfers and disclosure obligations to 
customers.

* * * * *
    (b) Notice to the Commission. Each futures commission merchant or 
introducing broker shall file with the Commission, at least ten 
business days in advance of the transfer, notice of any transfer of 
customer accounts carried or introduced by such futures commission 
merchant or introducing broker that is not initiated at the request of 
the customer, where the transfer involves the lesser of:
* * * * *
    (d) The notice required by paragraph (b) of this section shall be 
considered filed when submitted to the Director of the Division of Swap 
Dealer and Intermediary Oversight, in electronic form using a form of 
user authentication assigned in accordance with procedures established 
by or approved by the Commission, and otherwise in accordance with 
instructions issued by or approved by the Commission.
    (e) In the event that the notice required by paragraph (b) of this 
section cannot be filed with the Commission at least ten days prior to 
the account transfer, 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 accept a lesser time period for such 
notification at the Director's or designee's discretion. In any event, 
however, the transferee futures commission merchant or introducing 
broker shall file such notice as soon as practicable and no later than 
the day of the transfer. Such notice shall include a brief statement 
explaining the circumstances necessitating the delay in filing.
* * * * *

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0
7. The authority citation for part 23 continues 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.


0
8. Add section 23.100 to subpart E to read as follows:


Sec.  23.100  Definitions applicable to capital requirements.

    For purposes of Sec. Sec.  23.101 through 23.106 of subpart E, the 
following terms are defined as follows:
    Actual daily net trading profit and loss. This term is used in 
assessing the performance of a swap dealer's VaR measure and refers to 
changes in the swap dealer's portfolio value that would have occurred 
were end-of-day positions to remain unchanged (therefore, excluding 
fees, commissions, reserves, net interest income, and intraday 
trading).
    Advanced approaches Board-regulated institution. The term shall 
have the meaning ascribed to it in 12 CFR part 217.
    BHC equivalent risk-weighted assets. This term means the risk-
weighted assets of a swap dealer that elects to meet the capital 
requirements in Sec.  23.101(a)(1)(i) calculated as follows:
    (1) If the swap dealer is not approved to use internal models to 
calculate credit risk exposure under Sec.  23.102, it shall calculate 
its credit risk-weighted assets using the bank holding company 
regulations in subpart D of 12 CFR part 217, as if the swap dealer 
itself were a bank holding company, with the swap dealer permitted to 
calculate its exposure amount for OTC derivative contracts using either 
the current exposure method or the standardized approach for 
counterparty credit risk, without regard to the status of any affiliate 
of the swap dealer as an advanced approaches Board-regulated 
institution;
    (2) If the swap dealer is approved to use internal models to 
calculate credit risk exposure under Sec.  23.102, it shall calculate 
its credit risk-weighted assets using the bank holding company 
regulations in subpart E of 12 CFR part 217, as if the swap dealer 
itself were a bank holding company, with the swap dealer permitted to 
calculate its exposure amount for OTC derivative contracts using either 
the internal models methodology or the standardized approach for 
counterparty credit risk, without regard to the status of any affiliate 
of the swap dealer as an advanced approaches Board-regulated 
institution;
    (3) If the swap dealer is not approved to use internal models to 
calculate market risk exposure under Sec.  23.102, it shall compute a 
market risk capital charge for the positions that the swap dealer holds 
in its proprietary accounts using the applicable standardized market 
risk charges set forth in Sec.  240.18a-1 of this title and Sec.  1.17 
of this chapter for such positions, and multiplying that amount by a 
factor of 12.5;
    (4) If the swap dealer is approved to use internal models to 
calculate market risk exposure under Sec.  23.102, it shall calculate 
its market risk-weighted assets using subpart F of 12 CFR part 217; 
Provided, however, that the swap dealer may elect to apply either the 
provisions of such sections that are applicable to advanced approaches 
Board-regulated institutions or those that are applicable to Board-
regulated institutions that are not advanced approaches Board-regulated 
institutions.
    Credit risk. This term refers to the risk that the counterparty to 
an uncleared swap transaction could default before the final settlement 
of the transaction's cash flows.
    Credit risk exposure requirement. This term refers to the amount 
that the swap dealer (other than a swap dealer subject to the minimum 
capital requirements of Sec.  23.101(a)(1)(i)) is required to compute 
under Sec.  23.102 if approved to use internal credit risk models, or 
to compute under Sec.  23.103 if not approved to use internal credit 
risk models.
    Exempt foreign exchange swaps and foreign exchange forwards are 
those foreign exchange swaps and foreign exchange forwards that were 
exempted from the definition of a swap by the U.S. Department of the 
Treasury.
    Market risk exposure. This term means the risk of loss in a 
position or portfolio of positions resulting from movements in market 
prices and other factors. Market risk exposure is the sum of:
    (1) General market risks including changes in the market value of a 
particular assets that result from broad market movements, such as a 
changes in market interest rates, foreign exchange rates, equity 
prices, and commodity prices;
    (2) Specific risk, which includes risks that affect the market 
value of a specific instrument, such as the credit risk of the issuer 
of the particular instrument, but do not materially alter broad market 
conditions;

[[Page 57548]]

    (3) Incremental risk, which means the risk of loss on a position 
that could result from the failure of an obligor to make timely 
payments of principal and interest; and
    (4) Comprehensive risk, which is the measure of all material price 
risks of one or more portfolios of correlation trading positions.
    Market risk exposure requirement. This term refers to the amount 
that the swap dealer (other than a swap dealer subject to the minimum 
capital requirements of Sec.  23.101(a)(1)(i)) is required to compute 
under Sec.  23.102 if approved to use internal market risk models, or 
Sec.  23.103 if not approved to use internal market risk models.
    OTC derivative contract. This term shall have the meaning ascribed 
to it in 12 CFR part 217.
    Predominantly engaged in non-financial activities. A swap dealer is 
predominantly engaged in non-financial activities if: (1) The swap 
dealer's consolidated annual gross financial revenues, or if the swap 
dealer is a wholly owned subsidiary, then the swap dealer's 
consolidated parent's annual gross financial revenues, in either of its 
two most recently completed fiscal years represents less than 15 
percent of the swap dealer's consolidated gross revenue in that fiscal 
year (``15% revenue test''), and (2) the consolidated total financial 
assets of the swap dealer, or if the swap dealer is wholly owned 
subsidiary, the consolidated total financial assets of the swap 
dealer's parent, at the end of its two most recently completed fiscal 
years represents less than 15 percent of the swap dealer's consolidated 
total assets as of the end of the fiscal year (``15% asset test''). For 
purpose of computing the 15% revenue test or the 15% asset test, a swap 
dealer's activities or swap dealer's parent's activities shall be 
deemed financial activities if such activities are defined as financial 
activities under 12 CFR 242.3 and Appendix A to 12 CFR 242, including 
lending, investing for others, safeguarding money or securities for 
others, providing financial or investment advisory services, 
underwriting or making markets in securities, providing securities 
brokerage services, and engaging as principal in investing and trading 
activities; Provided, however, a swap dealer may exclude from its 
financial activities accounts receivable resulting from non-financial 
activities.
    Prudential regulator. This term has the same meaning as set forth 
in section 1a(39) of the Act, and includes 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, as applicable 
to a swap dealer or major swap participant.
    Regulatory capital. This term shall mean:
    (1) With respect to the capital requirement under Sec.  
23.101(a)(1)(i), the amount of common equity tier 1 capital, additional 
tier 1 capital, and tier 2 capital maintained by a covered SD, computed 
in accordance with Sec.  23.101(a)(1)(i);
    (2) With respect to the capital requirement under Sec.  
23.101(a)(1)(ii), the amount of tentative net capital and net capital 
maintained by a covered SD, computed in accordance with Sec.  
23.101(a)(1)(ii);
    (3) With respect to the capital requirement under Sec.  
23.101(a)(2)(i), the amount of tangible net worth as defined in this 
section and maintained by a covered SD; and
    (4) With respect to the capital requirement under 23.101(b), the 
amount of tangible net worth as defined in this section and maintained 
by a major swap participant.
    Regulatory capital requirement. This term refers to each of the 
capital requirements that Sec.  23.101 applies to a swap dealer or 
major swap participant.
    Tangible net worth. This term means the net worth of a swap dealer 
or major swap participant as determined in accordance with generally 
accepted accounting principles in the United States, excluding goodwill 
and other intangible assets. In determining net worth, all long and 
short positions in swaps, security-based swaps and related positions 
must be marked to their market value. A swap dealer or major swap 
participant must include in its computation of tangible net worth all 
liabilities or obligations of a subsidiary or affiliate that the swap 
dealer or major swap participant guarantees, endorses, or assumes 
either directly or indirectly.
    Uncleared swap margin. This term means the amount of initial 
margin, computed in accordance with Sec.  23.154, that a swap dealer 
would be required to collect from each counterparty for each 
outstanding swap position of the swap dealer. A swap dealer must 
include all swap positions in the calculation of the uncleared swap 
margin amount, including swaps that are exempt or excluded from the 
scope of the Commission's margin regulations for uncleared swaps 
pursuant to Sec.  23.150, exempt foreign exchange swaps or foreign 
exchange forwards, or netting set of swaps or foreign exchange swaps, 
for each counterparty, as if that counterparty was an unaffiliated swap 
dealer. Furthermore, in computing the uncleared swap margin amount, a 
swap dealer may not exclude the initial margin threshold amount or 
minimum transfer amount as such terms are defined in Sec.  23.151.

0
9. Add section 23.101 to subpart E to read as follows:


Sec.  23.101   Minimum financial requirements for swap dealers and 
major swap participants.

    (a)(1) Except as provided in paragraphs (a)(2) through (a)(5) of 
this section, each swap dealer must elect to be subject to the minimum 
capital requirements set forth in either paragraphs (a)(1)(i) or 
(a)(1)(ii) of this section:
    (i) A swap dealer that elects to meet the capital requirements in 
this paragraph (a)(1)(i) must at all times maintain regulatory capital 
that meets the following:
    (A) $20 million of common equity tier 1 capital, as defined under 
the bank holding company regulations in 12 CFR 217.20, as if the swap 
dealer itself were a bank holding company subject to 12 CFR part 217;
    (B) An aggregate of common equity tier 1 capital, additional tier 1 
capital, and tier 2 capital, all as defined under the bank holding 
company regulations in 12 CFR 217.20, equal to or greater than eight 
percent of the swap dealer's BHC equivalent risk-weighted assets; 
provided, however, that the swap dealer must maintain a minimum of 
common equity tier 1 capital equal to six point five percent of its BHC 
equivalent risk-weighted assets; provided further, that any capital 
that is subordinated debt under 12 CFR 217.20 and that is included in 
the swap dealer's capital for purposes of this paragraph (a)(1)(i)(B) 
must qualify as subordinated debt under Sec.  240.18a-1d of this title;
    (C) An aggregate of common equity tier 1 capital, additional tier 1 
capital, and tier 2 capital, all as defined under the bank holding 
company regulations in 12 CFR 217.20, equal to or greater than eight 
percent of the amount of uncleared swap margin, as that term is defined 
in Sec.  23.100 of this part, for each uncleared swap position open on 
the books of the swap dealer, computed on a counterparty by 
counterparty basis pursuant to Sec.  23.154 of this part; and
    (D) The amount of capital required by a registered futures 
association of which the swap dealer is a member.
    (ii)(A) A swap dealer that elects to meet the capital requirements 
in this paragraph (a)(1)(ii) must at all times maintain net capital, as 
defined and computed in accordance with

[[Page 57549]]

Sec.  240.18a-1 of this title as if the swap dealer were a security-
based swap dealer registered with the Securities and Exchange 
Commission and subject to Sec.  240.18a-1 of this title, that equals or 
exceeds the greater of:
    (1) $20 million; provided however, that if the swap dealer is 
approved under Sec.  23.102 of this part to use internal models to 
compute market risk capital charges or credit risk capital charges it 
must maintain tentative net capital, as defined and computed in 
accordance with Sec.  240.18a-1 of this title as if the swap dealer 
were a security-based swap dealer registered with the Securities and 
Exchange Commission and subject to Sec.  240.18a-1 of this title, of 
not less than $100 million and net capital of $20 million;
    (2) Two percent of the uncleared swap margin, as defined in Sec.  
23.100 of this part; or
    (3) The amount of capital required by a registered futures 
association of which the swap dealer is a member.
    (B) A swap dealer that uses internal models to compute market risk 
for its proprietary positions under Sec.  240.18a-1(d) of this title 
must calculate the total market risk as the sum of the VaR measure, 
stressed VaR measure, specific risk measure, comprehensive risk 
measure, and incremental risk measure of the portfolio of proprietary 
positions in accordance with Sec.  23.102 of this part and Appendix A 
to Subpart E of Part 23; and
    (C) A swap dealer may recognize as a current asset, receivables 
from third-party custodians that maintain the swap dealer's initial 
margin deposits associated with uncleared swap and security-based swap 
transactions pursuant to the margin rules of the Commission, the 
Securities and Exchange Commission, a prudential regulator, as defined 
in section 1a(39) of the Act, or a foreign jurisdiction that has 
received a margin Comparability Determination under Sec.  23.160 of 
this chapter.
    (2)(i) A swap dealer that is ``predominantly engaged in non-
financial activities'' as defined in Sec.  23.100 of this part may 
elect to meet the minimum capital requirements in this paragraph (a)(2) 
in lieu of the capital requirements in paragraph (a)(1) of this 
section.
    (ii) A swap dealer that satisfies the requirements of paragraph 
(a)(2)(i) of this section and elects to meet the requirements of this 
paragraph (a)(2) must maintain tangible net worth, as defined in Sec.  
23.100 of this part, equal to or in excess of the greatest of the 
following:
    (A) $20 million plus the amount of the swap dealer's market risk 
exposure requirement (as defined in Sec.  23.100 of this part) and its 
credit risk exposure requirement (as defined in Sec.  23.100 of this 
part) associated with the swap dealer's swap and related hedge 
positions that are part of the swap dealer's swap dealing activities. 
The swap dealer shall compute its market risk exposure requirement and 
credit risk exposure requirement for its swap positions in accordance 
with Sec.  23.102 of this part if the swap dealer has obtained approval 
to use internal capital models. The swap dealer shall compute its 
market risk exposure requirement and credit risk exposure requirement 
in accordance with the standardized approach of paragraphs (b)(1) and 
(c)(1) of Sec.  23.103 of this part if it has not been approved to use 
internal capital models;
    (B) Eight percent of the amount of uncleared swap margin, as that 
term is defined in Sec.  23.100 of this part, for each uncleared swap 
positions open on the books of the swap dealer, computed on a 
counterparty by counterparty basis pursuant to Sec.  23.154 of this 
part; or
    (C) The amount of capital required by a registered futures 
association of which the swap dealer is a member.
    (3) A swap dealer that is subject to minimum capital requirements 
established by the rules or regulations of a prudential regulator 
pursuant to section 4s(e) of the Act is not subject to the regulatory 
capital requirements set forth in paragraph (a)(1) or (2) of this 
section.
    (4) A swap dealer that is a futures commission merchant is subject 
to the minimum capital requirements of Sec.  1.17 of this title, and is 
not subject to the regulatory capital requirements set forth in 
paragraph (a)(1) or (2) of this section.
    (5) A swap dealer that is organized and domiciled outside of the 
United States, including a swap dealer that is an affiliate of a person 
organized and domiciled in the United States, may satisfy its 
requirements for capital adequacy under paragraphs (a)(1) or (2) of 
this section by substituted compliance with the capital adequacy 
requirement of its home country jurisdiction. In order to qualify for 
substituted compliance, a swap dealer's home country jurisdiction must 
receive from the Commission a Capital Comparability Determination under 
Sec.  23.106 of this part. A swap dealer that is a registered futures 
commission merchant may not apply for a Capital Comparability 
Determination and must comply with the minimum capital requirements set 
forth in Sec.  1.17 of this chapter.
    (6) A swap dealer that elects to meet the capital requirements of 
paragraph (a)(1)(i), (a)(1)(ii), or (a)(2) of this section may not 
subsequently change its election without the prior written approval of 
the Commission. A swap dealer that wishes to change its election must 
submit a written request to the Commission and must provide any 
additional information and documentation requested by the Commission.
    (b)(1) Every major swap participant for which there is not a 
prudential regulator must at all time have and maintain positive 
tangible net worth.
    (2) Notwithstanding paragraph (b)(1) of this section, each major 
swap participant for which there is no prudential regulator must meet 
the minimum capital requirements established by a registered futures 
association of which the major swap participant is a member.
    (3) Notwithstanding paragraphs (b)(1) and (2) of this section, a 
major swap participant that is a futures commission merchant is subject 
to the minimum capital requirements of Sec.  1.17 of this chapter, and 
is not subject to the regulatory capital requirements set forth in 
paragraph (b)(1) and (2) of this section.
    (4) A major swap participant that is organized and domiciled 
outside of the United States, including a major swap participant that 
is an affiliate of a person organized and domiciled in the United 
States, may satisfy its requirements for capital adequacy under 
paragraphs (b)(1) and (2) of this section by substituted compliance 
with the capital adequacy requirement of its home country jurisdiction. 
In order to qualify for substituted compliance, a major swap 
participant's home country jurisdiction must receive from the 
Commission a Capital Comparability Determination under Sec.  23.106 of 
this part. A major swap participant that is a registered futures 
commission merchant may not apply for a Capital Comparability 
Determination and must comply with the minimum capital requirements set 
forth in Sec.  1.17 of this chapter.
    (c)(1) Before any applicant may be registered as a swap dealer or 
major swap participant, the applicant must demonstrate to the 
satisfaction of a registered futures association of which it is a 
member, or applying for membership, one of the following:
    (i) That the applicant complies with the applicable regulatory 
capital requirements in paragraphs (a)(1), (a)(2), (b)(1), or (b)(2) of 
this section;

[[Page 57550]]

    (ii) That the applicant is a futures commission merchant that 
complies with Sec.  1.17 of this chapter;
    (iii) That the applicant is subject to minimum capital requirements 
established by the rules or regulations of a prudential regulator under 
paragraph (a)(3) of this section;
    (iv) That the applicant is organized and domiciled in a non-U.S. 
jurisdiction and is regulated in a jurisdiction for which the 
Commission has issued a Capital Comparability Determination under Sec.  
23.106 of this part, and the non-U.S. person has obtained confirmation 
from the Commission that it may rely upon the Commission's 
Comparability Determination under Sec.  23.106 of this part.
    (2) Each swap dealer and major swap participant subject to the 
minimum capital requirements set forth in paragraphs (a) and (b) of 
this section must be in compliance with such requirements at all times, 
and must be able to demonstrate such compliance to the satisfaction of 
the Commission and to the registered futures association of which the 
swap dealer or major swap participant is a member.

0
10. Add section 23.102 to subpart E to read as follows:


Sec.  23.102  Calculation of market risk exposure requirement and 
credit risk exposure requirement using internal models

    (a) A swap dealer may apply to the Commission or to a registered 
futures association of which the swap dealer is a member to obtain 
approval to use internal models under terms and conditions required by 
the Commission or the registered futures association and by these 
regulations, when calculating the swap dealer's market risk exposure 
and credit risk exposure under Sec. Sec.  23.101(a)(1)(i)(B), 
23.101(a)(1)(ii)(A), or 23.101(a)(2)(ii)(A); Provided however, that the 
Commission must issue a determination that the registered futures 
association's model requirements and review process are comparable to 
the Commission's requirements and review process in order for the 
registered futures association's model approval to be accepted as an 
alternative means of compliance with this section.
    (b) The swap dealer's application to use internal models to compute 
market risk exposure and credit risk exposure must be in writing and 
must be filed with the Commission and with a registered futures 
association of which the swap dealer is a member. The swap dealer must 
file the application in accordance with instructions established by the 
Commission and the registered futures association.
    (c) A swap dealer's application must include the following:
    (1) In the case of a swap dealer subject to the minimum capital 
requirements in Sec.  23.101(a)(1)(i) applying to use internal models 
to compute market risk exposure, the information required under subpart 
F of 12 CFR part 217, as if the swap dealer were itself a bank holding 
company subject to 12 CFR part 217.
    (2) In the case of a swap dealer subject to the minimum capital 
requirements in Sec.  23.101(a)(1)(i) applying to use internal models 
to compute credit risk exposure, the information required under subpart 
E of 12 CFR part 217 in order to calculate credit risk-weighted assets 
in accordance with sections 217.131 through 217.155 of that subpart, as 
if the swap dealer were itself a bank holding company subject to 12 CFR 
part 217.
    (3) In the case of a swap dealer subject to the minimum capital 
requirements in Sec.  23.101(a)(ii) or Sec.  23.101(a)(2), the 
information set forth in Appendix A to Subpart E of Part 23.
    (d) The Commission, or registered futures association upon 
obtaining the Commission's determination that its requirements and 
model approval process are comparable to the Commission's requirements 
and process, may approve or deny the application, or approve or deny an 
amendment to the application, in whole or in part, subject to any 
conditions or limitations the Commission or registered futures 
association may require, if the Commission or registered futures 
association finds the approval to be appropriate in the public 
interest, after determining, among other things, whether the applicant 
has met the requirements of this section. A swap dealer that has 
received Commission or registered futures association approval to 
compute market risk exposure requirements and credit risk exposure 
requirements pursuant to internal models must compute such charges in 
accordance with Appendix A to Subpart E of Part 23.
    (e) A swap dealer must cease using internal models to compute its 
market risk exposure requirement and credit risk exposure requirement, 
upon the occurrence of any of the following:
    (1) The swap dealer has materially changed a mathematical model 
described in the application or materially changed its internal risk 
management control system without first submitting amendments 
identifying such changes and obtaining the approval of the Commission 
or the registered futures association for such changes;
    (2) The Commission or the registered futures association of which 
the swap dealer is a member determines that the internal models are no 
longer sufficient for purposes of the capital calculations of the swap 
dealer as a result of changes in the operations of the swap dealer;
    (3) The swap dealer fails to come into compliance with its 
requirements under this section, after having received from the 
Director of the Commission's Division of Swap Dealer and Intermediary 
Oversight, or from the registered futures association of which the swap 
dealer is a member, written notification that the swap dealer is not in 
compliance with its requirements, and must come into compliance by a 
date specified in the notice; or
    (4) The Commission by written order finds that permitting the swap 
dealer to continue to use the internal models is no longer appropriate.
    (f)(1) Notwithstanding paragraphs (a) through (d) of this section, 
a swap dealer may use internal market risk or credit risk models upon 
the submission to the Commission and the registered futures association 
of which the swap dealer is a member a certification, signed by the 
Chief Executive Officer, Chief Financial Officer, or other appropriate 
official with knowledge of the swap dealer's capital requirements and 
the capital models, that such models are in substantial compliance with 
Commission's model requirements and have been approved for use in 
computing capital by the swap dealer, or an affiliate of the swap 
dealer, by the Securities and Exchange Commission, a prudential 
regulator (as defined in Sec.  1.3 of this chapter), a foreign 
regulatory authority in a jurisdiction that the Commission has found to 
be eligible for substituted compliance under Sec.  23.106, or a foreign 
regulatory authority whose capital adequacy requirements are consistent 
with the capital requirements issued by the Basel Committee on Banking 
Supervision. A swap dealer also must file an application containing the 
information required under paragraph (c) of this section with the 
Commission with its certification. A swap dealer may use such models 
pending the subsequent approval or denial of the swap dealer's capital 
model application by the Commission or the registered futures 
association of which the swap dealer is a member.
    (2) A swap dealer shall revise the certification required under 
paragraph (f)(1) of this section to address any material changes or 
revisions to the models, or to reflect any regulatory restrictions 
placed on the models since the certification was submitted.

[[Page 57551]]

    (3) A swap dealer shall cease using capital models subject to the 
certification under paragraph (f)(1) of this section if the regulatory 
authority that previously approved the models for use by the swap 
dealer, or by the swap dealer's affiliate, has withdrawn its approval 
and the Commission or a registered futures association has not approved 
the models.

0
11. Add section 23.103 to subpart E to read as follows:


Sec.  23.103  Calculation of market risk exposure requirement and 
credit risk requirement when models are not approved.

    (a) Non-model approach. A swap dealer that:
    (1) Does not compute its regulatory capital requirements under 
Sec.  23.101(a)(1)(i), and
    (2) Either:
    (A) has not received approval from the Commission or from a 
registered futures association of which the swap dealer is a member to 
compute its market risk exposure requirement and/or credit risk 
exposure requirement pursuant to internal models under Sec.  23.102, or
    (B) has had its approval to compute its market risk exposure 
requirement and/or credit risk exposure requirement pursuant to 
internal models under Sec.  23.102 revoked by the Commission or 
registered futures association must compute its market risk exposure 
requirement and/or credit risk exposure requirement pursuant to 
paragraphs (b) and/or (c) of this section.
    (b) Market risk exposure requirements. (1) A swap dealer that 
computes its regulatory capital under Sec.  23.101(a)(1)(ii) or (a)(2) 
shall compute a market risk capital charge for the positions that the 
swap dealer holds in its proprietary accounts using the applicable 
standardized market risk charges set forth in Sec.  240.18a-1 of this 
title and Sec.  1.17 of this chapter for such positions.
    (2) In computing its net capital under Sec.  23.101(a)(1)(ii), a 
swap dealer shall deduct from its tentative net capital the sum of the 
market risk capital charges computed under paragraph (b)(1) of this 
section.
    (3) In computing its minimum capital requirement under Sec.  
23.101(a)(2), a swap dealer must add the amount of the market risk 
capital charge computed under this section to the $20 million minimum 
capital requirement.
    (c) Credit risk charges. (1) A swap dealer that computes regulatory 
capital under Sec.  23.101(a)(1)(ii) shall compute counterparty credit 
risk charges using the applicable standardized credit risk charges set 
forth in Sec.  240.18a-1 of this title and Sec.  1.17 of this chapter 
for such positions.
    (2) In computing its net capital under Sec.  23.101(a)(1)(ii), a 
swap dealer shall reduce its tentative net capital by the sum of the 
counterparty credit risk charges computed under paragraph (c)(1) of 
this section.
    (3) In computing its minimum capital requirement under Sec.  
23.101(a)(2), a swap dealer must add the amount of the credit risk 
charge computed under this section to the $20 million minimum capital 
requirement.

0
12. Add section 23.104 to subpart E to read as follows:


Sec.  23.104  Equity Withdrawal Restrictions.

    (a) Equity withdrawal restrictions. The capital of a swap dealer, 
including the capital of any affiliate or subsidiary whose liabilities 
or obligations are guaranteed, endorsed, or assumed by the swap dealer 
may not be withdrawn by action of the swap dealer or its equity 
holders, or by redemption of shares of stock by the swap dealer or by 
such affiliates or subsidiaries, or through the payment of dividends or 
any similar distribution, nor may any unsecured advance or loan be made 
to an equity holder or employee if, after giving effect thereto and to 
any other such withdrawals, advances, or loans which are scheduled to 
occur within six months following such withdrawal, advance or loan, the 
swap dealer's regulatory capital is less than 120 percent of the 
minimum regulatory capital required under Sec.  23.101 of this part. 
The equity withdrawal restrictions, however, do not preclude a swap 
dealer from making required tax payments or from paying reasonable 
compensation to equity holders. The Commission may, upon application by 
the swap dealer, grant relief from this paragraph (a) if the Commission 
deems such relief to be in the public interest.
    (b) Temporary equity withdrawal restrictions by Commission order. 
(1) The Commission may by order restrict, for a period of up to twenty 
business days, any withdrawal by a swap dealer of capital or any 
unsecured loan or advance to a stockholder, partner, member, employee 
or affiliate under such terms and conditions as the Commission deems 
appropriate in the public interest if the Commission, based on the 
information available, concludes that such withdrawal, loan or advance 
may be detrimental to the financial integrity of the swap dealer, or 
may unduly jeopardize the swap dealer's ability to meet its financial 
obligations to counterparties or to pay other liabilities which may 
cause a significant impact on the markets or expose the counterparties 
and creditors of the swap dealer to loss.
    (2) An order temporarily prohibiting the withdrawal of capital 
shall be rescinded if the Commission determines that the restriction on 
capital withdrawal should not remain in effect. A hearing on an order 
temporarily prohibiting withdrawal of capital will be held within two 
business days from the date of the request in writing by the swap 
dealer.

0
13. Add section 23.105 to subpart E to read as follows:


Sec.  23.105  Financial recordkeeping, reporting and notification 
requirements for swap dealers and major swap participants.

    (a) Scope. (1) Except as provided in paragraphs (a)(2) and (a)(3) 
of this section, a swap dealer or major swap participant must comply 
with the applicable requirements set forth in paragraphs (b) through 
(p) of this section.
    (2) The requirements in paragraphs (b) through (o) of this section 
do not apply to any swap dealer or major swap participant that is 
subject to the capital requirements of a prudential regulator.
    (3) The requirements in paragraph (p) of this section do not apply 
to any swap dealer or major swap participant that is subject to the 
capital requirements of the Commission.
    (b) Current books and records. A swap dealer or major swap 
participant shall prepare and keep current ledgers or other similar 
records which show or summarize, with appropriate references to 
supporting documents, each transaction affecting its asset, liability, 
income, expense, and capital accounts, and in which all its asset, 
liability, and capital accounts are classified in accordance with U.S. 
generally accepted accounting principles, and as otherwise may be 
necessary for the capital calculations required under Sec.  23.101 of 
this part: Provided, however, that a swap dealer or major swap 
participant that is not otherwise required to prepare financial 
statements in accordance with U.S. generally accepted accounting 
principles, may prepare and keep records required by this section in 
accordance with International Financial Reporting Standards issued by 
the International Accounting Standards Board. Such records must be 
maintained in accordance with Sec.  1.31 of this chapter.
    (c) Notices. (1) A swap dealer or major swap participant who knows 
or should have known that its regulatory capital at any time is less 
than the minimum required by Sec.  23.101 of this part, must:

[[Page 57552]]

    (i) Provide immediate written notice to the Commission and to the 
registered futures association of which it is a member that the swap 
dealer's or major swap participant's regulatory capital is less than 
that required by Sec.  23.101 of this part; and
    (ii) Provide together with such notice, documentation in such form 
as necessary to adequately reflect the swap dealer's or major swap 
participant's regulatory capital condition as of any date such person's 
regulatory capital is less than the minimum required. The swap dealer 
or major swap participant must provide similar documentation for other 
days as the Commission or registered futures association may request.
    (2) A swap dealer or major swap participant who knows or should 
have known that its regulatory capital at any time is less than 120 
percent of its minimum regulatory capital requirement as determined 
under Sec.  23.101 of this part, must provide written notice to the 
Commission and to the registered futures association of which it is a 
member to that effect within 24 hours of such event.
    (3) If a swap dealer or major swap participant at any time fails to 
make or to keep current the books and records required by these 
regulations, such swap dealer or major swap participant must, on the 
same day such event occurs, provide written notice to the Commission 
and to the registered futures association of which it is a member of 
such fact, specifying the books and records which have not been made or 
which are not current, and within 48 hours after giving such notice 
file a written report stating what steps have been and are being taken 
to correct the situation.
    (4) A swap dealer or major swap participant must provide written 
notice to the Commission and to the registered futures association of 
which it is a member of a substantial reduction in capital as compared 
to that last reported in a financial report filed with the Commission 
pursuant to this section. The notice shall be provided if the swap 
dealer or major swap participant experiences a 30 percent or more 
decrease in the amount of capital that the swap dealer or major swap 
participant holds in excess of its regulatory capital requirement as 
computed under Sec.  23.101 of this part.
    (5) A swap dealer or major swap participant must provide written 
notice to the Commission and to the registered futures association of 
which it is a member two business days prior to the withdrawal of 
capital by action of the equity holders of the swap dealer or major 
swap participant where the withdrawal exceeds 30 percent of the swap 
dealer's or major swap participant's excess regulatory capital as 
computed under Sec.  23.101 of this part.
    (6) A swap dealer or major swap participant that is registered with 
the Securities and Exchange Commission as a security-based swap dealer 
or as a major security-based swap participant and files a notice with 
the Securities and Exchange Commission under 17 CFR 240.18a-8 or 17 CFR 
240.17a-11, as applicable, must file a copy of such notice with the 
Commission and with the registered futures association of which it is a 
member at the time the security-based swap dealer or major security-
based swap participant files the notice with the Securities and 
Exchange Commission.
    (7) A swap dealer or major swap participant must submit a written 
notice to the Commission and to the registered futures association of 
which it is a member within 24 hours of the occurrence of any of the 
following events:
    (i) A single counterparty, or group of counterparties that are 
under common ownership or control, fails to post initial margin or pay 
variation margin to the swap dealer or major swap participant for swap 
positions in compliance with Sec.  23.152 and Sec.  23.153 of this part 
and security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii), and such initial margin and 
variation margin, in the aggregate, is equal to or greater than 25 
percent of the swap dealer's minimum capital requirement or 25 percent 
of the major swap participant's tangible net worth;
    (ii) Counterparties fail to post initial margin or pay variation 
margin to the swap dealer or major swap participant for swap positions 
in compliance with Sec.  23.152 and Sec.  23.153 of this part and 
security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii) in an amount that, in the 
aggregate, exceeds 50 percent of the swap dealer's minimum capital 
requirement or 50 percent of the major swap participant's tangible net 
worth;
    (iii) A swap dealer or major swap participant fails to post initial 
margin or pay variation margin to a single counterparty or group of 
counterparties under common ownership and control for swap positions in 
compliance with Sec.  23.152 and Sec.  23.153 of this part and 
security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii), and such initial margin and 
variation margin, in the aggregate, exceeds 25 percent of the swap 
dealer's minimum capital requirement or 25 percent of the major swap 
participant's tangible net worth; or
    (iv) A swap dealer or major swap participant fails to post initial 
margin or pay variation margin to counterparties for swap positions in 
compliance with Sec.  23.152 and Sec.  23.153 of this part and 
security-based swap positions in compliance with 17 CFR 240.18a-
3(c)(1)(ii) and 17 CFR 240.18a-3(c)(2)(ii) in an amount that, in the 
aggregate, exceeds 50 percent of the swap dealer's s minimum capital 
requirement or 50 percent of the major swap participants tangible net 
worth.
    (d) Unaudited financial reports. (1) A swap dealer or major swap 
participant shall file with the Commission and with a registered 
futures association of which it is a member monthly financial reports 
meeting the requirements in paragraph (d)(2) of this section as of the 
close of business each month; Provided, however, that a swap dealer or 
major swap participant who is subject to the minimum capital 
requirements of Sec.  23.101(a)(2) or (b), respectively, may file 
quarterly financial reports meeting the requirements of paragraph 
(d)(2) of this section as of the close of business each quarter end. 
Such financial reports must be filed no later than 17 business days 
after the date for which the report is made.
    (2) The financial reports required by this section must be prepared 
in the English language and be denominated in United States dollars. 
The financial reports shall include a statement of financial condition, 
a statement of income/loss, a statement of changes in liabilities 
subordinated to the claims of general creditors, a statement of changes 
in ownership equity, a statement demonstrating compliance with and 
calculation of the applicable regulatory capital requirement under 
Sec.  23.101, and such further material information as may be necessary 
to make the required statements not misleading. The monthly report and 
schedules must be prepared in accordance with generally accepted 
accounting principles as established in the United States; Provided, 
however, that a swap dealer or major swap participant that is not 
otherwise required to prepare financial statements in accordance with 
U.S. generally accepted accounting principles, may prepare the monthly 
report and schedules required by this section in accordance with 
International Financial Reporting Standards issued by the International 
Accounting Standards Board.
    (3) A swap dealer or major swap participant that is also registered 
with

[[Page 57553]]

the Securities and Exchange Commission as a broker or dealer, security-
based swap dealer, or a major security-based swap participant and files 
a monthly Form X-17A-5 FOCUS Report Part II with the Securities and 
Exchange Commission pursuant to 17 CFR 240.18a-7 or 17 CFR 240.17a-5, 
as applicable, may file such Form X-17A-5 FOCUS Report Part II with the 
Commission and with the registered futures association in lieu of the 
financial reports required under paragraphs (d)(1) and (2) of the 
section. The swap dealer or major swap participant must file the form 
with the Commission and registered futures association when it files 
the Form X-17A-5 FOCUS Report Part II with the Securities and Exchange 
Commission, provided, however, that the swap dealer or major swap 
participant must file the Form X-17A-5 FOCUS Report Part II with the 
Commission and registered futures association no later than 17 business 
days after the end of each month.
    (4) A swap dealer or major swap participant that is also registered 
with the Commission as a futures commission merchant may file a Form 1-
FR-FCM in lieu of the monthly financial reports required under 
paragraphs (d)(1) and (2) of the section.
    (e) Annual audited financial report. (1) A swap dealer or major 
swap participant shall file with the Commission and with a registered 
futures association of which it is a member an annual financial report 
as of the close of its fiscal year, certified in accordance with 
paragraph (e)(2) of this section, and including the information 
specified in paragraph (e)(3) of this section no later than 60 days 
after the close of the swap dealer's or major swap participant's fiscal 
year-end: Provided, however, that a swap dealer or major swap 
participant who is subject to the minimum capital requirements of Sec.  
23.101(a)(2) or (b), respectively, of this part may file an annual 
financial report no later than 90 days after the close of the swap 
dealer's and major swap participant's fiscal year-end.
    (2) The annual financial report shall be audited and reported upon 
with an opinion expressed by an independent certified public accountant 
or independent licensed accountant that is in good standing in the 
accountant's home jurisdiction.
    (3) The annual financial reports shall be prepared in accordance 
with generally accepted accounting principles as established in the 
United States, be prepared in the English language, and denominated in 
United States dollars: Provided, however, that a swap dealer or major 
swap participant that does not otherwise prepare financial statements 
in accordance with U.S. generally accepted accounting principles, may 
prepare the annual financial report required by this section in 
accordance with International Financial Reporting Standards issued by 
the International Accounting Standards Board.
    (4) The annual financial report must include the following:
    (i) A statement of financial condition as of the date for which the 
report is made;
    (ii) Statements of income (loss), cash flows, changes in ownership 
equity for the period between the date of the most recent certified 
statement of financial condition filed with the Commission and 
registered futures association and the date for which the report is 
made, and changes in liabilities subordinated to claims of general 
creditors;
    (iii) Appropriate footnote disclosures;
    (iv) A statement demonstrating the swap dealer's or major swap 
participant's compliance with and calculation of the applicable 
regulatory capital requirement under Sec.  23.101 of this part;
    (v) A reconciliation of any material differences from the unaudited 
financial report prepared as of the swap dealer's or major swap 
participant's year-end date under paragraph (d) of this section and the 
swap dealer's or major swap participant's annual financial report 
prepared under this paragraph (e); and
    (vi) Such further material information as may be necessary to make 
the required statements not misleading.
    (5) A swap dealer or major swap participant that is also registered 
with the Securities and Exchange Commission as a broker or dealer, 
security-based swap dealer, or a major security-based swap participant 
and files an annual financial report with the Securities and Exchange 
Commission pursuant to 17 CFR 240.18a-7 or 17 CFR 240.17a-5, as 
applicable, may file such annual financial report with the Commission 
and the registered futures association in lieu of the annual financial 
report required under this paragraph (e). The swap dealer or major swap 
participant must file its annual financial report with the Commission 
and the registered futures association at the same time that it files 
the annual financial report with the Securities and Exchange 
Commission, provided that the annual financial report is filed with the 
Commission and registered futures association no later than 60 days 
from the swap dealer's or major swap participant's fiscal year-end 
date.
    (6) A swap dealer or major swap participant that is also registered 
with the Commission as a futures commission merchant may file an 
audited Form 1-FR-FCM in lieu of the annual financial report required 
under this paragraph (e).
    (f) Oath or affirmation. Attached to each unaudited and audited 
financial report must be an oath or affirmation that to the best 
knowledge and belief of the individual making such oath or affirmation 
the information contained in the financial report is true and correct. 
The individual making such oath or affirmation must be: If the swap 
dealer or major swap participant is a sole proprietorship, the 
proprietor; if a partnership, any general partner; if a corporation, 
the duly authorized officer; and, if a limited liability company or 
limited liability partnership, the chief executive officer, the chief 
financial officer, the manager, the managing member, or those members 
vested with the management authority for the limited liability company 
or limited liability partnership.
    (g) Change of fiscal year-end. A swap dealer or major swap 
participant may not change the date of its fiscal year-end from that 
used in its most recent annual financial report filed under paragraph 
(e) of this section unless the swap dealer or major swap participant 
has requested and received written approval for the change from a 
registered futures association of which it is a member.
    (h) Additional information requirements. From time to time the 
Commission or a registered futures association, may, by written notice, 
require any swap dealer or major swap participant to file financial or 
operational information on a daily basis or at such other times as may 
be specified by the Commission or registered futures association. Such 
information must be furnished in accordance with the requirements 
included in the written Commission or registered futures association 
notice.
    (i) Public disclosure and nonpublic treatment of reports. (1) A 
swap dealer or major swap participant must no less than six months 
after the date of the most recent annual audited financial report make 
publicly available on its website the following unaudited information:
    (i) The statement of financial condition; and
    (ii) A statement disclosing the amount of the swap dealer's or 
major swap participant's regulatory capital as of the end of the 
quarter and the amount of its minimum regulatory capital requirement, 
computed in accordance with Sec.  23.101.

[[Page 57554]]

    (2) A swap dealer or major swap participant must no less than 
annually make publicly available on its website the following 
information:
    (i) The statement of financial condition from the swap dealer or 
major swap participant's audited annual financial report including 
applicable footnotes; and
    (ii) A statement disclosing the amount of the swap dealer's or 
major swap participant's regulatory capital as of the fiscal year end 
and its minimum regulatory capital requirement, computed in accordance 
with Sec.  23.101.
    (3) Financial information required to be made publicly available 
pursuant to paragraph (i)(2) of this section must be posted within 10 
business days after the firm is required to file with the Commission 
the reports required under paragraph (e)(1).
    (4) Financial information required to be made publicly available 
pursuant to paragraph (i)(1) of this section must be posted within 30 
calendar days of the date of the statements required under paragraph 
(d)(1).
    (5) Financial information required to be filed with the Commission 
pursuant to this section, and not otherwise publicly available, will be 
treated as exempt from mandatory public disclosure for purposes of the 
Freedom of Information Act and the Government in the Sunshine Act and 
parts 145 and 147 of this chapter; Provided, however, that all 
information that is exempt from mandatory public disclosure will be 
available for official use by any official or employee of the United 
States or any State, by the National Futures Association and by any 
other person to whom the Commission believes disclosure of such 
information is in the public interest.
    (j) Extension of time to file financial reports. A swap dealer or 
major swap participant may file a request with the registered futures 
association of which it is a member for an extension of time to file a 
monthly unaudited financial report or an annual audited financial 
report required under paragraphs (d) and (e) of this section. Such 
request will be approved, conditionally or unconditionally, or 
disapproved by the registered futures association.
    (k) Additional reporting requirements for swap dealers approved to 
use models to calculate market risk and credit risk for computing 
capital requirements. (1) A swap dealer that has received approval or 
filed an application for provisional approval under Sec.  23.102(d) 
from the Commission, or from a registered futures association of which 
the swap dealer is a member, to use internal models to compute its 
market risk exposure requirement and credit risk exposure requirement 
in computing its regulatory capital under Sec.  23.101 must file with 
the Commission and with the registered futures association of which the 
swap dealer is a member the following information within 17 business 
days of the end of each month:
    (i) For each product for which the swap dealer calculates a 
deduction for market risk other than in accordance with a model 
approved or for which an application of provisional approval has been 
filed pursuant to Sec.  23.102(d), the product category and the amount 
of the deduction for market risk;
    (ii) A graph reflecting, for each business line, the daily intra-
month VaR;
    (iii) The aggregate VaR for the swap dealer;
    (iv) For each product for which the swap dealer uses scenario 
analysis, the product category and the deduction for market risk;
    (v) Credit risk information on swap, mixed swap and security-based 
swap exposures including:
    (A) Overall current exposure;
    (B) Current exposure (including commitments) listed by counterparty 
for the 15 largest exposures;
    (C) The 10 largest commitments listed by counterparty;
    (D) The swap dealer's maximum potential exposure listed by 
counterparty for the 15 largest exposures;
    (E) The swap dealer's aggregate maximum potential exposure;
    (F) A summary report reflecting the swap dealer's current and 
maximum potential exposures by credit rating category; and
    (G) A summary report reflecting the swap dealer's current exposure 
for each of the top ten countries to which the swap dealer is exposed 
(by residence of the main operating group of the counterparty).
    (2) A swap dealer that has received approval or filed an 
application of provisional approval under Sec.  23.102(d) from the 
Commission or from a registered futures association of which the swap 
dealer is a member to use internal models to compute its market risk 
exposure requirement and credit risk exposure requirement in computing 
its regulatory capital under Sec.  23.101 must file with the Commission 
and with the registered futures association of which the swap dealer is 
member the following information within 17 business days of the end of 
each calendar quarter:
    (i) A report identifying the number of business days for which the 
actual daily net trading loss exceeded the corresponding daily VaR; and
    (ii) The results of back-testing of all internal models used to 
compute allowable capital, including VaR, and credit risk models, 
indicating the number of back-testing exceptions.
    (l) Additional position and counterparty reporting requirements. A 
swap dealer or major swap participant must provide on a monthly basis 
to the Commission and to the registered futures association of which 
the swap dealer or major swap participant is a member the specific 
information required in Appendix B to Subpart E of this part.
    (m) Margin reporting. A swap dealer or major swap participant must 
file with the Commission and with the registered futures association of 
which the swap dealer or major swap participant is a member the 
following information as of the end of each month within 17 business 
days of the end of each month:
    (1) The name and address of each custodian holding initial margin 
or variation margin collected by the swap dealer or major swap 
participant for uncleared swap transactions pursuant to Sec. Sec.  
23.152 and 23.153;
    (2) The amount of initial margin and variation margin collected by 
the swap dealer or major swap participant that is held by each 
custodian listed in paragraph (m)(1) of this section;
    (3) The aggregate amount of initial margin that the swap dealer or 
major swap participant is required to collect from swap counterparties 
pursuant to Sec.  23.152(a);
    (4) The name and address of each custodian holding initial margin 
or variation margin posted by the swap dealer or major swap participant 
for uncleared swap transaction pursuant to Sec. Sec.  23.152 and 
23.153;
    (5) The amount of initial margin and variation margin posted by the 
swap dealer or major swap participant that is held by each custodian 
listed in paragraph (m)(4) of this section; and
    (6) The aggregate amount of initial margin that the swap dealer or 
majors swap participant is required to post to its swap counterparties 
pursuant to Sec.  23.152(b).
    (n) Electronic filing. All filings of financial reports, notices 
and other information required to be submitted to the Commission or 
registered futures association under paragraphs (b) through (m) of this 
section must be filed in electronic form using a form of user 
authentication assigned in accordance with procedures established by or 
approved by the Commission or registered futures association, and 
otherwise in accordance with

[[Page 57555]]

instructions issued by or approved by the Commission or registered 
futures association.
    A swap dealer or major swap participant must provide the Commission 
or registered futures association with the means necessary to read and 
to process the information contained in such report. Any such 
electronic submission must clearly indicate the swap dealer or major 
swap participant on whose behalf such filing is made and the use of 
such user authentication in submitting such filing will constitute and 
become a substitute for the manual signature of the authorized signer. 
In the case of a financial report required under paragraphs (d), (e), 
or (h) of this section and filed via electronic transmission in 
accordance with procedures established by or approved by the Commission 
or registered futures association, such transmission must be 
accompanied by the user authentication assigned to the authorized 
signer under such procedures, and the use of such user authentication 
will constitute and become a substitute for the manual signature of the 
authorized signer for the purpose of making the oath or affirmation 
referred to in paragraph (f) of this section.
    (o) Comparability determination for certain financial reporting. A 
swap dealer or major swap participant that is subject to the monthly 
financial reporting requirements of paragraph (d) of this section and 
the annual financial reporting requirements of paragraph (e) of this 
section may petition the Commission for a Capital Comparability 
Determination under Sec.  23.106 to file monthly financial reports and/
or annual financial reports prepared in accordance with the rules a 
foreign regulatory authority in lieu of the requirements contained in 
this section.
    (p) Quarterly financial reporting and notification provisions for 
swap dealers and major swap participants that are subject to the 
capital requirements of a prudential regulator. (1) Scope. A swap 
dealer or major swap participant that is subject to the capital 
requirements of a prudential regulator must comply with the 
requirements of this paragraph.
    (2) Financial report and position information. A swap dealer or 
major swap participant that is subject to the capital requirements of a 
prudential regulator shall file on a quarterly basis with the 
Commission the financial reports and specific position information set 
forth in Appendix C to subpart E of this part. The swap dealer or major 
swap participant must file Appendix B to subpart E of this part with 
the Commission within 30 calendar days of the date of the end of the 
swap dealer's or major swap participant's fiscal quarter.
    (3) Notices. A swap dealer or major swap participant that is 
subject to the capital requirements of a prudential regulator must 
comply with the following written notice provisions:
    (i) A swap dealer or major swap participant that files a notice of 
adjustment of its reported capital category with the Federal Reserve 
Board, the Office of the Comptroller of the Currency, or the Federal 
Deposit Insurance Corporation, or files a similar notice with its home 
country supervisor(s), must give written notice of this fact that same 
day by transmitting a copy of the notice of the adjustment of reported 
capital category, or the similar notice provided to its home country 
supervisor(s), to the Commission and with a registered futures 
association of which it is a member.
    (ii) A swap dealer or major swap participant must provide immediate 
written notice to the Commission and with a registered futures 
association of which it is a member that the swap dealer's or major 
swap participant's regulatory capital is less than the applicable 
minimum capital requirements set forth in 12 CFR 217.10, 12 CFR 3.10, 
or 12 CFR 324.10, or the minimum capital requirements established by 
its home country supervisor(s).
    (iii) If a swap dealer or major swap participant at any time fails 
to make or to keep current the books and records necessary to produce 
reports required under paragraph (p)(2) of this section, such swap 
dealer or major swap participant must, on the same day such event 
occurs, provide written notice to the Commission and with a registered 
futures association of which it is a member of such fact, specifying 
the books and records which have not been made or which are not 
current, and within 48 hours after giving such notice file a written 
report stating what steps have been and are being taken to correct the 
situation.
    (4) Additional information. From time to time the Commission may, 
by written notice, require a swap dealer or major swap participant that 
is subject to the capital rules of a prudential regulator to file 
financial or operational information on a daily basis or at such other 
times as may be specified by the Commission. Such information must be 
furnished in accordance with the requirements included in the written 
Commission notice.
    (5) Oath or affirmation. Attached to each financial report, must be 
an oath or affirmation that to the best knowledge and belief of the 
individual making such oath or affirmation the information contained in 
the filing is true and correct. The individual making such oath or 
affirmation must be: If the swap dealer or major swap participant is a 
sole proprietorship, the proprietor; if a partnership, any general 
partner; if a corporation, the duly authorized officer; and, if a 
limited liability company or limited liability partnership, the chief 
executive officer, the chief financial officer, the manager, the 
managing member, or those members vested with the management authority 
for the limited liability company or limited liability partnership.
    (6) Electronic filing. All filings of financial reports, notices, 
and other information made pursuant to this paragraph (p) must be 
submitted to the Commission in electronic form using a form of user 
authentication assigned in accordance with procedures established by or 
approved by the Commission, and otherwise in accordance with 
instructions issued by or approved by the Commission. Each swap dealer 
and major swap participant must provide the Commission with the means 
necessary to read and to process the information contained in such 
report. Any such electronic submission must clearly indicate the swap 
dealer or major swap participant on whose behalf such filing is made 
and the use of such user authentication in submitting such filing will 
constitute and become a substitute for the manual signature of the 
authorized signer. In the case of a financial report required under 
this paragraph (p) and filed via electronic transmission in accordance 
with procedures established by or approved by the Commission, such 
transmission must be accompanied by the user authentication assigned to 
the authorized signer under such procedures, and the use of such user 
authentication will constitute and become a substitute for the manual 
signature of the authorized signer for the purpose of making the oath 
or affirmation referred to in paragraph (p)(5) of this paragraph. Every 
notice or report required to be transmitted to the Commission pursuant 
to this paragraph (p) must also be filed with the Securities and 
Exchange Commission if the swap dealer or major swap participant also 
is registered with the Securities and Exchange Commission.
    (7) A swap dealer or major swap participant that is subject to 
rules of a prudential regulator and is also registered with the 
Securities and Exchange Commission as a security-based swap dealer or a 
major security-

[[Page 57556]]

based swap participant and files a quarterly Form X-17A-5 FOCUS Report 
Part IIC with the Securities and Exchange Commission pursuant to 17 CFR 
240.18a-7, may file such Form X-17A-5 FOCUS Report Part IIC with the 
Commission in lieu of the financial reports required under paragraphs 
(p)(2) of this section. The swap dealer or major swap participant must 
file the form with the Commission when it files the Form X-17A-5 FOCUS 
Report Part IIC with the Securities and Exchange Commission, provided, 
however, that the swap dealer or major swap participant must file the 
Form X-17A-5 FOCUS Report Part IIC with the Commission no later than 30 
calendar days from the date the report is made.

0
14. Add section 23.106 to subpart E to read as follows:


Sec.  23.106   Substituted compliance for swap dealer's and major swap 
participant's capital and financial reporting.

    (a)(1) Eligibility requirements. The following persons may, either 
individually or collectively, request a Capital Comparability 
Determination with respect to the Commission's capital adequacy and 
financial reporting requirements for swap dealers or major swap 
participants:
    (i) A swap dealer or major swap participant that is eligible for 
substituted compliance under Sec.  23.101 or a trade association or 
other similar group on behalf of its members who are swap dealers or 
major swap participants; or
    (ii) A foreign regulatory authority that has direct supervisory 
authority over one or more swap dealers or major swap participants that 
are eligible for substituted compliance under Sec.  23.101, and such 
foreign regulatory authority is responsible for administering the 
relevant foreign jurisdiction's capital adequacy and financial 
reporting requirements over the swap dealer or major swap participant.
    (2) Submission requirements. A person requesting a Capital 
Comparability Determination must electronically submit to the 
Commission:
    (i) A description of the objectives of the relevant foreign 
jurisdiction's capital adequacy and financial reporting requirements 
over entities that are subject to the Commission's capital adequacy and 
financial reporting requirements in this part;
    (ii) A description (including specific legal and regulatory 
provisions) of how the relevant foreign jurisdiction's capital adequacy 
and financial reporting requirements address the elements of the 
Commission's capital adequacy and financial reporting requirements for 
swap dealers and major swap participants, including, at a minimum, the 
methodologies for establishing and calculating capital adequacy 
requirements and whether such methodologies comport with any 
international standards, including Basel-based capital requirements for 
banking institutions; and
    (iii) A description of the ability of the relevant foreign 
regulatory authority or authorities to supervise and enforce compliance 
with the relevant foreign jurisdiction's capital adequacy and financial 
reporting requirements. Such description should discuss the powers of 
the foreign regulatory authority or authorities to supervise, 
investigate, and discipline entities for compliance with capital 
adequacy and financial reporting requirements, and the ongoing efforts 
of the regulatory authority or authorities to detect and deter 
violations, and ensure compliance with capital adequacy and financial 
reporting requirements. The description should address how foreign 
authorities and foreign laws and regulations address situations where a 
swap dealer or major swap participant is unable to comply with the 
foreign jurisdictions capital adequacy or financial reporting 
requirements.
    (iv) Upon request, such other information and documentation that 
the Commission deems necessary to evaluate the comparability of the 
capital adequacy and financial reporting requirements of the foreign 
jurisdiction.
    (v) All supplied documents shall be provided in English, or 
provided translated to the English language, with currency amounts 
stated in or converted to USD (conversions to be noted with applicable 
date).
    (3) Standard of Review. The Commission will issue a Capital 
Comparability Determination to the extent that it determines that some 
or all of the relevant foreign jurisdiction's capital adequacy and 
financial reporting requirements and related financial recordkeeping 
and reporting requirements for swap dealing financial intermediaries 
are comparable to the Commission's corresponding capital adequacy and 
financial recordkeeping and reporting requirements. In determining 
whether the requirements are comparable, the Commission may consider 
all relevant factors, including:
    (i) The scope and objectives of the foreign jurisdiction's capital 
adequacy and financial reporting requirements;
    (ii) Whether the relevant foreign jurisdiction's capital adequacy 
and financial reporting requirements achieve comparable outcomes to the 
Commission's corresponding capital adequacy and financial reporting 
requirements for swap dealers and major swap participants;
    (iii) The ability of the relevant regulatory authority or 
authorities to supervise and enforce compliance with the relevant 
foreign jurisdiction's capital adequacy and financial reporting 
requirements; and
    (iv) Any other facts or circumstances the Commission deems 
relevant.
    (4) Reliance. (i) A swap dealer or major swap participant that is 
subject to the supervision of a foreign jurisdiction that has received 
a Capital Comparability Determination from the Commission must file a 
notice of its intent to comply with the capital adequacy and financial 
reporting requirements of the foreign jurisdiction with the Commission.
    (ii) Any swap dealer or major swap participant that has filed the 
notice set forth in paragraph (a)(4)(i) of this section and has 
received confirmation from the Commission that it may comply with a 
foreign jurisdiction's capital adequacy and financial reporting 
requirements will be deemed to be in compliance with the Commission's 
corresponding capital adequacy and financial reporting requirements. 
Accordingly, if a swap dealer or major swap participant has failed to 
comply with the foreign jurisdiction's capital adequacy and financial 
reporting requirements, the Commission may initiate an action for a 
violation of the Commission's corresponding requirements. All swap 
dealers and major swap participants, regardless of whether they rely on 
a Capital Comparability Determination, remain subject to the 
Commission's examination and enforcement authority.
    (5) Conditions. In issuing a Capital Comparability Determination, 
the Commission may impose any terms and conditions it deems 
appropriate, including certain capital adequacy and financial reporting 
requirements on swap dealers or major swap participants. The violation 
of such terms and conditions may constitute a violation of the 
Commission's capital adequacy or financial reporting requirements and/
or result in the modification or revocation of the Capital 
Comparability Determination.
    (6) Modifications. The Commission reserves the right to further 
condition, modify, suspend or terminate or otherwise restrict a Capital 
Comparability Determination in the Commission's discretion.

0
15. Add Appendix A to subpart E of part 23 to read as follows:

[[Page 57557]]

Appendix A to Subpart E of Part 23--Application for Internal Models To 
Compute Market Risk Exposure Requirement and Credit Risk Exposure 
Requirement

    (a) A swap dealer that is requesting the approval of the 
Commission or the approval of a registered futures association of 
which the swap dealer is a member to use internal models to compute 
its market risk exposure requirement and credit risk exposure 
requirement under Sec.  23.102 must include the following 
information as part of its application:
    (1) An executive summary of the information within its 
application and, if applicable, an identification of the ultimate 
holding company of the swap dealer;
    (2) A list of the categories of positions that the swap dealer 
holds in its proprietary accounts and a brief description of the 
methods that the swap dealer will use to calculate deductions for 
market risk and credit risk on those categories of positions;
    (3) A description of the mathematical models used by the swap 
dealer under this Appendix A to compute the VaR of the swap dealer's 
positions; the stressed VaR of the swap dealer's positions; the 
specific risk of the swap dealer's positions subject to specific 
risk; comprehensive risk of the swap dealer's positions; and the 
incremental risk of the swap dealer's positions, and deductions for 
credit risk exposure. The description should encompass the creation, 
use, and maintenance of the mathematical models; a description of 
the swap dealer's internal risk management controls over the models, 
including a description of each category of persons who may input 
data into the models; if a mathematical model incorporates empirical 
correlations across risk categories, a description of the process 
for measuring correlations; a description of the back-testing 
procedures the swap dealer will use to back-test the mathematical 
models; a description of how each mathematical model satisfies the 
applicable qualitative and quantitative requirements set forth in 
this Appendix A and a statement describing the extent to which each 
mathematical model used to compute deductions for market risk 
exposures and credit risk exposures will be used as part of the risk 
analyses and reports presented to senior management;
    (4) If the swap dealer is applying to the Commission for 
approval or a registered futures association to use scenario 
analysis to calculate deductions for market risk for certain 
positions, a list of those types of positions, a description of how 
those deductions will be calculated using scenario analysis, and an 
explanation of why each scenario analysis is appropriate to 
calculate deductions for market risk on those types of positions;
    (5) A description of how the swap dealer will calculate current 
exposure;
    (6) A description of how the swap dealer will determine internal 
credit ratings of counterparties and internal credit risk-weights of 
counterparties, if applicable;
    (7) For each instance in which a mathematical model to be used 
by the swap dealer to calculate a deduction for market risk exposure 
or to calculate maximum potential exposure for a particular product 
or counterparty differs from the mathematical model used by the swap 
dealer's ultimate holding company or the swap dealer's affiliates 
(if applicable) to calculate an allowance for market risk exposure 
or to calculate maximum potential exposure for that same product or 
counterparty, a description of the difference(s) between the 
mathematical models;
    (8) A description of the swap dealer's process of re-estimating, 
re-evaluating, and updating internal models to ensure continued 
applicability and relevance; and
    (9) Sample risk reports that are provided to management at the 
swap dealer who are responsible for managing the swap dealer's risk.
    (b) The application of the swap dealer shall be supplemented by 
other information relating to the internal risk management control 
system, mathematical models, and financial position of the swap 
dealer that the Commission or a registered futures association may 
request to complete its review of the application.
    (c) A person who files an application with the Commission 
pursuant to this appendix for which it seeks confidential treatment 
may clearly mark each page or segregable portion of each page with 
the words ``Confidential Treatment Requested.'' All information 
submitted in connection with the application will be accorded 
confidential treatment by the Commission, to the extent permitted by 
law.
    (d) If any of the information filed with the Commission or a 
registered futures association as part of the application of the 
swap dealer is found to be or becomes inaccurate before the 
Commission or a registered futures association approves the 
application, the swap dealer must notify the Commission or the 
registered futures association promptly and provide the Commission 
or the registered futures association with a description of the 
circumstances in which the information was found to be or has become 
inaccurate along with updated, accurate information.
    (e) The Commission or the registered futures association may 
approve the application or an amendment to the application, in whole 
or in part, subject to any conditions or limitations the Commission 
or the registered futures association may require if the Commission 
or the registered futures association finds the approval to be 
appropriate in the public interest, after determining, among other 
things, whether the swap dealer has met all the requirements of this 
Appendix A.
    (f) A swap dealer shall amend its application under this 
Appendix A and submit the amendment to the Commission and the 
registered futures association for approval before it may materially 
change a mathematical model used to calculate market risk exposure 
requirements or credit risk exposure requirements or before it may 
materially change its internal risk management control system with 
respect to such model.
    (g) As a condition for a swap dealer to use internal models to 
compute deductions for market risk exposure and credit risk exposure 
under this Appendix A, the swap dealer agrees that:
    (1) It will notify the Commission and the registered futures 
association 45 days before it ceases to use internal models to 
compute deductions for market risk exposure and credit risk exposure 
under this Appendix A; and
    (2) The Commission or the registered futures association may 
determine that the notice will become effective after a shorter or 
longer period of time if the swap dealer consents or if the 
Commission determines that a shorter or longer period of time is 
appropriate in the public interest.
    (h) The Commission or the registered futures association may by 
written order revoke a swap dealer's approval to use internal models 
to compute market risk exposures and credit risk exposures on 
certain credit exposures arising from transactions in derivatives 
instruments if the Commission or the registered futures association 
finds that such approval is no longer appropriate in the public 
interest. In making its finding, the Commission or the registered 
futures association will consider the compliance history of the swap 
dealer related to its use of models and the swap dealer's compliance 
with its internal risk management controls. If the Commission or the 
registered futures association withdraws all or part of a swap 
dealer's approval to use internal models, the swap dealer shall 
compute market risk exposure requirements and credit risk exposure 
requirements in accordance with Sec.  23.103.
    (i) VaR models. A value-at-risk (``VaR'') model must meet the 
following minimum requirements in order to be approved:
    (1) Qualitative requirements. (i) The VaR model used to 
calculate market risk exposure or credit risk exposure for a 
position must be integrated into the daily internal risk management 
system of the swap dealer;
    (ii) The VaR model must be reviewed both periodically and 
annually. The periodic review may be conducted by personnel of the 
swap dealer that are independent from the personnel that perform the 
VaR model calculations. The annual review must be conducted by a 
qualified third party service. The review must include:
    (A) An evaluation of the conceptual soundness of, and empirical 
support for, the internal models;
    (B) An ongoing monitoring process that includes verification of 
processes and the comparison of the swap dealer's model outputs with 
relevant internal and external data sources or estimation 
techniques; and
    (C) An outcomes analysis process that includes back-testing. 
This process must include a comparison of the changes in the swap 
dealer's portfolio value that would have occurred were end-of-day 
positions to remain unchanged (therefore, excluding fees, 
commissions, reserves, net interest income, and intraday trading) 
with VaR-based measures during a sample period not used in model 
development.
    (iii) For purposes of computing market risk, the swap dealer 
must determine the appropriate multiplication factor as follows:
    (A) Beginning three months after the swap dealer begins using 
the VaR model to

[[Page 57558]]

calculate the market risk exposure, the swap dealer must conduct 
monthly back-testing of the model by comparing its actual daily net 
trading profit or loss with the corresponding VaR measure generated 
by the VaR model, using a 99 percent, one-tailed confidence level 
with price changes equivalent to a one business-day movement in 
rates and prices, for each of the past 250 business days, or other 
period as may be appropriate for the first year of its use;
    (B) On the last business day of each quarter, the swap dealer 
must identify the number of back-testing exceptions of the VaR model 
using actual daily net trading profit and loss, as that term is 
defined in Sec. Sec.  23.100. An exception has occurred when for a 
business day the actual net trading loss, if any, exceeds the 
corresponding VaR measure. The counting period shall be for the 
prior 250 business days except that during the first year of use of 
the model another appropriate period may be used; and
    (C) The swap dealer must use the multiplication factor indicated 
in Table 1 of this Appendix A in determining its market risk until 
it obtains the next quarter's back-testing results;

   Table 1--Multiplication Factor Based on the Number of Back-Testing
                       Exceptions of the VaR Model
------------------------------------------------------------------------
                                                          Multiplication
                  Number of exceptions                        factor
------------------------------------------------------------------------
4 or fewer..............................................            3.00
5.......................................................            3.40
6.......................................................            3.50
7.......................................................            3.65
8.......................................................            3.75
9.......................................................            3.85
10 or more..............................................            4.00
------------------------------------------------------------------------

    (iv) For purposes of computing the credit equivalent amount of 
the swap dealer's exposures to a counterparty, the swap dealer must 
determine the appropriate multiplication factor as follows:
    (A) Beginning three months after it begins using the VaR model 
to calculate maximum potential exposure, the swap dealer must 
conduct back-testing of the model by comparing, for at least 80 
counterparties (or the actual number of counterparties if the swap 
dealer does not have 80 counterparties) with widely varying types 
and sizes of positions with the firm, the ten business day change in 
its current exposure to the counterparty based on its positions held 
at the beginning of the ten-business day period with the 
corresponding ten-business day maximum potential exposure for the 
counterparty generated by the VaR model;
    (B) As of the last business day of each quarter, the swap dealer 
must identify the number of back-testing exceptions of the VaR 
model, that is, the number of ten-business day periods in the past 
250 business days, or other period as may be appropriate for the 
first year of its use, for which the change in current exposure to a 
counterparty, assuming the portfolio remains static for the ten-
business day period, exceeds the corresponding maximum potential 
exposure; and
    (C) The swap dealer will propose, as part of its application, a 
schedule of multiplication factors, which must be approved by the 
Commission, or a registered futures association of which the swap 
dealer is a member, based on the number of back-testing exceptions 
of the VaR model. The swap dealer must use the multiplication factor 
indicated in the approved schedule in determining the credit 
equivalent amount of its exposures to a counterparty until it 
obtains the next quarter's back-testing results, unless the 
Commission or the registered futures association determines, based 
on, among other relevant factors, a review of the swap dealer's 
internal risk management control system, including a review of the 
VaR model, that a different adjustment or other action is 
appropriate.
    (2) Quantitative requirements. (i) For purposes of determining 
market risk exposure, the VaR model must use a 99 percent, one-
tailed confidence level with price changes equivalent to a ten 
business-day movement in rates and prices;
    (ii) For purposes of determining maximum potential exposure, the 
VaR model must use a 99 percent, one-tailed confidence level with 
price changes equivalent to a one-year movement in rates and prices; 
or based on a review of the swap dealer's procedures for managing 
collateral and if the collateral is marked to market daily and the 
swap dealer has the ability to call for additional collateral daily, 
the Commission, or the registered futures association of which the 
swap dealer is a member, may approve a time horizon of not less than 
ten business days;
    (iii) The VaR model must use an effective historical observation 
period of at least one year. The swap dealer must consider the 
effects of market stress in its construction of the model. 
Historical data sets must be updated at least monthly and reassessed 
whenever market prices or volatilities change significantly or 
portfolio composition warrant; and
    (iv) The VaR model must take into account and incorporate all 
significant, identifiable market risk factors applicable to 
positions in the accounts of the swap dealer, including:
    (A) Risks arising from the non-linear price characteristics of 
derivatives and the sensitivity of the fair value of those positions 
to changes in the volatility of the derivatives' underlying rates, 
prices, or other material risk factors. A swap dealer with a large 
or complex portfolio with non-linear derivatives (such as options or 
positions with embedded optionality) must measure the volatility of 
these positions at different maturities and/or strike prices, where 
material;
    (B) Empirical correlations within and across risk factors 
provided that the swap dealer validates and demonstrates the 
reasonableness of its process for measuring correlations, if the 
VaR-based measure does not incorporate empirical correlations across 
risk categories, the swap dealer must add the separate measures from 
its internal models used to calculate the VaR-based measure for the 
appropriate risk categories (interest rate risk, credit spread risk, 
equity price risk, foreign exchange rate risk, and/or commodity 
price risk) to determine its aggregate VaR-based measure, or, 
alternatively, risk factors sufficient to cover all the market risk 
inherent in the positions in the proprietary or other trading 
accounts of the swap dealer, including interest rate risk, equity 
price risk, foreign exchange risk, and commodity price risk; and
    (C) Spread risk, where applicable, and segments of the yield 
curve sufficient to capture differences in volatility and imperfect 
correlation of rates along the yield curve for securities and 
derivatives that are sensitive to different interest rates. For 
material positions in major currencies and markets, modeling 
techniques must incorporate enough segments of the yield curve--in 
no case less than six--to capture differences in volatility and less 
than perfect correlation of rates along the yield curve.
    (j) Stressed VaR-based Measure. A stressed VaR model must meet 
the following minimum requirements in order to be approved:
    (1) Requirements for stressed VaR-based measure. (i) A swap 
dealer must calculate a stressed VaR-based measure for its positions 
using the same model(s) used to calculate the VaR-based measure 
under paragraph (i) of this appendix, subject to the same confidence 
level and holding period applicable to the VaR-based measure, but 
with model inputs calibrated to historical data from a continuous 
12-month period that reflects a period of significant financial 
stress appropriate to the swap dealer's current portfolio.
    (ii) The stressed VaR-based measure must be calculated at least 
weekly and be no less than the swap dealer's VaR-based measure.
    (iii) A swap dealer must have policies and procedures that 
describe how it determines the period of significant financial 
stress used to calculate the swap dealer's stressed VaR-based 
measure under this appendix and must be able to provide empirical 
support for the period used. The swap dealer must obtain the prior 
approval of the Commission, or a registered futures association of 
which the swap dealer is a member, if the swap dealer makes any 
material changes to these policies and procedures. The policies and 
procedures must address:
    (A) How the swap dealer links the period of significant 
financial stress used to calculate the stressed VaR-based measure to 
the composition and directional bias of its current portfolio; and
    (B) The swap dealer's process for selecting, reviewing, and 
updating the period of significant financial stress used to 
calculate the stressed VaR-based measure and for monitoring the 
appropriateness of the period to the swap dealer's current 
portfolio.
    (iv) Nothing in this appendix prevents the Commission or the 
registered futures association of which the swap dealer is a member 
from requiring a swap dealer to use a different period of 
significant financial stress in the calculation of the stressed VaR-
based measure.
    (k) Specific Risk. A specific risk model must meet the following 
minimum requirements in order to be approved:
    (1) General requirement. A swap dealer must use one of the 
methods in this

[[Page 57559]]

paragraph (k) to measure the specific risk for each of its debt, 
equity, and securitization positions with specific risk.
    (2) Modeled specific risk. A swap dealer may use models to 
measure the specific risk of its proprietary positions. A swap 
dealer must use models to measure the specific risk of correlation 
trading positions that are modeled under paragraph (m) of this 
appendix.
    (i) Requirements for specific risk modeling. (A) If a swap 
dealer uses internal models to measure the specific risk of a 
portfolio, the internal models must:
    (1) Explain the historical price variation in the portfolio;
    (2) Be responsive to changes in market conditions;
    (3) Be robust to an adverse environment, including signaling 
rising risk in an adverse environment; and
    (4) Capture all material components of specific risk for the 
debt and equity positions in the portfolio. Specifically, the 
internal models must:
    (i) Capture name-related basis risk;
    (ii) Capture event risk and idiosyncratic risk; and
    (iii) Capture and demonstrate sensitivity to material 
differences between positions that are similar but not identical and 
to changes in portfolio composition and concentrations.
    (B) If a swap dealer calculates an incremental risk measure for 
a portfolio of debt or equity positions under paragraph (l) of this 
appendix, the swap dealer is not required to capture default and 
credit migration risks in its internal models used to measure the 
specific risk of those portfolios.
    (C) A swap dealer shall validate a specific risk model through 
back-testing.
    (ii) Specific risk fully modeled for one or more portfolios. If 
the swap dealer's VaR-based measure captures all material aspects of 
specific risk for one or more of its portfolios of debt, equity, or 
correlation trading positions, the swap dealer has no specific risk 
add-on for those portfolios.
    (3) Specific risk not modeled. (i) If the swap dealer's VaR-
based measure does not capture all material aspects of specific risk 
for a portfolio of debt, equity, or correlation trading positions, 
the swap dealer must calculate a specific-risk add-on for the 
portfolio under the standardized measurement method as described in 
12 CFR 217.210.
    (ii) A swap dealer must calculate a specific risk add-on under 
the standardized measurement method as described in 12 CFR 217.200 
for all of its securitization positions that are not modeled under 
this paragraph (k).
    (l) Incremental Risk. An incremental risk model must meet the 
following minimum requirements in order to be approved:
    (1) General requirement. A swap dealer that measures the 
specific risk of a portfolio of debt positions under paragraph (k) 
of this appendix using internal models must calculate at least 
weekly an incremental risk measure for that portfolio according to 
the requirements in this appendix. The incremental risk measure is 
the swap dealer's measure of potential losses due to incremental 
risk over a one-year time horizon at a one-tail, 99.9 percent 
confidence level, either under the assumption of a constant level of 
risk, or under the assumption of constant positions. With the prior 
approval of the Commission or a registered futures association of 
which the swap dealer is a member, a swap dealer may choose to 
include portfolios of equity positions in its incremental risk 
model, provided that it consistently includes such equity positions 
in a manner that is consistent with how the swap dealer internally 
measures and manages the incremental risk of such positions at the 
portfolio level. If equity positions are included in the model, for 
modeling purposes default is considered to have occurred upon the 
default of any debt of the issuer of the equity position. A swap 
dealer may not include correlation trading positions or 
securitization positions in its incremental risk measure.
    (2) Requirements for incremental risk modeling. For purposes of 
calculating the incremental risk measure, the incremental risk model 
must:
    (i) Measure incremental risk over a one-year time horizon and at 
a one-tail, 99.9 percent confidence level, either under the 
assumption of a constant level of risk, or under the assumption of 
constant positions.
    (A) A constant level of risk assumption means that the swap 
dealer rebalances, or rolls over, the swap dealer's trading 
positions at the beginning of each liquidity horizon over the one-
year horizon in a manner that maintains the swap dealer's initial 
risk level. The swap dealer must determine the frequency of 
rebalancing in a manner consistent with the liquidity horizons of 
the positions in the portfolio. The liquidity horizon of a position 
or set of positions is the time required for a swap dealer to reduce 
its exposure to, or hedge all of its material risks of, the 
position(s) in a stressed market. The liquidity horizon for a 
position or set of positions may not be less than the shorter of 
three months or the contractual maturity of the position.
    (B) A constant position assumption means that the swap dealer 
maintains the same set of positions throughout the one-year horizon. 
If a swap dealer uses this assumption, it must do so consistently 
across all portfolios.
    (C) A swap dealer's selection of a constant position or a 
constant risk assumption must be consistent between the swap 
dealer's incremental risk model and its comprehensive risk model 
described in paragraph (m) of this appendix, if applicable.
    (D) A swap dealer's treatment of liquidity horizons must be 
consistent between the swap dealer's incremental risk model and its 
comprehensive risk model described in paragraph (m) of this 
appendix, if applicable.
    (ii) Recognize the impact of correlations between default and 
migration events among obligors.
    (iii) Reflect the effect of issuer and market concentrations, as 
well as concentrations that can arise within and across product 
classes during stressed conditions.
    (iv) Reflect netting only of long and short positions that 
reference the same financial instrument.
    (v) Reflect any material mismatch between a position and its 
hedge.
    (vi) Recognize the effect that liquidity horizons have on 
dynamic hedging strategies. In such cases, a swap dealer must:
    (A) Choose to model the rebalancing of the hedge consistently 
over the relevant set of trading positions;
    (B) Demonstrate that including rebalancing results in a more 
appropriate risk measurement;
    (C) Demonstrate that the market for the hedge is sufficiently 
liquid to permit rebalancing during periods of stress; and
    (D) Capture in the incremental risk model any residual risks 
arising from such hedging strategies.
    (vii) Reflect the nonlinear impact of options and other 
positions with material nonlinear behavior with respect to default 
and migration changes.
    (viii) Maintain consistency with the swap dealer's internal risk 
management methodologies for identifying, measuring, and managing 
risk.
    (m) Comprehensive Risk. A comprehensive risk model must meet the 
following minimum requirements in order to be approved:
    (1) General requirement. (i) Subject to the prior approval of 
the Commission or a registered futures association of which the swap 
dealer is a member, a swap dealer may use the method in this 
paragraph to measure comprehensive risk, that is, all price risk, 
for one or more portfolios of correlation trading positions.
    (ii) A swap dealer that measures the price risk of a portfolio 
of correlation trading positions using internal models must 
calculate at least weekly a comprehensive risk measure that captures 
all price risk according to the requirements of this paragraph (m). 
The comprehensive risk measure is either:
    (A) The sum of:
    (1) The swap dealer's modeled measure of all price risk 
determined according to the requirements in paragraph (m)(2) of this 
appendix; and
    (2) A surcharge for the swap dealer's modeled correlation 
trading positions equal to the total specific risk add-on for such 
positions as calculated under paragraph (k) of this appendix 
multiplied by 8.0 percent; or
    (B) With approval of the Commission, or the registered futures 
association of which the swap dealer is a member, and provided the 
swap dealer has met the requirements of this paragraph (m) for a 
period of at least one year and can demonstrate the effectiveness of 
the model through the results of ongoing model validation efforts 
including robust benchmarking, the greater of:
    (1) The swap dealer's modeled measure of all price risk 
determined according to the requirements in paragraph (b) of this 
appendix; or
    (2) The total specific risk add-on that would apply to the swap 
dealer's modeled correlation trading positions as calculated under 
paragraph (k) of this appendix multiplied by 8.0 percent.
    (2) Requirements for modeling all price risk. If a swap dealer 
uses an internal model to measure the price risk of a portfolio of 
correlation trading positions:
    (i) The internal model must measure comprehensive risk over a 
one-year time

[[Page 57560]]

horizon at a one-tail, 99.9 percent confidence level, either under 
the assumption of a constant level of risk, or under the assumption 
of constant positions.
    (ii) The model must capture all material price risk, including 
but not limited to the following:
    (A) The risks associated with the contractual structure of cash 
flows of the position, its issuer, and its underlying exposures;
    (B) Credit spread risk, including nonlinear price risks;
    (C) The volatility of implied correlations, including nonlinear 
price risks such as the cross-effect between spreads and 
correlations;
    (D) Basis risk;
    (E) Recovery rate volatility as it relates to the propensity for 
recovery rates to affect tranche prices; and
    (F) To the extent the comprehensive risk measure incorporates 
the benefits of dynamic hedging, the static nature of the hedge over 
the liquidity horizon must be recognized. In such cases, a swap 
dealer must:
    (1) Choose to model the rebalancing of the hedge consistently 
over the relevant set of trading positions;
    (2) Demonstrate that including rebalancing results in a more 
appropriate risk measurement;
    (3) Demonstrate that the market for the hedge is sufficiently 
liquid to permit rebalancing during periods of stress; and
    (4) Capture in the comprehensive risk model any residual risks 
arising from such hedging strategies;
    (iii) The swap dealer must use market data that are relevant in 
representing the risk profile of the swap dealer's correlation 
trading positions in order to ensure that the swap dealer fully 
captures the material risks of the correlation trading positions in 
its comprehensive risk measure in accordance with this appendix; and
    (iv) The swap dealer must be able to demonstrate that its model 
is an appropriate representation of comprehensive risk in light of 
the historical price variation of its correlation trading positions.
    (3) Requirements for stress testing. (i) A swap dealer must at 
least weekly apply specific, supervisory stress scenarios to its 
portfolio of correlation trading positions that capture changes in:
    (A) Default rates;
    (B) Recovery rates;
    (C) Credit spreads;
    (D) Correlations of underlying exposures; and
    (E) Correlations of a correlation trading position and its 
hedge.
    (ii) Other requirements. (A) A swap dealer must retain and make 
available to the Commission and to the registered futures 
association of which the swap dealer is a member the results and all 
assumptions and parameters of the supervisory stress testing, 
including comparisons with the capital requirements generated by the 
swap dealer's comprehensive risk model.
    (B) A swap dealer must report promptly to the Commission and to 
the registered futures association of which it is a member any 
instances where the stress tests indicate any material deficiencies 
in the comprehensive risk model.
    (n) Securitization Exposures. (1) To use the simplified 
supervisory formula approach (SSFA) to determine the specific risk-
weighting factor for a securitization position, a swap dealer must 
have data that enables it to assign accurately the parameters 
described in paragraph (n)(2) of this appendix. Data used to assign 
the parameters described in paragraph (n)(2) of this appendix must 
be the most currently available data; if the contracts governing the 
underlying exposures of the securitization require payments on a 
monthly or quarterly basis, the data used to assign the parameters 
described in paragraph (n)(2) of this appendix must be no more than 
91 calendar days old. A swap dealer that does not have the 
appropriate data to assign the parameters described in paragraph 
(n)(2) of this appendix must assign a specific risk-weighting of 100 
percent to the position.
    (2) SSFA parameters. To calculate the specific risk-weighting 
factor for a securitization position using the SSFA, a swap dealer 
must have accurate information on the five inputs to the SSFA 
calculation described in paragraphs (n)(2)(i) through (n)(2)(v) of 
this appendix.
    (i) KG is the weighted-average (with unpaid principal 
used as the weight for each exposure) total capital requirement of 
the underlying exposures calculated for a swap dealer's credit risk. 
KG is expressed as a decimal value between zero and one 
(that is, an average risk weight of 100 percent presents a value of 
KG equal to 0.08).
    (ii) Parameter W is expressed as a decimal value between zero 
and one. Parameter W is the ratio of the sum of the dollar amounts 
of any underlying exposures of the securitization that meet any of 
the criteria as set forth in paragraphs (n)(2)(ii)(A) through (F) of 
this appendix to the balance, measured in dollars, of underlying 
exposures:
    (A) Ninety days or more past due;
    (B) Subject to a bankruptcy or insolvency proceeding;
    (C) In the process of foreclosure;
    (D) Held as real estate owned;
    (E) Has contractually deferred payments for 90 days or more, 
other than principal or interest payments deferred on;
    (1) Federally-guaranteed student loans, in accordance with the 
terms of those guarantee programs; or
    (2) Consumer loans, including non-federally guaranteed student 
loans, provided that such payments are deferred pursuant to 
provisions included in the contract at the time funds are disbursed 
that provide for period(s) of deferral that are not initiated based 
on changes in the creditworthiness of the borrower; or
    (F) Is in default.
    (iii) Parameter A is the attachment point for the position, 
which represents the threshold at which credit losses will first be 
allocated to the position. Except as provided in 12 CFR 
217.210(b)(2)(vii)(D) for nth to default derivatives, parameter A 
equals the ratio of the current dollar amount of underlying 
exposures that are subordinated to the position of the swap dealer 
to the current dollar amount of underlying exposures. Any reserve 
account funded by the accumulated cash flows from the underlying 
exposures that is subordinated to the position that contains the 
swap dealer's securitization exposure may be included in the 
calculation of parameter A to the extent that cash is present in the 
account. Parameter A is expressed as a decimal value between zero 
and one.
    (iv) Parameter D is the detachment point for the position, which 
represents the threshold at which credit losses of principal 
allocated to the position would result in a total loss of principal. 
Except as provided in 12 CFR 210(b)(2)(vii)(D) for nth-to-default 
credit derivatives, parameter D equals parameter A plus the ratio of 
the current dollar amount of the securitization positions that are 
pari passu with the position (that is, have equal seniority with 
respect to credit risk) to the current dollar amount of the 
underlying exposures. Parameter D is expressed as a decimal value 
between zero and one.
    (v) A supervisory calibration parameter, p, is equal to 0.5 for 
securitization positions that are not resecuritization positions and 
equal to 1.5 for resecuritization positions.
    (3) Mechanics of the SSFA. KG and W are used to 
calculate KA, the augmented value of KG, which 
reflects the observed credit quality of the underlying exposures. 
KA is defined in paragraph (n)(4) of this appendix. The 
values of parameters A and D, relative to KA determine 
the specific risk-weighting factor assigned to a securitization 
position, or portion of a position, as appropriate, is the larger of 
the specific risk-weighting factor determined in accordance with 
this paragraph (n)(3), paragraph (n)(4) of this appendix, and a 
specific risk-weighting factor of 1.6 percent.
    (i) When the detachment point, parameter D, for a securitization 
position is less than or equal to KA, the position must 
be assigned a specific risk-weighting factor of 100 percent.
    (ii) When the attachment point, parameter A, for a 
securitization position is greater than or equal to KA, 
the swap dealer must calculate the specific risk-weighting factor in 
accordance with paragraph (n)(4) of this appendix.
    (iii) When A is less than KA and D is greater than 
KA, the specific risk-weighting factor is a weighted-
average of 1.00 and KSSFA calculated under paragraphs 
(n)(3)(iii)(A) and (3)(iii)(B) of this appendix. For the purpose of 
this calculation:
    (A) The weight assigned to 1.00 equals

[[Page 57561]]

[GRAPHIC] [TIFF OMITTED] TR15SE20.014

    (iii) The specific risk-weighting factor for the position 
(expressed as a percent) is equal to KSSFA x 100.
    (o) Additional conditions. As a condition for the swap dealer to 
use this Appendix A to calculate certain of its capital charges, the 
Commission, or registered futures association of which the swap 
dealer is a member, may impose additional conditions on the swap 
dealer, which may include, but are not limited to restricting the 
swap dealer's business on a product-specific, category-specific, or 
general basis; submitting to the Commission or the registered 
futures association a plan to increase the swap dealer's regulatory 
capital; filing more frequent reports with the Commission or the 
registered futures association; modifying the swap dealer's internal 
risk management control procedures; or computing the swap dealer's 
deductions for market and credit risk in accordance with Sec. Sec.  
23.102 as appropriate. If the Commission or registered futures 
association finds it is necessary or appropriate in the public 
interest, the Commission or registered futures association may 
impose additional conditions on the swap dealer, if:
    (1) The swap dealer is required to provide notice to the 
Commission or the registered futures association that the swap 
dealer's regulatory capital is less than $100 million;
    (2) The swap dealer fails to meet the reporting requirements set 
forth in Sec.  23.105;
    (3) Any event specified in Sec.  23.105 occurs;
    (4) There is a material deficiency in the internal risk 
management control system or in the mathematical models used to 
price securities or to calculate deductions for market and credit 
risk or allowances for market and credit risk, as applicable, of the 
swap dealer;
    (5) The swap dealer fails to comply with this Appendix A; or
    (6) The Commission finds that imposition of other conditions is 
necessary or appropriate in the public interest.


0
16. Add Appendix B to Subpart E of Part 23 to read as follows:

Appendix B to Subpart E of Part 23--Swap Dealer and Major Swap 
Participant Position Information

BILLING CODE 6351-01-P

[[Page 57562]]

[GRAPHIC] [TIFF OMITTED] TR15SE20.015


[[Page 57563]]


[GRAPHIC] [TIFF OMITTED] TR15SE20.016


[[Page 57564]]


[GRAPHIC] [TIFF OMITTED] TR15SE20.017


[[Page 57565]]


[GRAPHIC] [TIFF OMITTED] TR15SE20.018


0
17. Add Appendix C to Subpart E of Part 23 to read as follows:

Appendix C to Subpart E of Part 23--Financial Reports and Specific 
Position Information for Swap Dealers and Major Swap Participants 
Subject to the Capital Requirements of a Prudential Regulator

[[Page 57566]]

[GRAPHIC] [TIFF OMITTED] TR15SE20.019


[[Page 57567]]


[GRAPHIC] [TIFF OMITTED] TR15SE20.020


[[Page 57568]]


[GRAPHIC] [TIFF OMITTED] TR15SE20.021


[[Page 57569]]


[GRAPHIC] [TIFF OMITTED] TR15SE20.022

BILLING CODE 6351-01-C

[[Page 57570]]

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0
18. The authority citation for part 140 continues to read as follows:

    Authority:  7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and 
16(b).


0
19. In Sec.  140.91, redesignate paragraphs (a)(11) and (12) as 
paragraphs (a)(12) and (13), and add a new paragraph (a)(11) to read as 
follows:


Sec.  140.91   Delegation of authority to the Director of the Division 
of Clearing and Risk and to the Director of the Division of Swap Dealer 
and Intermediary Oversight.

    (a) * * *
    (11) All functions reserved to the Commission in Sec.  23.100-106 
of this chapter, except for those related to the revocation of a swap 
dealer's or major swap participant's approval to use internal models to 
compute capital requirements under Sec.  23.102 of this chapter, those 
related to the Commission's order under Sec.  23.104 of this chapter, 
and the issuance of Capital Comparability Determinations under Sec.  
23.106 of this chapter.
* * * * *

    Issued in Washington, DC, on July 24, 2020, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.

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

Appendices to Capital Requirements of Swap Dealers and Major Swap 
Participants--Commission Voting Summary, Chairman's Statement, and 
Commissioners' Statements

Appendix 1--Commission Voting Summary

    On this matter, Chairman Tarbert and Commissioners Quintenz and 
Stump voted in the affirmative. Commissioners Behnam and Berkovitz 
voted in the negative.

Appendix 2--Supporting Statement of Chairman Heath P. Tarbert

    Today marks 10 years and a day since the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act'') was signed 
into law. Much has changed during the past decade--our derivatives 
markets today are faster, increasingly digital, and more deeply 
connected to the global economy than they were in 2010. Yet amidst 
these changes, there has been at least one constant: The absence of 
capital requirements for swap dealers and major swap participants 
for which the CFTC is responsible.\1\ As a response to the credit 
crisis of 2008, Section 731 of the Dodd-Frank Act amended the 
Commodity Exchange Act (``CEA''), providing that the CFTC ``shall 
adopt'' capital and financial reporting requirements for these 
entities.\2\ It is high time to fulfill this mandate and close the 
book on our Dodd-Frank Act responsibilities.\3\ After all, ``late'' 
is always better than ``too late.''
---------------------------------------------------------------------------

    \1\ The CFTC does not have jurisdiction to establish capital 
requirements for swap dealers subject to the jurisdiction of a 
federal banking regulator as identified in Section 1a(39) of the 
CEA, 7 U.S.C. 1(a)(39) (2018).
    \2\ See Section 4s(e) and 4s(f)(2) of the CEA, 7 U.S.C. 6s(e), 
6s(f)(2) (2018).
    \3\ Section 731 of the Dodd-Frank Act also required the CFTC to 
establish initial and variation margin requirements for uncleared 
swaps, which are being implemented on a phased schedule that 
currently extends to all but the smallest swap market participants. 
See Statement of Chairman Heath P. Tarbert in Support of Extending 
the Phase 5 Initial Margin Compliance Deadline (May 28, 2020), 
https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement052820c.
---------------------------------------------------------------------------

    There is another compelling reason to finalize a capital rule 
that is more than a decade in the making: \4\ Certainty. One of our 
strategic goals as an agency is to enhance the regulatory experience 
for market participants at home and abroad.\5\ Certainty is the 
bedrock of this goal. Our swap dealers cannot effectively plan for 
compliance without clarity from us about what their capital 
obligations will look like. Today we lift this cloud of uncertainty 
by finalizing a capital rule that carefully accounts for the 
differences among our swap dealers.
---------------------------------------------------------------------------

    \4\ The capital rule was first proposed in 2011 and re-proposed 
in 2016. See Capital Requirements of Swap Dealers and Major Swap 
Participants, 76 FR 27802 (May 12, 2011); see also Capital 
Requirements of Swap Dealers and Major Swap Participants, 81 FR 
91252 (Dec. 16, 2016). The comment period was re-opened in December 
2019, allowing the Commission to glean additional insights from 
market participants prior to presenting today's final rule. See 
Capital Requirements of Swap Dealers and Major Swap Participants, 84 
FR 69664 (Dec. 16, 2019).
    \5\ See CFTC Strategic Plan 2020-2024, at 4 (discussing 
Strategic Goal 3), https://www.cftc.gov/media/3871/CFTC2020_2024StrategicPlan/download.
---------------------------------------------------------------------------

    The final capital rule is designed to enhance customer 
protection and reduce systemic risk in the financial system. Capital 
requirements are the ultimate backstop, ensuring that customers are 
protected and the financial system remains sound in the event that 
all other measures fail. While our uncleared margin rules have 
effectively absorbed the shocks of recent pandemic-driven 
volatility,\6\ a capital regime will provide further assurances that 
our markets and their participants can weather new storms.
---------------------------------------------------------------------------

    \6\ Heath Tarbert, Volatility Ain't What it Used to Be, Wall 
Street Journal (Mar. 23, 2020), https://www.wsj.com/articles/volatility-aint-what-it-used-to-be-11585004897.
---------------------------------------------------------------------------

Determining Capital

    The final capital rule requires swap dealers and major swap 
participants to maintain a level of minimum capital based on one of 
three basic approaches. Each approach incorporates minimum amounts 
of capital based on various criteria, including a $20 million floor, 
a level of capital required by the National Futures Association, and 
the amount of margin on uncleared swap transactions. The three basic 
approaches will be the focus of my remarks because they are 
effectively tailored to the distinctive type of swap dealer 
involved.

Regulatory Flexibility

    Our derivatives markets are vibrant in large part because of the 
diversity of swap dealers and other market participants. Of the 108 
provisionally registered swap dealers, 56 will be subject to the 
capital requirements. Of those, four are futures commission 
merchants that are dually registered with the SEC as broker-dealers 
and 12 are non-bank subsidiaries of bank holding companies. Others 
are non-banks that deal in financial swaps involving interest rates, 
foreign currency, credit, and the like; still more are primarily 
engaged in agricultural and energy businesses; and several are 
subject to the laws and regulations of other countries.
    The final capital rule applies to entities with a variety of 
business structures, asset profiles, and risk levels. For example, a 
swap dealer primarily involved in the energy business is 
fundamentally different from a large bank involved in financial 
swaps. A ``one-size-fits-all'' approach would be incompatible with 
the rich gradations in our derivatives markets. As a result, the 
final capital requirements offer regulatory flexibility by 
accounting for key differences among covered entities. This flexible 
approach is designed to enhance the regulatory experience for our 
market participants \7\ while safeguarding the markets, as more 
fully discussed below.
---------------------------------------------------------------------------

    \7\ See CFTC Strategic Plan, supra note 5, at 4.
---------------------------------------------------------------------------

1. Capital Requirements for FCM Swap Dealers

    The CFTC has longstanding capital requirements for Futures 
Commission Merchants (``FCMs'') to ensure customer funds are 
protected in the event of an FCM failure.\8\ The final rule 
preserves existing FCM capital rules for swap dealers that are also 
registered as FCMs, but makes a few key adjustments to better 
address risk and customer protection associated with dealing in 
swaps.
---------------------------------------------------------------------------

    \8\ See Regulation 1.17, 17 CFR 1.17 (2019).
---------------------------------------------------------------------------

    The final rule requires FCM swap dealers to maintain minimum 
capital equal to or greater than the sum of: (i) The current FCM 
risk margin amount of 8% of customer and noncustomer cleared 
futures, cleared foreign futures, and cleared swaps positions; and 
(ii) 2% of the total margin amount associated with uncleared swaps. 
Security-based swaps are excluded from both margin amounts. In 
addition, the final rule increases the $1 million minimum capital 
``floor'' for FCMs to $20 million for FCM swap dealers.
    These changes reflect sound policy. In particular, excluding 
security-based swaps comports with the CFTC's longstanding respect 
for the SEC's jurisdiction over those products. Moreover, excluding 
cleared swaps from the 2% risk margin amount brings our capital 
requirements in line with the lower credit risk posed by cleared 
products. This approach is also consistent with the CFTC's net 
capital requirement for Registered

[[Page 57571]]

Foreign Exchange Dealers,\9\ as well as the SEC's capital rules for 
broker dealers.\10\
---------------------------------------------------------------------------

    \9\ See Section 2(c)(2)(C) of the CEA, 7 U.S.C. 2(c)(2)(C) 
(2018), and Regulation 5.7(a), 17 CFR 5.7(a) (2019).
    \10\ See SEC Rule 240.15c3-1, 17 CFR 240.15C3-1 (2019).
---------------------------------------------------------------------------

2. Capital Requirements for Non-FCM Swap Dealers

    Well-crafted rules must account for the differences among our 
market participants. For swap dealers that are not FCMs, the final 
rule provides three methods of determining minimum capital that 
respond to their different business models, risk profiles, and 
capital structures.\11\
---------------------------------------------------------------------------

    \11\ See Regulation 23.101.
---------------------------------------------------------------------------

a. The Net Liquid Assets Approach

    Some swap dealers have responsibility for customer funds, such 
as those that are dually registered with the SEC as broker dealers. 
For these swap dealers, capital requirements can advance customer 
protection where all else has failed, by providing a ``cushion'' for 
orderly liquidation.\12\ An effective cushion requires liquidity, 
which can be analogized to the readily available cash in one's 
wallet. Consistent with this analogy, swap dealers may select the 
Net Liquid Assets approach in the final rule--requiring them to 
maintain 2% of the margin amount associated with uncleared swaps--
which we believe is sufficient to protect customer funds in the 
event of a liquidation.
---------------------------------------------------------------------------

    \12\ Former SEC Commissioner Dan Gallagher, ``The Philosophies 
of Capital Requirements'' (speech in Washington, DC, Jan. 15, 2014) 
at 1, https://www.sec.gov/news/speech/2014-spch011514dmg.
---------------------------------------------------------------------------

    The Net Liquid Assets approach is not only about customer 
protection: It also facilitates sensible harmonization with SEC 
capital requirements for dual registrants. In doing so, the Net 
Liquid Assets approach supports the CFTC's strategic goal of 
improving the regulatory experience for market participants.\13\
---------------------------------------------------------------------------

    \13\ See CFTC Strategic Plan, supra note 5 at 4 (discussing 
Strategic Goal 3).
---------------------------------------------------------------------------

b. The Bank-Based Approach

    Banks are the backbone of our financial system, and are subject 
to a specific statutory regime managed by the Federal Reserve Board 
and other federal banking regulators. Banks--and by extension their 
non-bank swap dealer subsidiaries--naturally raise greater systemic 
risk concerns than other types of swap dealers.
    While the cash in one's wallet is the appropriate analogy when 
thinking about capital as a measure of customer protection, the 
central role banks play in our financial system requires us to 
consider a much bigger picture. For banks, capital must facilitate 
safety and soundness, ensuring that they act prudently.\14\ The 
personal finance analogy for assessing bank capital, therefore, is 
not just cash-in-wallet, but also savings accounts, checking 
accounts, retirement funds, and other assets.
---------------------------------------------------------------------------

    \14\ See Gallagher, supra note 12, at 1.
---------------------------------------------------------------------------

    This broad view of bank capital as a window into solvency is 
designed to reduce overall risk in the financial system, advancing a 
strategic goal of the CFTC.\15\ As stated in the agency's 2020-2024 
Strategic Plan, ``[t]aking steps to avoid systemic risk will not 
only protect market participants, but increase confidence in the 
soundness of U.S. derivatives markets.'' \16\ Our bank-based capital 
approach is designed to meet this goal.
---------------------------------------------------------------------------

    \15\ See CFTC Strategic Plan, supra note 5, at 5 (discussing 
Strategic Goal 1, which is to strengthen the resilience and 
integrity of our derivatives markets while fostering their 
vibrancy).
    \16\ Id.
---------------------------------------------------------------------------

    Accordingly, swap dealers selecting the Bank-Based Approach may 
satisfy their capital requirements by retaining (i) 8% of risk-
weighted assets (``RWA''), composed of at least 6.5% of tier 1 
common equity (``CET1''), and (ii) 8% of their uncleared swap margin 
amount. Requiring at least 6.5% of a swap dealer's RWA to be 
composed of CET1--the highest-quality regulatory capital--addresses 
potential systemic risk by ensuring that available capital can 
immediately stem losses, avoiding financial contagion. Second, the 
requirement that swap dealers electing the Bank-Based Approach must 
retain 8% of margin for uncleared swaps reflects the uniquely 
critical role they play in the financial system.

c. The Tangible Net Worth Approach

    Finally, some swap dealers are not financial entities, but 
rather commercial businesses engaged in the agriculture and energy 
sectors. These swap dealers help American families put food on the 
table and gas in the car. Unlike financial entities, their balance 
sheets often contain significant physical assets, such as oil 
refineries, grain warehouses, and even railroad rolling stock. Net 
worth--inclusive of physical assets--is the appropriate measure to 
assess minimum capital for these commercial entities. In extending 
our analogy, capital for these swap dealers must be inclusive not 
just of cash or retirement account holdings, but one's house and 
car--the assets that could be pledged as collateral in borrowing.
    The final capital rule recognizes that commercial entities are 
fundamentally different from other swap dealers. This is reflected 
in the Tangible Net Worth (``TNW'') approach, which sets minimum 
capital at 8% of the margin amount for uncleared swaps. Eligibility 
for the TNW approach is determined at the consolidated parent level, 
which allows a financial subsidiary of a commercial entity that is 
registered as a swap dealer to elect the approach.

3. Market and Credit Risk Models

    In addition to capital requirements, today's final rule makes 
important adjustments to the requirements that swap dealers must 
satisfy to rely on internal market and credit risk models rather 
than the standardized models provided in Regulation 1.17. Like 
minimum capital requirements, market and credit risk models will be 
most effective when they reflect a swap dealer's unique business and 
risk profile. In addition, internal models specific to a swap 
dealer's portfolio can provide a more nuanced view of risk than 
standardized models.
    That said, the final rule provides a certification process for 
swap dealers relying on internal market and credit risk models, 
ensuring flexibility while retaining oversight through the National 
Futures Association. Permitting swap dealers to rely on bespoke 
models that best account for their particular situations is good 
governance and enhances the regulatory experience.\17\ At the same 
time, by subjecting those models to objective validation by the 
National Futures Association (and potentially other domestic and 
foreign regulators), there is a check on that flexibility. Further, 
this approach makes the CFTC's model approval process more closely 
aligned with the SEC and federal banking regulators.\18\
---------------------------------------------------------------------------

    \17\ See CFTC Strategic Plan, supra note 5, at 7.
    \18\ The market and credit risk model approval process in the 
final rule is similar to the requirements established by the Federal 
Reserve Board for bank holding companies, as well as the SEC's 
requirements for security-based swap dealers.
---------------------------------------------------------------------------

    Allowing swap dealers to rely on internal risk models is also an 
appropriate instance of principles-based regulation,\19\ as 
prescriptive requirements that do not account for differences among 
firms simply cannot measure risk as accurately as internal models 
that account for key differences among swap dealers.
---------------------------------------------------------------------------

    \19\ For a discussion of the circumstances in which to apply 
principles vs. rules, see Heath P. Tarbert, Rules for Principles and 
Principles for Rules: Tools for Crafting Sound Financial Regulation, 
10 Harvard Business Law Review (2020).
---------------------------------------------------------------------------

4. Financial Reporting

    Today's final rule also adopts financial reporting, 
recordkeeping, and notification requirements for swap dealers and 
major swap participants. These requirements include the obligation 
to provide financial statements and reports to the CFTC and the 
National Futures Association. Most importantly, covered entities 
must alert us when there is undercapitalization, a books and records 
problem, and/or a specified triggering event, such as the failure to 
post required margin. The rule also includes public reporting 
requirements for those swap dealers not subject to the jurisdiction 
of a banking regulator.
    These reporting requirements should serve as early warning 
systems for systemic risk, allowing the CFTC to react quickly to 
emerging threats to financial stability. At the same time, the 
reporting requirements are designed to harmonize, as appropriate, 
with existing financial reporting requirements for FCMs, bank swap 
dealers, and SEC-registered entities. The final rule also eliminates 
weekly position reporting, which does not materially advance our 
ability to monitor systemic risk. In short, balance is the 
touchstone of the financial reporting rules, allowing us to achieve 
greater insight into potential systemic risk without placing undue 
burdens on market participants.

5. Substituted Compliance

    Last, our final rule today accounts for non-U.S. domiciled swap 
dealers by allowing them to petition the CFTC for substituted 
compliance in satisfaction of their capital and financial reporting 
requirements. These swap dealers may seek a comparability 
determination based on the capital and

[[Page 57572]]

financial reporting rules of their home jurisdictions, provided 
certain conditions are met. In providing this option, the final rule 
supports international comity while enhancing the regulatory 
experience for market participants abroad.\20\
---------------------------------------------------------------------------

    \20\ See CFTC Strategic Plan, supra note 5, at 4 (discussing 
Strategic Goal 3).
---------------------------------------------------------------------------

Conclusion

    Today we mark a decade and a day following the enactment of the 
Dodd-Frank Act by completing the CFTC's required rulemakings under 
Section 731. The final capital rule is flexible and tailored, to 
accommodate the wide array of swap dealers that touch every corner 
of our markets. The final rule is also long on customer protection 
and systemic risk mitigation, advancing the CFTC's mission of 
promoting the integrity, resilience, and vibrancy of the U.S. 
derivatives markets through sound regulation. After 10 years of hard 
work by CFTC staff, I am pleased to support the final rule and the 
long-awaited certainty it brings to our markets. Given the current 
economic crisis the world faces in light of the continuing COVID-19 
pandemic, we are fortunate to have a final rule that has come late, 
but not too late.

Appendix 3--Supporting Statement of Commissioner Brian D. Quintenz

    Ten years and one day ago, the Dodd-Frank Act Wall Street Reform 
and Consumer Protection Act was enacted. I am proud to vote for 
today's final rule which, in my view, is the capstone of the 
Commodity Futures Trading Commission's (CFTC or Commission) work to 
appropriately calibrate the post-crisis reforms. Capital ensures 
that firms are able to continue to operate during times of economic 
and financial stress by providing an adequate cushion to protect 
them from losses. Just as important as the safety and soundness of 
individual firms, capital is designed to give the marketplace 
confidence that any given firm has a high probability of surviving 
the next crisis.
    But, capital requirements also create important incentives that 
drive market behavior. The cost of capital may be the most 
determinative factor in a firm's decision to remain, or become, a 
swap dealer (SD), or to continue to provide clearing services to 
clients, in the case of a futures commission merchant (FCM). If 
capital costs are too expensive, firms will restrict certain 
business activities, end unprofitable business lines, or, in some 
cases, exit the swaps or futures markets altogether. As a result, 
over time, the swaps and futures markets will become less liquid, 
less accessible to end users, more heavily concentrated, and less 
competitive. These are not the hallmarks of a healthy financial 
system. This is why I have always regarded the finalization of 
capital requirements for SDs and FCMs to be the most consequential 
rulemaking of the post-crisis reforms.
    I believe the final capital regulations for SDs and FCMs adopted 
today establish minimum capital requirements that will ensure the 
safety and soundness of these firms for years to come, through 
periods of economic growth and stability and through periods of 
market contraction and extreme volatility. They are appropriately 
calibrated to the true risks posed by an SD's or FCM's business and 
ensure these firms have the capital necessary to support their 
active participation in the markets and servicing of clients. They 
are also largely harmonized with the capital approaches of the 
prudential regulators and the Securities and Exchange Commission 
(SEC), which should reduce unnecessary burdens and facilitate 
compliance.
    No rule is perfect. I expect there will be aspects of this rule 
that need to be revised or recalibrated in the future--and I 
specifically discuss some areas below which I would like to see 
revisited. Nevertheless, it is a common saying that you cannot build 
a great house without a solid foundation. I am confident that 
today's capital regulations provide that foundation and will support 
vibrant, healthy derivatives markets, with future Commissions able 
to build upon this progress in the years to come. I would like to 
highlight a few aspects of the final rule below.
    The risk margin amount. We heard from many commenters that, of 
all the alternatives, the proposed eight percent risk margin amount 
would act not as a capital floor as intended, but rather as the 
primary driver of firms' capital requirements and as a potential 
binding constraint on their businesses. The final rule appropriately 
recalibrates the scope of products included in this calculation, 
while also adopting a risk margin amount percentage that is 
appropriately tailored to the capital approach elected by the firm. 
Specifically, the final rule maintains the existing minimum capital 
requirements for standalone FCMs, with those firms continuing to 
maintain minimum capital equal to or greater than 8% of the risk 
margin amount for customer futures and cleared swaps. For FCM-SDs, 
the final rule establishes a minimum capital requirement equal to or 
greater than (i) 8% of the risk margin amount for customer futures 
and cleared swaps, plus (ii) 2% of the risk margin amount for the 
FCM-SD's uncleared swaps. For non-FCM SDs that elect the Net Liquid 
Assets Approach, the Final Rule requires the firm to maintain 
minimum capital equal to or greater than 2% of the SD's uncleared 
swap margin. For non-FCM SDs electing either the Bank-Based Approach 
or the Tentative Net Worth Approach, the final rule establishes a 
minimum capital requirement equal to or greater than 8% of the 
firm's uncleared swap margin. For the reasons discussed below, I 
believe each of these adjustments from the proposal represents an 
improvement that more precisely tailors the capital requirements of 
a firm to its particular business and its selected capital approach.
    I support the removal of a firm's cleared and uncleared 
security-based swaps (SBS) from the risk margin amount calculation. 
It is appropriate that the Commission maintain its historical 
approach and establish minimum capital requirements for registrants 
that are based upon products within the CFTC's jurisdiction. I am 
also very pleased that proprietary cleared futures and swaps were 
removed from the risk margin amount. FCMs, FCM-SDs, and SDs electing 
the Net Liquid Assets Approach are all subject to rigorous market 
and credit risk capital charges on these proprietary cleared 
positions. I believe these capital charges adequately account for 
the risk of these positions and there is no reason to account for 
them yet again in the firm's minimum capital requirement. Moreover, 
for SDs that elect one of the other capital approaches, I also 
believe it is appropriate to exclude proprietary cleared positions 
given that the SD's credit exposure on such positions is limited to 
either a clearing organization or to the FCM that carries the SD's 
account.
    Finally, I also support the reduced 2% risk margin multiplier 
amount on uncleared swap margin for FCMs, FCM-SDs, and SDs electing 
the Net Liquid Assets Approach, while maintaining the 8% multiplier 
for other types of standalone SDs. Under the FCM capital rules and 
the Net Liquid Assets Capital Approach for standalone SDs, the types 
of capital that may be used to meet a firm's minimum capital 
requirement are significantly more conservative than the types of 
capital that may be used under the Bank-Based Capital Approach and 
the Tangible Net Worth Capital Approach. The Net Liquid Assets 
Approach is liquidity-focused and generally requires the firm to 
hold at least one dollar of highly liquid assets for each dollar of 
the firm's liabilities. As a result, when computing what qualifies 
as eligible capital under this approach, firms must subtract all 
illiquid assets, such as fixed assets and intangible assets. In 
contrast, the other capital approaches focus on the solvency of the 
firm and require the firms to maintain positive balance sheet 
equity. Under these approaches, firms are not required to subtract 
illiquid assets or fixed assets from their balance sheet equity. 
Given the significantly more restrictive standard for qualifying 
eligible capital under the Net Liquid Assets Approach, I think it is 
appropriate to lower the risk margin multiplier to 2% in order to 
minimize competitive disparities across the other two capital 
approaches.
    The final rule also expresses the Commission's ongoing 
commitment to monitor, and if necessary, adjust, the risk margin 
percentage. This should only be done, however, with a wealth of data 
and a highly robust economic analysis. With the benefit of the 
financial reporting the Commission will soon receive from SDs, the 
Commission may be able to further refine this metric to promote 
consistency across the possible SD capital approaches.
    Bank-based capital approach. In response to commenters, the 
final rule now permits firms to use a combination of common equity 
tier 1, additional tier 1, and tier 2 capital to meet its minimum 
capital requirements under both the 8% of risk-weighted assets and 
8% of uncleared swap margin alternatives. In particular, with 
respect to the 8% of uncleared swap margin alternative, the rule 
does not limit the amounts of additional tier 1 or tier 2 capital 
the firm can use to meet the requirement. Because of this additional 
flexibility, the final rule requires firms electing this approach to 
satisfy all of the four possible minimum capital alternatives.

[[Page 57573]]

The Commission will need to closely observe the impact of this 
change to ensure it does not create any competitive disadvantages 
for firms electing this approach. I anticipate that if additional 
data and analysis shows this outcome creates unintended 
consequences, the Commission will take action to address them.
    Model approval process. I am also pleased with the model 
approval process established in the final rule, which allows the 
Commission to realize the benefits of the NFA's considerable 
expertise and resources. Once the Commission, or the Director of the 
Division of Swap Dealer and Intermediary Oversight (DSIO) pursuant 
to delegated authority, makes a determination that the NFA's model 
review process is comparable to the Commission's process, the NFA's 
approval of a model will satisfy the Commission's model approval 
requirement. In addition, for a firm utilizing a model that has 
already been approved by its relevant regulator, the final rule 
provides a process whereby, upon making certain representations, the 
firm can continue to use the model pending approval by the 
Commission or NFA. These steps help ensure that firms seeking to use 
models will be able to do so by the rule's compliance date.
    Areas for further improvement. As I noted above, no rule is 
perfect. I would like to briefly highlight three areas not addressed 
in this final rule that I hope the Commission will address in the 
future.
    Standardized market risk capital charges. First, this final rule 
does not adjust any of the standardized market risk charges under 
Regulation 1.17. I believe that many of these standardized charges 
are too high given the liquidity and actual risks of the product. 
For example, the final rule applies a 20% notional standardized 
market risk charge on uncleared foreign exchange non-deliverable 
forwards. In contrast, the Commission's uncleared margin rules apply 
a 6% notional charge on these products for purposes of the 
standardized initial margin calculation. I hope that in the future 
the Commission can work with the SEC to recalibrate and update these 
charges to better reflect the risks of the underlying products.
    Alternative forms of collateral. Second, I hope that with the 
benefit of experience and information received from financial 
reporting, the Commission will consider modifying its rules to 
recognize alternative forms of collateral, such as letters of credit 
or liens, provided by commercial end users that are exempt from 
clearing and margin requirements when computing credit risk charges. 
Alternative collateral arrangements are frequently used by SDs in 
commodity derivatives transactions with end users to create ``right 
way'' risk and can be effective means of managing the credit risk of 
certain derivatives transactions. I think it would be beneficial for 
the Commission's capital regime to recognize, as appropriate, the 
risk-reducing nature of these arrangements.
    Net liquid assets approach. Third, I am also interested in 
continuing to explore commenters' suggestion that firms electing the 
Net Liquid Assets Approach be required to maintain tentative net 
capital in excess of the risk margin amount, as opposed to the 
current net capital requirement. I continue to have concerns that in 
periods of high volatility, the procyclicality of increasing margin 
requirements may cause unnecessary stress on these firms, as their 
capital charges for positions increase at the same time as their 
minimum capital requirement. I am interested in looking at possible 
adjustments that could be made to address this issue.
    In closing, I believe the capital regime adopted today strikes 
the necessary balance between capital levels that protect firms from 
losses on certain products, and levels that allow firms to earn an 
economic benefit from servicing their customers' risk management 
needs through those products. There is a direct tradeoff between the 
amount of capital regulators require firms to hold to ensure firms' 
resilience and viability, and the amount of available capital firms 
have to deploy in financial markets to support the market's ongoing 
liquidity and health. The capital standards adopted today protect 
the safety and soundness of firms, while ensuring they can continue 
to service their clients and make markets.
    I would also like to thank DSIO, in particular Tom Smith, for 
their thoughtfulness and tireless dedication to getting this rule 
right. It has truly been a pleasure to work with and learn from you 
throughout this process.

Appendix 4--Dissenting Statement of Commissioner Rostin Behnam

    I respectfully dissent from the Commodity Futures Trading 
Commission's (the ``Commission'' or ``CFTC'') rulemaking today 
regarding Capital Requirements of Swap Dealers and Major Swap 
Participants (the ``Final Capital Rule'').

Ten Years of Dodd-Frank

    Yesterday marked ten years since Congress passed the Dodd-Frank 
Wall Street Reform and Consumer Protection Act.\1\ Congress passed 
Dodd-Frank as a targeted legislative response to the 2008 financial 
crisis and the near obsolescence of the U.S. financial regulatory 
framework. The Great Recession wreaked havoc on Main Street 
Americans and the global economy. Undercapitalization was at the 
heart of the 2008 crisis, and the swift response to require 
financial institutions to hold additional capital mitigated both the 
blunt economic shock we endured this past March, and the substantial 
weight we continue to shoulder as a result of the Covid-19 pandemic.
---------------------------------------------------------------------------

    \1\ See The Dodd-Frank Wall Street Reform and Consumer 
Protection Act, Public Law 111-203 124 Stat. 1376 (2010) (the 
``Dodd-Frank Act'').
---------------------------------------------------------------------------

    Section 731 of the Dodd-Frank Act \2\ requires the CFTC to 
establish capital rules for all registered Swap Dealers (``SDs'') 
and Major Swap Participants (``MSPs'') that are not banks, as well 
as associated financial recordkeeping and reporting requirements. 
The capital requirements in Section 731, which established Section 
4s(e) of the Commodity Exchange Act (``the Act''), are clear: ``. . 
. [t]o offset the greater risk to the swap dealer or major swap 
participant and the financial system arising from the use of swaps 
that are not cleared,'' the Commission's capital requirements shall 
``help ensure the safety and soundness of the swap dealer or major 
swap participant'' and ``be appropriate to the risk associated with 
the non-cleared swaps held as a swap dealer or major swap 
participant.'' \3\ There can be no doubt that Congress intended to 
impose significant new requirements that would contribute to the 
protection from another financial crisis.
---------------------------------------------------------------------------

    \2\ Id.at section 731(e), 124 Stat. at 1704-6.
    \3\ Section 4s(e)(3) of the Commodity Exchange Act (``the 
Act''), 7 U.S.C. 6s(e)(3).
---------------------------------------------------------------------------

    Congress's 2010 response largely incorporated the international 
financial reform initiatives for over-the-counter derivatives laid 
out at the 2009 G20 Pittsburgh Summit aimed at improving 
transparency, mitigating systemic risk, and protecting against 
market abuse.\4\ One of the core initiatives in the G20 statement 
was the imposition of higher capital requirements. Paragraph 16 of 
the statement provides the purpose the G20 leaders agreed to aim 
for: ``To make sure our regulatory system for banks and other 
financial firms reins in the excesses that led to the crisis.'' \5\ 
Paragraph 17 then lays out what the G20 leaders agreed to do to rein 
in the excesses, and the first item is this: ``We committed to act 
together to raise capital standards.'' \6\ The G20 leaders said 
unequivocally that, for over-the-counter derivatives markets, 
``[n]on-centrally cleared contracts should be subject to higher 
capital requirements.'' \7\ Congress had this same goal in mind when 
enacting the Dodd-Frank Act a decade ago.\8\
---------------------------------------------------------------------------

    \4\ G20, Leaders' Statement, The Pittsburgh Summit (Sept. 24-25, 
2009), available at https://www.oecd.org/g20/summits/pittsburgh/.
    \5\ Id. at 2.
    \6\ Id.
    \7\ Id. at 9.
    \8\ See Statement of Sen. Christopher Dodd, Cong. Rec., Vol. 
156, Issue 104, S5828, S5832 (July 14, 2010) (``Derivatives are 
vitally important if utilized properly in terms of wealth creation 
and growing an economy. But what was once a way for companies to 
hedge against sudden price shocks has become a profit center in and 
of itself, and it can be a dangerous one as well, when dealers and 
other large market participants don't hold enough capital to back up 
their risky bets and regulators don't have information about where 
the risks lie.'').
---------------------------------------------------------------------------

Three and a Half Years of the Capital Proposal

    In 2016, the Commission issued a bipartisan proposal to 
implement capital requirements as directed by Congress through 
Section 731 of the Dodd-Frank Act.\9\ The Commission now jumps from 
a proposal issued in 2016 to a significantly different final rule 
nearly four years later, without any intervening reproposal to 
provide interested market participants clear proposed capital 
requirements to meaningfully comment upon. In so doing, the 
Commission undermines the spirit of the Dodd-Frank Act and violates 
the letter of the Administrative Procedure Act (``APA'').\10\
---------------------------------------------------------------------------

    \9\ Capital Requirements of Swap Dealers and Major Swap 
Participants, 81 FR 91252 (proposed Dec. 16, 2016) (the ``2016 
Proposal'').
    \10\ 5 U.S.C. 551 et seq.
---------------------------------------------------------------------------

    The preamble to the Final Capital Rule asserts that all of the 
actions taken today are

[[Page 57574]]

a ``logical outgrowth'' from the 2016 Proposal.\11\ The preamble 
even goes a step further, arguing that ``modifications described in 
the 2019 Capital Reopening, including a discussion and specific 
inclusion of potential rule language, were logical outgrowths'' of 
the 2016 Proposal.\12\ This simply cannot be true if the requirement 
that a final rule is a logical outgrowth of an agency's proposed 
rule is to have any meaning at all.\13\
---------------------------------------------------------------------------

    \11\ Final Capital Rule at 1.B.
    \12\ Id.; Capital Requirements for Swap Dealers and Major Swap 
Participants, 84 FR 69664 (Dec. 19, 2019).
    \13\ See Small Refiner Lead Phase-Down Task Force v. United 
States Envtl. Prot. Agency, 705 F.2d 506, 548-49 (D.C. Cir. 1983) 
(``Agency notice must describe the range of alternatives being 
considered with reasonable specificity. Otherwise, interested 
parties will not know what to comment on, and notice will not lead 
to better-informed agency decisionmaking.'').
---------------------------------------------------------------------------

    The changes in the Final Capital Rule to the amount of capital 
that a futures commission merchant SD (FCM-SD) must maintain are 
illustrative of the point. The 2016 Proposal would have required an 
FCM-SD to maintain regulatory capital equal to or greater than 8% of 
the initial margin associated with the FCM-SD's proprietary cleared 
and uncleared futures, foreign futures, swap, and security-based 
swap positions. In 2019, the Commission reopened the comment period 
on the 2016 Proposal.\14\ In the Federal Register release announcing 
the 2019 reopening, the Commission sought additional public input 
based on an initial review of comments received from the 2016 
Proposal on myriad alternatives, seeking comment ``on all aspects of 
the proposed risk margin amount, including comments regarding the 
possible increase or decrease of the risk margin percentage in 
coordination with the inclusion or exclusion of certain products in 
order to establish the most optimal capital requirement.'' \15\ 
This, in many respects, is a blank check. Not only does it allow for 
any conceivable percentage of risk margin, it simultaneously opens 
up multiple combinations of inputs. The Commission now states that 
any of the possible outcomes along this sliding scale would have 
been a logical outgrowth. It is the equivalent of saying that the 
Final Capital Rule is a logical outgrowth because it imposes any 
capital requirements at all, and that simply cannot be the case 
under the legal intent and plain reading of the principle of logical 
outgrowth.
---------------------------------------------------------------------------

    \14\ 84 FR 69664.
    \15\ Id. at 69668.
---------------------------------------------------------------------------

A Final Capital Rule (and Five Years of Review)

    Where did the Commission end up? The Commission decides today to 
set the multiplier for the uncleared swaps of FCM-SDs at 2%, rather 
than the 8% originally proposed. The Commission also is modifying 
the final rule from the proposal to remove security-based swaps, 
proprietary futures, foreign futures, and cleared swaps from the 
risk margin amount calculation. These are significant changes from 
the 2016 proposal, and they are just one of the possible outcomes 
suggested in the reopening of the comment period.
    I am not sure if 2% is the appropriate landing spot to insulate 
our markets from outsize risk. And based on the preamble to this 
Final Capital Rule, I do not think the Commission is certain either. 
The preamble states that the Commission does not have the data to 
determine whether or not 2% is the optimal or even adequate 
percentage.\16\ Instead, the Commission chooses 2% with the intent 
that ``the Commission's decision to modify the final rule by 
removing cleared and uncleared security-based swaps, as well as 
proprietary futures, foreign futures, and cleared swaps positions 
from the risk margin amount calculation, and to set the multiplier 
at 2% should mitigate many of the commenters' concerns that the 
proposed 8% risk margin amount calculation was over inclusive of the 
types of positions included in the calculation and was set at a 
percentage that was too high.'' \17\ Due to this lack of data, the 
Commission will need to conduct a 5-year post implementation review 
``to assess whether the minimum capital requirements for FCM-SDs are 
adequately calibrated to ensure their safety and soundness.'' \18\ 
And I applaud the Commission for including this critical regulatory 
component of the capital regime's implementation. However, this 
information is exactly the type of data that the Commission would 
have benefited from during the notice and comment process. By 
failing to issue a reproposal in 2019, allowing just a few 
additional months of concrete, data driven deliberation, which could 
have clearly stated a specific approach, we lost the opportunity to 
find out whether the minimum capital requirements that we selected 
are adequately calibrated to ensure safety and soundness.
---------------------------------------------------------------------------

    \16\ Final Capital Rule at II.B.2.b. (``The Commission does not 
have the benefit of . . . comprehensive data regarding the 
multiplier for the uncleared swaps risk margin amount at this 
time.'')
    \17\ Id.
    \18\ Id.
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    Because of the lack of clarity in the reopening of the comment 
period, we again received more general comments that 8% was too 
high. In justifying the selection of 2%, the preamble states that 
``2% should mitigate many of the commenters' concerns that the 
proposed 8% risk margin amount calculation was over inclusive of the 
types of positions included in the calculation and was set at a 
percentage that was too high.'' \19\ Because we did not provide a 
clear alternative, we again received comments on 8% rather than 
comments on 2%, or on some alternative.
---------------------------------------------------------------------------

    \19\ Id.
---------------------------------------------------------------------------

    Ultimately, this lack of information gathering impacts the CFTC 
and results in a Final Capital Rule that has not benefited from 
fulsome public comment. However, the impacts on our market 
participants are greater. They have been denied the ability to 
comment meaningfully. This is particularly true of the cost benefit 
analysis. Broadly asking stakeholders to comment on any variation 
results in a situation where no one had an opportunity to comment on 
anything approximating what the Commission has done in its Final 
Capital Rule. As a result, this rule ultimately derived from a 
process that is, in many respects, equivalent to not soliciting 
comments from the public and market participants at all.\20\
---------------------------------------------------------------------------

    \20\ See Texas v. United States EPA, 389 F.Supp. 3d. 497, 505 
(S.D. Tex. 2019) (``The APA does not envision requiring interested 
parties to parse through such vague references like tea leaves to 
discern an agency's regulatory intent regarding such significant 
changes to a final rule'').
---------------------------------------------------------------------------

    I note that, less than a month ago, the Commission voted to 
withdraw the Regulation Automated Trading proposal (``Regulation 
AT''),\21\ the most recent iteration of which had been issued in 
November 2016, a couple of weeks before the 2016 Proposal.\22\ At 
the same time that Regulation AT was withdrawn, the Commission 
issued a rebranded Electronic Trading Risk Principles proposal 
intended to ``accomplish a similar goal'' to the original Regulation 
AT.\23\ Following the logic set forth today for the Final Capital 
Rule, the Commission could have simply issued a final rule for 
Electronic Trading Risk Principles last month, arguing that it was 
merely a logical outgrowth of the latest iteration of Regulation AT. 
While I disagreed with last month's policy decision, procedurally 
the Commission did the right thing under the APA. We should have 
followed the same procedure for capital, and issued a 
reproposal.\24\ If we had done so last December, we could have 
received meaningful comments from market participants on a clearly 
stated reproposal, and we could well have been in position to 
finalize a stronger, more carefully considered Final Capital Rule 
today that addresses current market conditions in a manner that is 
more data driven.
---------------------------------------------------------------------------

    \21\ Press Release Number 8188-20, CFTC, CFTC Approves Two Final 
Rules and Two Proposed Rules at June 25 Open Meeting (June 25, 
2020), https://www.cftc.gov/PressRoom/PressReleases/8188-20.
    \22\ Regulation Automated Trading, 81 FR 85333 (proposed Nov. 
25, 2016).
    \23\ Electronic Trading Risk Principles (proposed Jun. 25, 
2020), at I.B.
    \24\ Statement of Dissent of Commissioner Rostin Behnam, Capital 
Requirements of Swap Dealers and Major Swap Participants (Dec. 10, 
2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement121019.
---------------------------------------------------------------------------

Conclusion

    Before I conclude, I would like to thank staff from the Division 
of Swap Dealer and Intermediary Oversight for their excellent work 
on this highly technical and complex rulemaking, and willingness to 
answer my questions and take feedback.
    While I would have liked to stand with my fellow Commissioners 
today, I cannot justify it under these circumstances. I truly wish 
that I could support today's Commission action as we mark the tenth 
anniversary of the Dodd-Frank Act this week. To reiterate sentiments 
made in my first speech as a CFTC Commissioner,\25\ capital is a

[[Page 57575]]

cornerstone financial crisis reform \26\ that is critical to 
protecting our financial institutions and our financial system as a 
whole from systemic risk and contagion. But it is also critical to 
protection from unintended consequences if capital (and margin) 
levels are applied and set without due regard to the uniqueness of 
our financial markets and market participants.
---------------------------------------------------------------------------

    \25\ See Rostin Behnam, Commissioner, CFTC, The Dodd-Frank 
Inflection Point: Building on Derivatives Reform, Remarks of CFTC 
Commissioner Rostin Behnam at the Georgetown Center for Financial 
Markets and Policy (Nov. 14, 2017), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam.
    \26\ G20, Leaders' Statement, Framework for Strong, Sustainable 
and Balanced Growth, The Pittsburgh Summit (September 24-25 2009), 
https://www.g20.utoronto.ca/2009/2009communique0925.html (``We 
committed to act together to raise capital standards . . .'').
---------------------------------------------------------------------------

    I appreciate that in moving forward, we must fulfill our 
directive to establish capital standards appropriately, and in 
consideration of other activities engaged in by SDs and MSPs such 
that we ensure that we do not penalize commercial end-users who need 
choices and benefit from competition in our markets. At the same 
time, we must heed Congressional intent without any compromise, 
regardless of what we think is best, remaining cognizant of the 
impact that capital requirements have on market stability, and 
follow APA rulemaking requirements when we do so.
    Shortly before the Commission voted on the reopening in 
December, 2019, Chairman Tarbert gave remarks about transparency 
\27\, making many very powerful and important points about the 
incredible importance of being mindful--as regulators--of ``. . . 
not only what we do, but how we do it.'' \28\ The Chairman ended 
that particular statement with a wonderful quote from Aristotle. 
Among many profound lessons from the Greek philosopher, he is also 
sometimes credited with the statement that ``[p]atience is bitter, 
but its fruit is sweet.'' In that vein, I simply wish the Commission 
had devoted a little bit more time to how we fulfill this 
foundational Dodd-Frank requirement.
---------------------------------------------------------------------------

    \27\ Heath P. Tarbert, Chairman, CFTC, Statement of Chairman 
Heath P. Tarbert Before the December 10, 2019 Open Meeting (Dec. 10, 
2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement121019.
    \28\ Id.
---------------------------------------------------------------------------

    The road has been long, far too long in many respects. But, 
unsure of what deadlines we are racing to meet at this point, or 
targets we are aiming to hit, I feel strongly the Commission and our 
markets, would have stood on sturdier ground, and perhaps even have 
landed at the same conclusion voted on today, if we had practiced a 
little patience.

Appendix 5--Dissenting Statement of Commissioner Dan M. Berkovitz

    Today, for the first time, the Commission adopts capital 
requirements for non-bank swap dealers (``Final Rule''). This is the 
last major swap dealer regulation required under the Dodd-Frank Act. 
The Dodd-Frank Act specified that the swap dealer capital 
requirement ``shall--(i) help ensure the safety and soundness of the 
swap dealer or major swap participant; and (ii) be appropriate for 
the risk associated with the non-cleared swaps held as a swap dealer 
or major swap participant.'' \1\
---------------------------------------------------------------------------

    \1\ CEA section 4s(e)(3)(A).
---------------------------------------------------------------------------

    Unfortunately, there is no rational basis to conclude that the 
minimum capital requirements in the Final Rule meet those standards 
and serve their intended purpose. The Final Rule is not based on 
quantitative analysis of data or the appropriate level of capital 
for the risks presented by a swap dealer. Rather, it appears to be 
designed with the objective of ensuring that most dealers will not 
need to raise more capital. In its consideration of costs and 
benefits, the Commission concludes that, depending on the type of 
swap dealer, ``the likelihood of . . . needing to raise additional 
capital due to this rule might be low,'' ``may not be significant,'' 
or ``that their tangible net worth greatly exceeds the Commission's 
requirement.'' \2\ For this reason, I dissent.
---------------------------------------------------------------------------

    \2\ Final Capital Rule release, Cost Benefit Considerations, 
Attachment A. The analysis also notes that a few non-bank financial 
swap dealers ``might need to raise additional capital and thus might 
incur significant cost to comply with the Commission's capital 
requirement.''
---------------------------------------------------------------------------

No Rational Basis To Conclude That Minimum Capital Levels Are 
Appropriate

    The Final Rule permits swap dealers, depending on their 
characteristics, to select one of three different approaches to 
calculate their minimum capital requirements. The approaches are 
identified as the: (1) ``Net Liquid Assets Capital Approach,'' (2) 
``Bank-Based Capital Approach,'' and (3) ``Tangible Net Worth 
Capital Approach.'' The first two approaches are based on existing 
CFTC, Securities and Exchange Commission (``SEC''), and Federal 
Reserve capital requirements for futures commission merchants 
(``FCMs''), securities broker-dealers (``BDs''), and banks. The 
third approach is designed to accommodate commercial swap dealers 
whose capital is normally in the form of physical assets.
    These methods are based on existing holistic, all-enterprise 
capital approaches that take into account a broad spectrum of risks. 
They are not necessarily suited to the swap dealers subject to the 
CFTC capital requirements, which are mostly stand-alone legal 
entities for swap dealing. Accordingly, it is not clear that these 
methodologies will generate capital requirements that are 
``appropriate for the risk associated with the non-cleared swaps 
held as a swap dealer or major swap participant.'' \3\ However, 
using those precedents has some advantages in that it allows the 
different types of swap dealers to manage capital using known 
structures. While these historical approaches were not specifically 
designed to be able to meet the statutory standard, it may be 
possible to achieve the intended outcome using these structures if 
the specific methods, limits, and other factors had been developed 
based on the swap dealer specific standard. Unfortunately, this did 
not happen.
---------------------------------------------------------------------------

    \3\ CEA section 4s(e)(3)(A).
---------------------------------------------------------------------------

    In December 2016, the Commission issued a re-proposal of the 
previously proposed capital regulations (``2016 Re-Proposal'') \4\ 
that contained minimum capital requirements in each approach that 
were largely based on existing levels for FCM capital requirements. 
The 2016 Re-Proposal included cleared and uncleared swaps and 
uncleared security-based swaps in the calculation of the minimum 
requirements.
---------------------------------------------------------------------------

    \4\ Proposed Rule, Capital Requirements of Swap Dealers and 
Major Swap Participants, 81 FR 91252 (Dec. 16, 2016).
---------------------------------------------------------------------------

    Commenters objected that the 2016 Re-Proposal was too costly and 
burdensome. At the end of last year the Commission, by a 3-2 vote, 
issued a second re-proposal (``2019 Second Re-Proposal'') consisting 
of over 140 mostly open-ended questions designed to invite comments 
supporting reduced minimum capital requirements or otherwise lower 
the costs for swap dealers to comply.\5\
---------------------------------------------------------------------------

    \5\ For a more in-depth discussion of the procedural and 
substantive problems inherent in the 2019 Second Re-Proposal, see 
Dissenting Statement of Commissioner Dan M. Berkovitz, ``Proposed'' 
Rule and ``Request for Additional Comment'' on Capital Requirements 
of Swap Dealers and Major Swap Participants (Dec. 10, 2019), 
available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatment121019b.
---------------------------------------------------------------------------

    Not surprisingly, the Final Rule adopts numerous provisions that 
are weaker than the 2016 Re-Proposal. The preamble to the Final Rule 
identifies ``lower capital charges,'' ``harmonization,'' and 
consistency with ``historical'' precedent as rationales for these 
provisions.
    While the Commission makes conclusory statements that the rule 
helps ``ensure the safety and soundness'' of the swap dealers, there 
is little or no analysis supporting these assertions. Similarly, 
there is no analysis as to how or why these capital levels are 
``appropriate for the risk associated with the non-cleared swaps 
held as a swap dealer or major swap participant.''
    The capital requirements for dually-registered FCM/BDs that are 
also swap dealers illustrate how this approach leads to arbitrary 
results from a risk-based perspective. Under the 2016 Re-Proposal, 
in addition to capital required to be held for non-swap activity, 
the FCM/BD swap dealer would be required to hold capital equal to a 
minimum of 8% of initial margin for uncleared swaps, security-based 
swaps, and certain futures positions of the swap dealer. As 
explained in the 2016 Re-Proposal, the 8% multiplier level is drawn 
from the Commission's experience with its risk-based capital 
requirements for FCMs.\6\
---------------------------------------------------------------------------

    \6\ See 17 CFR 1.17(a)(1)(i)(B).
---------------------------------------------------------------------------

    Based on comments received on the prior proposals, and on the 
desire to ``harmonize'' with the SEC, the Final Rule lowers the 
capital add-on multiplier level to 2%, and only applies the 
multiplier to uncleared swaps initial margin.\7\ Security-based 
swaps are not included in the calculation based on the rationale 
that only swaps are within the CFTC's jurisdiction. If the entity is 
also registered with the SEC and the SEC's capital requirements are 
greater than the CFTC's, then the entity can use the SEC's 
requirement with no add-on for uncleared swaps. The Commission makes 
these changes not based on any analysis of the risk to the 
registrant,

[[Page 57576]]

but because this approach ``maintains a consistency with the long-
standing historical approach that the Commission and SEC have 
followed with respect to dually-registered FCM/BDs.'' \8\
---------------------------------------------------------------------------

    \7\ While the Final Capital Rule selectively picks the 2% level 
purportedly to ``harmonize'' with the SEC's security-based swap 
dealer capital rule, the final rule uses different formulas and 
positions for the calculation. Furthermore, the SEC's rule has a 
built-in increase in the multiplier from 2% to 8% over time. The 
CFTC Final Capital Rule expressly choses to deviate from that SEC 
approach and has no such increases.
    \8\ Final Rule release, section II.C.2.
---------------------------------------------------------------------------

    The following example shows how this approach can result in an 
arbitrary outcome from a risk perspective. Under the Final Rule, if 
the amount of uncleared swap margin for an FCM that is not a BD is 
$1 billion, multiplying that amount by 2% yields a minimum capital 
add-on of $20 million. Similarly, under the SEC's capital rule, for 
a securities-based swap dealer that is not an FCM with $1 billion of 
required margin for uncleared security-based swaps, a 2% add-on 
would be $20 million.\9\ Now, let's consider the add-on for a 
dually-registered FCM/BD. Each of the CFTC and SEC capital rules 
individually require that the minimum capital requirements include 
capital based on either the uncleared swap positions or the 
uncleared security-based swap positions, respectively, but not the 
aggregate of both types of positions. A dually-registered firm with 
the same aggregate risk margin amount of $1 billion, but split half 
to swaps and half to security-based swaps, would be required to 
reserve $10 million ($500 million * 2%). Thus, the dually-registered 
firm with a total initial margin requirement of $1 billion held for 
a portfolio split evenly between swaps and security-based swaps 
would be required to reserve only half the capital required for the 
same amount of initial margin held for a portfolio that was either 
all swaps or all security-based swaps. For such dually-registered 
firms, the amount of capital required to be held may ultimately be 
based on irrelevant and arbitrary considerations of ``historical 
precedent'' and agency jurisdiction rather than swap risk-based 
calculations.
---------------------------------------------------------------------------

    \9\ While it is acknowledged that this example is somewhat 
simplified from the calculations and absolute minimum amounts 
specified in both the CFTC and SEC capital rules, the example 
illustrates a possible outcome of the rules.
---------------------------------------------------------------------------

Financial Data and Monitoring Capital Sufficiency

    The capital requirements for swap dealers are one of the most 
complex and highly technical areas in our regulations. The swap 
dealers subject to the CFTC capital requirements vary significantly 
and include (i) very large FCMs and/or BDs registered with the CFTC 
and the SEC; (ii) U.S. and foreign affiliates of banking 
organizations; (iii) large commercial enterprises and affiliates 
thereof; and (iv) other financial companies that are not affiliated 
with banks. Each grouping has unique capital structures. 
Furthermore, there was little available quantitative financial 
accounting data for the swap activities of these entities to 
calibrate the appropriate levels of capital. Given this complex and 
technical backdrop, the Final Rule notes in several places that the 
Commission will gather and analyze the new financial reporting data 
now required under the rule and may reassess components of the rule 
to determine whether it needs to be amended to be better fit for 
purpose. I strongly support that effort and will follow this 
monitoring and analysis closely.

Substituted Compliance for Capital Requirements

    Under the Final Rule, swap dealers organized and domiciled 
outside of the United States, including many subsidiaries of U.S. 
firms, can satisfy the capital requirements by complying with the 
capital requirements of the country of their domicile if the 
Commission grants substituted compliance. The methods and standards 
for such a determination are similar to those to be established in 
the final cross-border swap regulations scheduled for consideration 
by the Commission tomorrow. Unfortunately, those methods and 
standards are substantively weaker than the standards currently used 
by the Commission and may result in outsourcing swap dealer capital 
oversight to other jurisdictions where not appropriate.

Conclusion

    Notwithstanding my dissent, I want to once again acknowledge the 
complexity and highly technical nature of the capital requirements. 
Given these difficulties, I would like to recognize the hard-working 
staff of the CFTC for their efforts in fashioning the Final Rule. 
Some of you spent many a late night addressing comments and 
questions and revising the rule release. While I cannot support the 
outcome, I nonetheless appreciate and thank you for the dedication 
you bring to your work here at the CFTC.
    Unfortunately, the rule the Commission will be adopting today is 
simply an affirmation of the status quo. This is not what Congress 
intended when it directed the CFTC to adopt capital requirements 
``appropriate for the risk'' presented by uncleared swap activities 
of swap dealers. For this reason, I dissent.

[FR Doc. 2020-16492 Filed 9-14-20; 8:45 am]
BILLING CODE 6351-01-P

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