FDIC paves way for rollback of initial swap margin requirements

Originally developed as part of the regulatory reforms mandated by the 2010 Dodd-Frank Act, the swap margin rule, established in the fallout from the 2008 financial crisis and issued in 2015, is now seen by some as too stringent. When banks collect initial margin from their affiliates, “the financial collateral is locked up, frozen, and available only in the event that the affiliate fails,” said FDIC Chair Jelena McWilliams at an FDIC board meeting on Sept. 17. Thanks to other reforms, though, a failure scenario “has become much less likely” she continued.

At the same time, to comply with the old rule, banks had to borrow more and more money to meet stricter margin requirements than those found elsewhere in the world. “Foreign jurisdictions generally do not require initial margin for transactions with affiliates,” McWilliams said at the meeting.

Even without an initial margin requirement, plenty of other regulations still apply. “Removing the initial margin requirements for inter-affiliate transactions does not mean that there are no longer any rules or limitations for those transactions,” McWilliams said. Variation margins must still be exchanged for affiliate transactions, she noted. In addition, she added, the biggest banking institutions “remain subject to many layers of oversight.”

Internal and external support

FDIC staff support the development as a measure that will encourage prudent risk management. In a Sept. 17 memorandum to the FDIC board of directors, FDIC staff wrote the deletion of the initial margin requirement for affiliates would provide banks “with greater flexibility to allocate collateral internally.”

The American Bankers Association applauded the change as a measure that will boost the economy and bring U.S. requirements in line with international standards. “Today’s FDIC actions demonstrate regulators’ recognition that simpler rules can make for better and more effective supervision that promotes safety and soundness and benefits the economy,” said ABA President and CEO Rob Nichols in a statement.

Similarly, Securities Industry and Financial Markets Association (SIFMA) President and CEO Kenneth Bentsen Jr. praised the FDIC’s move. The association believes the FDIC’s rollback “is a beneficial step, as it unlocks liquidity for investments which contribute to economic growth,” he said in a statement.

Not everyone is pleased by the development. Repealing the inter-affiliate initial margin requirement will “provide an incentive for banking organizations to concentrate risky derivative activity in the insured depository institution because of the subsidy provided by the public safety net,” said FDIC board member Martin Gruenberg before voting against the rollback.

A survey by the International Swaps and Derivatives Association found that, as of the end of 2018, $39.4 billion in initial margin to cover inter-affiliate swaps was held by the 20 largest organizations subject to the old rule.

Next steps

Four other federal agencies—the Office of the Comptroller of the Currency, the Federal Reserve Board, the Federal Housing Finance Agency, and the Farm Credit Administration—must approve the proposed change before it is published in the Federal Register for public comment. A 30-day comment period is expected.

The proposed rule also addresses the transition from the London Interbank Offered Rate, or LIBOR, as it relates to derivate swaps, McWilliams noted in her statement at the FDIC meeting. In addition, the proposal would ease the regulatory burden on counterparties with small derivatives portfolios by extending the date by which they must comply with margin requirements to September 2021, she said.

In a separate development, the SEC announced Sept. 19 it had finalized its rule on recordkeeping and reporting requirements for security-based swap dealers, major security-based swap participants, and broker-dealers. Under the Dodd-Frank Act, both the SEC and the CFTC oversee U.S. over-the-counter derivatives markets. The SEC has oversight of security-based swaps.

The SEC’s recordkeeping and reporting rule “will help the Commission ensure compliance with rules designed to promote financial responsibility and investor protection,” said SEC Chair Jay Clayton in a release. The SEC’s rule will become effective 60 days after its publication in the Federal Register.

Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.