Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 53409-53431 [2023-16572]
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[FR Doc. 2023–16722 Filed 8–7–23; 8:45 am]
BILLING CODE 4910–13–P
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Part 23
RIN 3038–AF36
Margin Requirements for Uncleared
Swaps for Swap Dealers and Major
Swap Participants
Commodity Futures Trading
Commission
ACTION: Notice of proposed rulemaking.
AGENCY:
The Commodity Futures
Trading Commission (‘‘Commission’’ or
‘‘CFTC’’) is proposing to amend the
margin requirements for uncleared
swaps applicable to swap dealers
(‘‘SDs’’) and major swap participants
(‘‘MSPs’’) for which there is no
prudential regulator. The proposed
amendment would revise the definition
of ‘‘margin affiliate’’ to provide that
certain collective investment vehicles
(‘‘investment funds’’ or ‘‘funds’’) that
receive all of their start-up capital, or a
portion thereof, from a sponsor entity
(‘‘seeded funds’’) would be deemed not
to have any margin affiliates for the
purposes of calculating certain
thresholds that trigger the requirement
to exchange initial margin (‘‘IM’’) for
uncleared swaps. This proposed
amendment (‘‘Seeded Funds Proposal’’)
would effectively relieve SDs and MSPs
from the requirement to post and collect
IM with certain eligible seeded funds for
their uncleared swaps for a period of
three years from the date on which the
eligible seeded fund’s asset manager
first begins making investments on
behalf of the fund (‘‘trading inception
date’’). The Commission is also
proposing to eliminate a provision
disqualifying the securities issued by
certain pooled investment funds
(‘‘money market and similar funds’’)
that transfer their assets through
securities lending, securities borrowing,
repurchase agreements, reverse
repurchase agreements, and similar
arrangements from being used as
eligible IM collateral, thereby expanding
the scope of assets that qualify as
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eligible collateral (‘‘Money Market
Funds Proposal’’). Additionally, the
Commission is proposing an
amendment to the haircut schedule set
forth in a Commission Regulation to add
a footnote that was inadvertently
omitted when the rule was originally
promulgated.
With respect to the proposed
amendments, comments must be
received on or before October 10, 2023.
ADDRESSES: You may submit comments,
identified by RIN 3038–AF36, by any of
the following methods:
• CFTC Comments Portal: https://
comments.cftc.gov. Select the ‘‘Submit
Comments’’ link for this rulemaking and
follow the instructions on the Public
Comment Form.
• Mail: Send to Christopher
Kirkpatrick, Secretary of the
Commission, Commodity Futures
Trading Commission, Three Lafayette
Center, 1155 21st Street NW,
Washington, DC 20581.
• Hand Delivery/Courier: Follow the
same instructions as for Mail, above.
Please submit your comments using
only one of these methods. Submissions
through the CFTC Comments Portal are
encouraged.
All comments must be submitted in
English, or if not, accompanied by an
English translation. Comments will be
posted as received to https://
comments.cftc.gov. You should submit
only information that you wish to make
available publicly. If you wish the
Commission to consider information
that you believe is exempt from
disclosure under the Freedom of
Information Act (‘‘FOIA’’), a petition for
confidential treatment of the exempt
information may be submitted according
to the procedures established in § 145.9
of the Commission’s regulations.1
The Commission reserves the right,
but shall have no obligation, to review,
pre-screen, filter, redact, refuse or
remove any or all of your submission
from https://comments.cftc.gov that it
may deem to be inappropriate for
publication, such as obscene language.
All submissions that have been redacted
or removed that contain comments on
the merits of the rulemaking will be
retained in the public comment file and
will be considered as required under the
Administrative Procedure Act and other
applicable laws, and may be accessible
under the FOIA.
FOR FURTHER INFORMATION CONTACT:
Amanda L. Olear, Director, 202–418–
5283, aolear@cftc.gov; Thomas J. Smith,
Deputy Director, 202–418–5495,
DATES:
1 17 CFR 145.9. Commission regulations referred
to herein are found at 17 CFR Chapter I.
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53409
tsmith@cftc.gov; Warren Gorlick,
Associate Director, 202–418–5195,
wgorlick@cftc.gov; Rafael Martinez,
Associate Director, 202–418–5462,
rmartinez@cftc.gov; or Liliya
Bozhanova, Special Counsel, 202–418–
6232, lbozhanova@cftc.gov, Market
Participants Division, Commodity
Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Statutory and Regulatory Background
Section 4s(e) of the Commodity
Exchange Act (‘‘CEA’’ or ‘‘Act’’) 2
requires the Commission to adopt rules
establishing minimum initial and
variation margin requirements for all
swaps 3 that are: (i) entered into by an
SD 4 or MSP 5 for which there is no
prudential regulator 6 (collectively,
‘‘covered swap entities’’ or ‘‘CSEs’’); 7
and (ii) not cleared by a registered
derivatives clearing organization
(‘‘uncleared swaps’’).8 To offset the
greater risk to the SD or MSP and the
financial system arising from the use of
uncleared swaps, these requirements
must: (i) help ensure the safety and
soundness of the SD or MSP; and (ii) be
appropriate for the risk associated with
27
U.S.C. 6s(e) (capital and margin requirements).
section 1a(47), 7 U.S.C. 1a(47) (swap
definition); Commission Regulation 1.3, 17 CFR 1.3
(further definition of a swap). A swap includes,
among other things, an interest rate swap,
commodity swap, credit default swap, and currency
swap.
4 CEA section 1a(49), 7 U.S.C. 1a(49) (swap dealer
definition); Commission Regulation 1.3 (further
definition of swap dealer).
5 CEA section 1a(32), 7 U.S.C. 1a(32) (major swap
participant definition); Commission Regulation 1.3
(further definition of major swap participant).
6 CEA section 1a(39), 7 U.S.C. 1a(39) (defining the
term ‘‘prudential regulator’’ to include the Board of
Governors of the Federal Reserve System; the Office
of the Comptroller of the Currency; the Federal
Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance
Agency). The definition of ‘‘prudential regulator’’
further specifies the entities for which these
agencies act as prudential regulators. The
prudential regulators published final margin
requirements in November 2015. See generally
Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015) (‘‘Prudential
Regulators Margin Rule’’). The Prudential
Regulators Margin Rule is substantially similar to
the CFTC Margin Rule.
7 CEA section 4s(e)(1)(B), 7 U.S.C. 6s(e)(1)(B). SDs
and MSPs for which there is a prudential regulator
must meet the margin requirements for uncleared
swaps established by the applicable prudential
regulator. CEA section 4s(e)(1)(A), 7 U.S.C.
6s(e)(1)(A).
8 CEA section 4s(e)(2)(B)(ii), 7 U.S.C.
6s(e)(2)(B)(ii). In Commission Regulation 23.151,
the Commission further defined this statutory
language to mean all swaps that are not cleared by
a registered derivatives clearing organization or a
derivatives clearing organization that the
Commission has exempted from registration as
provided under the CEA. 17 CFR 23.151.
3 CEA
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Federal Register / Vol. 88, No. 151 / Tuesday, August 8, 2023 / Proposed Rules
the uncleared swaps held by the SD or
MSP.9 In 2016, the Commission
promulgated Commission Regulations
23.150 through 23.161 (‘‘CFTC Margin
Rule’’) to implement section 4s(e).10
The CFTC Margin Rule imposes IM
requirements on uncleared swaps
entered into by CSEs and certain
specified counterparties. More
specifically, Commission Regulation
23.152 requires CSEs to collect and post
IM 11 with each counterparty that is an
SD, MSP or financial end user (‘‘FEU’’)
with material swaps exposure
(‘‘MSE’’).12 Commission Regulation
23.151 defines the term FEU by listing
entities, persons, and arrangements
whose business is financial in nature,
including certain funds.13
Commission Regulation 23.161 sets
forth a phase-in schedule for
9 CEA
section 4s(e)(3)(A), 7 U.S.C. 6s(e)(3)(A).
generally Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 636 (Jan. 6, 2016) (‘‘Final
Margin Rule’’) (adopting the CFTC Margin Rule).
The CFTC Margin Rule became effective April 1,
2016 and is codified in part 23 of the Commission’s
regulations. 17 CFR 23.150–23.159, 23.161. In May
2016, the Commission amended the CFTC Margin
Rule to add Commission Regulation 23.160, 17 CFR
23.160, providing rules on its cross-border
application. See generally 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).
11 IM (or initial margin) is the collateral
(calculated as provided by Commission Regulation
23.154) that is collected or posted in connection
with one or more uncleared swaps pursuant to
Commission Regulation 23.152. IM is intended to
secure potential future exposure following default
of a counterparty (i.e., adverse changes in the value
of an uncleared swap that may arise during the
period of time when it is being closed out). See
CFTC Margin Rule, 81 FR at 683.
12 See 17 CFR 23.152. Commission Regulation
23.151 provides that MSE for an entity means that
the entity and its margin affiliates have an average
month-end aggregate notional amount of uncleared
swaps, uncleared security-based swaps, foreign
exchange forwards, and foreign exchange swaps
with all counterparties for March, April, or May of
the current calendar year that exceeds $8 billion,
where such amount is calculated only for the last
day of the month. 17 CFR 23.151.
13 See 17 CFR 23.151 for a full list of entities
subject to the FEU definition as well as a list of
entities excluded from the definition. Among other
entities, persons, and arrangements, whose business
is financial in nature, the definition of FEU
includes counterparties that are not an SD or MSP
and are: (i) investment companies registered with
the Securities and Exchange Commission under the
Investment Company Act of 1940; (ii) private funds
as defined in section 202(a) of the Investment
Advisers Act of 1940; entities that would be
investment companies under section 3 of the
Investment Company Act of 1940; or entities that
are deemed not to be investment companies under
section 3 of the Investment Company Act of 1940
pursuant to Investment Company Act Rule 3a–7 of
the Securities and Exchange Commission; (iii)
commodity pools; and (iv) entities, persons, or
arrangements that are, or hold themselves out as
being, entities, persons, or arrangements that raise
money from investors, accept money from clients,
or use their own money primarily for investing, or
trading, or facilitating the investing or trading, in
loans, securities, swaps, funds, or other assets.
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10 See
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compliance with the CFTC Margin
Rule.14 Under the schedule, which
commenced on September 1, 2016 and
concluded on September 1, 2022,
entities have been required to comply
with the IM requirements with respect
to their uncleared swaps in staggered
phases, starting with entities with
higher average aggregate notional
amount of uncleared swaps and certain
other financial products (‘‘AANA’’), and
then successively those with lesser
AANA.15 The AANA is calculated at a
group level (i.e., taking into
consideration the AANA of the CSE
combined with its margin affiliates,16
and the AANA of the counterparty
combined with its margin affiliates).
During the last phase of compliance,
which started on September 1, 2022,
CSEs and eligible covered
counterparties 17 that had not come into
the scope of the IM requirements in
prior phases of the phase-in schedule,
including FEUs with MSE of more than
$8 billion, became subject to the IM
requirements.
Under this phase-in approach, a fund
with MSE will come within the scope of
the IM requirements if it undertakes an
uncleared swap with a CSE. The CSE
and the fund will not be required to post
and collect IM for their uncleared swaps
until the IM threshold amount of $50
million has been exceeded. The IM
threshold amount will be calculated
based on the credit exposure from
uncleared swaps between the CSE and
its margin affiliates on the one hand,
and the fund and its margin affiliates on
the other.18
The CFTC Margin Rule provides that
the IM requirements may be satisfied
with only certain types of collateral.
14 17
CFR 23.161.
15 Id.
16 Commission Regulation 23.151 provides that a
company is a ‘‘margin affiliate’’ of another company
if: (i) either company consolidates the other on a
financial statement prepared in accordance with
U.S. Generally Accepted Accounting Principles
(‘‘U.S. GAAP’’), the International Financial
Reporting Standards (‘‘IFRS’’), or other similar
standards; (ii) both companies are consolidated
with a third company on a financial statement
prepared in accordance with such principles or
standards; or (iii) for a company that is not subject
to such principles or standards, if consolidation as
described in paragraph (1) or (2) of this definition
would have occurred if such principles or standards
had applied. 17 CFR 23.151.
17 The term ‘‘covered counterparty’’ is defined in
Commission Regulation 23.151 as FEU with MSE or
a swap entity, including an SD or MSP, that enters
into swaps with a CSE. See 17 CFR 23.151.
18 Commission Regulation 23.151 defines the
term ‘‘IM threshold amount’’ to mean an aggregate
credit exposure of $50 million resulting from all
uncleared swaps between an SD and its margin
affiliates (or an MSP and its margin affiliates) on the
one hand, and the SD’s (or MSP’s) counterparty and
its margin affiliates on the other. See 17 CFR
23.151.
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Commission Regulation 23.156(a)(1) sets
forth the types of collateral that CSEs
can post or collect as IM with covered
counterparties, including cash funds,
certain securities issued by the U.S.
government or other sovereign entities,
certain publicly traded debt or equity
securities, securities issued by money
market and similar funds, and gold.19
Under Commission Regulation
23.156(a)(1)(ix), the securities of money
market and similar funds 20 may qualify
as eligible collateral if the investments
of the fund are limited to securities that
are issued by, or unconditionally
guaranteed as to the timely payment of
principal and interest by, the U.S.
Department of Treasury, and
immediately-available cash
denominated in U.S. dollars; 21 or to
securities denominated in a common
currency and issued by, or fully
guaranteed as to the payment of
principal and interest by, the European
Central Bank, or a sovereign entity that
is assigned no higher than a 20 percent
risk weight under the capital rules
applicable to swap dealers subject to
regulation by a prudential regulator, and
immediately-available cash
denominated in the same currency.22
Also, the asset managers of the money
market and similar fund may not
transfer the assets of the fund through
securities lending, securities borrowing,
repurchase agreements, or other means
(‘‘repurchase or similar arrangements’’)
that involve the fund having rights to
acquire the same or similar assets from
the transferee (‘‘asset transfer
restriction’’).23
II. Market Participant Feedback
In January 2020, the CFTC’s Global
Markets Advisory Committee (‘‘GMAC’’)
established a subcommittee of market
participants to consider issues raised by
19 See
17 CFR 23.156(a)(1).
the scope of the eligible pooled
investment funds described in Commission
Regulation 23.156(a)(1)(ix) does not fully coincide
with the regulatory definition of money market
funds in Rule 2a–7 under the Investment Company
Act (17 CFR 270.2a–7), for simplicity purposes,
these funds will be referred to as ‘‘money market
and similar funds.’’ The securities of money market
and similar funds may also be used as collateral for
variation margin (‘‘VM’’) for uncleared swaps
between a CSE and a financial end user, provided
that the securities qualify as eligible collateral
under Commission Regulation 23.156(a)(1)(ix). See
17 CFR 23.156(b)(1)(ii). VM (or variation margin),
as defined in Commission Regulation 23.151, is the
collateral provided by a party to its counterparty to
meet the performance of its obligations under one
or more uncleared swaps between the parties as a
result of a change in the value of such obligations
since the trade was executed or the last time such
collateral was provided. 17 CFR 23.151.
21 17 CFR 23.156(a)(1)(ix)(A).
22 17 CFR 23.156(a)(1)(ix)(B).
23 17 CFR 23.156(a)(1)(ix)(C).
20 Although
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the implementation of margin
requirements for non-cleared swaps, to
identify challenges associated with
forthcoming implementation phases,
and to prepare a report with
recommendations.24 The subcommittee
issued a report with its
recommendations in May 2020 (‘‘Margin
Subcommittee Report’’ or ‘‘Report’’),
and the GMAC voted to adopt the
Margin Subcommittee Report and
recommended to the Commission that it
consider adopting the Report’s
recommendations.25
Among other things, the Margin
Subcommittee Report asserted that the
current criteria for determining whether
a counterparty comes within the scope
of the IM requirements unduly
penalizes certain funds. Because, under
accounting consolidation principles, a
fund will generally be consolidated with
its sponsor entity during the period in
which the start-up capital provided by
the sponsor entity exceeds that of thirdparty investors and represents up to 100
percent of the ownership interest in the
fund (‘‘seeding period’’), such fund,
referred to as a seeded fund, will be
considered a margin affiliate of the
sponsor entity.26 As such, the seeded
fund will be required to calculate
AANA on an aggregate basis with the
sponsor entity and the sponsor entity’s
margin affiliates. Although the fund
may individually have small amounts of
AANA, due to its affiliation with the
sponsor entity and its margin affiliates,
the fund may have MSE, on a collective
basis with the sponsor entity and its
margin affiliates, and may come within
the scope of the IM requirements. As
such, a CSE that undertakes uncleared
swaps with the fund would be required
to exchange IM with the fund.
The Report noted that regulators in
other major financial markets, including
Australia, Canada, the European Union
(‘‘EU’’), and Japan, have adopted the
Basel Committee on Banking
Supervision and Board of the
24 Membership of the GMAC Subcommittee on
Margin Requirements was comprised of a wide
range of industry participants that had expertise in,
and experience with, margin requirements for noncleared swaps and the impact of the requirements
on the marketplace and market participants. The
Subcommittee included representatives of SDs,
FEUs, asset managers, and third-party service
providers, among other market participants. The
full list of members is available at https://
www.cftc.gov/About/AdvisoryCommittees/GMAC.
25 See Recommendations to Improve Scoping and
Implementation of Initial Margin Requirements for
Non-Cleared Swaps, Report to the CFTC’s Global
Markets Advisory Committee by the Subcommittee
on Margin Requirements for Non-Cleared Swaps
(May 2020), https://www.cftc.gov/media/3886/
GMAC_051920MarginSubcommitteeReport/
download.
26 Supra note 16. See also CFTC Margin Rule, 81
FR at 646–47.
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International Organization of Securities
Commissions’ (‘‘BCBS/IOSCO’’)
Framework for margin requirements for
non-centrally cleared derivatives
(‘‘BCBS/IOSCO Framework’’) 27 without
requiring seeded funds to be
consolidated with the sponsor and to be
treated as a margin affiliate of the
sponsor.28
The Margin Subcommittee Report also
recommended that the Commission
eliminate the asset transfer restriction in
paragraph (C) of Commission Regulation
23.156(a)(1)(ix). The Report stated that
‘‘the ability to use redeemable securities
in a pooled investment fund, more
typically referred to as a money market
fund (‘‘MMF’’), as eligible collateral in
the U.S. has been severely restricted by
[such] condition.’’ 29
The Report noted that MMFs use
repurchase and similar arrangements to
earn returns on cash and other high
quality assets, to avoid any cash drag on
performance, to diversify their
investments, and to mitigate their
potential exposure to their custodian’s
insolvency and any consolidation issues
with respect to any cash held at the
custodian.30 MMF asset managers, as
fiduciaries, determine the types of
investments and transactions that are in
the best interest of the MMF and its
investors.31 The Report further stated
that nearly all U.S. MMFs engage in
some form of repurchase or similar
arrangements, and cited research that
found that, given the asset transfer
restriction, the securities of only four
MMFs, would qualify as eligible
collateral.32
Having considered the GMAC
Subcommittee’s arguments and based
on its experience administering the
CFTC Margin Rule for several years, the
Commission preliminarily believes that,
for the purpose of determining whether
a CSE should exchange IM with a
27 See BCBS/IOSCO, Margin requirements for
non-centrally cleared derivatives (April 2020),
https://www.bis.org/bcbs/publ/d499.pdf. The
BCBS/IOSCO Framework, which was established in
2013 and most recently amended in 2020, sets out
minimum standards for margin requirements for
non-centrally cleared derivatives. In connection
with the requirement for all covered entities to
exchange IM with a threshold not to exceed Ö50
million applied at the level of the consolidated
group, the Framework specifies that ‘‘investment
funds that are managed by an investment advisor
are considered distinct entities that are treated
separately when applying the threshold as long as
the funds are distinct legal entities that are not
collateralized by or are otherwise guaranteed or
supported by other investment funds or the
investment advisor in the event of fund insolvency
or bankruptcy.’’
28 Margin Subcommittee Report at 7 and 29.
29 Id. at 6.
30 Id. at 27.
31 Id.
32 Margin Subcommittee Report at 24.
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seeded fund for their uncleared swaps,
the seeded fund should be treated as a
separate legal entity, not affiliated with
the sponsor entity, for a period of three
years and subject to certain limitations.
Similarly, the Commission preliminarily
believes that the current restriction on
the use of securities of money market
and similar funds that transfer their
assets through repurchase and similar
arrangements should be removed.
III. Proposals
A. Seeded Funds Proposal
The Commission is proposing to
revise the definition of ‘‘margin
affiliate’’ to provide that a seeded fund
that meets certain requirements
(described in further detail below)
(‘‘eligible seeded fund’’), would be
deemed not to have any margin affiliates
for the purpose of calculating the fund’s
MSE and the IM threshold amount, for
a period of three years from the fund’s
trading inception date (‘‘eligible seeded
fund exception’’). The Commission is
also proposing to define the term
‘‘eligible seeded fund’’ to set forth the
conditions that investment funds must
meet to qualify for the eligible seeded
fund exception.
1. Commission Regulation 23.151—
Amendments to the Definition of
‘‘Margin Affiliate’’
Under the CFTC Margin Rule, a
company is a ‘‘margin affiliate’’ of
another company if, based on
accounting principles, either company
consolidates the other, or both
companies are consolidated with a third
company, on a financial statement.33
The Commission is proposing to adopt
the eligible seeded fund exception
through an amendment of the definition
of ‘‘margin affiliate,’’ which would
provide that an eligible seeded fund
would be deemed not to have margin
affiliates solely for the purposes of
calculating the fund’s MSE and the IM
threshold amount for a period of three
years after the fund’s trading inception
date, notwithstanding the consolidation
of the fund with another entity under
U.S. GAAP, IFRS, or other similar
accounting standards.
This proposed eligible seeded fund
exception would effectively relieve
CSEs that enter into uncleared swaps
with an eligible seeded fund from the
requirement to exchange IM with such
fund for three years after the fund’s
trading inception date. In addition,
uncleared swaps entered into between a
CSE and an eligible seeded fund during
the three-year period would continue to
33 Supra
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be relieved from the IM requirement
after expiration of such period.34 At the
end of the three-year period, a fund that
meets the accounting standards for
consolidation due to a sponsor entity
holding a significant equity stake in the
fund would be deemed to have margin
affiliates. As a result, a CSE would be
required to exchange IM with the fund,
if the fund, on a consolidated group
basis, has MSE and the IM threshold
amount has been exceeded, for swaps
entered into following the expiration of
the three-year period.
The proposed eligible seeded fund
exception is intended to address
challenges confronted by seeded funds
that have limited individual swaps
exposure, but, due to their affiliation
with an entity or group of entities, have
on a collective basis sufficient AANA to
meet the MSE threshold, therefore
requiring CSEs undertaking uncleared
swaps with the funds to post and collect
IM with such funds. To limit the relief
to only such funds, the proposed
treatment would be applicable only to
funds that have one or more margin
affiliates that are already subject to the
IM requirements and post and collect
IM pursuant to Commission Regulation
23.152. Also, the Commission notes that
notwithstanding the proposed eligible
seeded fund exception, CSEs would still
be required to count the uncleared
swaps that they undertake with eligible
seeded funds for purposes of calculating
their own AANA.
Market participants, including the
members of the GMAC Margin
Subcommittee, have argued that absent
relief, seeded funds would experience a
performance drag given that a portion of
their investment would be committed
to, and segregated as, IM and would also
incur operational costs that are not
commensurate with the size of their
uncleared swaps activity and the risks
of their swaps. In addition, the overall
ability of start-up funds to attract new
investors may be compromised as a
result.35
In its Report, the GMAC Margin
Subcommittee discussed the costs that
seeded funds would incur if the funds
were consolidated with their sponsor
entities and were treated as margin
affiliates of their sponsor entities,
including the cost of setting up and
maintaining margin accounts and
establishing custodial arrangements to
segregate IM collateral under
Commission Regulation 23.157.36 The
seeded funds would also be required to
engage in negotiation of complex margin
documentation and develop compliance
infrastructures to handle the exchange
of IM.37 The Report further observed
that, given their typically small size,
seeded funds are likely to encounter
difficulties in establishing the necessary
margin documentation and processes, as
CSEs and custodians, which face
competing demands for resources and
services to operationalize the exchange
of IM, may prioritize larger
counterparties.38
The Margin Subcommittee Report
stated that although seeded funds may
be consolidated with other entities on a
financial statement, they are legally and
operationally distinct and, as a result,
may not be able to share information
about their exposure for purposes of
managing the $50 million IM threshold
amount above which IM for uncleared
swaps must be exchanged. In addition
to operational challenges, the Report
indicated that potential confidentiality
obligations may prevent the different
affiliates within the seeded fund’s
consolidated group from sharing
uncleared swaps exposure information.
As an example, the Report noted that
because of regulatory restrictions, an
insurance company that sponsors a
seeded fund would not be permitted to
share information about the fund’s
trading activity with an affiliate
engaging in swap transactions for
purposes of hedging general insurance
risk.
Finally, the Report stated that seeded
funds that do not otherwise hold assets
qualifying as eligible IM collateral under
Commission Regulation 23.156 39 would
need to hold larger cash reserves, which
would be unavailable to implement the
fund’s investment strategy, or would
need to incur the costs of converting
fund assets into eligible IM collateral.
The operational costs and potential
difficulties arising in the execution of
margin documentation could also either
negatively impact a seeded fund’s
performance or inhibit its ability to
34 For purposes of clarity, the Commission notes,
however, that if at any point during the three-year
period from the fund’s trading inception date, the
fund’s AANA, calculated on an individual entity
basis, exceeds the MSE threshold and the fund,
individually, with its counterparty and the
counterparty’s margin affiliates crosses the IM
threshold amount, the exchange of IM would be
required.
35 Margin Subcommittee Report at 32.
36 For purposes of clarity, these arguments, as
well as the proposed rule amendments, pertain only
to the margin requirements for uncleared swap
transactions. The proposed amendments would not
impact any potential margin requirements that a
seeded fund would have to meet in connection with
futures contracts or cleared swap transactions.
37 Margin Subcommittee Report at 32.
38 Id.
39 Id.
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trade, defeating the purpose of the
original seed capital.40
The Commission notes that the
proposed eligible seeded fund exception
is consistent with the approach in other
countries. Jurisdictions such as
Australia, Canada and the EU have
adopted provisions that permit
investment funds to be treated as
distinct, separate entities for purposes of
calculating the relevant IM thresholds,
subject to conditions similar to those
that the Commission intends to adopt
through the proposed definition of
‘‘eligible seeded fund’’ discussed
below.41
The proposed approach is also
consistent with the BCBS–IOSCO
Framework, which provides that
investment funds should be treated as
separate legal entities when applying
the IM threshold amount provided that
they are distinct legal entities that are
not collateralized or otherwise
guaranteed or supported by other
investment funds or the investment
advisor in the event of fund insolvency
or bankruptcy.42 As such, the proposed
approach would contribute to global
harmonization with respect to the
treatment of investment funds,
preventing potential reductions in
liquidity or trading disruptions due to
non-U.S. funds’ limiting their trading
activities to non-U.S. counterparties to
take advantage of approaches to
40 Margin
Subcommittee Report at 31.
Subcommittee Report at 29. As noted in
the Report, Canada has excluded investment funds
from consolidated margin calculations via the
Office of the Superintendent for Financial
Institutions of Canada Guideline E–22 Margin
Requirements for Non-centrally Cleared Derivatives
effective as of June 2017, Section 1.1. Scope of
Applicability, Footnote 2, available at https://
www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/
Pages/e22.aspx; the EU adopted a similar approach
via Commission Delegated Regulation No. 2016/
2251 of October 4, 2016, Supplementing Regulation
(EU) No.648/2012 of the European Parliament and
of the Council of July 4, 2012 on OTC Derivatives,
Central Counterparties and Trade Repositories with
Regard to Regulatory Technical Standards for RiskMitigation Techniques for OTC Derivative Contracts
Not Cleared by a Central Counterparty, 2016 O.J.
L340/11, Articles 28(3); 29(3) and 39(2), available
at https://eur-lex.europa.eu/legal-content/EN/TXT/
?uri=uriserv%3AOJ.L_.2016.340.01.0009.01.ENG;
and the Australian Prudential Regulatory Authority
noted, in paragraph 25 of Prudential Standard CPS
226 (available here https://www.apra.gov.au/sites/
default/files/prudential_standard_cps_226_
margining_and_risk_mitigation_for_non-centrally_
cleared_derivatives.pdf) that for purposes of
calculating the IM threshold, an investment fund
may be treated separately from the investment
adviser and other investment vehicles, provided
certain conditions are met. The Margin
Subcommittee Report also noted that Japan has
adopted a similar approach, however, the
Commission could not verify that assertion because
the Report did not provide a citation to the relevant
Japanese rules.
42 BCBS–IOSCO Framework, Footnote 10, supra
note 27.
41 Margin
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consolidation that exist in other
jurisdictions.
The Commission recognizes, however,
that the proposed amendments would
be a departure from the prudential
regulators’ approach, whose margin
requirements for uncleared swaps
include a definition of ‘‘margin affiliate’’
that is equivalent to the current
definition in the CFTC Margin Rule.
Furthermore, the prudential regulators
have reserved the right to include any
entity as an affiliate or a subsidiary
based on the conclusion that an entity
may provide significant support to, or
may be materially subject to the risks of
losses of, another entity.43 As noted
below, the Commission requests
comment on whether it should proceed
with the Seeded Funds Proposal if the
prudential regulators do not amend
their rules in a manner consistent with
the proposal.
The Commission preliminarily
believes that the proposed approach
supports the CFTC Margin Rule’s
objective of imposing margin
requirements that are commensurate
with the risk of uncleared swaps entered
into by CSEs.44 The Commission
preliminarily believes, as discussed in
the Margin Subcommittee Report, that
seeded investment funds do not pose
significant risks to their swap
counterparties or the financial system
given that typically their capitalization
does not exceed $50–100 million and
the funds have limited notional
exposure. The Report cited the results of
an informal sampling conducted in 2018
among members of the Securities
Industry and Financial Markets
Association’s Asset Management Group
(‘‘SIFMA AMG’’) and the American
Council of Life Insurers. According to
the Report, the respondents identified a
total of 33 funds that would be within
the scope of the IM requirements due to
their derivatives notional exposures
being consolidated with entities with
MSE. The average gross notional
exposure for each seeded fund was $32
million. As the Report concluded, none
of these funds would be within the
scope of the IM requirements absent
consolidation with their sponsor entity.
Given their size and limited individual
swap activity, the Commission
preliminarily believes that affording
relief to seeded funds at the early stages
of formation from coming within the
scope of the IM requirements is
43 See Prudential Regulators Margin Rule at
74859–60.
44 See Section 4s(e)(3)(A)(2) of the CEA (directing
the Commission to adopt margin requirements
‘‘appropriate to the risks associated with’’ the
uncleared swaps held by the SD or the MSP). 7
U.S.C. 6s(e)(3)(A).
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consistent with the CFTC Margin Rule’s
risk-based approach.
The Commission also preliminarily
believes that safeguards already present
in the CEA and CFTC regulations would
mitigate the increase in uncollateralized
credit risk resulting from swap
transactions between CSEs and seeded
funds that would be relieved from the
IM requirements given the
disaggregation of eligible seeded funds
from their sponsor entities and other
affiliated entities for purposes of
calculating the funds’ MSE and the IM
threshold amount. The Commission
notes that notwithstanding the relief,
uncleared swap transactions between
CSEs and eligible seeded funds would
still be subject to the VM
requirements.45 Moreover, section
4s(j)(2) of the CEA mandates CSEs to
adopt a robust and professional risk
management system adequate for the
management of their swap activities 46
and Commission Regulation 23.600
requires that CSEs, in establishing a risk
management program to monitor and
manage risks associated with their swap
activities, must account for credit risk
and must set risk tolerance limits.47
As an additional safeguard, the
proposed eligible seeded fund exception
would be applicable only for a period of
three years from an eligible seeded
fund’s trading inception date. The threeyear term is designed to cover the
period during which the fund would
work towards establishing a
performance track record and towards
attracting unaffiliated investors.48
In adopting the CFTC Margin Rule,
the Commission stated that the
requirement to calculate MSE and the
IM threshold amount on a consolidated
basis was intended to prevent CSEs and
their counterparties from creating legal
entities and netting sets that have no
economic basis and are constructed
solely for the purpose of applying
additional thresholds to evade margin
requirements.49 Consistent with this
goal, the Commission intends for the
eligible seeded fund exception to be
applied only for purposes of calculating
MSE and the IM threshold amount of
the eligible seeded fund. Under the
Seeded Funds Proposal, a fund’s
sponsor entity and other margin
affiliates would continue to include the
45 See
17 CFR 23.153.
7 U.S.C. 6s(j).
47 17 CFR 23.600.
48 Market participants have noted that after three
years, investment funds have typically established
a sufficient record to draw in third-party investors
and are no longer consolidated with their sponsor
entity for AANA calculation purposes. See Margin
Subcommittee Report at 30.
49 CFTC Margin Rule, 81 FR at 652.
46 See
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eligible seeded fund’s exposure in the
calculation of their MSE and the IM
threshold amount, unless they
independently qualify for the proposed
eligible seeded fund exception. As such,
the proposed treatment for eligible
seeded funds would not serve as an
incentive for a sponsor entity to create
seeded funds merely to reduce its own
exposure and circumvent the
applicability of the IM requirements.
In addition, the Commission proposes
to make the eligible seeded fund
exception available only with respect to
funds that have a bona fide business and
economic purpose, meaning that the
funds are not created for the sole
purpose of evading the IM compliance
thresholds. Rather, the exception is
intended for funds that engage in
genuine efforts to test their investment
strategy and distribute the funds’ shares
to third-party investors.50 To that end,
in addition to relying on anti-evasion
provisions already existing in the
Commission regulations 51 to address
50 The Commission notes that this position is
consistent with the policy approach taken by the
prudential regulators and the Commission in the
regulations implementing the requirements of
section 619 of the Dodd-Frank Act, commonly
referred to as the ‘‘Volcker Rule.’’ The
implementing regulations recognize the concept of
a seeding period and exempt banking entities that
acquire and retain an ownership interest in a
covered fund (as the concept is defined under the
implementing regulations) from some of the
prohibitions of the Rule during the seeding period,
under certain conditions. See 12 CFR 248.12(a)(1)
and (2). In particular, these conditions include that
the covered fund must actively seek unaffiliated
investors to reduce, through redemption, sale,
dilution, or other methods, the aggregate amount of
all ownership interests of the banking entity in the
covered fund to the amount permitted under the
regulations. 12 CFR 248.12(a)(2)(i). Also, the
aggregate value of all ownership interests of the
banking entity and its affiliates in all covered funds
acquired and retained under the relevant
exemptions must not exceed 3 percent of the tier
1 capital of the banking entity. 12 CFR
248.12(a)(2)(iii). Although the Commission is not
proposing identical conditions, the Commission is
proposing to incorporate a number of requirements
to achieve the same purpose as appropriate in the
context of the CFTC Margin Rule, including the
requirement in the proposed definition discussed
below that an ‘‘eligible seeded fund’’ be managed
pursuant to a written investment strategy that
follows a written plan to reduce each sponsor
entity’s ownership interest in the fund.
51 See Commission regulation 23.402(a)(1)(ii)
(requiring CSEs to have written policies and
procedures to prevent the evasion, or participation
in or facilitation of an evasion, of any provision of
the CEA or Commission regulation). 17 CFR
23.402(a)(1)(ii). See also the definition of MSE in
Commission Regulation 23.151 (stating that
activities not carried out in the regular course of
business and willfully designed to circumvent the
calculation of the AANA at month-end to evade
meeting the definition of MSE shall be prohibited).
17 CFR 23.151. The Commission also reminds
market participants that section 4b of the CEA
prohibits any person entering into a swap with
another person from cheating, defrauding, or
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the potential circumvention of the IM
compliance thresholds, the Commission
proposes to limit the availability of the
proposed treatment for seeded funds to
entities that meet certain requirements.
These requirements would be
incorporated in the proposed definition
of ‘‘eligible seeded fund’’ discussed
below.
2. Commission Regulation 23.151—
Definition of ‘‘Eligible Seeded Fund’’
The Commission proposes to amend
Commission Regulation 23.151 by
adding a definition for the term ‘‘eligible
seeded fund.’’ ‘‘Eligible seeded fund’’
would be defined as a collective
investment vehicle that has received a
part or all of its start-up capital from a
parent and/or affiliate (each, a sponsor
entity) and that meets certain specified
conditions.
A seeded fund would meet the
proposed definition of eligible seeded
fund if, among other conditions: (i) the
fund is a distinct legal entity from each
sponsor entity; (ii) the fund is managed
by an asset manager pursuant to an
agreement that requires the fund’s assets
to be managed in accordance with a
specified written investment strategy;
(iii) the fund’s asset manager has
independence in carrying out its
management responsibilities and
exercising its investment discretion, and
to the extent applicable, has
independent fiduciary duties to other
investors of the fund; and (iv) the fund’s
written investment strategy includes a
written plan for reducing each sponsor
entity’s ownership interests in the fund
that stipulates divestiture targets over
the three-year period after the seeded
fund’s trading inception date.
Additionally, to meet the ‘‘eligible
seeded fund’’ definition, in respect of
any of the seeded fund’s obligations, a
fund must not be collateralized,
guaranteed, or otherwise supported,
directly or indirectly, by any sponsor
entity, any margin affiliate of any
sponsor entity, other collective
investment vehicles, or the fund’s asset
manager. These conditions are designed
to ensure that the sponsor entity would
not retain a level of influence or
exposure that is materially above that of
other minority or passive investors and
that the fund would follow a genuine
plan to emerge from the seeding phase
by attracting unaffiliated investors.
To ensure that the three-year period
contemplated by the eligible seeded
fund exception is not reinstated, due to
rollovers of fund assets or similar
activities, the proposed definition
willfully deceiving, or attempting to cheat, defraud,
or deceive, the other person. 7 U.S.C. 6b.
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would require that the seeded fund has
not received any of its assets, directly or
indirectly, from an eligible seeded fund
that has relied on the proposed
exception.
Furthermore, the Seeded Funds
Proposal is intended to be limited to
those seeded funds that, absent
amendments to the CFTC Margin Rule,
would have to exchange IM due to their
consolidation with a group that
collectively exceeds the thresholds
triggering compliance with the IM
requirements. That is, the Seeded Funds
Proposal, consistent with the Margin
Subcommittee Report, is intended to
address seeded funds that are ‘‘seeded’’
by parent entities that have MSE and
thus cause the seeded funds to come
within the scope of the IM
requirements. For purposes of targeting
these seeded funds, the proposed
definition of ‘‘eligible seeded fund’’
would require as a condition for
qualification that at least one of the
seeded fund’s margin affiliates must be
subject to the IM requirements and must
be required to post and collect IM
pursuant to Commission Regulation
23.152.
Finally, the proposed definition of
‘‘eligible seeded fund’’ would provide
that the seeded fund must not be a
securitization vehicle. This condition is
designed to further limit the proposed
treatment of seeded funds only to funds
subject to the Margin Subcommittee
Report’s recommendation. The
Commission notes that in adopting the
CFTC Margin Rule, despite receiving
multiple comments from industry
representatives to exclude securitization
vehicles from the definition of FEU, and
recommendations subsequent to the
adoption of the rule, the Commission
has maintained the position that there
are sufficient reasons to keep these
entities within the scope of the IM
requirements. The Commission stated in
the preamble to the final CFTC Margin
Rule that the relevant IM compliance
thresholds would address concerns
related to the applicability of the IM
requirements to these entities.52 At this
time, the Commission does not believe
that it is prudent to extend the proposed
eligible seeded fund exception to such
entities.
In adopting the CFTC Margin Rule,
the Commission modified the proposed
definition of ‘‘margin affiliate,’’ which
relied on the concept of legal control as
a criterion for affiliation, to the current
definition based on accounting
consolidation, in consideration of a
concern that the proposed definition
may have been over-inclusive. The
52 See
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Commission noted that the accounting
consolidation analysis typically results
in a positive outcome (consolidation) at
a higher level of an affiliation
relationship than the 25 percent voting
interest standard of the legal control
test.53
The Commission recognized,
however, that consolidation between a
seeded fund and the sponsor may occur
during the seeding period or other
periods in which the sponsor may hold
an outsized portion of the fund’s
interest. The Commission stated that
during those periods, when an entity
may hold up to 100 percent of the
ownership interests of an investment
fund, it was appropriate to treat the
investment fund as an affiliate.54 The
Commission further stated that such
treatment may be likewise justified for
a sponsor or asset manager and a special
purpose entity created for asset
management when accounting
standards, such as GAAP and IFRS
variable interest standards, require
consolidation for such entities even
though the manager might not hold an
interest comparable to a majority equity
or voting control share given the level
of influence and exposure typically
retained by the manager.55
The Commission notes that
subsequently, in letters to the CFTC,
SIFMA AMG (on behalf of its asset
manager members) requested relief from
the treatment as margin affiliate for
seeded funds, consistent with the
arguments made in the Margin
Subcommittee Report described above.
While acknowledging that a sponsor of
a seeded investment fund has influence
beyond that of a passive, unaffiliated
investor, SIFMA AMG urged that seeded
funds not be consolidated with their
sponsors in applying the CFTC’s margin
requirements because there are
structural and contractual safeguards
that limit the sponsor’s influence and
exposure with respect to the seeded
fund.56 In particular, SIFMA AMG
noted that each seeded fund is a distinct
legal entity that is managed by an
investment manager pursuant to an
investment advisory agreement that,
among other things, requires the assets
of the fund to be managed in accordance
with specified investment guidelines,
objectives, and strategies, and not
53 Id.
at 647.
54 Id.
55 Id.
56 Letter by SIFMA AMG to the Commission and
the Prudential Regulators Regarding Final Margin
Rules for Uncleared Swap Transactions (Jan., 19,
2016) (‘‘SIFMA AMG 2016 Letter’’) at 3; see also
Margin Subcommittee Report at 16.
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capriciously at the desire of the fund
sponsor.57
Further, the Margin Subcommittee
Report noted that neither the sponsor
nor its commonly consolidated entities
controls or has transparency into the
management or trading of the seeded
fund.58 Moreover, the Report stated that,
typically, the sponsor or affiliate of a
seeded fund does not guarantee the
obligations of the seeded fund or
participate in or control the
management of the fund.59 The Report
further noted that the sponsor’s
exposure to the seeded fund is generally
capped at its investment, similar to any
other passive investor in a third-party
instrument or vehicle.60
These arguments highlight the
safeguards generally exhibited in seeded
funds. As previously noted, the
Commission is proposing to incorporate
these safeguards, among other
conditions, in the proposed definition of
‘‘eligible seeded fund’’ as requirements
to be met by a fund in order to benefit
from the proposed treatment for eligible
seeded funds, discussed in more detail
above. In proposing these conditions,
the Commission seeks to ensure that
eligible seeded funds are sufficiently
independent and risk-remote from other
entities in their group such that treating
them separately for purposes of
determining whether the thresholds for
compliance with the IM requirements
have been met would be justified.
In particular, the proposed
requirements that the fund is managed
in accordance with a written investment
strategy, by an asset manager that
maintains independence in carrying out
its management responsibilities and
exercising its investment discretion, and
that, to the extent applicable, has
independent fiduciary duties to other
investors in the fund, seek to ensure that
no sponsor entity or an affiliate of a
sponsor entity has control or
transparency into the management or
trading of the seeded fund. Furthermore,
the proposed condition that the fund’s
investment strategy follows a written
plan for reducing each sponsor entity’s
ownership interest in the fund aims to
reserve the benefit of the proposed
approach to seeded funds that have a
genuine economic purpose and
intentions to emerge from the seeding
phase.
In addition, the proposed definition of
‘‘eligible seeded fund’’ would prohibit a
fund sponsor entity, entities affiliated
with a sponsor entity, other collective
57 SIFMA
AMG 2016 Letter at 3.
Subcommittee Report at 16.
59 Margin Subcommittee Report at 6 and16.
60 Margin Subcommittee Report at 16.
58 Margin
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investment vehicles, or the fund’s asset
manager from collateralizing,
guaranteeing or otherwise directly or
indirectly providing support in respect
of any of the fund’s obligations. The
Commission proposes this condition in
recognition that the sponsor of a seeded
fund or its asset manager may be
motivated to provide financial
assistance to the seeded fund whose
uncleared swaps may be
uncollateralized as a result of the
Seeded Funds Proposal, which might
heighten the risk of the fund’s swap
positions and weaken the fund’s
financial condition. The sponsor entity
or the asset manager may also be
inclined to provide financial assistance
to the fund because of reputational or
other concerns even in the absence of a
guarantee or formal commitment, and at
the risk of exhausting its own resources,
raising the risk of contagion and
systemic risk, in particular during times
of widespread financial stress. The
Commission preliminarily believes that
the requirements in the proposed
definition of ‘‘eligible seeded fund,’’
which seek to ensure the fund’s genuine
independence, would serve as effective
safeguards against financial contagion.
The Commission also intends to rely
on tools that already exist under the
CEA and the Commission regulations to
address evasion concerns. In particular,
the Commission notes that Commission
Regulation 23.402(a)(ii) requires CSEs to
have written policies and procedures to
prevent the evasion, or participation in
or facilitation of an evasion, of any
provision of the CEA or the Commission
regulations.61 The Commission also
reminds market participants that section
4b of the CEA prohibits any person
entering into a swap with another
person from cheating, defrauding, or
willfully deceiving, or attempting to
cheat, defraud, or deceive, the other
person.62
Request for comments: The
Commission requests comments
regarding the proposed amendments to
Commission Regulation 23.151,
generally. The Commission specifically
requests comment on the following
questions:
1. Under the Seeded Funds Proposal,
eligible seeded funds would be deemed
not to have margin affiliates for
purposes of calculating the fund’s MSE
61 17 CFR 23.402(a)(ii). As discussed above, the
Commission also notes that the definition of MSE
in Commission Regulation 23.151 prohibits
activities not carried out in the regular course of
business and willfully designed to circumvent the
calculation of the AANA at month-end to evade
meeting the definition of MSE shall be prohibited.
17 CFR 23.151.
62 7 U.S.C. 6b.
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and the IM threshold amount during a
period of three years from the fund’s
trading inception date. As such, CSEs
that undertake uncleared swaps with
such funds and would otherwise be
required to exchange IM with the funds,
may be relieved from such obligation, as
only each fund’s individual exposure
would be considered in determining
whether the IM requirements apply to
uncleared swaps between CSEs and the
fund. As a result, less margin may be
collected and posted for uncleared
swaps than would be otherwise required
under the current requirements. Is the
Seeded Funds Proposal appropriate in
light of the resulting potential
uncollateralized swap risk?
2. The Commission recognizes that
the proposed eligible seeded fund
exception would not only benefit the
eligible seeded funds but would also
relieve CSEs from their obligation to
post IM with seeded funds that would
otherwise come within the scope of the
CFTC IM requirements. Should only the
eligible seeded fund, and not its CSE
counterparty, be relieved of the IM
obligation?
3. Should the Commission impose
any additional limits or conditions to
the proposed eligible seeded fund
exception such as: (i) imposing a
separate MSE and/or IM threshold
amount, calculated on the basis of the
eligible seeded fund’s individual
exposure and proportionate to the
perceived risks associated with funds’
swap activities, (ii) imposing a limit on
the total number of eligible seeded
funds to which a sponsor entity
provides start-up capital that may rely
on the eligible seeded fund exception,
or (iii) requiring that all eligible seeded
funds, consolidated within the same
group on the basis of accounting
principles, aggregate their exposures for
purposes of calculating the MSE and IM
threshold amounts that apply to such
funds?
4. What are the costs associated with
a seeded fund calculating IM and
establishing a relationship with a
custodian to transfer IM?
5. The proposed amendments to
Commission Regulation 23.151, in
particular the requirements in the
proposed definition of ‘‘eligible seeded
fund,’’ aim to ensure that the relevant
funds are genuinely and practically
independent and risk-remote from their
sponsor entities and other affiliates. Do
the proposed amendments incorporate
sufficient safeguards to achieve this
goal? Given that other entities such as
sponsor entities or the asset manager
may be incentivized to provide
resources to a seeded fund in financial
distress even in the absence of an
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explicit business arrangement or
guarantee, potentially putting their own
financial position at risk and thereby
increasing the risk of contagion and
systemic risk, what measures could the
Commission take to limit the potential
risks to such other entities and
ultimately to the financial system?
6. The Commission proposes to
include, among other conditions, a
requirement providing that a fund
would qualify as an eligible seeded fund
only if one or more of the seeded fund’s
margin affiliates is required to post and
collect IM pursuant to Commission
Regulation 23.152. This condition is
intended to limit the availability of the
proposed eligible seeded fund exception
only to funds that, for reasons described
in the Margin Subcommittee Report, are
disadvantaged domestically and
globally due to their affiliation with a
group that has MSE. Is this condition
appropriate? Should the condition be
amended to ensure that the Commission
is appropriately circumscribing the
proposed treatment of eligible seeded
funds?
7. The Commission also proposes to
include, among other conditions, a
requirement providing that to qualify as
an eligible seeded fund, the seeded
fund’s investment strategy must follow
a written plan for reducing each sponsor
entity’s ownership interest in the seeded
fund that stipulates divestiture targets
over the three-year period after the
seeded fund’s trading inception date.
Should the Commission include more
specific requirements in connection
with the written plan?
8. The Prudential Regulators Margin
Rule contains a definition of ‘‘margin
affiliate’’ that is equivalent to the
current definition under the CFTC
Margin Rule. Furthermore, the
prudential regulators have reserved the
right to include any entity as an affiliate
or a subsidiary based on the conclusion
that an entity may provide significant
support to, or may be materially subject
to the risks or losses of, another entity.
If the Commission amends Commission
Regulation 23.151, counterparties that
trade with both prudentially regulated
SDs and CFTC-regulated SDs may need
to adjust their swap-related
documentation and collateral
management systems to reflect the
different margin requirements that may
apply under the CFTC’s and the
prudential regulators’ rules. In that
regard, the Commission requests
information on the potential additional
costs associated with maintaining two
separate and distinct documentation
and collateral management processes.
How much weight should the
Commission give with respect to the
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possible challenge that counterparties
may need to maintain two separate and
distinct documentation and collateral
management systems? Should the
Commission proceed to adopt the
proposed amendments to Commission
Regulation 23.151 if the prudential
regulators do not adopt similar
regulatory changes?
9. The Commission intends that the
final rule will become effective 30 days
after its publication in the Federal
Register. With respect to the Seeded
Funds Proposal, are there any comments
on the effective date?
B. Money Market Funds Proposal
The Commission proposes to amend
Commission Regulation 23.156(a)(1)(ix)
to eliminate the restriction on the use of
securities of money market and similar
funds that transfer their assets through
repurchase or similar arrangement (the
asset transfer restriction). The
Commission is also proposing an
amendment to the haircut schedule set
forth in Commission Regulation
23.156(a)(3)(i)(B) to add a footnote that
was inadvertently omitted when the
rule was originally promulgated.
1. Commission Regulation
23.156(a)(1)(ix)—Elimination of the
Asset Transfer Restriction
In adopting the CFTC Margin Rule,
the Commission added redeemable
securities in money market and similar
funds to the list of eligible collateral in
response to comments arguing for the
inclusion of MMF securities as eligible
collateral for IM.63 The Commission
explained that the addition of money
market and similar fund securities to the
list of eligible collateral would provide
flexibility while maintaining a level of
safety, noting that to qualify, such fund
securities would need to meet the
conditions in Commission Regulation
23.156(a)(1)(ix), including the asset
transfer restriction in paragraph (C),
which has the effect of disqualifying the
securities of funds that transfer their
assets through repurchase or similar
arrangements.64
As discussed above, market
participants, and the GMAC Margin
Subcommittee, have urged the
Commission to eliminate the asset
transfer restriction in paragraph (C),
noting that it disqualifies the securities
of most MMFs and significantly restricts
the ability of swap counterparties to use
such form of collateral.65 Based on its
experience implementing the margin
requirements for several years and for
63 See
CFTC Margin Rule, 81 FR at 666.
64 Id.
65 Margin
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the reasons described below, the
Commission preliminarily recommends
the elimination of the restriction.
MMFs are regulated, short-term
investment vehicles that are subject to
liquidity and diversification
requirements under U.S. regulations,
such as SEC Rule 2a–7.66 The MMFs
that could qualify as eligible IM
collateral under Commission Regulation
23.156 invest in high quality underlying
instruments, namely securities issued or
unconditionally guaranteed as to the
timely payment of principle and interest
by the U.S. Department of the Treasury
and cash. More generally, the Margin
Subcommittee Report stated that the
Commission has recognized MMFs as
safe, high quality investments, noting
that, for example, Commission
Regulation 1.25 permits the investment
of customer margin by futures
commission merchants (‘‘FCM’’) in
MMFs without an asset transfer
restriction.67
The elimination of the asset transfer
restriction in paragraph (C) of
Commission Regulation 23.156(a)(1)(ix)
would allow for a broader range of
money market and similar fund
securities to qualify as eligible IM
collateral.68 This is consistent with the
Commission’s intent in identifying
certain fund securities as eligible
collateral when it adopted the CFTC
Margin Rule. The Commission stated
that it intended to permit MMF
securities to be pledged as IM collateral
in order to permit flexibility, while also
‘‘maintaining a level of safety.’’ 69 As
noted above, according to the Margin
Subcommittee Report, most multibillion dollar MMFs available to the
institutional marketplace use
repurchase or similar arrangements as
part of their management strategy.70
Given the widespread use of repurchase
and similar arrangements by MMFs,
66 17
CFR 270.2a–7.
Subcommittee Report at 26. In the
Commission’s view, the fact that Commission
Regulation 1.25 permits investments in interests in
money market funds without imposing restrictions
on repurchase agreements and similar arrangements
is not dispositive in considering the proposed
amendment to Commission Regulation
23.156(a)(1)(ix). Commission Regulation 1.25 was
adopted under a different regime (concerning FCMs
and derivative clearing organizations) and
addresses different concerns than those
Commission Regulation 23.156 aims to target.
68 If adopted, the amendment would also result in
an expanded scope of money market and similar
fund securities that can serve as VM for uncleared
swap transactions between a CSE and an FEU, given
that Commission Regulation 23.156(b)(1)(ii),
defining the types of assets qualifying as VM
collateral for these transactions, incorporates the
assets identified as eligible collateral for IM in
Commission Regulation 23.156(a)(1).
69 See 81 FR at 666.
70 Margin Subcommittee Report at 27.
67 Margin
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only a few of the MMFs currently
available to institutional clients satisfy
the asset transfer restriction in
paragraph (C).71 As a result, unless the
restriction is eliminated, this form of
margin collateral would be of very
limited availability to swap
counterparties, contrary to the intent of
the Commission.
The Commission preliminarily
believes that expanding the scope of
eligible money market and similar fund
securities may lead to more efficient
collateral management practices. In
particular with respect to the use of
MMF securities as IM collateral, the
Margin Subcommittee Report noted that
many custodians offer money market
sweep programs, which facilitate buyside market participants’ timely meeting
margin calls in cash that is subsequently
used to purchase MMF securities,
thereby avoiding the settlement delays
or additional costs associated with the
purchase and posting of non-cash
assets.72 This is particularly important
given that under the custodian
arrangement rules under Commission
Regulation 23.157, IM collateral in cash
must be promptly converted into other
types of eligible collateral, such as
securities of MMF or similar funds, to
avoid the possibility that cash collateral
may become a deposit liability of the
custodian and to prevent
rehypothecation by the custodian.73
Moreover, the Report stated that the
use of MMF securities as collateral may
enable market participants to avoid
potential negative interest rate charges
that may be applied by custodian banks
on cash collateral.74 Finally, according
to the Report, the sweep of cash into
MMF securities helps market
participants mitigate the risk of
custodian insolvency as non-cash assets
would not be consolidated with the
custodian’s balance sheet or estate from
71 Id. at 24 (noting that a leading custodial bank
has researched all the U.S. MMFs currently
available to its institutional clients in the U.S. and
found that only four would meet the requirements
of Commission Regulation 23.156(a)(1)(ix)).
72 Under Commission Regulation 23.157, a
custodian may accept and hold cash collateral as IM
only if the funds are subsequently used to purchase
an asset that qualifies as an eligible form of
collateral under Commission Regulation
23.156(a)(1)(ii) through (x).
73 See 81 FR at 671.
74 See Margin Subcommittee Report at 27.
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a supplemental leverage ratio 75 or
bankruptcy perspective.76
Allowing a broader selection of
money market and similar fund
securities to serve as collateral may
address the potential concentration of
margin collateral in the securities of a
few MMFs.77 The removal of the asset
transfer restriction could lead to an
increased use of MMF securities as
margin collateral. The Commission
acknowledges the risk of concentration
of collateral in particular assets and
reiterates, as stated in the preamble to
the CFTC Margin Rule, that CSEs should
take concentration into account and
prudently manage their margin
collateral.78 For the same reasons, the
Commission preliminarily believes that
CSEs should consider the overall
investment strategy of a money market
or similar fund, including the terms of
repurchase or similar arrangements the
fund may undertake, in determining
whether to use the fund’s securities to
meet margin obligations under the CFTC
rules.
The Commission explained in the
preamble to the CFTC Margin Rule that
the asset transfer restriction in
paragraph (C) of Commission Regulation
23.156(a)(1)(ix) was included to ensure
consistency with the prohibition against
rehypothecation of IM collateral under
Commission Regulation 23.157(c)(1).
After further consideration and based on
its experience implementing the margin
requirements for several years, the
Commission now preliminarily believes
that although these rules are similar in
that they aim to mitigate loss, the
objectives of these rules are
distinguishable as further discussed
below.
Commission Regulation 23.157
provides for the segregation of IM
collateral with a third-party custodian to
ensure that: (i) the IM is available to a
counterparty when its counterparty
defaults and a loss is realized that
exceeds the amount of VM that has been
collected as of the time of default; and
(ii) the IM is returned to the posting
party after its swap obligations have
75 The supplementary leverage ratio represents
the amount of common equity capital that banks or
bank holding companies must hold relative to their
total leverage exposure. CSEs and SD or MSP
counterparties that are banks or bank holding
companies and supervised by a U.S. banking
regulator may be subject to this requirement. For
further information, see Regulatory Capital Rules:
Regulatory Capital, Revisions to the Supplementary
Leverage Ratio, 79 FR 57725 (Sept. 26, 2014).
76 Margin Subcommittee Report at 26–27.
77 As noted above, according to the Margin
Subcommittee Report (citing research by a leading
custodian bank), only four MMFs have securities
that qualify as eligible collateral under the current
rules. See Margin Subcommittee Report at 24.
78 See 81 FR at 666.
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53417
been fully discharged.79 In this context,
the prohibition in Commission
Regulation 23.157(c)(1) against
rehypothecation, repledging, reuse, or
other transfer (through securities
lending, repurchase agreement, reverse
repurchase agreement, or other means)
of funds or property held by the
custodian advances the Commission’s
goal of ensuring that the pledged assets
are available to the non-defaulting party
in the event of a default by its
counterparty.80 In the preamble to the
CFTC Margin Rule, the Commission
explained that rehypothecation could
allow the collateral posted by one
counterparty to be used by the other
counterparty as collateral for additional
swaps, resulting in rehypothecation
chains and embedded leverage
throughout the financial system.81
In contrast, Commission Regulation
23.156(a) aims to identify assets as
eligible collateral that are liquid, and,
with haircuts, will hold their value in
times of financial stress.82 Current
paragraph (C) of Commission Regulation
23.156(a)(1)(ix) furthers the goal that
money market and similar fund
securities posted as IM collateral remain
liquid and retain their value during
times of financial stress. More
specifically, paragraph (C) disqualifies
the securities of money market and
similar funds that transfer their assets
through repurchase or similar
arrangements to mitigate the potential
impact of such transfers on the liquidity
or value of fund securities.
For example, if the counterparty to a
money market and similar fund in a
repurchase or similar arrangement does
not fulfill its obligation under the
79 Id.
at 670.
this regard, the Margin Subcommittee Report
stated that ‘‘in [ ] MMF sweep arrangements, under
no circumstances does the pledgor’s custodian have
any right to rehypothecate, reuse the IM collateral
or take any other independent actions with respect
to the pledged MMF shares. Instead, the CSE and
financial end user agree upfront in the collateral
documentation to the list of eligible MMFs and any
associated haircuts, as pledgor any cash sweep into
a MMF is instructed by the financial end user or
its manager and absent any default, any transfers
into and out of the collateral account by the
custodian is instructed by the financial end user
and agreed to by the CSE (as secured party).’’
Margin Subcommittee Report at 25.
81 Id. at 688, n. 392 (describing as an example, the
situation where a default or liquidity event that
occurs at one link along the rehypothecation chain
may induce further defaults or liquidity events for
other links in the rehypothecation chain as access
to the collateral for other positions may be
obstructed by a default further up the chain, and
also explaining that in the event of default along a
rehypothecation chain, there is an increased chance
that each party along the chain will ask for the
rehypothecated collateral to be returned to them at
the same time, leaving just one party with the
collateral).
82 Id. at 665.
80 In
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arrangement, the fund may be left
holding assets that might not be easily
resold or that might not provide
sufficient compensation for the assets
tendered in the repurchase arrangement,
in particular during a period of financial
stress, reducing the overall net asset
value of the fund and the price of the
fund’s securities. Also, the inability to
liquidate assets that a money market
and similar fund might be left holding
upon the failure of a repurchase or
similar arrangement, or the inability to
extract assets originally tendered in the
repurchase arrangement, may impact a
fund’s ability to promptly respond to
redemption requests, which may hinder
the liquidity of the money market and
similar funds’ securities, making the
securities less suitable as margin
collateral.83 Repurchase and similar
arrangements may therefore undermine
efforts that collateral be ‘‘subject to low
credit, market, and liquidity risk.’’ 84
As discussed above, the asset transfer
restriction was included in the CFTC
Margin Rule to provide consistency
with the prohibition against
rehypothecation of IM collateral, given
the possibility that assets exchanged by
parties in a repurchase or similar
arrangement might be lost in a chain of
transactions similar to the chain of
hypothecations that the Commission
intended to avert by prohibiting the
rehypothecation of IM collateral by
custodians under Commission
Regulation 23.157(c)(1). However,
unlike in the rehypothecation situation,
where collateral might be lost at any
link of the chain with the posting
counterparty in the uncleared swap
transaction potentially losing its
collateral without any recourse, in the
repurchase or similar arrangement
context, each party to the arrangement
would be partially secured because the
parties would exchange assets with each
other under the arrangement. Hence, the
risk of loss would be mitigated. If a
party to the repurchase arrangement
83 The Commission, however, notes that any
potential risk of such a repurchase or similar
arrangement may be mitigated by the standard
industry practice of applying haircuts to non-cash
collateral in repurchase or similar arrangements to
compensate for the risk that the value of the
collateral may decline over the term of the
arrangement. See Primer: Money Market Funds and
the Repo Market, Prepared by the staff of the
Division of Investment Management, U.S. Securities
and Exchange Commission at pp. 5–6.
84 81 FR at 667 (noting that the CFTC Margin Rule
does not allow CSEs to fulfill the margin
requirements with any asset not included in the list
of eligible collateral set forth in Commission
Regulation 23.156, as the use of alternative types of
collateral could introduce liquidity, price volatility,
or other risks of collateral during a period of stress
that could further exacerbate such stress and could
undermine efforts to ensure that collateral be
subject to low credit, market, and liquidity risk).
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defaults by failing to return assets
tendered by its counterparty, the
counterparty would not lose the entire
value of its assets as it would hold the
assets committed by the other party
under the arrangement.85
While acknowledging the concerns
associated with repurchase and similar
arrangements, the Commission
preliminarily believes that the flexibility
and safety that it aimed to achieve by
specifically identifying assets as eligible
collateral, including certain money
market and similar fund securities, may
be advanced even if repurchase and
similar arrangements are not restricted
for the purpose of qualifying money
market and similar fund securities as
eligible collateral. In that regard, based
on its experience administering the
CFTC Margin Rule, the Commission
preliminarily believes that risks
associated with repurchase and similar
arrangements would be adequately
addressed even in the absence of the
asset transfer restriction by safeguards
already present in the CFTC regulations,
as further discussed below, which, in
the Commission’s view, can achieve the
desired level of safety with respect to
fund securities without restricting a
fund’s ability to undertake repurchase
or similar transactions.
First, Commission Regulation
23.156(a)(1)(ix)(A) and (B) qualify as
eligible collateral the securities of
money market and similar funds that
invest only in securities issued or
unconditionally guaranteed by the U.S.
Department of the Treasury, the
European Central Bank or certain other
sovereign entities, and cash. The
Commission preliminarily believes that
these provisions ensure that money
market and similar fund securities
present the fundamental characteristics
of liquidity and value stability
contemplated by the CFTC Margin
Rule.86 In addition, the Commission
notes that subparagraphs (A) and (B) of
Commission Regulation 23.156(a)(1)(ix)
effectively limit the types of assets that
a money market and similar fund can
receive in repurchase or similar
arrangements. As such, the securities of
money market and similar funds will
qualify as eligible collateral only if the
types of assets that the fund receives in
a repurchase or similar arrangement are
those described in subparagraphs (A)
and (B).
Second, Commission Regulation
23.156(c) requires that CSEs monitor the
market value and eligibility of all
85 Of course, it might experience some loss as the
retained assets might not fully compensate such
party for the unreturned assets.
86 See 81 FR at 665.
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collateral and, to the extent that the
market value has declined, promptly
collect or post additional eligible
collateral to maintain compliance with
Commission Regulations 23.150 through
23.161.87 Thus, even if the value or
liquidity of pledged money market and
similar fund securities may be affected
by a repurchase or similar arrangement
undertaken by the fund, CSEs have the
obligation to monitor the value and
suitability of the fund’s securities as
margin collateral and collect or post
additional eligible collateral to
compensate for collateral deficiencies.
In addition, section 4s(j)(2) of the CEA
requires CSEs to adopt a robust and
professional risk management system
that is adequate for the management of
their swap activities,88 and Commission
Regulation 23.600 mandates that CSEs
establish a risk management program to
monitor and manage risks associated
with their swap activities including,
among other things, credit and liquidity
risks. In particular, pursuant to
Commission Regulation 23.600(c)(4),
credit risk policies and procedures
should provide for the regular valuation
of collateral used to cover credit
exposures and the safeguarding of
collateral to prevent loss, disposal,
rehypothecation, or use unless
appropriately authorized, and liquidity
risk policies and procedures should
provide for, among other things, the
assessment of procedures for liquidating
all non-cash collateral in a timely
manner and without a significant effect
on price, and the application of
appropriate collateral haircuts that
accurately reflect market and credit
risk.89
Given these safeguards and the
recognition that the asset transfer
restriction is severely limiting the use of
money market and similar fund
securities as eligible collateral, the
Commission preliminary believes that it
is appropriate to eliminate the asset
transfer restriction. The Commission
also notes that the elimination of the
restriction would bring the CFTC’s
eligible collateral framework more in
line with the SEC approach, which does
not impose asset transfer restrictions on
funds whose securities are used as
collateral for margining purposes and
expressly permits the use of government
money market fund securities as
collateral, thereby potentially leading to
a reduction in costs for those market
participants that dually register as SDs
and security-based swap SDs with the
CFTC and the SEC, respectively.
87 17
CFR 23.156(c).
7 U.S.C. 6s(j).
89 17 CFR 23.600.
88 See
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2. Commission Regulation
23.156(a)(3)—Amendments to the
Haircut Schedule
Commission Regulation 23.156(a)(3)
sets forth percentage discounts to be
applied to the value of eligible collateral
collected or posted to satisfy IM
requirements, varying according to asset
class (‘‘haircut requirements’’).90 The
haircut requirements are intended to
address the possibility that the value of
non-cash eligible collateral may decline
between a counterparty’s default and
the close out of such counterparty’s
swap positions by the CSE.91
Although the Commission intended to
align its margin rule for uncleared
swaps with the Prudential Regulators
Margin Rule, in adopting its rule, the
Commission inadvertently omitted a
footnote to the haircut schedule
included in the Prudential Regulators
Margin Rule.92 The Commission is
therefore proposing an amendment to
Commission Regulation 23.156(a)(3) to
incorporate the omitted footnote. The
footnote, consistent with the footnote in
the Prudential Regulators Margin Rule,
would describe the haircut applicable to
the securities of money market and
similar funds. The haircut for such
money market and similar fund
securities would be the weighted
average discount on all assets within the
funds (the discount for each asset is
specified in Commission Regulation
23.156(a)(3)) at the end of the prior
month. The footnote would further
specify that the weights to be applied in
the weighted average should be
calculated as a fraction of each fund’s
total market value that is invested in
each asset with a given discount
amount.
Request for comments: The
Commission requests comment
regarding the proposed amendments to
Commission Regulation 23.156,
generally. The Commission specifically
requests comment on the following
questions:
10. Does the existing asset transfer
restriction significantly limit the use of
money market and similar fund
securities as eligible collateral under the
CFTC Margin Rule?
11. Under the Money Market Funds
Proposal, the securities of certain money
market and similar funds that engage in
repurchase or similar arrangements
would qualify as eligible collateral. A
90 17 CFR 23.156(a)(3). Also, Commission
Regulation 23.156(b)(1)(ii) provides that assets that
qualify as eligible collateral for IM can be used as
collateral for VM for swap transactions between a
CSE and a FEU, subject to the applicable haircuts
for each asset. See also supra note 20.
91 81 FR at 668.
92 Prudential Regulators Margin Rule at 74910.
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money market and similar fund that
engages in asset transfer transactions
under a repurchase or similar
arrangement may be exposed to
increased risks, which may affect the
liquidity and value of the fund’s
securities pledged as collateral under
the CFTC Margin Rule. In light of the
potential increased risk, should the
Commission consider an alternative to
the proposed rule amendment, such as
allowing the securities of money market
and similar funds to qualify as eligible
collateral only if a fund’s repurchase or
similar arrangements are cleared?
Should the Commission impose any
additional limits or conditions, such as
restrictions on the type and terms of the
repurchase or similar arrangements
permitted for money market and similar
funds for their shares to qualify as
eligible collateral?
12. If the Commission eliminates the
asset transfer restriction, should the
Commission impose an additional
haircut beyond that required by the
haircut schedule in Commission
Regulation 23.156(a)(3), as revised by
the proposed amendment? If an
additional haircut were to be adopted,
what should the haircut be and how
should the haircut be calculated?
Should such an additional haircut be
proportionate to the net asset value of
the assets of a money market and similar
fund that are subject to repurchase or
similar arrangements? Or instead,
should the additional haircut be a fixed
percentage similar to the percentages
applicable to other assets that qualify as
eligible collateral under the haircut
schedule, as it may be less complex to
administer? Should such additional
fixed haircut apply to all securities of
money market and similar funds that are
used as eligible collateral, or be
applicable only to such securities of
money market and similar funds that
engage in repurchase or similar
arrangements?
13. Given the potential impact that
repurchase or similar agreements may
have on the liquidity and value of
securities of money market and similar
funds that may be used as eligible
collateral, should there be a percentage
cap on the amount of assets that a fund
can use for repurchase or similar
arrangements, such as 10 percent of the
total net asset value of the fund?
14. To gain a better understanding of
the risks posed by repurchase and
similar arrangements, the Commission
requests information concerning the
types of counterparties that typically
face money market and similar funds in
repurchase or similar agreements; the
extent to which repurchase and similar
arrangements are used by money market
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53419
and similar funds; and whether the
market treats differently money market
and similar funds according to the types
of repurchase and similar arrangements
the funds enter into and the extent of
repurchase agreements or arrangements
the funds engage in. Further, the
Commission requests comment with
respect to the manner in which, and the
extent to which, CSEs will meet their
obligation to monitor the value and
suitability of securities of money market
and similar funds pledged as margin
collateral where the funds engage in
repurchase or similar arrangements.
15. Are the regulatory safeguards
referenced in the Money Market Funds
Proposal adequate to address the
potential risks that may arise from the
proposal? Are there other regulatory
safeguards that the Commission should
consider?
16. Are there any risks associated
with the Money Market Funds Proposal
that the Commission has not
considered? In addition to the possible
measures discussed above, including a
possible additive haircut, or a
percentage cap on the amount of assets
that funds could use in repurchase and
similar agreements, are there other
measures that the Commission could
take to mitigate such risks?
17. The Prudential Regulators Margin
Rule contains an equivalent asset
transfer restriction. If the Commission
amends Commission Regulation 23.156,
counterparties that trade with both
prudentially regulated SDs and CFTCregulated SDs may need to adjust their
swap-related documentation and
collateral management systems to reflect
the different treatments for fund
securities under the CFTC’s and the
prudential regulators’ rules. In that
regard, the Commission requests
information on the potential additional
costs associated with maintaining two
separate and distinct documentation
and collateral management processes.
How much weight should the
Commission give with respect to the
possible challenge that counterparties
may need to maintain two separate and
distinct documentation and collateral
management systems? Should the
Commission proceed to adopt the
proposed amendments to Commission
Regulation 23.156 if the prudential
regulators do not adopt similar
regulatory changes?
18. The Commission intends that the
final rule will become effective 30 days
after its publication in the Federal
Register. With respect to the Money
Market Funds Proposal, are there any
comments on the effective date?
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IV. Administrative Compliance
A. Regulatory Flexibility Act
The Regulatory Flexibility Act
(‘‘RFA’’) requires Federal agencies to
consider whether the rules they propose
pursuant to the notice-and-comment
provisions of the Administrative
Procedure Act, or any other law, will
have a significant economic impact on
a substantial number of small entities
and provide a regulatory flexibility
analysis respecting the impact or issue
a certification that the rule does not
have such impact.93 The Commission
previously has established certain
definitions of ‘‘small entities’’ to be used
in evaluating the impact of its
regulations on small entities in
accordance with the RFA.94 The
proposed amendments would only
affect certain SDs and MSPs and their
counterparties, which must be eligible
contract participants (‘‘ECPs’’).95 The
Commission has previously established
that SDs, MSPs and ECPs are not small
entities for purposes of the RFA.96
Accordingly, the Chairman, on behalf
of the Commission, hereby certifies
pursuant to 5 U.S.C. 605(b) that the
proposed amendments will not have a
significant economic impact on a
substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(‘‘PRA’’) 97 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
Commission may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a currently valid
Office of Management and Budget
control number. The proposed
amendments contain no requirements
subject to the PRA.
C. Cost-Benefit Considerations
Section 15(a) of the CEA requires the
Commission to consider the costs and
93 See
5 U.S.C. 601(2), 603, 604, and 605.
Registration of Swap Dealers and Major
Swap Participants, 77 FR 2613 (Jan. 19, 2012).
95 Pursuant to section 2(e) of the CEA, 7 U.S.C.
2(e), each counterparty to an uncleared swap must
be an ECP, as defined in section 1a(18) of the CEA,
7 U.S.C. 1a(18). Section 1a(18) of the CEA defines
ECP by listing certain entities and individuals
whose business is financial in nature or that meet
defined asset or net worth thresholds, as well
certain government entities.
96 See Further Definition of ‘‘Swap Dealer,’’
‘‘Security-Based Swap Dealer,’’ ‘‘‘Major Swap
Participant,’’ ‘‘Major Security-Based Swap
Participant’’ and ‘‘Eligible Contract Participant,’’ 77
FR 30596, 30701 (May 23, 2012).
97 44 U.S.C. 3501 et seq.
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94 See
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benefits of its actions before
promulgating a regulation under the
CEA.98 Section 15(a) further specifies
that the costs and benefits shall be
evaluated in light of the following five
broad areas of market and public
concern: (1) protection of market
participants and the public; (2)
efficiency, competitiveness and
financial integrity of futures markets; (3)
price discovery; (4) sound risk
management practices; and (5) other
public interest considerations. The
Commission considers the costs and
benefits resulting from its discretionary
determinations with respect to the
section 15(a) considerations, and seeks
comments from interested persons
regarding the nature and extent of such
costs and benefits.
As described in more detail above,
under the Seeded Funds Proposal, the
Commission is proposing to amend the
definition of ‘‘margin affiliate’’ to
provide for a limited eligible seeded
fund exception, pursuant to which,
during a period of three years after the
fund’s trading inception date, a seeded
fund meeting certain specified
requirements would be deemed to not
have margin affiliates for purposes of
calculating the fund’s MSE and the IM
threshold. This proposed treatment for
eligible seeded funds would effectively
relieve CSEs that enter into uncleared
swaps with certain seeded funds from
the requirement to exchange IM with
the seeded funds during the three-year
period after the funds’ trading inception
date. The Seeded Funds Proposal would
make the proposed treatment available
only with respect to eligible seeded
funds that, among other requirements:
(i) are distinct legal entities from each
sponsor entity; (ii) have one or more
margin affiliates that are required to
post and collect IM; (iii) are managed by
an asset manager pursuant to an
agreement that requires the assets of the
fund to be managed in accordance with
a specified written investment strategy;
(iv) have an asset manager who
maintains independence in carrying out
its management responsibilities and
exercising its investment discretion, and
has independent fiduciary duties to
other investors in the fund (if any), such
that no sponsor entity or any margin
affiliate of a sponsor entity controls or
has transparency into the management
or trading of the seeded fund; (v) follow
a written plan for the reduction of the
sponsor entity’s ownership interest in
the fund that stipulates divestiture
targets over the three-year period after
the seeded fund’s trading inception
date; (vi) are not collateralized,
98 7
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guaranteed or otherwise supported,
directly or indirectly by any sponsor
entity, any margin affiliate of a sponsor
entity, other collective investment
vehicles, or the seeded fund’s asset
manager, in respect of any of the fund’s
obligations; (vii) have not received any
of their assets, directly or indirectly,
from an eligible seeded fund that has
relied on the proposed eligible seeded
fund exception; and (viii) are not
securitization vehicles.
Under the Money Market Funds
Proposal, the Commission is proposing
to eliminate the asset transfer restriction
in paragraph (C) of Commission
Regulation 23.156(a)(1)(ix), which has
the effect of disqualifying as eligible
collateral the securities of money market
and similar funds that transfer their
assets through repurchase or similar
arrangements. The Margin
Subcommittee Report indicated that the
asset transfer restriction significantly
limits the money market fund securities
that are available for use as collateral
under the CFTC Margin Rule.99
The baseline against which the
benefits and costs associated with the
proposed rule amendments are
compared is the uncleared swaps
markets as they exist today, including
the treatment of seeded funds and the
securities of money market and similar
funds under the current CFTC Margin
Rule.
The Commission notes that the
consideration of costs and benefits
below is based on the understanding
that the markets function
internationally, with many transactions
involving U.S. firms taking place across
international boundaries; with some
Commission registrants being organized
outside of the United States; with
leading industry members typically
conducting operations both within and
outside the United States; and with
industry members commonly following
substantially similar business practices
wherever located. Where the
Commission does not specifically refer
to matters of location, the below
discussion of costs and benefits refers to
the effects of these proposed
amendments on all activity subject to
the proposed amended regulations,
whether by virtue of the activity’s
physical location in the United States or
by virtue of the activity’s connection
with activities in, or effect on, U.S.
99 As previously noted, according to the Margin
Subcommittee Report (citing research by a leading
custodian bank), the securities of only four MMFs
would qualify as eligible collateral under the
current rules. See Margin Subcommittee Report at
24.
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commerce under section 2(i) of the
CEA.100
The Commission recognizes that the
proposed rules may impose additional
costs on market participants, including
CSEs. Although the Commission has
endeavored to assess the expected costs
and benefits of the proposed rulemaking
in quantitative terms, due to the lack of
data and information to estimate those
costs, the Commission has identified
and considered the costs and benefits of
the proposal in qualitative terms. The
lack of data and information to estimate
costs is attributable to the nature of the
proposal and uncertainty relating to
how particular market participants
would implement the proposed rules.
The Commission specifically requests
data and information from market
participants and other commenters to
allow it to better estimate the costs of
the proposal.
1. General Cost-Benefits Considerations
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Seeded Funds Proposal
(a) Benefits
The Seeded Funds Proposal would
effectively relieve CSEs entering into
uncleared swaps with eligible seeded
funds from the requirement to collect
IM from the funds, subject to specified
conditions. Absent the Seeded Funds
Proposal, seeded funds would be
disadvantaged domestically and
globally in comparison to similar
investment funds that are not margin
affiliates of an entity required to
exchange IM or are subject to the rules
of jurisdictions such as Australia,
Canada and the EU that treat certain
investment funds as separate legal
entities, consistent with the
international standards established by
the BCBS–IOSCO Framework.101 The
Seeded Funds Proposal would therefore
level the playing field domestically and
globally with respect to the treatment of
seeded funds. However, the Seeded
Funds Proposal may incentivize trading
with CSEs over SDs or MSPs subject to
the U.S. prudential regulators’ margin
rules given that the prudential
regulators might not revise their rules in
a manner consistent with the Seeded
Funds Proposal and the prudential
regulators’ rules may continue to require
that seeded funds calculate the MSE and
IM threshold amount on a consolidated
basis with their margin affiliates.
The Commission preliminarily
believes that the Seeded Funds Proposal
would tend to benefit seeded funds
whose AANA falls below the $8 billion
MSE threshold and that, given their
100 7
U.S.C. 2(i).
Subcommittee Report at 7, 30 and 33.
101 Margin
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level of swap activity, such seeded
funds would pose relatively low risk to
the uncleared swaps market and the U.S
financial system in general. In that
regard, the Margin Subcommittee Report
stated that seeded funds have limited
notional exposure and their
capitalization typically does not exceed
$50–100 million.102 The Report further
cited an informal sampling of members
of SIFMA AMG and the American
Council of Life Insurers conducted in
2018, which indicated that a total of 33
funds would be in scope of the CFTC
margin requirements due to their
derivatives notional exposures being
consolidated with entities with MSE.
Individually, each of the funds had an
average gross notional exposure of $32
million.103
As a result, in the Commission’s
preliminary view, the Seeded Funds
Proposal, if adopted, would address
seeded funds that tend to engage in less
uncleared swap trading activity and, in
the aggregate, pose less systemic risk
than entities that meet the MSE
threshold. The impacted eligible seeded
funds, which would be in an initial
stage of development, would
presumably have fewer resources to
devote to IM compliance and hence
would benefit from being discharged
from posting IM during their seeding
period without contributing
significantly to systemic risk. The
eligible seeded fund’s sponsor entities
and their margin affiliates that do not
independently qualify for the proposed
eligible seeded fund exception would
continue to include the eligible seeded
funds’ exposure in their calculation of
the MSE and IM threshold amount. The
CSE counterparty to the eligible seeded
fund would also still be required to
count the uncleared swaps that it
undertakes with the eligible seeded
fund for purposes of calculating its own
AANA. The Commission preliminarily
believes that the flexibility provided by
the eligible seeded fund exception
would be instrumental for investment
funds during the seeding period when
funds typically use all their resources to
establish a performance track record to
attract unaffiliated investors.
In addition, the Commission believes
that the Seeded Funds Proposal would
be beneficial for CSEs that enter into
swap transactions with investment
funds. As a result of the proposed
amendments, CSEs would apply a
consistent approach in their swap
dealing activities with U.S. and nonU.S. investment funds, which may lead
to cost efficiencies. Also, as noted in the
102 Margin
Subcommittee Report at 31.
103 Id.
PO 00000
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Margin Subcommittee Report, a
consistent approach to seeded funds
would reduce the incentive for non-U.S.
funds to avoid business with CSEs given
the perceived more onerous treatment of
funds in the U.S.104
The proposed eligible seeded fund
exception may also incentivize some
market participants to expand their
swap business or enter into the swaps
markets because, by counting their
AANA and uncleared swaps credit
exposure individually, seeded funds
may not meet the thresholds that would
bring them within the scope of the IM
requirements. This would relieve CSEs
entering into uncleared swaps with the
funds from the requirement to exchange
IM with the funds. In turn, the
elimination of IM-related costs may
encourage uncleared swaps trading
between CSEs and investment funds
and increase the pool of potential swap
counterparties, enhancing competition
and liquidity and facilitating price
discovery in the uncleared swaps
markets.
(b) Costs
Amending the definition of ‘‘margin
affiliate’’ to provide for a limited eligible
seeded fund exception under which
seeded funds would be deemed to not
have margin affiliates for purposes of
calculating the funds’ MSE and the IM
threshold amount, subject to specified
conditions, may lead to the exchange of
less margin between a CSE and a seeded
fund. The Commission recognizes that
the uncollateralized exposure that may
result from the proposed change to the
‘‘margin affiliate’’ definition could
increase credit risk associated with
uncleared swaps. The Commission
believes, however, that a number of
safeguards exist to mitigate this risk.
The Commission notes that seeded
funds that would qualify for the eligible
seeded fund exception would typically
be smaller entities that have limited
swaps activity.105 To grow in size, the
funds would have to attract unaffiliated
investors, which may result in such
funds no longer being subject to
consolidation with their sponsor entity.
As such, the eligible seeded fund
exception under the Seeded Funds
Proposal would primarily impact the
exchange of IM between a CSE and
investment funds that are in their
seeding period. During that period, such
investment funds would pose less risk
to a CSE counterparty and the financial
system as a whole given the small size
of the funds and the scope of their
derivatives activity. To ensure that
104 Margin
105 See
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Subcommittee Report at 30.
Margin Subcommittee Report at 31.
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eligible seeded funds are afforded the
benefit of a separate treatment from
margin affiliates only during the seeding
period, the Commission proposes to
limit the applicability of the eligible
seeded fund exception only to three
years after the fund’s trading inception
date. To ensure that the three-year
period is not reinstated as a result of
rollovers of fund assets or similar
activities, the proposed definition of
eligible seeded fund would include a
condition that the seeded fund has not
received, directly or indirectly, any of
its assets from an eligible seeded fund
that has relied on the eligible seeded
fund exception to the definition of
‘‘margin affiliate.’’ The Commission
further notes that, pursuant to section
4s(j)(2) of the CEA and Commission
Regulation 23.600, CSEs are required to
monitor and manage risks related to
their swap activities, including credit
risk, and set risk tolerance limits.106
Thus, if the credit risk associated with
CSEs’ transactions with eligible seeded
funds exceeds the CSEs’ risk tolerance
limits, CSEs would be expected to take
mitigating measures.
In certain circumstances, the increase
in uncollateralized credit risk resulting
from the Seeded Funds Proposal could
also negatively impact the sponsor
entity or the asset manager of a seeded
fund. In particular, if a seeded fund is
facing financial distress, a sponsor
entity or the fund’s asset manager may
be incentivized to intervene, because of
reputational risks or other concerns, and
contribute additional resources even in
the absence of an explicit business
arrangement to provide financial
support or a guarantee. Similarly, if the
fund is suffering the consequences of a
swap counterparty default, the sponsor
entity or the asset manager may
contribute financial resources to
improve the fund’s condition and
increase its own exposure, potentially
putting at risk its own financial
position. Thus, the fund’s
uncollateralized exposure may lead the
sponsor entity or the asset manager to
incur risks, increasing the potential for
contagion and systemic risk. To account
for these risks, the Commission is
proposing to define the term ‘‘eligible
seeded fund’’ to incorporate
requirements meant to ensure that
seeded funds are genuinely independent
and that the risks associated with their
106 7 U.S.C. 6s(j)(2) (mandating that CSEs adopt a
robust and professional risk management system
adequate for the management of day-to-day swap
activities) and 17 CFR 23.600 (requiring CSEs, in
establishing a risk management program for the
monitoring and management of risk related to their
swap activities, to account for credit risk and to set
risk tolerance limits).
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activities are not assumed by other
entities such as their sponsor entities or
asset managers. Specifically, among
other conditions, the seeded fund would
have to be a distinct legal entity from
each sponsor entity that is not
collateralized, guaranteed, or otherwise
supported, directly or indirectly, by any
sponsor entity, any margin affiliate of
any sponsor entity, other collective
investment vehicles, or the seeded
fund’s asset manager, in respect of any
of the fund’s obligations. This should
mitigate the incentive for the sponsor’s
assets to be used if the seeded fund fails.
Treating seeded funds as separate
unaffiliated legal entities for purposes of
calculating the thresholds for
determining whether compliance with
the IM requirements is required could
also incentivize swap counterparties to
create legal entities that have no
economic basis and are constructed
solely for the purpose of applying
additional thresholds to evade margin
requirements. To address these
concerns, the Commission proposes to
limit the applicability of the eligible
seeded fund exception by providing that
eligible seeded funds would be deemed
not to have margin affiliates solely for
the purpose of calculating the fund’s
MSE and IM threshold amount. As such,
under the Seeded Funds Proposal, the
eligible seeded funds’ sponsor entities
and their margin affiliates would
continue to include the eligible seeded
funds’ exposures in the calculation of
the IM compliance thresholds
applicable to such sponsor entities and
margin affiliates. In addition, the
Commission proposes to include, in the
proposed definition of ‘‘eligible seeded
fund,’’ conditions designed to ensure
that funds that qualify as eligible seeded
funds have a bona fide business
purpose. In particular, the proposed
definition provides that the eligible
seeded fund must be managed by an
asset manager pursuant to an agreement
that requires that the assets of the fund
be managed in accordance with a
specified written investment strategy
and that the asset manager has
independence in carrying out its
management responsibilities and
exercising its investment discretion, and
to the extent applicable, has
independent fiduciary duties to other
investors in the fund, such that no
sponsor entity or a margin affiliate of a
sponsor entity controls or has
transparency into the management or
trading of the seeded fund. Furthermore,
the proposed definition of eligible
seeded fund would require that the
seeded fund’s investment strategy must
follow a written plan for reducing the
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sponsor entity’s ownership interest in
the fund.
The Commission, therefore, believes
that the costs associated with the
potential evasion of the IM requirements
would be mitigated by the proposed rule
amendment, which would be narrowly
tailored to make available the proposed
approach only for purposes of
calculating the IM compliance
thresholds applicable to seeded funds
that meet specified requirements and
only during the three years that follow
the fund’s trading inception date. In
addition, the Commission intends to use
its anti-evasion authority to prevent
circumvention of the margin
requirements.107
Furthermore, given that the U.S.
prudential regulators may not amend
their margin requirements in line with
the Seeded Funds Proposal, if the
Commission finalizes the proposal
described herein, the Commission
acknowledges the possibility that its
requirements with respect to the
treatment of eligible seeded funds may
diverge from that of the U.S. prudential
regulators, requiring funds that engage
in swaps transactions with both CSEs
and prudentially-regulated SDs to adjust
their swap-related documentation and
IM processes to reflect such different
treatments. Thus, market participants
may incur additional costs by having to
maintain two separate and distinct types
of documentation and IM management
processes. Similar costs may also be
incurred by CSEs that already transact
with seeded funds that are currently
consolidated. Also, as discussed
previously, given that the Seeded Funds
Proposal would provide for an eligible
seeded fund exception from the
definition of ‘‘margin affiliate,’’
effectively providing for the funds’
deconsolidation for purposes of
calculating the funds’ MSE and IM
threshold amount, seeded funds may
favor CSEs as counterparties over SDs or
MSPs subject to the prudential
regulators’ margin rules, which might
not be revised to provide for a similar
eligible seeded fund exception.
As noted above, to better assess the
impact of a potential divergence
between the CFTC Margin Rule and the
Prudential Regulators Margin Rule, the
Commission is requesting information
on the potential costs associated with
maintaining distinct documentation and
IM management processes.
Money Market Funds Proposal
(a) Benefits
The Money Market Funds Proposal
would expand the scope of assets that
107 See
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qualify as eligible collateral. In this
regard, the GMAC Margin
Subcommittee Report stated that absent
elimination of the asset transfer
restriction, the securities of very few
MMFs would qualify as eligible
collateral, noting that nearly all U.S.
MMFs engage in some form of
repurchase or similar arrangements.108
The Money Market Funds Proposal may
therefore reduce the potential
concentration of collateral in the few
MMFs whose securities currently
qualify as eligible collateral under
Commission Regulation 23.156(a)(1)(ix),
which could lead to greater diversity of
assets used for collateral, thereby
reducing the riskiness of IM assets.
Also, the Money Market Funds
Proposal, by increasing the number of
MMFs whose securities qualify as
eligible collateral, may promote more
efficient collateral management
practices. The Margin Subcommittee
Report stated that custodians offer
money market sweep programs that
afford institutional clients of such
custodians the ability to timely and
efficiently meet margin calls without
settlement delay, avoiding other
transaction costs that would otherwise
arise in the absence of the sweep
programs. Such direct sweeps from cash
into MMF securities mitigate the risk of
insolvency by the custodian because
non-cash collateral deposited with the
custodian will not be consolidated in
the custodian’s balance sheet. The
Margin Subcommittee Report also stated
that the use of MMFs may avoid the risk
of potential negative interest rate
charges that may be applied by
custodian banks on cash collateral.
By eliminating the asset transfer
restriction, the Money Market Funds
Proposal could also promote asset
management policies that improve the
performance of money market and
similar funds. Without the restriction,
the funds may undertake repurchase or
similar arrangements that increase
returns for investors, including the
return for CSEs that post money market
and similar fund securities as margin
collateral for uncleared swaps,
contributing to the fund securities’
liquidity and retention of value even
during periods of financial stress.
In summary, these benefits will
accrue to CSEs and their counterparties
that enter into uncleared swaps
transactions. As discussed above, the
potential concentration in certain types
of collateral has been acknowledged
previously by the Commission as a
potential risk that CSEs should consider
in managing their margin collateral.
108 Margin
Subcommittee Report at 24.
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CSEs and their counterparties will also
benefit from the more efficient use of
their capital as discussed above and
enhanced returns on securities posted as
collateral. Furthermore, the proposal
may lead to reduced costs for those
market participants that dually register
as SDs and security-based swap SDs
with the CFTC and the SEC,
respectively, as the proposed
amendment would bring the CFTC’s
eligible collateral framework more in
line with the SEC approach, which does
not impose asset transfer restrictions on
funds whose securities are used as
collateral for margining purposes and
expressly permits the use of government
money market fund securities as
collateral.
(b) Costs
The elimination of the asset transfer
restriction in paragraph (C) of
Commission Regulation 23.156(a)(1)(ix)
would remove a safeguard intended to
ensure that money market and similar
fund securities posted as margin
collateral remain liquid and maintain
their value in times of financial stress.
More specifically, paragraph (C)
prevents the transfer of money market
and similar fund assets through
repurchase or similar arrangements to
mitigate the impact of such transfers on
the liquidity or value of fund securities.
For example, if a counterparty to a
money market and similar fund in a
repurchase or similar arrangement
defaults, the fund may be left holding
assets that, in times of financial stress,
may not be easily resold and might not
compensate for the value of assets
tendered in the repurchase arrangement.
Such a default would reduce the overall
net asset value of the fund and the price
of the fund’s securities. Also, the
inability to liquidate assets that a money
market and similar fund might be left
holding upon the failure of a repurchase
or similar arrangement or the inability
to extract assets originally tendered in
the repurchase arrangement may impact
the fund’s ability to promptly respond
to redemption requests, hindering the
liquidity of the fund’s securities, making
them less suitable as margin collateral.
The Commission, however, notes that
subparagraphs (A) and (B) of
Commission Regulation 23.156(a)(1)(ix),
which are not being amended, limit the
types of assets that a money market and
similar fund can receive in repurchase
or similar arrangements to those assets
specifically identified in those
paragraphs, alleviating in part the risks
associated with repurchase or similar
arrangements.
In light of the proposed elimination of
the asset transfer restriction, the
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53423
Commission is also seeking input on
whether it would be appropriate to
include an additional haircut beyond
that required by the haircut schedule in
Commission Regulation 23.156(a)(3), as
corrected by the proposed amendment
discussed herein.
The Commission further notes that
Commission Regulation 23.156(c)
requires that CSEs monitor the market
value and eligibility of all collateral and,
to the extent that the market value has
declined, promptly collect or post
additional eligible collateral to maintain
compliance with Commission
Regulations 23.150 through 23.161.109
Thus, even if the value or liquidity of
pledged money market and similar fund
securities may be affected by repurchase
or similar arrangements undertaken by
the fund, CSEs have the obligation to
monitor the value and suitability of the
fund’s securities as margin collateral
and collect or post additional eligible
collateral to compensate for collateral
deficiencies.
The elimination of the asset transfer
restriction could give rise to other costs.
Given that the U.S. prudential regulators
may not amend their margin
requirements in line with the proposed
rule amendments, if the amendments
proposed herein are adopted as final,
the CFTC and U.S. prudential
regulators’ margin rules would diverge
with respect to the treatment of
securities of money market and similar
funds as eligible collateral, requiring
parties that trade with both
prudentially-regulated SDs and CSEs to
adjust their swap-related documentation
and collateral management systems to
reflect such different treatments. Thus,
market participants may incur
additional costs by having to maintain
two separate and distinct types of
documentation and collateral
management systems. Also, the Money
Market Funds Proposal may incentivize
trading with CSEs over SDs or MSPs
subject to the U.S. prudential regulators’
margin rules given that the prudential
regulators might not revise their rules in
a manner consistent with the Money
Market Funds Proposal and the
prudential regulators’ rules may
continue to restrict the use of securities
of money market and similar funds that
transfer their assets through repurchase
and similar agreements.
At the same time, the Commission
notes that the removal of the asset
transfer restriction would bring the
CFTC’s eligible collateral framework
closer to the approach adopted by the
Securities and Exchange Commission
(‘‘SEC’’), which does not impose asset
109 17
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CFR 23.156(c).
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transfer restrictions with respect to
money market and similar fund
securities and expressly permits the use
of government money market fund
securities as collateral.110 Therefore,
although there is the potential for
greater costs as a result of divergence
with the U.S. prudential regulators,
there may be lower costs overall, given
that many CSEs are also cross-registered
with the SEC as security-based SDs.
2. Section 15(a) Considerations
In light of the foregoing, the CFTC has
evaluated the costs and benefits of the
proposals pursuant to the five
considerations identified in section
15(a) of the CEA as follows:
Seeded Funds Proposal
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(a) Protection of Market Participants and
the Public
As discussed, the Seeded Funds
Proposal would provide that, during a
period of three years from the fund’s
trading inception date, a seeded fund
meeting specific requirements would be
deemed not to have margin affiliates
solely for purposes of calculating the
fund’s MSE and the IM threshold
amount. As a result, only the seeded
fund’s individual AANA would be used
to determine whether the fund has MSE,
and only the individual credit exposure
of the fund resulting from the fund’s
swaps with a CSE would be used to
determine whether the posting and
collection of IM is required, and not the
exposures calculated on an aggregate
basis with the fund’s sponsor entities
and other margin affiliates, as currently
required under the CFTC Margin Rule.
The Seeded Funds Proposal is thus
proposing an approach to eligible
seeded funds that is consistent with the
BCBS–IOSCO Framework and similar
approaches adopted by jurisdictions
such as Australia, Canada and the
EU.111 As such, the Seeded Funds
Proposal would eliminate a
disadvantage that U.S. investment funds
face compared to non-U.S. funds that
are not subject to a consolidation
requirement. The Seeded Funds
110 See Capital, Margin and Segregation
Requirements for Security-Based Swap Dealers and
Major Security-Based Swap Participants and Capital
and Segregation Requirements for Broker-Dealers,
Securities and Exchange Commission, 84 FR 43872,
43919 (Aug. 22, 2019). In the preamble to its final
rule, the SEC noted that the final rule does not
specifically exclude any type of security provided
it has a ready market, is readily transferable, and
does not consist of securities or money market
instruments issued by the counterparty or a party
related to the nonbank security-based SD or major
security-based swap participant, or the
counterparty. Generally, U.S. government money
market funds should be able to serve as collateral
under these conditions.
111 See supra notes 27 and 41.
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Proposal would also address the
potential liquidity drain and trading
disruptions that CSEs might encounter
if non-U.S. investments funds were to
avoid doing uncleared swaps business
with the CSEs because of the current
treatment of seeded funds in the U.S.
under the CFTC Margin Rule. In
addition, the Seeded Funds Proposal
would level the playing field between
U.S. seeded funds that are consolidated
within a group of entities that
collectively have MSE and other
domestic investment funds that are not
part of a group whose combined
exposure exceeds the threshold for
compliance with the IM requirements,
while, at the same time, potentially
spurring greater interest in seeded funds
as potential counterparties.
As a result of the Seeded Funds
Proposal, less collateral may be
collected by seeded funds given that
individually they may not meet the
threshold for exchanging IM. A seeded
fund’s uncollateralized swaps exposure
may negatively impact the sponsor
entities of the fund or its asset manager,
given that, for reputational reasons, a
sponsor entity or the asset manager may
provide financial support to the seeded
fund in times of financial distress,
potentially putting at risk their own
financial position.
The Seeded Funds Proposal may also
have implications for CSEs entering into
uncleared swap transactions with the
fund’s sponsor entity. Specifically, a
CSE evaluating the creditworthiness of
its counterparty—the fund’s sponsor
entity—may not be aware of the sponsor
entity’s potentially weakened financial
position. As such, the Seeded Funds
Proposal, by allowing seeded funds’
exposures to not be consolidated with
the exposures of their sponsor entities
and other margin affiliates for purposes
of determining the applicability of the
IM requirements, may increase the risk
of contagion.
The Commission, however, believes
that such concerns are mitigated by the
requirements incorporated in the
proposed definition of eligible seeded
fund, including the condition that the
seeded fund is not collateralized,
guaranteed or otherwise supported,
directly or indirectly by any sponsor
entity, any margin affiliate of any
sponsor entity, other collective
investment vehicles, or the fund’s asset
manager in respect of any of the fund’s
obligations. These conditions are
intended to ensure that seeded funds are
genuinely independent and risk remote
from the sponsor entities.
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(b) Efficiency, Competitiveness, and
Financial Integrity of Markets
The Seeded Funds Proposal would
amend the definition of ‘‘margin
affiliate’’ in Commission Regulation
23.151 to provide an exception for
eligible seeded funds, which would
effectively relieve CSEs from the
requirement to exchange IM for
uncleared swaps with such eligible
seeded funds, subject to specified
conditions. This eliminates a
competitive disadvantage between
seeded funds that are consolidated with
their sponsor entities and margin
affiliates, which collectively exceed the
thresholds for compliance with the IM
requirements on the one hand, from
those investment funds whose sponsor
entities and margin affiliates do not
have collective exposures exceeding
such thresholds on the other. This
would potentially spur greater interest
in seeded funds as potential
counterparties. In addition, the
proposed amendment to the ‘‘margin
affiliate’’ definition would level the
playing field between U.S. funds and
non-U.S. investment funds from
jurisdictions that do not require fund
swaps exposures to be considered on a
consolidated basis for purposes of
determining whether compliance with
the IM requirements is required.
The Seeded Funds Proposal would
relieve CSEs entering into uncleared
swaps with eligible seeded funds from
the requirement to exchange IM with
the funds if the funds meet specified
requirements. This would reduce the
operational costs associated with the
exchange of IM for CSEs and their
eligible seeded funds counterparties and
would allow seeded funds to allocate
their financial resources to testing their
investment strategy and attracting
unaffiliated investors. The cost
reduction may also incentivize more
market participants to enter into
uncleared swaps. The Seeded Funds
Proposal would thus promote efficiency
in the uncleared swaps market by
increasing the pool of swap
counterparties and fostering
competition.
Given that the Seeded Funds Proposal
would relieve CSEs from the exchange
of IM with certain eligible seeded funds
for their uncleared swaps, the
uncollateralized credit exposure for the
uncleared swaps would increase and
could undermine the integrity of the
markets. The Commission, however,
believes that the increased exposure
would be limited given the relatively
limited derivatives activity of seeded
funds that would benefit from the
eligible seeded fund exception. In
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addition, the proposed relief is narrowly
tailored given the requirements
incorporated in the proposed definition
of ‘‘eligible seeded fund’’ and the fact
that it would only apply for purposes of
calculating the MSE and IM threshold
amount applicable to the eligible seeded
funds, and not for the calculation of the
IM compliance thresholds applicable to
the funds’ sponsor entities and margin
affiliates that do not independently
qualify as eligible seeded funds (nor for
the funds’ CSE counterparties).
ddrumheller on DSK120RN23PROD with PROPOSALS1
(c) Price Discovery
By amending the definition of
‘‘margin affiliate’’ in Commission
Regulation 23.151, the Seeded Funds
Proposal would relieve CSEs from the
requirement to exchange IM when
entering into uncleared swaps with an
eligible seeded fund. As a counterparty
to a CSE, an eligible seeded fund
therefore would not have to incur
operational costs associated with setting
up and maintaining processes and
documentation to exchange IM. The
relief would permit eligible seeded
funds to direct more resources to
building a successful performance track
record and attracting new investors. As
a result, the overall cost of entering into
an uncleared swap transaction may
decrease, incentivizing increased
participation in the uncleared swaps
markets. In turn, the trading of
uncleared swaps may increase, leading
to increased liquidity and enhanced
price discovery.
(d) Sound Risk Management
Because the Seeded Funds Proposal
would relieve CSEs from the obligation
to exchange IM with certain seeded
funds, less margin may be collected and
posted to offset the risk of uncleared
swaps, which could increase the risk of
default. Nevertheless, the Commission
believes that the uncollateralized risk
would be mitigated because during the
seeding period, investment funds are
typically small and the extent of
uncleared swap activity a seeded fund
may undertake with CSEs may be
limited. In addition, CSEs are required
to manage the risk associated with their
uncleared swaps, including those swaps
that might be uncollateralized, by
maintaining a robust and professional
risk management program that provides,
among other things, for the
implementation of internal parameters
for the monitoring and management of
swap risk, including credit risk.
The Commission also notes that the
Seeded Funds Proposal, by relieving
CSEs from the requirement to exchange
IM with certain seeded funds, would
reduce the operational costs of both
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CSEs and their eligible seeded fund
counterparties, potentially encouraging
more market participants to enter the
uncleared swaps market. As such, by
increasing the pool of swap
counterparties, the Seeded Funds
Proposal would encourage the careful
consideration and selection of
counterparties, promoting sound risk
management.
(e) Other Public Interest Considerations
By proposing a treatment of certain
investment funds that is consistent with
the BCBS/IOSCO Framework, the
Seeded Funds Proposal would alleviate
the potential disadvantage that U.S.
seeded funds have compared to nonU.S. investment funds, which may be
perceived to be subject to more
favorable regulatory regimes than in the
United States given the differing
consolidation treatments applicable to
funds.
However, given that the U.S.
prudential regulators may not amend
their margin requirements in line with
the proposed amendments, the
possibility exists that the CFTC and U.S.
prudential regulators’ differing rules
may motivate certain investment funds
to undertake swaps with particular SDs
based on which U.S. regulatory agency
is responsible for setting margin
requirements for such SDs. In that
sense, the change can lead to trades that
do not reflect the relative merits of
competing SDs. The divergence could
also lead to additional costs for
investment funds that trade with both
CSEs and prudentially-regulated SDs
because such funds would need to
adjust their swap related documentation
and collateral management systems to
reflect the different margin requirements
that may apply under the CFTC’s and
the prudential regulators’ rules.
Money Market Funds Proposal
(a) Protection of Market Participants and
the Public
The Commission believes that the
Money Market Funds Proposal would
protect market participants and the
public by eliminating the asset transfer
restriction and allowing a broader range
of money market and similar fund
securities to serve as collateral, thus
addressing the potential that margin
collateral may be concentrated in the
securities of a few money market and
similar funds and leading to greater
diversification by increasing the range
of assets that may be used as collateral.
The elimination of the asset transfer
restriction would also promote effective
asset management policies for the
benefit of fund investors and market
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53425
participants in general. Without the
restriction, money market and similar
funds that otherwise would have
refrained from undertaking repurchase
or similar arrangements to avoid the
disqualification of their securities as
eligible collateral may enter into such
arrangements. The arrangements might
generate higher returns for investors,
including for CSEs that use money
market and similar fund securities as
margin collateral for uncleared swaps,
and enable funds to meet their
commitments to investors concerning
fund performance.
Nevertheless, market participants
might be harmed by the rule change if
a counterparty to the money market or
similar fund in a repurchase or similar
arrangement defaults, and the fund is
unable to recover assets tendered to the
counterparty in the arrangement and is
left holding assets of lesser value. The
fund’s overall net asset value may
decline, reducing the value and
liquidity of the fund’s securities. This
potential outcome would make the
securities less suitable as collateral for
margining uncleared swaps.
(b) Efficiency, Competitiveness, and
Financial Integrity of Markets
By eliminating the asset transfer
restriction, the Money Market Funds
Proposal would allow a broader range of
money market and similar fund
securities to serve as collateral for
margining uncleared swaps, increasing
diversification in the assets that can be
used as collateral, and fostering
competition among the funds whose
securities qualify as eligible collateral
under the Proposal.
The elimination of the asset transfer
restriction would also promote effective
asset management policies for the
benefit of fund investors and market
participants in general. Without the
restriction, money market or similar
funds would be able to undertake
repurchase and similar agreements,
which may enable them to generate
higher returns for investors, including
for CSEs that use the funds’ securities as
collateral, and to meet commitments to
investors concerning fund performance.
Notwithstanding these benefits, the
proposed elimination of the asset
transfer restriction might negatively
impact market participants. If a money
market and similar fund undertakes a
repurchase or similar arrangement and
the fund’s counterparty in the
arrangement defaults, the fund may be
unable to recover assets it tendered in
the arrangement and may be left holding
assets of lesser value. The fund’s overall
net asset value may decrease, affecting
the value and liquidity of the fund’s
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securities. This potential outcome
would make the fund’s securities less
suitable as collateral for margining
uncleared swaps.
ddrumheller on DSK120RN23PROD with PROPOSALS1
(c) Price Discovery
As previously discussed, with the
removal of the asset transfer restriction,
fund managers may have more
flexibility in determining the type of
investment and transactions that are in
the best interest of their fund and
investors, leading to higher returns for
investors, including CSEs using money
market and similar fund securities as
margin collateral for uncleared swaps.
With such increased returns, the overall
costs of entering into an uncleared swap
transaction may decrease, incentivizing
increased participation in the uncleared
swaps markets. In turn, trading in
uncleared swaps may increase, leading
to increased liquidity and enhanced
price discovery.
(d) Sound Risk Management
The proposed amendment would
eliminate the asset transfer restriction,
allowing the use of securities of money
market funds that undertake repurchase
or similar arrangements as collateral for
the margining of uncleared swaps. As
such, even if the asset manager for a
money market and similar fund, as a
fiduciary, acts in the best interest of the
fund and its investors, there is the risk
that the fund may incur a loss if the
fund’s counterparty in a repurchase or
similar arrangement defaults. Such a
default would leave the fund holding
assets that it may not be able to easily
resell in times of financial stress, which
might impact the value and liquidity of
pledged fund securities and make them
less suitable as margin collateral for
uncleared swaps. The Commission,
however, notes that any potential risk of
such a repurchase or similar
arrangement may be mitigated by the
standard industry practice of applying
haircuts to non-cash collateral in
repurchase or similar arrangements to
compensate for the risk that the value of
collateral may decline over the term of
the arrangement.112
In addition, the Commission notes
that Commission Regulation 23.156(c)
requires that CSEs monitor the market
value and eligibility of all collateral and,
to the extent that the market value has
declined, promptly collect or post
additional eligible collateral to maintain
compliance with Commission
Regulations 23.150 through 23.161.
Thus, even if the value or liquidity of
112 See Primer: Money Market Funds and the
Repo Market, Prepared by the staff of the Division
of Investment Management, U.S. Securities and
Exchange Commission at pp. 5–6.
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pledged money market and similar fund
securities may be affected by repurchase
or similar arrangements undertaken by
the fund, CSEs have the obligation to
monitor the value and suitability of the
fund securities as margin collateral and
collect or post additional eligible
collateral to compensate for collateral
deficiencies, although the risk that a
fund’s repurchase or similar
arrangements may fail remains. The
Commission further notes, however,
that subparagraphs (A) and (B) of
Commission Regulation 23.156(a)(1)(ix),
which are not being amended, limit the
types of assets that a money market and
similar fund can receive in repurchase
or similar arrangements to those assets
specifically identified in those
paragraphs, alleviating in part the risks
associated with repurchase or similar
arrangements.
While the Money Market Funds
Proposal could lead to more variability
in the value of the assets used as IM, it
can also promote sound risk
management in that it increases the
range of money market and similar fund
securities available as collateral for the
margining of uncleared swaps, reducing
the chance of concentration in a few
money market and similar funds and the
risks associated with such
concentration. As such, the removal of
the restriction may incentivize the
increased use of money market and
similar fund securities as collateral.
Consistent with Commission Regulation
23.156(c), which requires CSEs to
monitor the market value and eligibility
of collateral posted or collected as
margin for uncleared swaps, the
Commission notes that CSEs must take
into account the potential concentration
of collateral in particular assets and
prudently manage margin collateral.
(e) Other Public Interest Considerations
As is the case for the Seeded Funds
Proposal, it is possible that the U.S.
prudential regulators may not amend
their margin rule in line with the Money
Market Funds Proposal. As such, the
prudential regulators and the
Commission would diverge with respect
to the treatment of money market and
similar funds securities as eligible
collateral for margining uncleared
swaps. This divergence might lead to
increased costs for market participants
that trade both uncleared swaps subject
to the CFTC’s and the prudential
regulators’ margin rules, as they may
need to adjust or even maintain separate
documentation and collateral
management systems to address the
differing treatments for fund securities
under the different rules.
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On the other hand, the Money Market
Funds Proposal may lead to reduced
costs for those market participants that
dually register as SDs and securitybased swap SDs with the CFTC and the
SEC, respectively, as the proposed
amendment would bring the CFTC’s
eligible collateral framework more in
line with the SEC approach, which does
not impose asset transfer restrictions on
funds whose securities are used as
collateral for margining purposes and
expressly permits the use of government
money market fund securities as
collateral.
Request for Comments on Cost-Benefit
Considerations
The Commission invites public
comment on its cost-benefit
considerations, including the section
15(a) factors described above.
Commenters are also invited to submit
any data or other information they may
have quantifying or qualifying the costs
and benefits of the proposed
amendments. In particular, the
Commission seeks specific comment on
the following:
1. Has the Commission accurately
identified all the benefits of the
proposed amendments? Are there other
benefits to the Commission, market
participants, and/or the public that may
result from the adoption of the proposed
amendments that the Commission
should consider? Please provide specific
examples and explanations of any such
benefits.
2. Has the Commission accurately
identified all the costs of the proposed
amendments? Are there additional costs
to the Commission, market participants
and/or the public that may result from
the adoption of the proposed
amendments that the Commission
should consider? Please provide specific
examples and explanations of any such
costs.
3. Do the proposed amendments
impact the section 15(a) factors in any
way that is not described above? Please
provide specific examples and
explanations of any such impact.
4. Does the existing asset transfer
restriction significantly limit the use of
money market and similar fund
securities as eligible collateral under the
CFTC Margin Rule?
D. Antitrust Laws
Section 15(b) of the CEA requires the
Commission to take into consideration
the public interest to be protected by the
antitrust laws and endeavor to take the
least anticompetitive means of
achieving the purposes of this Act, in
issuing any order or adopting any
Commission rule or regulation
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(including any exemption under section
4(c) or 4c(b)), or in requiring or
approving any bylaw, rule or regulation
of a contract market or registered futures
association established pursuant to
section 17 of this Act.113
The Commission believes that the
public interest to be protected by the
antitrust laws is generally to protect
competition. The Commission requests
comment on whether the proposed
amendments implicate any other
specific public interest to be protected
by the antitrust laws.
The Commission has considered the
proposed amendments to determine
whether they are anticompetitive, and
has preliminarily identified no
anticompetitive effects. The
Commission requests comment on
whether the proposed amendments are
anticompetitive and, if so, what the
anticompetitive effects are.
Because the Commission has
preliminarily determined that the
proposed amendments are not
anticompetitive and have no
anticompetitive effects, the Commission
has not identified any less competitive
means of achieving the purposes of the
Act. The Commission requests comment
on whether there are less
anticompetitive means of achieving the
relevant purposes of the Act that would
otherwise be served by adopting the
proposed amendments.
List of Subjects in 17 CFR Part 23
Capital and margin requirements,
Major Swap Participants, Swap Dealers,
Swaps.
For the reasons stated in the
preamble, the Commodity Futures
Trading Commission proposes to amend
17 CFR part 23 as set forth below:
PART 23—SWAP DEALERS AND
MAJOR SWAP PARTICIPANTS
1. 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. Section 23.160 also issued
under 7 U.S.C. 2(i); Sec. 721(b), Pub. L. 111–
203, 124 Stat. 1641 (2010).
2. In § 23.151, add the definition of
‘‘Eligible seeded fund’’ in alphabetical
order and revise the definition of
‘‘Margin affiliate’’.
The addition and revision read as
follows:
ddrumheller on DSK120RN23PROD with PROPOSALS1
■
§ 23.151 Definitions applicable to margin
requirements.
*
*
*
*
*
Eligible seeded fund: An eligible
seeded fund is a collective investment
113 7
U.S.C. 19(b).
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vehicle that has received a part or all of
its start-up capital from a parent and/or
affiliate (each, a sponsor entity) where:
(1) The seeded fund is a distinct legal
entity from each sponsor entity;
(2) One or more of the seeded fund’s
margin affiliates is required to post and
collect initial margin pursuant to
§ 23.152;
(3) The seeded fund is managed by an
asset manager pursuant to an agreement
that requires the seeded fund’s assets to
be managed in accordance with a
specified written investment strategy;
(4) The seeded fund’s asset manager
has independence in carrying out its
management responsibilities and
exercising its investment discretion,
and, to the extent applicable, has
independent fiduciary duties to other
investors in the fund, such that no
sponsor entity or any of the sponsor
entity’s margin affiliates controls or has
transparency into the management or
trading of the seeded fund;
(5) The seeded fund’s investment
strategy follows a written plan for
reducing each sponsor entity’s
ownership interest in the seeded fund
that stipulates divestiture targets over
the three-year period after the date on
which the seeded fund’s asset manager
first begins to make investments on
behalf of the fund;
(6) In respect of any of the seeded
fund’s obligations, the seeded fund is
not collateralized, guaranteed, or
otherwise supported, directly or
indirectly, by any sponsor entity, any
margin affiliate of any sponsor entity,
other collective investment vehicle, or
the seeded fund’s asset manager;
(7) The seeded fund has not received
any of its assets, directly or indirectly,
from an eligible seeded fund that has
relied on the exception provided in
paragraph 2 of the definition of margin
affiliate in § 23.151; and
(8) The seeded fund is not a
securitization vehicle.
*
*
*
*
*
Margin affiliate has the following
meaning:
(1) A company is a margin affiliate of
another company if:
(i) Either company consolidates the
other on a financial statement prepared
in accordance with U.S. Generally
Accepted Accounting Principles, the
International Financial Reporting
Standards, or other similar standards,
(ii) Both companies are consolidated
with a third company on a financial
statement prepared in accordance with
such principles or standards, or
(iii) For a company that is not subject
to such principles or standards, if
consolidation as described in paragraph
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53427
(i) or (ii) of this definition would have
occurred if such principles or standards
had applied.
(2) Eligible seeded fund exception.
Notwithstanding paragraph (1) of this
definition, until the date that is three
years after the date on which an eligible
seeded fund’s asset manager first begins
to make investments on behalf of the
fund, an eligible seeded fund will be
deemed not to have any margin affiliates
solely for purposes of calculating the
fund’s material swaps exposure and the
initial margin threshold amount.
*
*
*
*
*
■ 3. In § 23.156:
■ a. Republish the introductory text of
paragraph (a)(1);
■ b. Republish the introductory text of
paragraph (a)(1)(ix);
■ c. Republish paragraph (a)(1)(ix)(A);
■ d. Revise paragraph (a)(1)(ix)(B);
■ e. Remove paragraph (a)(1)(ix)(C);
■ f. Revise paragraph (a)(3)(i)(B).
The republications and revisions read
as follows:
§ 23.156
Forms of Margin
(a) * * * (1) Eligible collateral. A
covered swap entity shall collect and
post as initial margin for trades with a
covered counterparty only the following
types of collateral:
*
*
*
*
*
(ix) Securities in the form of
redeemable securities in a pooled
investment fund representing the
security-holder’s proportional interest
in the fund’s net assets and that are
issued and redeemed only on the basis
of the market value of the fund’s net
assets prepared each business day after
the security-holder makes its investment
commitment or redemption request to
the fund, if the fund’s investments are
limited to the following:
(A) Securities that are issued by, or
unconditionally guaranteed as to the
timely payment of principal and interest
by, the U.S. Department of the Treasury,
and immediately-available cash funds
denominated in U.S. dollars; or
(B) Securities denominated in a
common currency and issued by, or
fully guaranteed as to the payment of
principal and interest by, the European
Central Bank or a sovereign entity that
is assigned no higher than a 20 percent
risk weight under the capital rules
applicable to swap dealers subject to
regulation by a prudential regulator, and
immediately-available cash funds
denominated in the same currency; or
*
*
*
*
*
(3) * * *
(i) * * *
(B) The discounts set forth in the
following table:
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STANDARDIZED HAIRCUT SCHEDULE 1
Cash in same currency as swap obligation ........................................................................................................................................
Eligible government and related debt (e.g., central bank, multilateral development bank, GSE securities identified in paragraph
(a)(1)(v) of this section): Residual maturity less than one-year ......................................................................................................
Eligible government and related debt (e.g., central bank, multilateral development bank, GSE securities identified in paragraph
(a)(1)(v) of this section): Residual maturity between one and five years .......................................................................................
Eligible government and related debt (e.g., central bank, multilateral development bank, GSE securities identified in paragraph
(a)(1)(v) of this section): Residual maturity greater than five years ................................................................................................
Eligible corporate debt (including eligible GSE debt securities not identified in paragraph (a)(1)(v) of this section): Residual maturity less than one-year ..................................................................................................................................................................
Eligible corporate debt (including eligible GSE debt securities not identified in paragraph (a)(1)(v) of this section): Residual maturity between one and five years ....................................................................................................................................................
Eligible corporate debt (including eligible GSE debt securities not identified in paragraph (a)(1)(v) of this section): Residual maturity greater than five years ............................................................................................................................................................
Equities included in S&P 500 or related index ....................................................................................................................................
Equities included in S&P 1500 Composite or related index but not S&P 500 or related index .........................................................
Gold .....................................................................................................................................................................................................
Additional (additive) haircut on asset in which the currency of the swap obligation differs from that of the collateral asset ............
0.0
0.5
2.0
4.0
1.0
4.0
8.0
15.0
25.0
15.0
8.0
1 The discount to be applied to an eligible investment fund is the weighted average discount on all assets within the eligible investment fund at
the end of the prior month. The weights to be applied in the weighted average should be calculated as a fraction of the fund’s total market value
that is invested in each asset with a given discount amount. As an example, an eligible investment fund that is comprised solely of $100 of 91
day Treasury bills and $100 of 3 year U.S. Treasury bonds would receive a discount of (100/200) * 0.5 + (100/200) * 2.0 = (0.5) * 0.5 + (0.5) *
2.0 = 1.25 percent.
*
*
*
*
*
Issued in Washington, DC, on July 31,
2023, 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 Margin Requirements for
Uncleared Swaps for Swap Dealers and
Major Swap Participants—Voting
Summary and Chairman’s and
Commissioners’ Statements
Appendix 1—Voting Summary
On this matter, Chairman Behnam and
Commissioners Mersinger and Pham voted in
the affirmative. Commissioner Goldsmith
Romero voted in the negative. Commissioner
Johnson voted to concur.
ddrumheller on DSK120RN23PROD with PROPOSALS1
Appendix 2—Statement of Chairman
Rostin Behnam
Today the Commission considered an
eligible seeded funds proposal and a money
market funds proposal within a notice of
proposed rulemaking on margin
requirements for uncleared swaps for swap
dealers (SDs) and major swap participants
(MSPs) for which there is no prudential
regulator. The proposal would amend the
CFTC’s margin rule for SDs and MSPs, as
promulgated in 2016, to incorporate two
recommendations in the 2020 report to the
CFTC’s Global Markets Advisory Committee
(GMAC) by the Subcommittee on Margin
Requirements for Non-Cleared Swaps (the
‘‘GMAC Subcommittee Report’’).1
1 See Recommendations to Improve Scoping and
Implementation of Initial Margin Requirements for
Non-Cleared Swaps, Report to the CFTC’s Global
Markets Advisory Committee by the Subcommittee
on Margin Requirements for Non-Cleared Swaps
(May 2020), https://www.cftc.gov/media/3886/
GMAC_051920MarginSubcommitteeReport/
download.
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The seeded funds proposal would revise
the definition of ‘‘margin affiliate’’ in
Commission Regulation 23.151 to provide
that certain investment funds that receive all
of their start-up capital, or a portion thereof,
from a sponsor entity would be deemed not
to have any margin affiliates for the purposes
of calculating certain thresholds that trigger
the requirement to exchange initial margin
for uncleared swaps. This proposed
amendment would effectively relieve SDs
and MSPs from the requirement to post and
collect initial margin with a limited number
of eligible seeded funds for their uncleared
swaps for a period of three years from the
date on which the eligible seeded fund’s
asset manager first begins making
investments on behalf of the fund. While
today’s proposal builds upon the GMAC
Subcommittee Report’s 2020
recommendation, the proposal today also sets
forth eight carefully calibrated conditions to
ensure that only the investment funds that
were intended to be targeted by the GMAC
Subcommittee Report’s recommendations are
eligible to qualify for the seeded funds
exception.
I support today’s seeded funds proposal as
it is consistent with the CFTC’s margin rule
risk-based approach of imposing margin
requirements that are commensurate with the
risk of uncleared swaps entered into by SDs
and MSPs; is appropriately calibrated to
acknowledge the operational challenges for
start-up funds; and supports international
harmonization as the approach is consistent
with the BCBS–IOSCO Framework.
The money market funds proposal would
eliminate the current provision in
Commission Regulation 23.156(a)(1)(ix)(C)
that disqualifies certain securities issued by
certain money market funds (MMFs) from
being used as eligible initial margin
collateral. This would expand the scope of
assets that qualify as eligible collateral. I
support today’s MMF proposal as it would
remove a restriction that has unintentionally
and severely restricted the use of securities
of MMF and similar assets that transfer their
assets through repurchase and similar
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arrangements. According to the GMAC
Subcommittee Report, the impact of the
restriction was that only securities of four
U.S. MMFs would meet the requirements to
be used as eligible collateral.2
Lastly, the proposal would also add a
footnote that was inadvertently omitted for
the haircut schedule in Regulation
23.156(a)(3)(i)(B), when the Commission
originally promulgated the margin rule in
2016.
I look forward to receiving public
comments on this proposal.
Appendix 3—Dissenting Statement of
Commissioner Christy Goldsmith
Romero
I cannot support the proposed rule.
Seeded Funds
I am concerned that the proposed
exception to initial margin requirements for
seeded funds rolls back Dodd-Frank Act
reforms designed for financial stability. I
cannot support the Commission changing our
existing requirements—requirements that
match U.S. banking regulator requirements.
The proposed change would relieve initial
margin requirements for uncleared swaps
that are not prudentially regulated in certain
affiliate transactions known as ‘‘seeded
funds’’ for three years.1
The buildup of uncleared swap positions
during the crisis exposed swap entities to
losses, putting the financial system at risk.
Dodd-Frank Act reforms required all
uncleared swaps be subject to initial and
variation margin requirements, whether
prudentially regulated or not.2 Post Dodd2 Id.
at 24.
funds are investment vehicles that
receive start-up capital from a sponsor entity. Under
the Commission’s current regulatory requirements,
a seeded fund is treated as a margin affiliate of a
sponsor entity for the purpose of triggering the
exchange of initial margin for uncleared swaps.
2 7 U.S.C. 6s(e)(2)—Registration and regulation of
swap dealers and major swap participants. Dodd
Frank Act reforms provide that:
1 Seeded
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Frank, the Commission and federal banking
agencies adopted margin rules to protect the
safety and soundness of swap entities and to
guard against risks to financial stability.
Dodd Frank Act reforms in the Commodity
Exchange Act required that to offset the
greater risk to the swap dealer or major swap
participant and the financial system arising
from the use of uncleared swaps, the
Commission’s margin requirements for
uncleared swaps must (i) help ensure the
safety and soundness of the swap dealer or
major swap participant and (ii) be
appropriate for the risk associated with the
uncleared swaps held by the swap dealer or
major swap participant.3
I do not find that standard to be met in the
proposed rule. Post Dodd-Frank, regulators
recognized that derivatives transactions with
affiliated parties can pose important risks
that necessitate margin requirements. The
Commission and banking regulators adopted
the same definition of ‘‘margin affiliate’’ to
cover both swaps that are, and are not,
prudentially regulated. The proposed rule
would depart from that definition where
there is not a prudential regulator.
The proposed rule raises concerns about
the prudence of the Commission having two
different definitions of ‘‘margin affiliate’’ for
swap dealers, particularly when the majority
of swap dealers (55 of 106) are prudentially
regulated, and they account for a substantial
majority of swap activity. In a regulatory
system where jurisdiction is shared with
other U.S. market and banking regulators, it
is important that the Commission maintain
regulatory harmonization with U.S.
regulators where we can. Otherwise, we risk
a race to the bottom.
The proposed rule discusses the
importance of harmonization with global
regulation but not U.S. banking regulations.
And this proposed rule came from
recommendations by the Global Markets
Advisory Committee in 2020 (during the last
Administration). The majority of the nonbank
swap dealers are U.S.-domiciled (27 of 51).
Also, importantly, the GMAC public interest
representative from Better Markets at that
time did not vote for these recommendations.
I have serious concerns with potentially
increasing risks related to uncleared swaps,
(A) Swap dealers and major swap participants
that are banks. The prudential regulators, in
consultation with the Commission and the
Securities and Exchange Commission, shall jointly
adopt rules for swap dealers and major swap
participants, with respect to their activities as a
swap dealer or major swap participant, for which
there is a prudential regulator imposing—(i) capital
requirements; and (ii) both initial and variation
margin requirements on all swaps that are not
cleared by a registered derivatives clearing
organizations.
(B) Swap dealers and major swap participants
that are not banks. The Commission shall adopt
rules for swap dealers and major swap participants,
with respect to their activities as a swap dealer or
major swap participant, for which there is not a
prudential regulator imposing—(i) capital
requirements; and (ii) both initial and variation
margin requirements on all swaps that are not
cleared by a registered derivatives clearing
organization (emphasis added). See Section 4s(e) of
the Commodity Exchange Act.
3 7 U.S C. 6s(e)(3)(A); CEA section 4s(e)(3)(A).
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including risks to financial stability by
adopting a definition that harmonizes with
global regulation, but not domestic banking
regulation. U.S. banking regulators are aware
of the Basel Committee on Banking
Supervision and the International
Organization for Securities Commission’s
‘‘International Margin Framework,’’ but have
chosen not to change their definition of
‘‘margin affiliate.’’
Likewise, I do not support the Commission
changing our existing definition. I appreciate
that Commission staff have tried to put
constraints on this initial margin exception.4
The constraints are not enough in my view
to break from U.S. banking regulators on the
definition of margin affiliate. I am concerned
that the effect of this proposal would be to
roll back Dodd-Frank Act reforms. Given that
those reforms were designed to promote the
safety and soundness of U.S. financial
institutions and our financial system, I am
concerned that this change could produce
unacceptable levels of risk, possibly even
systemic risk and harm to financial stability.
We do not know the full consequences of this
change. While it may save costs for these
start-up funds, we cannot increase any risk
to financial stability of institutions or our
financial system.
Therefore, I must dissent.
Money Market Funds
I have concerns about the Commission’s
proposal to expand money market funds that
could be used for eligible non-cash collateral
for swap dealers for initial margin. The
proposal contemplates eliminating the
restriction on the money market fund’s use
of repurchase agreements or similar
agreements.
In Dodd-Frank Act reforms contained in
the Commodity Exchange Act section
4s(e)(3)(C), Congress provided that ‘‘[i]n
prescribing margin requirements,’’ the
Commission ‘‘shall permit the use of noncash
collateral’’ as ‘‘determine[d] to be consistent
with—preserving the financial integrity of
markets trading’’ non-cleared derivatives and
‘‘preserving the stability of the United States
financial system.’’ I have not seen an analysis
that such standard is met. I am very
interested in public comment about whether
that standard is met.
We must not forget the lessons of the 2008
financial crises, including when the Reserve
Primary Fund ‘‘broke the buck’’, and the role
it had in the 2008 crisis. Money market funds
are designed to give retail customers and
institutional investors a market-based
instrument that is highly liquid with lower
risk and limited volatility. For many
4 For example, the exception requires that the
seeded fund ‘‘is not a securitization vehicle.’’
Should the Commission move forward with this
proposed rule, I have other concerns that I invite
public comment. This includes whether the
proposed 3-year exception period is too long a
runway. Also, whether the exemption is meant to
apply to private funds? Private funds are part of a
‘‘shadow banking system’’, and unlike banks, are
not fully subject to risk, liquidity, or capital
restrictions. Private funds and shadow banking
contributed to the 2008 financial crisis, which has
grown larger since the crisis, and continues to pose
risks to American investors, pensioners, and the
U.S. financial system.
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53429
Americans, money market funds often appear
on their bank app, right next to checking and
savings accounts, as they are financial
vehicles often thought of as similar to a bank
account. That’s why it came as such a shock
when the Reserve Primary Fund broke the
buck.
I was counsel to the SEC Chairman when
the Reserve Primary Fund broke the buck,
which contributed to Lehman failing, and
short-term lending drying up. Repurchase
agreements also contributed to liquidity
problems at financial institutions. In my role
as the Special Inspector General for TARP, I
reported to Congress about the
interconnectedness of these events. These
experiences show how interconnected money
market funds and repurchase agreements are
to the overall stability of our financial
institutions and the broader financial system.
As a result, the SEC and other regulators
implemented reforms to make money market
funds more stable and repurchase agreements
more transparent. Despite these reforms, in
March 2020, during the Covid-19 pandemic,
money market funds and the short-term
funding markets experienced stress when
institutional investors withdrew cash from
money market funds to avoid liquidity fees
and gates, safeguards that were part of postcrisis reforms.
With 2008 and 2020 as the backdrop, the
Commission must be careful how it
approaches changes to our regulations that
impact money market funds and the shortterm funding markets. These are highly
interconnected markets. Changes in one can
impact changes in the other markets. Before
we take any action, it will be critical for the
Commission to determine that the change is
‘‘consistent with preserving the financial
integrity of markets trading’’ non-cleared
derivatives and ‘‘preserving the stability of
the United States financial system.’’ I look
forward to public comment on whether the
rule meets this standard.
I thank the staff for their work. I am also
grateful to the former GMAC members. It
must be remembered that advisory
committees’ role is to advise the
Commission. While I may not agree with
their recommendations, I am grateful for their
service.
Appendix 4—Statement of
Commissioner Caroline D. Pham
I support the notice of proposed
rulemaking on margin requirements for
uncleared swaps for swap dealers and major
swap participants (Seeded Funds and MMFs
Proposal) because it provides a solution for
seeded funds, and it supports greater
liquidity by providing more flexibility for
money market and similar funds that use
repos, among other things. I thank the team
in the Market Participants Division for their
dedication to ensuring the Commission’s
uncleared swaps rules do not unduly burden
market participants, and for proposing
workable solutions to challenges that arose
during an implementation period. I
specifically commend Amanda Olear, Tom
Smith, Warren Gorlick, Rafael Martinez, and
Liliya Bozhanova for their work on the
proposal.
This Seeded Funds and MMFs Proposal,
looking at the big picture, actually benefits
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ddrumheller on DSK120RN23PROD with PROPOSALS1
the end investors who will be able to more
efficiently deploy capital, access liquidity,
and provide investment returns at less cost
to funds, such as pension plans that manage
Americans’ hard-earned savings. The key
public interest here is providing more
liquidity to markets. We have seen over the
past several years many recent market
stresses, which seem to occur with greater
and greater frequency and high volatility, low
liquidity market conditions. Where there is
shallow depth of liquidity, costs for end
users, customers, and investors go up, and
access to markets is restricted. When there is
not enough liquidity, risks to financial
stability increase. The most significant and
systemic financial crises in recent years,
including the 2008 financial crisis, were
caused by a critical lack of liquidity in
markets, and our post-crisis reforms have
traded less credit risk for more liquidity risk.
Simply put, less liquidity means higher
costs and more risk. And risk to not only
financial stability, but also systemic risk. In
light of ongoing capital reforms, it is
incumbent upon me to remind everyone that
of course markets are interconnected, and
that’s why we need to take a holistic
approach to market structure with a full
understanding of the impact of various
regulatory regimes, particularly the impact of
prudential requirements on the ability of
markets to function well, and especially the
ability for market participants to access
markets for the benefit of American savers.
As an advocate for good policy that enables
growth, progress, and access to markets, I
strongly support workable solutions to any
problems with our rules. While regulations
play a critical role in safeguarding our
markets, we must acknowledge that issues—
ranging from technical 1 to policy—must be
continuously evaluated for regulations to
remain both effective and relevant in an everchanging landscape.
The first step in evaluating our regulations
is to conduct thorough assessments and
identify areas for improvement. Collaboration
and open dialogue are key to formulating
well-rounded solutions that consider the
interests of all impacted. That is why I am
grateful for the efforts of former
Commissioner Dawn Stump, who, as sponsor
of the Global Markets Advisory Committee
(GMAC), established the GMAC’s
Subcommittee on Margin Requirements for
Non-Cleared Swaps to evaluate the CFTC’s
uncleared margin rules.2 The subcommittee’s
thorough assessment, engagement with
stakeholders, and practical, flexible
recommendations have given staff a
comprehensive roadmap to follow in
implementing fixes that minimize adverse
impacts on market participants. I appreciate
that staff is continuing 3 to try to adopt the
1 Statement of Commissioner Caroline D. Pham
on Staff Letter Regarding ADM Investor Services,
Inc., U.S. Commodity Futures Trading Commission
(June 16, 2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/phamstatement061623.
2 CFTC Commissioner Stump Announces New
GMAC Subcommittee on Margin Requirements for
Non-Cleared Swaps, U.S. Commodity Futures
Trading Commission (Oct. 28, 2019), https://
www.cftc.gov/PressRoom/PressReleases/8064-19.
3 In 2020, the Commission adopted rules that
addressed different GMAC recommendations on the
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recommendations that came out of the GMAC
subcommittee.
The adoption of margin requirements for
uncleared swaps was a key pillar of the 2008
financial crisis reform.4 Today, we continue
to appreciate that the requirements help
ensure the exchange of margin between large,
systemic, and interconnected financial
institutions for their uncleared swap
transactions.
Consistent with the G20 commitments, the
Commodity Exchange Act (CEA or Act) 5
requires that the Commission adopt rules
establishing margin requirements for all
uncleared swaps that are entered into by a
swap dealer or major swap participant for
which there is no prudential regulator. These
requirements help ensure the safety and
soundness of the swap dealer or major swap
participant. In 2016, the Commission
adopted Regulations 23.150 through 23.161
to implement section 4s(e).6
Currently, a fund with material swaps
exposure will fall within the scope of the
initial margin requirements if it undertakes
an uncleared swap with a covered swap
entity. The covered swap entity and the fund
will not be required to post and collect initial
margin for their uncleared swaps until the
initial margin threshold amount of $50
million has been exceeded. The initial
margin threshold amount will be calculated
based on the credit exposure from uncleared
swaps between the covered swap entity and
its margin affiliates on the one hand, and the
fund and its margin affiliates on the other.7
uncleared margin rules. See Statement of
Commissioner Dawn D. Stump in Support of Final
Uncleared Margin Rules Based on
Recommendations of Global Markets Advisory
Committee, U.S. Commodity Futures Trading
Commission (Dec. 8, 2020), https://www.cftc.gov/
PressRoom/SpeechesTestimony/
stumpstatement120820. Commissioner Mersinger
has advocated for adopting additional
recommendations. See Dissenting Statement of
Commissioner Summer K. Mersinger Regarding
CFTC’s Regulatory Agenda, U.S. Commodity
Futures Trading Commission (Jan. 9, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
mersingerstatement010923. Commissioner Pham
now sponsors the GMAC. See Commissioner Pham
Announces CFTC Global Markets Advisory
Committee Meeting on July 17, U.S. Commodity
Futures Trading Commission (July 17, 2023),
https://www.cftc.gov/PressRoom/Events/
opaeventgmac071723.
4 G20 Pittsburgh Summit (Sept. 24–25, 2009).
5 7 U.S.C. 6s(e) (capital and margin requirements).
6 See Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants, 81
FR 636 (Jan. 6, 2016) (effective April 1, 2016 and
codified in part 23 of the Commission’s
regulations). 17 CFR 23.150—23.159, and 23.161. In
May 2016, the Commission added Regulation
23.160 (17 CFR 23.160), providing rules on its
cross-border application. 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).
7 Commission Regulation 23.151 defines the term
‘‘IM threshold amount’’ to mean an aggregate credit
exposure of $50 million resulting from all uncleared
swaps between an SD and its margin affiliates (or
an MSP and its margin affiliates) on the one hand,
and the SD’s (or MSP’s) counterparty and its margin
affiliates on the other. See 17 CFR 23.151.
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As discussed above, this requirement has
unduly burdened certain funds.
Initial margin requirements may be
satisfied with only certain types of
collateral.8 Under Regulation 23.156(a)(1)(ix),
the securities of money market and similar
funds 9 may qualify as eligible collateral if
the investments of the fund are limited to
securities that are issued by, or
unconditionally guaranteed as to the timely
payment of principal and interest by, the U.S.
Department of Treasury, and immediatelyavailable cash denominated in U.S. dollars; 10
or to securities denominated in a common
currency and issued by, or fully guaranteed
as to the payment of principal and interest
by, the European Central Bank, or a sovereign
entity that is assigned no higher than a 20
percent risk weight under the capital rules
applicable to swap dealers subject to
regulation by a prudential regulator, and
immediately-available cash denominated in
the same currency.11 Also, the asset
managers of the money market and similar
fund may not transfer the assets of the fund
through securities lending, securities
borrowing, repurchase agreements, or any
other means that involve the fund having
rights to acquire the same or similar assets
from the transferee.12 As discussed above,
this requirement has unintentionally
restricted funds.
Of course, compliance with significant
reforms necessarily entails significant
resource expenditure by regulated entities.
Because of the vast number of counterparties
impacted by the uncleared margin rules,
swap dealers and major swap participants
have been forced to engage in significant
operational and technological development
to avoid disruptions which would limit their
options for taking on and hedging risk.13 As
I have stated in the past, it is imperative that
the Commission continuously—or at least
periodically—evaluate its rules to ensure
they are functioning as intended, and
propose workable solutions to any challenges
discovered to ensure that firms are able to
effectively comply with our rules.14
8 Commission Regulation 23.156(a)(1) sets forth
the types of collateral that CSEs can post or collect
as IM with covered counterparties, including cash
funds, certain securities issued by the U.S.
government or other sovereign entities, certain
publicly traded debt or equity securities, securities
issued by money market and similar funds, and
gold. 17 CFR 23.156(a)(1).
9 Although the scope of the eligible pooled
investment funds described in Commission
Regulation 23.156(a)(1)(ix) does not fully coincide
with the regulatory definition of money market
funds in Rule 2a–7 under the Investment Company
Act (17 CFR 270.2a–7), for simplicity purposes,
these funds will be referred to as ‘‘money market
and similar funds.’’
10 17 CFR 23.156(a)(1)(ix)(A).
11 17 CFR 23.156(a)(1)(ix)(B).
12 17 CFR 23.156(a)(1)(ix)(C).
13 Joint ISDA–SIFMA Report, Initial Margin for
Non-Centrally Cleared Derivatives: Issues for 2019
and 2020, 3–4 (July 2018), https://www.isda.org/a/
D6fEE/ISDA-SIFMA-Initial-Margin-Phase-in-WhitePaper-July-2018.pdf.
14 See, e.g., Statement of Commissioner Caroline
D. Pham Regarding Reporting and Information
Requirements for Derivatives Clearing
Organizations, U.S. Commodity Futures Trading
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I encourage commenters to comment on
whether the Commission’s proposal
sufficiently addresses the practical and
operational issues, and whether it gives
sufficient time for firms to implement and
comply with a final rule.
[FR Doc. 2023–16572 Filed 8–7–23; 8:45 am]
BILLING CODE 6351–01–P
ENVIRONMENTAL PROTECTION
AGENCY
40 CFR Part 52
[EPA–R09–OAR–2023–0352; FRL–10399–
01–R9]
RIN 2009–AA05
Federal Implementation Plan for
Contingency Measures for the Fine
Particulate Matter Standards; San
Joaquin Valley, California
Environmental Protection
Agency (EPA).
ACTION: Proposed rule.
AGENCY:
The Environmental Protection
Agency (EPA) is proposing to
promulgate a Federal Implementation
Plan (FIP) under the Clean Air Act
(CAA) that consists of contingency
measures for the 1997, 2006, and 2012
fine particulate matter (PM2.5) national
ambient air quality standards (NAAQS
or ‘‘standards’’) for the San Joaquin
Valley PM2.5 nonattainment area. The
contingency measures would apply to
residential wood burning heaters and
fireplaces and rural open areas. The
proposed FIP, if finalized, would be
implemented by the EPA, unless and
until replaced through the EPA’s
approval of a contingency measure state
implementation plan (SIP) submission.
DATES:
Comments: Comments must be
received on or before September 22,
2023. Under the Paperwork Reduction
Act (PRA), comments on the
information collection provisions are
best assured of consideration if the
Office of Management and Budget
(OMB) receives a copy of your
comments on or before September 7,
2023.
Public Hearing: The EPA will hold a
virtual public hearing on August 23,
2023. Please refer to the SUPPLEMENTARY
INFORMATION section for additional
information on the public hearing.
ADDRESSES: You may send comments,
identified by Docket ID No. EPA–R09–
OAR–2023–0352; via the Federal
eRulemaking Portal: https://
ddrumheller on DSK120RN23PROD with PROPOSALS1
SUMMARY:
Commission (Nov. 10, 2022), https://www.cftc.gov/
PressRoom/SpeechesTestimony/
phamstatement111022b.
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www.regulations.gov (our preferred
method). Follow the online instructions
for submitting comments.
Instructions: All submissions received
must include the Docket ID No. for this
rulemaking. Comments received may be
posted without change to https://
www.regulations.gov, including any
personal information provided. For
detailed instructions on sending
comments and additional information
on the rulemaking process, see the
‘‘Public Participation’’ heading of the
SUPPLEMENTARY INFORMATION section of
this document. Hand deliveries and
couriers may be received by scheduled
appointment only. For further
information on EPA Docket Center
services and the current status, please
visit us online at https://www.epa.gov/
dockets.
FOR FURTHER INFORMATION CONTACT: For
questions regarding this proposed rule,
please contact Rory Mays, Planning and
Analysis Branch (AIR–2), Air and
Radiation Division, EPA Region IX,
(415) 972–3227. For questions regarding
the virtual public hearing, please
contact Kobi Cook, Communities and
Partnerships Branch (AIR–4), Air and
Radiation Division, EPA Region IX,
(415) 972–3989. Both can be reached by
emailing SJVPublicMeetings@epa.gov.
SUPPLEMENTARY INFORMATION:
Throughout this document, ‘‘we,’’ ‘‘us,’’
and ‘‘our’’ refer to the EPA.
Public Participation
A. Written Comments
Submit your comments, identified by
Docket ID No. EPA–R09–OAR–2023–
0352 at https://www.regulations.gov
(our preferred method), or the other
methods identified in the ADDRESSES
section. Once submitted, comments
cannot be edited or removed from the
docket. The EPA may publish any
comment received to its public docket.
Do not submit to the EPA’s docket at
https://www.regulations.gov any
information you consider to be
Confidential Business Information (CBI)
or other information whose disclosure is
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The written comment is considered the
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consider comments or comment
contents located outside of the primary
submission (i.e., on the web, cloud, or
other file sharing system). For
additional submission methods, the full
EPA public comment policy,
information about CBI or multimedia
submissions, and general guidance on
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Frm 00048
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53431
making effective comments, please visit
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The EPA will begin pre-registering
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sanjoaquinvalley for online registration.
The last day to pre-register to speak at
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The virtual public hearing will be
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may close the session 15 minutes after
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testified if there are no additional
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about the public hearing, please contact
Kobi Cook, per the FOR FURTHER
INFORMATION CONTACT section of this
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sanjoaquinvalley.
The EPA will make every effort to
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The EPA may ask clarifying questions
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E:\FR\FM\08AUP1.SGM
08AUP1
Agencies
[Federal Register Volume 88, Number 151 (Tuesday, August 8, 2023)]
[Proposed Rules]
[Pages 53409-53431]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-16572]
=======================================================================
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AF36
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants
AGENCY: Commodity Futures Trading Commission
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend the margin requirements for uncleared
swaps applicable to swap dealers (``SDs'') and major swap participants
(``MSPs'') for which there is no prudential regulator. The proposed
amendment would revise the definition of ``margin affiliate'' to
provide that certain collective investment vehicles (``investment
funds'' or ``funds'') that receive all of their start-up capital, or a
portion thereof, from a sponsor entity (``seeded funds'') would be
deemed not to have any margin affiliates for the purposes of
calculating certain thresholds that trigger the requirement to exchange
initial margin (``IM'') for uncleared swaps. This proposed amendment
(``Seeded Funds Proposal'') would effectively relieve SDs and MSPs from
the requirement to post and collect IM with certain eligible seeded
funds for their uncleared swaps for a period of three years from the
date on which the eligible seeded fund's asset manager first begins
making investments on behalf of the fund (``trading inception date'').
The Commission is also proposing to eliminate a provision disqualifying
the securities issued by certain pooled investment funds (``money
market and similar funds'') that transfer their assets through
securities lending, securities borrowing, repurchase agreements,
reverse repurchase agreements, and similar arrangements from being used
as eligible IM collateral, thereby expanding the scope of assets that
qualify as eligible collateral (``Money Market Funds Proposal'').
Additionally, the Commission is proposing an amendment to the haircut
schedule set forth in a Commission Regulation to add a footnote that
was inadvertently omitted when the rule was originally promulgated.
DATES: With respect to the proposed amendments, comments must be
received on or before October 10, 2023.
ADDRESSES: You may submit comments, identified by RIN 3038-AF36, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Sec. 145.9 of the Commission's
regulations.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR Chapter I.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, [email protected]; Thomas J. Smith, Deputy Director, 202-418-5495,
[email protected]; Warren Gorlick, Associate Director, 202-418-5195,
[email protected]; Rafael Martinez, Associate Director, 202-418-5462,
[email protected]; or Liliya Bozhanova, Special Counsel, 202-418-6232,
[email protected], Market Participants Division, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Statutory and Regulatory Background
Section 4s(e) of the Commodity Exchange Act (``CEA'' or ``Act'')
\2\ requires the Commission to adopt rules establishing minimum initial
and variation margin requirements for all swaps \3\ that are: (i)
entered into by an SD \4\ or MSP \5\ for which there is no prudential
regulator \6\ (collectively, ``covered swap entities'' or ``CSEs'');
\7\ and (ii) not cleared by a registered derivatives clearing
organization (``uncleared swaps'').\8\ To offset the greater risk to
the SD or MSP and the financial system arising from the use of
uncleared swaps, these requirements must: (i) help ensure the safety
and soundness of the SD or MSP; and (ii) be appropriate for the risk
associated with
[[Page 53410]]
the uncleared swaps held by the SD or MSP.\9\ In 2016, the Commission
promulgated Commission Regulations 23.150 through 23.161 (``CFTC Margin
Rule'') to implement section 4s(e).\10\
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\2\ 7 U.S.C. 6s(e) (capital and margin requirements).
\3\ CEA section 1a(47), 7 U.S.C. 1a(47) (swap definition);
Commission Regulation 1.3, 17 CFR 1.3 (further definition of a
swap). A swap includes, among other things, an interest rate swap,
commodity swap, credit default swap, and currency swap.
\4\ CEA section 1a(49), 7 U.S.C. 1a(49) (swap dealer
definition); Commission Regulation 1.3 (further definition of swap
dealer).
\5\ CEA section 1a(32), 7 U.S.C. 1a(32) (major swap participant
definition); Commission Regulation 1.3 (further definition of major
swap participant).
\6\ CEA section 1a(39), 7 U.S.C. 1a(39) (defining the term
``prudential regulator'' to include the Board of Governors of the
Federal Reserve System; the Office of the Comptroller of the
Currency; the Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency). The
definition of ``prudential regulator'' further specifies the
entities for which these agencies act as prudential regulators. The
prudential regulators published final margin requirements in
November 2015. See generally Margin and Capital Requirements for
Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential
Regulators Margin Rule''). The Prudential Regulators Margin Rule is
substantially similar to the CFTC Margin Rule.
\7\ CEA section 4s(e)(1)(B), 7 U.S.C. 6s(e)(1)(B). SDs and MSPs
for which there is a prudential regulator must meet the margin
requirements for uncleared swaps established by the applicable
prudential regulator. CEA section 4s(e)(1)(A), 7 U.S.C. 6s(e)(1)(A).
\8\ CEA section 4s(e)(2)(B)(ii), 7 U.S.C. 6s(e)(2)(B)(ii). In
Commission Regulation 23.151, the Commission further defined this
statutory language to mean all swaps that are not cleared by a
registered derivatives clearing organization or a derivatives
clearing organization that the Commission has exempted from
registration as provided under the CEA. 17 CFR 23.151.
\9\ CEA section 4s(e)(3)(A), 7 U.S.C. 6s(e)(3)(A).
\10\ See generally Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016)
(``Final Margin Rule'') (adopting the CFTC Margin Rule). The CFTC
Margin Rule became effective April 1, 2016 and is codified in part
23 of the Commission's regulations. 17 CFR 23.150-23.159, 23.161. In
May 2016, the Commission amended the CFTC Margin Rule to add
Commission Regulation 23.160, 17 CFR 23.160, providing rules on its
cross-border application. See generally 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).
---------------------------------------------------------------------------
The CFTC Margin Rule imposes IM requirements on uncleared swaps
entered into by CSEs and certain specified counterparties. More
specifically, Commission Regulation 23.152 requires CSEs to collect and
post IM \11\ with each counterparty that is an SD, MSP or financial end
user (``FEU'') with material swaps exposure (``MSE'').\12\ Commission
Regulation 23.151 defines the term FEU by listing entities, persons,
and arrangements whose business is financial in nature, including
certain funds.\13\
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\11\ IM (or initial margin) is the collateral (calculated as
provided by Commission Regulation 23.154) that is collected or
posted in connection with one or more uncleared swaps pursuant to
Commission Regulation 23.152. IM is intended to secure potential
future exposure following default of a counterparty (i.e., adverse
changes in the value of an uncleared swap that may arise during the
period of time when it is being closed out). See CFTC Margin Rule,
81 FR at 683.
\12\ See 17 CFR 23.152. Commission Regulation 23.151 provides
that MSE for an entity means that the entity and its margin
affiliates have an average month-end aggregate notional amount of
uncleared swaps, uncleared security-based swaps, foreign exchange
forwards, and foreign exchange swaps with all counterparties for
March, April, or May of the current calendar year that exceeds $8
billion, where such amount is calculated only for the last day of
the month. 17 CFR 23.151.
\13\ See 17 CFR 23.151 for a full list of entities subject to
the FEU definition as well as a list of entities excluded from the
definition. Among other entities, persons, and arrangements, whose
business is financial in nature, the definition of FEU includes
counterparties that are not an SD or MSP and are: (i) investment
companies registered with the Securities and Exchange Commission
under the Investment Company Act of 1940; (ii) private funds as
defined in section 202(a) of the Investment Advisers Act of 1940;
entities that would be investment companies under section 3 of the
Investment Company Act of 1940; or entities that are deemed not to
be investment companies under section 3 of the Investment Company
Act of 1940 pursuant to Investment Company Act Rule 3a-7 of the
Securities and Exchange Commission; (iii) commodity pools; and (iv)
entities, persons, or arrangements that are, or hold themselves out
as being, entities, persons, or arrangements that raise money from
investors, accept money from clients, or use their own money
primarily for investing, or trading, or facilitating the investing
or trading, in loans, securities, swaps, funds, or other assets.
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Commission Regulation 23.161 sets forth a phase-in schedule for
compliance with the CFTC Margin Rule.\14\ Under the schedule, which
commenced on September 1, 2016 and concluded on September 1, 2022,
entities have been required to comply with the IM requirements with
respect to their uncleared swaps in staggered phases, starting with
entities with higher average aggregate notional amount of uncleared
swaps and certain other financial products (``AANA''), and then
successively those with lesser AANA.\15\ The AANA is calculated at a
group level (i.e., taking into consideration the AANA of the CSE
combined with its margin affiliates,\16\ and the AANA of the
counterparty combined with its margin affiliates). During the last
phase of compliance, which started on September 1, 2022, CSEs and
eligible covered counterparties \17\ that had not come into the scope
of the IM requirements in prior phases of the phase-in schedule,
including FEUs with MSE of more than $8 billion, became subject to the
IM requirements.
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\14\ 17 CFR 23.161.
\15\ Id.
\16\ Commission Regulation 23.151 provides that a company is a
``margin affiliate'' of another company if: (i) either company
consolidates the other on a financial statement prepared in
accordance with U.S. Generally Accepted Accounting Principles
(``U.S. GAAP''), the International Financial Reporting Standards
(``IFRS''), or other similar standards; (ii) both companies are
consolidated with a third company on a financial statement prepared
in accordance with such principles or standards; or (iii) for a
company that is not subject to such principles or standards, if
consolidation as described in paragraph (1) or (2) of this
definition would have occurred if such principles or standards had
applied. 17 CFR 23.151.
\17\ The term ``covered counterparty'' is defined in Commission
Regulation 23.151 as FEU with MSE or a swap entity, including an SD
or MSP, that enters into swaps with a CSE. See 17 CFR 23.151.
---------------------------------------------------------------------------
Under this phase-in approach, a fund with MSE will come within the
scope of the IM requirements if it undertakes an uncleared swap with a
CSE. The CSE and the fund will not be required to post and collect IM
for their uncleared swaps until the IM threshold amount of $50 million
has been exceeded. The IM threshold amount will be calculated based on
the credit exposure from uncleared swaps between the CSE and its margin
affiliates on the one hand, and the fund and its margin affiliates on
the other.\18\
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\18\ Commission Regulation 23.151 defines the term ``IM
threshold amount'' to mean an aggregate credit exposure of $50
million resulting from all uncleared swaps between an SD and its
margin affiliates (or an MSP and its margin affiliates) on the one
hand, and the SD's (or MSP's) counterparty and its margin affiliates
on the other. See 17 CFR 23.151.
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The CFTC Margin Rule provides that the IM requirements may be
satisfied with only certain types of collateral. Commission Regulation
23.156(a)(1) sets forth the types of collateral that CSEs can post or
collect as IM with covered counterparties, including cash funds,
certain securities issued by the U.S. government or other sovereign
entities, certain publicly traded debt or equity securities, securities
issued by money market and similar funds, and gold.\19\
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\19\ See 17 CFR 23.156(a)(1).
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Under Commission Regulation 23.156(a)(1)(ix), the securities of
money market and similar funds \20\ may qualify as eligible collateral
if the investments of the fund are limited to securities that are
issued by, or unconditionally guaranteed as to the timely payment of
principal and interest by, the U.S. Department of Treasury, and
immediately-available cash denominated in U.S. dollars; \21\ or to
securities denominated in a common currency and issued by, or fully
guaranteed as to the payment of principal and interest by, the European
Central Bank, or a sovereign entity that is assigned no higher than a
20 percent risk weight under the capital rules applicable to swap
dealers subject to regulation by a prudential regulator, and
immediately-available cash denominated in the same currency.\22\ Also,
the asset managers of the money market and similar fund may not
transfer the assets of the fund through securities lending, securities
borrowing, repurchase agreements, or other means (``repurchase or
similar arrangements'') that involve the fund having rights to acquire
the same or similar assets from the transferee (``asset transfer
restriction'').\23\
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\20\ Although the scope of the eligible pooled investment funds
described in Commission Regulation 23.156(a)(1)(ix) does not fully
coincide with the regulatory definition of money market funds in
Rule 2a-7 under the Investment Company Act (17 CFR 270.2a-7), for
simplicity purposes, these funds will be referred to as ``money
market and similar funds.'' The securities of money market and
similar funds may also be used as collateral for variation margin
(``VM'') for uncleared swaps between a CSE and a financial end user,
provided that the securities qualify as eligible collateral under
Commission Regulation 23.156(a)(1)(ix). See 17 CFR 23.156(b)(1)(ii).
VM (or variation margin), as defined in Commission Regulation
23.151, is the collateral provided by a party to its counterparty to
meet the performance of its obligations under one or more uncleared
swaps between the parties as a result of a change in the value of
such obligations since the trade was executed or the last time such
collateral was provided. 17 CFR 23.151.
\21\ 17 CFR 23.156(a)(1)(ix)(A).
\22\ 17 CFR 23.156(a)(1)(ix)(B).
\23\ 17 CFR 23.156(a)(1)(ix)(C).
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II. Market Participant Feedback
In January 2020, the CFTC's Global Markets Advisory Committee
(``GMAC'') established a subcommittee of market participants to
consider issues raised by
[[Page 53411]]
the implementation of margin requirements for non-cleared swaps, to
identify challenges associated with forthcoming implementation phases,
and to prepare a report with recommendations.\24\ The subcommittee
issued a report with its recommendations in May 2020 (``Margin
Subcommittee Report'' or ``Report''), and the GMAC voted to adopt the
Margin Subcommittee Report and recommended to the Commission that it
consider adopting the Report's recommendations.\25\
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\24\ Membership of the GMAC Subcommittee on Margin Requirements
was comprised of a wide range of industry participants that had
expertise in, and experience with, margin requirements for non-
cleared swaps and the impact of the requirements on the marketplace
and market participants. The Subcommittee included representatives
of SDs, FEUs, asset managers, and third-party service providers,
among other market participants. The full list of members is
available at https://www.cftc.gov/About/AdvisoryCommittees/GMAC.
\25\ See Recommendations to Improve Scoping and Implementation
of Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (May 2020), https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
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Among other things, the Margin Subcommittee Report asserted that
the current criteria for determining whether a counterparty comes
within the scope of the IM requirements unduly penalizes certain funds.
Because, under accounting consolidation principles, a fund will
generally be consolidated with its sponsor entity during the period in
which the start-up capital provided by the sponsor entity exceeds that
of third-party investors and represents up to 100 percent of the
ownership interest in the fund (``seeding period''), such fund,
referred to as a seeded fund, will be considered a margin affiliate of
the sponsor entity.\26\ As such, the seeded fund will be required to
calculate AANA on an aggregate basis with the sponsor entity and the
sponsor entity's margin affiliates. Although the fund may individually
have small amounts of AANA, due to its affiliation with the sponsor
entity and its margin affiliates, the fund may have MSE, on a
collective basis with the sponsor entity and its margin affiliates, and
may come within the scope of the IM requirements. As such, a CSE that
undertakes uncleared swaps with the fund would be required to exchange
IM with the fund.
---------------------------------------------------------------------------
\26\ Supra note 16. See also CFTC Margin Rule, 81 FR at 646-47.
---------------------------------------------------------------------------
The Report noted that regulators in other major financial markets,
including Australia, Canada, the European Union (``EU''), and Japan,
have adopted the Basel Committee on Banking Supervision and Board of
the International Organization of Securities Commissions' (``BCBS/
IOSCO'') Framework for margin requirements for non-centrally cleared
derivatives (``BCBS/IOSCO Framework'') \27\ without requiring seeded
funds to be consolidated with the sponsor and to be treated as a margin
affiliate of the sponsor.\28\
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\27\ See BCBS/IOSCO, Margin requirements for non-centrally
cleared derivatives (April 2020), https://www.bis.org/bcbs/publ/d499.pdf. The BCBS/IOSCO Framework, which was established in 2013
and most recently amended in 2020, sets out minimum standards for
margin requirements for non-centrally cleared derivatives. In
connection with the requirement for all covered entities to exchange
IM with a threshold not to exceed [euro]50 million applied at the
level of the consolidated group, the Framework specifies that
``investment funds that are managed by an investment advisor are
considered distinct entities that are treated separately when
applying the threshold as long as the funds are distinct legal
entities that are not collateralized by or are otherwise guaranteed
or supported by other investment funds or the investment advisor in
the event of fund insolvency or bankruptcy.''
\28\ Margin Subcommittee Report at 7 and 29.
---------------------------------------------------------------------------
The Margin Subcommittee Report also recommended that the Commission
eliminate the asset transfer restriction in paragraph (C) of Commission
Regulation 23.156(a)(1)(ix). The Report stated that ``the ability to
use redeemable securities in a pooled investment fund, more typically
referred to as a money market fund (``MMF''), as eligible collateral in
the U.S. has been severely restricted by [such] condition.'' \29\
---------------------------------------------------------------------------
\29\ Id. at 6.
---------------------------------------------------------------------------
The Report noted that MMFs use repurchase and similar arrangements
to earn returns on cash and other high quality assets, to avoid any
cash drag on performance, to diversify their investments, and to
mitigate their potential exposure to their custodian's insolvency and
any consolidation issues with respect to any cash held at the
custodian.\30\ MMF asset managers, as fiduciaries, determine the types
of investments and transactions that are in the best interest of the
MMF and its investors.\31\ The Report further stated that nearly all
U.S. MMFs engage in some form of repurchase or similar arrangements,
and cited research that found that, given the asset transfer
restriction, the securities of only four MMFs, would qualify as
eligible collateral.\32\
---------------------------------------------------------------------------
\30\ Id. at 27.
\31\ Id.
\32\ Margin Subcommittee Report at 24.
---------------------------------------------------------------------------
Having considered the GMAC Subcommittee's arguments and based on
its experience administering the CFTC Margin Rule for several years,
the Commission preliminarily believes that, for the purpose of
determining whether a CSE should exchange IM with a seeded fund for
their uncleared swaps, the seeded fund should be treated as a separate
legal entity, not affiliated with the sponsor entity, for a period of
three years and subject to certain limitations. Similarly, the
Commission preliminarily believes that the current restriction on the
use of securities of money market and similar funds that transfer their
assets through repurchase and similar arrangements should be removed.
III. Proposals
A. Seeded Funds Proposal
The Commission is proposing to revise the definition of ``margin
affiliate'' to provide that a seeded fund that meets certain
requirements (described in further detail below) (``eligible seeded
fund''), would be deemed not to have any margin affiliates for the
purpose of calculating the fund's MSE and the IM threshold amount, for
a period of three years from the fund's trading inception date
(``eligible seeded fund exception''). The Commission is also proposing
to define the term ``eligible seeded fund'' to set forth the conditions
that investment funds must meet to qualify for the eligible seeded fund
exception.
1. Commission Regulation 23.151--Amendments to the Definition of
``Margin Affiliate''
Under the CFTC Margin Rule, a company is a ``margin affiliate'' of
another company if, based on accounting principles, either company
consolidates the other, or both companies are consolidated with a third
company, on a financial statement.\33\ The Commission is proposing to
adopt the eligible seeded fund exception through an amendment of the
definition of ``margin affiliate,'' which would provide that an
eligible seeded fund would be deemed not to have margin affiliates
solely for the purposes of calculating the fund's MSE and the IM
threshold amount for a period of three years after the fund's trading
inception date, notwithstanding the consolidation of the fund with
another entity under U.S. GAAP, IFRS, or other similar accounting
standards.
---------------------------------------------------------------------------
\33\ Supra note 16.
---------------------------------------------------------------------------
This proposed eligible seeded fund exception would effectively
relieve CSEs that enter into uncleared swaps with an eligible seeded
fund from the requirement to exchange IM with such fund for three years
after the fund's trading inception date. In addition, uncleared swaps
entered into between a CSE and an eligible seeded fund during the
three-year period would continue to
[[Page 53412]]
be relieved from the IM requirement after expiration of such
period.\34\ At the end of the three-year period, a fund that meets the
accounting standards for consolidation due to a sponsor entity holding
a significant equity stake in the fund would be deemed to have margin
affiliates. As a result, a CSE would be required to exchange IM with
the fund, if the fund, on a consolidated group basis, has MSE and the
IM threshold amount has been exceeded, for swaps entered into following
the expiration of the three-year period.
---------------------------------------------------------------------------
\34\ For purposes of clarity, the Commission notes, however,
that if at any point during the three-year period from the fund's
trading inception date, the fund's AANA, calculated on an individual
entity basis, exceeds the MSE threshold and the fund, individually,
with its counterparty and the counterparty's margin affiliates
crosses the IM threshold amount, the exchange of IM would be
required.
---------------------------------------------------------------------------
The proposed eligible seeded fund exception is intended to address
challenges confronted by seeded funds that have limited individual
swaps exposure, but, due to their affiliation with an entity or group
of entities, have on a collective basis sufficient AANA to meet the MSE
threshold, therefore requiring CSEs undertaking uncleared swaps with
the funds to post and collect IM with such funds. To limit the relief
to only such funds, the proposed treatment would be applicable only to
funds that have one or more margin affiliates that are already subject
to the IM requirements and post and collect IM pursuant to Commission
Regulation 23.152. Also, the Commission notes that notwithstanding the
proposed eligible seeded fund exception, CSEs would still be required
to count the uncleared swaps that they undertake with eligible seeded
funds for purposes of calculating their own AANA.
Market participants, including the members of the GMAC Margin
Subcommittee, have argued that absent relief, seeded funds would
experience a performance drag given that a portion of their investment
would be committed to, and segregated as, IM and would also incur
operational costs that are not commensurate with the size of their
uncleared swaps activity and the risks of their swaps. In addition, the
overall ability of start-up funds to attract new investors may be
compromised as a result.\35\
---------------------------------------------------------------------------
\35\ Margin Subcommittee Report at 32.
---------------------------------------------------------------------------
In its Report, the GMAC Margin Subcommittee discussed the costs
that seeded funds would incur if the funds were consolidated with their
sponsor entities and were treated as margin affiliates of their sponsor
entities, including the cost of setting up and maintaining margin
accounts and establishing custodial arrangements to segregate IM
collateral under Commission Regulation 23.157.\36\ The seeded funds
would also be required to engage in negotiation of complex margin
documentation and develop compliance infrastructures to handle the
exchange of IM.\37\ The Report further observed that, given their
typically small size, seeded funds are likely to encounter difficulties
in establishing the necessary margin documentation and processes, as
CSEs and custodians, which face competing demands for resources and
services to operationalize the exchange of IM, may prioritize larger
counterparties.\38\
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\36\ For purposes of clarity, these arguments, as well as the
proposed rule amendments, pertain only to the margin requirements
for uncleared swap transactions. The proposed amendments would not
impact any potential margin requirements that a seeded fund would
have to meet in connection with futures contracts or cleared swap
transactions.
\37\ Margin Subcommittee Report at 32.
\38\ Id.
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The Margin Subcommittee Report stated that although seeded funds
may be consolidated with other entities on a financial statement, they
are legally and operationally distinct and, as a result, may not be
able to share information about their exposure for purposes of managing
the $50 million IM threshold amount above which IM for uncleared swaps
must be exchanged. In addition to operational challenges, the Report
indicated that potential confidentiality obligations may prevent the
different affiliates within the seeded fund's consolidated group from
sharing uncleared swaps exposure information. As an example, the Report
noted that because of regulatory restrictions, an insurance company
that sponsors a seeded fund would not be permitted to share information
about the fund's trading activity with an affiliate engaging in swap
transactions for purposes of hedging general insurance risk.
Finally, the Report stated that seeded funds that do not otherwise
hold assets qualifying as eligible IM collateral under Commission
Regulation 23.156 \39\ would need to hold larger cash reserves, which
would be unavailable to implement the fund's investment strategy, or
would need to incur the costs of converting fund assets into eligible
IM collateral. The operational costs and potential difficulties arising
in the execution of margin documentation could also either negatively
impact a seeded fund's performance or inhibit its ability to trade,
defeating the purpose of the original seed capital.\40\
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\39\ Id.
\40\ Margin Subcommittee Report at 31.
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The Commission notes that the proposed eligible seeded fund
exception is consistent with the approach in other countries.
Jurisdictions such as Australia, Canada and the EU have adopted
provisions that permit investment funds to be treated as distinct,
separate entities for purposes of calculating the relevant IM
thresholds, subject to conditions similar to those that the Commission
intends to adopt through the proposed definition of ``eligible seeded
fund'' discussed below.\41\
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\41\ Margin Subcommittee Report at 29. As noted in the Report,
Canada has excluded investment funds from consolidated margin
calculations via the Office of the Superintendent for Financial
Institutions of Canada Guideline E-22 Margin Requirements for Non-
centrally Cleared Derivatives effective as of June 2017, Section
1.1. Scope of Applicability, Footnote 2, available at https://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/Pages/e22.aspx;
the EU adopted a similar approach via Commission Delegated
Regulation No. 2016/2251 of October 4, 2016, Supplementing
Regulation (EU) No.648/2012 of the European Parliament and of the
Council of July 4, 2012 on OTC Derivatives, Central Counterparties
and Trade Repositories with Regard to Regulatory Technical Standards
for Risk-Mitigation Techniques for OTC Derivative Contracts Not
Cleared by a Central Counterparty, 2016 O.J. L340/11, Articles
28(3); 29(3) and 39(2), available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv%3AOJ.L_.2016.340.01.0009.01.ENG;
and the Australian Prudential Regulatory Authority noted, in
paragraph 25 of Prudential Standard CPS 226 (available here https://www.apra.gov.au/sites/default/files/prudential_standard_cps_226_margining_and_risk_mitigation_for_non-centrally_cleared_derivatives.pdf) that for purposes of calculating
the IM threshold, an investment fund may be treated separately from
the investment adviser and other investment vehicles, provided
certain conditions are met. The Margin Subcommittee Report also
noted that Japan has adopted a similar approach, however, the
Commission could not verify that assertion because the Report did
not provide a citation to the relevant Japanese rules.
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The proposed approach is also consistent with the BCBS-IOSCO
Framework, which provides that investment funds should be treated as
separate legal entities when applying the IM threshold amount provided
that they are distinct legal entities that are not collateralized or
otherwise guaranteed or supported by other investment funds or the
investment advisor in the event of fund insolvency or bankruptcy.\42\
As such, the proposed approach would contribute to global harmonization
with respect to the treatment of investment funds, preventing potential
reductions in liquidity or trading disruptions due to non-U.S. funds'
limiting their trading activities to non-U.S. counterparties to take
advantage of approaches to
[[Page 53413]]
consolidation that exist in other jurisdictions.
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\42\ BCBS-IOSCO Framework, Footnote 10, supra note 27.
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The Commission recognizes, however, that the proposed amendments
would be a departure from the prudential regulators' approach, whose
margin requirements for uncleared swaps include a definition of
``margin affiliate'' that is equivalent to the current definition in
the CFTC Margin Rule. Furthermore, the prudential regulators have
reserved the right to include any entity as an affiliate or a
subsidiary based on the conclusion that an entity may provide
significant support to, or may be materially subject to the risks of
losses of, another entity.\43\ As noted below, the Commission requests
comment on whether it should proceed with the Seeded Funds Proposal if
the prudential regulators do not amend their rules in a manner
consistent with the proposal.
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\43\ See Prudential Regulators Margin Rule at 74859-60.
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The Commission preliminarily believes that the proposed approach
supports the CFTC Margin Rule's objective of imposing margin
requirements that are commensurate with the risk of uncleared swaps
entered into by CSEs.\44\ The Commission preliminarily believes, as
discussed in the Margin Subcommittee Report, that seeded investment
funds do not pose significant risks to their swap counterparties or the
financial system given that typically their capitalization does not
exceed $50-100 million and the funds have limited notional exposure.
The Report cited the results of an informal sampling conducted in 2018
among members of the Securities Industry and Financial Markets
Association's Asset Management Group (``SIFMA AMG'') and the American
Council of Life Insurers. According to the Report, the respondents
identified a total of 33 funds that would be within the scope of the IM
requirements due to their derivatives notional exposures being
consolidated with entities with MSE. The average gross notional
exposure for each seeded fund was $32 million. As the Report concluded,
none of these funds would be within the scope of the IM requirements
absent consolidation with their sponsor entity. Given their size and
limited individual swap activity, the Commission preliminarily believes
that affording relief to seeded funds at the early stages of formation
from coming within the scope of the IM requirements is consistent with
the CFTC Margin Rule's risk-based approach.
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\44\ See Section 4s(e)(3)(A)(2) of the CEA (directing the
Commission to adopt margin requirements ``appropriate to the risks
associated with'' the uncleared swaps held by the SD or the MSP). 7
U.S.C. 6s(e)(3)(A).
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The Commission also preliminarily believes that safeguards already
present in the CEA and CFTC regulations would mitigate the increase in
uncollateralized credit risk resulting from swap transactions between
CSEs and seeded funds that would be relieved from the IM requirements
given the disaggregation of eligible seeded funds from their sponsor
entities and other affiliated entities for purposes of calculating the
funds' MSE and the IM threshold amount. The Commission notes that
notwithstanding the relief, uncleared swap transactions between CSEs
and eligible seeded funds would still be subject to the VM
requirements.\45\ Moreover, section 4s(j)(2) of the CEA mandates CSEs
to adopt a robust and professional risk management system adequate for
the management of their swap activities \46\ and Commission Regulation
23.600 requires that CSEs, in establishing a risk management program to
monitor and manage risks associated with their swap activities, must
account for credit risk and must set risk tolerance limits.\47\
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\45\ See 17 CFR 23.153.
\46\ See 7 U.S.C. 6s(j).
\47\ 17 CFR 23.600.
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As an additional safeguard, the proposed eligible seeded fund
exception would be applicable only for a period of three years from an
eligible seeded fund's trading inception date. The three-year term is
designed to cover the period during which the fund would work towards
establishing a performance track record and towards attracting
unaffiliated investors.\48\
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\48\ Market participants have noted that after three years,
investment funds have typically established a sufficient record to
draw in third-party investors and are no longer consolidated with
their sponsor entity for AANA calculation purposes. See Margin
Subcommittee Report at 30.
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In adopting the CFTC Margin Rule, the Commission stated that the
requirement to calculate MSE and the IM threshold amount on a
consolidated basis was intended to prevent CSEs and their
counterparties from creating legal entities and netting sets that have
no economic basis and are constructed solely for the purpose of
applying additional thresholds to evade margin requirements.\49\
Consistent with this goal, the Commission intends for the eligible
seeded fund exception to be applied only for purposes of calculating
MSE and the IM threshold amount of the eligible seeded fund. Under the
Seeded Funds Proposal, a fund's sponsor entity and other margin
affiliates would continue to include the eligible seeded fund's
exposure in the calculation of their MSE and the IM threshold amount,
unless they independently qualify for the proposed eligible seeded fund
exception. As such, the proposed treatment for eligible seeded funds
would not serve as an incentive for a sponsor entity to create seeded
funds merely to reduce its own exposure and circumvent the
applicability of the IM requirements.
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\49\ CFTC Margin Rule, 81 FR at 652.
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In addition, the Commission proposes to make the eligible seeded
fund exception available only with respect to funds that have a bona
fide business and economic purpose, meaning that the funds are not
created for the sole purpose of evading the IM compliance thresholds.
Rather, the exception is intended for funds that engage in genuine
efforts to test their investment strategy and distribute the funds'
shares to third-party investors.\50\ To that end, in addition to
relying on anti-evasion provisions already existing in the Commission
regulations \51\ to address
[[Page 53414]]
the potential circumvention of the IM compliance thresholds, the
Commission proposes to limit the availability of the proposed treatment
for seeded funds to entities that meet certain requirements. These
requirements would be incorporated in the proposed definition of
``eligible seeded fund'' discussed below.
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\50\ The Commission notes that this position is consistent with
the policy approach taken by the prudential regulators and the
Commission in the regulations implementing the requirements of
section 619 of the Dodd-Frank Act, commonly referred to as the
``Volcker Rule.'' The implementing regulations recognize the concept
of a seeding period and exempt banking entities that acquire and
retain an ownership interest in a covered fund (as the concept is
defined under the implementing regulations) from some of the
prohibitions of the Rule during the seeding period, under certain
conditions. See 12 CFR 248.12(a)(1) and (2). In particular, these
conditions include that the covered fund must actively seek
unaffiliated investors to reduce, through redemption, sale,
dilution, or other methods, the aggregate amount of all ownership
interests of the banking entity in the covered fund to the amount
permitted under the regulations. 12 CFR 248.12(a)(2)(i). Also, the
aggregate value of all ownership interests of the banking entity and
its affiliates in all covered funds acquired and retained under the
relevant exemptions must not exceed 3 percent of the tier 1 capital
of the banking entity. 12 CFR 248.12(a)(2)(iii). Although the
Commission is not proposing identical conditions, the Commission is
proposing to incorporate a number of requirements to achieve the
same purpose as appropriate in the context of the CFTC Margin Rule,
including the requirement in the proposed definition discussed below
that an ``eligible seeded fund'' be managed pursuant to a written
investment strategy that follows a written plan to reduce each
sponsor entity's ownership interest in the fund.
\51\ See Commission regulation 23.402(a)(1)(ii) (requiring CSEs
to have written policies and procedures to prevent the evasion, or
participation in or facilitation of an evasion, of any provision of
the CEA or Commission regulation). 17 CFR 23.402(a)(1)(ii). See also
the definition of MSE in Commission Regulation 23.151 (stating that
activities not carried out in the regular course of business and
willfully designed to circumvent the calculation of the AANA at
month-end to evade meeting the definition of MSE shall be
prohibited). 17 CFR 23.151. The Commission also reminds market
participants that section 4b of the CEA prohibits any person
entering into a swap with another person from cheating, defrauding,
or willfully deceiving, or attempting to cheat, defraud, or deceive,
the other person. 7 U.S.C. 6b.
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2. Commission Regulation 23.151--Definition of ``Eligible Seeded Fund''
The Commission proposes to amend Commission Regulation 23.151 by
adding a definition for the term ``eligible seeded fund.'' ``Eligible
seeded fund'' would be defined as a collective investment vehicle that
has received a part or all of its start-up capital from a parent and/or
affiliate (each, a sponsor entity) and that meets certain specified
conditions.
A seeded fund would meet the proposed definition of eligible seeded
fund if, among other conditions: (i) the fund is a distinct legal
entity from each sponsor entity; (ii) the fund is managed by an asset
manager pursuant to an agreement that requires the fund's assets to be
managed in accordance with a specified written investment strategy;
(iii) the fund's asset manager has independence in carrying out its
management responsibilities and exercising its investment discretion,
and to the extent applicable, has independent fiduciary duties to other
investors of the fund; and (iv) the fund's written investment strategy
includes a written plan for reducing each sponsor entity's ownership
interests in the fund that stipulates divestiture targets over the
three-year period after the seeded fund's trading inception date.
Additionally, to meet the ``eligible seeded fund'' definition, in
respect of any of the seeded fund's obligations, a fund must not be
collateralized, guaranteed, or otherwise supported, directly or
indirectly, by any sponsor entity, any margin affiliate of any sponsor
entity, other collective investment vehicles, or the fund's asset
manager. These conditions are designed to ensure that the sponsor
entity would not retain a level of influence or exposure that is
materially above that of other minority or passive investors and that
the fund would follow a genuine plan to emerge from the seeding phase
by attracting unaffiliated investors.
To ensure that the three-year period contemplated by the eligible
seeded fund exception is not reinstated, due to rollovers of fund
assets or similar activities, the proposed definition would require
that the seeded fund has not received any of its assets, directly or
indirectly, from an eligible seeded fund that has relied on the
proposed exception.
Furthermore, the Seeded Funds Proposal is intended to be limited to
those seeded funds that, absent amendments to the CFTC Margin Rule,
would have to exchange IM due to their consolidation with a group that
collectively exceeds the thresholds triggering compliance with the IM
requirements. That is, the Seeded Funds Proposal, consistent with the
Margin Subcommittee Report, is intended to address seeded funds that
are ``seeded'' by parent entities that have MSE and thus cause the
seeded funds to come within the scope of the IM requirements. For
purposes of targeting these seeded funds, the proposed definition of
``eligible seeded fund'' would require as a condition for qualification
that at least one of the seeded fund's margin affiliates must be
subject to the IM requirements and must be required to post and collect
IM pursuant to Commission Regulation 23.152.
Finally, the proposed definition of ``eligible seeded fund'' would
provide that the seeded fund must not be a securitization vehicle. This
condition is designed to further limit the proposed treatment of seeded
funds only to funds subject to the Margin Subcommittee Report's
recommendation. The Commission notes that in adopting the CFTC Margin
Rule, despite receiving multiple comments from industry representatives
to exclude securitization vehicles from the definition of FEU, and
recommendations subsequent to the adoption of the rule, the Commission
has maintained the position that there are sufficient reasons to keep
these entities within the scope of the IM requirements. The Commission
stated in the preamble to the final CFTC Margin Rule that the relevant
IM compliance thresholds would address concerns related to the
applicability of the IM requirements to these entities.\52\ At this
time, the Commission does not believe that it is prudent to extend the
proposed eligible seeded fund exception to such entities.
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\52\ See CFTC Margin Rule, 81 FR at 683.
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In adopting the CFTC Margin Rule, the Commission modified the
proposed definition of ``margin affiliate,'' which relied on the
concept of legal control as a criterion for affiliation, to the current
definition based on accounting consolidation, in consideration of a
concern that the proposed definition may have been over-inclusive. The
Commission noted that the accounting consolidation analysis typically
results in a positive outcome (consolidation) at a higher level of an
affiliation relationship than the 25 percent voting interest standard
of the legal control test.\53\
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\53\ Id. at 647.
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The Commission recognized, however, that consolidation between a
seeded fund and the sponsor may occur during the seeding period or
other periods in which the sponsor may hold an outsized portion of the
fund's interest. The Commission stated that during those periods, when
an entity may hold up to 100 percent of the ownership interests of an
investment fund, it was appropriate to treat the investment fund as an
affiliate.\54\ The Commission further stated that such treatment may be
likewise justified for a sponsor or asset manager and a special purpose
entity created for asset management when accounting standards, such as
GAAP and IFRS variable interest standards, require consolidation for
such entities even though the manager might not hold an interest
comparable to a majority equity or voting control share given the level
of influence and exposure typically retained by the manager.\55\
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\54\ Id.
\55\ Id.
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The Commission notes that subsequently, in letters to the CFTC,
SIFMA AMG (on behalf of its asset manager members) requested relief
from the treatment as margin affiliate for seeded funds, consistent
with the arguments made in the Margin Subcommittee Report described
above. While acknowledging that a sponsor of a seeded investment fund
has influence beyond that of a passive, unaffiliated investor, SIFMA
AMG urged that seeded funds not be consolidated with their sponsors in
applying the CFTC's margin requirements because there are structural
and contractual safeguards that limit the sponsor's influence and
exposure with respect to the seeded fund.\56\ In particular, SIFMA AMG
noted that each seeded fund is a distinct legal entity that is managed
by an investment manager pursuant to an investment advisory agreement
that, among other things, requires the assets of the fund to be managed
in accordance with specified investment guidelines, objectives, and
strategies, and not
[[Page 53415]]
capriciously at the desire of the fund sponsor.\57\
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\56\ Letter by SIFMA AMG to the Commission and the Prudential
Regulators Regarding Final Margin Rules for Uncleared Swap
Transactions (Jan., 19, 2016) (``SIFMA AMG 2016 Letter'') at 3; see
also Margin Subcommittee Report at 16.
\57\ SIFMA AMG 2016 Letter at 3.
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Further, the Margin Subcommittee Report noted that neither the
sponsor nor its commonly consolidated entities controls or has
transparency into the management or trading of the seeded fund.\58\
Moreover, the Report stated that, typically, the sponsor or affiliate
of a seeded fund does not guarantee the obligations of the seeded fund
or participate in or control the management of the fund.\59\ The Report
further noted that the sponsor's exposure to the seeded fund is
generally capped at its investment, similar to any other passive
investor in a third-party instrument or vehicle.\60\
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\58\ Margin Subcommittee Report at 16.
\59\ Margin Subcommittee Report at 6 and16.
\60\ Margin Subcommittee Report at 16.
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These arguments highlight the safeguards generally exhibited in
seeded funds. As previously noted, the Commission is proposing to
incorporate these safeguards, among other conditions, in the proposed
definition of ``eligible seeded fund'' as requirements to be met by a
fund in order to benefit from the proposed treatment for eligible
seeded funds, discussed in more detail above. In proposing these
conditions, the Commission seeks to ensure that eligible seeded funds
are sufficiently independent and risk-remote from other entities in
their group such that treating them separately for purposes of
determining whether the thresholds for compliance with the IM
requirements have been met would be justified.
In particular, the proposed requirements that the fund is managed
in accordance with a written investment strategy, by an asset manager
that maintains independence in carrying out its management
responsibilities and exercising its investment discretion, and that, to
the extent applicable, has independent fiduciary duties to other
investors in the fund, seek to ensure that no sponsor entity or an
affiliate of a sponsor entity has control or transparency into the
management or trading of the seeded fund. Furthermore, the proposed
condition that the fund's investment strategy follows a written plan
for reducing each sponsor entity's ownership interest in the fund aims
to reserve the benefit of the proposed approach to seeded funds that
have a genuine economic purpose and intentions to emerge from the
seeding phase.
In addition, the proposed definition of ``eligible seeded fund''
would prohibit a fund sponsor entity, entities affiliated with a
sponsor entity, other collective investment vehicles, or the fund's
asset manager from collateralizing, guaranteeing or otherwise directly
or indirectly providing support in respect of any of the fund's
obligations. The Commission proposes this condition in recognition that
the sponsor of a seeded fund or its asset manager may be motivated to
provide financial assistance to the seeded fund whose uncleared swaps
may be uncollateralized as a result of the Seeded Funds Proposal, which
might heighten the risk of the fund's swap positions and weaken the
fund's financial condition. The sponsor entity or the asset manager may
also be inclined to provide financial assistance to the fund because of
reputational or other concerns even in the absence of a guarantee or
formal commitment, and at the risk of exhausting its own resources,
raising the risk of contagion and systemic risk, in particular during
times of widespread financial stress. The Commission preliminarily
believes that the requirements in the proposed definition of ``eligible
seeded fund,'' which seek to ensure the fund's genuine independence,
would serve as effective safeguards against financial contagion.
The Commission also intends to rely on tools that already exist
under the CEA and the Commission regulations to address evasion
concerns. In particular, the Commission notes that Commission
Regulation 23.402(a)(ii) requires CSEs to have written policies and
procedures to prevent the evasion, or participation in or facilitation
of an evasion, of any provision of the CEA or the Commission
regulations.\61\ The Commission also reminds market participants that
section 4b of the CEA prohibits any person entering into a swap with
another person from cheating, defrauding, or willfully deceiving, or
attempting to cheat, defraud, or deceive, the other person.\62\
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\61\ 17 CFR 23.402(a)(ii). As discussed above, the Commission
also notes that the definition of MSE in Commission Regulation
23.151 prohibits activities not carried out in the regular course of
business and willfully designed to circumvent the calculation of the
AANA at month-end to evade meeting the definition of MSE shall be
prohibited. 17 CFR 23.151.
\62\ 7 U.S.C. 6b.
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Request for comments: The Commission requests comments regarding
the proposed amendments to Commission Regulation 23.151, generally. The
Commission specifically requests comment on the following questions:
1. Under the Seeded Funds Proposal, eligible seeded funds would be
deemed not to have margin affiliates for purposes of calculating the
fund's MSE and the IM threshold amount during a period of three years
from the fund's trading inception date. As such, CSEs that undertake
uncleared swaps with such funds and would otherwise be required to
exchange IM with the funds, may be relieved from such obligation, as
only each fund's individual exposure would be considered in determining
whether the IM requirements apply to uncleared swaps between CSEs and
the fund. As a result, less margin may be collected and posted for
uncleared swaps than would be otherwise required under the current
requirements. Is the Seeded Funds Proposal appropriate in light of the
resulting potential uncollateralized swap risk?
2. The Commission recognizes that the proposed eligible seeded fund
exception would not only benefit the eligible seeded funds but would
also relieve CSEs from their obligation to post IM with seeded funds
that would otherwise come within the scope of the CFTC IM requirements.
Should only the eligible seeded fund, and not its CSE counterparty, be
relieved of the IM obligation?
3. Should the Commission impose any additional limits or conditions
to the proposed eligible seeded fund exception such as: (i) imposing a
separate MSE and/or IM threshold amount, calculated on the basis of the
eligible seeded fund's individual exposure and proportionate to the
perceived risks associated with funds' swap activities, (ii) imposing a
limit on the total number of eligible seeded funds to which a sponsor
entity provides start-up capital that may rely on the eligible seeded
fund exception, or (iii) requiring that all eligible seeded funds,
consolidated within the same group on the basis of accounting
principles, aggregate their exposures for purposes of calculating the
MSE and IM threshold amounts that apply to such funds?
4. What are the costs associated with a seeded fund calculating IM
and establishing a relationship with a custodian to transfer IM?
5. The proposed amendments to Commission Regulation 23.151, in
particular the requirements in the proposed definition of ``eligible
seeded fund,'' aim to ensure that the relevant funds are genuinely and
practically independent and risk-remote from their sponsor entities and
other affiliates. Do the proposed amendments incorporate sufficient
safeguards to achieve this goal? Given that other entities such as
sponsor entities or the asset manager may be incentivized to provide
resources to a seeded fund in financial distress even in the absence of
an
[[Page 53416]]
explicit business arrangement or guarantee, potentially putting their
own financial position at risk and thereby increasing the risk of
contagion and systemic risk, what measures could the Commission take to
limit the potential risks to such other entities and ultimately to the
financial system?
6. The Commission proposes to include, among other conditions, a
requirement providing that a fund would qualify as an eligible seeded
fund only if one or more of the seeded fund's margin affiliates is
required to post and collect IM pursuant to Commission Regulation
23.152. This condition is intended to limit the availability of the
proposed eligible seeded fund exception only to funds that, for reasons
described in the Margin Subcommittee Report, are disadvantaged
domestically and globally due to their affiliation with a group that
has MSE. Is this condition appropriate? Should the condition be amended
to ensure that the Commission is appropriately circumscribing the
proposed treatment of eligible seeded funds?
7. The Commission also proposes to include, among other conditions,
a requirement providing that to qualify as an eligible seeded fund, the
seeded fund's investment strategy must follow a written plan for
reducing each sponsor entity's ownership interest in the seeded fund
that stipulates divestiture targets over the three-year period after
the seeded fund's trading inception date. Should the Commission include
more specific requirements in connection with the written plan?
8. The Prudential Regulators Margin Rule contains a definition of
``margin affiliate'' that is equivalent to the current definition under
the CFTC Margin Rule. Furthermore, the prudential regulators have
reserved the right to include any entity as an affiliate or a
subsidiary based on the conclusion that an entity may provide
significant support to, or may be materially subject to the risks or
losses of, another entity. If the Commission amends Commission
Regulation 23.151, counterparties that trade with both prudentially
regulated SDs and CFTC-regulated SDs may need to adjust their swap-
related documentation and collateral management systems to reflect the
different margin requirements that may apply under the CFTC's and the
prudential regulators' rules. In that regard, the Commission requests
information on the potential additional costs associated with
maintaining two separate and distinct documentation and collateral
management processes. How much weight should the Commission give with
respect to the possible challenge that counterparties may need to
maintain two separate and distinct documentation and collateral
management systems? Should the Commission proceed to adopt the proposed
amendments to Commission Regulation 23.151 if the prudential regulators
do not adopt similar regulatory changes?
9. The Commission intends that the final rule will become effective
30 days after its publication in the Federal Register. With respect to
the Seeded Funds Proposal, are there any comments on the effective
date?
B. Money Market Funds Proposal
The Commission proposes to amend Commission Regulation
23.156(a)(1)(ix) to eliminate the restriction on the use of securities
of money market and similar funds that transfer their assets through
repurchase or similar arrangement (the asset transfer restriction). The
Commission is also proposing an amendment to the haircut schedule set
forth in Commission Regulation 23.156(a)(3)(i)(B) to add a footnote
that was inadvertently omitted when the rule was originally
promulgated.
1. Commission Regulation 23.156(a)(1)(ix)--Elimination of the Asset
Transfer Restriction
In adopting the CFTC Margin Rule, the Commission added redeemable
securities in money market and similar funds to the list of eligible
collateral in response to comments arguing for the inclusion of MMF
securities as eligible collateral for IM.\63\ The Commission explained
that the addition of money market and similar fund securities to the
list of eligible collateral would provide flexibility while maintaining
a level of safety, noting that to qualify, such fund securities would
need to meet the conditions in Commission Regulation 23.156(a)(1)(ix),
including the asset transfer restriction in paragraph (C), which has
the effect of disqualifying the securities of funds that transfer their
assets through repurchase or similar arrangements.\64\
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\63\ See CFTC Margin Rule, 81 FR at 666.
\64\ Id.
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As discussed above, market participants, and the GMAC Margin
Subcommittee, have urged the Commission to eliminate the asset transfer
restriction in paragraph (C), noting that it disqualifies the
securities of most MMFs and significantly restricts the ability of swap
counterparties to use such form of collateral.\65\ Based on its
experience implementing the margin requirements for several years and
for the reasons described below, the Commission preliminarily
recommends the elimination of the restriction.
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\65\ Margin Subcommittee Report at 23.
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MMFs are regulated, short-term investment vehicles that are subject
to liquidity and diversification requirements under U.S. regulations,
such as SEC Rule 2a-7.\66\ The MMFs that could qualify as eligible IM
collateral under Commission Regulation 23.156 invest in high quality
underlying instruments, namely securities issued or unconditionally
guaranteed as to the timely payment of principle and interest by the
U.S. Department of the Treasury and cash. More generally, the Margin
Subcommittee Report stated that the Commission has recognized MMFs as
safe, high quality investments, noting that, for example, Commission
Regulation 1.25 permits the investment of customer margin by futures
commission merchants (``FCM'') in MMFs without an asset transfer
restriction.\67\
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\66\ 17 CFR 270.2a-7.
\67\ Margin Subcommittee Report at 26. In the Commission's view,
the fact that Commission Regulation 1.25 permits investments in
interests in money market funds without imposing restrictions on
repurchase agreements and similar arrangements is not dispositive in
considering the proposed amendment to Commission Regulation
23.156(a)(1)(ix). Commission Regulation 1.25 was adopted under a
different regime (concerning FCMs and derivative clearing
organizations) and addresses different concerns than those
Commission Regulation 23.156 aims to target.
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The elimination of the asset transfer restriction in paragraph (C)
of Commission Regulation 23.156(a)(1)(ix) would allow for a broader
range of money market and similar fund securities to qualify as
eligible IM collateral.\68\ This is consistent with the Commission's
intent in identifying certain fund securities as eligible collateral
when it adopted the CFTC Margin Rule. The Commission stated that it
intended to permit MMF securities to be pledged as IM collateral in
order to permit flexibility, while also ``maintaining a level of
safety.'' \69\ As noted above, according to the Margin Subcommittee
Report, most multi-billion dollar MMFs available to the institutional
marketplace use repurchase or similar arrangements as part of their
management strategy.\70\ Given the widespread use of repurchase and
similar arrangements by MMFs,
[[Page 53417]]
only a few of the MMFs currently available to institutional clients
satisfy the asset transfer restriction in paragraph (C).\71\ As a
result, unless the restriction is eliminated, this form of margin
collateral would be of very limited availability to swap
counterparties, contrary to the intent of the Commission.
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\68\ If adopted, the amendment would also result in an expanded
scope of money market and similar fund securities that can serve as
VM for uncleared swap transactions between a CSE and an FEU, given
that Commission Regulation 23.156(b)(1)(ii), defining the types of
assets qualifying as VM collateral for these transactions,
incorporates the assets identified as eligible collateral for IM in
Commission Regulation 23.156(a)(1).
\69\ See 81 FR at 666.
\70\ Margin Subcommittee Report at 27.
\71\ Id. at 24 (noting that a leading custodial bank has
researched all the U.S. MMFs currently available to its
institutional clients in the U.S. and found that only four would
meet the requirements of Commission Regulation 23.156(a)(1)(ix)).
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The Commission preliminarily believes that expanding the scope of
eligible money market and similar fund securities may lead to more
efficient collateral management practices. In particular with respect
to the use of MMF securities as IM collateral, the Margin Subcommittee
Report noted that many custodians offer money market sweep programs,
which facilitate buy-side market participants' timely meeting margin
calls in cash that is subsequently used to purchase MMF securities,
thereby avoiding the settlement delays or additional costs associated
with the purchase and posting of non-cash assets.\72\ This is
particularly important given that under the custodian arrangement rules
under Commission Regulation 23.157, IM collateral in cash must be
promptly converted into other types of eligible collateral, such as
securities of MMF or similar funds, to avoid the possibility that cash
collateral may become a deposit liability of the custodian and to
prevent rehypothecation by the custodian.\73\
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\72\ Under Commission Regulation 23.157, a custodian may accept
and hold cash collateral as IM only if the funds are subsequently
used to purchase an asset that qualifies as an eligible form of
collateral under Commission Regulation 23.156(a)(1)(ii) through (x).
\73\ See 81 FR at 671.
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Moreover, the Report stated that the use of MMF securities as
collateral may enable market participants to avoid potential negative
interest rate charges that may be applied by custodian banks on cash
collateral.\74\ Finally, according to the Report, the sweep of cash
into MMF securities helps market participants mitigate the risk of
custodian insolvency as non-cash assets would not be consolidated with
the custodian's balance sheet or estate from a supplemental leverage
ratio \75\ or bankruptcy perspective.\76\
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\74\ See Margin Subcommittee Report at 27.
\75\ The supplementary leverage ratio represents the amount of
common equity capital that banks or bank holding companies must hold
relative to their total leverage exposure. CSEs and SD or MSP
counterparties that are banks or bank holding companies and
supervised by a U.S. banking regulator may be subject to this
requirement. For further information, see Regulatory Capital Rules:
Regulatory Capital, Revisions to the Supplementary Leverage Ratio,
79 FR 57725 (Sept. 26, 2014).
\76\ Margin Subcommittee Report at 26-27.
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Allowing a broader selection of money market and similar fund
securities to serve as collateral may address the potential
concentration of margin collateral in the securities of a few MMFs.\77\
The removal of the asset transfer restriction could lead to an
increased use of MMF securities as margin collateral. The Commission
acknowledges the risk of concentration of collateral in particular
assets and reiterates, as stated in the preamble to the CFTC Margin
Rule, that CSEs should take concentration into account and prudently
manage their margin collateral.\78\ For the same reasons, the
Commission preliminarily believes that CSEs should consider the overall
investment strategy of a money market or similar fund, including the
terms of repurchase or similar arrangements the fund may undertake, in
determining whether to use the fund's securities to meet margin
obligations under the CFTC rules.
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\77\ As noted above, according to the Margin Subcommittee Report
(citing research by a leading custodian bank), only four MMFs have
securities that qualify as eligible collateral under the current
rules. See Margin Subcommittee Report at 24.
\78\ See 81 FR at 666.
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The Commission explained in the preamble to the CFTC Margin Rule
that the asset transfer restriction in paragraph (C) of Commission
Regulation 23.156(a)(1)(ix) was included to ensure consistency with the
prohibition against rehypothecation of IM collateral under Commission
Regulation 23.157(c)(1). After further consideration and based on its
experience implementing the margin requirements for several years, the
Commission now preliminarily believes that although these rules are
similar in that they aim to mitigate loss, the objectives of these
rules are distinguishable as further discussed below.
Commission Regulation 23.157 provides for the segregation of IM
collateral with a third-party custodian to ensure that: (i) the IM is
available to a counterparty when its counterparty defaults and a loss
is realized that exceeds the amount of VM that has been collected as of
the time of default; and (ii) the IM is returned to the posting party
after its swap obligations have been fully discharged.\79\ In this
context, the prohibition in Commission Regulation 23.157(c)(1) against
rehypothecation, repledging, reuse, or other transfer (through
securities lending, repurchase agreement, reverse repurchase agreement,
or other means) of funds or property held by the custodian advances the
Commission's goal of ensuring that the pledged assets are available to
the non-defaulting party in the event of a default by its
counterparty.\80\ In the preamble to the CFTC Margin Rule, the
Commission explained that rehypothecation could allow the collateral
posted by one counterparty to be used by the other counterparty as
collateral for additional swaps, resulting in rehypothecation chains
and embedded leverage throughout the financial system.\81\
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\79\ Id. at 670.
\80\ In this regard, the Margin Subcommittee Report stated that
``in [ ] MMF sweep arrangements, under no circumstances does the
pledgor's custodian have any right to rehypothecate, reuse the IM
collateral or take any other independent actions with respect to the
pledged MMF shares. Instead, the CSE and financial end user agree
upfront in the collateral documentation to the list of eligible MMFs
and any associated haircuts, as pledgor any cash sweep into a MMF is
instructed by the financial end user or its manager and absent any
default, any transfers into and out of the collateral account by the
custodian is instructed by the financial end user and agreed to by
the CSE (as secured party).'' Margin Subcommittee Report at 25.
\81\ Id. at 688, n. 392 (describing as an example, the situation
where a default or liquidity event that occurs at one link along the
rehypothecation chain may induce further defaults or liquidity
events for other links in the rehypothecation chain as access to the
collateral for other positions may be obstructed by a default
further up the chain, and also explaining that in the event of
default along a rehypothecation chain, there is an increased chance
that each party along the chain will ask for the rehypothecated
collateral to be returned to them at the same time, leaving just one
party with the collateral).
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In contrast, Commission Regulation 23.156(a) aims to identify
assets as eligible collateral that are liquid, and, with haircuts, will
hold their value in times of financial stress.\82\ Current paragraph
(C) of Commission Regulation 23.156(a)(1)(ix) furthers the goal that
money market and similar fund securities posted as IM collateral remain
liquid and retain their value during times of financial stress. More
specifically, paragraph (C) disqualifies the securities of money market
and similar funds that transfer their assets through repurchase or
similar arrangements to mitigate the potential impact of such transfers
on the liquidity or value of fund securities.
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\82\ Id. at 665.
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For example, if the counterparty to a money market and similar fund
in a repurchase or similar arrangement does not fulfill its obligation
under the
[[Page 53418]]
arrangement, the fund may be left holding assets that might not be
easily resold or that might not provide sufficient compensation for the
assets tendered in the repurchase arrangement, in particular during a
period of financial stress, reducing the overall net asset value of the
fund and the price of the fund's securities. Also, the inability to
liquidate assets that a money market and similar fund might be left
holding upon the failure of a repurchase or similar arrangement, or the
inability to extract assets originally tendered in the repurchase
arrangement, may impact a fund's ability to promptly respond to
redemption requests, which may hinder the liquidity of the money market
and similar funds' securities, making the securities less suitable as
margin collateral.\83\ Repurchase and similar arrangements may
therefore undermine efforts that collateral be ``subject to low credit,
market, and liquidity risk.'' \84\
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\83\ The Commission, however, notes that any potential risk of
such a repurchase or similar arrangement may be mitigated by the
standard industry practice of applying haircuts to non-cash
collateral in repurchase or similar arrangements to compensate for
the risk that the value of the collateral may decline over the term
of the arrangement. See Primer: Money Market Funds and the Repo
Market, Prepared by the staff of the Division of Investment
Management, U.S. Securities and Exchange Commission at pp. 5-6.
\84\ 81 FR at 667 (noting that the CFTC Margin Rule does not
allow CSEs to fulfill the margin requirements with any asset not
included in the list of eligible collateral set forth in Commission
Regulation 23.156, as the use of alternative types of collateral
could introduce liquidity, price volatility, or other risks of
collateral during a period of stress that could further exacerbate
such stress and could undermine efforts to ensure that collateral be
subject to low credit, market, and liquidity risk).
---------------------------------------------------------------------------
As discussed above, the asset transfer restriction was included in
the CFTC Margin Rule to provide consistency with the prohibition
against rehypothecation of IM collateral, given the possibility that
assets exchanged by parties in a repurchase or similar arrangement
might be lost in a chain of transactions similar to the chain of
hypothecations that the Commission intended to avert by prohibiting the
rehypothecation of IM collateral by custodians under Commission
Regulation 23.157(c)(1). However, unlike in the rehypothecation
situation, where collateral might be lost at any link of the chain with
the posting counterparty in the uncleared swap transaction potentially
losing its collateral without any recourse, in the repurchase or
similar arrangement context, each party to the arrangement would be
partially secured because the parties would exchange assets with each
other under the arrangement. Hence, the risk of loss would be
mitigated. If a party to the repurchase arrangement defaults by failing
to return assets tendered by its counterparty, the counterparty would
not lose the entire value of its assets as it would hold the assets
committed by the other party under the arrangement.\85\
---------------------------------------------------------------------------
\85\ Of course, it might experience some loss as the retained
assets might not fully compensate such party for the unreturned
assets.
---------------------------------------------------------------------------
While acknowledging the concerns associated with repurchase and
similar arrangements, the Commission preliminarily believes that the
flexibility and safety that it aimed to achieve by specifically
identifying assets as eligible collateral, including certain money
market and similar fund securities, may be advanced even if repurchase
and similar arrangements are not restricted for the purpose of
qualifying money market and similar fund securities as eligible
collateral. In that regard, based on its experience administering the
CFTC Margin Rule, the Commission preliminarily believes that risks
associated with repurchase and similar arrangements would be adequately
addressed even in the absence of the asset transfer restriction by
safeguards already present in the CFTC regulations, as further
discussed below, which, in the Commission's view, can achieve the
desired level of safety with respect to fund securities without
restricting a fund's ability to undertake repurchase or similar
transactions.
First, Commission Regulation 23.156(a)(1)(ix)(A) and (B) qualify as
eligible collateral the securities of money market and similar funds
that invest only in securities issued or unconditionally guaranteed by
the U.S. Department of the Treasury, the European Central Bank or
certain other sovereign entities, and cash. The Commission
preliminarily believes that these provisions ensure that money market
and similar fund securities present the fundamental characteristics of
liquidity and value stability contemplated by the CFTC Margin Rule.\86\
In addition, the Commission notes that subparagraphs (A) and (B) of
Commission Regulation 23.156(a)(1)(ix) effectively limit the types of
assets that a money market and similar fund can receive in repurchase
or similar arrangements. As such, the securities of money market and
similar funds will qualify as eligible collateral only if the types of
assets that the fund receives in a repurchase or similar arrangement
are those described in subparagraphs (A) and (B).
---------------------------------------------------------------------------
\86\ See 81 FR at 665.
---------------------------------------------------------------------------
Second, Commission Regulation 23.156(c) requires that CSEs monitor
the market value and eligibility of all collateral and, to the extent
that the market value has declined, promptly collect or post additional
eligible collateral to maintain compliance with Commission Regulations
23.150 through 23.161.\87\ Thus, even if the value or liquidity of
pledged money market and similar fund securities may be affected by a
repurchase or similar arrangement undertaken by the fund, CSEs have the
obligation to monitor the value and suitability of the fund's
securities as margin collateral and collect or post additional eligible
collateral to compensate for collateral deficiencies.
---------------------------------------------------------------------------
\87\ 17 CFR 23.156(c).
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In addition, section 4s(j)(2) of the CEA requires CSEs to adopt a
robust and professional risk management system that is adequate for the
management of their swap activities,\88\ and Commission Regulation
23.600 mandates that CSEs establish a risk management program to
monitor and manage risks associated with their swap activities
including, among other things, credit and liquidity risks. In
particular, pursuant to Commission Regulation 23.600(c)(4), credit risk
policies and procedures should provide for the regular valuation of
collateral used to cover credit exposures and the safeguarding of
collateral to prevent loss, disposal, rehypothecation, or use unless
appropriately authorized, and liquidity risk policies and procedures
should provide for, among other things, the assessment of procedures
for liquidating all non-cash collateral in a timely manner and without
a significant effect on price, and the application of appropriate
collateral haircuts that accurately reflect market and credit risk.\89\
---------------------------------------------------------------------------
\88\ See 7 U.S.C. 6s(j).
\89\ 17 CFR 23.600.
---------------------------------------------------------------------------
Given these safeguards and the recognition that the asset transfer
restriction is severely limiting the use of money market and similar
fund securities as eligible collateral, the Commission preliminary
believes that it is appropriate to eliminate the asset transfer
restriction. The Commission also notes that the elimination of the
restriction would bring the CFTC's eligible collateral framework more
in line with the SEC approach, which does not impose asset transfer
restrictions on funds whose securities are used as collateral for
margining purposes and expressly permits the use of government money
market fund securities as collateral, thereby potentially leading to a
reduction in costs for those market participants that dually register
as SDs and security-based swap SDs with the CFTC and the SEC,
respectively.
[[Page 53419]]
2. Commission Regulation 23.156(a)(3)--Amendments to the Haircut
Schedule
Commission Regulation 23.156(a)(3) sets forth percentage discounts
to be applied to the value of eligible collateral collected or posted
to satisfy IM requirements, varying according to asset class (``haircut
requirements'').\90\ The haircut requirements are intended to address
the possibility that the value of non-cash eligible collateral may
decline between a counterparty's default and the close out of such
counterparty's swap positions by the CSE.\91\
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\90\ 17 CFR 23.156(a)(3). Also, Commission Regulation
23.156(b)(1)(ii) provides that assets that qualify as eligible
collateral for IM can be used as collateral for VM for swap
transactions between a CSE and a FEU, subject to the applicable
haircuts for each asset. See also supra note 20.
\91\ 81 FR at 668.
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Although the Commission intended to align its margin rule for
uncleared swaps with the Prudential Regulators Margin Rule, in adopting
its rule, the Commission inadvertently omitted a footnote to the
haircut schedule included in the Prudential Regulators Margin Rule.\92\
The Commission is therefore proposing an amendment to Commission
Regulation 23.156(a)(3) to incorporate the omitted footnote. The
footnote, consistent with the footnote in the Prudential Regulators
Margin Rule, would describe the haircut applicable to the securities of
money market and similar funds. The haircut for such money market and
similar fund securities would be the weighted average discount on all
assets within the funds (the discount for each asset is specified in
Commission Regulation 23.156(a)(3)) at the end of the prior month. The
footnote would further specify that the weights to be applied in the
weighted average should be calculated as a fraction of each fund's
total market value that is invested in each asset with a given discount
amount.
---------------------------------------------------------------------------
\92\ Prudential Regulators Margin Rule at 74910.
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Request for comments: The Commission requests comment regarding the
proposed amendments to Commission Regulation 23.156, generally. The
Commission specifically requests comment on the following questions:
10. Does the existing asset transfer restriction significantly
limit the use of money market and similar fund securities as eligible
collateral under the CFTC Margin Rule?
11. Under the Money Market Funds Proposal, the securities of
certain money market and similar funds that engage in repurchase or
similar arrangements would qualify as eligible collateral. A money
market and similar fund that engages in asset transfer transactions
under a repurchase or similar arrangement may be exposed to increased
risks, which may affect the liquidity and value of the fund's
securities pledged as collateral under the CFTC Margin Rule. In light
of the potential increased risk, should the Commission consider an
alternative to the proposed rule amendment, such as allowing the
securities of money market and similar funds to qualify as eligible
collateral only if a fund's repurchase or similar arrangements are
cleared? Should the Commission impose any additional limits or
conditions, such as restrictions on the type and terms of the
repurchase or similar arrangements permitted for money market and
similar funds for their shares to qualify as eligible collateral?
12. If the Commission eliminates the asset transfer restriction,
should the Commission impose an additional haircut beyond that required
by the haircut schedule in Commission Regulation 23.156(a)(3), as
revised by the proposed amendment? If an additional haircut were to be
adopted, what should the haircut be and how should the haircut be
calculated? Should such an additional haircut be proportionate to the
net asset value of the assets of a money market and similar fund that
are subject to repurchase or similar arrangements? Or instead, should
the additional haircut be a fixed percentage similar to the percentages
applicable to other assets that qualify as eligible collateral under
the haircut schedule, as it may be less complex to administer? Should
such additional fixed haircut apply to all securities of money market
and similar funds that are used as eligible collateral, or be
applicable only to such securities of money market and similar funds
that engage in repurchase or similar arrangements?
13. Given the potential impact that repurchase or similar
agreements may have on the liquidity and value of securities of money
market and similar funds that may be used as eligible collateral,
should there be a percentage cap on the amount of assets that a fund
can use for repurchase or similar arrangements, such as 10 percent of
the total net asset value of the fund?
14. To gain a better understanding of the risks posed by repurchase
and similar arrangements, the Commission requests information
concerning the types of counterparties that typically face money market
and similar funds in repurchase or similar agreements; the extent to
which repurchase and similar arrangements are used by money market and
similar funds; and whether the market treats differently money market
and similar funds according to the types of repurchase and similar
arrangements the funds enter into and the extent of repurchase
agreements or arrangements the funds engage in. Further, the Commission
requests comment with respect to the manner in which, and the extent to
which, CSEs will meet their obligation to monitor the value and
suitability of securities of money market and similar funds pledged as
margin collateral where the funds engage in repurchase or similar
arrangements.
15. Are the regulatory safeguards referenced in the Money Market
Funds Proposal adequate to address the potential risks that may arise
from the proposal? Are there other regulatory safeguards that the
Commission should consider?
16. Are there any risks associated with the Money Market Funds
Proposal that the Commission has not considered? In addition to the
possible measures discussed above, including a possible additive
haircut, or a percentage cap on the amount of assets that funds could
use in repurchase and similar agreements, are there other measures that
the Commission could take to mitigate such risks?
17. The Prudential Regulators Margin Rule contains an equivalent
asset transfer restriction. If the Commission amends Commission
Regulation 23.156, counterparties that trade with both prudentially
regulated SDs and CFTC-regulated SDs may need to adjust their swap-
related documentation and collateral management systems to reflect the
different treatments for fund securities under the CFTC's and the
prudential regulators' rules. In that regard, the Commission requests
information on the potential additional costs associated with
maintaining two separate and distinct documentation and collateral
management processes. How much weight should the Commission give with
respect to the possible challenge that counterparties may need to
maintain two separate and distinct documentation and collateral
management systems? Should the Commission proceed to adopt the proposed
amendments to Commission Regulation 23.156 if the prudential regulators
do not adopt similar regulatory changes?
18. The Commission intends that the final rule will become
effective 30 days after its publication in the Federal Register. With
respect to the Money Market Funds Proposal, are there any comments on
the effective date?
[[Page 53420]]
IV. Administrative Compliance
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider whether the rules they propose pursuant to the notice-and-
comment provisions of the Administrative Procedure Act, or any other
law, will have a significant economic impact on a substantial number of
small entities and provide a regulatory flexibility analysis respecting
the impact or issue a certification that the rule does not have such
impact.\93\ The Commission previously has established certain
definitions of ``small entities'' to be used in evaluating the impact
of its regulations on small entities in accordance with the RFA.\94\
The proposed amendments would only affect certain SDs and MSPs and
their counterparties, which must be eligible contract participants
(``ECPs'').\95\ The Commission has previously established that SDs,
MSPs and ECPs are not small entities for purposes of the RFA.\96\
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\93\ See 5 U.S.C. 601(2), 603, 604, and 605.
\94\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR 2613 (Jan. 19, 2012).
\95\ Pursuant to section 2(e) of the CEA, 7 U.S.C. 2(e), each
counterparty to an uncleared swap must be an ECP, as defined in
section 1a(18) of the CEA, 7 U.S.C. 1a(18). Section 1a(18) of the
CEA defines ECP by listing certain entities and individuals whose
business is financial in nature or that meet defined asset or net
worth thresholds, as well certain government entities.
\96\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ```Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
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Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed amendments will
not have a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \97\ 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 Commission may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid Office of Management
and Budget control number. The proposed amendments contain no
requirements subject to the PRA.
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\97\ 44 U.S.C. 3501 et seq.
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C. Cost-Benefit Considerations
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA.\98\ Section 15(a) further specifies that the costs and
benefits shall be evaluated in light of the following five broad areas
of market and public concern: (1) protection of market participants and
the public; (2) efficiency, competitiveness and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the section 15(a) considerations, and
seeks comments from interested persons regarding the nature and extent
of such costs and benefits.
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\98\ 7 U.S.C. 19(a).
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As described in more detail above, under the Seeded Funds Proposal,
the Commission is proposing to amend the definition of ``margin
affiliate'' to provide for a limited eligible seeded fund exception,
pursuant to which, during a period of three years after the fund's
trading inception date, a seeded fund meeting certain specified
requirements would be deemed to not have margin affiliates for purposes
of calculating the fund's MSE and the IM threshold. This proposed
treatment for eligible seeded funds would effectively relieve CSEs that
enter into uncleared swaps with certain seeded funds from the
requirement to exchange IM with the seeded funds during the three-year
period after the funds' trading inception date. The Seeded Funds
Proposal would make the proposed treatment available only with respect
to eligible seeded funds that, among other requirements: (i) are
distinct legal entities from each sponsor entity; (ii) have one or more
margin affiliates that are required to post and collect IM; (iii) are
managed by an asset manager pursuant to an agreement that requires the
assets of the fund to be managed in accordance with a specified written
investment strategy; (iv) have an asset manager who maintains
independence in carrying out its management responsibilities and
exercising its investment discretion, and has independent fiduciary
duties to other investors in the fund (if any), such that no sponsor
entity or any margin affiliate of a sponsor entity controls or has
transparency into the management or trading of the seeded fund; (v)
follow a written plan for the reduction of the sponsor entity's
ownership interest in the fund that stipulates divestiture targets over
the three-year period after the seeded fund's trading inception date;
(vi) are not collateralized, guaranteed or otherwise supported,
directly or indirectly by any sponsor entity, any margin affiliate of a
sponsor entity, other collective investment vehicles, or the seeded
fund's asset manager, in respect of any of the fund's obligations;
(vii) have not received any of their assets, directly or indirectly,
from an eligible seeded fund that has relied on the proposed eligible
seeded fund exception; and (viii) are not securitization vehicles.
Under the Money Market Funds Proposal, the Commission is proposing
to eliminate the asset transfer restriction in paragraph (C) of
Commission Regulation 23.156(a)(1)(ix), which has the effect of
disqualifying as eligible collateral the securities of money market and
similar funds that transfer their assets through repurchase or similar
arrangements. The Margin Subcommittee Report indicated that the asset
transfer restriction significantly limits the money market fund
securities that are available for use as collateral under the CFTC
Margin Rule.\99\
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\99\ As previously noted, according to the Margin Subcommittee
Report (citing research by a leading custodian bank), the securities
of only four MMFs would qualify as eligible collateral under the
current rules. See Margin Subcommittee Report at 24.
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The baseline against which the benefits and costs associated with
the proposed rule amendments are compared is the uncleared swaps
markets as they exist today, including the treatment of seeded funds
and the securities of money market and similar funds under the current
CFTC Margin Rule.
The Commission notes that the consideration of costs and benefits
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
below discussion of costs and benefits refers to the effects of these
proposed amendments on all activity subject to the proposed amended
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with
activities in, or effect on, U.S.
[[Page 53421]]
commerce under section 2(i) of the CEA.\100\
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\100\ 7 U.S.C. 2(i).
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The Commission recognizes that the proposed rules may impose
additional costs on market participants, including CSEs. Although the
Commission has endeavored to assess the expected costs and benefits of
the proposed rulemaking in quantitative terms, due to the lack of data
and information to estimate those costs, the Commission has identified
and considered the costs and benefits of the proposal in qualitative
terms. The lack of data and information to estimate costs is
attributable to the nature of the proposal and uncertainty relating to
how particular market participants would implement the proposed rules.
The Commission specifically requests data and information from market
participants and other commenters to allow it to better estimate the
costs of the proposal.
1. General Cost-Benefits Considerations
Seeded Funds Proposal
(a) Benefits
The Seeded Funds Proposal would effectively relieve CSEs entering
into uncleared swaps with eligible seeded funds from the requirement to
collect IM from the funds, subject to specified conditions. Absent the
Seeded Funds Proposal, seeded funds would be disadvantaged domestically
and globally in comparison to similar investment funds that are not
margin affiliates of an entity required to exchange IM or are subject
to the rules of jurisdictions such as Australia, Canada and the EU that
treat certain investment funds as separate legal entities, consistent
with the international standards established by the BCBS-IOSCO
Framework.\101\ The Seeded Funds Proposal would therefore level the
playing field domestically and globally with respect to the treatment
of seeded funds. However, the Seeded Funds Proposal may incentivize
trading with CSEs over SDs or MSPs subject to the U.S. prudential
regulators' margin rules given that the prudential regulators might not
revise their rules in a manner consistent with the Seeded Funds
Proposal and the prudential regulators' rules may continue to require
that seeded funds calculate the MSE and IM threshold amount on a
consolidated basis with their margin affiliates.
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\101\ Margin Subcommittee Report at 7, 30 and 33.
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The Commission preliminarily believes that the Seeded Funds
Proposal would tend to benefit seeded funds whose AANA falls below the
$8 billion MSE threshold and that, given their level of swap activity,
such seeded funds would pose relatively low risk to the uncleared swaps
market and the U.S financial system in general. In that regard, the
Margin Subcommittee Report stated that seeded funds have limited
notional exposure and their capitalization typically does not exceed
$50-100 million.\102\ The Report further cited an informal sampling of
members of SIFMA AMG and the American Council of Life Insurers
conducted in 2018, which indicated that a total of 33 funds would be in
scope of the CFTC margin requirements due to their derivatives notional
exposures being consolidated with entities with MSE. Individually, each
of the funds had an average gross notional exposure of $32
million.\103\
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\102\ Margin Subcommittee Report at 31.
\103\ Id.
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As a result, in the Commission's preliminary view, the Seeded Funds
Proposal, if adopted, would address seeded funds that tend to engage in
less uncleared swap trading activity and, in the aggregate, pose less
systemic risk than entities that meet the MSE threshold. The impacted
eligible seeded funds, which would be in an initial stage of
development, would presumably have fewer resources to devote to IM
compliance and hence would benefit from being discharged from posting
IM during their seeding period without contributing significantly to
systemic risk. The eligible seeded fund's sponsor entities and their
margin affiliates that do not independently qualify for the proposed
eligible seeded fund exception would continue to include the eligible
seeded funds' exposure in their calculation of the MSE and IM threshold
amount. The CSE counterparty to the eligible seeded fund would also
still be required to count the uncleared swaps that it undertakes with
the eligible seeded fund for purposes of calculating its own AANA. The
Commission preliminarily believes that the flexibility provided by the
eligible seeded fund exception would be instrumental for investment
funds during the seeding period when funds typically use all their
resources to establish a performance track record to attract
unaffiliated investors.
In addition, the Commission believes that the Seeded Funds Proposal
would be beneficial for CSEs that enter into swap transactions with
investment funds. As a result of the proposed amendments, CSEs would
apply a consistent approach in their swap dealing activities with U.S.
and non-U.S. investment funds, which may lead to cost efficiencies.
Also, as noted in the Margin Subcommittee Report, a consistent approach
to seeded funds would reduce the incentive for non-U.S. funds to avoid
business with CSEs given the perceived more onerous treatment of funds
in the U.S.\104\
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\104\ Margin Subcommittee Report at 30.
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The proposed eligible seeded fund exception may also incentivize
some market participants to expand their swap business or enter into
the swaps markets because, by counting their AANA and uncleared swaps
credit exposure individually, seeded funds may not meet the thresholds
that would bring them within the scope of the IM requirements. This
would relieve CSEs entering into uncleared swaps with the funds from
the requirement to exchange IM with the funds. In turn, the elimination
of IM-related costs may encourage uncleared swaps trading between CSEs
and investment funds and increase the pool of potential swap
counterparties, enhancing competition and liquidity and facilitating
price discovery in the uncleared swaps markets.
(b) Costs
Amending the definition of ``margin affiliate'' to provide for a
limited eligible seeded fund exception under which seeded funds would
be deemed to not have margin affiliates for purposes of calculating the
funds' MSE and the IM threshold amount, subject to specified
conditions, may lead to the exchange of less margin between a CSE and a
seeded fund. The Commission recognizes that the uncollateralized
exposure that may result from the proposed change to the ``margin
affiliate'' definition could increase credit risk associated with
uncleared swaps. The Commission believes, however, that a number of
safeguards exist to mitigate this risk. The Commission notes that
seeded funds that would qualify for the eligible seeded fund exception
would typically be smaller entities that have limited swaps
activity.\105\ To grow in size, the funds would have to attract
unaffiliated investors, which may result in such funds no longer being
subject to consolidation with their sponsor entity.
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\105\ See Margin Subcommittee Report at 31.
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As such, the eligible seeded fund exception under the Seeded Funds
Proposal would primarily impact the exchange of IM between a CSE and
investment funds that are in their seeding period. During that period,
such investment funds would pose less risk to a CSE counterparty and
the financial system as a whole given the small size of the funds and
the scope of their derivatives activity. To ensure that
[[Page 53422]]
eligible seeded funds are afforded the benefit of a separate treatment
from margin affiliates only during the seeding period, the Commission
proposes to limit the applicability of the eligible seeded fund
exception only to three years after the fund's trading inception date.
To ensure that the three-year period is not reinstated as a result of
rollovers of fund assets or similar activities, the proposed definition
of eligible seeded fund would include a condition that the seeded fund
has not received, directly or indirectly, any of its assets from an
eligible seeded fund that has relied on the eligible seeded fund
exception to the definition of ``margin affiliate.'' The Commission
further notes that, pursuant to section 4s(j)(2) of the CEA and
Commission Regulation 23.600, CSEs are required to monitor and manage
risks related to their swap activities, including credit risk, and set
risk tolerance limits.\106\ Thus, if the credit risk associated with
CSEs' transactions with eligible seeded funds exceeds the CSEs' risk
tolerance limits, CSEs would be expected to take mitigating measures.
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\106\ 7 U.S.C. 6s(j)(2) (mandating that CSEs adopt a robust and
professional risk management system adequate for the management of
day-to-day swap activities) and 17 CFR 23.600 (requiring CSEs, in
establishing a risk management program for the monitoring and
management of risk related to their swap activities, to account for
credit risk and to set risk tolerance limits).
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In certain circumstances, the increase in uncollateralized credit
risk resulting from the Seeded Funds Proposal could also negatively
impact the sponsor entity or the asset manager of a seeded fund. In
particular, if a seeded fund is facing financial distress, a sponsor
entity or the fund's asset manager may be incentivized to intervene,
because of reputational risks or other concerns, and contribute
additional resources even in the absence of an explicit business
arrangement to provide financial support or a guarantee. Similarly, if
the fund is suffering the consequences of a swap counterparty default,
the sponsor entity or the asset manager may contribute financial
resources to improve the fund's condition and increase its own
exposure, potentially putting at risk its own financial position. Thus,
the fund's uncollateralized exposure may lead the sponsor entity or the
asset manager to incur risks, increasing the potential for contagion
and systemic risk. To account for these risks, the Commission is
proposing to define the term ``eligible seeded fund'' to incorporate
requirements meant to ensure that seeded funds are genuinely
independent and that the risks associated with their activities are not
assumed by other entities such as their sponsor entities or asset
managers. Specifically, among other conditions, the seeded fund would
have to be a distinct legal entity from each sponsor entity that is not
collateralized, guaranteed, or otherwise supported, directly or
indirectly, by any sponsor entity, any margin affiliate of any sponsor
entity, other collective investment vehicles, or the seeded fund's
asset manager, in respect of any of the fund's obligations. This should
mitigate the incentive for the sponsor's assets to be used if the
seeded fund fails.
Treating seeded funds as separate unaffiliated legal entities for
purposes of calculating the thresholds for determining whether
compliance with the IM requirements is required could also incentivize
swap counterparties to create legal entities that have no economic
basis and are constructed solely for the purpose of applying additional
thresholds to evade margin requirements. To address these concerns, the
Commission proposes to limit the applicability of the eligible seeded
fund exception by providing that eligible seeded funds would be deemed
not to have margin affiliates solely for the purpose of calculating the
fund's MSE and IM threshold amount. As such, under the Seeded Funds
Proposal, the eligible seeded funds' sponsor entities and their margin
affiliates would continue to include the eligible seeded funds'
exposures in the calculation of the IM compliance thresholds applicable
to such sponsor entities and margin affiliates. In addition, the
Commission proposes to include, in the proposed definition of
``eligible seeded fund,'' conditions designed to ensure that funds that
qualify as eligible seeded funds have a bona fide business purpose. In
particular, the proposed definition provides that the eligible seeded
fund must be managed by an asset manager pursuant to an agreement that
requires that the assets of the fund be managed in accordance with a
specified written investment strategy and that the asset manager has
independence in carrying out its management responsibilities and
exercising its investment discretion, and to the extent applicable, has
independent fiduciary duties to other investors in the fund, such that
no sponsor entity or a margin affiliate of a sponsor entity controls or
has transparency into the management or trading of the seeded fund.
Furthermore, the proposed definition of eligible seeded fund would
require that the seeded fund's investment strategy must follow a
written plan for reducing the sponsor entity's ownership interest in
the fund.
The Commission, therefore, believes that the costs associated with
the potential evasion of the IM requirements would be mitigated by the
proposed rule amendment, which would be narrowly tailored to make
available the proposed approach only for purposes of calculating the IM
compliance thresholds applicable to seeded funds that meet specified
requirements and only during the three years that follow the fund's
trading inception date. In addition, the Commission intends to use its
anti-evasion authority to prevent circumvention of the margin
requirements.\107\
---------------------------------------------------------------------------
\107\ See supra note 51.
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Furthermore, given that the U.S. prudential regulators may not
amend their margin requirements in line with the Seeded Funds Proposal,
if the Commission finalizes the proposal described herein, the
Commission acknowledges the possibility that its requirements with
respect to the treatment of eligible seeded funds may diverge from that
of the U.S. prudential regulators, requiring funds that engage in swaps
transactions with both CSEs and prudentially-regulated SDs to adjust
their swap-related documentation and IM processes to reflect such
different treatments. Thus, market participants may incur additional
costs by having to maintain two separate and distinct types of
documentation and IM management processes. Similar costs may also be
incurred by CSEs that already transact with seeded funds that are
currently consolidated. Also, as discussed previously, given that the
Seeded Funds Proposal would provide for an eligible seeded fund
exception from the definition of ``margin affiliate,'' effectively
providing for the funds' deconsolidation for purposes of calculating
the funds' MSE and IM threshold amount, seeded funds may favor CSEs as
counterparties over SDs or MSPs subject to the prudential regulators'
margin rules, which might not be revised to provide for a similar
eligible seeded fund exception.
As noted above, to better assess the impact of a potential
divergence between the CFTC Margin Rule and the Prudential Regulators
Margin Rule, the Commission is requesting information on the potential
costs associated with maintaining distinct documentation and IM
management processes.
Money Market Funds Proposal
(a) Benefits
The Money Market Funds Proposal would expand the scope of assets
that
[[Page 53423]]
qualify as eligible collateral. In this regard, the GMAC Margin
Subcommittee Report stated that absent elimination of the asset
transfer restriction, the securities of very few MMFs would qualify as
eligible collateral, noting that nearly all U.S. MMFs engage in some
form of repurchase or similar arrangements.\108\ The Money Market Funds
Proposal may therefore reduce the potential concentration of collateral
in the few MMFs whose securities currently qualify as eligible
collateral under Commission Regulation 23.156(a)(1)(ix), which could
lead to greater diversity of assets used for collateral, thereby
reducing the riskiness of IM assets.
---------------------------------------------------------------------------
\108\ Margin Subcommittee Report at 24.
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Also, the Money Market Funds Proposal, by increasing the number of
MMFs whose securities qualify as eligible collateral, may promote more
efficient collateral management practices. The Margin Subcommittee
Report stated that custodians offer money market sweep programs that
afford institutional clients of such custodians the ability to timely
and efficiently meet margin calls without settlement delay, avoiding
other transaction costs that would otherwise arise in the absence of
the sweep programs. Such direct sweeps from cash into MMF securities
mitigate the risk of insolvency by the custodian because non-cash
collateral deposited with the custodian will not be consolidated in the
custodian's balance sheet. The Margin Subcommittee Report also stated
that the use of MMFs may avoid the risk of potential negative interest
rate charges that may be applied by custodian banks on cash collateral.
By eliminating the asset transfer restriction, the Money Market
Funds Proposal could also promote asset management policies that
improve the performance of money market and similar funds. Without the
restriction, the funds may undertake repurchase or similar arrangements
that increase returns for investors, including the return for CSEs that
post money market and similar fund securities as margin collateral for
uncleared swaps, contributing to the fund securities' liquidity and
retention of value even during periods of financial stress.
In summary, these benefits will accrue to CSEs and their
counterparties that enter into uncleared swaps transactions. As
discussed above, the potential concentration in certain types of
collateral has been acknowledged previously by the Commission as a
potential risk that CSEs should consider in managing their margin
collateral. CSEs and their counterparties will also benefit from the
more efficient use of their capital as discussed above and enhanced
returns on securities posted as collateral. Furthermore, the proposal
may lead to reduced costs for those market participants that dually
register as SDs and security-based swap SDs with the CFTC and the SEC,
respectively, as the proposed amendment would bring the CFTC's eligible
collateral framework more in line with the SEC approach, which does not
impose asset transfer restrictions on funds whose securities are used
as collateral for margining purposes and expressly permits the use of
government money market fund securities as collateral.
(b) Costs
The elimination of the asset transfer restriction in paragraph (C)
of Commission Regulation 23.156(a)(1)(ix) would remove a safeguard
intended to ensure that money market and similar fund securities posted
as margin collateral remain liquid and maintain their value in times of
financial stress. More specifically, paragraph (C) prevents the
transfer of money market and similar fund assets through repurchase or
similar arrangements to mitigate the impact of such transfers on the
liquidity or value of fund securities. For example, if a counterparty
to a money market and similar fund in a repurchase or similar
arrangement defaults, the fund may be left holding assets that, in
times of financial stress, may not be easily resold and might not
compensate for the value of assets tendered in the repurchase
arrangement. Such a default would reduce the overall net asset value of
the fund and the price of the fund's securities. Also, the inability to
liquidate assets that a money market and similar fund might be left
holding upon the failure of a repurchase or similar arrangement or the
inability to extract assets originally tendered in the repurchase
arrangement may impact the fund's ability to promptly respond to
redemption requests, hindering the liquidity of the fund's securities,
making them less suitable as margin collateral. The Commission,
however, notes that subparagraphs (A) and (B) of Commission Regulation
23.156(a)(1)(ix), which are not being amended, limit the types of
assets that a money market and similar fund can receive in repurchase
or similar arrangements to those assets specifically identified in
those paragraphs, alleviating in part the risks associated with
repurchase or similar arrangements.
In light of the proposed elimination of the asset transfer
restriction, the Commission is also seeking input on whether it would
be appropriate to include an additional haircut beyond that required by
the haircut schedule in Commission Regulation 23.156(a)(3), as
corrected by the proposed amendment discussed herein.
The Commission further notes that Commission Regulation 23.156(c)
requires that CSEs monitor the market value and eligibility of all
collateral and, to the extent that the market value has declined,
promptly collect or post additional eligible collateral to maintain
compliance with Commission Regulations 23.150 through 23.161.\109\
Thus, even if the value or liquidity of pledged money market and
similar fund securities may be affected by repurchase or similar
arrangements undertaken by the fund, CSEs have the obligation to
monitor the value and suitability of the fund's securities as margin
collateral and collect or post additional eligible collateral to
compensate for collateral deficiencies.
---------------------------------------------------------------------------
\109\ 17 CFR 23.156(c).
---------------------------------------------------------------------------
The elimination of the asset transfer restriction could give rise
to other costs. Given that the U.S. prudential regulators may not amend
their margin requirements in line with the proposed rule amendments, if
the amendments proposed herein are adopted as final, the CFTC and U.S.
prudential regulators' margin rules would diverge with respect to the
treatment of securities of money market and similar funds as eligible
collateral, requiring parties that trade with both prudentially-
regulated SDs and CSEs to adjust their swap-related documentation and
collateral management systems to reflect such different treatments.
Thus, market participants may incur additional costs by having to
maintain two separate and distinct types of documentation and
collateral management systems. Also, the Money Market Funds Proposal
may incentivize trading with CSEs over SDs or MSPs subject to the U.S.
prudential regulators' margin rules given that the prudential
regulators might not revise their rules in a manner consistent with the
Money Market Funds Proposal and the prudential regulators' rules may
continue to restrict the use of securities of money market and similar
funds that transfer their assets through repurchase and similar
agreements.
At the same time, the Commission notes that the removal of the
asset transfer restriction would bring the CFTC's eligible collateral
framework closer to the approach adopted by the Securities and Exchange
Commission (``SEC''), which does not impose asset
[[Page 53424]]
transfer restrictions with respect to money market and similar fund
securities and expressly permits the use of government money market
fund securities as collateral.\110\ Therefore, although there is the
potential for greater costs as a result of divergence with the U.S.
prudential regulators, there may be lower costs overall, given that
many CSEs are also cross-registered with the SEC as security-based SDs.
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\110\ See Capital, Margin and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital and Segregation Requirements for Broker-
Dealers, Securities and Exchange Commission, 84 FR 43872, 43919
(Aug. 22, 2019). In the preamble to its final rule, the SEC noted
that the final rule does not specifically exclude any type of
security provided it has a ready market, is readily transferable,
and does not consist of securities or money market instruments
issued by the counterparty or a party related to the nonbank
security-based SD or major security-based swap participant, or the
counterparty. Generally, U.S. government money market funds should
be able to serve as collateral under these conditions.
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2. Section 15(a) Considerations
In light of the foregoing, the CFTC has evaluated the costs and
benefits of the proposals pursuant to the five considerations
identified in section 15(a) of the CEA as follows:
Seeded Funds Proposal
(a) Protection of Market Participants and the Public
As discussed, the Seeded Funds Proposal would provide that, during
a period of three years from the fund's trading inception date, a
seeded fund meeting specific requirements would be deemed not to have
margin affiliates solely for purposes of calculating the fund's MSE and
the IM threshold amount. As a result, only the seeded fund's individual
AANA would be used to determine whether the fund has MSE, and only the
individual credit exposure of the fund resulting from the fund's swaps
with a CSE would be used to determine whether the posting and
collection of IM is required, and not the exposures calculated on an
aggregate basis with the fund's sponsor entities and other margin
affiliates, as currently required under the CFTC Margin Rule.
The Seeded Funds Proposal is thus proposing an approach to eligible
seeded funds that is consistent with the BCBS-IOSCO Framework and
similar approaches adopted by jurisdictions such as Australia, Canada
and the EU.\111\ As such, the Seeded Funds Proposal would eliminate a
disadvantage that U.S. investment funds face compared to non-U.S. funds
that are not subject to a consolidation requirement. The Seeded Funds
Proposal would also address the potential liquidity drain and trading
disruptions that CSEs might encounter if non-U.S. investments funds
were to avoid doing uncleared swaps business with the CSEs because of
the current treatment of seeded funds in the U.S. under the CFTC Margin
Rule. In addition, the Seeded Funds Proposal would level the playing
field between U.S. seeded funds that are consolidated within a group of
entities that collectively have MSE and other domestic investment funds
that are not part of a group whose combined exposure exceeds the
threshold for compliance with the IM requirements, while, at the same
time, potentially spurring greater interest in seeded funds as
potential counterparties.
---------------------------------------------------------------------------
\111\ See supra notes 27 and 41.
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As a result of the Seeded Funds Proposal, less collateral may be
collected by seeded funds given that individually they may not meet the
threshold for exchanging IM. A seeded fund's uncollateralized swaps
exposure may negatively impact the sponsor entities of the fund or its
asset manager, given that, for reputational reasons, a sponsor entity
or the asset manager may provide financial support to the seeded fund
in times of financial distress, potentially putting at risk their own
financial position.
The Seeded Funds Proposal may also have implications for CSEs
entering into uncleared swap transactions with the fund's sponsor
entity. Specifically, a CSE evaluating the creditworthiness of its
counterparty--the fund's sponsor entity--may not be aware of the
sponsor entity's potentially weakened financial position. As such, the
Seeded Funds Proposal, by allowing seeded funds' exposures to not be
consolidated with the exposures of their sponsor entities and other
margin affiliates for purposes of determining the applicability of the
IM requirements, may increase the risk of contagion.
The Commission, however, believes that such concerns are mitigated
by the requirements incorporated in the proposed definition of eligible
seeded fund, including the condition that the seeded fund is not
collateralized, guaranteed or otherwise supported, directly or
indirectly by any sponsor entity, any margin affiliate of any sponsor
entity, other collective investment vehicles, or the fund's asset
manager in respect of any of the fund's obligations. These conditions
are intended to ensure that seeded funds are genuinely independent and
risk remote from the sponsor entities.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
The Seeded Funds Proposal would amend the definition of ``margin
affiliate'' in Commission Regulation 23.151 to provide an exception for
eligible seeded funds, which would effectively relieve CSEs from the
requirement to exchange IM for uncleared swaps with such eligible
seeded funds, subject to specified conditions. This eliminates a
competitive disadvantage between seeded funds that are consolidated
with their sponsor entities and margin affiliates, which collectively
exceed the thresholds for compliance with the IM requirements on the
one hand, from those investment funds whose sponsor entities and margin
affiliates do not have collective exposures exceeding such thresholds
on the other. This would potentially spur greater interest in seeded
funds as potential counterparties. In addition, the proposed amendment
to the ``margin affiliate'' definition would level the playing field
between U.S. funds and non-U.S. investment funds from jurisdictions
that do not require fund swaps exposures to be considered on a
consolidated basis for purposes of determining whether compliance with
the IM requirements is required.
The Seeded Funds Proposal would relieve CSEs entering into
uncleared swaps with eligible seeded funds from the requirement to
exchange IM with the funds if the funds meet specified requirements.
This would reduce the operational costs associated with the exchange of
IM for CSEs and their eligible seeded funds counterparties and would
allow seeded funds to allocate their financial resources to testing
their investment strategy and attracting unaffiliated investors. The
cost reduction may also incentivize more market participants to enter
into uncleared swaps. The Seeded Funds Proposal would thus promote
efficiency in the uncleared swaps market by increasing the pool of swap
counterparties and fostering competition.
Given that the Seeded Funds Proposal would relieve CSEs from the
exchange of IM with certain eligible seeded funds for their uncleared
swaps, the uncollateralized credit exposure for the uncleared swaps
would increase and could undermine the integrity of the markets. The
Commission, however, believes that the increased exposure would be
limited given the relatively limited derivatives activity of seeded
funds that would benefit from the eligible seeded fund exception. In
[[Page 53425]]
addition, the proposed relief is narrowly tailored given the
requirements incorporated in the proposed definition of ``eligible
seeded fund'' and the fact that it would only apply for purposes of
calculating the MSE and IM threshold amount applicable to the eligible
seeded funds, and not for the calculation of the IM compliance
thresholds applicable to the funds' sponsor entities and margin
affiliates that do not independently qualify as eligible seeded funds
(nor for the funds' CSE counterparties).
(c) Price Discovery
By amending the definition of ``margin affiliate'' in Commission
Regulation 23.151, the Seeded Funds Proposal would relieve CSEs from
the requirement to exchange IM when entering into uncleared swaps with
an eligible seeded fund. As a counterparty to a CSE, an eligible seeded
fund therefore would not have to incur operational costs associated
with setting up and maintaining processes and documentation to exchange
IM. The relief would permit eligible seeded funds to direct more
resources to building a successful performance track record and
attracting new investors. As a result, the overall cost of entering
into an uncleared swap transaction may decrease, incentivizing
increased participation in the uncleared swaps markets. In turn, the
trading of uncleared swaps may increase, leading to increased liquidity
and enhanced price discovery.
(d) Sound Risk Management
Because the Seeded Funds Proposal would relieve CSEs from the
obligation to exchange IM with certain seeded funds, less margin may be
collected and posted to offset the risk of uncleared swaps, which could
increase the risk of default. Nevertheless, the Commission believes
that the uncollateralized risk would be mitigated because during the
seeding period, investment funds are typically small and the extent of
uncleared swap activity a seeded fund may undertake with CSEs may be
limited. In addition, CSEs are required to manage the risk associated
with their uncleared swaps, including those swaps that might be
uncollateralized, by maintaining a robust and professional risk
management program that provides, among other things, for the
implementation of internal parameters for the monitoring and management
of swap risk, including credit risk.
The Commission also notes that the Seeded Funds Proposal, by
relieving CSEs from the requirement to exchange IM with certain seeded
funds, would reduce the operational costs of both CSEs and their
eligible seeded fund counterparties, potentially encouraging more
market participants to enter the uncleared swaps market. As such, by
increasing the pool of swap counterparties, the Seeded Funds Proposal
would encourage the careful consideration and selection of
counterparties, promoting sound risk management.
(e) Other Public Interest Considerations
By proposing a treatment of certain investment funds that is
consistent with the BCBS/IOSCO Framework, the Seeded Funds Proposal
would alleviate the potential disadvantage that U.S. seeded funds have
compared to non-U.S. investment funds, which may be perceived to be
subject to more favorable regulatory regimes than in the United States
given the differing consolidation treatments applicable to funds.
However, given that the U.S. prudential regulators may not amend
their margin requirements in line with the proposed amendments, the
possibility exists that the CFTC and U.S. prudential regulators'
differing rules may motivate certain investment funds to undertake
swaps with particular SDs based on which U.S. regulatory agency is
responsible for setting margin requirements for such SDs. In that
sense, the change can lead to trades that do not reflect the relative
merits of competing SDs. The divergence could also lead to additional
costs for investment funds that trade with both CSEs and prudentially-
regulated SDs because such funds would need to adjust their swap
related documentation and collateral management systems to reflect the
different margin requirements that may apply under the CFTC's and the
prudential regulators' rules.
Money Market Funds Proposal
(a) Protection of Market Participants and the Public
The Commission believes that the Money Market Funds Proposal would
protect market participants and the public by eliminating the asset
transfer restriction and allowing a broader range of money market and
similar fund securities to serve as collateral, thus addressing the
potential that margin collateral may be concentrated in the securities
of a few money market and similar funds and leading to greater
diversification by increasing the range of assets that may be used as
collateral.
The elimination of the asset transfer restriction would also
promote effective asset management policies for the benefit of fund
investors and market participants in general. Without the restriction,
money market and similar funds that otherwise would have refrained from
undertaking repurchase or similar arrangements to avoid the
disqualification of their securities as eligible collateral may enter
into such arrangements. The arrangements might generate higher returns
for investors, including for CSEs that use money market and similar
fund securities as margin collateral for uncleared swaps, and enable
funds to meet their commitments to investors concerning fund
performance.
Nevertheless, market participants might be harmed by the rule
change if a counterparty to the money market or similar fund in a
repurchase or similar arrangement defaults, and the fund is unable to
recover assets tendered to the counterparty in the arrangement and is
left holding assets of lesser value. The fund's overall net asset value
may decline, reducing the value and liquidity of the fund's securities.
This potential outcome would make the securities less suitable as
collateral for margining uncleared swaps.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
By eliminating the asset transfer restriction, the Money Market
Funds Proposal would allow a broader range of money market and similar
fund securities to serve as collateral for margining uncleared swaps,
increasing diversification in the assets that can be used as
collateral, and fostering competition among the funds whose securities
qualify as eligible collateral under the Proposal.
The elimination of the asset transfer restriction would also
promote effective asset management policies for the benefit of fund
investors and market participants in general. Without the restriction,
money market or similar funds would be able to undertake repurchase and
similar agreements, which may enable them to generate higher returns
for investors, including for CSEs that use the funds' securities as
collateral, and to meet commitments to investors concerning fund
performance.
Notwithstanding these benefits, the proposed elimination of the
asset transfer restriction might negatively impact market participants.
If a money market and similar fund undertakes a repurchase or similar
arrangement and the fund's counterparty in the arrangement defaults,
the fund may be unable to recover assets it tendered in the arrangement
and may be left holding assets of lesser value. The fund's overall net
asset value may decrease, affecting the value and liquidity of the
fund's
[[Page 53426]]
securities. This potential outcome would make the fund's securities
less suitable as collateral for margining uncleared swaps.
(c) Price Discovery
As previously discussed, with the removal of the asset transfer
restriction, fund managers may have more flexibility in determining the
type of investment and transactions that are in the best interest of
their fund and investors, leading to higher returns for investors,
including CSEs using money market and similar fund securities as margin
collateral for uncleared swaps. With such increased returns, the
overall costs of entering into an uncleared swap transaction may
decrease, incentivizing increased participation in the uncleared swaps
markets. In turn, trading in uncleared swaps may increase, leading to
increased liquidity and enhanced price discovery.
(d) Sound Risk Management
The proposed amendment would eliminate the asset transfer
restriction, allowing the use of securities of money market funds that
undertake repurchase or similar arrangements as collateral for the
margining of uncleared swaps. As such, even if the asset manager for a
money market and similar fund, as a fiduciary, acts in the best
interest of the fund and its investors, there is the risk that the fund
may incur a loss if the fund's counterparty in a repurchase or similar
arrangement defaults. Such a default would leave the fund holding
assets that it may not be able to easily resell in times of financial
stress, which might impact the value and liquidity of pledged fund
securities and make them less suitable as margin collateral for
uncleared swaps. The Commission, however, notes that any potential risk
of such a repurchase or similar arrangement may be mitigated by the
standard industry practice of applying haircuts to non-cash collateral
in repurchase or similar arrangements to compensate for the risk that
the value of collateral may decline over the term of the
arrangement.\112\
---------------------------------------------------------------------------
\112\ See Primer: Money Market Funds and the Repo Market,
Prepared by the staff of the Division of Investment Management, U.S.
Securities and Exchange Commission at pp. 5-6.
---------------------------------------------------------------------------
In addition, the Commission notes that Commission Regulation
23.156(c) requires that CSEs monitor the market value and eligibility
of all collateral and, to the extent that the market value has
declined, promptly collect or post additional eligible collateral to
maintain compliance with Commission Regulations 23.150 through 23.161.
Thus, even if the value or liquidity of pledged money market and
similar fund securities may be affected by repurchase or similar
arrangements undertaken by the fund, CSEs have the obligation to
monitor the value and suitability of the fund securities as margin
collateral and collect or post additional eligible collateral to
compensate for collateral deficiencies, although the risk that a fund's
repurchase or similar arrangements may fail remains. The Commission
further notes, however, that subparagraphs (A) and (B) of Commission
Regulation 23.156(a)(1)(ix), which are not being amended, limit the
types of assets that a money market and similar fund can receive in
repurchase or similar arrangements to those assets specifically
identified in those paragraphs, alleviating in part the risks
associated with repurchase or similar arrangements.
While the Money Market Funds Proposal could lead to more
variability in the value of the assets used as IM, it can also promote
sound risk management in that it increases the range of money market
and similar fund securities available as collateral for the margining
of uncleared swaps, reducing the chance of concentration in a few money
market and similar funds and the risks associated with such
concentration. As such, the removal of the restriction may incentivize
the increased use of money market and similar fund securities as
collateral. Consistent with Commission Regulation 23.156(c), which
requires CSEs to monitor the market value and eligibility of collateral
posted or collected as margin for uncleared swaps, the Commission notes
that CSEs must take into account the potential concentration of
collateral in particular assets and prudently manage margin collateral.
(e) Other Public Interest Considerations
As is the case for the Seeded Funds Proposal, it is possible that
the U.S. prudential regulators may not amend their margin rule in line
with the Money Market Funds Proposal. As such, the prudential
regulators and the Commission would diverge with respect to the
treatment of money market and similar funds securities as eligible
collateral for margining uncleared swaps. This divergence might lead to
increased costs for market participants that trade both uncleared swaps
subject to the CFTC's and the prudential regulators' margin rules, as
they may need to adjust or even maintain separate documentation and
collateral management systems to address the differing treatments for
fund securities under the different rules.
On the other hand, the Money Market Funds Proposal may lead to
reduced costs for those market participants that dually register as SDs
and security-based swap SDs with the CFTC and the SEC, respectively, as
the proposed amendment would bring the CFTC's eligible collateral
framework more in line with the SEC approach, which does not impose
asset transfer restrictions on funds whose securities are used as
collateral for margining purposes and expressly permits the use of
government money market fund securities as collateral.
Request for Comments on Cost-Benefit Considerations
The Commission invites public comment on its cost-benefit
considerations, including the section 15(a) factors described above.
Commenters are also invited to submit any data or other information
they may have quantifying or qualifying the costs and benefits of the
proposed amendments. In particular, the Commission seeks specific
comment on the following:
1. Has the Commission accurately identified all the benefits of the
proposed amendments? Are there other benefits to the Commission, market
participants, and/or the public that may result from the adoption of
the proposed amendments that the Commission should consider? Please
provide specific examples and explanations of any such benefits.
2. Has the Commission accurately identified all the costs of the
proposed amendments? Are there additional costs to the Commission,
market participants and/or the public that may result from the adoption
of the proposed amendments that the Commission should consider? Please
provide specific examples and explanations of any such costs.
3. Do the proposed amendments impact the section 15(a) factors in
any way that is not described above? Please provide specific examples
and explanations of any such impact.
4. Does the existing asset transfer restriction significantly limit
the use of money market and similar fund securities as eligible
collateral under the CFTC Margin Rule?
D. Antitrust Laws
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of this Act, in issuing any order or adopting any Commission
rule or regulation
[[Page 53427]]
(including any exemption under section 4(c) or 4c(b)), or in requiring
or approving any bylaw, rule or regulation of a contract market or
registered futures association established pursuant to section 17 of
this Act.\113\
---------------------------------------------------------------------------
\113\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the proposed amendments implicate any other
specific public interest to be protected by the antitrust laws.
The Commission has considered the proposed amendments to determine
whether they are anticompetitive, and has preliminarily identified no
anticompetitive effects. The Commission requests comment on whether the
proposed amendments are anticompetitive and, if so, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
proposed amendments are not anticompetitive and have no anticompetitive
effects, the Commission has not identified any less competitive means
of achieving the purposes of the Act. The Commission requests comment
on whether there are less anticompetitive means of achieving the
relevant purposes of the Act that would otherwise be served by adopting
the proposed amendments.
List of Subjects in 17 CFR Part 23
Capital and margin requirements, Major Swap Participants, Swap
Dealers, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 23 as set forth below:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. 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. Section 23.160 also
issued under 7 U.S.C. 2(i); Sec. 721(b), Pub. L. 111-203, 124 Stat.
1641 (2010).
0
2. In Sec. 23.151, add the definition of ``Eligible seeded fund'' in
alphabetical order and revise the definition of ``Margin affiliate''.
The addition and revision read as follows:
Sec. 23.151 Definitions applicable to margin requirements.
* * * * *
Eligible seeded fund: An eligible seeded fund is a collective
investment vehicle that has received a part or all of its start-up
capital from a parent and/or affiliate (each, a sponsor entity) where:
(1) The seeded fund is a distinct legal entity from each sponsor
entity;
(2) One or more of the seeded fund's margin affiliates is required
to post and collect initial margin pursuant to Sec. 23.152;
(3) The seeded fund is managed by an asset manager pursuant to an
agreement that requires the seeded fund's assets to be managed in
accordance with a specified written investment strategy;
(4) The seeded fund's asset manager has independence in carrying
out its management responsibilities and exercising its investment
discretion, and, to the extent applicable, has independent fiduciary
duties to other investors in the fund, such that no sponsor entity or
any of the sponsor entity's margin affiliates controls or has
transparency into the management or trading of the seeded fund;
(5) The seeded fund's investment strategy follows a written plan
for reducing each sponsor entity's ownership interest in the seeded
fund that stipulates divestiture targets over the three-year period
after the date on which the seeded fund's asset manager first begins to
make investments on behalf of the fund;
(6) In respect of any of the seeded fund's obligations, the seeded
fund is not collateralized, guaranteed, or otherwise supported,
directly or indirectly, by any sponsor entity, any margin affiliate of
any sponsor entity, other collective investment vehicle, or the seeded
fund's asset manager;
(7) The seeded fund has not received any of its assets, directly or
indirectly, from an eligible seeded fund that has relied on the
exception provided in paragraph 2 of the definition of margin affiliate
in Sec. 23.151; and
(8) The seeded fund is not a securitization vehicle.
* * * * *
Margin affiliate has the following meaning:
(1) A company is a margin affiliate of another company if:
(i) Either company consolidates the other on a financial statement
prepared in accordance with U.S. Generally Accepted Accounting
Principles, the International Financial Reporting Standards, or other
similar standards,
(ii) Both companies are consolidated with a third company on a
financial statement prepared in accordance with such principles or
standards, or
(iii) For a company that is not subject to such principles or
standards, if consolidation as described in paragraph (i) or (ii) of
this definition would have occurred if such principles or standards had
applied.
(2) Eligible seeded fund exception. Notwithstanding paragraph (1)
of this definition, until the date that is three years after the date
on which an eligible seeded fund's asset manager first begins to make
investments on behalf of the fund, an eligible seeded fund will be
deemed not to have any margin affiliates solely for purposes of
calculating the fund's material swaps exposure and the initial margin
threshold amount.
* * * * *
0
3. In Sec. 23.156:
0
a. Republish the introductory text of paragraph (a)(1);
0
b. Republish the introductory text of paragraph (a)(1)(ix);
0
c. Republish paragraph (a)(1)(ix)(A);
0
d. Revise paragraph (a)(1)(ix)(B);
0
e. Remove paragraph (a)(1)(ix)(C);
0
f. Revise paragraph (a)(3)(i)(B).
The republications and revisions read as follows:
Sec. 23.156 Forms of Margin
(a) * * * (1) Eligible collateral. A covered swap entity shall
collect and post as initial margin for trades with a covered
counterparty only the following types of collateral:
* * * * *
(ix) Securities in the form of redeemable securities in a pooled
investment fund representing the security-holder's proportional
interest in the fund's net assets and that are issued and redeemed only
on the basis of the market value of the fund's net assets prepared each
business day after the security-holder makes its investment commitment
or redemption request to the fund, if the fund's investments are
limited to the following:
(A) Securities that are issued by, or unconditionally guaranteed as
to the timely payment of principal and interest by, the U.S. Department
of the Treasury, and immediately-available cash funds denominated in
U.S. dollars; or
(B) Securities denominated in a common currency and issued by, or
fully guaranteed as to the payment of principal and interest by, the
European Central Bank or a sovereign entity that is assigned no higher
than a 20 percent risk weight under the capital rules applicable to
swap dealers subject to regulation by a prudential regulator, and
immediately-available cash funds denominated in the same currency; or
* * * * *
(3) * * *
(i) * * *
(B) The discounts set forth in the following table:
[[Page 53428]]
Standardized Haircut Schedule \1\
------------------------------------------------------------------------
------------------------------------------------------------------------
Cash in same currency as swap obligation................ 0.0
Eligible government and related debt (e.g., central 0.5
bank, multilateral development bank, GSE securities
identified in paragraph (a)(1)(v) of this section):
Residual maturity less than one-year...................
Eligible government and related debt (e.g., central 2.0
bank, multilateral development bank, GSE securities
identified in paragraph (a)(1)(v) of this section):
Residual maturity between one and five years...........
Eligible government and related debt (e.g., central 4.0
bank, multilateral development bank, GSE securities
identified in paragraph (a)(1)(v) of this section):
Residual maturity greater than five years..............
Eligible corporate debt (including eligible GSE debt 1.0
securities not identified in paragraph (a)(1)(v) of
this section): Residual maturity less than one-year....
Eligible corporate debt (including eligible GSE debt 4.0
securities not identified in paragraph (a)(1)(v) of
this section): Residual maturity between one and five
years..................................................
Eligible corporate debt (including eligible GSE debt 8.0
securities not identified in paragraph (a)(1)(v) of
this section): Residual maturity greater than five
years..................................................
Equities included in S&P 500 or related index........... 15.0
Equities included in S&P 1500 Composite or related index 25.0
but not S&P 500 or related index.......................
Gold.................................................... 15.0
Additional (additive) haircut on asset in which the 8.0
currency of the swap obligation differs from that of
the collateral asset...................................
------------------------------------------------------------------------
\1\ The discount to be applied to an eligible investment fund is the
weighted average discount on all assets within the eligible investment
fund at the end of the prior month. The weights to be applied in the
weighted average should be calculated as a fraction of the fund's
total market value that is invested in each asset with a given
discount amount. As an example, an eligible investment fund that is
comprised solely of $100 of 91 day Treasury bills and $100 of 3 year
U.S. Treasury bonds would receive a discount of (100/200) * 0.5 + (100/
200) * 2.0 = (0.5) * 0.5 + (0.5) * 2.0 = 1.25 percent.
* * * * *
Issued in Washington, DC, on July 31, 2023, 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 Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Voting Summary and Chairman's and
Commissioners' Statements
Appendix 1--Voting Summary
On this matter, Chairman Behnam and Commissioners Mersinger and
Pham voted in the affirmative. Commissioner Goldsmith Romero voted
in the negative. Commissioner Johnson voted to concur.
Appendix 2--Statement of Chairman Rostin Behnam
Today the Commission considered an eligible seeded funds
proposal and a money market funds proposal within a notice of
proposed rulemaking on margin requirements for uncleared swaps for
swap dealers (SDs) and major swap participants (MSPs) for which
there is no prudential regulator. The proposal would amend the
CFTC's margin rule for SDs and MSPs, as promulgated in 2016, to
incorporate two recommendations in the 2020 report to the CFTC's
Global Markets Advisory Committee (GMAC) by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (the ``GMAC Subcommittee
Report'').\1\
---------------------------------------------------------------------------
\1\ See Recommendations to Improve Scoping and Implementation of
Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (May 2020), https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
---------------------------------------------------------------------------
The seeded funds proposal would revise the definition of
``margin affiliate'' in Commission Regulation 23.151 to provide that
certain investment funds that receive all of their start-up capital,
or a portion thereof, from a sponsor entity would be deemed not to
have any margin affiliates for the purposes of calculating certain
thresholds that trigger the requirement to exchange initial margin
for uncleared swaps. This proposed amendment would effectively
relieve SDs and MSPs from the requirement to post and collect
initial margin with a limited number of eligible seeded funds for
their uncleared swaps for a period of three years from the date on
which the eligible seeded fund's asset manager first begins making
investments on behalf of the fund. While today's proposal builds
upon the GMAC Subcommittee Report's 2020 recommendation, the
proposal today also sets forth eight carefully calibrated conditions
to ensure that only the investment funds that were intended to be
targeted by the GMAC Subcommittee Report's recommendations are
eligible to qualify for the seeded funds exception.
I support today's seeded funds proposal as it is consistent with
the CFTC's margin rule risk-based approach of imposing margin
requirements that are commensurate with the risk of uncleared swaps
entered into by SDs and MSPs; is appropriately calibrated to
acknowledge the operational challenges for start-up funds; and
supports international harmonization as the approach is consistent
with the BCBS-IOSCO Framework.
The money market funds proposal would eliminate the current
provision in Commission Regulation 23.156(a)(1)(ix)(C) that
disqualifies certain securities issued by certain money market funds
(MMFs) from being used as eligible initial margin collateral. This
would expand the scope of assets that qualify as eligible
collateral. I support today's MMF proposal as it would remove a
restriction that has unintentionally and severely restricted the use
of securities of MMF and similar assets that transfer their assets
through repurchase and similar arrangements. According to the GMAC
Subcommittee Report, the impact of the restriction was that only
securities of four U.S. MMFs would meet the requirements to be used
as eligible collateral.\2\
---------------------------------------------------------------------------
\2\ Id. at 24.
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Lastly, the proposal would also add a footnote that was
inadvertently omitted for the haircut schedule in Regulation
23.156(a)(3)(i)(B), when the Commission originally promulgated the
margin rule in 2016.
I look forward to receiving public comments on this proposal.
Appendix 3--Dissenting Statement of Commissioner Christy Goldsmith
Romero
I cannot support the proposed rule.
Seeded Funds
I am concerned that the proposed exception to initial margin
requirements for seeded funds rolls back Dodd-Frank Act reforms
designed for financial stability. I cannot support the Commission
changing our existing requirements--requirements that match U.S.
banking regulator requirements. The proposed change would relieve
initial margin requirements for uncleared swaps that are not
prudentially regulated in certain affiliate transactions known as
``seeded funds'' for three years.\1\
---------------------------------------------------------------------------
\1\ Seeded funds are investment vehicles that receive start-up
capital from a sponsor entity. Under the Commission's current
regulatory requirements, a seeded fund is treated as a margin
affiliate of a sponsor entity for the purpose of triggering the
exchange of initial margin for uncleared swaps.
---------------------------------------------------------------------------
The buildup of uncleared swap positions during the crisis
exposed swap entities to losses, putting the financial system at
risk. Dodd-Frank Act reforms required all uncleared swaps be subject
to initial and variation margin requirements, whether prudentially
regulated or not.\2\ Post Dodd-
[[Page 53429]]
Frank, the Commission and federal banking agencies adopted margin
rules to protect the safety and soundness of swap entities and to
guard against risks to financial stability.
---------------------------------------------------------------------------
\2\ 7 U.S.C. 6s(e)(2)--Registration and regulation of swap
dealers and major swap participants. Dodd Frank Act reforms provide
that:
(A) Swap dealers and major swap participants that are banks. The
prudential regulators, in consultation with the Commission and the
Securities and Exchange Commission, shall jointly adopt rules for
swap dealers and major swap participants, with respect to their
activities as a swap dealer or major swap participant, for which
there is a prudential regulator imposing--(i) capital requirements;
and (ii) both initial and variation margin requirements on all swaps
that are not cleared by a registered derivatives clearing
organizations.
(B) Swap dealers and major swap participants that are not banks.
The Commission shall adopt rules for swap dealers and major swap
participants, with respect to their activities as a swap dealer or
major swap participant, for which there is not a prudential
regulator imposing--(i) capital requirements; and (ii) both initial
and variation margin requirements on all swaps that are not cleared
by a registered derivatives clearing organization (emphasis added).
See Section 4s(e) of the Commodity Exchange Act.
---------------------------------------------------------------------------
Dodd Frank Act reforms in the Commodity Exchange Act required
that to offset the greater risk to the swap dealer or major swap
participant and the financial system arising from the use of
uncleared swaps, the Commission's margin requirements for uncleared
swaps must (i) help ensure the safety and soundness of the swap
dealer or major swap participant and (ii) be appropriate for the
risk associated with the uncleared swaps held by the swap dealer or
major swap participant.\3\
---------------------------------------------------------------------------
\3\ 7 U.S C. 6s(e)(3)(A); CEA section 4s(e)(3)(A).
---------------------------------------------------------------------------
I do not find that standard to be met in the proposed rule. Post
Dodd-Frank, regulators recognized that derivatives transactions with
affiliated parties can pose important risks that necessitate margin
requirements. The Commission and banking regulators adopted the same
definition of ``margin affiliate'' to cover both swaps that are, and
are not, prudentially regulated. The proposed rule would depart from
that definition where there is not a prudential regulator.
The proposed rule raises concerns about the prudence of the
Commission having two different definitions of ``margin affiliate''
for swap dealers, particularly when the majority of swap dealers (55
of 106) are prudentially regulated, and they account for a
substantial majority of swap activity. In a regulatory system where
jurisdiction is shared with other U.S. market and banking
regulators, it is important that the Commission maintain regulatory
harmonization with U.S. regulators where we can. Otherwise, we risk
a race to the bottom.
The proposed rule discusses the importance of harmonization with
global regulation but not U.S. banking regulations. And this
proposed rule came from recommendations by the Global Markets
Advisory Committee in 2020 (during the last Administration). The
majority of the nonbank swap dealers are U.S.-domiciled (27 of 51).
Also, importantly, the GMAC public interest representative from
Better Markets at that time did not vote for these recommendations.
I have serious concerns with potentially increasing risks
related to uncleared swaps, including risks to financial stability
by adopting a definition that harmonizes with global regulation, but
not domestic banking regulation. U.S. banking regulators are aware
of the Basel Committee on Banking Supervision and the International
Organization for Securities Commission's ``International Margin
Framework,'' but have chosen not to change their definition of
``margin affiliate.''
Likewise, I do not support the Commission changing our existing
definition. I appreciate that Commission staff have tried to put
constraints on this initial margin exception.\4\ The constraints are
not enough in my view to break from U.S. banking regulators on the
definition of margin affiliate. I am concerned that the effect of
this proposal would be to roll back Dodd-Frank Act reforms. Given
that those reforms were designed to promote the safety and soundness
of U.S. financial institutions and our financial system, I am
concerned that this change could produce unacceptable levels of
risk, possibly even systemic risk and harm to financial stability.
We do not know the full consequences of this change. While it may
save costs for these start-up funds, we cannot increase any risk to
financial stability of institutions or our financial system.
---------------------------------------------------------------------------
\4\ For example, the exception requires that the seeded fund
``is not a securitization vehicle.'' Should the Commission move
forward with this proposed rule, I have other concerns that I invite
public comment. This includes whether the proposed 3-year exception
period is too long a runway. Also, whether the exemption is meant to
apply to private funds? Private funds are part of a ``shadow banking
system'', and unlike banks, are not fully subject to risk,
liquidity, or capital restrictions. Private funds and shadow banking
contributed to the 2008 financial crisis, which has grown larger
since the crisis, and continues to pose risks to American investors,
pensioners, and the U.S. financial system.
---------------------------------------------------------------------------
Therefore, I must dissent.
Money Market Funds
I have concerns about the Commission's proposal to expand money
market funds that could be used for eligible non-cash collateral for
swap dealers for initial margin. The proposal contemplates
eliminating the restriction on the money market fund's use of
repurchase agreements or similar agreements.
In Dodd-Frank Act reforms contained in the Commodity Exchange
Act section 4s(e)(3)(C), Congress provided that ``[i]n prescribing
margin requirements,'' the Commission ``shall permit the use of
noncash collateral'' as ``determine[d] to be consistent with--
preserving the financial integrity of markets trading'' non-cleared
derivatives and ``preserving the stability of the United States
financial system.'' I have not seen an analysis that such standard
is met. I am very interested in public comment about whether that
standard is met.
We must not forget the lessons of the 2008 financial crises,
including when the Reserve Primary Fund ``broke the buck'', and the
role it had in the 2008 crisis. Money market funds are designed to
give retail customers and institutional investors a market-based
instrument that is highly liquid with lower risk and limited
volatility. For many Americans, money market funds often appear on
their bank app, right next to checking and savings accounts, as they
are financial vehicles often thought of as similar to a bank
account. That's why it came as such a shock when the Reserve Primary
Fund broke the buck.
I was counsel to the SEC Chairman when the Reserve Primary Fund
broke the buck, which contributed to Lehman failing, and short-term
lending drying up. Repurchase agreements also contributed to
liquidity problems at financial institutions. In my role as the
Special Inspector General for TARP, I reported to Congress about the
interconnectedness of these events. These experiences show how
interconnected money market funds and repurchase agreements are to
the overall stability of our financial institutions and the broader
financial system.
As a result, the SEC and other regulators implemented reforms to
make money market funds more stable and repurchase agreements more
transparent. Despite these reforms, in March 2020, during the Covid-
19 pandemic, money market funds and the short-term funding markets
experienced stress when institutional investors withdrew cash from
money market funds to avoid liquidity fees and gates, safeguards
that were part of post-crisis reforms.
With 2008 and 2020 as the backdrop, the Commission must be
careful how it approaches changes to our regulations that impact
money market funds and the short-term funding markets. These are
highly interconnected markets. Changes in one can impact changes in
the other markets. Before we take any action, it will be critical
for the Commission to determine that the change is ``consistent with
preserving the financial integrity of markets trading'' non-cleared
derivatives and ``preserving the stability of the United States
financial system.'' I look forward to public comment on whether the
rule meets this standard.
I thank the staff for their work. I am also grateful to the
former GMAC members. It must be remembered that advisory committees'
role is to advise the Commission. While I may not agree with their
recommendations, I am grateful for their service.
Appendix 4--Statement of Commissioner Caroline D. Pham
I support the notice of proposed rulemaking on margin
requirements for uncleared swaps for swap dealers and major swap
participants (Seeded Funds and MMFs Proposal) because it provides a
solution for seeded funds, and it supports greater liquidity by
providing more flexibility for money market and similar funds that
use repos, among other things. I thank the team in the Market
Participants Division for their dedication to ensuring the
Commission's uncleared swaps rules do not unduly burden market
participants, and for proposing workable solutions to challenges
that arose during an implementation period. I specifically commend
Amanda Olear, Tom Smith, Warren Gorlick, Rafael Martinez, and Liliya
Bozhanova for their work on the proposal.
This Seeded Funds and MMFs Proposal, looking at the big picture,
actually benefits
[[Page 53430]]
the end investors who will be able to more efficiently deploy
capital, access liquidity, and provide investment returns at less
cost to funds, such as pension plans that manage Americans' hard-
earned savings. The key public interest here is providing more
liquidity to markets. We have seen over the past several years many
recent market stresses, which seem to occur with greater and greater
frequency and high volatility, low liquidity market conditions.
Where there is shallow depth of liquidity, costs for end users,
customers, and investors go up, and access to markets is restricted.
When there is not enough liquidity, risks to financial stability
increase. The most significant and systemic financial crises in
recent years, including the 2008 financial crisis, were caused by a
critical lack of liquidity in markets, and our post-crisis reforms
have traded less credit risk for more liquidity risk.
Simply put, less liquidity means higher costs and more risk. And
risk to not only financial stability, but also systemic risk. In
light of ongoing capital reforms, it is incumbent upon me to remind
everyone that of course markets are interconnected, and that's why
we need to take a holistic approach to market structure with a full
understanding of the impact of various regulatory regimes,
particularly the impact of prudential requirements on the ability of
markets to function well, and especially the ability for market
participants to access markets for the benefit of American savers.
As an advocate for good policy that enables growth, progress,
and access to markets, I strongly support workable solutions to any
problems with our rules. While regulations play a critical role in
safeguarding our markets, we must acknowledge that issues--ranging
from technical \1\ to policy--must be continuously evaluated for
regulations to remain both effective and relevant in an ever-
changing landscape.
---------------------------------------------------------------------------
\1\ Statement of Commissioner Caroline D. Pham on Staff Letter
Regarding ADM Investor Services, Inc., U.S. Commodity Futures
Trading Commission (June 16, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement061623.
---------------------------------------------------------------------------
The first step in evaluating our regulations is to conduct
thorough assessments and identify areas for improvement.
Collaboration and open dialogue are key to formulating well-rounded
solutions that consider the interests of all impacted. That is why I
am grateful for the efforts of former Commissioner Dawn Stump, who,
as sponsor of the Global Markets Advisory Committee (GMAC),
established the GMAC's Subcommittee on Margin Requirements for Non-
Cleared Swaps to evaluate the CFTC's uncleared margin rules.\2\ The
subcommittee's thorough assessment, engagement with stakeholders,
and practical, flexible recommendations have given staff a
comprehensive roadmap to follow in implementing fixes that minimize
adverse impacts on market participants. I appreciate that staff is
continuing \3\ to try to adopt the recommendations that came out of
the GMAC subcommittee.
---------------------------------------------------------------------------
\2\ CFTC Commissioner Stump Announces New GMAC Subcommittee on
Margin Requirements for Non-Cleared Swaps, U.S. Commodity Futures
Trading Commission (Oct. 28, 2019), https://www.cftc.gov/PressRoom/PressReleases/8064-19.
\3\ In 2020, the Commission adopted rules that addressed
different GMAC recommendations on the uncleared margin rules. See
Statement of Commissioner Dawn D. Stump in Support of Final
Uncleared Margin Rules Based on Recommendations of Global Markets
Advisory Committee, U.S. Commodity Futures Trading Commission (Dec.
8, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement120820. Commissioner Mersinger has advocated for
adopting additional recommendations. See Dissenting Statement of
Commissioner Summer K. Mersinger Regarding CFTC's Regulatory Agenda,
U.S. Commodity Futures Trading Commission (Jan. 9, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/mersingerstatement010923.
Commissioner Pham now sponsors the GMAC. See Commissioner Pham
Announces CFTC Global Markets Advisory Committee Meeting on July 17,
U.S. Commodity Futures Trading Commission (July 17, 2023), https://www.cftc.gov/PressRoom/Events/opaeventgmac071723.
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The adoption of margin requirements for uncleared swaps was a
key pillar of the 2008 financial crisis reform.\4\ Today, we
continue to appreciate that the requirements help ensure the
exchange of margin between large, systemic, and interconnected
financial institutions for their uncleared swap transactions.
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\4\ G20 Pittsburgh Summit (Sept. 24-25, 2009).
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Consistent with the G20 commitments, the Commodity Exchange Act
(CEA or Act) \5\ requires that the Commission adopt rules
establishing margin requirements for all uncleared swaps that are
entered into by a swap dealer or major swap participant for which
there is no prudential regulator. These requirements help ensure the
safety and soundness of the swap dealer or major swap participant.
In 2016, the Commission adopted Regulations 23.150 through 23.161 to
implement section 4s(e).\6\
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\5\ 7 U.S.C. 6s(e) (capital and margin requirements).
\6\ See Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (effective
April 1, 2016 and codified in part 23 of the Commission's
regulations). 17 CFR 23.150--23.159, and 23.161. In May 2016, the
Commission added Regulation 23.160 (17 CFR 23.160), providing rules
on its cross-border application. 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).
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Currently, a fund with material swaps exposure will fall within
the scope of the initial margin requirements if it undertakes an
uncleared swap with a covered swap entity. The covered swap entity
and the fund will not be required to post and collect initial margin
for their uncleared swaps until the initial margin threshold amount
of $50 million has been exceeded. The initial margin threshold
amount will be calculated based on the credit exposure from
uncleared swaps between the covered swap entity and its margin
affiliates on the one hand, and the fund and its margin affiliates
on the other.\7\ As discussed above, this requirement has unduly
burdened certain funds.
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\7\ Commission Regulation 23.151 defines the term ``IM threshold
amount'' to mean an aggregate credit exposure of $50 million
resulting from all uncleared swaps between an SD and its margin
affiliates (or an MSP and its margin affiliates) on the one hand,
and the SD's (or MSP's) counterparty and its margin affiliates on
the other. See 17 CFR 23.151.
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Initial margin requirements may be satisfied with only certain
types of collateral.\8\ Under Regulation 23.156(a)(1)(ix), the
securities of money market and similar funds \9\ may qualify as
eligible collateral if the investments of the fund are limited to
securities that are issued by, or unconditionally guaranteed as to
the timely payment of principal and interest by, the U.S. Department
of Treasury, and immediately-available cash denominated in U.S.
dollars; \10\ or to securities denominated in a common currency and
issued by, or fully guaranteed as to the payment of principal and
interest by, the European Central Bank, or a sovereign entity that
is assigned no higher than a 20 percent risk weight under the
capital rules applicable to swap dealers subject to regulation by a
prudential regulator, and immediately-available cash denominated in
the same currency.\11\ Also, the asset managers of the money market
and similar fund may not transfer the assets of the fund through
securities lending, securities borrowing, repurchase agreements, or
any other means that involve the fund having rights to acquire the
same or similar assets from the transferee.\12\ As discussed above,
this requirement has unintentionally restricted funds.
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\8\ Commission Regulation 23.156(a)(1) sets forth the types of
collateral that CSEs can post or collect as IM with covered
counterparties, including cash funds, certain securities issued by
the U.S. government or other sovereign entities, certain publicly
traded debt or equity securities, securities issued by money market
and similar funds, and gold. 17 CFR 23.156(a)(1).
\9\ Although the scope of the eligible pooled investment funds
described in Commission Regulation 23.156(a)(1)(ix) does not fully
coincide with the regulatory definition of money market funds in
Rule 2a-7 under the Investment Company Act (17 CFR 270.2a-7), for
simplicity purposes, these funds will be referred to as ``money
market and similar funds.''
\10\ 17 CFR 23.156(a)(1)(ix)(A).
\11\ 17 CFR 23.156(a)(1)(ix)(B).
\12\ 17 CFR 23.156(a)(1)(ix)(C).
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Of course, compliance with significant reforms necessarily
entails significant resource expenditure by regulated entities.
Because of the vast number of counterparties impacted by the
uncleared margin rules, swap dealers and major swap participants
have been forced to engage in significant operational and
technological development to avoid disruptions which would limit
their options for taking on and hedging risk.\13\ As I have stated
in the past, it is imperative that the Commission continuously--or
at least periodically--evaluate its rules to ensure they are
functioning as intended, and propose workable solutions to any
challenges discovered to ensure that firms are able to effectively
comply with our rules.\14\
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\13\ Joint ISDA-SIFMA Report, Initial Margin for Non-Centrally
Cleared Derivatives: Issues for 2019 and 2020, 3-4 (July 2018),
https://www.isda.org/a/D6fEE/ISDA-SIFMA-Initial-Margin-Phase-in-White-Paper-July-2018.pdf.
\14\ See, e.g., Statement of Commissioner Caroline D. Pham
Regarding Reporting and Information Requirements for Derivatives
Clearing Organizations, U.S. Commodity Futures Trading Commission
(Nov. 10, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement111022b.
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[[Page 53431]]
I encourage commenters to comment on whether the Commission's
proposal sufficiently addresses the practical and operational
issues, and whether it gives sufficient time for firms to implement
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and comply with a final rule.
[FR Doc. 2023-16572 Filed 8-7-23; 8:45 am]
BILLING CODE 6351-01-P