Proposed Rule2023-13446
Notice of Proposed Order and Request for Comment on an Application for a Capital Comparability Determination Submitted on Behalf of Nonbank Swap Dealers Domiciled in the French Republic and Federal Republic of Germany and Subject to Capital and Financial Reporting Requirements of the European Union
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
June 27, 2023
Issuing agencies
Commodity Futures Trading Commission
Abstract
The Commodity Futures Trading Commission is soliciting public comment on an application submitted by the Institute of International Bankers, International Swaps and Derivatives Association, and Securities Industry and Financial Markets Association requesting that the Commission determine that the capital and financial reporting laws and regulations of the European Union applicable to CFTC-registered swap dealers organized and domiciled in the French Republic and Federal Republic of Germany provide sufficient bases for an affirmative finding of comparability with respect to the Commission's swap dealer capital and financial reporting requirements adopted under the Commodity Exchange Act. The Commission is also soliciting public comment on a proposed order providing for the conditional availability of substituted compliance in connection with the application.
Full Text
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[Federal Register Volume 88, Number 122 (Tuesday, June 27, 2023)]
[Proposed Rules]
[Pages 41774-41813]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-13446]
[[Page 41773]]
Vol. 88
Tuesday,
No. 122
June 27, 2023
Part III
Commodity Futures Trading Commission
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17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an Application for
a Capital Comparability Determination Submitted on Behalf of Nonbank
Swap Dealers Domiciled in the French Republic and Federal Republic of
Germany and Subject to Capital and Financial Reporting Requirements of
the European Union; Proposed Rule
Federal Register / Vol. 88 , No. 122 / Tuesday, June 27, 2023 /
Proposed Rules
[[Page 41774]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination Submitted on
Behalf of Nonbank Swap Dealers Domiciled in the French Republic and
Federal Republic of Germany and Subject to Capital and Financial
Reporting Requirements of the European Union
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed order and request for comment.
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SUMMARY: The Commodity Futures Trading Commission is soliciting public
comment on an application submitted by the Institute of International
Bankers, International Swaps and Derivatives Association, and
Securities Industry and Financial Markets Association requesting that
the Commission determine that the capital and financial reporting laws
and regulations of the European Union applicable to CFTC-registered
swap dealers organized and domiciled in the French Republic and Federal
Republic of Germany provide sufficient bases for an affirmative finding
of comparability with respect to the Commission's swap dealer capital
and financial reporting requirements adopted under the Commodity
Exchange Act. The Commission is also soliciting public comment on a
proposed order providing for the conditional availability of
substituted compliance in connection with the application.
DATES: Comments must be received on or before August 28, 2023.
ADDRESSES: You may submit comments, identified by ``EU Swap Dealer
Capital Comparability Determination,'' by any of the following methods:
<bullet> CFTC Comments Portal: <a href="https://comments.cftc.gov">https://comments.cftc.gov</a>. Select
the ``Submit Comments'' link for this proposed order and follow the
instructions on the Public Comment Form.
<bullet> Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
<bullet> Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
<a href="https://comments.cftc.gov">https://comments.cftc.gov</a>. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Commission Regulation 145.9.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to in this
release are found at 17 CFR chapter I, and are accessible on the
Commission's website: <a href="https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm">https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm</a>.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from <a href="https://comments.cftc.gov">https://comments.cftc.gov</a> that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the proposed determination and order will be retained in
the public comment file and will be considered as required under the
Administrative Procedure Act and other applicable laws, and may be
accessible under the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, <a href="/cdn-cgi/l/email-protection#b3d2dcdfd6d2c1f3d0d5c7d09dd4dcc5"><span class="__cf_email__" data-cfemail="c3a2acafa6a2b183a0a5b7a0eda4acb5">[email protected]</span></a>; Thomas Smith, Deputy Director, 202-418-5495,
<a href="/cdn-cgi/l/email-protection#89fdfae4e0fde1c9eaeffdeaa7eee6ff"><span class="__cf_email__" data-cfemail="0276716f6b766a42616476612c656d74">[email protected]</span></a>; Rafael Martinez, Associate Director, 202-418-5462,
<a href="/cdn-cgi/l/email-protection#b6c4dbd7c4c2dfd8d3ccf6d5d0c2d598d1d9c0"><span class="__cf_email__" data-cfemail="acdec1cdded8c5c2c9d6eccfcad8cf82cbc3da">[email protected]</span></a>; Liliya Bozhanova, Special Counsel, 202-418-6232,
<a href="/cdn-cgi/l/email-protection#f19d939e8b99909f9e8790b192978592df969e87"><span class="__cf_email__" data-cfemail="503c323f2a38313e3f263110333624337e373f26">[email protected]</span></a>; Joo Hong, Risk Analyst, 202-418-6221,
<a href="/cdn-cgi/l/email-protection#18727077767f587b7e6c7b367f776e"><span class="__cf_email__" data-cfemail="f8929097969fb89b9e8c9bd69f978e">[email protected]</span></a>; Justin McPhee, Risk Analyst, 202-418-6223;
<a href="/cdn-cgi/l/email-protection#abc1c6c8c3dbceceebc8cddfc885ccc4dd"><span class="__cf_email__" data-cfemail="bbd1d6d8d3cbdedefbd8ddcfd895dcd4cd">[email protected]</span></a>, Market Participants Division; Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') is soliciting public comment on an
application dated September 24, 2021 (the ``EU Application'') submitted
by the Institute of International Bankers, International Swaps and
Derivatives Association, and Securities Industry and Financial Markets
Association (together, the ``Applicants'').\2\ The Applicants request
that the Commission determine that registered nonbank swap dealers \3\
(``nonbank SDs'') organized and domiciled within the European Union
(``EU'') (``EU nonbank SDs'') may satisfy certain capital and financial
reporting requirements under the Commodity Exchange Act (``CEA'') \4\
by being subject to, and complying with, comparable capital and
financial reporting requirements under EU laws and regulations. As
described below, the EU Application addresses nonbank SDs located in
the French Republic (``France'') and the Federal Republic of Germany
(``Germany''), the two member states of the EU (``EU Member States'')
in which EU nonbank SDs currently registered with the Commission are
located.\5\ The Commission also is soliciting public comment on a
proposed order under which EU nonbank SDs organized and domiciled in
France and Germany would be able, subject to defined conditions, to
comply with certain CFTC nonbank SD capital and financial reporting
requirements in the manner set forth in the proposed order.
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\2\ See Letter dated September 24, 2021 from Stephanie Webster,
General Counsel, Institute of International Bankers, Steven Kennedy,
Global Head of Public Policy, International Swaps and Derivatives
Association, and Kyle Brandon, Managing Director, Head of
Derivatives Policy, Securities Industry and Financial Markets
Association. The EU Application is available on the Commission's
website at: <a href="https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm">https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm</a>.
\3\ As discussed in Section I.A. immediately below, the
Commission has the authority to impose capital requirements on
registered swap dealers (``SDs'') that are not subject to regulation
by a U.S. prudential regulator (i.e., nonbank SDs).
\4\ 7 U.S.C. 1 et seq. The CEA may be accessed through the
Commission's website at: <a href="https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm">https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm</a>.
\5\ As further discussed below, there are currently four EU
nonbank SDs registered with the Commission: BofA Securities Europe
SA and Goldman Sachs Paris Inc. et Cie are organized and domiciled
in France; Citigroup Global Markets Europe AG and Morgan Stanley
Europe SE are organized and domiciled in Germany.
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I. Introduction
A. Regulatory Background--Swap Dealer and Major Swap Participant
Capital and Financial Reporting Requirements
Section 4s(e) of the CEA \6\ directs the Commission and
``prudential regulators'' \7\ to impose capital requirements on all SDs
and major swap participants (``MSPs'') registered with the
Commission.\8\ Sections 4s(e) of the
[[Page 41775]]
CEA also directs the Commission and prudential regulators to adopt
regulations imposing initial and variation margin requirements on swaps
entered into by SDs and MSPs that are not cleared by a registered
derivatives clearing organization (``uncleared swaps'').
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\6\ 7 U.S.C. 6s(e).
\7\ The term ``prudential regulator'' is defined in the CEA to
mean the Board of Governors of the Federal Reserve System (``Federal
Reserve Board''); the Office of the Comptroller of the Currency; the
Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency. See 7 U.S.C.
1a(39).
\8\ Subject to certain exceptions, the term ``swap dealer'' is
generally defined as any person that (i) holds itself out as a
dealer in swaps; (ii) makes a market in swaps; (iii) regularly
enters into swaps with counterparties as an ordinary course of
business for its own account; or (iv) engages in any activity
causing the person to be commonly known in the trade as a dealer or
market maker in swaps. See 7 U.S.C. 1a(49). The term ``major swap
participant'' is generally defined as any person who is not an SD,
and (i) subject to certain exclusions, maintains a substantial
position in swaps for any of the major swap categories as determined
by the Commission; (ii) whose outstanding swaps create substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the U.S. banking system or financial markets;
or (iii) maintains a substantial position in outstanding swaps in
any major swap category as determined by the Commission. See 7
U.S.C. 1a(33).
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Section 4s(e) applies a bifurcated approach with respect to the
above Congressional directives, requiring each SD and MSP that is
subject to the regulation of a prudential regulator (``bank SD'' and
``bank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the applicable
prudential regulator, and requiring each SD and MSP that is not subject
to the regulation of a prudential regulator (``nonbank SD'' and
``nonbank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the Commission.\9\
Therefore, the Commission's authority to impose capital requirements
and margin requirements for uncleared swap transactions extends to
nonbank SDs and nonbank MSPs, including nonbanking subsidiaries of bank
holding companies regulated by the Federal Reserve Board.\10\
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\9\ 7 U.S.C. 6s(e)(2).
\10\ 7 U.S.C. 6s(e)(1) and (2).
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The prudential regulators implemented Section 4s(e) in 2015 by
amending existing capital requirements applicable to bank SDs and bank
MSPs to incorporate swap transactions into their respective bank
capital frameworks, and by adopting rules imposing initial and
variation margin requirements on bank SDs and bank MSPs that engage in
uncleared swap transactions.\11\ The Commission adopted final rules
imposing initial and variation margin obligations on nonbank SDs and
nonbank MSPs for uncleared swap transactions on January 6, 2016.\12\
The Commission also approved final capital requirements for nonbank SDs
and nonbank MSPs on July 24, 2020, which were published in the Federal
Register on September 15, 2020 with a compliance date of October 6,
2021 (``CFTC Capital Rules'').\13\
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\11\ See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
\12\ See Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\13\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 85 FR 57462 (Sept. 15, 2020).
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Section 4s(f) of the CEA addresses SD and MSP financial reporting
requirements.\14\ Section 4s(f) of the CEA authorizes the Commission to
adopt rules imposing financial condition reporting obligations on all
SDs and MSPs (i.e., nonbank SDs, nonbank MSPs, bank SDs, and bank
MSPs). Specifically, Section 4s(f)(1)(A) of the CEA provides, in
relevant part, that each registered SD and MSP must make financial
condition reports as required by regulations adopted by the
Commission.\15\ The Commission's financial reporting obligations were
adopted with the Commission's nonbank SD and nonbank MSP capital
requirements, and have a compliance date of October 6, 2021 (``CFTC
Financial Reporting Rules'').\16\
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\14\ 7 U.S.C. 6s(f).
\15\ 7 U.S.C. 6s(f)(1)(A).
\16\ See 85 FR 57462.
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B. Commission Capital Comparability Determinations for Non-U.S. Nonbank
Swap Dealers and Non-U.S. Nonbank Major Swap Participants
Commission Regulation 23.106 establishes a substituted compliance
framework whereby the Commission may determine that compliance by a
non-U.S. domiciled nonbank SD or non-U.S. domiciled nonbank MSP with
its home country's capital and financial reporting requirements will
satisfy all or parts of the CFTC Capital Rules and all or parts of the
CFTC Financial Reporting Rules (such a determination referred to as a
``Capital Comparability Determination'').\17\ The availability of such
substituted compliance is conditioned upon the Commission issuing a
determination that the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements, and related financial
recordkeeping requirements, for non-U.S. nonbank SDs and/or non-U.S.
nonbank MSPs are comparable to the corresponding CFTC Capital Rules and
CFTC Financial Reporting Rules. The Commission will issue a Capital
Comparability Determination in the form of a Commission order
(``Capital Comparability Determination Order'').\18\
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\17\ 17 CFR 23.106. Commission Regulation 23.106(a)(1) provides
that a request for a Capital Comparability Determination may be
submitted by a non-U.S. nonbank SD or a non-U.S. nonbank MSP, a
trade association or other similar group on behalf of its SD or MSP
members, or a foreign regulatory authority that has direct
supervisory authority over one or more non-U.S. nonbank SDs or non-
U.S. nonbank MSPs. In addition, Commission regulations provide that
any non-U.S. nonbank SD or non-U.S. nonbank MSP that is dually-
registered with the Commission as a futures commission merchant
(``FCM'') is subject to the capital requirements of Commission
Regulation 1.17 (17 CFR 1.17) and may not petition the Commission
for a Capital Comparability Determination. See 17 CFR 23.101(a)(5)
and (b)(4), respectively. Furthermore, non-U.S. bank SDs and non-
U.S. bank MSPs may not petition the Commission for a Capital
Comparability Determination with respect to their respective
financial reporting requirements under Commission Regulation
23.105(p) (17 CFR 23.105(p)). Commission staff has issued, however,
a time-limited no-action letter stating that the Market Participants
Division will not recommend enforcement action against a non-U.S.
bank SD that files with the Commission certain financial information
that is provided to its home country regulator in lieu of certain
financial reports required by Commission Regulation 23.105(p). See
CFTC Staff Letter 21-18, issued on August 31, 2021.
\18\ 17 CFR 23.106(a)(3).
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The Commission's approach for conducting a Capital Comparability
Determination with respect to the CFTC Capital Rules and the CFTC
Financial Reporting Rules is a principles-based, holistic approach that
focuses on whether the applicable foreign jurisdiction's capital and
financial reporting requirements achieve comparable outcomes to the
corresponding CFTC requirements.\19\ In this regard, the approach is
not a line-by-line assessment or comparison of a foreign jurisdiction's
regulatory requirements with the Commission's requirements.\20\ In
performing the analysis, the Commission recognizes that jurisdictions
may adopt differing approaches to achieving comparable outcomes, and
the Commission will focus on whether the foreign jurisdiction's capital
and financial reporting requirements are comparable to the Commission's
in purpose and effect, and not whether they are comparable in every
aspect or contain identical elements.
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\19\ See 85 FR 57462 at 57521.
\20\ Id.
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A person requesting a Capital Comparability Determination is
required to submit an application to the Commission containing: (i) a
description of the objectives of the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements applicable to
entities that are subject to the CFTC Capital Rules and the CFTC
Financial Reporting Rules; (ii) a description (including specific legal
and regulatory provisions) of how the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements address
[[Page 41776]]
the elements of the CFTC Capital Rules and CFTC Financial Reporting
Rules, including, at a minimum, the methodologies for establishing and
calculating capital adequacy requirements and whether such
methodologies comport with any international standards; and (iii) a
description of the ability of the relevant foreign regulatory authority
to supervise and enforce compliance with the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements.
The applicant must also submit, upon request, such other information
and documentation as the Commission deems necessary to evaluate the
comparability of the capital adequacy and financial reporting
requirements of the foreign jurisdiction.\21\
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\21\ 17 CFR 23.106(a)(2).
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The Commission may consider all relevant factors in making a
Capital Comparability Determination, including: (i) the scope and
objectives of the relevant foreign jurisdiction's capital and financial
reporting requirements; (ii) whether the relevant foreign
jurisdiction's capital and financial reporting requirements achieve
comparable outcomes to the Commission's corresponding capital
requirements and financial reporting requirements; (iii) the ability of
the relevant foreign regulatory authority or authorities to supervise
and enforce compliance with the relevant foreign jurisdiction's capital
adequacy and financial reporting requirements; and (iv) any other facts
or circumstances the Commission deems relevant, including whether the
Commission and foreign regulatory authority or authorities have a
memorandum of understanding (``MOU'') or similar arrangement that would
facilitate supervisory cooperation.\22\
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\22\ See 17 CFR 23.106(a)(3) and 85 FR 57520-57522.
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In performing the comparability assessment for foreign nonbank SDs,
the Commission's review will include the extent to which the foreign
jurisdiction's requirements address: (i) the process of establishing
minimum capital requirements for nonbank SDs and how such process
addresses risk, including market risk and credit risk of the nonbank
SD's on-balance sheet and off-balance sheet exposures; (ii) the types
of equity and debt instruments that qualify as regulatory capital in
meeting minimum requirements; (iii) the financial reports and other
financial information submitted by a nonbank SD to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank SD; and (iv) the regulatory
notices and other communications between a nonbank SD and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank's SDs compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
In performing the comparability assessment for foreign nonbank
MSPs,\23\ the Commission's review will include the extent to which the
foreign jurisdiction's requirements address: (i) the process of
establishing minimum capital requirements for a nonbank MSP and how
such process establishes a minimum level of capital to ensure the
safety and soundness of the nonbank MSP; (ii) the financial reports and
other financial information submitted by a nonbank MSP to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank MSP; and (iii) the regulatory
notices and other communications between a nonbank MSP and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank MSPs' compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
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\23\ Commission Regulation 23.101(b) requires a nonbank MSP to
maintain positive tangible net worth. There are no MSPs currently
registered with the Commission. 17 CFR 23.101(b).
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Commission Regulation 23.106 further provides that the Commission
may impose any terms or conditions that it deems appropriate in issuing
a Capital Comparability Determination.\24\ Any specific terms or
conditions with respect to capital adequacy or financial reporting
requirements will be set forth in the Commission's Capital
Comparability Determination Order. As a general condition to all
Capital Comparability Determination Orders, the Commission expects to
require notification from applicants of any material changes to
information submitted by the applicants in support of a comparability
finding, including, but not limited to, changes in the relevant foreign
jurisdiction's supervisory or regulatory regime.
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\24\ See 17 CFR 23.106(a)(5).
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The Commission's capital adequacy and financial reporting
requirements are designed to address and manage risks that arise from a
firm's operation as a SD or MSP. Given their functions, both sets of
requirements and rules must be applied on an entity-level basis
(meaning that the rules apply on a firm-wide basis, irrespective of the
type of transactions involved) to effectively address risk to the firm
as a whole. Therefore, in order to rely on a Capital Comparability
Determination, a nonbank SD or nonbank MSP domiciled in the foreign
jurisdiction and subject to supervision by the relevant regulatory
authority (or authorities) in the foreign jurisdiction must file a
notice with the Commission of its intent to comply with the applicable
capital adequacy and financial reporting requirements of the foreign
jurisdiction set forth in the Capital Comparability Determination in
lieu of all or parts of the CFTC Capital Rules and/or CFTC Financial
Reporting Rules.\25\ Notices must be filed electronically with the
Commission's Market Participants Division (``MPD'').\26\ The filing of
a notice by a non-U.S. nonbank SD or non-U.S. nonbank MSP provides MPD
staff, acting pursuant to authority delegated by the Commission,\27\
with the opportunity to engage with the firm and to obtain
representations that it is subject to, and complies with, the laws and
regulations cited in the Capital Comparability Determination and that
it will comply with any listed conditions. MPD will issue a letter
under its delegated authority from the Commission confirming that the
non-U.S. nonbank SD or non-U.S. nonbank MSP may comply with foreign
laws and regulations cited in the Capital Comparability Determination
in lieu of
[[Page 41777]]
complying with the CFTC Capital Rules and the CFTC Financial Reporting
Rules upon MPD's determination that the firm is subject to and complies
with the applicable foreign laws and regulations, is subject to the
jurisdiction of the applicable foreign regulatory authority (or
authorities), and can meet any conditions in the Capital Comparability
Determination.
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\25\ 17 CFR 23.106(a)(4).
\26\ Notices must be filed in electronic form to the following
email address: <a href="/cdn-cgi/l/email-protection#a7eaf7e3e1cec9c6c9c4cec6cbf5c2d6d2ced5c2cac2c9d3d4e7c4c1d3c489c0c8d1"><span class="__cf_email__" data-cfemail="2d607d696b44434c434e444c417f485c58445f48404843595e6d4e4b594e034a425b">[email protected]</span></a>.
\27\ See 17 CFR 140.91(a)(11).
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Each non-U.S. nonbank SD and/or non-U.S. nonbank MSP that receives,
in accordance with the applicable Commission Capital Comparability
Determination Order, confirmation from the Commission that it may
comply with a foreign jurisdiction's capital adequacy and/or financial
reporting requirements will be deemed by the Commission to be in
compliance with the corresponding CFTC Capital Rules and/or CFTC
Financial Reporting Rules.\28\ Accordingly, if a nonbank SD or nonbank
MSP fails to comply with the foreign jurisdiction's capital adequacy
and/or financial reporting requirements, the Commission may initiate an
action for a violation of the corresponding CFTC Capital Rules and or
CFTC Financial Reporting Rules.\29\ In addition, a non-U.S. nonbank SD
or non-U.S. nonbank MSP that receives confirmation of its ability to
use substituted compliance remains subject to the Commission's
examination and enforcement authority.\30\
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\28\ 17 CFR 23.106(a)(4).
\29\ Id.
\30\ Id.
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The Commission will consider an application for a Capital
Comparability Determination to be a representation by the applicant
that the laws and regulations of the foreign jurisdiction that are
submitted in support of the application are finalized and in force,
that the description of such laws and regulations is accurate and
complete, and that, unless otherwise noted, the scope of such laws and
regulations encompasses the relevant non-U.S. nonbank SDs and/or non-
U.S. nonbank MSPs domiciled in the foreign jurisdiction.\31\ A non-U.S.
nonbank SD or non-U.S. nonbank MSP that is not legally required to
comply with a foreign jurisdiction's laws or regulations determined to
be comparable in a Capital Comparability Determination may not
voluntarily comply with such laws or regulations in lieu of compliance
with the CFTC Capital Rules or the CFTC Financial Reporting Rules. Each
non-U.S. nonbank SD or non-U.S. nonbank MSP that seeks to rely on a
Capital Comparability Determination Order is responsible for
determining whether it is subject to the foreign laws and regulations
found comparable in the Capital Comparability Determination and the
Capital Comparability Determination Order.
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\31\ The Commission has provided the Applicants with an
opportunity to review for accuracy and completeness, and comment on,
the Commission's description of relevant EU laws and regulations on
which this proposed Capital Comparability Determination is based.
The Commission relies on this review and any corrections received
from the Applicants in making its proposal. Thus, to the extent that
the Commission relies on an inaccurate description of foreign laws
and regulations submitted by the Applicants, the comparability
determination may not be valid.
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C. Application for a Capital Comparability Determination for Certain EU
Nonbank Swap Dealers
The Applicants submitted the EU Application requesting that the
Commission issue a Capital Comparability Determination finding that an
EU nonbank SD's compliance with the capital requirements of the EU and
the financial reporting requirements of the EU, as specified in the EU
Application, satisfies corresponding CFTC Capital Rules and the CFTC
Financial Reporting Rules applicable to a nonbank SD under Sections
4s(e)-(f) of the CEA and Commission Regulations 23.101 and 23.105.\32\
There are currently four EU nonbank SDs registered with the Commission:
BofA Securities Europe SA and Goldman Sachs Paris Inc. et Cie are
organized and domiciled in France; Citigroup Global Markets Europe AG
and Morgan Stanley Europe SE are organized and domiciled in Germany.
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\32\ EU Application, p. 1. There are currently no MSPs
registered with the Commission, and the Applicants have not
requested that the Commission issue a Capital Comparability
Determination concerning EU nonbank MSPs. Accordingly, the
Commission's Capital Comparability Determination and proposed
Capital Comparability Determination Order do not address EU nonbank
MSPs.
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The capital and financial reporting framework applicable to EU
financial institutions is established by EU regulations and directives.
Specifically, the Capital Requirements Regulation \33\ and the Capital
Requirements Directive \34\ set forth capital and financial reporting
requirements applicable to entities defined as ``credit institutions''
or ``investment firms,'' including EU nonbank SDs.
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\33\ Regulation (EU) No 575/2013 of the European Parliament and
of the Council of 26 June 2013 on prudential requirements for credit
institutions and amending Regulation (EU) No 648/2012, as amended
(``Capital Requirements Regulation'' or ``CRR'').
\34\ Directive 2013/36/EU of the European Parliament and of the
Council of 26 June 2013 on access to the activity of credit
institutions and the prudential supervision of credit institutions,
amending Directive 2002/87/EC and repealing Directives 2006/48/EC
and 2006/49/EC, as amended (``Capital Requirements Directive'' or
``CRD'').
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The term ``credit institution'' includes an entity engaged in
taking deposits or other repayable funds from the public and granting
credits for its own account (``Banking Activities'').\35\ An entity
engaged in Banking Activities is subject to the capital and financial
reporting requirements of CRR and CRD.
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\35\ CRR, Article 4(1)(1) (defining the term ``credit
institution'').
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The term ``credit institution'' also includes an entity engaged in
(i) dealing for its own account, (ii) underwriting financial
instruments, or (iii) placing financial instruments on a firm
commitment basis (collectively, ``Investment Activities''), provided
that the entity also meets certain defined financial thresholds set
forth in the definition.\36\ Specifically, an entity engaged in
Investment Activities that maintains a total value of consolidated
assets equal to or in excess of EUR 30 billion is required to be
authorized as a ``credit institution'' and is subject to the capital
and financial reporting requirements of CRR and CRD.\37\
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\36\ Id.
\37\ Id. and CRD, Articles 8 and 8a (requiring an entity that
engages in Investment Activities and meets the financial thresholds
to submit an application for authorization as a ``credit
institution'' under the relevant provisions of the applicable
national law).
CRR, Article 4(1)(1) provides that an entity carrying out
Investment Activities meets the financial threshold for
authorization as a credit institution if: (i) the total value of the
consolidated assets of the entity is equal to or in excess of EUR 30
billion; (ii) the total value of the assets of the entity is less
than EUR 30 billion, and the entity is part of a group in which the
total value of the consolidated assets of all entities in that group
that individually have total assets of less than EUR 30 billion and
that engage in Investment Activities is equal to or in excess of EUR
30 billion; or (iii) the total value of the assets of the entity is
less than EUR 30 billion, and the entity is part of a group in which
the total value of the consolidated assets of all entities in the
group that engage in Investment Activities is equal to or in excess
of EUR 30 billion, where the consolidated supervisor, in
consultation with the supervisory college, decides that the entity
must be authorized as a credit institution in order to address
potential risks of circumvention and potential risks for financial
stability of the EU.
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Credit institutions that qualify as ``significant supervised
entities'' are subject to the direct prudential supervision of the
European Central Bank (``ECB'').\38\ Credit institutions that
[[Page 41778]]
are ``less significant supervised entities'' are prudentially
supervised by the applicable prudential supervisory authority in the
entity's home EU Member State (``national competent authority'').\39\
The term ``competent authority'' is used in this document to refer to
the ECB or the national competent authority, as appropriate.
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\38\ See generally, Council Regulation (EU) 1024/2013 of 15
October 2013 Conferring Specific Tasks to the European Central Bank
Concerning Policies Relating to the Prudential Supervision of Credit
Institutions (''SSM Regulation'') and Regulation (EU) No 468/2014 of
the European Central Bank of 16 April 2014 Establishing the
Framework for Cooperation within the Single Supervisory Mechanism
Between the European Central Bank and the National Competent
Authorities and with National Designated Authorities (''SSM
Framework Regulation'').
The criteria for determining whether credit institutions are
considered ``significant supervised entities'' include size,
economic importance for the specific EU Member State or the EU
economy, significance of cross-border activities, and request for or
receipt of direct public financial assistance. See SSM Regulation,
Article 6 and SSM Framework Regulation, Articles 39-44 and 50-62.
\39\ SSM Regulation, Article 6. Less significant entities are
supervised by their national competent authorities in close
cooperation with the ECB. With respect to the prudential supervision
of less significant entities, the ECB has the power to issue
regulations, guidelines or general instructions to the national
competent authorities. SSM Regulation, Article 6(5)(a). At any time,
the ECB can also decide to directly supervise a less significant
entity to ensure that high supervisory standards are applied
consistently. SSM Regulation, Article 6(5)(b).
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The term ``investment firm'' is defined as an entity authorized
under the Markets in Financial Instruments Directive,\40\ and whose
regular business is the provision of one or more investment services to
third parties and/or the performance of one or more investment-related
activities on a professional basis (including Investment Activities as
defined above).\41\ An investment firm that engages in Investment
Activities and maintains total consolidated assets of at least EUR 15
billion is also subject to the capital and financial reporting
requirements of CRR and CRD.\42\ The investment firm, however, is not
required to be authorized as a ``credit institution'' under the
relevant provisions of the applicable national law in the EU Member
State and is prudentially supervised by the national competent
authority.
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\40\ Directive 2014/65/EU of the European Parliament and of the
Council of 15 May 2014 on markets in financial instruments and
amending Directive 2002/92/EC and Directive 2011/61/EU (``Markets in
Financial Instruments Directive'' or ``MiFID'').
\41\ CRR, Article 4(1)(2) cross-referencing Article 4(1)(1) of
MiFID.
\42\ See Regulation (EU) 2019/2033 of the European Parliament
and of the Council of 27 November 2019 on the prudential
requirements of investment firms and amending Regulations (EU) No
1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014
(``Investment Firms Regulation'' or ``IFR''), Article 1(1) and
(1)(2) (indicating that an investment firm that engages in
Investment Activities is subject to CRR (and by cross-reference to
CRD) if any of the following applies: (i) the total value of the
consolidated assets of the investment firm is equal to or exceeds
EUR 15 billion; (ii) the total value of the consolidated assets of
the investment firm is less than EUR 15 billion, and the investment
firm is part of a group in which the total value of the consolidated
assets of all investment firms in the group that individually have
total assets of less than EUR 15 billion and that engage in
Investment Activities is equal to or exceeds EUR 15 billion; or
(iii) the total value of the consolidated assets of the investment
firm is equal to or exceeds EUR 5 billion, the investment firm
engages in Investment Activities, and the competent authority has
determined that the investment firm should be subject to CRR based
on criteria set forth in Article 5 of Directive (EU) 2019/2034). See
also, Directive (EU) 2019/2034 of the European Parliament and of the
Council of 27 November 2019 on the prudential supervision of
investment firms and amending Directives 2002/87/EC, 2009/65/EC,
2011/61/EU, 2013/36/EU, 2014/59/EU and 2014/65/EU (``Investment
Firms Directive'' or ``IFD''), Article 5 (providing that the
competent authority may decide to apply the requirements of CRR to
an investment firm whose consolidated assets are equal or exceed EUR
5 billion and that engages in Investment Activities if one or more
of the following criteria apply: (i) the investment firm engages in
Investment Activities on a scale that the failure or distress of the
investment firm could lead to systemic risk; (ii) the investment
firm is a clearing member; and/or (iii) the competent authority
considers it to be justified in light of the size, nature, scale and
complexity of the activities of the investment firm considering the
importance of the investment firm for the economy of the EU or of
the relevant EU Member State, the significance of the investment
firm's cross-border activities, and the interconnectedness of the
investment firm with the financial system).
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Lastly, an entity defined as an ``investment firm'' that does not
engage in Investment Activities, or that engages in Investment
Activities but does not meet the criteria of either maintaining
consolidated assets of at least EUR 15 billion or maintaining
consolidated assets of at least EUR 5 billion and meeting certain
criteria of significance and interconnectedness, is not subject to CRR
and CRD.\43\ Such an investment firm is subject to new capital and
financial reporting requirements established by IFR and IFD, which EU
Member States were required to adopt and apply by June 26, 2021.\44\
The new IFR and IFD capital and financial reporting requirements are
tailored to the risks faced and posed by smaller investment firms that
operate differently from banking entities and larger investment firms.
Such smaller investment firms are also prudentially supervised by the
national competent authority.
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\43\ See IFD, Article 5 (setting forth the criteria that may
justify a decision by the competent authority to apply the
requirements of CRR to an investment firm that engages in Investment
Activities and whose consolidated assets equal or exceed EUR 5
billion).
\44\ IFR, Article 66 and IFD, Article 67.
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The four EU nonbank SDs currently registered with the Commission
are subject to CRR and CRD.\45\ The EU Application does not include an
analysis of the comparability of the capital and financial reporting
rules under the IFR and IFD to the CFTC Capital Rules and CFTC
Financial Reporting Rules. Therefore, the Commission is not assessing
the comparability of the capital and financial reporting requirements
imposed by IFR and IFD on smaller investment firms with the CFTC
Capital Rules and CFTC Financial Reporting Rules. Thus, an EU nonbank
SD, or a future EU nonbank SD applicant, that is subject to the IFR and
IFD framework and seeks substituted compliance for some or all of the
CFTC Capital Rules and CFTC Financial Reporting Rules must submit an
application to the Commission in accordance with Commission Regulation
23.106.\46\ The application must include a description of how IFR and
IFD address the elements of the Commission's capital adequacy and
financial reporting requirements for nonbank SDs, including, at a
minimum, the methodologies for establishing and calculating capital
adequacy requirements.\47\
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\45\ BofA Securities Europe SA, Citigroup Global Markets Europe
AG and Morgan Stanley Europe SE have been authorized as credit
institutions. The three EU nonbank SDs also qualify as ``significant
supervised entities'' subject to the direct supervision of the ECB.
Goldman Sachs Paris Inc. et Cie has a pending application for
authorization as a credit institution. CRD, Article 8a allows
entities engaged in Investment Activities to continue carrying out
such activities until they obtain authorization as credit
institutions. The Applicants represented that Goldman Sachs Paris
Inc et Cie would likely be a categorized as a ``less significant
supervised entity'' and subject to direct supervision by the
national competent authority. According to the Applicants, however,
the ECB is still considering whether it may exercise direct
supervisory authority over the entity, pursuant to SSM Regulation,
Article 6. See Responses to Staff Questions of May 15, 2023.
\46\ 17 CFR 23.106.
\47\ Commission Regulation 23.106(a)(2)(ii). 17 CFR
23.106(a)(2)(ii).
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In addition, as noted above, the four EU nonbank SDs that are
currently registered with the Commission are domiciled in the EU Member
States of France and Germany. As further described below, the
Commission's analysis therefore involves an assessment of how certain
EU directives were implemented into the national laws of France and
Germany. The Commission has not reviewed the implementation of the
relevant EU directives in other EU Member States. Therefore, an entity
organized and domiciled in an EU Member State other than France or
Germany that seeks to register with the Commission as an SD and to
comply with some or all of the Commission's capital and financial
reporting rules via substituted compliance would have to submit an
application for a Capital Comparability Determination under Commission
Regulation 23.106. Commission staff expects that it will engage with
such entities during the registration process
[[Page 41779]]
and rely to the extent practicable on the analysis performed in this
document to assess the comparability of the applicant's home country
capital and financial reporting requirements with the Commission's
corresponding requirements.
As noted above, the EU nonbank SDs currently registered with the
Commission are subject to CRR and CRD. CRR, as a regulation, is binding
in its entirety and directly applicable in all EU Member States.\48\
CRD, as a directive, was required to be transposed into EU Member
States' national law.\49\ France implemented CRD in various provisions
of its Monetary and Financial Code (``MFC'') \50\ and through several
ministerial orders, including Ministerial Order on Capital Buffers \51\
and Ministerial Order on Internal Control.\52\ France also adopted
Ministerial Order on Distribution Restrictions \53\ and amended
relevant national law provisions, including the above-referenced
ministerial orders, to implement CRD V.\54\ Germany implemented CRD via
amendments to the Banking Act (Kreditwesengesetz, ``KWG'') and its
subordinate statutory instruments.\55\ In addition, Germany adopted and
published the Risk Reduction Act (Risikoreduzierungsgesetz, ``RiG'') on
December 14, 2020 to implement CRD V, with most of the relevant changes
becoming effective on December 28, 2020. CRR and CRD as implemented in
French and German law are collectively referred to hereafter as the
``EU Capital Rules.''
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\48\ Consolidated Version of the Treaty on the Functioning of
the European Union, OJ (C 326) 171, Oct. 26, 2012 (``TFEU''),
Article 288. Accordingly, CRR is directly applicable and binding law
in France and Germany, the two EU Member States where EU nonbank SDs
are currently organized and operating. Most CRR requirements,
including provisions introduced by Regulation (EU) 2019/876 of the
European Parliament and of the Council of 20 May 2019 amending
Regulation (EU) No 575/2013 (``CRR II''), have been in effect since
June 28, 2021, with some provisions having an earlier effective
date. CRR II, Article 3. Several provisions have a delayed effective
date. These include market risk-related amendments to CRR, Article
106 (Internal Hedges) and new Article 204a (Eligible Types of Equity
Derivatives), which will come into effect on June 28, 2023. Id.
\49\ TFEU, Article 288 (stating that a directive is binding as
to the result to be achieved upon each EU Member State to which the
directive is addressed, and further provides, however, that each EU
Member State elects the form and method of implementing the
directive). In this connection, EU Member States were required to
implement and start applying amendments to CRD, introduced by
Directive (EU) 2019/878 of the European Parliament and of the
Council of 20 May 2019 amending Directive 2013/36/EU as regards
exempted entities, financial holding companies, mixed financial
holding companies, remuneration, supervisory measures and powers and
capital conservation measures (``CRD V'') by December 29, 2020. Some
CRD V provisions were subject to delayed implementation deadlines of
June 28, 2021 and January 1, 2022, but all CRD V provisions are
currently effective. CRD V, Article 2.
\50\ In particular, MFC, Articles L.511-41 to L.511-50-1 contain
provisions relating to prudential requirements applicable to credit
institutions. In addition, MFC, Articles L.612-1 to L.612-50 relate
to the role, functioning, and powers of the national competent
authority.
\51\ Arr[ecirc]t[eacute] of 3 November 2014 Relating to Capital
Buffers of Banking Services Providers and Investment Firms Other
Than Portfolio Management Companies.
\52\ Arr[ecirc]t[eacute] of 3 November 2014 on Internal Control
of Companies in the Banking, Payment Services and Investment
Services Sector Subject to the Control of Autorit[eacute] de
Contr[ocirc]le Prudentiel et de R[eacute]solution.
\53\ Arr[ecirc]t[eacute] of 25 February 2021 Relating to
Distribution Restrictions Applicable to Credit Institutions,
Financial Companies and Certain Investment Firms.
\54\ Specifically, to implement CRD V, France amended the MFC
via Ordinance No. 2020-1635 of December 21, 2020 and Decree No.
2020-1637 of December 22, 2020, with most of the relevant changes
becoming effective on December 29, 2020. France also introduced
consecutive amendments to Ministerial Order on Capital Buffers and
Ministerial Order on Internal Control, with the latest changes
effective as of August 1, 2021.
\55\ Specifically, the KWG includes, among other things,
provisions related to capital adequacy requirements, including
provisions granting power the Federal Ministry of Finance to issue
statutory instruments to provide details on capital adequacy
requirements (Section 10(1)), provisions specifying the basis for
imposing higher capital requirements (Section 10(3)), provisions
setting forth requirements related to capital buffers (Sections 10c
to 10i) and provisions describing the powers of the competent
authority (Sections 6b, 56, 60b).
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The Applicants also represent that in addition to CRR and CRD, the
Bank Recovery and Resolution Directive (``BRRD'') includes relevant EU
capital requirements.\56\ BRRD establishes a framework for recovery and
resolution of credit institutions and investment firms, and mandates
that EU Member States require such institutions to satisfy ``a minimum
requirement for own funds and eligible liabilities'' (``MREL'') if they
meet certain requirements.\57\ France implemented BRRD primarily via
amendments to the MFC.\58\ Germany transposed BRRD into national law by
the Recovery and Resolution Act (Sanierungs und Abwicklungsgesetz,
``SAG'').\59\
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\56\ Directive 2014/59/EU of the European Parliament and of the
Council of 15 May 2014 establishing a framework for the recovery and
resolution of credit institutions and investment firms and amending
Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC,
2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/
36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of
the European Parliament and of the Council. See EU Application, p.
5.
\57\ EU Member States were required to transpose BRRD into
national law and start applying the implementing measures from
January 1, 2015. BRRD, Article 130. BRRD was amended by Directive
(EU) 2019/879 of the European Parliament and of the Council of 20
May 2019 amending Directive 2014/59/EU as regards loss-absorbing and
recapitalization capacity of credit institutions and investment
firms and Directive 98/26/EC (``Bank Recovery and Resolution
Directive II'' or ``BRRD II'') and EU Member States were required to
start applying national law measures implementing BRRD II by
December 28, 2020. BRRD II, Article 3. BRRD as amended by BRRD II
will be referred to as ``BRRD'' in this document, unless otherwise
stated.
\58\ Among other provisions, MFC Article L.613-44 relates in
particular to the MREL requirement and Article R.613-46-1 defines
the conditions that items and instruments need to meet to qualify as
``eligible liabilities.''
\59\ In particular, SAG, Section 49(1) and (2) relate to the
MREL requirement.
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The Applicants further represent that with respect to supervisory
financial reporting, Commission Implementing Regulation (EU) 2021/451
\60\ supplements CRR with implementing technical standards (``CRR
Reporting ITS'') specifying, among other things, uniform formats and
frequencies for the financial reporting required under CRR.\61\ In
addition, the ECB has adopted a regulation setting forth a common
minimum set of financial information that should be reported by credit
institutions subject to CRR, including EU nonbank SDs, on the basis of
the CRR Reporting ITS (``ECB FINREP Regulation'').\62\ The Applicants
also represent that Directive 2013/34/EU \63\ contains provisions
related to financial reporting, including a mandate that entities of a
certain size be required to prepare annual audited financial statements
and a management report.\64\ CRR, CRR Reporting ITS, ECB FINREP
Regulation, relevant provisions of CRD regarding certain notice
requirements as implemented in French and German law, and the relevant
provisions of the Accounting Directive as implemented in French and
German law are collectively referred to hereafter as the ``EU Financial
Reporting Rules.''
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\60\ Commission Implementing Regulation (EU) 2021/451 of 17
December 2020 laying down implementing technical standards for the
application of Regulation (EU) No 575/2013 of the European
Parliament and of the Council with regard to supervisory reporting
of institutions and repealing Implementing Regulation (EU) No 680/
2014.
\61\ EU Application, p. 21 and Responses to Staff Questions of
May 15, 2023.
\62\ Regulation (EU) 2015/534 of the European Central Bank of 17
March 2015 on reporting of supervisory financial information.
\63\ Directive 2013/34/EU of the European Parliament and of the
Council of 26 June 2013 on the annual financial statements,
consolidated financial statements and related reports of certain
types of undertakings, amending Directive 2006/43/EC of the European
Parliament and of the Council and repealing Council Directives 78/
660/EEC and 83/394/EEC (``Accounting Directive'').
\64\ EU Application, p. 5. Accounting Directive, Articles 4, 19
and 34.
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The Applicants also note that the U.S. Securities and Exchange
Commission (``SEC'') has issued orders permitting an SEC-registered
nonbank security-based swap dealer domiciled in France or
[[Page 41780]]
Germany (``EU nonbank SBSD'') to satisfy SEC capital \65\ and financial
reporting requirements via substituted compliance with applicable
French and German capital and financial reporting.\66\ The French Order
and German Order conditioned substituted compliance for capital
requirements on an EU nonbank SBSD complying with specified laws and
regulations, including CRR, CRD, and BRRD, and also maintaining total
liquid assets in an amount that exceeds the EU nonbank SBSD's total
liabilities by at least $100 million and by at least $20 million after
applying certain deductions to the value of the liquid assets to
reflect market, credit, and other potential risks to the value of the
assets.\67\
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\65\ Section 15F(e)(1)(B) of the Exchange Act (15 U.S.C. 78o-10)
directs the SEC to adopt capital rules for security-based swap
dealers (``SBSDs'') that do not have a prudential regulator.
\66\ See Amended and Restated Order Granting Conditional
Substituted Compliance in Connection with Certain Requirements
Applicable to Non-U.S. Security-Based Swap Dealers and Major
Security-Based Swap Participants Subject to Regulation in the
Federal Republic of Germany; Amended Orders Addressing Non-U.S.
Security-Based Swap Entities Subject to Regulation in the French
Republic or the United Kingdom; and Order Extending the Time to Meet
Certain Conditions Relating to Capital and Margin, 86 FR 59797 (Oct.
28, 2021) (``German Order''); Order Granting Conditional Substituted
Compliance in Connection with Certain Requirements Applicable to
Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap
Participants Subject to Regulation in the French Republic, 86 FR
41612 (Aug. 8, 2021) (``French Order''); and Order Specifying the
Manner and Format of Filing Unaudited Financial and Operational
Information by Security-Based Swap Dealers and Major Security-Based
Swap Participants that are not U.S. Persons and are Relying on
Substituted Compliance with Respect to Rule 18a-7, 86 FR 59208 (Oct.
26, 2021) (``SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information'').
\67\ The conditioning of the German and French substituted
compliance orders on EU nonbank SBSDs maintaining liquid assets in
an amount that exceeds the EU nonbank SBSD's total liabilities by at
least $100 million and by at least $20 million after applying
certain deductions to the value of the liquid assets reflects that
the SEC's capital rule for nonbank SBSDs is a liquidity-based
requirement and that the SEC capital requirements are not based on
the Basel bank capital standards. See 17 CFR 240.18a-1(a)(1)
(requiring a SBSD to maintain, in relevant part, net capital of $20
million or, if approved to use capital models, $100 million of
tentative net capital and $20 million of net capital).
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II. General Overview of Commission and EU Nonbank Swap Dealer Capital
Rules
A. General Overview of the CFTC Nonbank Swap Dealer Capital Rules
The CFTC Capital Rules provide nonbank SDs with three alternative
capital approaches: (i) the Tangible Net Worth Capital Approach (``TNW
Approach''); (ii) the Net Liquid Assets Capital Approach (``NLA
Approach''); and (iii) the Bank-Based Capital Approach (``Bank-Based
Approach'').\68\
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\68\ 17 CFR 23.101.
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Nonbank SDs that are ``predominantly engaged in non-financial
activities'' may elect the TNW Approach.\69\ The TNW Approach requires
a nonbank SD to maintain a level of ``tangible net worth'' \70\ equal
to or greater than the higher of: (i) $20 million plus the amount of
the nonbank SD's ``market risk exposure requirement'' \71\ and ``credit
risk exposure requirement'' \72\ associated with the nonbank SD's swap
and related hedge positions that are part of the nonbank SD's swap
dealing activities; (ii) 8 percent of the nonbank SD's ``uncleared swap
margin'' amount; \73\ or (iii) the amount of capital required by a
registered futures association of which the nonbank SD is a member.\74\
The TNW Approach is intended to ensure the safety and soundness of a
qualifying nonbank SD by requiring the firm to maintain a minimum level
of tangible net worth that is based on the nonbank SD's swap dealing
activities to provide a sufficient level of capital to absorb losses
resulting from its swap dealing and other business activities.
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\69\ 17 CFR 23.101(a)(2). The term ``predominantly engaged in
non-financial activities'' is defined in Commission Regulation
23.100 and generally provides that: (i) the nonbank SD's, or its
parent entity's, annual gross financial revenues for either of the
previous two completed fiscal years represents less than 15 percent
of the nonbank SD's or the nonbank SD's parent's, annual gross
revenues for all operations (i.e., commercial and financial) for
such years; and (ii) the nonbank SD's, or its parent entity's, total
financial assets at the end of its two most recently completed
fiscal years represents less than 15 percent of the nonbank SD's, or
its parent's, total consolidated financial and nonfinancial assets
as of the end of such years. 17 CFR 23.100.
\70\ The term ``tangible net worth'' is defined in Commission
Regulation 23.100 and generally means the net worth (i.e., assets
less liabilities) of a nonbank SD, computed in accordance with
applicable accounting principles, with assets further reduced by a
nonbank SD's recorded goodwill and other intangible assets. 17 CFR
23.100.
\71\ The terms ``market risk exposure'' and ``market risk
exposure requirement'' are defined in Commission Regulation 23.100
and generally mean the risk of loss in a financial position or
portfolio of financial positions resulting from movements in market
prices and other factors. 17 CFR 23.100. Market risk exposure is the
sum of: (i) general market risks including changes in the market
value of a particular asset that results from broad market
movements, which may include an additive for changes in market value
under stressed conditions; (ii) specific risk, which includes risks
that affect the market value of a specific instrument but do not
materially alter broad market conditions; (iii) incremental risk,
which means the risk of loss on a position that could result from
the failure of an obligor to make timely payments of principal and
interest; and (iv) comprehensive risk, which is the measure of all
material price risks of one or more portfolios of correlation
trading positions.
\72\ The term ``credit risk exposure requirement'' is defined in
Commission Regulation 23.100 and generally reflects the amount at
risk if a counterparty defaults before the final settlement of a
swap transaction's cash flows. 17 CFR 23.100.
\73\ The term ``uncleared swap margin'' is defined in Commission
Regulation 23.100 to generally mean the amount of initial margin
that a nonbank SD would be required to collect from each
counterparty for each outstanding swap position of the nonbank SD.
17 CFR 23.100. A nonbank SD must include all swap positions in the
calculation of the uncleared swap margin amount, including swaps
that are exempt or excluded from the scope of the Commission's
uncleared swap margin regulations. A nonbank SD must compute the
uncleared swap margin amount in accordance with the Commission's
margin rules for uncleared swaps. See 17 CFR 23.154.
\74\ The National Futures Association (``NFA'') is currently the
only entity that is a registered futures association. The Commission
will refer to NFA in this document when referring to the
requirements or obligations of a registered futures association.
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The TNW approach requires a nonbank SD to compute its market risk
exposure requirement and credit risk exposure requirement using
standardized capital charges set forth in SEC Rule 18a-1 \75\ that are
applicable to entities registered with the SEC as SBSDs or standardized
capital charges set forth in Commission Regulation 1.17 applicable to
entities registered as FCMs or entities dually-registered as an FCM and
nonbank SD.\76\ Nonbank SDs that have received Commission or NFA
approval pursuant to Commission Regulation 23.102 may use internal
models to compute market risk and/or credit risk capital charges in
lieu of the SEC or CFTC standardized capital charges.\77\
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\75\ 17 CFR 240.18a-1.
\76\ 17 CFR 23.101(a)(2)(ii)(A).
\77\ Id.
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A nonbank SD that elects the NLA Approach is required to maintain
``net capital'' in an amount that equals or exceeds the greater of: (i)
$20 million; (ii) 2 percent of the nonbank SD's uncleared swap margin
amount; or (iii) the amount of capital required by NFA.\78\ The NLA
Approach is intended to ensure the safety and soundness of a nonbank SD
by requiring the firm to maintain at all times at least one dollar of
highly liquid assets to cover each dollar of the nonbank SD's
liabilities.
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\78\ 17 CFR 23.101(a)(1)(ii)(A). ``Net capital'' consists of a
nonbank SD's highly liquid assets (subject to haircuts) less all of
the firm's liabilities, excluding certain qualified subordinated
debt. See 17 CFR 240.18a-1 for the calculation of ``net capital.''
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A nonbank SD is required to reduce the value of its highly liquid
assets by the market risk exposure requirement and/or the credit risk
exposure requirement in computing its net capital.\79\ A nonbank SD
that does not have Commission or NFA approval to use internal models
must compute its market risk exposure requirement and/
[[Page 41781]]
or credit risk exposure requirement using the standardized capital
charges contained in SEC Rule 18a-1 as modified by the Commission's
rule.\80\
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\79\ See 17 CFR 240.18a-1(c) and (d).
\80\ See 17 CFR 23.101(a)(1)(ii).
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A nonbank SD that has obtained Commission or NFA approval, may use
internal market risk and/or credit risk models to compute market risk
and/or credit risk capital charges in lieu of the standardized capital
charges.\81\ A nonbank SD that is approved to use internal market risk
and/or credit risk models is further required to maintain a minimum of
$100 million of ``tentative net capital.'' \82\
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\81\ See 17 CFR 23.102.
\82\ 17 CFR 23.101(a)(1)(ii)(A)(1). The term ``tentative net
capital'' is defined in Commission Regulation 23.101(a)(1)(ii)(A)(1)
by reference to SEC Rule 18a-1 and generally means a nonbank SD's
net capital prior to deducting market risk and credit risk capital
charges.
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The Commission's NLA Approach is consistent with the SEC's SBSD
capital rule, and is based on the Commission's capital rule for FCMs
and the SEC's capital rule for securities broker-dealers (``BDs''). The
quantitative and qualitative requirements for NLA Approach internal
market and credit risk models are also consistent with the quantitative
and qualitative requirements of the Commission's Bank-Based Approach as
described below.
The Commission's Bank-Based Approach for computing regulatory
capital for nonbank SDs is based on certain capital requirements
imposed by the Federal Reserve Board for bank holding companies.\83\
The Bank-Based Approach also is consistent with the Basel Committee on
Banking Supervision's (``BCBS'') international framework for bank
capital requirements.\84\ The Bank-Based Approach requires a nonbank SD
to maintain regulatory capital equal to or in excess of each of the
following requirements: (i) $20 million of common equity tier 1
capital; (ii) an aggregate of common equity tier 1 capital, additional
tier 1 capital, and tier 2 capital (including qualifying subordinated
debt) equal to or greater than 8 percent of the nonbank SD's risk-
weighted assets (provided that common equity tier 1 capital comprises
at least 6.5 percent of the 8 percent minimum requirement); (iii) an
aggregate of common equity tier 1 capital, additional tier 1 capital,
and tier 2 capital equal to or greater than 8 percent of the nonbank
SD's uncleared swap margin amount; and (iv) an amount of capital
required by NFA.\85\ The Bank-Based Approach is intended to ensure that
the safety and soundness of a nonbank SD by requiring the firm to
maintain at all times qualifying capital in an amount sufficient to
absorb unexpected losses, expenses, decrease in firm assets, or
increases in firm liabilities without the firm becoming insolvent.
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\83\ See 17 CFR 23.101(a)(1)(i).
\84\ The BCBS is the primary global standard-setter for the
prudential regulation of banks and provides a forum for cooperation
on banking supervisory matters. Institutions represented on the BCBS
include the Federal Reserve Board, the European Central Bank,
Deutsche Bundesbank, Bank of England, Bank of France, Bank of Japan,
Banco de Mexico, and Bank of Canada. The BCBS framework is available
at <a href="https://www.bis.org/basel_framework/index.htm">https://www.bis.org/basel_framework/index.htm</a>.
\85\ 17 CFR 23.101(a)(1)(i).
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The terms used in the Commission's Bank-Based Approach are defined
by reference to regulations of the Federal Reserve Board.\86\
Specifically, the term ``common equity tier 1 capital'' is defined for
purposes of the CFTC Capital Rules to generally mean the sum of a
nonbank SD's common stock instruments and any related surpluses,
retained earnings, and accumulated other comprehensive income.\87\ The
term ``additional tier 1 capital'' is defined to include equity
instruments that are subordinated to claims of general creditors and
subordinated debt holders, but contain certain provisions that are not
available to common stock, such as the right of nonbank SD to call the
instruments for redemption or to convert the instruments to other forms
of equity.\88\ The term ``tier 2 capital'' is defined to include
certain types of instruments that include both debt and equity
characteristics (e.g., certain perpetual preferred stock instruments
and subordinated term debt instruments).\89\ Subordinated debt also
must meet certain requirements to qualify as tier 2 capital, including
that the term of the subordinated debt instrument is for a minimum of
one year (with the exception of approved revolving subordinated debt
agreements which may have a maturity term that is less than one year),
and the debt instrument is an effective subordination of the rights of
the lender to receive any payment, including accrued interest, to other
creditors.\90\
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\86\ Id. Commission Regulation 23.101(a)(1)(i) references
Federal Reserve Board Rule 217.20 for purposes of defining the terms
used in establishing the minimum capital requirements under the
Bank-Based Approach. 17 CFR 23.101(a)(1)(i) and 12 CFR 217.20.
\87\ See 12 CFR 217.20(b).
\88\ See 12 CFR 217.20(c).
\89\ See 12 CFR 217.20(d).
\90\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B) providing that the subordinated debt used by a
nonbank SD to meet its minimum capital requirement under the Bank-
Based Approach must satisfy the conditions for subordinated debt
under SEC Rule 18a-1d.
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are unencumbered and generally long-term or permanent forms of
capital that help ensure that a nonbank SD will be able to absorb
losses resulting from its operations and maintain confidence in the
nonbank SD as a going concern. In addition, in setting an equity ratio
requirement, this limits the amount of asset growth and leverage a
nonbank SD can incur, as a nonbank SD must fund its asset growth with a
certain percentage of regulatory capital.
A nonbank SD also must compute its risk-weighted assets using
standardized capital charges or, if approved, internal models. Risk-
weighting assets involves adjusting the notional or carrying value of
each asset based on the inherent risk of the asset. Less risky assets
are adjusted to lower values (i.e., have less risk-weight) than more
risky assets. As a result, nonbank SDs are required to hold lower
levels of regulatory capital for less risky assets and higher levels of
regulatory capital for riskier assets.
Nonbank SDs not approved to use internal models to risk-weight
their assets must compute market risk capital charges using the
standardized charges contained in Commission Regulation 1.17 and SEC
Rule 18a-1, and must compute their credit risk charges using the
standardized capital charges set forth in regulations of the Federal
Reserve Board for bank holding companies in Subpart D of 12 CFR part
217.\91\
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\91\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC risk-weighted assets in 17 CFR 23.100.
---------------------------------------------------------------------------
Standardized market risk charges are computed under Commission
Regulation 1.17 and SEC Rule 18a-1 by multiplying, as appropriate to
the specific asset schedule, the notional value or market value of the
nonbank SD's proprietary financial positions (such as swaps, security-
based swaps, futures, equities, and U.S. Treasuries) by fixed
percentages set forth in the Regulation or Rule.\92\ Standardized
credit risk charges require the nonbank SD to multiply on-balance sheet
and off-balance sheet exposures (such as receivables from
counterparties, debt instruments, and exposures from derivatives) by
predefined percentages set forth in the applicable Federal Reserve
Board regulations contained in Subpart D of 12 CFR part 217.
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\92\ See 17 CFR 1.17(c)(5) and 17 CFR 240.15c3-1(c)(2).
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A nonbank SD also may apply to the Commission or NFA for approval
to use internal models to compute market risk exposure and/or credit
risk exposure for
[[Page 41782]]
purposes of determining its total risk-weighted assets.\93\ Nonbank SDs
approved to use internal models for the calculation of credit risk or
market risk, or both, must follow the model requirements set forth in
Federal Reserve Board regulations for bank holding companies codified
in Subpart E and F, respectively, of 12 CFR part 217. Credit risk and
market risk capital charges computed with internal models require the
estimation of potential losses, with a certain degree of likelihood,
within a specified time period, of a portfolio of assets. Internal
models allow for consideration of potential co-movement of prices
across assets in the portfolio, leading to offsets of gains and losses.
Internal credit risk models can also further include estimation of the
likelihood of default of counterparties.
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\93\ See 17 CFR 23.102.
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B. General Overview of EU Capital Rules for EU Nonbank SDs
The Applicants state that the EU Capital Rules impose bank-like
capital requirements on an EU nonbank SD that are consistent with the
BCBS framework for international bank-based capital standards.\94\ The
Applicants further state that the EU Capital Rules are intended to
require each EU nonbank SD to hold a sufficient amount of qualifying
equity capital and subordinated debt based on the EU nonbank SD's
activities, to absorb decreases in the value of firm assets, increases
in the value of firm liabilities, and to cover losses from business
activities, including possible counterparty defaults and margin
collateral shortfalls associated with swap dealing activities, without
the firm becoming insolvent.\95\
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\94\ See EU Application, p. 10.
\95\ See EU Application, pp. 5-6, 10 and 15.
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The EU Capital Rules require each EU nonbank SD to hold and
maintain regulatory capital in the form of qualifying common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital in an
aggregate amount that equals or exceeds 8 percent of the EU nonbank
SD's total risk exposure amount, which is calculated as a sum of the
firm's risk-weighted assets and exposures.\96\ Common equity tier 1
capital must comprise a minimum of 4.5 percent of the 8 percent capital
ratio,\97\ and tier 1 capital (which is the aggregate of common equity
tier 1 capital and additional tier 1 capital) must comprise a minimum
of 6 percent of the total 8 percent capital ratio.\98\ Tier 2 capital
may comprise a maximum of 2 percent of the total 8 percent capital
ratio.\99\
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\96\ CRR, Articles 26, 28, 50-52, 61-63 and 92.
\97\ Id., Article 92(1)(a).
\98\ Id., Article 92(1)(b).
\99\ Id., Article 92(1)(c), which provides that the total
capital ratio must be equal to or greater than 8 percent, with a
minimum common equity and additional tier 1 capital comprising at
least 6 percent of the 8 percent minimum requirement. In addition to
the requirement to maintain minimum capital ratios, an EU nonbank SD
will not be authorized as a credit institution by its competent
authorities unless it maintains at least EUR 5 million of common
equity tier 1 capital. CRD, Article 12.
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Under the EU Capital Rules, common equity tier 1 capital is
composed of common equity capital instruments, retained earnings,
accumulated other comprehensive income, and other reserves of the EU
nonbank SD.\100\ Additional tier 1 capital is composed of capital
instruments other than common equity and retained earnings (i.e.,
common equity tier 1 capital), and includes certain long-term
convertible debt securities.\101\ Tier 2 capital instruments, which
provide an additional layer of supplementary capital, include other
reserves, hybrid capital instruments, and certain subordinated
debt.\102\
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\100\ CRR, Articles 26 and 28. Retained earnings, accumulated
other comprehensive income and other reserves qualify as common
equity tier 1 capital only where the funds are available to the EU
nonbank SD for unrestricted and immediate use to cover risks or
losses as such risks or losses occur. See CRR, Article 26(1).
\101\ Id., Articles 50-52.
\102\ Id., Articles 62-63.
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To qualify as tier 2 regulatory capital, capital instruments and
subordinated debt must meet certain conditions including that: (i) the
capital instruments are issued by the EU nonbank SD and are fully paid-
up; (ii) the capital instruments are not purchased by the EU nonbank SD
or its subsidiaries; (iii) the claims on the principal amount of the
capital instruments rank below any claim from instruments that are
``eligible liabilities,'' \103\ meaning that they are effectively
subordinated to claims of all non-subordinated creditors of the EU
nonbank SD; (iv) the capital instruments have an original maturity of
at least five years; and (v) the provisions governing the capital
instruments do not include any incentive for the principal amount to be
redeemed or repaid by the EU nonbank SD prior to the capital
instruments' respective maturities.\104\
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\103\ ``Eligible liabilities'' are non-capital instruments,
including instruments that are directly issued by the EU nonbank SD
and fully paid up with remaining maturities of at least a year. CRR,
Articles 72a and 72b. In addition, the liabilities cannot be owned,
secured, or guaranteed, by the EU nonbank SD itself, and the EU
nonbank SD cannot have either directly or indirectly funded their
purchase. CRR, Article 72b.
\104\ Id., Article 63 (listing the conditions that capital
instruments must meet to qualify as tier 2 instruments) and Articles
72a-72b (listing the conditions that liabilities must meet to
qualify as eligible liabilities). See also infra note 123.
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In addition to the requirement to maintain total regulatory capital
in an amount equal to or in excess of 8 percent of its risk-weighted
assets, the EU Capital Rules also require an EU nonbank SD to maintain
a capital conservation buffer composed exclusively of common equity
tier 1 capital in an amount equal to 2.5 percent of the firm's total
risk-weighted assets.\105\ The common equity tier 1 capital used to
meet the 2.5 percent capital conservation buffer must be separate and
independent of the 4.5 percent of common equity tier 1 capital used to
meet the 8 percent core capital requirement.\106\
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\105\ CRD, Articles 129. CRD, Article 129(1) directs EU Member
States to impose a capital conservation buffer on certain
institutions, including the four EU nonbank SDs that are currently
registered with the Commission, that requires each institution to
maintain a capital conservation buffer of common equity tier 1
capital equal to 2.5 percent of the institution's total risk
exposure amount. CRD, Article 129(1) was transposed into French law
by Article L.511-41-1-A of the French MFC and Article 2 of
Ministerial Order on Capital Buffers and was transposed into German
law by Section 10c(1) of KWG.
\106\ Id. In effect, the EU Capital Rules require an EU nonbank
SD to hold common equity tier 1 capital equal to or in excess of 7
percent of the firm's risk-weighted assets, and total capital equal
to or in excess of 10.5 percent of the firm's risk-weighted assets.
In addition, an EU nonbank SD may also be subject to: (i) an
institution-specific capital countercyclical buffer, if the EU
Member States in which the EU nonbank SD has exposures have
implemented a capital countercyclical buffer; (ii) a global
systemically important institution (``G-SII'') or other systemically
important institution (``O-SII'') buffer, if the EU nonbank SD has
been designated as a G-SII or O-SII; and (iii) a systemic risk
buffer if the EU Member State in which the EU nonbank SD is
domiciled, or at least one EU Member State in which the EU nonbank
SD has exposures, has implemented a systemic risk buffer. See CRD,
Articles 130, 131 and 133. To meet these additional capital buffer
requirements, the EU nonbank SD must maintain a level of common
equity tier 1 capital that is in addition to the common equity tier
1 capital required to meet its core capital requirement of 4.5
percent of its risk-weighted assets and the common equity tier 1
capital required to meet its capital conservation buffer. See CRR,
Article 92(1) and CRD, Article 130(5). The total amount of common
equity tier 1 capital required to meet all applicable capital buffer
requirements is referred to as the ``combined buffer requirement.''
CRD, Article 128. In practice, several EU Member States, including
France and Germany, have implemented countercyclical capital buffers
with rates ranging from 0.5 percent to 2.5 percent of risk-weighted
assets and several EU Member States, including Germany, have
implemented systemic risk buffers with rates ranging from 0.5 to 9
percent of risk-weighted assets, varying across subsets of
exposures. Germany's systemic risk buffer applies only with respect
to exposures secured by residential property. In addition, as of
January 2023, none of the four EU nonbank SDs registered with the
Commission has been designated as G-SII and only one entity,
Citigroup Global Markets Europe AG has been designated as an O-SII
and subject to a 0.25 percent additional capital requirement.
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[[Page 41783]]
The EU Capital Rules further impose a 3 percent leverage ratio
floor on EU nonbank SDs as an additional element of the capital
requirements.\107\ Specifically, each EU nonbank SD is required to
maintain tier 1 capital (i.e., an aggregate of common equity tier 1
capital and additional tier 1 capital) equal to or in excess of 3
percent of the firm's total on-balance sheet and off-balance sheet
exposures, including exposures on uncleared swaps, without regard to
any risk-weighting.\108\ The leverage ratio is a non-risk based minimum
capital requirement that is intended to prevent an EU nonbank SD from
engaging in excessive leverage, and complements the risk-based minimum
capital requirement that is based on the EU nonbank SD's risk-weighted
assets.
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\107\ CRR, Article 92(1).
\108\ Total exposures are required to be computed in accordance
with CRR, Article 429.
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As noted above, the amount of regulatory capital that an EU nonbank
SD is required to hold is determined by calculating the firm's total
risk exposure, which requires the EU nonbank SD to risk-weight its on-
balance sheet and off-balance sheet assets and exposures using
specified standardized weights or, if approved for use by competent
authorities, internal model-based methodologies.\109\ Risk-weighting
assets and exposures involves adjusting the notional or carrying value
of each asset and risk exposure based on the inherent risk of the asset
or exposure. Less risky assets and exposures are adjusted to lower
values (i.e., have less weight) than more risky assets or exposures. As
a result, EU nonbank SDs are required to hold lower levels of
regulatory capital for less risky assets and exposures and higher
levels of regulatory capital for riskier assets and exposures. The
categories of risk charges that an EU nonbank SD must include in
determining its total risk exposure include charges reflecting: (i)
market risk; (ii) credit risk; (iii) settlement risk; (iv) CVA risk of
OTC derivative instruments; and (v) operational risk.\110\ The methods
for calculating such risk charges are based on the BCBS framework.\111\
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\109\ With regulator permission, EU nonbank SDs may use internal
models to calculate credit risk (CRR, Article 143), including
certain counterparty credit risk exposures (CRR, Article 283),
operational risk (CRR, Article 312(2)), market risk (CRR, Article
363), and credit valuation adjustment risk (``CVA risk'') of over-
the-counter (``OTC'') derivatives instruments (CRR, Article 383).
The permission to use, and continue using, internal models is
subject to strict criteria and supervisory oversight by the
competent authorities.
\110\ CRR, Article 92(3).
\111\ EU Application, pp. 10-11.
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Standardized market risk charges are generally calculated by
multiplying the notional or carrying amount of net positions or of
adjusted net positions by risk-weighting factors, which are based on
the underlying market risk of each asset or exposure. The sum of the
calculated amounts comprises the portion of the risk exposure amount
attributable to market risk.\112\ Standardized credit risk charges are
generally calculated by multiplying the notional or carrying value of
the EU nonbank SD's on-balance sheet and off-balance sheet assets and
exposures by clearly defined risk-weighting factors, which are based on
the underlying credit risk of each asset or exposure. The sum of the
calculated amounts comprises the portion of the risk exposure amount
attributable to credit risk.\113\
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\112\ CRR, Articles 326-350.
\113\ Id., Articles 111-134.
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Settlement risk charges are intended to account for the price
difference to which an EU nonbank SD is exposed if its transactions
remain unsettled after the respective transaction's due delivery
date.\114\ CVA risk charges reflect the current market value of the
credit risk of the counterparty to the EU nonbank SD in an OTC
derivatives transaction.\115\ Operational risk charges reflect the risk
of loss resulting from inadequate or failed internal processes, people
and systems or from external events, and includes legal risk.\116\
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\114\ Id., Article 378.
\115\ Id., Article 381.
\116\ Id., Article 4(1)(52).
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As noted above, EU nonbank SDs may use internal model-based
methodologies to calculate certain categories of risk charges in lieu
of standardized charges if they have obtained the requisite regulatory
approval.\117\ EU Capital Rules set out quantitative and qualitative
requirements that internal models must meet in order to obtain and
maintain approval.\118\ Quantitative and qualitative requirements
address, among other issues, governance, validation, monitoring, and
review. Modeled risk charges generally require the estimation of
potential losses, with a certain degree of likelihood, within a
specified time period, of a portfolio of assets.\119\ Internal models
allow for consideration of potential co-movement of prices across
assets in the portfolio, leading to offsets of gains and losses. Credit
risk models can also further include estimation of the likelihood of
default of counterparties.
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\117\ Id., Articles 143 (credit risk), 283 (counterparty credit
risk); 312(2) (operational risk), 363 (market risk), and 383 (CVA
risk).
\118\ See e.g., CRR, Articles 144, 283(2); 321-322 and 365-369.
\119\ The EU Capital Rules require EU nonbank SDs with internal
model approval for market risk to use a VaR model with a 99 percent,
one-tailed confidence interval with: (i) price change equivalent to
10 business-day movement in rates and prices; (ii) effective
historical observation periods of at least one year; and (iii) at
least monthly data set updates. See CRR, Article 365(1). EU nonbank
SDs approved to use internal ratings-based credit risk models must
support the assessment of credit risk, the assignment of exposures
to rating grades or pools, and the quantification of default and
loss estimates that have been developed for a certain type of
exposures, among other conditions. See CRR, Articles 142-144. In
addition, when EU nonbank SDs are approved to use a model to
calculate counterparty credit risk exposures for OTC derivatives
transactions, the model must specify the forecasting distribution
for changes in the market value of a netting set attributable to
joint changes in relevant market variables and calculate the
exposure value for the netting set at each of the future dates on
the basis of the joint changes in the market variables. See CRR,
Article 284. EU nonbank SDs allowed to follow the ``advanced
method'' of calculating CVA risk charges for OTC derivatives
transactions must also use an internal market risk model to simulate
changes in the credit spreads of counterparties, applying a 99
percent confidence interval and a 10-day equivalent holding period.
See CRR, Article 383. Finally, EU nonbank SDs using ``advanced
measurement approaches'' based on their own measurement systems to
compute operational risk exposures must calculate capital
requirements as comprising both expected loss and unexpected loss
and capture potentially severe tail events, achieving a sound
standard comparable to a 99.9 confidence interval over a one-year
period. See CRR, Article 322.
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Furthermore, the EU Capital Rules also impose separate requirements
on an EU nonbank SD to address liquidity risk. The liquidity
requirements are composed of three main obligations. First, an EU
nonbank SD is required to hold an amount of sufficiently liquid assets
to meet the firm's expected payment obligations under stressed
conditions for 30 days.\120\ Second, an EU nonbank SD is subject to a
stable funding requirement whereby the firm must hold a diversity of
stable funding instruments \121\ sufficient to meet long-term
obligations under both normal and stressed conditions.\122\ Third, to
ensure that an EU nonbank SD continues to meet its liquidity
requirements, the firm is required to maintain robust strategies,
policies, processes, and system for the
[[Page 41784]]
identification of liquidity risk over an appropriate set of time
horizons, including intra-day.\123\ The EU Capital Rules' liquidity
requirements are intended to help ensure that EU nonbank SDs can
continue to fund their operations over various time horizons, including
the timely making of payments to customers and counterparties.
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\120\ CRR, Article 412(1). Liquid assets primarily include cash,
exposures to central banks, government-backed assets and other
highly liquid assets with high credit quality. Id. Article 416(1).
\121\ Stable funding instruments include common equity tier 1
capital instruments, additional tier 1 capital instruments, tier 2
capital instruments, and other preferred shares and capital
instruments in excess of the tier 2 allowable amount with an
effective maturity of one year or greater. CRR, Article 427(1).
\122\ CRR, Article 413(1).
\123\ CRD, Article 86 provides that EU Member States' competent
authorities must ensure that institutions, including EU nonbank SDs,
have robust strategies, policies, processes and systems for the
identification, measurement, management and monitoring of liquidity
risk over an appropriate set of time horizons, including intra-day,
so as to ensure that entities maintain adequate levels of liquidity
buffers. The strategies, policies, processes, and systems must be
tailored to business lines, currencies, branches, and legal entities
and must include adequate allocation mechanisms of liquidity costs,
benefits and risks.
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In addition, resolution authorities \124\ in EU Member States may
require that EU nonbank SDs satisfy an institution-specific MREL
pursuant to provisions transposing BRRD.\125\ The MREL requirement is
separate from the minimum capital requirements imposed on EU nonbank
SDs under CRR and CRD and is designed to ensure that credit
institutions and investment firms, including the EU nonbank SDs subject
to the requirement,\126\ maintain at all times sufficient eligible
instruments to facilitate the implementation of the preferred
resolution strategy.\127\ Specifically, the MREL is intended to permit
loss absorption, where appropriate, such that the EU nonbank SD's
capital and leverage ratios could be restored to the level necessary
for compliance with its capital requirements.\128\ The MREL is set by
the relevant resolution authority and is expressed as two ratios that
have to be met in parallel: (i) a percentage of the entity's total risk
exposure amount, and (ii) a percentage of the entity's total leverage
ratio exposure measure.\129\ The MREL amount varies depending on the
entity's size, funding model, and risk profile, among other
considerations.\130\
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\124\ In application of BRRD, Article 3, EU Member States
designate resolution authorities that are empowered to apply the
resolution tools and exercise the resolution powers described in
BRRD. EU Member States may provide that the resolution authority is
the competent authority for supervision for the purposes of CRR and
CRD, provided an operational independence exists between the
resolution functions and the supervisory or other functions of the
relevant authority. BRRD, Article 3(3).
\125\ BRRD, Articles 45, 45a to 45h; French MFC, Article L.613-
44; and German SAG, Sections 49(1) and (2). Eligible liabilities
include, among others items, instruments that are directly issued by
the EU nonbank SD and fully paid up with remaining maturities of at
least a year. CRR, Articles 72a and 72b. In addition, the
liabilities cannot be owned, secured or guaranteed, by the EU
nonbank SD itself, and the EU nonbank SD cannot have either directly
or indirectly funded its purchase. CRR, Article 72b. The inclusion
of derivatives is possible if certain requirements are met. BRRD,
Article 45b(2); French MFC, Article R. 613-46-1; German SAG, Section
49b.
\126\ Of the four EU nonbank SDs currently registered with the
Commission, two--Citigroup Global Markets Europe AG and and Morgan
Stanley Europe SE--are subject to MREL. See Responses to Staff
Questions of May 15, 2023.
\127\ BRRD, Article 45c. See also Single Resolution Board,
Minimum Requirement for Own Funds and Eligible Liabilities (MREL),
June 2022 (``SRB MREL Policy 2022''), at 5, available at: <a href="https://www.srb.europa.eu/system/files/media/document/2022-06-08_MREL_clean.pdf">https://www.srb.europa.eu/system/files/media/document/2022-06-08_MREL_clean.pdf</a>.
\128\ BRRD, Article 45c.
\129\ BRRD, Articles 45 and 45c. Pursuant to BRRD, Article 45,
the total risk exposure amount is calculated in accordance with CRR,
Article 92(3) and the total leverage ratio exposure measure is
calculated in accordance with CRR, Articles 429 and 429a.
\130\ BRRD, Article 45c(1)(d).
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Furthermore, CRR imposes an additional supplemental standard of
total loss absorbing capacity (``TLAC'') for G-SII entities \131\
identified as resolution entities \132\ and requires such entities to
maintain a risk-based capital and eligible liabilities ratio of 18
percent of the entity's total risk exposure amount and a non-risk-based
capital and eligible liabilities ratio of 6.75 percent of the firm's
total leverage ratio exposure measure.\133\ In addition, CRR requires
that ``material subsidiaries'' of non-EU G-SIIs, including subsidiaries
of U.S. GSIBs, that are not resolution entities maintain MREL equal to
90 percent of the foregoing as applied to their parent entity at all
times.\134\
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\131\ ``G-SII entity'' is defined in CRR, Article 4(1)(136) as
entity that is a G-SII or is part of a G-SII or of a non-EU G-SII.
Although none of the EU nonbank SDs that are currently registered
with the Commission has been designated as a G-SII in France or
Germany as of January 2023, all four EU nonbank SDs are subsidiaries
of a U.S. global systemically important bank (``GSIB'') and
therefore considered a G-SII entity.
\132\ ``Resolution entity'' is defined in general terms to mean
a legal entity established in the EU, which has been identified by
the resolution authority as an entity in respect of which the
resolution plan provides for a resolution action. BRRD, Article
1(1)(83a). None of the four EU nonbank SDs is currently designated
as a resolution entity as of March 30, 2023. See Responses to Staff
Questions of May 15, 2023. As such, the EU nonbank SDs currently
registered with the Commission are not subject to a TLAC
requirement.
\133\ CRR, Article 92a(1). As indicated in CRR, Article 92a(1),
the total risk exposure amount is calculated in accordance with CRR,
Articles 92(3) and 92(4) and the total leverage ratio exposure
measure is calculated in accordance with CRR, Article 429(4).
\134\ Id., Article 92b(1). An EU nonbank SD may become subject
to the requirement of CRR, Article 92b should it become a ``material
subsidiary'' of non-EU G-SII. The term ``material subsidiary'' is
defined as a subsidiary that on an individual or consolidated basis
meets any of the following conditions: (i) the subsidiary holds more
than 5 percent of the consolidated risk-weighted assets of the
parent entity; (ii) the subsidiary generates more than 5 percent of
the total operating income of the parent entity; or (iii) the total
exposure measure (i.e., the total on-balance sheet and off-balance
sheet exposures) of the subsidiary is more than 5 percent of the
consolidated total exposure measure of the parent entity. See CRR,
Article 4(135) (defining the term ``material subsidiary'') and
Article 429 (setting forth the method for calculating the total
exposure measure). None of the EU nonbank SDs registered with the
Commission is currently considered a ``material subsidiary'' of a
non-EU G-SII and, therefore, subject to the 90 percent of MREL
requirement.
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III. Commission Analysis of the Comparability of the EU Capital Rules
and EU Financial Reporting Rules With CFTC Capital Rules and CFTC
Financial Reporting Rules
The following section provides a description and comparative
analysis of the regulatory requirements of the EU Capital Rules and EU
Financial Reporting Rules to the CFTC Capital Rules and CFTC Financial
Reporting Rules. Immediately following a description of the
requirement(s) of the CFTC Capital Rules or the CFTC Financial
Reporting Rules for which a comparability determination was requested
by the Applicants, the Commission provides a description of the EU's
corresponding laws, regulations, or rules. The Commission then provides
a comparative analysis of the EU Capital Rules or the EU Financial
Reporting Rules with the corresponding CFTC Capital Rules or CFTC
Financial Reporting Rules and identifies any material differences
between the respective rules.
The Commission performed this proposed Capital Comparability
Determination by assessing the comparability of the EU Capital Rules
for EU nonbank SDs as set forth in the EU Application with the
Commission's Bank-Based Approach. For clarity, the Commission did not
assess the comparability of the EU Capital Rules to the Commission's
TNW Approach or NLA Approach as the Commission understands that the EU
nonbank SDs, as of the date of the EU Application, are subject to the
current bank-based capital approach of the EU Capital Rules. In
addition, as noted in Section I.C. above, the Applicants did not
include the capital framework and requirements imposed on small
investment firms under the IFR and IFD as part of the EU Application,
and the Commission did not assess the comparability of the IFR and IFD
capital requirements with the CFTC Capital Rules. Accordingly, when the
Commission makes a preliminary determination herein regarding the
comparability of the EU Capital Rules with the CFTC Capital Rules, the
determination pertains to the comparability of the EU Capital Rules as
imposed under CRR and CRD with the
[[Page 41785]]
Bank-Based Approach under the CFTC Capital Rules.
As described below, it is proposed that any material changes to the
EU Capital Rules will require notification to the Commission.
Therefore, if there are subsequent material changes to the EU Capital
Rules to include, for example, another capital approach, the Commission
will review and assess the impact of such changes on the Capital
Comparability Determination Order as it is then in effect, and may
amend or supplement the Order.\135\
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\135\ The Commission also may amend or supplement the Capital
Comparability Determination Order to address any material changes to
the CFTC Capital Rules and CFTC Financial Reporting Rules that are
adopted after a final Order is issued.
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In addition, although the BCBS bank capital standards establish
minimum capital standards that are consistent with the requirements of
the Commission's Bank-Based Approach, the Commission notes that
consistency with the international standards is not determinative of a
finding of comparability with the CFTC Capital Rules. In the
Commission's view, a foreign jurisdiction's consistency with the BCBS
international bank capital standards is an element in the Commission's
comparability assessment, but, in and of itself, it may not be
sufficient to demonstrate comparability with the CFTC Capital Rules
without an assessment of the individual elements of the foreign
jurisdiction's capital framework.
Capital and financial reporting regimes are complex structures
comprised of a number of interrelated regulatory components.
Differences in how jurisdictions approach and implement these regimes
are expected, even among jurisdictions that base their requirements on
the principles and standards set forth in the BCBS international bank
capital framework. Therefore, the Commission's comparability
determination involves a detailed assessment of the relevant
requirements of the foreign jurisdiction and whether those
requirements, viewed in the aggregate, lead to an outcome that is
comparable to the outcome of the CFTC's corresponding requirements.
Consistent with this approach, the Commission has grouped the CFTC
Capital Rules and CFTC Financial Reporting Rules into the key
categories that focus the analysis on whether the EU capital and
financial reporting requirements are comparable to the Commission's SD
requirements in purpose and effect, and not whether the EU requirements
meet every aspect or contain identical elements as the Commission's
requirements.
Specifically, as discussed in detail below, the Commission used the
following key categories in its review: (i) the quality of the equity
and debt instruments that qualify as regulatory capital, and the extent
to which the regulatory capital represents committed and permanent
capital that would be available to absorb unexpected losses or
counterparty defaults; (ii) the process of establishing minimum capital
requirements for an EU nonbank SD and how such process addresses market
risk and credit risk of the firm's on-balance sheet and off-balance
sheet exposures; (iii) the financial reports and other financial
information submitted by an EU nonbank SD to its relevant regulatory
authorities to effectively monitor the financial condition of the firm;
and (iv) the regulatory notices and other communications between the EU
nonbank SD and its relevant regulatory authorities that detail
potential adverse financial or operational issues that may impact the
firm. The Commission also reviewed the manner in which compliance by an
EU nonbank SD with the EU Capital Rules and EU Financial Reporting
rules is monitored and enforced. The Commission invites public comment
on all aspects of the EU Application and on the Commission's proposed
Capital Comparability Determination discussed below.
A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules and EU Capital Rules and EU Financial Reporting Rules
1. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules
The regulatory objectives of the CFTC Capital Rules and the CFTC
Financial Reporting Rules are to further the Congressional mandate to
ensure the safety and soundness of nonbank SDs to mitigate the greater
risk to nonbank SDs and the financial system arising from the use of
swaps that are not cleared.\136\ A primary function of the nonbank SD's
capital is to protect the solvency of the firm from decreases in the
value of firm assets, increases in the value of firm liabilities, and
from losses, including losses resulting from counterparty defaults and
margin collateral failures, by requiring the firm to maintain an
appropriate level of quality capital, including qualifying subordinated
debt, to absorb such losses without becoming insolvent. With respect to
swap positions, capital and margin perform complementary risk
mitigation functions by protecting nonbank SDs, containing the amount
of risk in the financial system as a whole, and reducing the potential
for contagion arising from uncleared swaps.
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\136\ See 7 U.S.C. 6s(e)(3)(A).
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The objective of the CFTC Financial Reporting Rules is to provide
the Commission with the means to monitor and assess a nonbank SD's
financial condition, including the nonbank SD's compliance with minimum
capital requirements. The CFTC Financial Reporting Rules are designed
to provide the Commission and NFA, which, along with the Commission,
oversees nonbank SDs' compliance with Commission regulations, with a
comprehensive view of the financial health and activities of the
nonbank SD. The Commission's rules require nonbank SDs to file
financial information, including periodic unaudited and annual audited
financial statements, specific financial position information, and
notices of certain events that may indicate a potential financial or
operational issue that may adversely impact the nonbank SD's ability to
meet its obligations to counterparties and other creditors in the swaps
market, or impact the firm's solvency.\137\
---------------------------------------------------------------------------
\137\ See 17 CFR 23.105.
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2. Regulatory Objective of EU Capital Rules and EU Financial Reporting
Rules
The regulatory objective of the EU Capital Rules is to ensure the
safety and soundness of EU financial institutions, including EU nonbank
SDs.\138\ The EU Capital Rules are designed to preserve the financial
stability and solvency of an EU nonbank SD by requiring the firm to
maintain a sufficient amount of qualifying equity capital and
subordinated debt based on the EU nonbank SD's activities to absorb
decreases in the value of firm assets, increases in the value of firm
liabilities, and to cover losses from business activities, including
possible counterparty defaults and margin collateral shortfalls
associated with the firm's swap dealing activities.\139\ The EU Capital
Rules are also designed to ensure that the EU nonbank SDs have
sufficient liquidity to meet their financial obligations to
counterparties and other creditors in a distress scenario by requiring
each firm to hold an amount of sufficiently liquid assets to meet
expected payment obligations under stressed conditions for 30 days
\140\
[[Page 41786]]
and to hold a diversity of stable funding instruments sufficient to
meet long-term obligations under both normal and stressed
conditions.\141\
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\138\ EU Application, pp. 5-6.
\139\ Id.
\140\ CRR, Article 412(1). Liquid assets primarily include cash,
exposures to central banks, government-backed assets and other
highly liquid assets with high credit quality. CRR, Article 416(1).
\141\ Stable funding instruments include common equity tier 1
capital instruments, additional tier 1 capital instruments, tier 2
capital instruments, and other preferred shares and capital
instruments in excess of the tier 2 allowable amount with an
effective maturity of one year or greater. CRR, Article 427(1).
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With respect to financial reporting, the objective of the EU
Financial Reporting Rules is to enable the applicable supervisory
authorities to assess the financial condition and safety and soundness
of EU nonbank SDs. The EU Financial Reporting Rules aim to achieve this
objective by requiring an EU nonbank SD to provide financial reports
and other financial position and capital information to the applicable
supervisory authorities on a regular basis.\142\ The financial
reporting by an EU nonbank SD provides the supervisory authorities with
information necessary to effectively monitor the EU nonbank SD's
overall financial condition and its ability to meet its regulatory
obligations as a nonbank SD.
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\142\ CRR, Article 430.
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3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the overall
objectives of the EU Capital Rules and CFTC Capital Rules are
comparable in that both sets of rules are intended to ensure the safety
and soundness of nonbank SDs by establishing a regulatory regime that
requires nonbank SDs to maintain a sufficient amount of qualifying
regulatory capital to absorb losses, including losses from swaps and
other trading activities, and to absorb decreases in the value of firm
assets and increases in the value of firm liabilities without the
nonbank SDs becoming insolvent. The EU Capital Rules and CFTC Capital
Rules are also based on, and consistent with, the BCBS international
bank capital framework, which is designed to ensure that banking
entities hold sufficient levels of capital to absorb losses and
decreases in the value of assets without the banks becoming insolvent.
The Commission further preliminarily believes that the EU Financial
Reporting Rules have comparable objectives with the CFTC Financial
Reporting Rules as both sets of rules require nonbank SDs to file and/
or publish, as applicable, periodic financial reports, including
unaudited financial reports and an annual audited financial report,
detailing their financial operations and demonstrating their compliance
with minimum capital requirements, with the goal of providing the EU
supervisory authorities and the CFTC staff with information necessary
to comprehensively assess the financial condition of a nonbank SD on an
ongoing basis. In addition, to achieve this objective, the financial
reports further provide the CFTC and EU authorities with information
regarding potential changes in a nonbank SD's risk profile by
disclosing changes in account balances reported over a period of time.
Such changes in account balances may indicate that the nonbank SD has
entered into new lines of business, has increased its activity in an
existing line of business relative to other activities, or has
terminated a previous line of business.
The prompt and effective monitoring of the financial condition of
nonbank SDs through the receipt and review of periodic financial
reports supports the Commission and EU supervisory authorities in
meeting their respective objectives of ensuring the safety and
soundness of nonbank SDs. In connection with these objectives, the
early identification of potential financial issues provides the
Commission and EU supervisory authorities with an opportunity to
address such issues with the nonbank SD before the issues develop to a
state where the financial condition of the firm is impaired such that
it may no longer hold a sufficient amount of qualifying regulatory
capital to absorb decreases in the value of firm assets or increases in
the value of firm liabilities, or to cover losses from the firm's
business activities, including the firm's swap dealing activities and
obligations to swap counterparties.
The Commission invites public comment on its analysis above,
including comment on the EU Application and relevant EU laws and
regulations.
B. Nonbank Swap Dealer Qualifying Capital
1. CFTC Capital Rules: Qualifying Capital Under Bank-Based Approach
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital in the form of common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital in
amounts that meet certain stated minimum requirements set forth in
Commission Regulation 23.101.\143\ Common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital are composed of certain
defined forms of equity of the nonbank SD, including common stock,
retained earnings, and qualifying subordinated debt.\144\ The
Commission's requirement for a nonbank SD to maintain a minimum amount
of defined qualifying capital and subordinated debt is intended to
ensure that the firm maintains a sufficient amount of regulatory
capital to absorb decreases in the value of the firm's assets and
increases in the value of the firm's liabilities, and to cover losses
resulting from the firm's swap dealing and other activities, including
possible counterparty defaults and margin collateral shortfalls,
without the firm becoming insolvent.
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\143\ See 17 CFR 23.101(a)(1)(i).
\144\ The terms ``common equity tier 1 capital,'' ``additional
tier 1 capital,'' and ``tier 2 capital'' are defined in the bank
holding company regulations of the Federal Reserve Board. See 12 CFR
217.20.
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Common equity tier 1 capital is generally composed of an entity's
common stock instruments and any related surpluses, retained earnings,
and accumulated other comprehensive income, and is a more conservative
or permanent form of capital than additional tier 1 and tier 2
capital.\145\ Additional tier 1 capital is generally composed of equity
instruments such as preferred stock and certain hybrid securities that
may be converted to common stock if triggering events occur.\146\ Total
tier 1 capital is composed of common equity tier 1 capital and further
includes additional tier 1 capital.\147\ Tier 2 capital includes
certain types of instruments that include both debt and equity
characteristics such as qualifying subordinated debt.\148\
---------------------------------------------------------------------------
\145\ 12 CFR 217.20.
\146\ Id.
\147\ Id.
\148\ Id.
---------------------------------------------------------------------------
Subordinated debt must meet certain conditions to qualify as tier 2
capital under the CFTC Capital Rules. Specifically, subordinated debt
instruments must have a term of at least one year (with the exception
of approved revolving subordinated debt agreements which may have a
maturity term that is less than one year), and contain terms that
effectively subordinate the rights of lenders to receive any payments,
including accrued interest, to other creditors of the firm.\149\
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\149\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B) (providing that the subordinated debt used by a
nonbank SD to meet its minimum capital requirement under the Bank-
Based Approach must satisfy the conditions for subordinated debt
under SEC Rule 18a-1d).
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[[Page 41787]]
Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in a nonbank SD's regulatory
capital and used to meet the firm's minimum capital requirement due to
their characteristics of being permanent forms of capital that are
subordinate to the claims of other creditors, which ensures that a
nonbank SD will have this regulatory capital to absorb decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities, and to cover losses from business activities, including
swap dealing activities, without the firm becoming insolvent.
2. EU Capital Rules: Qualifying Capital
The EU Capital Rules require an EU nonbank SD to maintain an amount
of regulatory capital (i.e., equity capital and qualifying subordinated
debt) equal to or greater than 8 percent of the EU nonbank SD's total
risk exposure, which is calculated as the sum of the firm's: (i)
capital charges for market risk; (ii) risk-weighted exposure amounts
for credit risk; (iii) capital charges for settlement risk; (iv) CVA
risk of OTC derivatives instruments; and (v) capital charges for
operational risk.\150\ The EU Capital Rules limit the composition of
regulatory capital to common equity tier 1 capital, additional tier 1
capital, and tier 2 capital in a manner consistent with the BCBS bank
capital framework.\151\ In this regard, the EU Capital Rules provide
that an EU nonbank SD's regulatory capital may be composed of: (i)
common equity tier 1 capital instruments, which generally include the
EU nonbank SD's common equity, retained earnings, and accumulated other
comprehensive income; \152\ (ii) additional tier 1 capital instruments,
which include other forms of capital instruments and certain long-term
convertible debt instruments; \153\ and (iii) tier 2 capital
instruments, which includes other reserves, hybrid capital instruments,
and certain qualifying subordinated term debt.\154\
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\150\ CRR, Article 92.
\151\ Id.
\152\ CRR, Articles 26 and 28. Capital instruments that qualify
as common equity tier 1 capital under the EU Capital Rules include
instruments that: (i) are issued directly by the EU nonbank SD; (ii)
are paid in full and not funded directly or indirectly by the EU
nonbank SD; and (iii) are perpetual. In addition, the principal
amount of the instruments may not be reduced or repaid, except in
the liquidation of the EU nonbank SD or the repurchase of shares
pursuant to the permission of the appropriate regulatory authority.
\153\ Id., Articles 50-52. To qualify as additional tier 1
capital, the instruments must meet certain conditions including: (i)
the instruments are issued directly by the EU nonbank SD and paid in
full; (ii) the instruments are not owned by the EU nonbank SD or its
subsidiaries; (iii) the purchase of the instruments is not funded
directly or indirectly by the EU nonbank SD; (iv) the instruments
rank below tier 2 instruments in the event of the insolvency of the
EU nonbank SD; (v) the instruments are not secured or guaranteed by
the EU nonbank SD or an affiliate; (vi) the instruments are
perpetual and do not include an incentive for the EU nonbank SD to
redeem them; and (vii) distributions under the instruments are
pursuant to defined terms and may be cancelled under the full
discretion of the EU nonbank SD.
\154\ Id., Articles 62-63.
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Furthermore, subordinated debt instruments must meet certain
conditions to qualify as tier 2 regulatory capital under the EU Capital
Rules, including that the: (i) loans are not granted by the EU nonbank
SD or its subsidiaries; (ii) claims on the principal amount of the
subordinated loans under the provisions governing the subordinated loan
agreement rank below any claim from eligible liabilities instruments
(i.e., certain non-capital instruments), meaning that they are
effectively subordinated to claims of all non-subordinated creditors of
the EU nonbank SD; (iii) subordinated loans are not secured, or subject
to a guarantee that enhances the seniority of the claim, by the EU
nonbank SD, its subsidiaries, or affiliates; (iv) loans have an
original maturity of at least five years; and (v) provisions governing
the loans do not include any incentive for the principal amount to be
repaid by the EU nonbank SD prior to the loans' maturity.\155\
---------------------------------------------------------------------------
\155\ Id., Article 63.
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An EU nonbank SD must also maintain a capital conservation buffer
equal to 2.5 percent of the firm's total risk exposure in addition to
the requirement to maintain qualifying regulatory capital in excess of
8 percent of its total risk exposure.\156\ The 2.5 percent capital
conservation buffer must be met with common equity tier 1 capital.\157\
Common equity tier 1 capital, as noted above, is limited to the EU
nonbank SD's common equity, retained earnings, and accumulated other
comprehensive income, and represents a more permanent form of capital
than equity instruments that qualify as additional tier 1 capital and
tier 2 capital.
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\156\ CRD, Article 129(1). In addition, an EU nonbank SD may
also be subject to a capital countercyclical buffer which requires
the EU nonbank SD to hold an additional amount of common equity tier
1 capital equal to its total risk-weighted assets multiplied by the
weighted average of the countercyclical buffer rates that apply in
all EU countries where the relevant exposures of the EU nonbank SD
are located. CRD, Articles 130 and 140. EU nonbank SDs may also be
subject to a G-SII or an O-SII buffer if they are of systemic
importance. CRD, Article 131. In practice, however, only one of the
EU nonbank SD registered with the Commission, Citigroup Global
Markets Europe AG, is subject to an O-SII buffer (of 0.25 percent)
as of January 2023 and none of the entities is subject to a G-SII
buffer. Finally, EU nonbank SDs may be subject to a systemic risk
buffer if the EU Member State in which they are domiciled or at
least one EU Member State in which they have exposures has
implemented a systemic risk buffer. CRD, Article 133. To meet the
additional buffer requirements, if applicable, an EU nonbank SD must
maintain a level of common equity tier 1 capital that is in addition
to the common equity tier 1 capital required to meet its core
capital requirement of 4.5 percent of its risk-weighted assets and
the common equity tier 1 capital required to meet its capital
conservation buffer. See CRD, Articles 130(1), 131(4), 131(5a) and
133(1). For EU Member States that have implemented capital
countercyclical buffer rates, the rate varies between 0.5 percent
and 2.5 percent of total risk exposure. See information about EU
Member States' countercyclical capital buffer rate available here:
<a href="https://www.esrb.europa.eu/national_policy/ccb/html/index.en.html">https://www.esrb.europa.eu/national_policy/ccb/html/index.en.html</a>.
\157\ CRD, Article 129(1).
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The EU Capital Rules also impose different ratios for the various
components of regulatory capital that are consistent with the BCBS bank
capital framework.\158\ In this regard, the EU Capital Rules provide
that an EU nonbank SD's minimum regulatory capital must satisfy the
following requirements: (i) common equity tier 1 capital ratio of 4.5
percent of the firm's total risk exposure amount; (ii) total tier 1
capital (i.e., common equity tier 1 capital plus additional tier 1
capital) ratio of 6 percent of the firm's total risk exposure amount;
and (iii) total capital (i.e., an aggregate amount of common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital) ratio of
8 percent of the firm's total risk exposure amount. As noted above, an
EU nonbank SD must also maintain a capital conservation buffer of 2.5
percent of its total risk exposure amount that must be met with common
equity tier 1 capital.\159\ With the addition of the capital
conservation buffer, each EU nonbank SD is required to maintain minimum
regulatory capital that equals or exceeds 10.5 percent of the firm's
total risk exposure amount, with common equity tier 1 capital
comprising at least 7 percent of the 10.5 percent minimum regulatory
capital requirement.\160\
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\158\ CRR, Article 92(1).
\159\ CRD, Article 129(1).
\160\ The countercyclical capital buffer, the G-SII or O-SII
buffer, and the systemic risk buffer are not included in the
analysis given their varying implementation by EU Member States and
limited applicability to the EU nonbank SDs that are currently
registered with the Commission.
---------------------------------------------------------------------------
Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in an EU nonbank SD's regulatory
capital and used to meet the firm's minimum capital requirement due to
their characteristics of being permanent forms of capital that are
subordinate to the claims of other creditors, which ensures
[[Page 41788]]
that an EU nonbank SD will have this regulatory capital to absorb
decreases in the value of the firm's assets and increases in the value
of the firm's liabilities, and to cover losses from business
activities, including swap dealing activities, without the firm
becoming insolvent.
3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the EU
Capital Rules are comparable in purpose and effect to the CFTC Capital
Rules with regard to the types and characteristics of a nonbank SD's
equity that qualifies as regulatory capital in meeting its minimum
requirements. The EU Capital Rules and the CFTC Capital Rules for
nonbank SDs both require a nonbank SD to maintain a quantity of high-
quality capital and permanent capital, all defined in a manner that is
consistent with the BCBS international bank capital framework, that
based on the firm's activities and on-balance sheet and off-balance
sheet exposures, is sufficient to absorb losses and decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities without resulting in the firm becoming insolvent.
Specifically, equity instruments that qualify as common equity tier 1
capital and additional tier 1 capital under the EU Capital Rules and
the CFTC Capital Rules have similar characteristics (e.g., the equity
must be in the form of high-quality, committed and permanent capital)
and the equity instruments generally have no priority in distribution
of firm assets or income with respect to other shareholders or
creditors of the firm, which makes the equity available to a nonbank SD
to absorb unexpected losses, including counterparty defaults.\161\
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\161\ Compare 12 CFR 217.20(b) (defining capital instruments
that qualify as common equity tier 1 capital under the rules of the
Federal Reserve Board) and 12 CFR 217.20(c) (defining capital
instruments that qualify as additional tier 1 capital under the
rules of the Federal Reserve Board) with CRR, Articles 26 and 28
(defining items and capital instruments that qualify as common
equity tier 1 capital under the EU Capital Rules) and CRR, Article
52 (defining capital instruments that qualify as additional tier 1
capital under the EU Capital Rules).
---------------------------------------------------------------------------
In addition, the Commission has preliminarily determined that the
conditions imposed on subordinated debt instruments under the EU
Capital Rules and the CFTC Capital Rules are comparable and are
designed to ensure that the subordinated debt has qualities that
support its recognition by a nonbank SD as equity for regulatory
capital purposes. Specifically, in both sets of rules, the conditions
include a requirement that the debt holders have effectively
subordinated their claims for repayment of the debt to the claims of
other creditors of the nonbank SD.\162\
---------------------------------------------------------------------------
\162\ Compare 17 CFR 240.18a-1d with CRR, Article 63(d).
---------------------------------------------------------------------------
Having reviewed the EU Application and the relevant EU laws and
regulations, the Commission has made a preliminary determination that
the EU Capital Rules and CFTC Capital Rules impose comparable
requirements on EU nonbank SDs with respect to the types and
characteristics of equity capital that must be used to meet minimum
regulatory capital requirements. The Commission invites public comment
on its analysis above, including comment on the EU Application and
relevant EU laws and regulations.
C. Nonbank Swap Dealer Minimum Capital Requirement
1. CFTC Capital Rules: Nonbank SD Minimum Capital Requirement
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital that satisfies each of the
following criteria: (i) an amount of common equity tier 1 capital of at
least $20 million; (ii) an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
in excess of 8 percent of the nonbank SD's uncleared swap margin
amount; (iii) an aggregate amount of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital equal to or greater than
8 percent of the nonbank SD's total risk-weighted assets, provided that
common equity tier 1 capital comprises at least 6.5 percent of the 8
percent; and (iv) the amount of capital required by the NFA.\163\
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\163\ See 17 CFR 23.101(a)(1)(i). NFA has adopted the CFTC
minimum capital requirements for nonbank SDs, but has not adopted
additional capital requirements at this time.
---------------------------------------------------------------------------
Prong (i) above requires each nonbank SD electing the Bank-Based
Approach to maintain a minimum of $20 million of common equity tier 1
capital to operate as a nonbank SD. The requirement that each nonbank
SD electing the CFTC Bank-Based Approach maintain a minimum of $20
million of common equity tier 1 capital is also consistent with the
minimum capital requirement for nonbank SDs electing the NLA Approach
and the TNW Approach.\164\ The Commission adopted this minimum
requirement as it believed that the role a nonbank SD performs in the
financial markets by engaging in swap dealing activities warranted a
minimum level of capital, stated as a fixed dollar amount that does not
fluctuate with the level of the firm's dealing activities to help
ensure the safety and soundness of the nonbank SD.\165\
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\164\ Nonbank SDs electing the NLA Approach are subject to a
minimum capital requirement that includes a fixed minimum dollar
amount of net capital of $20 million. See 17 CFR
23.101(a)(1)(ii)(A)(1). Nonbank SDs electing the TNW Approach are
required to maintain levels of tangible net worth that equals or
exceeds $20 million plus the amount of the nonbank SDs' market risk
and credit risk associated with the firms' dealing activities. See
17 CFR 23.101(a)(2)(ii)(A).
\165\ See, e.g., 85 FR 57492.
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Prong (ii) above is a minimum capital requirement that is based on
the amount of uncleared margin for swap transactions entered into by
the nonbank SD and is computed on a counterparty by counterparty basis.
The requirement for a nonbank SD to maintain minimum capital equal to
or greater than 8 percent of the firm's uncleared swap margin provides
a capital floor based on a measure of the risk and volume of the swap
positions, and the number of counterparties and the complexity of
operations, of the nonbank SD. The intent of the minimum capital
requirement based on a percentage of the nonbank SD's uncleared swap
margin was to establish a minimum capital requirement that would help
ensure that the nonbank SD meets all of its obligations as a SD to
market participants, and to cover potential operational risk, legal
risk, and liquidity risk in addition to the risks associated with its
trading portfolio.\166\
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\166\ See 85 FR 57462.
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Prong (iii) above is a minimum capital requirement that is based on
the Federal Reserve Board's capital requirements for bank holding
companies and is consistent with the BCBS international capital
framework for banking institutions. As noted above, a nonbank SD under
prong (iii) must maintain an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
greater than 8 percent of the nonbank SD's total risk-weighted assets,
with common equity tier 1 capital comprising at least 6.5 percent of
the 8 percent. Risk-weighted assets are a nonbank SD's on-balance sheet
and off-balance sheet exposures, including proprietary swap, security-
based swap, equity, and futures positions, weighted according to risk.
The Bank-Based Approach requires each nonbank SD to maintain regulatory
capital in an amount that equals or exceeds 8 percent of the firm's
total risk-weighted assets to help ensure that the nonbank SD's level
of capital is sufficient to absorb decreases in the value of the firm's
assets and increases
[[Page 41789]]
in the value of the firm's liabilities, and to cover unexpected losses
resulting from business activities, including uncollateralized defaults
from swap counterparties, without the nonbank SD becoming insolvent.
A nonbank SD must compute its risk-weighted assets using
standardized market risk and/or credit risk charges, unless the nonbank
SD has been approved by the Commission or NFA to use internal
models.\167\ For standardized market risk charges, the Commission
incorporates by reference the standardized market risk charges set
forth in Commission Regulation 1.17 for FCMs and SEC Rule 18a-1 for
nonbank SBSDs.\168\ The standardized market risk charges under
Commission Regulation 1.17 and SEC Rule 18a-1 are calculated as a
percentage of the market value or notional value of the nonbank SD's
marketable securities and derivatives positions, with the percentages
applied to the market value or notional value increasing as the
expected or anticipated risk of the positions increases.\169\ The
resulting total market risk exposure amount is multiplied by a factor
of 12.5 to cancel the effect of the 8 percent multiplication factor
applied to all of the nonbank SD's risk-weighted assets, which
effectively requires a nonbank SD to hold qualifying regulatory capital
equal to or greater than 100 percent of the amount of its market risk
exposure.\170\
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\167\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC equivalent risk-weighted assets in 17 CFR 23.100.
\168\ See paragraph (3) of the definition of the term BHC
equivalent risk-weighted assets in 17 CFR 23.100.
\169\ See 17 CFR 240.18a-1(c)(1).
\170\ See 17 CFR 23.100 (Definition of BHC equivalent risk-
weighted assets). As noted, a nonbank SD is required to maintain
qualifying capital (i.e., an aggregate of common equity tier 1
capital, additional tier 1 capital, and tier 2 capital) in an amount
that exceeds 8 percent of its market risk-weighted assets and
credit-risk-weighted assets. The regulations, however, require the
nonbank SD to effectively maintain qualifying capital in excess of
100 percent of its market risk-weighted assets by requiring the
nonbank SD to multiply its market-risk-weighted assets by 12.5.
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With respect to standardized credit risk charges for exposures from
non-derivatives positions, a nonbank SD computes its on-balance sheet
and off-balance sheet exposures in accordance with the standardized
credit risk charges adopted by the Federal Reserve Board and set forth
in Subpart D of 12 CFR 217 as if the SD itself were a bank holding
company subject to Subpart D.\171\ Standardized credit risk charges are
computed by multiplying the amount of the exposure by defined
counterparty credit risk factors that range from 0 percent to 150
percent.\172\ A nonbank SD with off-balance sheet exposures is required
to calculate a credit risk charge by multiplying each exposure by a
credit conversion factor that ranges from 0 percent to 100 percent,
depending on the type of exposure.\173\ In addition to the risk-
weighted assets for general credit risk, a nonbank SD calculating risk
charges under Subpart D of 12 CFR 217 must also calculate risk-weighted
assets for unsettled transactions involving securities, foreign
exchange instruments, and commodities that have a risk of delayed
settlement or delivery.
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\171\ See 17 CFR 23.101(a)(1)(i)(B) and paragraph (1) of the
definition of the term BHC equivalent risk-weighted assets in 17 CFR
23.100.
\172\ See 17 CFR 217.32. Lower credit risk factors are assigned
to entities with lower credit risk and higher credit risk factors
are assigned to entities with higher credit risk. For example, a
credit risk factor of 0% is applied to exposures to the U.S.
government, the Federal Reserve Bank, and U.S. government agencies
(see 12 CFR 217.32 (a)(1)), and a credit risk factor of 100% is
assigned to an exposure to foreign sovereigns that are not members
of the Organization of Economic Co-operation and Development (see 12
CFR 217.32(a)(2)).
\173\ See 17 CFR 217.33.
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A nonbank SD may compute standardized credit risk charges for
derivatives positions, including uncleared swaps and non-cleared
security-based swaps, using either the current exposure method
(``CEM'') or the standardized approach for measuring counterparty
credit risk (``SA-CCR'').\174\ Both CEM and SA-CCR are non-model,
rules-based, approaches to calculating counterparty credit risk
exposures for derivatives positions. Credit risk exposure under CEM is
the sum of: (i) the current exposure (i.e., the positive mark-to-
market) of the derivatives contract; and (ii) the potential future
exposure, which is calculated as the product of the notional principal
amount of the derivatives contract multiplied by a standard credit risk
conversion factor set forth in the rules of the Federal Reserve
Board.\175\ Credit risk exposure under SA-CCR is defined as the
exposure at default amount of a derivatives contract, which is computed
by multiplying a factor of 1.4 by the sum of: (i) the replacement costs
of the contract (i.e., the positive mark-to market); and (ii) the
potential future exposure of the contract.\176\
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\174\ See 17 CFR 217.34. See also, Commission Regulation 23.100
(17 CFR 23.100) defining the term BHC risk-weighted assets, which
provides that a nonbank SD that does not have model approval may use
either CEM or SA-CCR to compute its exposures for over-the-counter
derivative contracts without regard to the status of its affiliate
entities with respect to the use of a calculation approach under the
Federal Reserve Board's capital rules.
\175\ See 12 CFR 217.34.
\176\ See 12 CFR 217.132(c).
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A nonbank SD may also obtain approval from the Commission or NFA to
use internal models to compute market risk and/or credit risk charges
in lieu of the standardized charges. A nonbank SD seeking approval to
use an internal model is required to submit an application to the
Commission or NFA.\177\ The application is required to include, among
other things, a list of categories of positions that the nonbank SD
holds in its proprietary accounts and a brief description of the
methods that the nonbank SD will use to calculate market risk and/or
credit risk charges for such positions, as well as a description of the
mathematical models used to compute market risk and credit risk
charges.
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\177\ See 17 CFR 23.102(c).
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A nonbank SD approved by the Commission or NFA to use internal
models to compute market risk is required to comply with Subpart F of
the Federal Reserve Board's Part 217 regulations (``Subpart F'').\178\
Subpart F is based on models that are consistent with the BCBS Basel
2.5 capital framework.\179\ The Commission's qualitative and
quantitative requirements for internal capital models are also
comparable to the SEC's existing internal capital model requirements
for broker-dealers in securities and SBSDs,\180\ which are broadly
based on the BCBS Basel 2.5 capital framework.
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\178\ See paragraph (4) of the definition of BHC equivalent
risk-weighted assets in 17 CFR 23.100.
\179\ Compare 17 CFR 23.100 (providing for a nonbank SD that is
approved to use internal models to calculate market and credit risk
to calculate its risk-weighted assets using Subparts E and F of 12
CFR part 217), Subpart F of 12 CFR, 17 CFR 23.101(a)(1)(ii)
(providing for an SD that elects the Net Liquid Assets Approach to
calculate its net capital in accordance with Rule 18a-1), and 17 CFR
23.102(a), with Basel Committee on Banking Supervision, Revisions to
the Basel II Market Risk Framework (2011), <a href="https://www.bis.org/publ/bcbs193.pdf">https://www.bis.org/publ/bcbs193.pdf</a> (describing the revised internal model approach under
Basel 2.5).
\180\ The SEC internal model requirements for SBSDs are listed
in 17 CFR 240.18a-1(d).
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A nonbank SD approved to use internal models to compute credit risk
charges is required to perform such computation in accordance with
Subpart E of the Federal Reserve Board's Part 217 regulations \181\ as
if the SD itself were a bank holding company subject to Subpart E.\182\
The internal credit risk modeling requirements are also based on the
Basel 2.5 capital framework and the Basel 3 capital framework. A
nonbank SD that computes its credit risk charges using internal models
must multiply the resulting capital requirement by a factor of
12.5.\183\
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\181\ 12 CFR 217 Subpart E.
\182\ See 85 FR 57462 at 57496.
\183\ 12 CFR 217.131(e)(1)(iii), 217.131(e)(2)(iv), and
217.132(d)(9)(iii).
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[[Page 41790]]
In adopting the final Bank-Based Approach rules, the Commission
also noted that in choosing an alternative calculation, the nonbank SD
must adopt the entirety of the alternative. As such, if the nonbank SD
is calculating its risk-weighted assets using the regulations in
Subpart E of 12 CFR 217, the nonbank SD must include charges reflecting
all categories of risk-weighted assets applicable under these
regulations, which include among other things, charges for operational
risk, CVA of OTC derivatives contracts, and unsettled transactions
involving securities, foreign exchange instruments, and commodities
that have a risk of delayed settlement or delivery.\184\ The capital
charge for operational risk and CVA of OTC derivatives contracts
calculated in accordance with Subpart E of 12 CFR 217 must also be
multiplied by a factor of 12.5.\185\
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\184\ Settlement risk for OTC derivatives contracts is addressed
as part of the counterparty-credit risk calculation methodology
described in 12 CFR 217.132.
\185\ 12 CFR 217.162(c) (operational risk) and 217.132(e)(4)
(CVA of OTC derivative contracts).
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Under the Basel 2.5 capital framework, nonbank SDs have flexibility
in developing their internal models, but must follow certain minimum
standards. Internal market risk and credit risk models must follow a
Value-at-Risk (``VaR'') structure to compute, on a daily basis, a 99th
percentile, one-tailed confidence interval for the potential losses
resulting from an instantaneous price shock equivalent to a 10-day
movement in prices (unless a different time-frame is specifically
indicated). The simulation of this price shock must be based on a
historical observation period of minimum length of one year, but there
is flexibility on the method used to render simulations, such as
variance-covariance matrices, historical simulations, or Monte Carlo.
The Commission and the Basel standards for internal models also
have requirements on the selection of appropriate risk factors as well
as on data quality and update frequency.\186\ One specific concern is
that internal models must capture the non-linear price characteristics
of options positions, including but not limited to, relevant
volatilities at different maturities.\187\
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\186\ See 17 CFR Appendix A to Subpart E of Part 23(i)(2)(iii),
and Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(e), available
at: <a href="https://www.bis.org/publ/bcbs193.pdf">https://www.bis.org/publ/bcbs193.pdf</a>.
\187\ The Commission's requirement is set forth in paragraph
(i)(2)(iv)(A) of Appendix A to Subpart E of 17 CFR part 23. See
also, Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(h), available
at: <a href="https://www.bis.org/publ/bcbs193.pdf">https://www.bis.org/publ/bcbs193.pdf</a>.
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In addition, BCBS standards for market risk models include a series
of additive components for risks for which the broad VaR is ill-suited
or that may need targeted calculation. These include the calculation of
a Stressed VaR measure (with the same specifications as the VaR, but
calibrated to historical data from a continuous 12-month period of
significant financial stress relevant to the firm's portfolio); a
Specific Risk measure (which includes the effect of a specific
instrument); an Incremental Risk measure (which addresses changes in
the credit rating of a specific obligor which may appear as a reference
in an asset); and a Comprehensive Risk measure (which addresses risk of
correlation trading positions).
2. EU Capital Rules: EU Nonbank Swap Dealer Minimum Capital
Requirements
The EU Capital Rules impose bank-like capital requirements on an EU
nonbank SD that, consistent with the BCBS international bank capital
framework, require the EU nonbank SD to hold a sufficient amount of
qualifying equity capital and subordinated debt based on the EU nonbank
SD's activities to absorb decreases in the value of firm assets and
increases in the value of the firm's liabilities, and to cover losses
from its business activities, including possible counterparty defaults
and margin collateral shortfalls associated with the firm's swap
dealing activities, without the firm becoming insolvent. Specifically,
the EU Capital Rules require each EU nonbank SD to maintain sufficient
levels of capital to satisfy the following capital ratios, expressed as
a percentage of the EU nonbank SD's total risk exposure amount (i.e.,
the sum of the EU nonbank SD's risk-weighted assets and exposures): (i)
a common equity tier 1 capital ratio of 4.5 percent; \188\ (ii) a tier
1 capital ratio of 6 percent; \189\ and (iii) a total capital ratio of
8 percent.\190\ The EU Capital Rules further require an EU nonbank SD
to maintain a capital conservation buffer composed of common equity
capital tier 1 capital in amount equal to 2.5 percent of the firm's
total risk exposure.\191\ The common equity tier 1 capital used to meet
the capital conservation buffer must be separate and in addition to the
4.5 percent of common equity tier 1 capital that the EU nonbank is
required to maintain in meeting its core 8 percent capital
requirement.\192\ Thus, an EU nonbank SD is required to maintain
regulatory capital equal to at least 10.5 percent of its total risk
exposure amount, with common equity tier 1 capital comprising at least
7 percent of the regulatory capital (4.5 percent of the core capital
plus the 2.5 percent capital conservation buffer).
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\188\ CRR, Article 92(1)(a).
\189\ Id., Article 92(1)(b). Tier 1 capital is the sum of the EU
nonbank SD's common equity tier 1 capital and additional tier 1
capital.
\190\ Id., Article 92(1)(c). The total capital is the sum of the
EU nonbank SD's tier 1 capital and tier 2 capital.
\191\ CRD, Article 129(1).
\192\ Id. An EU nonbank SD may also be required to maintain a
countercyclical capital buffer composed of common equity tier 1
capital equal to the firm's total risk exposure multiplied by an
entity-specific countercyclical buffer rate. The entity-specific
countercyclical capital buffer rate is determined by calculating the
weighted average of the countercyclical buffer rates that apply in
the jurisdictions in which the EU nonbank SD has relevant credit
exposures. See CRD, Article 140. In each EU Member State, the
countercyclical buffer rate is set by a designated authority on a
quarterly basis. See CRD, Article 136. In addition, an EU nonbank SD
may be subject to a G-SII or O-SII buffer, if the entity is of
systemic importance, and a systemic risk buffer if the EU Member
State in which the EU nonbank SD is domiciled or at least one EU
Member State in which the EU nonbank SD has exposures has
implemented one. See CRD, Articles 131 and 133. In practice,
however, currently only one of the EU nonbank SD registered with the
Commission, Citigroup Global Markets Europe AG, is subject to O-SII
buffer (of 0.25 percent) as of January 2023 and none of the
registered EU nonbank SDs is subject to a G-SII buffer.
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An EU nonbank SD's total risk exposure amount is calculated as the
sum of the firm's: (i) capital requirements for market risk; (ii) risk-
weighted exposure amounts for credit risk; (iii) capital requirements
for settlement risk; (iv) capital requirements for CVA risk of OTC
derivatives instruments; and (v) capital requirements for operational
risk.\193\ Capital charges for market risk and risk-weighted exposures
for credit risk are computed based on the EU nonbank SD's on-balance
sheet and off-balance sheet exposures, including proprietary swap,
security-based swap, equity, and futures positions, weighted according
to risk.\194\ Settlement risk capital charges reflect the price
difference to which an
[[Page 41791]]
EU nonbank SD is exposed if its transactions in debt instruments,
equity, foreign currency, and commodities remain unsettled after the
respective product's due delivery date.\195\ CVA is an adjustment to
the mid-market value of the portfolio of OTC derivative transactions
with a counterparty and reflects the current market value of the credit
risk of the counterparty to the EU nonbank SD.\196\ Operational risk
capital charges reflect the risk of loss resulting from inadequate or
failed internal processes, people and systems or from external events,
and includes legal risk.\197\ To compute its total risk exposure
amount, an EU nonbank SDs is also required to multiply the capital
requirements for market risk, settlement risk, CVA risk, and
operational risk, calculated in accordance with the EU Capital Rules,
by a factor of 12.5, which effectively requires an EU nonbank SD to
hold qualifying regulatory capital equal to or greater than the full
amount of the relevant risk exposures.\198\ The formulae for
calculating risk-weighted exposure amounts for credit risk also include
a 12.5 multiplication factor.\199\
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\193\ CRR, Article 92(3).
\194\ To compute capital requirements for market risk, EU
nonbank SDs are required to calculate capital charges for all
trading book positions and non-trading book positions that are
subject to foreign exchange or commodity risk. See CRR, Article 325.
The risk-weighted exposure amounts for credit risk include: (i)
risk-weighted exposure amounts for credit risk and dilution risk in
respect of all the business activities of the EU nonbank SD,
excluding risk-weighted exposure amounts from the trading book
business of the firm; and (ii) risk-weighted exposure amounts for
counterparty risk arising from the trading book business for certain
derivatives transactions, repurchase agreements, securities or
commodities lending or borrowing transactions, margin lending or
long settlement transactions. See CRR, Article 92(3)(a) and (f).
\195\ CRR, Article 378. Settlement risk is calculated as 8
percent, 50 percent, 75 percent, or 100 percent of the price
difference for transactions that are not settled within 5 to 15
business days, 16 to 30 business days, 31 to 45 business days, or 46
or more business days, respectively, from the due settlement date.
\196\ Id., Article 381.
\197\ Id., Article 4(1)(52).
\198\ Id., Article 92(4).
\199\ Id., Article 153 et seq.
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Consistent with the Commission's Bank-Based Approach and the BCBS
capital framework, the EU Capital Rules require EU nonbank SDs to
compute market risk exposures and credit risk exposures using a
standardized approach or, if approved by the relevant competent
authorities, internal risk models.\200\ In addition, EU Capital Rules,
consistent with the BCBS capital framework, require EU nonbank SDs to
compute capital charges for CVA risk and operational risk using
standardized approaches, unless approved to use internal models by
relevant competent authorities.\201\
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\200\ With the permission of the relevant competent authority,
an EU nonbank SD may use internal models to calculate market risk
(see CRR, Article 363) and credit risk (see CRR, Articles 143 and
283).
\201\ See, CRR, Articles 382-384 for CVA risk calculations; and
Article 312(2) for operational risk.
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EU nonbank SDs calculate standardized market risk charges generally
by multiplying the notional or carrying amount of net positions by
risk-weighting factors, which are based on the underlying market risk
of each asset or exposure and increase as the expected risk of the
positions increase. Market risk requirements for debt instruments and
equity instruments are calculated separately under the standardized
approach, and are each calculated as the sum of specific risk and
general risk of the positions. Securitizations are treated as debt
instruments for market risk requirements,\202\ whereas derivative
positions are generally treated as exposures on their underlying
assets,\203\ with options being delta-adjusted.\204\
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\202\ Id., Article 326. See also CRR, Articles 334-340
(provisions related to debt instruments) and 341-343 (provisions
related to equities).
\203\ Id., Articles 328-330, 358.
\204\ Id., Article 329.
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The EU Capital Rules also require EU nonbank SDs to include in
their risk-weighted assets market risk exposures to certain foreign
currency and gold positions. Specifically, an EU nonbank SD with net
positions in foreign exchange and gold that exceed 2 percent of the
firm's total capital must calculate capital requirements for foreign
exchange risk.\205\ The capital requirement for foreign exchange risk
under the standardized approach is 8 percent of the EU nonbank SD's net
positions in foreign exchange and gold.\206\
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\205\ Id., Article 351.
\206\ Id.
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The EU Capital Rules further require EU nonbank SDs to include
exposures to commodity positions in calculating the firm's risk-
weighted assets. The standardized calculation of commodity risk
exposures may follow one of three approaches depending on type of
position or exposure. The first is the sum of a flat percentage rate
for net positions, with netting allowed among tightly defined sets,
plus another flat percentage rate for the gross position.\207\ The
other two standardized approaches are based on maturity-ladders, where
unmatched portions of each maturity band (i.e., portions that do not
net out to zero) are charged at a step-up rate in comparison to the
base charges for matched portions.\208\
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\207\ Id., Article 360.
\208\ Id., Articles 359-361.
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With respect to credit risk, the EU Capital Rules require an EU
nonbank SD to calculate its standardized credit risk exposure in a
manner aligned with the Commission's Bank-Based Approach and the BCBS
framework by taking the carrying value or notional value of each of the
EU nonbank SD's on-balance sheet and off-balance sheet exposures,
making certain additional credit risk adjustments, and then applying
specific risk-weights based on the type of counterparty and the asset's
credit quality.\209\ For instance, high quality credit exposures, such
as exposures to EU Member States' central banks, carry a zero percent
risk-weight. Exposures to EU banks, other investment firms, or other
businesses, however, may carry risk-weights between 20 percent and 150
percent depending on the credit ratings available for the entity or,
for exposures to banks and investment firms, for its central
government.\210\ If no credit rating is available, the EU nonbank SD
must generally apply a 100 percent risk-weight, meaning the total
accounting value of the exposure is used.\211\
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\209\ Id., Articles 111 and 113(1).
\210\ Id., Articles 114-122.
\211\ Id., Articles 121(2) and 122(2).
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With respect to counterparty credit risk for derivatives
transactions and certain other agreements that give rise to bilateral
credit risk, the EU Capital Rules require an EU nonbank SD that is not
approved to use credit risk models to calculate its exposure using the
standardized approach for counterparty credit risk (i.e., SA-CCR),\212\
which is one of the methods that a nonbank SD may use to calculate its
credit risk exposure under a derivatives transaction pursuant to the
Commission's Bank-Based Approach.\213\ The exposure amount under the
SA-CCR is computed, under both the EU Capital Rules and the
Commission's Bank-Based Approach, as the sum of the replacement cost of
the contract and the potential future exposure of the contract,
multiplied by a factor of 1.4.\214\
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\212\ CRR, Articles 92(3)(f) and 274-280e. EU nonbank SDs with
smaller-sized derivatives business may also use a ``simplified
standardized approach to counterparty credit risk'' (CRR, Article
281) or an ``original exposure method'' (CRR, Article 282) as
simpler methods for calculating exposure values. To use either of
these alternative methods, an entity's on-and off-balance sheet
derivatives business must be equal or less than 10 percent of the
entity's total assets and EUR 300 million or 5 percent of the
entity's total assets and EUR 100 million, respectively. CRR,
Article 273a.
\213\ 12 CFR 217.34.
\214\ CRR, Article 274(2) and 12 CFR 217.132(c).
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EU Capital Rules also require an EU nonbank SD to calculate capital
requirements for settlement risk.\215\ Consistent with the BCBS
framework, the capital charge for settlement risk for transactions
settled on a delivery-versus-payment basis is computed by multiplying
the price difference to which an EU nonbank SD is exposed as a result
of an unsettled transaction by a
[[Page 41792]]
percentage factor that varies from 8 percent to 100 percent based on
the number of working days after the due settlement date during which
the transaction remains unsettled.\216\ The CFTC's Bank-Based Approach
provides for a similar calculation methodology for risk-weighted asset
amounts for unsettled transactions involving securities, foreign
exchange instruments, and commodities.\217\
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\215\ CRR, Article 378 (indicating that if transactions in which
debt instruments, equities, foreign currencies and commodities
excluding repurchase transactions and securities or commodities
lending and securities or commodities borrowing are unsettled after
their due delivery dates, an EU nonbank SD must calculate the price
difference to which it is exposed).
\216\ Id. The price difference to which an EU nonbank SD is
exposed is the difference between the agreed settlement price for an
instrument (i.e., a debt instrument, equity, foreign currency or
commodity) and the instrument's current market value, where the
difference could involve a loss for the firm. CRR, Article 378.
\217\ 17 CFR 23.100 (definition of BHC equivalent risk-weighted
assets), 12 CFR 217.38 and 12 CFR 217.136.
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Consistent with the BCBS framework, an EU nonbank SD is also
required to calculate capital charges for CVA risk for OTC derivative
instruments \218\ to reflect the current market value of the credit
risk of the counterparty to the EU nonbank SD.\219\ CVA can be
calculated following similar methodologies as those described in
Subpart E of the Federal Reserve Board's Part 217 regulations.\220\
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\218\ CRR, Article 382 (1). CVA risk charges need not be
calculated for credit derivatives recognized to reduce risk-weighted
exposure amounts for credit risk. Id.
\219\ Id., Article 381. CVA is defined to exclude debit
valuation adjustment.
\220\ See CRR, Articles 383-384 and 12 CFR 217.132(e)(5) and
(6). Under the CFTC's Bank-Based Approach, nonbank SDs calculating
their credit risk-weighted assets using the regulations in Subpart D
of the Federal Reserve Board's Part 217 regulations, do not
calculate CVA of OTC derivatives instruments.
---------------------------------------------------------------------------
EU nonbank SD's total risk exposure amount also includes
operational risk charges. Consistent with the BCBS framework, EU
nonbank SDs may calculate standardized operational risk charges using
either one of two approaches--the Basic Indicator Approach or the
Standardized Approach.\221\ Both the Basic Indicator Approach and the
Standardized Approach use as a calculation basis the three-year average
of the ``relevant indicator,'' which is the sum of certain items on the
statement of income/loss (i.e., the firm's net interest income and net
non-interest income). Under the Basic Indicator Approach, EU nonbank
SDs are required to multiply the relevant indicator by a factor of 15
percent. When using the Standardized Approach, firms need to allocate
the relevant indicator into eight business lines specified by
regulation (e.g., trading and sales; retail brokerage; corporate
finance) and multiply the corresponding portion by a percentage factor
ranging from 12 to 18 percent depending on the business line. The
capital requirements for operational risk are calculated as the sum of
the individual business lines' charges.
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\221\ CRR, Article 312.
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As noted above, if approved by its relevant supervisory authority,
an EU nonbank SD may use internal models to calculate its market risk
charges, credit risk charges, including counterparty credit risk
charges, CVA risk charges, and operational risk charges in lieu of
using a standardized approach.\222\ To obtain permission, an EU nonbank
SD must demonstrate to the satisfaction of the relevant authority that
it meets certain conditions for the use of models.\223\
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\222\ Id., Articles 143 (credit risk), 283 (counterparty credit
risk), 312 (operational risk), 363 (market risk) and 383 (CVA risk).
EU nonbank SDs are not permitted, however, to calculated
counterparty credit risk charges using internal models when
calculating large exposures. CRR, Article 390(4).
\223\ Id., Articles 143, 283, 312(2) and 363(1).
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With respect to market risk, the relevant supervisory authority may
grant an EU nonbank SD permission to use internal models to calculate
one or more of the following risk categories: (i) general risk of
equity instruments, (ii) specific risk of equity instruments, (iii)
general risk of debt instruments, (iv) specific risk of debt
instruments, (v) foreign exchange risk, or (vi) commodities risk,\224\
along with interest rate risk on derivatives.\225\ To obtain approval
to use a market risk model, an EU nonbank SD must meet conditions
related to specified model elements and controls including risk and
stressed risk calculations,\226\ back-testing and multiplication
factors,\227\ risk measurement requirements,\228\ governance and
qualitative requirements,\229\ internal validation,\230\ and specific
requirements by risk categories.\231\ An EU nonbank SD approved to use
models must also obtain approval from the relevant authority to
implement a material change to the model or make a material extension
to the use of the model.\232\ The EU Capital Rules' market risk model-
based methodology is based on the Basel 2.5 standard \233\ and
incorporates relevant aspects of the BCBS framework in terms of
requiring EU nonbank SDs with model approval to use a VaR model with a
99 percent, one-tailed confidence level with (i) price changes
equivalent to a 10-business day movement in rates and prices, (ii)
effective historical observation periods of at least one year, and
(iii) at least monthly data set updates.\234\ EU Capital Rules also
include a framework for governance that includes requirements related
to the implementation of independent risk management,\235\ senior
management's involvement in the risk-control process,\236\
establishment of procedures for monitoring and ensuring compliance with
a documented set of internal policies and controls,\237\ and the
conducting of independent review of the models as part of the internal
audit process.\238\
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\224\ Id., Article 363(1).
\225\ Id., Article 331(1), using sensitivity models.
\226\ Id., Articles 364-365.
\227\ Id., Article 366.
\228\ Id., Article 367.
\229\ Id., Article 368.
\230\ Id., Article 369.
\231\ Id., Articles 364-377.
\232\ Id., Article 363(3).
\233\ Compare CRR, Articles 362-377 with Revisions to the Basel
II Market Risk Framework.
\234\ Id., Article 365(1).
\235\ Id., Articles 368 (1)(b).
\236\ Id., Articles 368 (1)(c).
\237\ Id., Articles 368 (1)(e).
\238\ Id., Articles 368 (1)(h).
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With regulatory permission, EU nonbank SDs may also use models to
calculate credit risk exposures.\239\ Credit risk models may include
internal ratings based on the estimation of default probabilities and
loss given default, consistent with the BCBS framework and subject to
similar model risk management guidelines.\240\ To obtain approval for
the use of internal ratings-based models, an EU nonbank SD must meet
requirements related to, among other things, the structure of its
rating systems and its criteria for assigning exposures to grades and
pools within a rating system, the parameters of risk quantification,
the validation of internal estimates, and the internal governance and
oversight of the rating systems and estimation processes.\241\
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\239\ Id., Article 143.
\240\ Id.
\241\ Id., Articles 170-177 (rating systems), 178-184 (risk
quantification), 185 (validation of internal estimates), and 189-191
(internal governance and oversight).
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In addition, subject to regulatory approval, EU nonbank SDs may use
internal models to calculate counterparty credit risk exposures for
derivatives, securities financing, and long settlement
transactions.\242\ The prerequisites for approval for such models
include requirements related to the establishment and maintenance of a
counterparty credit risk management framework, stress testing, the
integrity of the modelling process, the risk
[[Page 41793]]
management system, and validation.\243\ The EU Capital Rules' internal
counterparty credit risk model-based methodology is also based on the
Basel 2.5 standard.\244\ The EU Capital Rules allow for the estimation
of expected exposure as a measure of the average of the distribution of
exposures at a particular future date,\245\ with adjustments to the
period of risk, as appropriate to the asset and counterparty.
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\242\ Id., Article 283. As noted above, however, EU nonbank SDs
are not permitted to calculate counterparty credit risk charges
using internal models when calculating large exposures. CRR, Article
390(4).
\243\ Id., Articles 283-294.
\244\ Compare CRR, Article 362-377 with Revisions to the Basel
II Market Risk Framework.
\245\ CRR, Article 272(19), 283-285.
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EU nonbank SDs may also obtain regulatory permission to use
``advanced measurement approaches'' based on their own operational risk
measurement systems, to calculate capital charges for operational risk.
To obtain such permission, EU nonbank SDs must meet qualitative and
quantitative standards, as well as general risk management standards
set forth in the EU Capital Rules.\246\ Specifically, among other
qualitative standards, EU nonbank SDs must meet requirements related to
the governance and documentation of their operational risk management
processes and measurement systems.\247\ In addition, EU nonbank SDs
must meet quantitative standards related to process, data, scenario
analysis, business environment and internal control factors laid down
in the EU Capital Rules.\248\
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\246\ CRR, Article 312(1), cross-referencing CRR, Articles 321
and 322 and CRD, Articles 74 and 85.
\247\ CRR, Article 321.
\248\ Id., Article 322.
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As an additional element to the capital requirements, the EU
Capital Rules further impose a 3 percent leverage ratio floor on EU
nonbank SDs.\249\ Specifically, each EU nonbank SD is required to
maintain an aggregate amount of common equity tier 1 capital and
additional tier 1 capital equal to or in excess of 3 percent of the
firm's total on-balance sheet and off-balance sheet exposures,
including exposures on uncleared swaps, without regard to any risk-
weighting.\250\ The leverage ratio is a non-risk based minimum capital
requirement that is intended to prevent an EU nonbank SD from engaging
in excessive leverage, and complements the risk-based minimum capital
requirement that is based on the EU nonbank SD's risk-weighted assets.
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\249\ Id., Article 92(1)(d).
\250\ Total exposures are required to be computed in accordance
with CRR, Article 429.
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Furthermore, the EU Capital Rules also impose separate liquidity
requirements on an EU nonbank SD to address liquidity risk. The
liquidity requirements are composed of three main obligations. First,
an EU nonbank SD is required to hold an amount of sufficiently liquid
assets to meet the firm's expected payment obligations under stressed
conditions for 30 days.\251\ Second, an EU nonbank SD is subject to a
stable funding requirement whereby the firm must hold a diversity of
stable funding instruments \252\ sufficient to meet long-term
obligations under both normal and stressed conditions.\253\ Third, to
ensure that an EU nonbank SD continues to meet its liquidity
requirements, the firm is required to maintain robust strategies,
policies, processes, and systems for the identification of liquidity
risk over an appropriate set of time horizons, including intra-
day.\254\ The EU Capital Rules' liquidity requirements are intended to
help ensure that EU nonbank SDs can continue to fund their operations
over various time horizons, including the timely making of payments to
customers and counterparties.
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\251\ CRR, Article 412(1) provides that an EU nonbank SD shall
hold liquid assets in amount sufficient to cover the liquidity
outflows less the liquidity inflows under stressed conditions so as
to ensure the firm maintains levels of liquidity buffers that are
adequate to address any possible imbalance between liquidity inflows
and outflows under stressed conditions over a period of 30 days.
Liquid assets primarily include cash, deposits with central banks
(to the extent that the deposits can be withdrawn at any times in
periods of stress), government-backed assets and other highly liquid
assets with high credit quality. Id., Article 416(1).
\252\ Stable funding instruments include common equity tier 1
capital instruments, additional tier 1 capital instruments, tier 2
capital instruments, and other preferred shares and capital
instruments in excess of the tier 2 allowable amount with an
effective maturity of one year or greater. CRR, Article 427(1).
\253\ CRR, Article 413(1).
\254\ CRD, Article 86 provides that EU Member States' competent
authorities must ensure that institutions, including EU nonbank SDs,
have robust strategies, policies, processes and systems for the
identification, measurement, management and monitoring of liquidity
risk over an appropriate set of time horizons, including intra-day,
so as to ensure that entities maintain adequate levels of liquidity
buffers. The strategies, policies, processes, and systems must be
tailored to business lines, currencies, branches, and legal entities
and must include adequate allocation mechanisms of liquidity costs,
benefits, and risks. CRD, Article 86 was implemented into French law
by MFC, Articles L.511-41-1-B and L.511-41-1-C for credit
institutions and L.533-2-1 for investment firms subject to the CRR/
CRD framework, as well as the Articles 148 to 186 of the Ministerial
Order on Internal Control. Article 86 was implemented into German
law by Bundesanstalt f[uuml]r Finanzdienstleistungsaufsicht's
(``BaFin'') Minimum Requirements for Risk Management (``MaRisk'')
Circular.
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The EU Capital Rules also require EU nonbank SDs to comply with a
minimum initial capital requirement of EUR 5 million in order to become
and remain licensed as a credit institution.\255\ The initial capital
requirement must be met with common equity tier 1 capital.\256\
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\255\ CRD, Article 12(1).
\256\ Id., Article 12(2).
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3. Commission Analysis
The Commission has reviewed the EU Application and the relevant EU
laws and regulations, and has preliminarily determined that the EU
Capital Rules are comparable in purpose and effect to the CFTC Capital
Rules with regard to the establishment of the nonbank SD's minimum
capital requirement and the calculation of the nonbank SD's amount of
regulatory capital to meet that requirement.\257\ Although there are
differences between the EU Capital Rules and the CFTC Capital Rules, as
discussed below, the Commission preliminarily believes that the EU
Capital Rules and the CFTC Capital Rules are designed to ensure the
safety and soundness of a nonbank SD and, subject to the proposed
conditions discussed below, will achieve comparable outcomes by
requiring the firm to maintain a minimum level of qualifying regulatory
capital, including subordinated debt, to absorb losses from the firm's
business activities, including swap dealing activities, and decreases
in the value of the firm's assets and increases in the value of the
firm's liabilities, without the nonbank SD becoming insolvent. The
Commission's preliminary finding of comparability is based on a
comparative analysis of the three minimum capital requirements
thresholds of the CFTC Capital Rules' Bank-Based Approach (i.e., the
three prongs recited in Section III.C.1 above) and the respective
elements of the EU Capital Rules' requirements, as discussed below.
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\257\ The Commission notes that pursuant to Article 7 of CRR,
the competent authority may exempt an entity subject to CRR from the
applicable capital requirements, provided certain conditions are
met. In such case, the relevant requirements would apply to the
entity's parent entity, on a consolidated basis. The Commission's
assessment does not cover the application of Article 7 of CRR and
therefore an entity that benefits from an exemption under Article 7
of CRR would not qualify for substituted compliance under the
Capital Comparability Determination Order.
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a. Fixed Amount Minimum Capital Requirement
CFTC Capital Rules and the EU Capital Rules both require nonbank
SDs to hold a minimum amount of regulatory capital that is not based on
the risk-weighted assets of the firms. Prong (i) of the CFTC Capital
Rules requires each nonbank SD electing the Bank-Based Approach to
maintain a minimum of $20 million of common
[[Page 41794]]
equity tier 1 capital. The CFTC's $20 million fixed-dollar minimum
capital requirement is intended to ensure that each nonbank SD
maintains a level of regulatory capital, without regard to the level of
the firm's dealing and other activities, sufficient to meet its
obligations to swap market participants given the firm's status as a
CFTC-registered nonbank SD and to help ensure the safety and soundness
of the nonbank SD.\258\ The EU Capital Rules also contain a requirement
that an EU nonbank SD maintain a fixed amount of minimum initial
capital of EUR 5 million of common equity tier 1 capital in order to
become and remain authorized as a credit institution.\259\
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\258\ 85 FR 57492.
\259\ CRD, Article 12.
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The Commission recognizes that the $20 million fixed-dollar minimum
capital required under the CFTC Capital Rules is substantially higher
than the EUR 5 million minimum initial capital required under the EU
Capital Rules and the Commission preliminarily believes that the $20
million represents a more appropriate level of minimum capital to help
ensure the safety and soundness of the nonbank SD that is engaging in
uncleared swap transactions. Accordingly, the Commission is proposing
to condition the Capital Comparability Determination Order to require
each EU nonbank SD to maintain, at all times, a minimum level of $20
million regulatory capital in the form of common equity tier 1 items as
defined in Article 26 of CRR.\260\ The proposed condition would require
each EU nonbank SD to maintain an amount of common equity tier 1
capital denominated in euro that is equivalent to the $20 million in
U.S. dollars.\261\ The Commission is also proposing that an EU nonbank
SD may convert the euro-denominated common equity tier 1 capital amount
to the U.S. dollar equivalent based on a commercially reasonable and
observable exchange rate.
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\260\ The Commission notes that the proposed requirement that EU
nonbank SDs maintain a minimum level of $20 million of common equity
tier 1 capital is consistent with conditions set forth in the
proposed Capital Comparability Determination Orders for Japan and
Mexico, respectively. See, Notice of Proposed Order and Request for
Comment on an Application for a Capital Comparability Determination
from the Financial Services Agency of Japan, 87 FR 48092 (Aug. 8,
2022) (``Proposed Japan Order''); Notice of Proposed Order and
Request for Comment on an Application for a Capital Comparability
Determination Submitted on behalf of Nonbank Swap Dealers subject to
Regulation by the Mexican Comision Nacional Bancaria y de Valores,
87 FR 76374 (Dec. 13, 2022) (``Proposed Mexico Order'').
\261\ Each of the four current EU nonbank SDs currently
maintains common equity tier 1 capital in excess of $20 million
based on financial filings made with the Commission. Therefore, the
Commission does not anticipate that the proposed condition would
have any material impact on the EU nonbank SDs currently registered
with the Commission. Nonetheless, the Commission requests comment on
the proposed condition.
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b. Minimum Capital Requirement Based on Risk-Weighted Assets
Prong (iii) of the CFTC Capital Rules requires each nonbank SD to
maintain an aggregate of common equity tier 1 capital, additional tier
1 capital, and tier 2 capital in an amount equal to or greater than 8
percent of the nonbank SD's total risk-weighted assets, with common
equity tier 1 capital comprising at least 6.5 percent of the 8
percent.\262\ Risk-weighted assets are a nonbank SD's on-balance sheet
and off-balance sheet market risk and credit risk exposures, including
exposures associated with proprietary swap, security-based swap,
equity, and futures positions, weighted according to risk. The
requirements and capital ratios set forth in prong (iii) are based on
the Federal Reserve Board's capital requirements for bank holding
companies and are consistent with the BCBS international bank capital
adequacy framework. The requirement for each nonbank SD to maintain
regulatory capital in an amount that equals or exceeds 8 percent of the
firm's total risk-weighted assets is intended to help ensure that the
nonbank SD's level of capital is sufficient to absorb decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities, and to cover unexpected losses resulting from the firm's
business activities, including losses resulting from uncollateralized
defaults from swap counterparties, without the nonbank SD becoming
insolvent.
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\262\ 17 CFR 23.101(a)(1)(B).
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The EU Capital Rules contain capital requirements for EU nonbank
SDs that the Commission preliminarily believes are comparable to the
requirements contained in prong (iii) of the CFTC Capital Rules.
Specifically, the EU Capital Rules require an EU nonbank SD to
maintain: (i) common equity tier 1 capital equal to at least 4.5
percent of the EU nonbank SD's total risk exposure amount; (ii) total
tier 1 capital (i.e., common equity tier 1 capital plus additional tier
1 capital) equal to at least 6 percent of the EU nonbank SD's total
risk exposure amount; and (iii) total capital (i.e., an aggregate
amount of common equity tier 1 capital, additional tier 1 capital, and
tier 2 capital) equal to at least 8 percent of the EU nonbanks SD's
total risk exposure amount.\263\ In addition, the EU Capital Rules
further require each EU nonbank SD to maintain an additional capital
conservation buffer equal to 2.5 percent of the EU nonbank SD's total
risk exposure amount, which must be met with common equity tier 1
capital.\264\ Thus, an EU nonbank SD is effectively required to
maintain total qualifying regulatory capital in an amount equal to or
in excess of 10.5 percent of the market risk, credit risk, CVA risk,
settlement risk and operational risk of the firm (i.e., total capital
requirement of 8 percent of risk-weighted assets and an additional 2.5
percent of risk-weighted assets as a capital conservation buffer),
which is higher than the 8 percent required of nonbank SDs under prong
(iii) of the CFTC Capital Rules.\265\
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\263\ CRR, Article 92(1).
\264\ CRD, Article 129(1).
\265\ CRR, Article 92(1) and CRD, Article 129(1).
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The Commission also preliminarily believes that the EU Capital
Rules and the CFTC Capital Rules are comparable with respect to the
calculation of capital charges for market risk and credit risk
(including as it relates to aspects of settlement risk and CVA risk),
in determining the nonbank SD's risk-weighted assets. More
specifically, with respect to the calculation of market risk charges
and general credit risk charges, both regimes require a nonbank SD to
use standardized approaches to compute market and credit risk, unless
the firms are approved to use internal models. The standardized
approaches follow the same structure that is now the common global
standard: (i) allocating assets to categories according to risk and
assigning each a risk-weight; (ii) allocating counterparties according
to risk assessments and assigning each a risk factor; (iii) calculating
gross exposures based on valuation of assets; (iv) calculating a net
exposure allowing offsets following well defined procedures and subject
to clear limitations; (v) adjusting the net exposure by the market
risk-weights; and (vi) finally, for credit risk exposures, multiplying
the sum of net exposures to each counterparty by their corresponding
risk factor.
Internal market risk and credit risk models under the EU Capital
Rules and the CFTC Capital Rules are based on the BCBS framework and
contain comparable quantitative and qualitative requirements, covering
the same risks, though with slightly different categorization, and
including comparable model risk management requirements. As both rule
sets address the same types of risk, with similar allowed methodologies
and under similar controls, the Commission
[[Page 41795]]
preliminarily believes that these requirements are comparable.
The Commission also preliminarily believes that the EU Capital
Rules and CFTC Capital Rules are comparable in that nonbank SDs are
required to account for operational risk in computing their minimum
capital requirements. In this connection, the EU Capital Rules require
an EU nonbank SD to calculate an operational risk exposure as a
component of the firm's total risk exposure amount.\266\ EU nonbank SDs
may use either a standardized approach or, if the EU nonbank SD has
obtained regulatory permission, an internal approach based on the
firm's own measurement systems, to calculate their capital charges for
operational risk. The CFTC Capital Rules address operational risk both
as a stand-alone, separate minimum capital requirement that a nonbank
SD is required to meet under prong (ii) of the Bank-Based Approach
\267\ and as a component of the calculation of risk-weighted assets for
nonbank SDs that use Subpart E of the Federal Reserve Board's Part 217
regulations to calculate their credit risk-weighted assets via internal
models.\268\
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\266\ CRR, Article 92(3).
\267\ Specifically, as further discussed below, prong (ii) of
the CFTC Capital Rules' Bank-Based Approach requires a nonbank SD to
maintain regulatory capital in an amount equal to or greater than 8
percent of the firm's total uncleared swaps margin amount associated
with its uncleared swap transactions to address potential
operational, legal, and liquidity risks. 17 CFR 101(a)(i)(C). The
term ``uncleared swap margin'' is defined by Commission Regulation
23.100 as the amount of initial margin, computed in accordance with
the Commission's margin rules for uncleared swaps, that a nonbank SD
would be required to collect from each counterparty for each
outstanding swap position of the nonbank SD. 17 CFR 23.100 and
23.154. A nonbank SD must include all swap positions in the
calculation of the uncleared swap margin amount, including swaps
that are exempt or excluded from the scope of the Commission's
margin regulations for uncleared swaps pursuant to Commission
Regulation 23.150, exempt foreign exchange swaps or foreign exchange
forwards, or netting set of swaps or foreign exchange swaps, for
each counterparty, as if that counterparty was an unaffiliated swap
dealer. 17 CFR 23.100 and 23.150. Furthermore, in computing the
uncleared swap margin amount, a nonbank SD may not exclude any de
minis thresholds contained in Commission Regulation 23.151. 17 CFR
23.100 and 23.151.
\268\ 17 CFR 23.101(a)(1)(i) and 17 CFR 23.100 (definition of
BHC equivalent risk-weighted assets).
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c. Minimum Capital Requirement Based on the Uncleared Swap Margin
Amount
As noted above, prong (ii) of the CFTC Capital Rules' Bank-Based
Approach requires a nonbank SD to maintain regulatory capital in an
amount equal to or greater than 8 percent of the firm's total uncleared
swaps margin amount associated with its uncleared swap transactions to
address potential operational, legal, and liquidity risks.
The EU Capital Rules differ from the CFTC Capital Rules in that
th
[…truncated; see source link]Indexed from Federal Register on June 27, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.