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From Banking and Finance Law Daily, September 21, 2018

Margin rules on swaps not cleared by central clearinghouses amended

By Richard A. Roth, J.D.

Five federal regulatory agencies with authority over registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants have jointly amended their margin rules to conform with recent restrictions on qualified financial contracts. The amendments were adopted jointly by the Federal Reserve Board, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, Federal Housing Finance Agency, and Farm Credit Administration.

The agencies’ Swap Margin Rule sets minimum capital and margin requirements for swaps that are not cleared by a registered clearing entity. It requires covered companies to collect or post, as appropriate, initial margin for non-cleared swaps with counterparties that either are financial end-users that have a material swap exposure or are "swap entities." The rule also sets variation margin requirements. However, swaps that were entered into before the rule’s compliance date—referred to as "legacy swaps’"—generally are not subject to margin requirements as long as they are not later amended or novated.

A swap’s status as a legacy swap also affects how a swaps entity treats its netting portfolios. Initial margin with a counterparty may be calculated on a portfolio basis under an eligible master netting agreement (EMNA), and variation margin may be calculated on an aggregate net basis under an EMNA. Also, separate netting portfolios that include only legacy swaps may be identified under an EMNA.

Qualified financial contract rules. The Fed, OCC, and FDIC subsequently adopted rules on qualified financial contracts (QFCs) that apply to U.S. global systemically important banking institutions and U.S. operations of foreign GSIBs. The rules require covered QFCs to include contract provisions that stay a party’s right to terminate, liquidate, or net a QFC (close-out rights) if the counterparty enters into resolution. This is intended to allow the transfer of the QFC to a solvent counterparty.

According to the current notice, the QFC rules required amendments to the banking agencies’ capital and liquidity rule provisions that define "qualifying master netting agreement" (QMNA) in order to permit the restriction on close-out rights. Otherwise, a banking organization would lose the ability to net exposures, which would result in higher capital and liquidity requirements.

Swap Rule amendments. The current notice says that the new rule will amend the QMNA definition to permit the close-out restrictions required by the QFC rule. In other words, a QMNA will continue to be an EMNA, with the preferable margin calculation, even if it is amended as required by the QFC rule. QMNA changes needed to conform to the QFC rule requirements will not cause a swap to lose its legacy swap status.

The rule will take effect 30 days after it is published in the Federal Register.

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