Prudential Regulators Capital and Margin Rules for Covered Swap Entities: FDIC and OCC Adopt Rules Imposing Margin Requirements for Uncleared Swaps and Capital Requirements on Covered Swaps Entities

Sullivan & Cromwell LLP - October 26, 2015

On October 22, 2015, the Federal Deposit Insurance Corporation (the “FDIC”) voted to adopt final rules (the “Final Rules”) establishing, for swap entities subject to its prudential regulation (“Covered Swap Entities”), minimum initial and variation margin requirements for swaps and security-based swaps that are not cleared through a derivatives clearing organization (“DCO”) registered under the Commodity Exchange Act (the “CEA”) or a clearing agency registered under the Securities Exchange Act of 1934, respectively (“uncleared swaps”), and capital requirements.  The Final Rules are substantially the same as the rules adopted on the same day by the Office of the Comptroller of the Currency (the “OCC”), and expected to be adopted by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Farm Credit Administration and the Federal Housing Finance Agency (collectively, the “Prudential Regulators”).  The Final Rules were adopted under Sections 731 and 764 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and are the final form of the rules that the Prudential Regulators re-proposed on September 3, 2014 (the “Proposed Rules”).  The FDIC also adopted an interim final rule to exclude from the requirements of the Final Rules most uncleared swaps that a Covered Swap Entity enters into with commercial end users and financial institutions with $10 billion or less in total assets, consistent with Sections 731 and 764 of the Dodd-Frank Act, as amended by the Terrorism Risk Insurance Program Reauthorization Act of 2015 (the “TRIPRA”).

The Final Rules represent a significant regulatory burden on the over-the-counter swaps market, which previously had not existed.  Although the Final Rules include certain important modifications to the swap margin framework embodied in the Proposed Rules, the Final Rules provide only limited relief in the context of inter-affiliate uncleared swaps and leave the framework for applying margin requirements in a cross-border context little changed from the Proposed Rules.  Because the Commodity Futures Trading Commission (the “CFTC”) and the Securities and Exchange Commission (the “SEC”) have authority to establish minimum margin requirements for registered swap entities that are not subject to the jurisdiction of a Prudential Regulator, which include non-bank subsidiaries of a bank holding company, the full framework for inter-affiliate margin requirements for banking organizations will not be known until those agencies finalize their rules.   We will supplement this memorandum with a more comprehensive memorandum in the near future, once the other agencies, including the CFTC, have adopted final margin requirements.