CFTC final non-cleared margin rules

Commissioners yesterday voted 2-to-1 to pass margin rules for uncleared swaps. The rules are broadly in line with those passed by the Prudential Regulators on 30 October 2015. Initial margin (IM) will be exchanged between covered swap entities (CSEs) and SDs, MSPs and financial end-users, subject to the $8bn gross notional exposure. IM may be posted in cash, sovereign bonds, government-sponsored debt, investment-grade corporate bonds, gold and certain equities. Trades between SDs and financial end-users can use eligible collateral for daily variation margin, interdealer trades must be collateralised in cash.

The CFTC rules differ in allowing an exemption for initial margin payments between affiliates, the exemption will apply in all cases except those in which the affiliate trade mirrors a third-party swap in which initial margin is not collected. Initial margin wil be calculated using a model incorporating a 99% confidence level over a 10 day liquidation period. Variation margin is in line with prudential rules- daily exchange between covered swap entities and affiliates that are swap entities or financial end-users.

The inter-affiliate exemption prompted Commissioner Bowen to vote against the rule, the first time she has not voted lockstep with Chairman Massad. Her dissenting statement concludes:

“Our prudential colleagues have agreed that initial margin is the correct tool to manage the risks of transactions across affiliates. We should not be trying to guess whether a large, complex financial institution’s global risk controls will be sufficient to protect the swap dealers we regulate. Our failure to provide comparable protection for our swap dealers is inexplicable to me.”

John Lawton, CFTC deputy director for risk surveillance, estimated that interaffiliate swaps account for approximate 50% of the market. Although voting in favour, Commissioner Giancarlo had strong reservations over the mandatory 10-day liquidation period, referring to it as a “made-up number”, as well as his belief that the cost burden of margin rules has been made intentionally high in order to force migration to a cleared environment.

“Today’s rule also reflects a disingenuous reading of the Dodd-Frank Act to favor cleared derivatives over uncleared swaps. In fact, there is no provision in the law directing regulators to set punitive levels of margin to drive hedging market participants toward cleared products.”

Harmonisation with the Prudential ruleset has been well-flagged , their broad consonance comes as no surprise, although the broad interaffiliate exemption does represent a notable difference. The rules come into effect on 1 April 2016. IM requirements will be phased-in from 1 September 2016 to 1 September 2020. VM requirements will be effective 1 September 2016 for the largest participants and from 1 March 2017 for the rest.

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