Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

Complementing its recently proposed rules establishing margin requirements for swap dealers (SDs) and major swap participants (MSPs), the CFTC proposed rules regarding capital requirements for these “covered swap entities” at yesterday’s open meeting. Although the Commission has not released the text of the rule yet, its announcements, fact sheet, and Q&A regarding the rules provide a basic outline of the new capital requirements.

The Capital Requirements

The capital requirements for an SD or MSP depend on whether the entity is a futures commission merchant (FCM) and, if not, whether it is a subsidiary of a U.S. bank holding company:

SDs and MSPs that are also FCMs

These SDs and MSPs would be required to meet existing FCM requirements to hold minimum levels of adjusted net capital, and also would be required to calculate the required minimum level as the greatest of the following:
• a fixed dollar amount, which under the proposed rules would be $20 million;
• the amount required for FCMs that also act as retail forex exchange dealers;
• 8 percent of the risk margin required for customer and non-customer exchange-traded futures positions and over-the-counter (OTC) swap positions that are cleared by a clearing organization;
• the amount of adjusted net capital required by a registered futures association of which the FCM is a member; and
• for an FCM that also is registered as a securities broker or dealer, the amount of net capital required by SEC rules.

SDs and MSPs that are not FCMs and are nonbank subsidiaries of U.S. bank holding companies

These SDs and MSPs would be required to meet the same capital requirements that U.S. banking regulations apply to the bank holding company. Generally, such banking regulations require a minimum ratio of qualifying total capital to risk-weighted assets of 8 percent, of which at least half, i.e., 4 percent, should be in the form of Tier 1 capital. The proposed rules also specify a minimum fixed dollar amount of at least $20 million of Tier 1 capital.

SDs and MSPs that are neither FCMs nor a bank holding company subsidiary as described above

These SDs and MSPs would be required to maintain tangible net equity equal to $20 million, plus additional amounts for market risk and over-the-counter derivatives credit risk. A firm’s tangible net equity generally would be based on net equity as determined under U.S. GAAP, minus intangibles such as goodwill.

Capital Calculations, Reporting, and Recordkeeping

SDs and MSPs will be required to use approved models for their capital calculations, but can apply for Commission approval of their own internal models. FCMs will be required to continue meeting current requirements for unaudited monthly financial reports and annual audited financial statements. SDs and MSPs that are not subject to supervision by a prudential regulator (e.g., the Federal Reserve Board) will be subject to similar financial condition reporting requirements under the proposed rules.

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