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

Five federal agencies have taken a second stab at a  proposed rule to establish margin requirements for swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The rule is proposed by the Federal Reserve Board, the Farm Credit Administration, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the Office of the Comptroller of the Currency.

The rule proposal applies to swap provider counterparties that are regulated by the agencies and are referred to as “covered swap entities.”  The initial April 2011 proposal was controversial because in the view of the banking regulators the Dodd-Frank Act  required the regulators to adopt rules for covered swap entities imposing margin requirements on all non-cleared swaps. According to the bank regulators, the Dodd-Frank Act, by its terms, did not exclude a swap with a counterparty that is a commercial end user, or in regulatory-speak, “nonfinancial end user,” from the margin requirements.

The bank regulators didn’t think the initial proposal was all that onerous because the 2011 proposal permitted a covered swap entity to adopt, where appropriate, thresholds below which the covered swap entity would not be required to collect initial or variation margin from nonfinancial end users.

The new proposal takes a different approach to nonfinancial end users than the 2011 proposal. Like the 2011 proposal, the new proposal follows the statutory framework and proposes a risk-based approach to imposing margin requirements. Unlike the 2011 proposal, the new proposal does not require that the covered swap entity determine a specific, numerical threshold for each nonfinancial end user counterparty. In addition the new proposed rule does not require a covered swap entity to collect initial margin and variation margin from nonfinancial end users as a matter of course, but instead requires it to collect initial and variation margin at such times and in such forms and amounts (if any) as the covered swap entity determines would appropriately address the credit risk posed by swaps entered into with “other counterparties.”

The term “nonfinancial end user,” although used in the text explaining the new proposal, is not defined in or used in the text of the proposed rule. For the most part, nonfinancial end users are basically those that are not “financial end users” and are treated as “other counterparties” in the proposal.

The proposal’s definition of “financial end user” takes a different approach than the 2011 proposal, which was based on the definition of a “financial entity” that is ineligible for the exemption from mandatory clearing requirements of the Dodd-Frank Act. In order to provide certainty and clarity to counterparties as to whether  they would be financial end users for purposes of the proposal, the financial end user definition provides a list of entities that would be financial end users as well as a list of entities excluded from the definition. This approach would mean that covered swap entities would not need to make a determination regarding whether their counterparties are predominantly engaged in activities that are financial in nature, as defined in section 4(k) of the Bank Holding Company Act of 1956, as amended.  In contrast to the 2011 proposal, the banking regulators now are proposing to rely, to the greatest extent possible, on the counterparty’s legal status as a regulated financial entity.

Some commentators have noted that that the proposal is unclear whether treasury subsidiaries of commercial end users will or will not be considered financial end users under the proposal.


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