Federal Deposit Insurance Corporation Open Meeting on Inter-Affiliate Initial Margin Requirements

Federal Deposit Insurance Corporation

Board of Directors Open Meeting

Tuesday, September 17, 2019

Key Topics & Takeaways

  • Swap Margin NPR Approved: The FDIC approved a notice of proposed rulemaking to amend swap margin requirements for non-cleared cleared swaps. Specifically, the proposed rulemaking would repeal the requirement for a covered swap entity to collect initial margin from its affiliates.
  • Community Bank Leverage Ratio Final Rule Approved: The FDIC approved a final rule that introduces an optional simplified measure of capital adequacy, the Community Bank Leverage Ratio (CBLR), for qualifying community banking organizations. The CBLR framework will be available for banks to use in their March 21, 2020 Call Report.

FDIC Board

Memorandum and resolution re: Interagency Final Rule on Capital Simplification for Qualifying Community Banking Organizations

FDIC staff provided an overview of the final rule on the Community Bank Leverage Ratio (CBLR). Staff stated that under the final rule, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and that meet other qualifying criteria will be eligible to opt into the CBLR framework and will not be required to calculate and report risk-based capital. The FDIC Board unanimously approved the final rule. This rule will now be issued on an interagency basis with an effective date of January 1, 2020.

Memorandum and resolution re: Notice of Proposed Rulemaking on Swap Margin Requirements

FDIC staff provided an overview of the proposed rulemaking that was developed jointly with the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Farm Credit Administration and the Federal Housing Finance Agency. Staff provided background on the 2015 issuing of regulations referred to as the Swap Margin Rule and stated that the agencies have worked closely with industry and end-users to understand how to improve the rules to reduce regulatory burden while maintaining robust margin requirements.  Staff noted that the landscape in which derivatives are contracted has evolved, citing the move away from LIBOR as the key reference rate for derivatives contracts as an example of this evolution.

Staff stated that this proposed rulemaking is designed to reduce regulatory burden and promote an orderly transition away from LIBOR while maintaining robust margin requirements. They explained that the proposed rulemaking would allow legacy swaps to be amended to replace exiting interest rate provisions based on certain interbank offered rates such as LIBOR and other interest rates that are reasonably expected to be discontinued or reasonably determined to have lost their relevance as a reliable benchmark due to a significant impairment without such swaps losing their legacy status. Staff referenced the uncertainty facing covered swap entities due to the potential discontinuation of LIBOR at the end of 2021 as a necessitating factor for the proposed rulemaking.

Staff continued that the proposed rulemaking would also repeal the requirement for a covered swap entity to collect initial margin from its affiliates but would retain the requirement that variation margin be exchanged for affiliate transactions. They added that the proposed rulemaking would also substitute the definition of ‘affiliate’ by focusing on consolidation under applicable accounting rules and establishing catch-all legal standards for affiliation in banking focused on the direct and indirect exercise of controlling influence over the management or policies of the controlled company. Staff cited: 1) supervisory experience showing that inter-affiliate swaps are used by covered swap entities for prudent internal risk management purposes; and 2) the increase in the amount of inter-affiliate initial margin collected by covered swap entities leading to affected banking organizations borrowing increasing amounts of cash in the debt markets to fund collateral; as reasons to remove the Inter-Affiliate Initial Margin (IA-IM).Staff stated that that removal of IA-IM would provide banking organizations with additional flexibility for the internal allocation of collateral.

Staff noted that this proposed rulemaking does not remove the requirement that covered swap entities must collect and post initial margin with other non-affiliate covered swap entities, and that affiliate transactions would remain subject to the requirements of Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve’s Regulation W, which may require the collection of initial margin from certain affiliates. The proposed rulemaking would also reduce the regulatory burden for smaller swap entities by adding an additional initial margin compliance period and clarifying the existing trading documentation requirements in the swap margin rule.

Staff stated that the agencies will request comments on all aspects of the proposed rulemaking within the public comment period of 30 days after publication in the Federal Register.

Jelena McWilliams, Chair, Federal Deposit Insurance Corporation (FDIC)

McWilliams stated that inter-affiliate transactions are used by banks for internal risk management purposed and that collection initial margin on these transactions freezes financial collateral, making it available only in the event of failure and that IA-IM also undercuts affiliates’ resilience. She noted that the removal of this requirement does not mean that there are no longer any rules or limitations on these transactions. McWilliams cited Sections 23A and 23B of the Federal Reserve Act and the substantial layers of oversight levied upon the largest banking organizations as evidence that the proposed rulemaking would not leave banking organizations underregulated.

Martin Gruenberg, Director, FDIC

Gruenberg stated that the proposed rulemaking would remove an important prudential protection and expose banks to one of the most significant risks identified in the financial crisis. He proposed that the arguments in favor of the proposed rulemaking are flawed, arguing that while there is value in centralized risk management of the banking organizations, it is not a substitute for actual loss-absorbing collateral. He also noted that the scope of rules such as 23A and 23B of the Federal Reserve Act are narrower than the IA-IM requirement of the 2015 final rule and that they serve as complements, not substitutes, to the 2015 rule.

Joseph Otting, Comptroller of the Currency

Otting stated that he supports the proposed rulemaking and already approved it for the Office of the Comptroller of the Currency (OCC).

Kathleen Laura Kraninger, Director, Consumer Financial Protection Bureau (CFPB)

Kraninger declined to make any statement.

Final Vote

The FDIC Board approved the proposed rulemaking in a 3-1 vote, with only Gruenberg opposing.

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