Margin Requirements for Uncleared Swaps: CFTC and Prudential Regulators Finalize Rules Imposing Minimum Margin and Capital Requirements on Covered Swap Entities

Sullivan & Cromwell LLP - January 7, 2016
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On December 16, 2015, the Commodity Futures Trading Commission (“CFTC”) voted to adopt final rules (the “CFTC Final Rules”) to establish initial margin and variation margin requirements for uncleared swaps, i.e., swaps that are not cleared by a derivatives clearing organization registered under the Commodity Exchange Act or by a clearing organization that the CFTC has exempted from registration.  The CFTC Final Rules apply to swap dealers and major swap participants that are subject to the CFTC’s jurisdiction and are generally consistent with the final rules promulgated on October 22, 2015 by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration and the Federal Housing Finance Agency (collectively, the “Prudential Regulators”) establishing minimum initial margin and variation margin requirements for uncleared swaps and security-based swaps that are not cleared by a clearing agency (such swaps and security-based swaps, “Covered Swaps”) entered into by swap dealers, major swap participants, security-based swap dealers and major security-based swap participants subject to the jurisdiction of one of the Prudential Regulators (the “Prudential Regulators’ Final Rules” and, together with the CFTC Final Rules, the “Final Rules”).  In addition, the CFTC and the Prudential Regulators each adopted substantially similar interim final rules that exclude from the requirements of the Final Rules most Covered Swaps that a covered entity enters into with commercial end users and certain financial institutions with total assets of $10 billion or less.

The Final Rules effect a fundamental shift in over-the-counter swap markets by requiring swap dealers, major swap participants, security-based swap dealers and major security-based swap participants to collect and post minimum initial and variation margin from and to certain swap counterparties, depending on the type of counterparty, in connection with certain non-centrally cleared derivative transactions.
 
Compliance with the Final Rules will be required beginning as early as September 1, 2016 for certain covered entities.

The Final Rules issued by the CFTC and the Prudential Regulators are substantially similar, with some notable exceptions, most significantly in the treatment of swaps between affiliates and the requirements for calculating variation margin, as discussed below.  This memorandum generally highlights the key components of the Final Rules together, noting significant differences between the CFTC Final Rules and Prudential Regulators’ Final Rules where applicable.