CFTC Chair talks to commercial hedgers
Margin for Uncleared Swaps
We also kept the interests of commercial end-users top of mind as the Commission finalized its rule setting margin requirements for uncleared swaps.
Our margin rule is one of the most important elements of swaps market regulation set forth in the Dodd-Frank Act. There will always be a large part of the market that is not cleared – many swaps are not suitable for central clearing and our clearinghouses will be stronger if we exercise care in what is required to be cleared. And in the absence of clearing, margin requirements protect against posing excessive risk to the system.
Our rule does not require swap dealers to collect margin from end-users. I know that is important to many of you. The banking regulators also changed their rules, in the course of working with us, to the same standard.
The rule we have adopted is strong and sensible. We’ve focused it on where the primary risk is – the uncleared swaps between large financial institutions, because we want to prevent one default from leading to further defaults, given the interconnectedness of our financial system. It requires swap dealers and major swap participants to post and collect margin with financial entities with whom they have significant exposures. It requires initial margin, which is designed to protect against potential future loss on a default, as well as variation margin, which serves as mark-to-market protection.
Our handling of how our rule should apply to inter-affiliate transactions was in large part to strike the proper balance between benefits and costs. Inter-affiliate transactions are not outward-facing and thus do not increase the overall risk exposure of the consolidated enterprise to third-parties. We were concerned that imposing the exact same standards on these internal activities of consolidated entities is likely to significantly increase costs to end-users without any commensurate benefit.
But we must have appropriate protections to help ensure the safety and soundness of swap dealers. So we require that full variation margin be exchanged for all inter-affiliate swaps. We require initial margin in certain cases, in order to prevent evasion of the requirements to collect margin from third parties and to protect insured depositary institutions. And we require that inter-affiliate swaps be subject to a centralized risk management program appropriate to monitor and to manage these risks.
Centralized Treasury Unit Legislation
Further, we recently worked with lawmakers on Capitol Hill and the Administration on legislation that would assist end-users that use “centralized treasury units” or CTUs.
Specifically, the legislation ensures that an end-user company that uses a CTU to streamline and manage all its derivatives activity would continue to be exempt from margin and clearing requirements that are designed for financial institutions.
The measure recently became law as part of the recent transportation bill. It is important to many American businesses. And now that it has become law, the CFTC is working to implement these Congressional changes.
De Minimis Threshold
In November, the Commission addressed another issue that may have an impact on the derivatives market for commercial entities when staff released a preliminary report on what is known as the “de minimis threshold” for swap dealing and major swap participants.
The de minimis limit was set by the CFTC and the Securities and Exchange Commission’s joint rule defining swap dealers. As you may know, if an entity engaged in swap dealing exceeds that threshold –which is currently $8 billion dollars in notional amount of swaps over the year – it must register as a swap dealer, in which case capital and margin requirements as well as disclosure, recordkeeping and other requirements apply. The rule also provides that in about two years, that level will fall to $3 billion, unless the Commission takes action.
When our two agencies wrote the “de minimis exception” we originally did it without the benefit of much data. But we now have a wealth of information that we can use to have a discussion about what is the appropriate level at which to set the de minimis threshold. And our staff report aims to start that conversation, by taking a fresh look at the issue. The staff’s preliminary report does not make a recommendation as to what the level should be. It instead explores the issues, and invites public comment on the data, the methodology and the issues discussed.
The comment period on this study recently closed. We will now begin the process of carefully studying the feedback we’ve received, producing a final report, and making a decision on what, if any, action to take.