Proposed Rule2024-02070
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 Capital and Financial Reporting Requirements of the United Kingdom and Regulated by the United Kingdom Prudential Regulation Authority
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
February 5, 2024
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 United Kingdom applicable to CFTC-registered swap dealers organized and domiciled in the United Kingdom, which are licensed under the United Kingdom Financial Services and Markets Act 2000 as investment firms and designated for prudential supervision by the United Kingdom Prudential Regulation Authority, 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
<html>
<head>
<title>Federal Register, Volume 89 Issue 24 (Monday, February 5, 2024)</title>
</head>
<body><pre>
[Federal Register Volume 89, Number 24 (Monday, February 5, 2024)]
[Proposed Rules]
[Pages 8026-8063]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-02070]
[[Page 8025]]
Vol. 89
Monday,
No. 24
February 5, 2024
Part III
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 Subject to Capital and Financial Reporting Requirements of
the United Kingdom and Regulated by the United Kingdom Prudential
Regulation Authority; Proposed Rule
Federal Register / Vol. 89 , No. 24 / Monday, February 5, 2024 /
Proposed Rules
[[Page 8026]]
-----------------------------------------------------------------------
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 Subject to Capital and Financial
Reporting Requirements of the United Kingdom and Regulated by the
United Kingdom Prudential Regulation Authority
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed order and request for comment.
-----------------------------------------------------------------------
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 United Kingdom applicable to CFTC-registered
swap dealers organized and domiciled in the United Kingdom, which are
licensed under the United Kingdom Financial Services and Markets Act
2000 as investment firms and designated for prudential supervision by
the United Kingdom Prudential Regulation Authority, 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 March 24, 2024.
ADDRESSES: You may submit comments, identified by ``UK-PRA 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\
---------------------------------------------------------------------------
\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>.
---------------------------------------------------------------------------
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#4627292a232734067a27662e3423207b" http: cftc.gov">cftc.gov</a>">aolear@<a href="http://cftc.gov">cftc.gov</a></a>; Thomas Smith, Deputy Director, 202-418-5495,
<a href="/cdn-cgi/l/email-protection#1165627c786579512d7031796374772c" http: cftc.gov">cftc.gov</a>">tsmith@<a href="http://cftc.gov">cftc.gov</a></a>; Rafael Martinez, Associate Director, 202-418-5462,
<a href="/cdn-cgi/l/email-protection#7a08171b080e13141f003a461b5a12081f1c47" http: cftc.gov">cftc.gov</a>">rmartinez@<a href="http://cftc.gov">cftc.gov</a></a>; Liliya Bozhanova, Special Counsel, 202-418-6232,
<a href="/cdn-cgi/l/email-protection#7d111f1207151c13120b1c3d411c5d150f181b40" http: cftc.gov">cftc.gov</a>">lbozhanova@<a href="http://cftc.gov">cftc.gov</a></a>; Joo Hong, Risk Analyst, 202-418-6221,
<a href="/cdn-cgi/l/email-protection#a8c2c0c7c6cfe894c988c0dacdce95" http: cftc.gov">cftc.gov</a>">jhong@<a href="http://cftc.gov">cftc.gov</a></a>; Justin McPhee, Risk Analyst, 202-418-6223;
<a href="/cdn-cgi/l/email-protection#452f28262d352020057924652d37202378" http: cftc.gov">cftc.gov</a>">jmchpee@<a href="http://cftc.gov">cftc.gov</a></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 May 4, 2021 (the ``UK 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 United Kingdom
(``UK''), which are licensed as investment firms and designated for
prudential supervision by the UK Prudential Regulation Authority
(``PRA'') (``PRA-designated UK 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 UK laws
and regulations.\5\ The Commission also is soliciting public comment on
a proposed order under which PRA-designated UK nonbank SDs 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.
---------------------------------------------------------------------------
\2\ See Letter dated May 4, 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 UK 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\ The Applicants also requested that the Commission determine
that nonbank SDs licensed as investment firms and prudentially
regulated by the UK Financial Conduct Authority (``FCA'') (``FCA-
regulated UK nonbank SDs'') may satisfy certain capital and
financial reporting requirements under the CEA by being subject to,
and complying with, comparable capital and financial reporting
requirements under UK laws and regulations. Due to the differences
between the capital and financial reporting regimes applicable to
PRA-designated UK nonbank SD and FCA-regulated UK nonbank SDs, the
Commission anticipates assessing the comparability of the rules
applicable to FCA-regulated UK nonbank SDs through a separate
capital comparability determination.
---------------------------------------------------------------------------
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
[[Page 8027]]
requirements on all SDs and major swap participants (``MSPs'')
registered with the Commission.\8\ Section 4s(e) of the 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'').
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\9\ 7 U.S.C. 6s(e)(2).
\10\ 7 U.S.C. 6s(e)(1) and (2).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\14\ 7 U.S.C. 6s(f).
\15\ 7 U.S.C. 6s(f)(1)(A).
\16\ See 85 FR 57462.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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, and CFTC Staff
Letter 23-11, issued on July 10, 2023 (extending the expiration of
CFTC Staff Letter 21-18 until the earlier of October 6, 2025 or the
adoption of any revised financial reporting requirements applicable
to bank SDs under Regulation 23.105(p)). On December 15, 2023, the
Commission issued for public comment proposed amendments to
Regulation 23.105(p) addressing the financial reporting requirements
applicable to bank SDs in a manner consistent with the position
taken in CFTC Letters 21-18 and 23-11. See CFTC Press Release 8836-
23 issued on December 15, 2023, available at <a href="http://cftc.gov">cftc.gov</a>.
\18\ 17 CFR 23.106(a)(3).
---------------------------------------------------------------------------
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
[[Page 8028]]
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.
---------------------------------------------------------------------------
\19\ See 85 FR 57462 at 57521.
\20\ Id.
---------------------------------------------------------------------------
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 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\
---------------------------------------------------------------------------
\21\ 17 CFR 23.106(a)(2).
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\22\ See 17 CFR 23.106(a)(3) and 85 FR 57520-57522.
---------------------------------------------------------------------------
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 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.
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\24\ See 17 CFR 23.106(a)(5).
---------------------------------------------------------------------------
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
[[Page 8029]]
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 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.
---------------------------------------------------------------------------
\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#024f5246446b6c636c616b636e506773776b70676f676c7671423e63226a7067643f" http: cftc.gov">cftc.gov</a>">MPDFinancialRequirements@<a href="http://cftc.gov">cftc.gov</a></a>.
\27\ See 17 CFR 140.91(a)(11).
---------------------------------------------------------------------------
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 a
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\ A finding of a
violation by a foreign jurisdiction's regulatory authority is not a
prerequisite for the exercise of such examination and enforcement
authority by the Commission.
---------------------------------------------------------------------------
\28\ 17 CFR 23.106(a)(4).
\29\ Id.
\30\ Id.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\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 UK 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.
---------------------------------------------------------------------------
C. Application for a Capital Comparability Determination for PRA-
Designated UK Nonbank Swap Dealers
The Applicants submitted the UK Application requesting that the
Commission issue a Capital Comparability Determination finding that a
PRA-designated UK nonbank SD's compliance with the capital requirements
of the UK and the financial reporting requirements of the UK, as
specified in the UK Application and applicable to PRA-designated UK
nonbank SDs, 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\
---------------------------------------------------------------------------
\32\ UK 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 UK nonbank MSPs. Accordingly, the
Commission's Capital Comparability Determination and proposed
Capital Comparability Determination Order do not address UK nonbank
MSPs.
---------------------------------------------------------------------------
To be designated for prudential supervision by the PRA, a UK-
domiciled investment firm must be authorized, or have requested
authorization, to deal in investments as principal.\33\ For an
investment firm that is authorized, or has requested authorization, to
deal in investments as principal, the PRA may designate the firm for
prudential supervision if the PRA determines that the dealing
activities of the firm should be a PRA-regulated activity. The PRA
considers the following in determining whether an investment firm
should be subject to PRA supervision: (i) the assets of the investment
firm; and (ii) where the investment firm is a member of a group, (a)
the assets of other firms within the group that are authorized, or have
sought authorization, to deal in investments as principal, (b) whether
any other member of the group is subject to prudential supervision by
the PRA, and (c) whether the investment firm's activities have, or
might have, a material impact on the ability of the PRA to advance any
of its objectives in relation to PRA-authorized person in its
group.\34\ The PRA also must consult with the FCA before designating a
person for prudential supervision.\35\
---------------------------------------------------------------------------
\33\ Article 3(1) and (2) of The Financial Services and Markets
Act 2000 (PRA-regulated Activities) Order 2013.
\34\ Id., Article 3(4).
\35\ Id., Article 3(6).
---------------------------------------------------------------------------
The PRA also has issued a Statement of Policy providing further
detail regarding the factors that are considered in assessing an
investment firm for prudential supervision.\36\ The factors include:
(i) whether the firm's balance sheet exceeds an average of GBP 15
billion total gross assets over four quarters; (ii) where the
investment firm is part of a group, whether the sum of the balance
sheets of all firms within the group that are authorized, or have
requested authorization, to deal in investments as principals exceeds
an average of GBP 15 billion over four quarters; and/or (iii) where the
firm is part of a group subject to PRA supervision, whether the
investment firm's revenues, balance sheet and risk taking is
significant relative to the group's revenues, balance sheet, and risk-
taking.\37\ There are currently six PRA-designated UK nonbank SDs
registered with the Commission:
[[Page 8030]]
Citigroup Global Markets Limited, Goldman Sachs International, Merrill
Lynch International, Morgan Stanley & Co. International Plc, MUFG
Securities EMEA Plc, and Nomura International Plc.
---------------------------------------------------------------------------
\36\ See PRA, Statement of Policy, Designation of Investment
Firms for Prudential Supervision by the Prudential Regulation
Authority, December 2021, available here: <a href="https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/statement-of-policy/2021/designation-of-investment-firms-for-prudential-supervision-by-the-pra-december-2021.pdf?la=en&hash=007EB17EDF2FA84714D372095F9E03627355776F">https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/statement-of-policy/2021/designation-of-investment-firms-for-prudential-supervision-by-the-pra-december-2021.pdf?la=en&hash=007EB17EDF2FA84714D372095F9E03627355776F</a>.
\37\ Id., at p. 5.
---------------------------------------------------------------------------
The Applicants represent that the capital and financial reporting
framework applicable to PRA-designated UK nonbank SDs is primarily
based on the framework established by the European Union's (``EU'')
Capital Requirements Regulation \38\ and Capital Requirements
Directive,\39\ which set forth capital and financial reporting
requirements applicable to ``credit institutions'' \40\ and
``investment firms.'' \41\ CRR, as a regulation, is directly applicable
in all member states of the EU (``EU Member States'') and was,
therefore, binding law in the UK during the UK's membership in the
EU.\42\ CRD, as a directive, was required to be transposed into EU
Member States' national law, including UK law.\43\ With regard to PRA-
designated UK nonbank SDs, the UK implemented CRD primarily through a
series of regulations, including the Capital Requirements Regulations
2013 \44\ and the Capital Requirements (Capital Buffers and Macro-
prudential Measures) Regulations 2014,\45\ and the rules of the
PRA.\46\
---------------------------------------------------------------------------
\38\ 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 (``Capital
Requirements Regulation'' or ``CRR'').
\39\ 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 (``Capital Requirements Directive'' or ``CRD'').
\40\ The term ``credit institution'' is defined as an entity
whose business consists of taking deposits and other repayable funds
from the public and granting credits. CRR, Article 4(1), as
applicable in the UK. For a reference to CRR provisions applicable
in the UK, see infra notes 49 and 50.
\41\ The term ``investment firm'' is defined as an entity
authorized under 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''), 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, which
includes dealing in derivatives for its own account. CRR, Article
4(1)(2) cross-referencing Article 4(1)(1) of MiFID.
\42\ Consolidated Version of the Treaty on the Functioning of
the European Union, OJ (C 326) 171, Oct. 26, 2012 (``TFEU''),
Article 288.
\43\ Id., 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. CRD V, Article 2.
\44\ Capital Requirements Regulations 2013, Statutory Instrument
2013 No. 3115 (``Capital Requirements Regulations 2013'').
\45\ Capital Requirements (Capital Buffers and Macro-prudential
Measures) Regulations 2014, Statutory Instrument 2014 No. 894
(``Capital Requirements (Capital Buffers and Macro-prudential
Measures) Regulations 2014'').
\46\ The PRA's rules (``PRA Rulebook'') are available here:
<a href="https://www.prarulebook.co.uk/">https://www.prarulebook.co.uk/</a>.
---------------------------------------------------------------------------
Following the UK's withdrawal from EU membership (``Brexit''), EU
laws that were in effect and applicable as of December 31, 2020, were
retained in UK law subject to certain non-substantive amendments
seeking to reflect the UK's new position outside of the EU.\47\ As
such, directly applicable EU law, such as CRR, was converted into
domestic UK law and UK legislation implementing EU directives, such as
CRD, was preserved. The UK subsequently adopted additional changes,
generally consistent with amendments introduced by the EU to CRR, CRD
and other relevant EU provisions,\48\ and incorporated certain CRR
provisions in the PRA Rulebook.\49\ The CRR provisions as applicable in
the UK are referred hereafter as ``UK CRR.'' \50\ The UK capital and
financial reporting framework also comprises UK-specific requirements
in respect of certain matters. Requirements applicable to PRA-
designated UK nonbank SDs are included in the PRA Rulebook. In
addition, Commission Delegated Regulation (EU) 2015/61,\51\ which
supplements UK CRR with regard to liquidity coverage requirement for
credit institutions, applies to PRA-designated UK nonbank SDs and
imposes separate liquidity requirements to these firms.\52\
---------------------------------------------------------------------------
\47\ See, An Act to Repeal the European Communities Act 1972 and
make other provisions in connection with the withdrawal of the
United Kingdom from the EU (2018 c.16) (``European Union
(Withdrawal) Act 2018'').
\48\ See PRA, Policy Statement 21/21--The UK Leverage Framework,
October 2021, available here: <a href="https://www.bankofengland.co.uk/prudential-regulation/publication/2021/june/changes-to-the-uk-leverage-ratio-framework">https://www.bankofengland.co.uk/prudential-regulation/publication/2021/june/changes-to-the-uk-leverage-ratio-framework</a>, and Policy Statement 22/21--Implementation
of Basel standards: Final rules, October 2021, available here:
<a href="https://www.bankofengland.co.uk/prudential-regulation/publication/2021/october/implementation-of-basel-standards">https://www.bankofengland.co.uk/prudential-regulation/publication/2021/october/implementation-of-basel-standards</a>.
\49\ Pursuant to the Financial Services and Markets Act 2023
(``FSMA 2023''), the UK revoked CRR and replaced it with: (i) PRA
rules adopted under Section 144 of the Financial Services and
Markets Act 2000 (``FSMA'') and (ii) UK regulations, adopted under
Section 4 of FSMA 2023, restating CRR provisions.
\50\ The UK CRR is available here: <a href="https://www.legislation.gov.uk/eur/2013/575/contents">https://www.legislation.gov.uk/eur/2013/575/contents</a>. The provisions that
were incorporated in the PRA Rulebook are no longer part of UK CRR
and appear instead in the PRA Rulebook.
\51\ Commission Delegated Regulation (EU) 2015/61 of 10 October
2014 to supplement Regulation (EU) No 575/2013 of the European
Parliament and the Council with regard to liquidity coverage
requirement for Credit Institutions (``Liquidity Coverage Delegated
Regulation'').
\52\ See PRA Rulebook, CRR Firms, Liquidity Coverage
Requirement--UK Designated Investment Firms Part.
---------------------------------------------------------------------------
The Applicants also represent that in addition to UK CRR and the
PRA Rulebook, the Banking Act 2009 and its related secondary
legislation, through which the UK transposed the Bank Recovery and
Resolution Directive (``BRRD''), include relevant UK capital
requirements.\53\ Specifically, pursuant to the Banking Act 2009 and
its secondary legislation, the Bank of England, in its role as
resolution authority, requires certain investment firms, including PRA-
designated UK nonbank SDs, to satisfy a firm-specific minimum
requirement for own funds and eligible liabilities (``MREL'').\54\
---------------------------------------------------------------------------
\53\ 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 UK Application, p.
7.
\54\ Banking Act 2009, Section 3A(4) and (4B); Bank Recovery and
Resolution (No 2) Order 2014, Statutory Instrument No. 3348 (``Bank
Recovery and Resolution (No 2) Order 2014''), Part 9.
---------------------------------------------------------------------------
UK CRR, Capital Requirements Regulations 2013, Capital Requirements
(Capital Buffers and Macro-prudential Measures) Regulations 2014,
Liquidity Coverage Delegated Regulation, the Banking Act 2009 and its
secondary legislation, and relevant parts of the PRA Rulebook are
referred to hereafter as the ``UK PRA Capital Rules.''
The Applicants further represent that with respect to supervisory
financial reporting, the framework applicable to PRA-designated UK
nonbank SDs is also based on the EU requirements. In addition, the
framework comprises PRA-specific rules for matters not addressed by the
EU-based requirements. Specifically, Commission Implementing Regulation
(EU) 680/2014,\55\ which was initially retained in UK law following
Brexit, supplemented CRR with implementing technical standards (``CRR
Reporting ITS'')
[[Page 8031]]
specifying, among other things, uniform formats and frequencies for the
financial and capital requirements reporting required under CRR.\56\
CRR Reporting ITS included templates for the common reporting
(``COREP'') and the financial reporting (``FINREP'') that specify the
contents of the EU-based supervisory reporting requirements. As part of
the regulatory reforms that followed Brexit and sought to implement
Basel III standards, the PRA incorporated the entire body of the UK
version of COREP and FINREP requirements into the PRA Rulebook to
create a single source for reporting requirements for firms.\57\ For
PRA-designated UK nonbank SDs that are not subject to the EU-based
FINREP requirements, the PRA Rulebook includes PRA-specific
requirements.\58\
---------------------------------------------------------------------------
\55\ Commission Implementing Regulation (EU) 680/2014 of 16
April 2014 laying down implementing technical standards with regard
to supervisory reporting of institutions according to Regulation
(EU) No 575/2013 of the European Parliament and of the Council.
\56\ UK Application, p. 24 and Responses to Staff Questions
dated October 5, 2023.
\57\ PRA Rulebook, CRR Firms, Reporting (CRR) Part.
\58\ PRA Rulebook, CRR Firms, Regulatory Reporting Part.
---------------------------------------------------------------------------
The Applicants also represent that the Companies Act 2006 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 strategic report.\59\ UK CRR, relevant
provisions of the PRA Rulebook, and relevant provisions of the
Companies Act 2006, are collectively referred to hereafter as the ``UK
PRA Financial Reporting Rules.''
---------------------------------------------------------------------------
\59\ UK Application, p.7. Companies Act 2006, Part 15 and 16.
The Companies Act 2006 is available here: <a href="https://www.legislation.gov.uk/ukpga/2006/46/contents">https://www.legislation.gov.uk/ukpga/2006/46/contents</a>.
---------------------------------------------------------------------------
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 the UK (``UK nonbank
SBSD'') \60\ to satisfy SEC capital \61\ and financial reporting
requirements via substituted compliance with applicable UK capital and
financial reporting.\62\ The UK Order conditioned substituted
compliance for capital requirements on a UK nonbank SBSD complying with
specified laws and regulations, including relevant parts of UK CRR and
the PRA Rulebook, and also maintaining total liquid assets in an amount
that exceeds the UK 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.\63\
---------------------------------------------------------------------------
\60\ All six of the PRA-designated UK nonbank SDs currently
registered with the Commission are also UK nonbank SBSDs.
\61\ 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.
\62\ See 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 United Kingdom, 86 FR
43318 (July 30, 2021) (``Final UK Order''); 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) (``Amended UK Order,''
together with the Final UK Order, ``UK 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'').
\63\ The conditioning of the UK substituted compliance order on
UK nonbank SBSDs maintaining liquid assets in an amount that exceeds
the UK 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).
---------------------------------------------------------------------------
II. General Overview of Commission and UK PRA 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'').\64\
---------------------------------------------------------------------------
\64\ 17 CFR 23.101.
---------------------------------------------------------------------------
Nonbank SDs that are ``predominantly engaged in non-financial
activities'' may elect the TNW Approach.\65\ The TNW Approach requires
a nonbank SD to maintain a level of ``tangible net worth'' \66\ equal
to or greater than the higher of: (i) $20 million plus the amount of
the nonbank SD's ``market risk exposure requirement'' \67\ and ``credit
risk exposure requirement'' \68\ 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; \69\ or (iii) the amount of capital required by a
registered futures association of which the nonbank SD is a member.\70\
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.
---------------------------------------------------------------------------
\65\ 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.
\66\ 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.
\67\ 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.
\68\ 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.
\69\ 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.
\70\ 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.
---------------------------------------------------------------------------
The TNW approach requires a nonbank SD to compute its market risk
exposure requirement and credit risk
[[Page 8032]]
exposure requirement using standardized capital charges set forth in
SEC Rule 18a-1 \71\ 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.\72\ 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.\73\
---------------------------------------------------------------------------
\71\ 17 CFR 240.18a-1.
\72\ 17 CFR 23.101(a)(2)(ii)(A).
\73\ Id.
---------------------------------------------------------------------------
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.\74\ 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.
---------------------------------------------------------------------------
\74\ 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.''
---------------------------------------------------------------------------
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.\75\ A nonbank SD
that does not have Commission or NFA approval to use internal models
must compute its market risk exposure requirement and/or credit risk
exposure requirement using the standardized capital charges contained
in SEC Rule 18a-1 as modified by the Commission's rule.\76\
---------------------------------------------------------------------------
\75\ See 17 CFR 240.18a-1(c) and (d).
\76\ See 17 CFR 23.101(a)(1)(ii).
---------------------------------------------------------------------------
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.\77\ 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.'' \78\
---------------------------------------------------------------------------
\77\ See 17 CFR 23.102.
\78\ 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.
---------------------------------------------------------------------------
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.\79\
The Bank-Based Approach also is consistent with the Basel Committee on
Banking Supervision's (``BCBS'') international framework for bank
capital requirements.\80\ 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.\81\ 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.
---------------------------------------------------------------------------
\79\ See 17 CFR 23.101(a)(1)(i).
\80\ 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>.
\81\ 17 CFR 23.101(a)(1)(i).
---------------------------------------------------------------------------
The terms used in the Commission's Bank-Based Approach are defined
by reference to regulations of the Federal Reserve Board.\82\
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.\83\ 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.\84\ 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).\85\ 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.\86\
---------------------------------------------------------------------------
\82\ 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.
\83\ See 12 CFR 217.20(b).
\84\ See 12 CFR 217.20(c).
\85\ See 12 CFR 217.20(d).
\86\ 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.
---------------------------------------------------------------------------
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
[[Page 8033]]
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.\87\
---------------------------------------------------------------------------
\87\ 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.\88\ 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.
---------------------------------------------------------------------------
\88\ See 17 CFR 1.17(c)(5) and 17 CFR 240.15c3-1(c)(2).
---------------------------------------------------------------------------
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 purposes of determining its total risk-weighted
assets.\89\ 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.
---------------------------------------------------------------------------
\89\ See 17 CFR 23.102.
---------------------------------------------------------------------------
B. General Overview of UK PRA Capital Rules for PRA-Designated UK
Nonbank SDs
The Applicants state that the UK PRA Capital Rules impose bank-like
capital requirements on a PRA-designated UK nonbank SD that are
consistent with the BCBS framework for international bank-based capital
standards.\90\ The Applicants further state that the UK PRA Capital
Rules are intended to require each PRA-designated UK nonbank SD to hold
a sufficient amount of qualifying equity capital and subordinated debt
based on the PRA-designated UK 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.\91\
---------------------------------------------------------------------------
\90\ See UK Application, p. 12.
\91\ See UK Application, pp. 7 and 12.
---------------------------------------------------------------------------
The UK PRA Capital Rules require each PRA-designated UK 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
PRA-designated UK nonbank SD's total risk exposure amount, which is
calculated as a sum of the firm's risk-weighted assets and
exposures.\92\ Common equity tier 1 capital must comprise a minimum of
4.5 percent of the 8 percent capital ratio,\93\ 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.\94\ Tier 2 capital may comprise a maximum of 2
percent of the total 8 percent capital ratio.\95\
---------------------------------------------------------------------------
\92\ UK CRR, Articles 26, 28, 50-52, 61-63 and 92.
\93\ Id., Article 92(1)(a).
\94\ Id., Article 92(1)(b).
\95\ Id., Article 92(1)(c) (providing 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, a PRA-designated UK
nonbank SD must maintain at all times capital resources equal to or
in excess of GBP 750,000. PRA Rulebook, CRR Firms, Definition of
Capital Part, Chapter 12 Base Capital Resource Requirement, Rule
12.1.
---------------------------------------------------------------------------
Under the UK PRA 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 PRA-
designated UK nonbank SD.\96\ 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.\97\ Tier 2 capital instruments, which
provide an additional layer of supplementary capital, include other
reserves, hybrid capital instruments, and certain subordinated
debt.\98\
---------------------------------------------------------------------------
\96\ UK 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 PRA-
designated UK nonbank SD for unrestricted and immediate use to cover
risks or losses as such risks or losses occur. See UK CRR, Article
26(1).
\97\ Id., Articles 51-52.
\98\ Id., Articles 62-63.
---------------------------------------------------------------------------
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 PRA-designated UK nonbank SD and
are fully paid-up; (ii) the capital instruments are not purchased by
the PRA-designated UK 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,'' \99\ meaning that
they are effectively subordinated to claims of all non-subordinated
creditors of the PRA-designated UK 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 PRA-
designated UK nonbank SD prior to the capital instruments' respective
maturities.\100\
---------------------------------------------------------------------------
\99\ ``Eligible liabilities'' are non-capital instruments,
including instruments that are directly issued by the PRA-designated
UK nonbank SD and fully paid up with remaining maturities of at
least a year. Bank Recovery and Resolution (No. 2) Order 2014,
Article 123. In addition, the liabilities cannot be owned, secured,
or guaranteed, by the PRA-designated UK nonbank SD itself, and the
PRA-designated UK nonbank SD cannot have either directly or
indirectly funded their purchase. Id.
\100\ UK CRR, Article 63 (listing the conditions that capital
instruments must meet to qualify as tier 2 instruments) and Bank
Recovery and Resolution (No. 2) Order 2014, Article 123. See also
infra note 121.
---------------------------------------------------------------------------
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 UK PRA Capital Rules also require a PRA-designated UK
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-
[[Page 8034]]
weighted assets.\101\ 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.\102\
---------------------------------------------------------------------------
\101\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
\102\ Id. In effect, the UK PRA Capital Rules require a PRA-
designated UK 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, a PRA-designated nonbank SD may also be subject to
a firm-specific countercyclical capital buffer, whose rate consists
of the weighted average of the countercyclical buffer rates that
apply to exposures in the jurisdictions where the firm's relevant
credit exposures are located. The rate for each jurisdiction is
determined by the UK Financial Policy Committee or a third country
countercyclical buffer authority, as applicable. See PRA Rulebook,
CRR Firms, Capital Buffers Part, Chapter 3 Countercyclical Capital
Buffer, Rule 3.1., and Capital Requirements (Capital Buffers and
Macro-prudential Measures) Regulations 2014, Articles 7-20. The sum
of the capital conservation buffer and the countercyclical buffer is
referred to as the ``combined buffer.'' PRA Rulebook, CRR Firms,
Capital Buffers Part, Chapter 1 Application and Definitions, Rule
1.2. To meet these additional capital buffer requirements, the PRA-
designated UK 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 PRA Rulebook, CRR
Firms, Capital Buffers Part, Chapter 1 Application and Definitions,
Rule 1.2, and Capital Buffers Part, Chapter 4 Capital Conservation
Measures, Rule 4.1. In practice, the countercyclical buffer rate in
the UK, as of July 2023, is 2 percent of risk-weighted assets.
Several EU Member States of relevance to the UK have also
implemented countercyclical capital buffers with rates ranging from
0.5 percent to 2.5 percent of risk-weighted assets. The
countercyclical capital buffer rate is published by the Bank of
England, and is available at: <a href="https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer">https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer</a>.
---------------------------------------------------------------------------
The UK PRA Capital Rules also impose a 3.25 percent leverage ratio
floor on PRA-designated UK nonbank SDs that hold significant amounts of
non-UK assets, as an additional element to the capital
requirements.\103\ Specifically, a PRA-designated UK nonbank SD that
has non-UK assets equal to or greater than GBP 10 billion is required
to maintain an aggregate amount of common equity tier 1 capital and
additional tier 1 capital equal to or in excess of 3.25 percent of the
firm's on-balance sheet and off-balance sheet exposures, including
exposures on uncleared swaps but excluding certain exposures to central
banks, without regard to any risk-weighting.\104\ The leverage ratio is
a non-risk based minimum capital requirement that is intended to
prevent a PRA-designated UK nonbank SD from engaging in excessive
leverage, and complements the risk-based minimum capital requirement
that is based on the PRA-designated UK nonbank SD's risk-weighted
assets.
---------------------------------------------------------------------------
\103\ PRA Rulebook, CRR Firms, Leverage Ratio--Capital
Requirements and Buffers Part, Chapter 1 Application and Definitions
and Chapter 3 Minimum Leverage Ratio. The Applicants represented
that the six PRA-designated UK nonbank SDs currently registered with
the Commission are subject to a leverage ratio floor requirement.
See Responses to Staff Questions dated October 5, 2023.
\104\ Total exposures are required to be computed in accordance
with PRA Rulebook, CRR Firms, Leverage Ratio (CRR) Part, Chapter 3
Leverage Ratio (Part Seven CRR), Article 429 et seq. A PRA-
designated UK nonbank SD may also be subject to a countercyclical
leverage ratio buffer of common equity tier 1 capital equal to the
firm's institution-specific countercyclical capital buffer rate
multiplied by 35 percent, multiplied by the firm's total exposures.
PRA Rulebook, CRR Firms, Leverage Ratio--Capital Requirements and
Buffers Part, Chapter 4 Countercyclical Leverage Ratio Buffer.
---------------------------------------------------------------------------
As noted above, the amount of regulatory capital that a PRA-
designated UK nonbank SD is required to hold is determined by
calculating the firm's total risk exposure, which requires the PRA-
designated UK 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 the PRA, internal model-based
methodologies.\105\ 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, PRA-
designated UK 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 a PRA-designated UK 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.\106\ The methods for calculating such risk charges are based on
the BCBS framework.\107\
---------------------------------------------------------------------------
\105\ With regulator permission, PRA-designated UK nonbank SDs
may use internal models to calculate credit risk (UK CRR, Article
143), including certain counterparty credit risk exposures (UK CRR,
Article 283), operational risk (UK CRR, Article 312(2)), market risk
(UK CRR, Article 363), and credit valuation adjustment risk (``CVA
risk'') of over-the-counter (``OTC'') derivatives instruments (UK
CRR, Article 383). The permission to use, and continue using,
internal models is subject to strict criteria and supervisory
oversight by the PRA.
\106\ UK CRR, Article 92(3).
\107\ UK Application, pp. 12-15.
---------------------------------------------------------------------------
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.\108\ Standardized credit risk charges are
generally calculated by multiplying the notional or carrying value of
the PRA-designated UK 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.\109\
---------------------------------------------------------------------------
\108\ UK CRR, Articles 326-361.
\109\ Id., Articles 111-134 and PRA Rulebook, CRR Firms,
Standardised Approach and Internal Ratings Based Approach to Credit
Risk (CRR) Part, Chapter 3 Credit Risk (Part Three Title Two
Chapters Two and Three CRR), Article 132.
---------------------------------------------------------------------------
Settlement risk charges are intended to account for the price
difference to which a PRA-designated UK nonbank SD is exposed if its
transactions remain unsettled after the respective transaction's due
delivery date.\110\ CVA risk charges reflect the current market value
of the credit risk of the counterparty to the PRA-designated UK nonbank
SD in an OTC derivatives transaction.\111\ 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.\112\
---------------------------------------------------------------------------
\110\ UK CRR, Article 378.
\111\ Id., Article 381.
\112\ Id., Article 4(1)(52).
---------------------------------------------------------------------------
As noted above, PRA-designated UK 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.\113\ The UK PRA Capital Rules set out
quantitative and qualitative requirements that internal models must
meet in order to obtain and maintain approval.\114\ 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
[[Page 8035]]
period, of a portfolio of assets.\115\ 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.
---------------------------------------------------------------------------
\113\ Id., Articles 143 (credit risk), 283 (counterparty credit
risk); 312(2) (operational risk), 363 (market risk), and 383 (CVA
risk).
\114\ See e.g., UK CRR, Articles 144, 283; 321-322 and 365-369.
\115\ The UK PRA Capital Rules require PRA-designated UK 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 UK CRR, Article
365(1). PRA-designated UK 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 UK CRR, Articles 142-144. In addition, when PRA-designated UK
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 UK CRR, Article 284. PRA-designated
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 UK CRR, Article 383. Finally,
PRA-designated UK 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
UK CRR, Article 322.
---------------------------------------------------------------------------
Furthermore, the UK PRA Capital Rules also impose separate
requirements on an PRA-designated UK nonbank SD to address liquidity
risk. More specifically, PRA-designated UK nonbank SDs are subject to
the liquidity coverage requirement applicable under UK CRR to credit
institutions.\116\ The liquidity coverage requirement provides that
PRA-designated UK nonbank SDs must hold liquid assets in an amount
sufficient to cover liquidity outflows (less liquidity inflows) under
stressed conditions over a period of 30 days.\117\ For purposes of the
liquidity coverage requirement, the term ``stressed'' means a sudden or
severe deterioration in the solvency or liquidity position of a firm
due to changes in market conditions or idiosyncratic factors as a
result of which there is a significant risk that the firm becomes
unable to meet its commitments as they become due within the next 30
days.\118\
---------------------------------------------------------------------------
\116\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part and PRA
Rulebook, CRR Firms, Liquidity Coverage Requirement--UK Designated
Investment Firms Part.
\117\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 412(1).
\118\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 411(10).
---------------------------------------------------------------------------
In addition, Article 413 of UK CRR, which has been incorporated
into the PRA Rulebook, establishes a general requirement that firms
ensure that long-term obligations and off-balance sheet items are
adequately met with a diverse set of funding instruments that are
stable under both normal and stressed conditions.\119\
---------------------------------------------------------------------------
\119\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 413(1).
---------------------------------------------------------------------------
In addition, the Bank of England, in its capacity of resolution
authority,\120\ requires that PRA-designated UK nonbank SDs satisfy a
firm-specific MREL pursuant to provisions of the Banking Act 2009 and
the Bank Recovery and Resolution (No. 2) Order 2014, which transposed
BRRD.\121\ The MREL requirement is separate from the minimum capital
requirements imposed on PRA-designated UK nonbank SDs under UK CRR and
PRA Rulebook and is designed to ensure that PRA-designated UK nonbank
SDs maintain at all times sufficient eligible instruments to facilitate
resolution consistently with the resolution objectives under the
preferred resolution strategy.\122\ Specifically, the MREL is intended
to permit loss absorption, where appropriate, such that the PRA-
designated UK nonbank SD's capital ratio could be restored to the level
necessary for compliance with its capital requirements.\123\ The Bank
of England calculates a firm's baseline MREL as the sum of two
component: a loss absorption amount and a recapitalization amount.\124\
The loss absorption amount is equal to a firm's capital requirements
plus its capital buffers.\125\ The Bank of England has some discretion
to adjust the amount. The MREL amount varies depending on the entity's
size, funding model, and risk profile, among other considerations.\126\
---------------------------------------------------------------------------
\120\ 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. In the UK, the resolution authority is the Bank of England.
\121\ Banking Act 2009, Section 3A(4) and (4B) and the Bank
Recovery and Resolution (No. 2) Order 2014, Part 9. Eligible
liabilities include, among others items, instruments that are
directly issued by the PRA-designated UK nonbank SD and fully paid
up with remaining maturities of at least a year. See Bank Recovery
and Resolution (No. 2) Order 2014, Part 9, Article 123(4). In
addition, the liabilities cannot arise from a derivative, be owned,
secured or guaranteed by the PRA-designated UK nonbank SD itself,
and the PRA-designated UK nonbank SD cannot have either directly or
indirectly funded its purchase. Id.
\122\ The Bank of England's Approach to Setting a Minimum
Requirement for Own Funds and Eligible Liabilities (MREL), Statement
of Policy, 3 December 2021, at 3, available at: <a href="https://www.bankofengland.co.uk/-/media/boe/files/paper/2021/mrel-statement-of-policy-december-2021-updating-2018.pdf">https://www.bankofengland.co.uk/-/media/boe/files/paper/2021/mrel-statement-of-policy-december-2021-updating-2018.pdf</a>. See also The Minimum
Requirement for Own Funds and Eligible Liabilities (MREL)--Buffers
and Threshold Conditions, Supervisory Statement 16/16, 28 December
2020, available at: <a href="https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss1616-update-dec-2020.pdf">https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss1616-update-dec-2020.pdf</a>.
\123\ Bank Recovery and Resolution (No. 2) Order 2014, Part 9,
Article 123(6).
\124\ See The Bank of England's Approach to Setting a Minimum
Requirement for Own Funds and Eligible Liabilities (MREL), Statement
of Policy, Dec. 3, 2021, at 5.
\125\ Id. The reference to ``capital requirements'' in this
context means the amount of capital the PRA thinks the firm should
maintain at all times under PRA Rulebook, CRR Firms, Internal
Capital Adequacy Assessment.
\126\ Bank Recovery and Resolution (No. 2) Order 2014, Part 9,
Article 123(6).
---------------------------------------------------------------------------
III. Commission Analysis of the Comparability of the UK PRA Capital
Rules and UK PRA 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 UK PRA Capital Rules and
UK PRA 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 UK's
corresponding laws, regulations, or rules. The Commission then provides
a comparative analysis of the UK PRA Capital Rules or the UK PRA
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 UK PRA Capital
Rules for PRA-designated UK nonbank SDs as set forth in the UK
Application with the Commission's Bank-Based Approach. For clarity, the
Commission did not assess the comparability of the UK PRA Capital Rules
to the Commission's TNW Approach or NLA Approach as the Commission
understands that PRA-designated UK nonbank SDs, as of the date of the
UK Application, are subject to bank-based capital requirements pursuant
to the UK
[[Page 8036]]
PRA Capital Rules. In addition, as noted above, due to the differences
between the capital and financial reporting regimes applicable to PRA-
designated UK nonbank SD and FCA-regulated UK nonbank SDs, the
Commission anticipates assessing the comparability of the rules
applicable to FCA-regulated UK nonbank SDs through a separate capital
comparability determination.\127\ Accordingly, when the Commission
makes a preliminary determination herein regarding the comparability of
the UK PRA Capital Rules with the CFTC Capital Rules, the determination
solely pertains to the comparability of the UK PRA Capital Rules as
applicable to PRA-designated UK nonbank SD with the Bank-Based Approach
under the CFTC Capital Rules.
---------------------------------------------------------------------------
\127\ See supra note 5.
---------------------------------------------------------------------------
As described below, it is proposed that any material changes to the
UK PRA Capital Rules would require notification to the Commission.
Therefore, if there are subsequent material changes to the UK PRA
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.\128\
---------------------------------------------------------------------------
\128\ 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.
The Commission is aware that the UK PRA is considering changes
to the PRA Capital Rules to implement Basel 3.1 standards. See PRA,
PS17/23--Implementation of the Basel 3.1 Standards Near-Final Part
1, December 12, 2023, available here: <a href="https://www.bankofengland.co.uk/news/2023/december/pra-publishes-first-of-two-policy-statements-for-basel-3-1-standards-implementation">https://www.bankofengland.co.uk/news/2023/december/pra-publishes-first-of-two-policy-statements-for-basel-3-1-standards-implementation</a>. If the
UK PRA proceeds with the implementation of the Basel 3.1 standards
as proposed, the regulatory changes would be applicable after July
1, 2025 with a 4.5-year transitional period ending on January 1,
2030. The Commission will monitor progress on the UK PRA's proposed
regulatory changes and may amend or supplement the Capital
Comparability Determination Order, as appropriate, after a final
Order is issued. As noted, the Commission proposes to require
notification of any material changes to the UK PRA Capital Rules,
including any Basel 3.1 implementing provisions.
---------------------------------------------------------------------------
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 UK PRA capital and
financial reporting requirements are comparable to the Commission's SD
requirements in purpose and effect, and not whether the UK PRA
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 a PRA-designated UK 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 a PRA-designated nonbank SD to the
PRA to effectively monitor the financial condition of the firm; and
(iv) the regulatory notices and other communications between the PRA-
designated UK nonbank SD and the PRA that detail potential adverse
financial or operational issues that may impact the firm. The
Commission also reviewed the manner in which compliance by a PRA-
designated UK nonbank SD with the UK PRA Capital Rules and UK PRA
Financial Reporting rules is monitored and enforced. The Commission
invites public comment on all aspects of the UK 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 UK PRA Capital Rules and UK PRA 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.\129\ 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.
---------------------------------------------------------------------------
\129\ See 7 U.S.C. 6s(e)(3)(A).
---------------------------------------------------------------------------
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
[[Page 8037]]
swaps market, or impact the firm's solvency.\130\
---------------------------------------------------------------------------
\130\ See 17 CFR 23.105.
---------------------------------------------------------------------------
2. Regulatory Objective of UK PRA Capital Rules and UK PRA Financial
Reporting Rules
The regulatory objective of the UK PRA Capital Rules is to ensure
the safety and soundness of PRA-designated UK nonbank SDs.\131\ The UK
PRA Capital Rules are designed to preserve the financial stability and
solvency of a PRA-designated UK nonbank SD by requiring the firm to
maintain a sufficient amount of qualifying equity capital and
subordinated debt based on the PRA-designated UK 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.\132\ The UK PRA Capital Rules are also designed to ensure
that the PRA-designated UK 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
liquid assets to ensure that the firm could face any possible imbalance
between liquidity inflows and outflows under gravely stressed
conditions over a period of 30 days \133\ and to hold a diversity of
stable funding instruments sufficient to meet long-term obligations
under both normal and stressed conditions.\134\
---------------------------------------------------------------------------
\131\ See PRA, The Prudential Regulation Authority's Approach to
Banking Supervision, July 2023, available here: <a href="https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors">https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors</a>.
\132\ Id.
\133\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 412 (Liquidity Coverage
Requirement). Liquid assets primarily include cash, exposures to
central banks, government-backed assets and other highly liquid
assets with high credit quality. PRA Rulebook, CRR Firms, Liquidity
(CRR) Part, Chapter 4 Liquidity (Part Six CRR), Article 416
(Reporting on Liquid Assets).
\134\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 413 (Stable Funding Requirement).
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. PRA Rulebook, CRR Firms Liquidity (CRR) Part,
Chapter 4 Liquidity (Part Six CRR), Article 427 (Reporting on Stable
Funding).
---------------------------------------------------------------------------
With respect to financial reporting, the objective of the UK PRA
Financial Reporting Rules is to enable the PRA to assess the financial
condition and safety and soundness of PRA-designated UK nonbank
SDs.\135\ The UK PRA Financial Reporting Rules aim to achieve this
objective by requiring a PRA-designated nonbank SD to provide financial
reports and other financial position and capital information to the PRA
on a regular basis.\136\ The financial reporting by a PRA-designated UK
nonbank SD provides the PRA with information necessary to effectively
monitor the PRA-designated UK nonbank SD's overall financial condition
and its ability to meet its regulatory obligations as a nonbank SD.
---------------------------------------------------------------------------
\135\ See generally PRA, The Prudential Regulation Authority's
Approach to Banking Supervision, July 2023, available here: <a href="https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors">https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors</a>.
\136\ PRA Rulebook, CRR Firms, Reporting (CRR) Part.
---------------------------------------------------------------------------
3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the overall
objectives of the UK PRA 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 UK PRA 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 UK PRA
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 PRA 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 the PRA 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 the PRA 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 the PRA 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 UK Application and relevant UK 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.\137\ 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.\138\ The
Commission's requirement for a nonbank SD to maintain a minimum amount
of defined qualifying capital and subordinated debt is intended to
[[Page 8038]]
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.
---------------------------------------------------------------------------
\137\ See 17 CFR 23.101(a)(1)(i).
\138\ 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.
---------------------------------------------------------------------------
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.\139\ 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.\140\ Total
tier 1 capital is composed of common equity tier 1 capital and further
includes additional tier 1 capital.\141\ Tier 2 capital includes
certain types of instruments that include both debt and equity
characteristics such as qualifying subordinated debt.\142\
---------------------------------------------------------------------------
\139\ 12 CFR 217.20.
\140\ Id.
\141\ Id.
\142\ 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.\143\
---------------------------------------------------------------------------
\143\ 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).
---------------------------------------------------------------------------
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. UK PRA Capital Rules: Qualifying Capital
The UK PRA Capital Rules require a PRA-designated 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
PRA-designated UK 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.\144\ The UK 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.\145\ In this regard,
the UK PRA Capital Rules provide that a PRA-designated UK nonbank SD's
regulatory capital may be composed of: (i) common equity tier 1 capital
instruments, which generally include the PRA-designated UK nonbank SD's
common equity, retained earnings, and accumulated other comprehensive
income; \146\ (ii) additional tier 1 capital instruments, which include
other forms of capital instruments and certain long-term convertible
debt instruments; \147\ and (iii) tier 2 capital instruments, which
includes other reserves, hybrid capital instruments, and certain
qualifying subordinated term debt.\148\
---------------------------------------------------------------------------
\144\ UK CRR, Article 92.
\145\ Id.
\146\ UK CRR, Articles 26 and 28. Capital instruments that
qualify as common equity tier 1 capital under the UK PRA Capital
Rules include instruments that: (i) are issued directly by the PRA-
designated UK nonbank SD; (ii) are paid in full and not funded
directly or indirectly by the PRA-designated UK 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 PRA-designated UK nonbank SD.
\147\ Id., Articles 51-52. To qualify as additional tier 1
capital, the instruments must meet certain conditions including: (i)
the instruments are issued directly by the PRA-designated UK nonbank
SD and paid in full; (ii) the instruments are not owned by the PRA-
designated UK nonbank SD or its subsidiaries; (iii) the purchase of
the instruments is not funded directly or indirectly by the PRA-
designated UK nonbank SD; (iv) the instruments rank below tier 2
instruments in the event of the insolvency of the PRA-designated UK
nonbank SD; (v) the instruments are not secured or guaranteed by the
PRA-designated UK nonbank SD or an affiliate; (vi) the instruments
are perpetual and do not include an incentive for the PRA-designated
UK 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 PRA-designated UK nonbank SD.
\148\ Id., Articles 62-63.
---------------------------------------------------------------------------
Furthermore, subordinated debt instruments must meet certain
conditions to qualify as tier 2 regulatory capital under the UK PRA
Capital Rules, including that the: (i) loans are not granted by the
PRA-designated UK 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 PRA-designated UK nonbank SD;
(iii) subordinated loans are not secured, or subject to a guarantee
that enhances the seniority of the claim, by the PRA-designated UK
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 PRA-designated UK nonbank SD prior to the loans'
maturity.\149\
---------------------------------------------------------------------------
\149\ UK CRR, Article 63.
---------------------------------------------------------------------------
A PRA-designated UK 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.\150\ The 2.5 percent capital conservation buffer must be met
with common equity tier 1 capital.\151\ Common equity tier 1 capital,
as noted above, is limited to the
[[Page 8039]]
PRA-designated UK 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.
---------------------------------------------------------------------------
\150\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1. In addition, a PRA-designated
nonbank SD may also be subject to a firm-specific countercyclical
capital buffer, which requires the PRA-designated UK 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 to exposures in the
jurisdictions where the firm's relevant credit exposures are
located. The rate for each jurisdiction is determined by the UK
Financial Policy Committee or a third country countercyclical buffer
authority, as applicable. See PRA Rulebook, CRR Firms, Capital
Buffers Part, Chapter 3 Countercyclical Capital Buffer, Rule 3.1.,
and Capital Requirements (Capital Buffers and Macro-prudential
Measures) Regulations 2014, Articles 7-20. In practice, the
countercyclical buffer rate in the UK, as of July 2023, is 2 percent
of risk-weighted assets. The countercyclical capital buffer rate is
published by the Bank of England, and is available at: <a href="https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer">https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer</a>. Several EU Member States of relevance to the UK have also
implemented countercyclical capital buffers with rates ranging from
0.5 percent to 2.5 percent of risk-weighted assets.
\151\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
---------------------------------------------------------------------------
The UK PRA Capital Rules also impose different ratios for the
various components of regulatory capital that are consistent with the
BCBS bank capital framework.\152\ In this regard, the UK PRA Capital
Rules provide that a PRA-designated UK 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, a PRA-designated UK 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.\153\ With the addition of the capital conservation buffer,
each PRA-designated UK 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.\154\
---------------------------------------------------------------------------
\152\ UK CRR, Article 92(1).
\153\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
\154\ The countercyclical capital buffer is not included in the
analysis given that it is firm-specific and its rate depends on the
location of the firm's exposures.
---------------------------------------------------------------------------
Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in a PRA-designated UK 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 PRA-designated UK 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 UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the UK PRA
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 UK PRA 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 UK PRA 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.\155\
---------------------------------------------------------------------------
\155\ 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 UK CRR, Articles 26 and 28
(defining items and capital instruments that qualify as common
equity tier 1 capital under the UK PRA Capital Rules) and UK CRR,
Article 52 (defining capital instruments that qualify as additional
tier 1 capital under the UK PRA Capital Rules).
---------------------------------------------------------------------------
In addition, the Commission has preliminarily determined that the
conditions imposed on subordinated debt instruments under the UK PRA
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.\156\
---------------------------------------------------------------------------
\156\ Compare 17 CFR 240.18a-1d with UK CRR, Article 63(d).
---------------------------------------------------------------------------
Having reviewed the UK Application and the relevant UK laws and
regulations, the Commission has made a preliminary determination that
the UK PRA Capital Rules and CFTC Capital Rules impose comparable
requirements on PRA-designated UK 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 UK Application and
relevant UK 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 1capital 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.\157\
---------------------------------------------------------------------------
\157\ 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.\158\ The Commission adopted this minimum
requirement as it believed that the role a nonbank SD performs in the
financial
[[Page 8040]]
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.\159\
---------------------------------------------------------------------------
\158\ 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).
\159\ See, e.g., 85 FR 57492.
---------------------------------------------------------------------------
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.\160\
---------------------------------------------------------------------------
\160\ See 85 FR 57462.
---------------------------------------------------------------------------
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 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.\161\ 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.\162\ 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.\163\ 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.\164\
---------------------------------------------------------------------------
\161\ 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.
\162\ See paragraph (3) of the definition of the term BHC
equivalent risk-weighted assets in 17 CFR 23.100.
\163\ See 17 CFR 240.18a-1(c)(1).
\164\ 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.
---------------------------------------------------------------------------
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.\165\ 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.\166\ 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.\167\ 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.
---------------------------------------------------------------------------
\165\ 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.
\166\ 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)).
\167\ See 17 CFR 217.33.
---------------------------------------------------------------------------
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'').\168\ 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.\169\ 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.\170\
---------------------------------------------------------------------------
\168\ 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.
\169\ See 12 CFR 217.34.
\170\ See 12 CFR 217.132(c).
---------------------------------------------------------------------------
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
[[Page 8041]]
application to the Commission or NFA.\171\ 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.
---------------------------------------------------------------------------
\171\ See 17 CFR 23.102(c).
---------------------------------------------------------------------------
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'').\172\
Subpart F is based on models that are consistent with the BCBS Basel
2.5 capital framework.\173\ 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,\174\ which are broadly
based on the BCBS Basel 2.5 capital framework.
---------------------------------------------------------------------------
\172\ See paragraph (4) of the definition of BHC equivalent
risk-weighted assets in 17 CFR 23.100.
\173\ 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).
\174\ The SEC internal model requirements for SBSDs are listed
in 17 CFR 240.18a-1(d).
---------------------------------------------------------------------------
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 \175\ as
if the SD itself were a bank holding company subject to subpart E.\176\
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.\177\
---------------------------------------------------------------------------
\175\ 12 CFR 217 subpart E.
\176\ See 85 FR 57462 at 57496.
\177\ 12 CFR 217.131(e)(1)(iii), 217.131(e)(2)(iv), and
217.132(d)(9)(iii).
---------------------------------------------------------------------------
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.\178\ 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.\179\
---------------------------------------------------------------------------
\178\ Settlement risk for OTC derivatives contracts is addressed
as part of the counterparty-credit risk calculation methodology
described in 12 CFR 217.132.
\179\ 12 CFR 217.162(c) (operational risk) and 217.132(e)(4)
(CVA of OTC derivative contracts).
---------------------------------------------------------------------------
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.\180\ 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.\181\
---------------------------------------------------------------------------
\180\ 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>.
\181\ 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>.
---------------------------------------------------------------------------
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. UK PRA Capital Rules: PRA-Designated UK Nonbank Swap Dealer Minimum
Capital Requirements
The UK PRA Capital Rules impose bank-like capital requirements on a
PRA-designated UK nonbank SD that, consistent with the BCBS
international bank capital framework, require the PRA-designated UK
nonbank SD to hold a sufficient amount of qualifying equity capital and
subordinated debt based on the PRA-designated UK 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 UK PRA Capital Rules require each PRA-designated UK nonbank SD to
maintain sufficient levels of capital to satisfy the following capital
ratios, expressed as a percentage of the PRA-designated UK nonbank SD's
total risk exposure amount (i.e., the sum of the PRA-designated UK
nonbank SD's risk-weighted assets and exposures): (i) a common equity
tier 1 capital ratio of 4.5 percent; \182\ (ii) a tier 1 capital ratio
of 6 percent; \183\ and (iii) a total capital ratio of 8 percent.\184\
The UK PRA Capital Rules further require a PRA-designated UK 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.\185\ The common equity tier 1 capital used to
[[Page 8042]]
meet the capital conservation buffer must be separate and in addition
to the 4.5 percent of common equity tier 1 capital that the PRA-
designated UK nonbank is required to maintain in meeting its core 8
percent capital requirement.\186\ Thus, a PRA-designated UK 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).
---------------------------------------------------------------------------
\182\ UK CRR, Article 92(1)(a).
\183\ Id., Article 92(1)(b). Tier 1 capital is the sum of the
PRA-designated UK nonbank SD's common equity tier 1 capital and
additional tier 1 capital.
\184\ Id., Article 92(1)(c). The total capital is the sum of the
PRA-designated UK nonbank SD's tier 1 capital and tier 2 capital.
\185\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
\186\ Id. A PRA-designated UK 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 institution-specific countercyclical buffer rate. The
institution-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 PRA-designated UK nonbank SD has relevant credit
exposures. See PRA Rulebook, CRR Firms, Capital Buffers Part,
Chapter 3 Countercyclical Capital Buffer. The rate for each
jurisdiction is determined by the UK Financial Policy Committee or a
third country countercyclical buffer authority, as applicable. See
PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 3
Countercyclical Capital Buffer, Rule 3.1., and Capital Requirements
(Capital Buffers and Macro-prudential Measures) Regulations 2014,
Articles 7-20. In practice, the countercyclical buffer rate in the
UK, as of July 2023, is 2 percent of risk-weighted assets. The
countercyclical capital buffer rate is published by the Bank of
England, and is available at: <a href="https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer">https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer</a>. Several EU Member
States of relevance to the UK have also implemented countercyclical
capital buffers with rates ranging from 0.5 percent to 2.5 percent
of risk-weighted assets.
---------------------------------------------------------------------------
A PRA-designated UK 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.\187\ Capital charges for market risk and risk-
weighted exposures for credit risk are computed based on the PRA-
designated UK 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.\188\ Settlement risk
capital charges reflect the price difference to which a PRA-designated
UK 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.\189\ 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 PRA-designated UK nonbank SD.\190\
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.\191\
---------------------------------------------------------------------------
\187\ UK CRR, Article 92(3).
\188\ To compute capital requirements for market risk, PRA-
designated UK 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 UK 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 PRA-
designated UK 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 UK
CRR, Article 92(3)(a) and (f).
\189\ UK 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.
\190\ Id., Article 381.
\191\ Id., Article 4(1)(52).
---------------------------------------------------------------------------
To compute its total risk exposure amount, a PRA-designated UK
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 UK PRA Capital Rules, by a factor of
12.5, which effectively requires a PRA-designated UK nonbank SD to hold
qualifying regulatory capital equal to or greater than the full amount
of the relevant risk exposures.\192\ The formulae for calculating risk-
weighted exposure amounts for credit risk also include a 12.5
multiplication factor.\193\
---------------------------------------------------------------------------
\192\ Id., Article 92(4).
\193\ Id., Article 153 et seq.
---------------------------------------------------------------------------
Consistent with the Commission's Bank-Based Approach and the BCBS
capital framework, the UK PRA Capital Rules require PRA-designated UK
nonbank SDs to compute market risk exposures and credit risk exposures
using a standardized approach or, if approved by the PRA, internal risk
models.\194\ In addition, UK PRA Capital Rules, consistent with the
BCBS capital framework, require PRA-designated UK nonbank SDs to
compute capital charges for CVA risk and operational risk using
standardized approaches, unless approved to use internal models by the
PRA.\195\
---------------------------------------------------------------------------
\194\ With the permission of the PRA, a PRA-designated UK
nonbank SD may use internal models to calculate market risk (see UK
CRR, Article 363) and credit risk (see UK CRR, Articles 143 and
283).
\195\ See UK CRR, Articles 382-384 for CVA risk calculations;
and Article 312(2) for operational risk.
---------------------------------------------------------------------------
PRA-designated UK 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.\196\ Securitizations are
treated as debt instruments for market risk requirements,\197\ whereas
derivative positions are generally treated as exposures on their
underlying assets,\198\ with options being delta-adjusted.\199\
---------------------------------------------------------------------------
\196\ Id., Article 326.
\197\ Id. See also UK CRR, Articles 334-340 (provisions related
to debt instruments) and 341-343 (provisions related to equities).
\198\ Id., Articles 328-330, 358.
\199\ Id., Article 329.
---------------------------------------------------------------------------
The UK PRA Capital Rules also require PRA-designated UK nonbank SDs
to include in their risk-weighted assets market risk exposures to
certain foreign currency and gold positions. Specifically, a PRA-
designated UK 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.\200\ The capital
requirement for foreign exchange risk under the standardized approach
is 8 percent of the PRA-designated UK nonbank SD's net positions in
foreign exchange and gold.\201\
---------------------------------------------------------------------------
\200\ Id., Article 351.
\201\ Id.
---------------------------------------------------------------------------
The UK PRA Capital Rules further require PRA-designated UK 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.\202\ 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
[[Page 8043]]
to the base charges for matched portions.\203\
---------------------------------------------------------------------------
\202\ Id., Article 360.
\203\ Id., Articles 359 and 361.
---------------------------------------------------------------------------
With respect to credit risk, the UK PRA Capital Rules require a
PRA-designated UK 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 PRA-designated UK 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.\204\ For instance,
credit exposures to the ECB, the UK government, and the Bank of England
carry a zero percent risk-weight; exposures to other central
governments and central banks may carry risk-weights between 0 and 150,
depending on the credit rating available for the central government or
central bank; and exposures to banks, PRA-designated investment firms,
or other businesses 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 the central government
of the jurisdiction in which the entity is incorporated.\205\ If no
credit rating is available, the PRA-designated UK nonbank SD must
generally apply a 100 percent risk-weight, meaning the total accounting
value of the exposure is used.\206\
---------------------------------------------------------------------------
\204\ Id., Articles 111 and 113(1).
\205\ Id., Articles 114-122.
\206\ Id., Articles 121(2) and 122(2).
---------------------------------------------------------------------------
With respect to counterparty credit risk for derivatives
transactions and certain other agreements that give rise to bilateral
credit risk, the UK PRA Capital Rules require a PRA-designated UK
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),\207\ 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.\208\ The
exposure amount under the SA-CCR is computed, under both the UK PRA
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.\209\
---------------------------------------------------------------------------
\207\ UK CRR, Articles 92(3)(f) and PRA Rulebook, CRR Firms,
Counterparty Credit Risk (CRR) Part, Chapter 3 Counterparty Credit
Risk (Part Three, Title Two, Chapter Six CRR). PRA-designated UK
nonbank SDs with smaller-sized derivatives business may also use a
``simplified standardized approach to counterparty credit risk'' or
an ``original exposure method'' as simpler methods for calculating
exposure values. PRA Rulebook, CRR Firms, Counterparty Credit Risk
(CRR) Part, Chapter 3 Counterparty Credit Risk (Part Three, Title
Two, Chapter Six CRR), Articles 281-282. 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 GBP 260 million or 5 percent of the
entity's total assets and GBP 88 million, respectively. PRA
Rulebook, CRR Firms, Counterparty Credit Risk (CRR) Part, Chapter 3
Counterparty Credit Risk (Part Three, Title Two, Chapter Six CRR),
Article 273a.
\208\ 12 CFR 217.34.
\209\ PRA Rulebook, CRR Firms, Counterparty Credit Risk (CRR)
Part, Chapter 3 Counterparty Credit Risk (Part Three, Title Two,
Chapter Six CRR), Article 274 and 12 CFR 217.132(c).
---------------------------------------------------------------------------
UK PRA Capital Rules also require a PRA-designated UK nonbank SD to
calculate capital requirements for settlement risk.\210\ 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 a PRA-designated UK nonbank
SD is exposed as a result of an unsettled transaction by a 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.\211\ 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.\212\
---------------------------------------------------------------------------
\210\ UK 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, a PRA-designated UK nonbank SD must
calculate the price difference to which it is exposed).
\211\ Id. The price difference to which a PRA-designated UK
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. UK
CRR, Article 378.
\212\ 17 CFR 23.100 (definition of BHC equivalent risk-weighted
assets), 12 CFR 217.38 and 12 CFR 217.136.
---------------------------------------------------------------------------
Consistent with the BCBS framework, a PRA-designated UK nonbank SD
is also required to calculate capital charges for CVA risk for OTC
derivative instruments \213\ to reflect the current market value of the
credit risk of the counterparty to the PRA-designated UK nonbank
SD.\214\ CVA can be calculated following similar methodologies as those
described in subpart E of the Federal Reserve Board's part 217
regulations.\215\
---------------------------------------------------------------------------
\213\ UK 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.
\214\ Id., Article 381. CVA is defined to exclude debit
valuation adjustment.
\215\ See UK 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.
---------------------------------------------------------------------------
A PRA-designated UK nonbank SD's total risk exposure amount also
includes operational risk charges. Consistent with the BCBS framework,
PRA-designated UK nonbank SDs may calculate standardized operational
risk charges using either one of two approaches--the Basic Indicator
Approach or the Standardized Approach.\216\ 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, PRA-designated UK 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.
---------------------------------------------------------------------------
\216\ UK CRR, Article 312 and PRA Rulebook, CRR Firms,
Operational Risk (CRR) Part.
---------------------------------------------------------------------------
As noted above, if approved by the PRA, a PRA-designated UK 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.\217\ To obtain permission, a PRA-designated UK nonbank SD
must demonstrate to the satisfaction of the PRA that it meets
[[Page 8044]]
certain conditions for the use of models.\218\
---------------------------------------------------------------------------
\217\ UK CRR, Articles 143 (credit risk), 283 (counterparty
credit risk), 312 (operational risk), 363 (market risk) and 383 (CVA
risk). PRA-designated UK nonbank SDs are not permitted, however, to
calculated counterparty credit risk charges using internal models
when calculating large exposures. PRA Rulebook, CRR Firms, Large
Exposures (CRR) Part, Chapter 4 Large Exposures (Part Four CRR),
Article 390.
\218\ UK CRR, Articles 143, 283, 312(2) and 363(1).
---------------------------------------------------------------------------
With respect to market risk, the PRA may grant a PRA-designated UK
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,\219\ along with
interest rate risk on derivatives.\220\ To obtain approval to use a
market risk model, a PRA-designated UK nonbank SD must meet conditions
related to specified model elements and controls including risk and
stressed risk calculations,\221\ back-testing and multiplication
factors,\222\ risk measurement requirements,\223\ governance and
qualitative requirements,\224\ internal validation,\225\ and specific
requirements by risk categories.\226\ A PRA-designated UK nonbank SD
approved to use models must also obtain approval from the PRA to
implement a material change to the model or make a material extension
to the use of the model.\227\ The UK PRA Capital Rules' market risk
model-based methodology is based on the Basel 2.5 standard \228\ and
incorporates relevant aspects of the BCBS framework in terms of
requiring PRA-designated UK 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.\229\ The UK PRA
Capital Rules also include a framework for governance that includes
requirements related to the implementation of independent risk
management,\230\ senior management's involvement in the risk-control
process,\231\ establishment of procedures for monitoring and ensuring
compliance with a documented set of internal policies and
controls,\232\ and the conducting of independent review of the models
as part of the internal audit process.\233\
---------------------------------------------------------------------------
\219\ Id., Article 363(1).
\220\ Id., Article 331(1), using sensitivity models.
\221\ Id., Articles 364-365.
\222\ Id., Article 366.
\223\ Id., Article 367.
\224\ Id., Article 368.
\225\ Id., Article 369.
\226\ Id., Articles 364-377.
\227\ Id., Article 363(3).
\228\ Compare UK CRR, Articles 362-377 with Revisions to the
Basel II Market Risk Framework.
\229\ UK CRR, Article 365(1).
\230\ Id., Articles 368 (1)(b).
\231\ Id., Articles 368 (1)(c).
\232\ Id., Articles 368 (1)(e).
\233\ Id., Articles 368 (1)(h).
---------------------------------------------------------------------------
With regulatory permission, PRA-designated UK nonbank SDs may also
use models to calculate credit risk exposures.\234\ 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.\235\
To obtain approval for the use of internal ratings-based models, a PRA-
designated UK 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.\236\
---------------------------------------------------------------------------
\234\ Id., Article 143.
\235\ Id.
\236\ Id., Articles 170-177 (rating systems), 178-184 (risk
quantification), 185 (validation of internal estimates), and 189-191
(internal governance and oversight).
---------------------------------------------------------------------------
In addition, subject to regulatory approval, PRA-designated UK
nonbank SDs may use internal models to calculate counterparty credit
risk exposures for derivatives, securities financing, and long
settlement transactions.\237\ 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 management
system, and validation.\238\ The UK PRA Capital Rules' internal
counterparty credit risk model-based methodology is also based on the
Basel 2.5 standard.\239\ The UK PRA 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,\240\ with
adjustments to the period of risk, as appropriate to the asset and
counterparty.
---------------------------------------------------------------------------
\237\ Id., Article 283. As noted above, however, PRA-designated
UK nonbank SDs are not permitted to calculate counterparty credit
risk charges using internal models when calculating large exposures.
PRA Rulebook, CRR Firms, Large Exposures (CRR) Part, Chapter 4 Large
Exposures (Part Four CRR), Article 390.
\238\ Id., Articles 283-294.
\239\ Compare UK CRR, Article 362-377 with Revisions to the
Basel II Market Risk Framework.
\240\ UK CRR, Article 272(19), 283-285.
---------------------------------------------------------------------------
PRA-designated UK 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, PRA-designated UK nonbank
SDs must meet qualitative and quantitative standards, as well as
general risk management standards set forth in the UK PRA Capital
Rules.\241\ Specifically, among other qualitative standards, PRA-
designated UK nonbank SDs must meet requirements related to the
governance and documentation of their operational risk management
processes and measurement systems.\242\ In addition, PRA-designated UK
nonbank SDs must meet quantitative standards related to process, data,
scenario analysis, business environment and internal control factors
laid down in the UK PRA Capital Rules.\243\
---------------------------------------------------------------------------
\241\ UK CRR, Article 312(1), cross-referencing UK CRR, Articles
321 and 322; PRA Rulebook, CRR Firms, General Organizational
Requirements Part, Rules 2.1 and 2.2; and PRA Rulebook, CRR Firms,
Internal Liquidity Adequacy Assessment Part.
\242\ UK CRR, Article 321.
\243\ Id., Article 322.
---------------------------------------------------------------------------
As an additional element to the capital requirements, the UK PRA
Capital Rules further impose a 3.25 percent leverage ratio floor on
PRA-designated UK nonbank SDs that hold significant amounts of non-UK
assets.\244\ Specifically, a PRA-designated UK nonbank SD that has non-
UK assets equal to or greater than GBP 10 billion is required to
maintain an aggregate amount of common equity tier 1 capital and
additional tier 1 capital equal to or in excess of 3.25 percent of the
firm's on-balance sheet and off-balance sheet exposures, including
exposures on uncleared swaps but excluding certain exposures to central
banks, without regard to any risk-weighting.\245\ For the purposes of
complying with the leverage ratio requirement, at least 75 percent of
the firm's tier 1 capital must consist of common equity tier 1
capital.\246\ The leverage ratio is a non-risk based minimum capital
requirement that is intended to prevent a PRA-designated
[[Page 8045]]
UK nonbank SD from engaging in excessive leverage, and complements the
risk-based minimum capital requirement that is based on the PRA-
designated UK nonbank SD's risk-weighted assets.
---------------------------------------------------------------------------
\244\ PRA Rulebook, CRR Firms, Leverage Ratio--Capital
Requirements and Buffers Part, Chapter 1 Application and Definitions
and Chapter 3 Minimum Leverage Ratio.
\245\ Total exposures are required to be computed in accordance
with PRA Rulebook, CRR Firms, Leverage Ratio (CRR) Part, Chapter 3
Leverage Ratio (Part Seven CRR), Article 429 et seq. A PRA-
designated UK nonbank SD may also be subject to a countercyclical
leverage ratio buffer of common equity tier 1 capital equal to the
firm's institution-specific countercyclical capital buffer rate
multiplied by 35 percent, multiplied by the firm's total exposures.
PRA Rulebook, CRR Firms, Leverage Ratio--Capital Requirements and
Buffers Part, Chapter 4 Countercyclical Leverage Ratio Buffer.
\246\ PRA Rulebook, CRR Firms, Leverage Ratio--Capital
Requirements and Buffers Part, Chapter 3 Minimum Leverage Ratio,
Rule 3.2.
---------------------------------------------------------------------------
Furthermore, the UK PRA Capital Rules also impose a separate
liquidity coverage requirement on a PRA-designated UK nonbank SD to
address liquidity risk. The liquidity coverage requirement provides
that PRA-designated UK nonbank SDs must hold liquid assets in an amount
sufficient to cover liquidity outflows (less liquidity inflows) under
stressed conditions over a period of 30 days.\247\ For purposes of the
liquidity coverage requirement, the term ``stressed'' means a sudden or
severe deterioration in the solvency or liquidity position of a firm
due to changes in market conditions or idiosyncratic factors as a
result of which there is a significant risk that the firm becomes
unable to meet its commitments as they become due within the next 30
days.\248\ In addition, Article 413 of UK CRR, which has been
incorporated into the PRA Rulebook, establishes a general requirement
that firms ensure that long-term obligations and off-balance sheet
items are adequately met with a diverse set of funding instruments that
are stable under both normal and stressed conditions.\249\
---------------------------------------------------------------------------
\247\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 412(1).
\248\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 411(10).
\249\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 413(1).
---------------------------------------------------------------------------
The UK PRA Capital Rules also require PRA-designated UK nonbank SDs
to maintain at all times a minimum base capital requirement of GBP
750,000.\250\
---------------------------------------------------------------------------
\250\ PRA Rulebook, CRR Firms, Definition of Capital Part,
Chapter 12 Base Capital Resource Requirement, Rule 12.1.
---------------------------------------------------------------------------
3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the UK PRA
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.\251\ Although there are
differences between the UK PRA Capital Rules and the CFTC Capital
Rules, as discussed below, the Commission preliminarily believes that
the UK PRA 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 UK PRA Capital Rules' requirements, as discussed below.
---------------------------------------------------------------------------
\251\ The Commission notes that pursuant to Article 7 of UK CRR,
the PRA may exempt an entity subject to UK 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 UK CRR and therefore an
entity that benefits from an exemption under Article 7 of UK CRR
would not qualify for substituted compliance under the Capital
Comparability Determination Order.
---------------------------------------------------------------------------
a. Fixed Amount Minimum Capital Requirement
CFTC Capital Rules and the UK PRA 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 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.\252\ The
UK PRA Capital Rules also contain a requirement that a PRA-designated
UK nonbank SD maintain a fixed amount of minimum initial capital of GBP
750,000.\253\
---------------------------------------------------------------------------
\252\ 85 FR 57492.
\253\ PRA Rulebook, CRR Firms, Definition of Capital Part,
Chapter 12 Base Capital Resource Requirement, Rule 12.1.
---------------------------------------------------------------------------
The Commission recognizes that the $20 million fixed-dollar minimum
capital required under the CFTC Capital Rules is substantially higher
than the GBP 750,000 minimum base capital required under the UK PRA
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 PRA-designated UK 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 UK CRR.\254\ The proposed
condition would require each PRA-designated UK nonbank SD to maintain
an amount of common equity tier 1 capital denominated in British pound
that is equivalent to the $20 million in U.S. dollars.\255\ The
Commission is also proposing that a PRA-designated UK nonbank SD may
convert the pound-denominated common equity tier 1 capital amount to
the U.S. dollar equivalent based on a commercially reasonable and
observable exchange rate.
---------------------------------------------------------------------------
\254\ The Commission notes that the proposed requirement that
PRA-designated UK 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, Mexico, and the EU, 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''); and 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 (June 27, 2023) (``Proposed EU Order'').
\255\ Each of the six current PRA-designated UK 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 PRA-designated UK
nonbank SDs currently registered with the Commission. Nonetheless,
the Commission requests comment on the proposed condition.
---------------------------------------------------------------------------
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
[[Page 8046]]
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.\256\ 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.
---------------------------------------------------------------------------
\256\ 17 CFR 23.101(a)(1)(B).
---------------------------------------------------------------------------
The UK PRA Capital Rules contain capital requirements for PRA-
designated UK nonbank SDs that the Commission preliminarily believes
are comparable to the requirements contained in prong (iii) of the CFTC
Capital Rules. Specifically, the UK PRA Capital Rules require a PRA-
designated UK nonbank SD to maintain: (i) common equity tier 1 capital
equal to at least 4.5 percent of the PRA-designated UK 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 PRA-designated UK 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 PRA-designated UK nonbank SD's total
risk exposure amount.\257\ In addition, the UK PRA Capital Rules
further require each PRA-designated UK nonbank SD to maintain an
additional capital conservation buffer equal to 2.5 percent of the PRA-
designated UK nonbank SD's total risk exposure amount, which must be
met with common equity tier 1 capital.\258\ Thus, a PRA-designated UK
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.\259\
---------------------------------------------------------------------------
\257\ UK CRR, Article 92(1).
\258\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer.
\259\ UK CRR, Article 92(1) and PRA Rulebook, CRR Firms, Capital
Buffers Part, Chapter 2 Capital Conservation Buffer.
---------------------------------------------------------------------------
The Commission also preliminarily believes that the UK PRA 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 UK PRA
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 preliminarily believes that these requirements are
comparable.
The Commission also preliminarily believes that the UK PRA 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 UK PRA Capital Rules
require a PRA-designated UK nonbank SD to calculate an operational risk
exposure as a component of the firm's total risk exposure amount.\260\
PRA-designated UK nonbank SDs may use either a standardized approach
or, if the PRA-designated UK 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 \261\ 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.\262\
---------------------------------------------------------------------------
\260\ UK CRR, Article 92(3).
\261\ 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.
\262\ 17 CFR 23.101(a)(1)(i) and 17 CFR 23.100 (definition of
BHC equivalent risk-weighted assets).
---------------------------------------------------------------------------
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 UK PRA Capital Rules differ from the CFTC Capital Rules in that
they do not impose a capital requirement on PRA-designated UK nonbank
SDs based
[[Page 8047]]
on a percentage of the margin for uncleared swap transactions. The
Commission notes, however, that the UK PRA Capital Rules impose capital
and liquidity requirements that may compensate for the lack of direct
analogue to the 8 percent uncleared swap margin requirement.
Specifically, as discussed above, under the UK PRA Capital Rules, the
total risk exposure amount is computed as the sum of the PRA-designated
UK nonbank SD's capital charges for market risk, credit risk,
settlement risk, CVA risk of OTC derivatives instruments, and
operational risk.\263\ Notably, the UK PRA Capital Rules require that
PRA-designated UK nonbank SDs, including firms that do not use internal
models, calculate capital charges for operational risk as a separate
component of the total risk exposure amount. The UK PRA Capital Rules
also impose separate liquidity requirements designed to ensure that the
PRA-designated UK nonbank SDs can meet both short- and long-term
obligations, in addition to the general requirement to maintain
processes and systems for the identification of liquidity risk.\264\ In
comparison, the Commission requires nonbank SDs to maintain a risk
management program covering liquidity risk, among other risk
categories, but does not have a distinct liquidity requirement.\265\
---------------------------------------------------------------------------
\263\ UK CRR, Article 92(3).
\264\ More specifically, the UK PRA Capital Rules impose
separate liquidity buffers and ``stable funding'' requirements
designed to ensure that PRA-designated UK nonbank SDs can cover both
long-term obligations and short-term payment obligations under
stressed conditions for 30 days. PRA Rulebook, CRR Firms, Liquidity
(CRR) Part, Chapter 4 Liquidity (Part Six CRR), Article 412-413. In
addition, PRA-designated UK nonbank SDs are 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. PRA Rulebook, CRR Firms, Internal
Liquidity Adequacy Assessment Part.
\265\ Specifically, CFTC Regulation 23.600(b) requires each SD
to establish, document, maintain, and enforce a system of risk
management policies and procedures designed to monitor and manage
the risks related to swaps, and any products used to hedge swaps,
including futures, options, swaps, security-based swaps, debt or
equity securities, foreign currency, physical commodities, and other
derivatives. The elements of the SD's risk management program are
required to include the identification of risks and risk tolerance
limits with respect to applicable risks, including operational,
liquidity, and legal risk, together with a description of the risk
tolerance limits set by the SD and the underlying methodology in
written policies and procedures. 17 CFR 23.600.
---------------------------------------------------------------------------
As such, the Commission preliminarily believes the inclusion of an
operational risk charge in the PRA-designated UK nonbank SD's total
risk exposure amount in all circumstances, and the existence of
separate liquidity requirements, will achieve a comparable outcome to
the Commission's requirement for nonbank SDs to hold regulatory capital
in excess of 8 percent of its uncleared swap margin amount. In that
regard, the Commission, in establishing the requirement that a nonbank
SD must maintain a level of regulatory capital in excess of 8 percent
of the uncleared swap margin amount associated with the firm's swap
transactions, stated that the intent of the requirement was to
establish a method of developing a minimum amount of required capital
for a nonbank SD to meet its obligations as an SD to market
participants, and to cover potential operational, legal, and liquidity
risks.\266\
---------------------------------------------------------------------------
\266\ See 85 FR 57462 at 57485.
---------------------------------------------------------------------------
d. Preliminary Finding of Comparability
Based on a principles-based, holistic assessment, the Commission
has preliminarily determined, subject to the proposed condition below,
and further subject to its consideration of public comments to the
proposed Capital Comparability Determination and Order, that the
purpose and effect of the UK PRA Capital Rules and the CFTC Capital
Rules are comparable. In this regard, the UK PRA Capital Rules and the
CFTC Capital Rules are both designed to require a nonbank SD to
maintain a sufficient amount of qualifying regulatory capital and
subordinated debt to absorb losses resulting from the firm's business
activities, and decreases in the value of firm
[…truncated; see source link]Indexed from Federal Register on February 5, 2024.
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.