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FDIC Board Meeting on Margin and Capital Requirements for Swap Entities

Federal
Deposit Insurance Corporation

Board Meeting on Margin and Capital for Swap Entities,

Update on the Deposit Insurance Fund, and the Reserve Ratio

Thursday, October 22,
2015                       

 

Key
Topics & Takeaways:

    International
    Consistency:     Chairman Gruenberg said the Final Rule on margin and
    capital is consistent with the international agreement published in September
    2013 by the BCBS and IOSCO. He added that “jurisdictions around the world have
    issued similar proposals,” and he “strongly support[s] their expeditious
    completion.”

    Much Accomplished by the
    Rule:     Vice Chairman Hoenig expressed support for the Final Rule,
    stating “while the system overall would have been best served in my opinion if
    banks posted and collected margins with their affiliate, much is accomplished with
    the requirement that the insured bank collect margins.” 

    Internal Risk Management
    Transactions:     The Final Rule on margin and capital would require a
    covered swap entity (CSE) to collect IM when transacting with another swap
    entity, regardless of whether that counterparty CSE is an affiliate (in effect
    resulting in a collect and post regime for IM among affiliated CSEs).  A
    CSE would not, however, be required to post IM to an affiliate counterparty
    that is financial end-user with material swaps exposure.

 

FDIC
Board:

Opening Statement

Martin
Gruenberg, Chair of the Federal Deposit Insurance Corporation (FDIC), and the
rest of the board approved the summary
agenda for the meeting before introducing the FDIC staff to present the
Notice of Final
Rulemaking to Establish Margin and Capital Requirements for Covered Swap
Entities and an Interim
Final Rule to Exempt Commercial End Users and Small Banks

Staff Presentation – Margin and Capital for Swap Entities

FDIC
staff began with a discussion of its recommendation regarding a Final Rule on
Margin and Capital Requirements for Covered Swap Entities (CSEs), a joint
rulemaking effort in concert with the Federal Reserve Board, Farm Credit
Administration (FCA), Federal Housing Finance Agency (FHFA) and Office of the
Comptroller of the Currency (OCC).  FDIC staff further stated that they
would also be providing notice regarding an interim final rule to exempt
commercial end-users and small banks for requirements.

FDIC
staff expressed their view that the Final Rule on Margin and Capital
Requirements for CSEs is consistent with the final policy framework agreed by
the Basel Committee on Banking Supervision (BCBS) and the International
Organization of Securities Commissions (IOSCO) regarding margin requirements
for non-centrally cleared derivatives (the BCBS/IOSCO Final Framework). 
Staff then went into detail explaining some the specific requirements of the
rule.

Staff
highlighted the circumstances under which a CSE would be required to collect or
post initial margin (IM) and/or variation margin (VM) for uncleared swaps with
certain counterparties.  Under the Final Rule, a CSE generally would be
required to exchange IM with counterparties that are swap entities or financial
end-users with a material swaps exposure, “defined as those with an annual
notional amount of swap activity exceeding $8 billion.”  A CSE would be
required to exchange VM on uncleared swaps with “all counterparties that are
swap entities or financial end-users, regardless of whether the financial
end-user has a material swap exposure.”

Staff
next discussed allowable IM calculation methods under the Final Rule, stating
that a CSE would be required to use a standardized table or an internal margin
model that satisfies the criteria outlined within the Final Rule and has been
approved by the supervising agency.  Staff went on to note that the Final
Rule would allow for CSEs to calculate IM for swaps “under an eligible master
netting agreement with the counterparty on a portfolio basis” in some
instances.

Staff
provided details on the types of eligible collateral allowed under the Final
Rule.  For IM, staff indicated that cash and certain highly liquid assets,
“which are subject to a robust risk-based haircut, such as debts that are
issued or guaranteed by the U.S. Treasury, certain U.S. government-sponsored
debt securities, certain foreign government debt securities, certain corporate
debt securities, certain listed equities, and municipal securities, and gold”
would eligible.  Further, staff indicated “interest in certain pooled
investment funds that invest in U.S. government securities or high-quality
securities issued by certain sovereign entities” would also be deemed eligible.

For
VM, staff stated that for CSEs transacting with other swap entities, the CSE
would “only be permitted to exchange immediately available cash funds
denominated either in U.S. dollars, a major currency, or the currency of
settlement for that contract.”  For CSEs transacting with financial
end-users staff noted that, in addition to the above, the parties would also be
allowed to exchange non-cash collateral.  Staff clarified that in order to
determine collateral values, a CSE would be required to apply haircuts as
detailed in the Final Rule.

Staff
next explained the Final Rule would require segregation of collateral, and
require “any collateral other than VM that the swap entity posts to be
segregated at one or more custodians that are not affiliates of the CSE or the
counterparty” and “for any IM that a CSE collects from a swap entity or a financial
end-user with material swap exposures” with one or more custodians that are not
affiliates of the CSE or the counterparty. Staff explained that these
custodians “must be prohibited by agreement from rehypothecation, re- pledging,
reusing, or otherwise transferring any of the funds or other property that it
holds for this purpose.”

Regarding
the cross-border application of requirements, staff stated that: 1) certain
swaps by foreign CSEs with foreign counterparties would be exempt from margin
requirements under the rule; 2) certain cross-border swaps that do not meet the
standards for the exemptions may be eligible for substituted compliance, if the
agencies jointly determine the foreign jurisdiction’s requirements are
comparable to those of the Final Rule; 3) swaps conducted by CSEs, including
foreign branches of U.S. CSEs would not be eligible for substituted compliance;
and 4) specific rules would apply when a CSE enters into a swap with a
counterparty that is located in a jurisdiction where “limitations and legal or
operational structure make it impractical for the covered swap entity and the
counterparty to post any form of eligible initial margin in compliance with the
Final Rule segregation requirements.”

Regarding
internal
risk management transactions, staff indicated the Final Rule would require a
CSE to collect IM when transacting with another CSE, regardless of whether that
counterparty CSE is an affiliate (in effect resulting in a collect and post
regime for IM among affiliated CSEs).  A CSE would not, however, be
required to post IM to an affiliate counterparty that is financial end-user
with material swaps exposure, though the CSE would be required to calculate the
amount of IM it would have been required to post to its affiliate under the Final
Rule and provide documentation of that amount daily. Lastly, staff stated CSEs
would be required to exchange VM with affiliates subject to requirements in the
Final Rule. 

The
compliance timeline for requirements in the Final Rule, staff noted, were
drafted to be consistent with the BCBS/IOSCO Final Framework. They stated that
VM requirements would apply to large CSEs starting September 1, 2016 and to all
remaining CSEs on March 1, 2017, and said IM requirements would be phased in
between September 1, 2016 and September 1, 2020.

FDIC
Board Comments and Questions

Following
the staff’s description, FDIC Chairman Gruenberg expressed
support for the Final Rule and Interim Final Rule, stating that, “establishing
margin requirements for non-cleared swaps is one of the most important reforms”
of the Dodd-Frank Act and that the rules are “an important step toward
implementing essential reforms for non-cleared swaps activities and to limit
risk in the financial system.”  Gruenberg went on to note that international
consistency in the implementation of margin requirements “has been an important
concern for the regulatory community, as well as for the industry.” He added
that the Final Rule “is consistent with the international agreement published
in September 2013 by the [BCBS] and [IOSCO]” and that “jurisdictions around the
world have issued similar proposals,” saying he “strongly support[s] their
expeditious completion.”

FDIC
Vice Chairman Hoenig next asked staff whether any thought
had been given to updating eligible collateral – whether it might be on an
annual or semiannual basis.  Staff answered that while there was not a
definitive timeline, they typically “look to see the direction in which the
industry starts to migrate as far as the collateral and to make sure that the
posting, that the collateral list remains prudent.”

Hoenig
went on to express support for the Final Rule, stating “while the system
overall would have been best served in my opinion if banks posted and collected
margins with their affiliate, much is accomplished with the requirement that
the insured bank collect margins.”  He further noted “the Final Rule does
a good job of balancing the market need to compete and take risk with the
broader goal of managing risk and ensuring financial stability.”

Thomas
Curry, Comptroller of the Currency, also expressed support
for the Final Rule, stating that it “reduces risk, increases transparency,
promotes market integrity within the financial system, and addresses a number
of weaknesses in the regulation structure of the swaps market that became all
too evident during the financial crisis.”  He added that the rule “will go
a long way toward guarding against future crises and I’m pleased to support it
today.”

Richard
Cordray, Director of the Consumer Financial Protection
Bureau, asked staff to explain why thresholds were raised from $3 billion to $8
billion in the Final Rule, and what effect that has on entities being excluded
from requirements.  Staff explained that the $8 billion threshold was
incorporated to align with international agreements, but the impact is
“virtually minimal” on the number of entities that would no longer be subject
to requirements of the Final Rule.  Staff noted that other safeguards
exist, including supervisory authority and the ability to amend rules, as well
as well as the fact that requirements will apply to any designated swap dealer
or security-based swap dealer.

The
FDIC Board then unanimously approved the final rule and interim final rule.

Staff Presentation – Deposit Insurance Fund, Reserve Ratios, and
Restoration Plan

FDIC
staff noted that the Dodd-Frank Act raised the minimum reserve ratio of the
FDIC’s Deposit Insurance Fund (DIF) from 1.15 to 1.35, which must be reached by
2020. Staff said they project the ratio to reach 1.15 in the first quarter of
2016 and noted that once this level is met, lower assessment rates will go into
effect. This lower rate, they said, would result in decline of regular
assessments paid by banks of 30 percent, on average.

FDIC
staff noted that the DIF balance was $67.6 billion as of June 30, 2015 and that
they project bank failures to cost the fund $2 billion from 2015-2019. Staff
said the DIF earned assessment income of $4.5 billion in the first half of 2015
and that the expected 2015 total is about $9 billion. The reserve ratio stood
at 1.09 percent as of June 13, 2015, they added.

Staff Presentation – Proposal to Implement an Increase in the
Minimum Reserve Ratio

FDIC
staff then recommended that the Board authorize publication of a Notice
of Proposed Rulemaking (NPR) to implement Dodd-Frank provisions that
require increasing the FDIC’s reserve ratio to 1.35. The proposal, they
explained, has three parts: 1) large banks ($10 billion or more in total
assets) would have to pay quarterly surcharges of 4.5 basis points in addition
to their regular risk-based assessment, once the reserve ratio reaches 1.15
percent; 2) if the ratio has not reached 1.35 percent by the end of 2018, a
shortfall assessment would be imposed on large banks; and 3) small banks would
receive credits to offset the portion of their assessment that they contributed
to raise the ratio from 1.15 to 1.35 percent.

Staff
noted for any given quarter, a large bank assessment for the surcharge would
equal its regular assessment base for the quarter with two adjustments: 1)
adding the regular quarterly assessment basis of any affiliate and small banks;
and 2) deducting $10 billion from the base. They noted that for banking
organizations that include more than one large bank, the assessment basis of
any affiliated small banks and the $10 billion deduction would be pro-rated
among the affiliated large banks.

Staff
said they analyzed the effect of these surcharges on large banks with low
income and found there would not be significant effects on capital levels,
saying, on average, the annual surcharges would amount to about 2.4 percent of
large banks’ pre-tax earnings.

FDIC
Board Comments and Questions

Gruenberg
said that the surcharges would be spread out over time and “should be fully
manageable for the institutions.”

Curry
said the surcharge approach is the “best option” and that it comes at a time
when the banking industry is experiencing improved health and is in “a better
position to afford it without significant impact to earnings, capital, or
liquidity.” He also noted that the surcharge is a quarterly expense “just as a
regular quarterly assessment is treated from an accounting standpoint.”

Cordray
said Congress intended that “the burden” of the proposal be shifted to larger
banks which he said “seems quite appropriate.”

The
FDIC Board unanimously approved the notice of proposed rulemaking.

For
more information on this meeting, please click here.