The “prudential regulators” (i.e., the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Farm Credit Administration, and the Federal Housing Finance Agency) re-proposed their April 2011 proposed rule imposing initial and variation margin requirements on banks and their counterparties in connection with uncleared swaps. The April 2011 proposed rule has been re-proposed rather than simply finalized in light of significant differences from the original proposal and the issuance of the 2013 final policy framework by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions.
The prudential regulators’ re-proposed rule imposes the following requirements, among others, on a bank or bank holding company that is a swap dealer or major swap participant (“covered swap entity”) entering into an uncleared swap:
Initial margin collection:
- If its counterparty is either a “swap entity” (i.e., a swap dealer or major swap participant) or a “financial end user with material swaps exposure” (as described below), the covered swap entity must collect an “initial margin collection amount,” calculated either in accordance with the standardized margin schedule set forth in the re-proposed rule or through an internal margin model satisfying certain criteria and approved by the relevant prudential regulator.
- For other counterparties, the covered swap entity must collect initial margin only at such times and in such forms as it determines appropriately address the credit risk of its counterparty and/or the risks associated with the relevant product being traded.
- Initial margin must be transferred at least on a daily basis in response to changes in portfolio composition or any other factors that would change the required initial margin amounts.
- Initial margin is required to be segregated at a third-party custodian and generally may not be reused or rehypothecated by the custodian.
- The covered swap entity may establish and apply an initial margin threshold against a counterparty (on a consolidated basis) up to $65 million.
Initial margin posting:
- If its counterparty is a financial end user with material swaps exposure, the covered swap entity must post an initial margin collection amount calculated as described above but applied to the counterparty of the covered swap entity.
- However, the covered swap entity is not required to post initial margin below its established initial margin threshold amount of up to $65 million.
- Also, the covered swap entity is not required to post initial margin unless and until the total amount to be posted exceeds a minimum transfer amount of $650,000.
Variation margin collection and posting:
- The covered swap entity must collect from and post with a counterparty that is a swap entity or financial end user a “variation margin amount,” meaning the cumulative mark-to-mark change in value of the swap, adjusted for variation margin previously collected or posted.
- The covered swap entity is not required to collect or post variation margin unless and until the total amount to be collected or posted exceeds a minimum transfer amount of $650,000.
- Historical trades generally are excluded from variation margin requirements. However, if an internal margin model is used by the covered swap entity, then historical trades covered by a single master netting agreement with new trades need to be margined.
- Variation margin must be transferred at least once per business day, with no threshold of uncollateralized exposure.
- Variation margin is not required to be segregated at a third-party custodian and may be reused or rehypothecated by the custodian.
The re-proposed rule lists various types of entities that constitute “financial end users,” including, for example, a bank holding company or an affiliate thereof, or a private fund or an entity that “raises money from investors primarily for the purpose of investing in loans, securities, swaps, funds or other assets for resale or other disposition or otherwise trading in loans, securities, swaps, funds or other assets.” Sovereign entities, the Bank for International Settlements and several others are specifically excluded from the definition of “financial end user.” An entity has “material swaps exposure” if it and its affiliates have a daily average aggregate notional amount of outstanding uncleared swaps, uncleared security-based swaps, foreign exchange forwards, and foreign exchange swaps with all counterparties for June, July, and August of the previous calendar year in excess of $3 billion. (The re-proposed rule states that using June, July, and August of the previous year, instead of a single as-of date, “is appropriate to gather a more comprehensive assessment of the financial end user’s participation in the swaps market, and address the possibility that a market participant might ‘window dress’ its exposure on an as-of date.”)
Highly-liquid assets such as cash (in USD or the currency in which payment obligations are required to be settled), high-quality government securities, gold and publicly-traded debt securities and asset-backed securities fully guaranteed by a U.S. government sponsored enterprise may be delivered and posted to satisfy initial margin requirements. Eligible assets would be subject to haircuts specified in an exhibit attached to the re-proposed rule. However, only cash may be delivered to satisfy variation margin requirements.
None of the foregoing margin requirements are applicable to a swap between a “foreign” covered swap entity and a “foreign” counterparty (unless either counterparty’s obligations have a non-“foreign” guarantor). A party is “foreign” if it is other than: (i) a U.S.-organized entity, including a U.S. branch, agency, or subsidiary of a foreign bank; (ii) a branch or office of a U.S.-organized entity; or (iii) a covered swap entity that is directly or indirectly controlled by a U.S.-organized entity.
The foregoing initial and variation margin requirements would be applicable as follows to swaps entered into after the following dates:
- December 1, 2015: Variation margin.
- December 1, 2015: Initial margin where both the covered swap entity combined with its affiliates and the counterparty combined with its affiliates have an average daily aggregate notional amount of covered swaps for June, July, and August of 2015 exceeding $4 trillion.
- December 1, 2016: Initial margin where such amount for 2016 exceeds $3 trillion.
- December 1, 2017: Initial margin where such amount for 2017 exceeds $2 trillion.
- December 1, 2018: Initial margin where such amount for 2018 exceeds $1 trillion.
- December 1, 2019: Initial margin for any other covered swap entity with respect to covered swaps with any other counterparty.
Following the release of the prudential regulators’ re-proposed rule, the Commodity Futures Trading Commission (“CFTC”) re-proposed its own April 2011 proposed rule imposing initial and variation margin requirements on non-bank swap dealers and major swap participants (“SD/MSPs”) and their counterparties in connection with uncleared swaps. The CFTC’s re-proposed margin rule is substantially similar to that of the prudential regulators summarized above, including with respect to the compliance timeline. However, the CFTC’s re-proposed margin rule contains three alternative options for its cross-border application, and it requests public comment as to which option should be adopted in the final rule.
The three options are as follows: (i) following the cross-border approach provided in the prudential regulators’ re-proposed margin rule, summarized above; (ii) following the CFTC Cross-Border Guidance, summarized below; or (iii) following an “Entity-Level Approach,” summarized below.
CFTC Cross-Border Guidance:
Under this approach, the CFTC’s margin requirements would be potentially applicable only if: (i) one or both counterparties constitute a U.S. person; or (ii) the non-U.S. counterparty of the non-U.S. SD/MSP is guaranteed by, or an “affiliate conduit” of, a U.S. person. However, in the case of (ii), substituted compliance may be available.
Under this approach, the CFTC’s margin requirements (if otherwise applicable) generally would apply to a swap between any SD/MSP (regardless of whether located in the U.S.) and any counterparty (regardless of whether located in the U.S.). However, substituted compliance generally would be available for a swap between a non-U.S. SD/MSP not guaranteed by a U.S. person and any counterparty (regardless of whether located in the U.S.). Additionally, with respect to a swap between an SD/MSP (regardless of whether located in the U.S.) and a non-U.S. counterparty not guaranteed by a U.S. person, substituted compliance would be available with respect to the initial margin collected by the non-U.S. counterparty not guaranteed by a U.S. person.
 Margin and Capital Requirements for Covered Swap Entities, 79 Fed. Reg. 57,348, 57,391-92 (September 24, 2014) (“Re-Proposed Rule”).
 Id. at 57,392.
 Although foreign exchange swaps and forwards are relevant for determining whether “material swaps exposure” exists with respect to a party, foreign exchange swaps and forwards are not subject to the prudential regulators’ margin requirements. Id. at 57,391; Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, 77 Fed. Reg. 69,694 (November 20, 2012).
 Re-Proposed Rule at 57,363