The CFTC adopted an amended substituted compliance determination relating to Japanese swaps margin requirements.
The new determination updates a previous determination by finding comparability as to (1) the scope of entities subject to margin requirements and (2) the treatment of inter-affiliate transactions. As to scope of entities, the CFTC states that it applies to requirements for both initial and variation margin requirements. As to inter-affiliate requirements, the CFTC noted that Japanese requirements do not require variation margin between affiliates, as the CFTC rules do, but cited the "inability to affirmatively transfer risk to U.S. margin affiliates that are [swap dealers] without variation margin, the historic level of relevant inter-affiliate activity, and the capital and risk management requirements of both the [Japan Financial Services Committee] and the [CFTC], and considerations of comity. . . ."
CFTC Chair J. Christopher Giancarlo supported the determination, and said that the prior determination reflected an "overly complex and unduly narrow approach" to comparability determinations. CFTC Commissioner Brian Quintenz commended the amendments to the determination, saying that the expanded determination is appropriately deferential to the agency's counterpart in Japan. CFTC Commissioner Dan Berkovitz also supported the determination, expressing his view that "a comparability determination should not be based solely on the home country's written laws and regulations, but also consider the country's broader system of regulation, including oversight and enforcement." Mr. Berkovitz stressed that this approach means CFTC staff should "periodically assess the implementation of this determination to confirm our expectations are accurate."
The amendment becomes effective upon its publication in the Federal Register.
Commentary / Nihal Patel
In the determination, the CFTC said "the absence of a finding of comparability regarding the scope of entities and inter-affiliate swaps issues was causing some confusion in applying the original determination." This arose because in Japan, like in the European Union, Switzerland, and elsewhere (and unlike the United States), variation margin requirements do not apply solely based on the type of counterparty; rather, those jurisdictions require that entities also have derivatives activities above specified thresholds. The CFTC has now acted to clear up the confusion. Similar actions would seem to be merited to clear up the equally "confusing" European margin comparability determination that was "explained" in a speech by Mr. Giancarlo.
While the goals sought in this determination - comity, regulatory deference, etc. - are reasonable, U.S. regulators should also consider how this approach to substituted compliance affects U.S.-regulated firms in their domestic business. These determinations create a clear solution for smaller market participants (i.e., those below the relevant thresholds set under non-U.S. law) who don't want to post or collect variation margin on swaps: don't trade with Americans. The CFTC (and bank regulators) ought to consider whether the United States should follow the lead of other countries on this point and consider whether systemic risk concerns merit margin collection and posting with respect to financial firms with small amounts of derivatives activity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
