Rule2024-15092
Order Granting Conditional Substituted Compliance in Connection With Certain Capital and Financial Reporting Requirements Applicable to Nonbank Swap Dealers Subject to Regulation by the Financial Services Agency of Japan
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
July 18, 2024
Issuing agencies
Commodity Futures Trading Commission
Abstract
On August 8, 2022, the Commodity Futures Trading Commission issued a notice and request for comment on an application submitted by the Financial Services Agency of Japan requesting that the Commission determine that registered nonbank swap dealers organized and domiciled in Japan may comply with certain capital and financial reporting requirements under the Commodity Exchange Act and Commission regulations by being subject to, and complying with, corresponding capital and financial reporting requirements of Japan. The Commission also solicited public comment on a proposed comparability determination and related order providing for the conditional availability of substituted compliance in connection with the application. The Commission is adopting the proposed order with certain modifications and clarifications to address comments. The final order provides that a nonbank swap dealer organized and domiciled in Japan may satisfy the capital requirements under the Commodity Exchange Act and applicable Commission regulations and the financial reporting rules under the Commodity Exchange Act and applicable Commission regulations by complying with certain specified Japanese laws and regulations and conditions set forth in the order.
Full Text
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<title>Federal Register, Volume 89 Issue 138 (Thursday, July 18, 2024)</title>
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[Federal Register Volume 89, Number 138 (Thursday, July 18, 2024)]
[Rules and Regulations]
[Pages 58470-58505]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-15092]
[[Page 58469]]
Vol. 89
Thursday,
No. 138
July 18, 2024
Part II
Commodity Futures Trading Commission
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17 CFR Chapter I
Order Granting Conditional Substituted Compliance in Connection With
Certain Capital and Financial Reporting Requirements Applicable to
Nonbank Swap Dealers Subject to Regulation by the Financial Services
Agency of Japan, by the United Kingdom Prudential Regulation Authority,
by the Mexican Comision Nacional Bancaria y de Valores and Banco de
Mexico, and Domiciled in the French Republic and Federal Republic of
Germany and Subject to Regulation in the European Union; Final Rule
Federal Register / Vol. 89, No. 138 / Thursday, July 18, 2024 / Rules
and Regulations
[[Page 58470]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Order Granting Conditional Substituted Compliance in Connection
With Certain Capital and Financial Reporting Requirements Applicable to
Nonbank Swap Dealers Subject to Regulation by the Financial Services
Agency of Japan
AGENCY: Commodity Futures Trading Commission.
ACTION: Order.
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SUMMARY: On August 8, 2022, the Commodity Futures Trading Commission
issued a notice and request for comment on an application submitted by
the Financial Services Agency of Japan requesting that the Commission
determine that registered nonbank swap dealers organized and domiciled
in Japan may comply with certain capital and financial reporting
requirements under the Commodity Exchange Act and Commission
regulations by being subject to, and complying with, corresponding
capital and financial reporting requirements of Japan. The Commission
also solicited public comment on a proposed comparability determination
and related order providing for the conditional availability of
substituted compliance in connection with the application.
The Commission is adopting the proposed order with certain
modifications and clarifications to address comments. The final order
provides that a nonbank swap dealer organized and domiciled in Japan
may satisfy the capital requirements under the Commodity Exchange Act
and applicable Commission regulations and the financial reporting rules
under the Commodity Exchange Act and applicable Commission regulations
by complying with certain specified Japanese laws and regulations and
conditions set forth in the order.
DATES: This determination was made by the Commission on June 24, 2024.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, <a href="/cdn-cgi/l/email-protection#80e1efece5e1f2c0e3e6f4e3aee7eff6"><span class="__cf_email__" data-cfemail="80e1efece5e1f2c0e3e6f4e3aee7eff6">[email protected]</span></a>; Thomas Smith, Deputy Director, 202-418-5495,
<a href="/cdn-cgi/l/email-protection#0d797e606479654d6e6b796e236a627b"><span class="__cf_email__" data-cfemail="e692958b8f928ea685809285c8818990">[email protected]</span></a>; Rafael Martinez, Associate Director, 202-418-5462,
<a href="/cdn-cgi/l/email-protection#92e0fff3e0e6fbfcf7e8d2f1f4e6f1bcf5fde4"><span class="__cf_email__" data-cfemail="3d4f505c4f49545358477d5e5b495e135a524b">[email protected]</span></a>; Warren Gorlick, Associate Director, 202-418-5195,
<a href="/cdn-cgi/l/email-protection#a1d6c6ced3cdc8c2cae1c2c7d5c28fc6ced7"><span class="__cf_email__" data-cfemail="d0a7b7bfa2bcb9b3bb90b3b6a4b3feb7bfa6">[email protected]</span></a>; Liliya Bozhanova, Special Counsel, 202-418-6232,
<a href="/cdn-cgi/l/email-protection#81ede3eefbe9e0efeef7e0c1e2e7f5e2afe6eef7"><span class="__cf_email__" data-cfemail="4e222c2134262f2021382f0e2d283a2d60292138">[email protected]</span></a>; Joo Hong, Risk Analyst, 202-418-6221,
<a href="/cdn-cgi/l/email-protection#167c7e797871567570627538717960"><span class="__cf_email__" data-cfemail="78121017161f381b1e0c1b561f170e">[email protected]</span></a>; Justin McPhee, Risk Analyst, 202-418-6223;
<a href="/cdn-cgi/l/email-protection#4e24232d263e2b2b0e2d283a2d60292138"><span class="__cf_email__" data-cfemail="6e04030d061e0b0b2e0d081a0d40090118">[email protected]</span></a>, Market Participants Division; Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') is issuing an order providing that
registered nonbank swap dealers organized and domiciled in Japan
(``Japanese nonbank SDs'') may satisfy certain capital and financial
reporting requirements under the Commodity Exchange Act (``CEA'') \1\
and Commission regulations \2\ by being subject to, and complying with,
comparable capital and financial reporting requirements under relevant
Japanese laws and regulations, subject to certain conditions set forth
in the order below. The order is based on the proposed comparability
determination and related proposed order published by the Commission on
August 8, 2022,\3\ as modified in certain aspects to address comments
and to clarify its terms.
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\1\ 7 U.S.C. 1 et seq. The CEA may be accessed through the
Commission's website, <a href="http://www.cftc.gov">www.cftc.gov</a>.
\2\ 17 CFR Chapter I. Commission regulations may be accessed
through the Commission's website, <a href="http://www.cftc.gov">www.cftc.gov</a>.
\3\ Notice of Proposed Order and Request for Comment on an
Application for Capital Comparability Determination from the
Financial Services Agency of Japan, 87 FR 48092 (Aug. 8, 2022)
(``2022 Proposal'').
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I. Introduction
A. Regulatory Background--CFTC Capital, Margin, and Financial Reporting
Requirements for Swap Dealers and Major Swap Participants
Section 4s(e) of the CEA \4\ directs the Commission and
``prudential regulators'' \5\ to impose capital requirements on swap
dealers (``SDs'') and major swap participants (``MSPs'') registered
with the Commission.\6\ Section 4s(e) also directs the Commission and
prudential regulators to adopt regulations imposing initial and
variation margin requirements on swaps entered into by SDs and MSPs
that are not cleared by a registered derivatives clearing organization
(``uncleared swaps'').
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\4\ 7 U.S.C. 6s(e).
\5\ The term ``prudential regulators'' 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. 7 U.S.C.
1a(39).
\6\ 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. 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) is a financial entity
that: (a) is highly leveraged relative to the amount of capital it
holds and that is not subject to capital requirements established by
an appropriate Federal banking agency; and (b) maintains a
substantial position in outstanding swaps in any major swap category
as determined by the Commission. 7 U.S.C. 1a(33).
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Section 4s(e) applies a bifurcated approach with respect to the
above Congressional directives, requiring each SD and MSP that is
subject to the regulation of a prudential regulator (``bank SD'' and
``bank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the applicable
prudential regulator, and requiring each SD and MSP that is not subject
to the regulation of a prudential regulator (``nonbank SD'' and
``nonbank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the Commission.\7\
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.\8\
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\7\ 7 U.S.C. 6s(e)(2).
\8\ 7 U.S.C. 6s(e)(1) and (2).
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The prudential regulators implemented Section 4s(e) in 2015 by
amending existing capital requirements applicable to bank SDs and bank
MSPs to incorporate swap transactions into their respective bank
capital frameworks, and by adopting rules imposing initial and
variation margin requirements on bank SDs and bank MSPs that engage in
uncleared swap transactions.\9\ 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.\10\
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
[[Page 58471]]
compliance date of October 6, 2021 (``CFTC Capital Rules'').\11\
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\9\ Margin and Capital Requirements for Covered Swap Entities,
80 FR 74840 (Nov. 30, 2015).
\10\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\11\ Capital Requirements of Swap Dealers and Major Swap
Participants, 85 FR 57462 (Sept. 15, 2020). On April 30, 2024, the
Commission amended the capital and financial reporting requirements
to revise certain financial reporting obligations, among other
changes. See Capital and Financial Reporting Requirements for Swap
Dealers and Major Swap Participants, 89 FR 45569 (May 23, 2024). The
amendments have limited impact on nonbank SDs covered by this order.
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Section 4s(f) of the CEA addresses SD and MSP financial reporting
requirements.\12\ Section 4s(f) 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) provides, in relevant part, that each
registered SD and MSP must make financial condition reports as required
by regulations adopted by the Commission.\13\ The Commission's
financial reporting obligations were adopted with the Commission's
nonbank SD and nonbank MSP capital requirements, and also had a
compliance date of October 6, 2021 (``CFTC Financial Reporting
Rules'').\14\
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\12\ 7 U.S.C. 6s(f).
\13\ 7 U.S.C. 6s(f)(1)(A).
\14\ 85 FR 57462.
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B. Commission Capital Comparability Determinations for Non-U.S. Nonbank
Swap Dealers and Non-U.S. Nonbank Major Swap Participants
Commission Regulation 23.106 establishes a substituted compliance
framework whereby the Commission may determine that compliance by a
non-U.S. domiciled nonbank SD or non-U.S. domiciled nonbank MSP with
its home country's capital and financial reporting requirements will
satisfy all or parts of the CFTC Capital Rules and all or parts of the
CFTC Financial Reporting Rules (such a determination referred to as a
``Comparability Determination'').\15\ The Commission's capital adequacy
and financial reporting requirements are designed to address and manage
risks that arise from a firm's operation as an 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. The availability of such
substituted compliance is conditioned upon the Commission issuing a
Comparability Determination finding that the relevant foreign
jurisdiction's capital adequacy and financial reporting 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 would issue a Comparability Determination in the
form of an order (``Comparability Order'').\16\
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\15\ 17 CFR 23.106. Commission Regulation 23.106(a)(1) provides
that a request for a Comparability Determination may be submitted by
a non-U.S. nonbank SD or non-US 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-US nonbank SDs or non-U.S. nonbank MSPs. However,
Commission regulations also 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 Comparability Determination. 17 CFR
23.101(a)(5) and (b)(4), respectively.
Furthermore, substituted compliance is not available to non-U.S.
bank SDs and non-U.S. bank MSPs with respect to their respective
financial reporting requirements under Commission Regulation
23.105(p). Commission Regulation 23.105(p), however, permits non-
U.S. bank SDs and non-U.S. bank MSPs that do not submit financial
reports to a U.S. prudential regulator to file with the Commission a
statement of financial condition, certain regulatory capital
information, and Schedule 1 of Appendix C to Subpart E of Part 23 of
the Commission's regulations prepared and presented in accordance
with the accounting standards permitted by the non-U.S. bank SD's or
non-U.S. bank MSP's home country regulatory authorities. 17 CFR
23.105(p)(2).
\16\ 17 CFR 23.106(a)(3).
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The Commission's approach for conducting a Comparability
Determination with respect to the CFTC Capital Rules and the CFTC
Financial Reporting Rules is a principles-based, holistic approach that
focuses on assessing whether the applicable foreign jurisdiction's
capital and financial reporting requirements have comparable objectives
with, and achieve comparable outcomes to, corresponding CFTC
requirements.\17\ The Commission's assessment is not a line-by-line
evaluation or comparison of a foreign jurisdiction's regulatory
requirements with the Commission's requirements.\18\ In performing the
analysis, the Commission recognizes that jurisdictions may adopt
differing approaches to achieving regulatory objectives and outcomes,
and the Commission will focus on whether the foreign jurisdiction's
capital and financial reporting requirements are based on regulatory
objectives, and produce regulatory outcomes, that are comparable to the
Commission's in purpose and effect, and not whether they are comparable
in every aspect or contain identical elements.
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\17\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57462 at 57521.
\18\ See 85 FR 57462 at 57521.
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A person requesting a 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 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.\19\
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\19\ 17 CFR 23.106(a)(2).
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The Commission will consider an application for a 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.\20\ Each non-U.S. nonbank SD or non-U.S.
nonbank MSP that seeks to rely on a Comparability Order is responsible
for determining whether it is subject to the foreign laws and
regulations found comparable in the Comparability Order. A non-U.S.
nonbank SD or non-U.S. nonbank MSP
[[Page 58472]]
that is not legally required to comply with a foreign jurisdiction's
laws and/or regulations determined to be comparable in a Comparability
Order may not voluntarily comply with such laws and/or regulations in
lieu of compliance with the CFTC Capital Rules or the CFTC Financial
Reporting Rules.
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\20\ The Commission provides the applicant with an opportunity
to review for accuracy and completeness the Commission's description
of relevant home country laws and regulations on which a proposed
Comparability Determination and a proposed Comparability Order are
based. The Commission relies on this review, and any corrections or
feedback received, as part of the comparability assessment. A
Comparability Determination and Comparability Order based on an
inaccurate description of foreign laws and regulations may not be
valid.
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The Commission may consider all relevant factors in making a
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
or similar arrangement that would facilitate supervisory
cooperation.\21\
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\21\ 17 CFR 23.106(a)(3) and 85 FR 57462 at 57520-57522.
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In performing the comparability assessment for foreign nonbank SDs,
the Commission's review will include the extent to which the foreign
jurisdiction's requirements address: (i) the process of establishing
minimum capital requirements for nonbank SDs and how such process
addresses risk, including market risk and credit risk of the nonbank
SD's on-balance sheet and off-balance sheet exposures; (ii) the types
of equity and debt instruments that qualify as regulatory capital in
meeting minimum requirements; (iii) the financial reports and other
financial information submitted by a nonbank SD to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank SD; and (iv) the regulatory
notices and other communications between a nonbank SD and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
an assessment 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.\22\
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\22\ The Commission would conduct a similar analysis, adjusted
as appropriate to account for regulatory distinctions, in performing
a comparability assessment for foreign nonbank MSPs. Commission
Regulation 23.101(b) requires a nonbank MSP to maintain positive
tangible net worth. There are no MSPs currently registered with the
Commission. 17 CFR 23.101(b).
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Commission Regulation 23.106 further provides that the Commission
may impose any terms or conditions that it deems appropriate in issuing
a Comparability Determination.\23\ Any specific terms or conditions
with respect to capital adequacy or financial reporting requirements
will be set forth in the Commission's Comparability Order. As a general
condition to all Comparability Orders, the Commission will require
notification from the 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 foreign jurisdiction's
relevant laws and regulations, as well as changes to the relevant
supervisory or regulatory regime.
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\23\ 17 CFR 23.106(a)(5).
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To rely on a Comparability Order, 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 Comparability
Order in lieu of all or parts of the CFTC Capital Rules and/or CFTC
Financial Reporting Rules.\24\ Notices must be filed electronically
with the Commission's Market Participants Division (``MPD'').\25\ The
filing of a notice by a non-U.S. nonbank SD or non-U.S. nonbank MSP
provides MPD staff 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 Comparability Order and that it will
comply with any listed conditions. MPD will issue a letter under
delegated authority from the Commission confirming that the non-U.S.
nonbank SD or non-U.S. nonbank MSP may comply with the foreign laws and
regulations cited in the Comparability Order in lieu of complying with
the CFTC Capital Rules and CFTC Financial Reporting Rules upon MPD's
confirmation through discussions with the non-U.S. nonbank SD or non-
U.S. nonbank MSP that the firm is subject to, and complies with, such
foreign laws and regulations, is subject to the jurisdiction of the
applicable foreign regulatory authority (or authorities), and can meet
the conditions in the Comparability Order.\26\
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\24\ 17 CFR 23.106(a)(4)(i).
\25\ Notices must be filed in electronic form to the following
email address: <a href="/cdn-cgi/l/email-protection#cd809d898ba4a3aca3aea4aca19fa8bcb8a4bfa8a0a8a3b9be8daeabb9aee3aaa2bb"><span class="__cf_email__" data-cfemail="fbb6abbfbd92959a9598929a97a99e8a8e92899e969e958f88bb989d8f98d59c948d">[email protected]</span></a>.
\26\ 17 CFR 23.106(a)(4)(ii) and 17 CFR 140.91(a)(11).
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Each non-U.S. nonbank SD and each non-U.S. nonbank MSP that
receives confirmation from the Commission that it may comply with a
foreign jurisdiction's capital adequacy and 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.\27\ A non-U.S. nonbank SD or non-U.S. nonbank MSP that receives
confirmation of substituted compliance remains subject, however, to the
Commission's examination and enforcement authority.\28\ Accordingly, if
a nonbank SD or nonbank MSP fails to comply with the foreign
jurisdiction's capital adequacy and/or financial reporting
requirements, the Commission may initiate an action for a violation of
the corresponding CFTC Capital Rules and/or CFTC Financial Reporting
Rules.\29\ In addition, a 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.
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\27\ 17 CFR 23.106(a)(4)(ii). Confirmation will be issued by MPD
under authority delegated by the Commission. Commission Regulation
140.91(a)(11). 17 CFR 140.91(a)(11).
\28\ 17 CFR 23.106(a)(4)(ii).
\29\ Id.
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C. Japan Financial Services Agency's Application for a Comparability
Determination for Japan-Domiciled Nonbank Swap Dealers
On September 30, 2021, the Financial Services Agency of Japan
(``FSA'') submitted an application (``FSA Application'') requesting
that the Commission conduct a Comparability Determination and issue a
Comparability Order finding that compliance with certain designated
capital requirements of Japan (the ``Japanese Capital Rules'') and
certain designated financial reporting requirements of Japan (the
``Japanese Financial Reporting Rules'') by a Japanese nonbank SD
registered with
[[Page 58473]]
the FSA as a Type I Financial Instruments Business Operator (``FIBO'')
satisfies corresponding CFTC Capital Rules and CFTC Financial Reporting
Rules applicable to a nonbank SD under Sections 4s(e) and (f) of the
CEA and Commission Regulations 23.101 and 23.105.\30\ There are
currently three Japanese nonbank SDs registered with the Commission,
and the FSA represented in its application that each of the three
Japanese nonbank SDs are FSA-registered and regulated FIBOs.\31\
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\30\ Letter from Yuji Yamashita, Deputy Commissioner for
International Affairs, Financial Services Agency of Japan, dated
September 30, 2021, pp. 4-5 (fn. 11). The FSA 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>.
\31\ The three Japanese nonbank SDs currently registered with
the Commission are: BofA Securities Japan Co., Ltd.; Goldman Sachs
Japan Co., Ltd.; and Morgan Stanley MUFG Securities Co., Ltd. The
FSA's application did not request a Comparability Determination with
respect to nonbank MSPs as currently there are no MSPs registered
with the Commission and, accordingly, no nonbank MSPs domiciled in
Japan and registered with the FSA. Accordingly, the Commission's
Comparability Determination and Comparability Order do not address
nonbank MSPs.
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The FSA represented that the capital adequacy and financial
reporting requirements for swap activities in Japan are governed by the
Japanese legal framework for financial regulation, which is mainly
composed of Acts, Cabinet Orders, Ministerial Orders, and FSA
Notices.\32\ With regard to the Japanese Capital Rules and the Japanese
Financial Reporting Rules, the Financial Instruments and Exchange Act
(Act No. 25 of 1948) (``FIEA'') and its related order, Cabinet Office
Order on Financial Instruments Business (Cabinet Office Order No. 52 of
2007) (``COO''), set forth the prudential capital and financial
reporting requirements applicable to FIBOs, including the Japanese
nonbank SDs.\33\ FIEA, COO, and related FSA Notices impose mandatory
capital and reporting requirements on FIBOs, including Japanese nonbank
SDs. Comprehensive Guidelines for Supervision of Financial Instruments
Business Operators, etc. (``Supervisory Guidelines for FIBO'') also
supplement the framework.\34\ The technical requirements for FIBOs,
including Japanese nonbank SDs, to calculate capital adequacy ratios
are specified in the FSA Notice No. 59 of 2007 (``Notice on Capital'')
in accordance with Article 177(8) and Article 178(1) of the COO.
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\32\ FSA Application at p. 4.
\33\ Businesses categorized as Type I Financial Instruments
Business (Article 28(1) of the FIEA) can only be conducted by Type I
FIBOs registered under Article 29 of the FIEA. Type I Financial
Instruments Business includes market transactions of derivatives and
foreign market derivatives transactions pertaining to certain highly
liquid securities and over-the-counter transactions of derivatives.
\34\ To implement and reinforce the legal framework, the FSA has
developed and published supervisory guidelines. The supervisory
guidelines are meant for FSA staff, but are public documents, which
are expected to be followed by the applicable financial
institutions. Financial institutions are consulted in connection
with the establishment of, and any amendments to, the supervisory
guidelines. FSA staff conducts supervision and enforcement based on
the supervisory guidelines.
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D. Proposed Comparability Determination and Proposed Comparability
Order for Japan-Domiciled Nonbank Swap Dealers
On August 8, 2022, the Commission published the 2022 Proposal,
seeking comment on the FSA Application and the Commission's proposed
Comparability Determination and related Comparability Order.\35\ The
2022 Proposal set forth the Commission's preliminary Comparability
Determination and proposed Comparability Order providing that, based on
its review of the FSA Application and applicable Japanese laws and
regulations, the Commission preliminarily found that the Japanese
Capital Rules and the Japanese Financial Reporting Rules, subject to
the conditions set forth in the proposed Comparability Order, achieve
comparable outcomes and are comparable in purpose and effect to the
CFTC Capital Rules and CFTC Financial Reporting Rules.\36\ The
Commission, however, noted that there were certain differences between
the Japanese Capital Rules and CFTC Capital Rules and certain
differences between the Japanese Financial Reporting Rules and the CFTC
Financial Reporting Rules. As such, the Commission proposed certain
conditions to the Comparability Order.\37\ The proposed conditions were
designed to promote consistency in regulatory outcomes, to reflect the
scope of substituted compliance that would be available notwithstanding
the differences, and to ensure that the Commission and National Futures
Association (``NFA'') receive information to monitor Japanese nonbank
SDs for ongoing compliance with the Comparability Order.\38\ The
Commission further stated that, in its preliminary view, the identified
differences would not be inconsistent with providing a substituted
compliance framework for Japanese nonbank SDs subject to the conditions
specified in the proposed Comparability Order.\39\
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\35\ 2022 Proposal, 87 FR 48092 (Aug. 8, 2022).
\36\ See 2022 Proposal at 48092. Consistent with the process
specified in section I.B. above for conducting Comparability
Determinations, the Commission provided the FSA with an opportunity
to review for factual accuracy and completeness the Commission's
description of relevant Japanese laws and regulations on which the
proposed Comparability Determination and proposed Comparability
Order were based. The Commission has relied on FSA's review, and has
incorporated feedback and corrections received from the FSA. As
previously noted, a Comparability Determination and Comparability
Order based on an inaccurate description of foreign laws and
regulations may not be valid.
\37\ See 2022 Proposal at 48114.
\38\ NFA is a registered futures association under section 17 of
the CEA (7 U.S.C. 21). Each SD registered with the Commission is
required to be an NFA member. 17 CFR 170.16. NFA, as a registered
futures association, is also required by the CEA to adopt rules
imposing minimum capital, segregation, and other financial
requirements, as applicable, to its members, including SDs, that are
at least as stringent as the Commission's minimum capital,
segregation, and other financial requirements for such registrants,
and to implement a program to audit and enforce such requirements. 7
U.S.C. 21(p). Therefore, the Commission's proposed Comparability
Order required Japanese nonbank SDs to file certain financial
reports and notices with NFA so that it may perform oversight of
such firms as required under section 17 of the CEA. The Commission
will refer to NFA in this Comparability Determination when referring
to the requirements or obligations of a registered futures
association.
\39\ 2022 Proposal at 48114.
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The proposed Comparability Order was limited to the comparison of
the Japanese Capital Rules to the CFTC Capital Rules' Bank-Based
Capital Approach (``Bank-Based Approach'') for computing regulatory
capital for nonbank SDs, which is based on certain capital requirements
imposed by the Federal Reserve Board for bank holding companies.\40\ As
noted by the Commission in the 2022 Proposal, the FSA had not
requested, nor has the Commission performed, a comparison of the
Japanese Capital Rules to the Commission's TNW Approach or NLA
Approach.\41\
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\40\ Id. As described in the 2022 Proposal, 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 Approach. See 2022 Proposal at 48095-48096, and 17
CFR 23.101. The Bank-Based Approach is consistent with the Basel
Committee on Banking Supervision's (``BCBS'') international
framework for bank capital requirements (``BCBS framework'' or
``Basel standards''). 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>.
\41\ See 2022 Proposal at 48114.
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[[Page 58474]]
E. General Comments on the FSA Application and the Commission's
Proposed Finding of Comparability Between the CFTC Capital Rules and
CFTC Financial Reporting Rules and the Japanese Capital Rules and
Japanese Financial Reporting Rules
The public comment period on the FSA Application, the proposed
Comparability Determination, and the proposed Comparability Order ended
on October 7, 2022. The Commission received six comment letters from
the following interested parties: Better Markets, Inc. (``Better
Markets''); the FSA; the International Bankers Association of Japan
(``IBAJ''); a joint letter from the Institute of International Bankers
(``IIB''), the International Swaps and Derivatives Association
(``ISDA''), and the Securities Industry and Financial Markets
Association (``SIFMA''); and two letters from William J.
Harrington.\42\
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\42\ Letter From Stephen Hall, Legal Director and Securities
Specialist, Better Markets (Oct. 7, 2022) (``Better Markets
Letter''); Letter from Yuji Yamashita, Deputy Commissioner for
International Affairs, FSA (Oct. 7, 2022) (``FSA Letter''); Letter
From Philippe Avril, Chair, IBAJ (Oct. 6, 2022) (``IBAJ Letter'');
Letter From Stephanie Webster, General Counsel, IIB; Steven Kennedy,
Global Head of Public Policy, ISDA; Kyle L. Brandon, Managing
Director, Head of Derivatives Policy, SIFMA (collectively,
``Associations'') (Oct. 7, 2022) (``Associations Letter''); Letters
from William J. Harrington (``Harrington'') (Oct. 7 and Oct. 20,
2022) (``Harrington 10/7/2022 Letter'' and ``Harrington 10/20/2022
Letter'') The comment letters for the 2022 Proposal are available
at: <a href="https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7301">https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7301</a>.
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Two commenters expressed support for the proposed Comparability
Determination and proposed Comparability Order, agreeing with the
Commission's overall analysis and determination of comparability of the
CFTC Capital Rules and CFTC Financial Reporting Rules and the Japanese
Capital Rules and Japanese Financial Reporting Rules.\43\ In addition,
the FSA submitted a comment letter in support of the Commission's
proposal, and recommending several technical amendments to the proposed
Comparability Determination and Comparability Order that were
corrective or typographical in nature.\44\
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\43\ Associations Letter at p. 1; IBAJ Letter at p. 1.
\44\ FSA Letter. In particular, the FSA recommended that the
Commission add Article 47 of the FIEA to the list of relevant
provisions comprising the Japanese Capital Rules enumerated in
proposed Condition 4. FSA Letter at p. 2. The Commission has revised
final Condition 4 to that effect.
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Conversely, two commenters disagreed with the CFTC's proposed
Comparability Determination and proposed Comparability Order.\45\
Better Markets asserted that the principles-based, holistic approach
applied by the Commission, which assesses whether the applicable
foreign jurisdiction's capital and financial requirements achieve
comparable outcomes to the corresponding Commission requirements, is
``insufficiently rigorous, leaving far too much room for inaccurate and
unwarranted comparability determinations.'' \46\
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\45\ Better Markets Letter at p. 2; Harrington 10/20/2022 Letter
at p. 20.
\46\ Better Markets Letter at p. 2.
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The Commission does not believe that the principles-based, holistic
assessment that it conducted on the comparability of the Japanese
Capital Rules and Japanese Financial Reporting Rules with the CFTC
Capital Rules and CFTC Financial Reporting Rules was ``insufficiently
rigorous,'' nor does the Commission believe that it left ``room for
inaccurate and unwarranted comparability determinations.'' The
principles-based, holistic approach employed in the Comparability
Determination was performed in accordance with the substituted
compliance assessment framework adopted by the Commission for capital
and financial reporting requirements for foreign nonbank SDs and set
out in Commission Regulation 23.106. Consistent with this assessment
framework, the Commission focused on whether the Japanese Capital Rules
and Japanese Financial Reporting Rules are designed with the objective
of ensuring overall safety and soundness of the Japanese nonbank SDs in
a manner that is comparable with the Commission's overall objective of
ensuring the safety and soundness of nonbank SDs.
As stated in the 2022 Proposal, due to the detailed and complex
nature of the capital frameworks, differences in how jurisdiction
approach and implement the requirements are expected, even among
jurisdictions that base their requirements on the principles and
standards set forth in the BCBS framework.\47\ Furthermore, as
discussed in Section I.B. above, when adopting Commission Regulation
23.106, the Commission stated that ``its approach to substituted
compliance is a principles-based, holistic approach that focuses on
whether the foreign regulations are designed with the objectives of
ensuring the overall safety and soundness of the [non-US nonbank SD] in
a manner that is comparable with the Commission's overall capital and
financial reporting requirements, and is not based on a line-by-line
assessment or comparison of a foreign jurisdiction's regulatory
requirements with the Commission's requirements.'' \48\
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\47\ See 2022 Proposal at 48098.
\48\ 85 FR 57462 at 57521.
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The approach and standards set forth in Commission Regulation
23.106, with the focus on ``comparable outcomes,'' are also consistent
with the Commission's precedents of undertaking a principles-based,
holistic assessment of the comparability of foreign regulatory regimes
for purposes of substituted compliance for cross-border swap
transactions. The Commission first outlined its approach to substituted
compliance with respect to swaps requirements in 2013, when it issued
an Interpretive Guidance and Policy Statement Regarding Compliance with
Certain Swap Regulations.\49\ In the Guidance, the Commission stated
that ``[i]n evaluating whether a particular category of foreign
regulatory requirement(s) is comparable and comprehensive to the
applicable requirement(s) under the CEA and Commission regulations, the
Commission will take into consideration all relevant factors, including
but not limited to, the comprehensiveness of those requirement(s), the
scope and objectives of the relevant regulatory requirement(s), the
comprehensiveness of the foreign regulator's supervisory compliance
program, as well as the home jurisdiction's authority to support and
enforce its oversight of the registrant.'' \50\ The Commission
emphasized that in this context, ``comparable does not necessarily mean
identical.'' \51\ Rather, the Commission stated that it would evaluate
whether the home jurisdiction's regulatory requirement is comparable
to, and as comprehensive as, the corresponding U.S. regulatory
requirement(s).\52\ In conducting comparability determinations based on
the policy set forth in the Guidance, the Commission noted that the
``outcome-based'' approach recognizes that ``foreign regulatory systems
differ and their approaches vary and may differ from how the Commission
chose to address an issue, but that the foreign jurisdiction's
regulatory requirements nonetheless achieve the regulatory outcome
sought to be achieved by a certain provision of the CEA or Commission
regulation.'' \53\
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\49\ Interpretative Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,
2013) (``Guidance'').
\50\ Guidance at 45343.
\51\ Id.
\52\ Id.
\53\ See e.g., Comparability Determination for the European
Union: Certain Entity-Level Requirements, 78 FR 78923 (December 27,
2013) at 78926.
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[[Page 58475]]
The Commission further elaborated on the required elements of
comparability in 2016, when it issued final rules to address the cross-
border application of the Commission's margin requirements for
uncleared swap transactions. Specifically, the Commission stated that
its substituted compliance approach reflects an outcome-based
assessment of the comparability of a foreign jurisdiction's margin
requirements with the Commission's corresponding requirements.\54\ The
Commission further stated that it would evaluate the objectives and
outcomes of the foreign margin requirements in light of foreign
regulator(s)' supervisory and enforcement authority.\55\ Consistent
with its previously stated position, the Commission recognized that
jurisdictions may adopt different approaches to achieving the same
outcome and, therefore, the assessment would focus on whether the
foreign jurisdiction's margin requirements are comparable to the
Commission's in purpose and effect, not whether they are comparable in
every aspect or contain identical elements.\56\ The Commission's policy
thus reflects an understanding that a line-by-line evaluation of a
foreign jurisdiction's regulatory regime is not the optimum approach to
assessing the comparability of complex structures whose individual
components may differ based on jurisdiction-specific considerations,
but which achieve the objective and outcomes set forth in the
Commission's framework.
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\54\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34817, 34836-34837 (May 31, 2016).
\55\ Id.
\56\ Id.
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With respect to the FSA Application, the process leading to the
Comparability Determination involved Commission staff obtaining English
language translations of relevant Japanese laws, rules, and regulations
cited in the FSA Application from the FSA.\57\ Staff verified the
assertions and citations contained in the FSA Application regarding the
specific Japanese Capital Rules and Japanese Financial Reporting Rules
to the relevant English language versions of the Japanese laws, rules,
and regulations.\58\
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\57\ Commission staff received English translations on May 11,
2021.
\58\ Staff also reviewed the FSA website to confirm various
provisions of Japanese laws and regulations that were relevant to
the proposed Comparability Determination and proposed Comparability
Order.
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Commission staff also evaluated the comparability of the Japanese
Capital Rules and Japanese Financial Reporting Rules with the CFTC
Capital Rules and CFTC Financial Reporting Rules with respect to the
following areas: (i) the process of establishing minimum capital
requirements for Japanese nonbank SDs and how such process addresses
risk, including market risk and credit risk of the Japanese 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 a Japanese nonbank SD's minimum capital requirements; (iii) the
financial reports and other financial information submitted by a
Japanese nonbank SD to the FSA, and whether such information provides
the FSA with the means necessary to effectively monitor the financial
condition of the Japanese nonbank SD; and (iv) the regulatory notices
and other communications between a Japanese nonbank SD and the FSA that
address potential adverse financial or operational issues that may
impact the firm.\59\ With respect to the ability of the FSA to
supervise and enforce compliance with the Japanese Capital Rules and
Japanese Financial Reporting Rules, the Commission's assessment
included a review of the FSA's surveillance program for monitoring
Japanese nonbank SDs compliance with Japanese Capital Rules and
Japanese Financial Reporting Rules, and the disciplinary process
imposed on firms that fail to comply with such requirements.\60\
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\59\ 2022 Proposal at 48098-48112.
\60\ Id. at 48112-48113.
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Contrary to the position articulated by Better Markets regarding
the nature of the comparability assessment, the Commission believes
that the principles-based, holistic assessment of the Japanese Capital
Rules and Japanese Financial Reporting Rules against the CFTC Capital
Rules and CFTC Financial Reporting Rules, as outlined above and
discussed in detail in Section II below, was sufficiently rigorous for
purposes of determining if the Japanese laws and regulations are
comparable in purpose and effect to the CEA and Commission regulations.
Better Markets further asserted that even under a principles-based,
holistic approach, the FSA capital and financial reporting requirements
for Japanese nonbank SDs do not satisfy the test for an order granting
substituted compliance because the FSA's regulatory framework governing
capital and financial reporting is not comparable to the corresponding
CFTC requirements.\61\ Better Markets cited the Commission's inclusion
of conditions in the proposed Comparability Order as demonstrating the
Commission's need ``to compensate for the acknowledged obvious gaps in
the FSA framework.'' \62\ Better Markets further stated that the
differences between the Japanese and the CFTC capital and financial
reporting regimes mandate denial of the FSA Application for a
comparability determination.\63\
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\61\ Better Markets Letter at p. 2.
\62\ Id.
\63\ Id.
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The Commission disagrees that the inclusion of conditions in the
Comparability Order precludes a finding of comparability with respect
to the Japanese Capital Rules and Japanese Financial Reporting Rules.
The Commission's comparability assessment process, consistent with the
holistic approach, contemplates the potential need for a Comparability
Order to contain conditions. Specifically, Commission Regulation
23.106(a)(5) states that the Commission may impose any terms and
conditions it deems appropriate in issuing a Comparability Order,
including conditions with respect to capital adequacy and financial
reporting requirements of non-U.S. nonbank SDs.\64\
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\64\ 17 CFR 23.106(a)(5), which provides that in issuing a
Capital Comparability Determination, the Commission may impose any
terms and conditions it deems appropriate, including certain capital
adequacy and financial reporting requirements on swap dealers. . .
(Emphasis added). Commission Regulation 23.106(a)(3) establishes the
Commission's standard of review for performing a Comparability
Determination and provides that the Commission may consider all
relevant factors, including whether the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements
achieve comparable outcomes to the Commission's corresponding
capital adequacy and financial reporting requirements for SDs. 17
CFR 23.106(a)(3)(ii).
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The process employed in this Comparability Determination is
consistent with the Commission's established approach to conducting
comparability assessments. Upon a finding of comparability, the
Commission's policy generally is that eligible entities may comply with
a substituted compliance regime subject to the conditions the
Commission places on its finding, and subject to the Commission's
retention of its examination authority and its enforcement
authority.\65\ In this regard, the Commission has stated that certain
conditions included in a Comparability Order may be designed to ensure
the
[[Page 58476]]
Commission's direct access to books and records required to be
maintained by an SD registered with the Commission.\66\ Other
conditions may address areas where the foreign jurisdiction lacks
analogous requirements.\67\ The inclusion of conditions in a
Comparability Order was contemplated as an integral part of the
Commission's holistic, principle-based approach to conducting
comparability assessments and is not inconsistent with a grant of
substituted compliance. In particular, Commission Regulation
23.106(a)(5) states the Commission's authority to impose conditions in
issuing a Comparability Determination in connection with the CFTC
Capital Rules and the CFTC Financial Reporting Rules. As further
discussed below, the conditions proposed in the 2022 Proposal are
clearly of the nature contemplated by Commission Regulation
23.106(a)(5).
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\65\ 85 FR 57462 at 57520. See also Guidance at 45342-45344 and
Comparability Determination for the European Union: Certain
Transaction Level Requirements, 78 FR 78878 (December 27, 2013) at
78880.
\66\ Comparability Determination for the European Union: Certain
Transaction Level Requirements, 78 FR 78878 (December 27, 2013) at
78880.
\67\ Guidance at 45343.
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The Commission also does not believe that the inclusion of the
conditions in the proposed Comparability Order demonstrates ``obvious
gaps in the FSA framework'' as asserted by Better Markets. Consistent
with the Commission's policy described above, a majority of the
conditions contained in the proposed Comparability Order are designed
to ensure that: (i) the Japanese nonbank SD is eligible for substituted
compliance based on the Japanese laws and regulations that were
reviewed by the Commission in performing the comparability assessment,
and (ii) the Commission and the NFA receive timely financial
information and notices to effectively monitor a Japanese nonbank SD's
compliance with the Comparability Order and to assess the ongoing
safety and soundness of the Japanese nonbank SD. Specifically, there
are 23 conditions in the final Comparability Order. Four conditions set
forth criteria that a Japanese nonbank SD must meet to be eligible for
substituted compliance pursuant to the Comparability Order.\68\ The
four conditions ensure that only Japanese nonbank SDs that are within
the scope of, and comply with, the Japanese Capital Rules and Japanese
Financial Reporting Rules that were part of the Commission's
comparability assessment may apply for substituted compliance. Eight
additional conditions require Japanese nonbank SDs within scope of the
Comparability Order to provide notice to the Commission and NFA of
certain defined events,\69\ and a further three conditions require
Japanese nonbank SDs to file with the Commission and NFA copies of
certain unaudited and audited financial reports that the firms provide
to the FSA.\70\ In addition, two additional conditions reflect
administrative matters necessary to implement the substituted
compliance framework.\71\ Lastly, five conditions impose obligations on
Japanese nonbank SDs that align with certain of the Commission's
requirements for nonbank SDs. The five conditions require a Japanese
nonbank SD to: (i) maintain a minimum level of capital defined as Basic
Items \72\ in an amount equivalent to at least $20 million (Condition
5); (ii) prepare and keep current financial books and records
(Condition 7); (iii) file a monthly schedule of the firm's financial
positions on Schedule 1 of appendix B to Subpart E of part 23 of the
Commission's regulations (Condition 11); (iv) file a monthly report
listing the custodians holding margin posted by, and collected by, the
Japanese nonbank SD, the amount of margin held by each custodian, and
the aggregate amount of margin required to be posted and collected by
the Japanese nonbank SD (Condition 13); and (v) submit, with each
filing of financial information, a statement by an authorized
representative that, to the best knowledge and belief of the person
making the representation, the information is true and correct
(Condition 14).\73\
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\68\ The four criteria provide that the Japanese nonbank SD: (i)
is not subject to capital rules of a U.S. prudential regulator
(Condition 1); (ii) is organized and domiciled in Japan (Condition
2); (iii) is registered as a FIBO (Condition 3); and (iv) is subject
to the Japanese Capital Rules and Japanese Financial Reporting Rules
that are part of the Commission's comparability assessment
(Condition 4).
\69\ The eight conditions require a Japanese nonbank SD to
provide notice to the Commission in the event that the firm: (i) is
informed by the FSA that it failed to comply with any component of
the Japanese Capital Rules or Japanese Financial Reporting Rules
(Condition 15); (ii) fails to maintain regulatory capital in the
form of Basic Items of at least the equivalent of $20 million
(Condition 16); (iii) its capital adequacy ratio is below the early
warning level of 140 percent (Condition 17); (iv) its capital
adequacy ratio is below the minimum requirement of 120 percent
(Condition 18); (v) fails to make or keep current financial books
and records (Condition 19); (vi) fails to post or collect margin for
uncleared swaps and non-cleared security-based swaps with one or
more counterparties in amounts that exceed defined limits (Condition
20); (vii) changes its fiscal year-end date (Condition 21); and
(viii) is subject to material changes to the Japanese Capital Rules,
Japanese Financial Reporting Rules, or the supervisory authority of
the Japanese Commission (Condition 22).
\70\ The three conditions provide that a Japanese nonbank SD
must file with the Commission and NFA: (i) English language copies
of certain financial reporting forms that the Japanese nonbank SD is
required to submit to the FSA pursuant to Article 56-2(1) of the
FIEA (Condition 8); (ii) an English language copy of the annual
business report that the Japanese nonbank SDs is required to submit
to the FSA pursuant to Article 46-3(1) of the FIEA and Article 172
of the COO (Condition 9); and (iii) English language copies of the
Japanese nonbank SD's annual audited financial statements and
management report that are required to be prepared pursuant to
Article 435(2) of the Japanese Companies Act (Act No. 86 of 2005)
(Condition 10).
\71\ One of the administrative conditions provides that a
Japanese nonbank SD must provide a notice to the Commission of its
intent to comply with the Comparability Order and the Japanese
Capital Rules and Japanese Financial Reporting Rules in lieu of the
CFTC Capital Rules and CFTC Financial Reporting Rules. The notice
must include the Japanese nonbank SD's representation that the firm
is organized and domiciled in Japan, is a registered FIBO, and is
subject to and complies with the Japanese Capital Rules and the
Japanese Financial Reporting Rules (Condition 6). The second
administrative condition provides that a Japanese nonbank SD must
file any documents with the Commission and NFA via electronic
transmission (Condition 23). With respect to Condition 6, the
Commission also notes that the language of the proposed condition
required that a Japanese nonbank SD provide a notice of its intent
to comply with ``applicable'' Japanese Capital Rules and Japanese
Financial Reporting Rules. Given that ``Japanese Capital Rules and
Japanese Financial Reporting Rules'' is a term defined in the
Comparability Order to include laws and regulations that apply to
Japanese nonbank SDs, the word ``applicable'' is superfluous and is,
therefore, not included in final Condition 6 of the Comparability
Order.
\72\ ``Basic Items'' are analogous to common equity tier 1
capital as defined in the CFTC Capital Rules. See discussion in
section II.B.
\73\ Another condition specifies that Japanese nonbank SDs that
are registered with the U.S. Securities and Exchange Commission
(``SEC'') as security-based swap dealers (``SBSDs'') and required to
file with the SEC, or its designee, Form X-17A-5 (``FOCUS Report''),
must file a copy of such FOCUS Report with the Commission and NFA
within 35 calendar days after the end of each month (Condition 12).
A Japanese nonbank SD that files a FOCUS Report pursuant to
Condition 12 will not be required to file the reports and schedules
specified in Conditions 8 and 11. Currently, no Japanese nonbank SD
is registered as a SBSD.
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As the substance of these conditions demonstrates, the primary
objective of a majority of the conditions is not to compensate for
regulatory gaps in the Japanese capital and financial reporting
framework, but rather to ensure that the Commission and NFA receive
information to conduct ongoing monitoring of Japanese nonbank SDs for
compliance with relevant capital and financial reporting requirements.
As discussed above, in issuing the Comparability Order, the Commission
is not ceding its supervisory and enforcement authorities. The
Comparability Order permits Japanese nonbank SDs to satisfy the
Commission's capital and financial reporting requirements by complying
with certain laws and/or regulations of Japan that have been found
comparable to the Commission's laws and/or regulations in purpose and
effect. The Commission and NFA, however, have a continuing obligation
to conduct
[[Page 58477]]
ongoing oversight, including potential examination, of Japanese nonbank
SDs to ensure compliance with the Comparability Order, including its
conditions. To that effect, the notice and financial reporting
conditions set forth in the Comparability Order provide the Commission
and NFA with information necessary to monitor for such compliance, and
to evaluate the operational condition and ongoing financial condition
of Japanese nonbank SDs. The Commission may also initiate an
enforcement action against a Japanese nonbank SD that fails to comply
with the conditions of the Comparability Order.\74\
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\74\ As the Commission stated in the 2022 Proposal, a non-U.S.
nonbank SD that operates under a Comparability Order issued by the
Commission remains subject to the Commission's examination and
enforcement authority. Specifically, the Commission may initiate an
enforcement action against a non-U.S. nonbank SD that fails to
comply with its home-country capital adequacy and/or financial
reporting requirements cited in a Comparability Order. See 2022
Proposal at 48094-48095. See also 17 CFR 23.106(a)(4)(ii), which
provides that the Commission may examine all nonbank SDs, regardless
of whether the nonbank SDs rely on substituted compliance, and that
the Commission may initiate an enforcement action under the
Commission's capital and financial reporting regulations against a
non-U.S. nonbank SD that fails to comply with a foreign
jurisdiction's capital adequacy and financial reporting
requirements.
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Furthermore, to the extent that a condition imposes a new
obligation on Japanese nonbank SDs, the imposition of such condition is
also consistent with Commission Regulation 23.106 and the Commission's
established policy with regard to comparability determinations. As
discussed above, the Commission contemplated that even in circumstances
where the Commission finds two regulatory regimes comparable, the
Commission may impose requirements on entities relying on substituted
compliance where the Commission determines that the home jurisdiction's
regime lacks comparable and comprehensive regulation on a specific
issue.\75\ The Commission's authority to impose such conditions is set
out in Commission Regulation 23.106(a)(5), which states that the
Commission may impose ``any terms and conditions it deems appropriate,
including certain capital adequacy and financial reporting requirements
[on SDs].'' \76\
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\75\ Guidance at 45343.
\76\ 17 CFR 23.106(a)(5).
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Better Markets further stated that if the Commission grants
substituted compliance with regard to materially different regulatory
requirements, it must make a well-supported comparability determination
by, at a minimum, clearly and specifically setting forth the desired
regulatory outcome and providing a detailed, evidence-based explanation
as to how the jurisdiction's different legal requirements nonetheless
lead to a comparable regulatory outcome.\77\ Better Markets also stated
that if the Commission grants the Comparability Determination and
Comparability Order, it must, at a minimum, ensure that the conditions
are applied and enforced with full force and without exception or
dilution.\78\ Better Markets asserted that ``[a] determination that a
foreign jurisdiction's nonbank SDs rules would produce comparable
regulatory outcomes is the beginning, not the end, of the CFTC's
obligation to ensure that the activities of the foreign nonbank SD
entities do not pose risks to the U.S. financial system. As time goes
on, regulatory requirements that, in theory, are expected to produce
one regulatory outcome may, in practice, produce a different one. And,
of course, the regulatory requirements may themselves be changed in a
variety of ways. Finally, the effectiveness of an authority's
supervision and enforcement program can become weakened for any number
of reasons--the CFTC cannot assume that an enforcement program that is
presently effective will continue to be effective.'' \79\ Better
Markets further asserted that to fulfill its obligation to protect the
U.S. financial system, the Commission must ensure, on an ongoing basis,
that each grant of substituted compliance remains appropriate over time
by, at a minimum, requiring each Comparability Order to impose an
obligation on the applicant, as appropriate, to: (i) periodically
apprise the Commission of the activities and results of its supervision
and enforcement programs, to ensure that they remain sufficiently
robust to deter and address violations of the law; and (ii) immediately
apprise the Commission of any material changes to the regulatory
regime, including changes to rules or interpretations of rules.\80\
---------------------------------------------------------------------------
\77\ Better Markets at p. 6.
\78\ Id. at p. 2.
\79\ Id. at p. 6.
\80\ Id.
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Although the Commission disagrees that the Japanese Capital Rules
and the Japanese Financial Reporting Rules, as a whole, are materially
different or do not achieve comparable regulatory outcomes, the
Commission concurs that granting substituted compliance should be the
result of a well-supported comparability assessment. Consistent with
that view, the Commission believes that this final Comparability
Determination articulates the Commission's analysis in sufficient
detail and provides an appropriate explanation of how the foreign
jurisdiction's requirements are comparable in purpose and effect with
the Commission's requirements, and lead to comparable regulatory
outcomes with the Commission's requirements. Specifically, Section III
of the 2022 Proposal and Section II of the final Comparability
Determination reflect, among other observations, the Commission's
detailed analysis with respect to each of the elements for
consideration listed in Commission Regulation 23.106(a)(3).
The Commission also concurs that the availability of substituted
compliance is conditioned upon a non-US nonbank SD's ongoing compliance
with the terms and conditions of the final Comparability Order, and the
Commission's ongoing assessment that the Japanese Capital Rules and
Japanese Financial Reporting Rules remain comparable in purpose and
effect with the CFTC Capital Rules and CFTC Financial Reporting Rules.
As noted above, and discussed in more detail in Sections II.D. and E.
below, Japanese nonbank SDs are subject to notice and financial
reporting requirements under the final Comparability Order that provide
Commission and NFA staff with the ability to monitor the Japanese
nonbank SDs' ongoing compliance with the conditions set forth in the
final Comparability Order. In addition, the final Comparability Order
requires Japanese nonbank SDs or the FSA to inform the Commission of
changes to the relevant Japanese Capital Rules and Japanese Financial
Reporting Rules so that the Commission may assess the continued
effectiveness of the Comparability Order in ensuring that the Japanese
laws and regulations have the comparable regulatory objectives of the
CEA and Commission regulations of ensuring the safety and soundness of
nonbank SDs.\81\ Commission staff will also monitor the Japanese
nonbank SDs directly as part of its supervisory program and will
discuss with the firms any proposed or pending revisions to specific
laws and rules cited in the final
[[Page 58478]]
Comparability Order. Lastly, in addition to assessing the effectiveness
of the Comparability Order as a result of revisions or proposed
revisions to the Japanese laws, regulations, or supervisory regime, the
Commission further notes that future material changes to the CFTC
Capital Rules or CFTC Financial Reporting Rules, or the Commission's or
NFA's supervisory programs, may necessitate an amendment to the
Comparability Determination and Comparability Order to reflect those
changes.\82\
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\81\ Condition 22 of the final Comparability Order requires
Japanese nonbank SDs or the FSA to notify the Commission of any
material changes to the information submitted in the FSA
Application, including, but not limited to, proposed and final
material changes to the Japanese Capital Rules or Japanese Financial
Reporting Rules and proposed and final material changes to the FSA's
supervisory authority or supervisory regime over Japanese nonbank
SDs. The Commission notes that it also made certain non-substantive,
clarifying changes to the language of final Condition 22 as compared
to the proposed condition.
\82\ 2022 Proposal at 48098 (n. 72).
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Another commenter, Harrington, stated that the Commission ``must
prevent every regulated [SD] globally from providing a swap contract
with a ``flip clause [. . .].'' \83\ Harrington further recommended
that the Commission condition the Comparability Order on specifying
that a Japanese nonbank SD that is party to a swap contract with a flip
clause must hold additional capital determined based on the required
margin and the contract market value.\84\ Alternatively, Harrington
argued that the Commission should prohibit a Japanese nonbank SD from
entering into a new swap contract with a flip clause or extending an
existing one.\85\ Harrington has elsewhere referred to a description of
a ``flip clause'' as a provision in swap contracts with structured debt
issuers that reverses or ``flips'' the priority of payment obligations
owed to the swap counterparty on the one hand and the noteholders on
the other, following a specified event of default.\86\ Based on
Harrington's description, flip clauses present a risk to the SD in
synthetic transactions where payments under a swap contract are secured
with the same collateral that would serve to cover payments under the
notes issued by a structured debt issuer. In such circumstances, an
``event of default'' by the SD would cause the SD's priority of payment
from the collateral under a swap to ``flip'' to a more junior priority
position, including for mark-to-market gains on ``in the money''
swaps.\87\
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\83\ Harrington 10/20/2022 Letter at p. 3.
\84\ Harrington 10/20/2022 Letter at p. 23.
\85\ Id.
\86\ William J. Harrington, Submission to the U.S. Securities
and Exchange Commission Re: File No. S7-08-12 (Nov. 19, 2018) at
p.8.
\87\ For additional information on the legal mechanics of a flip
clause, see Lehman Brothers Special Financing Inc v. Bank of America
N.A., No. 18-1079 (2nd Cir. 2020).
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Harrington argued that no element of the CFTC Capital Rules or the
Japanese Capital Rules addresses ``the 100% self-exposure that [an SD]
incurs with each swap with flip clause.'' \88\ Harrington recognized,
however, that the CFTC margin requirements for uncleared swap
transactions address his concerns associated with the inclusion of a
flip clause.\89\ Nonetheless, according to Harrington, risks arise in
circumstances when non-U.S. margin rules exempt SDs from margin
obligations in connection with swaps with a structured debt issuer.\90\
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\88\ Harrington 10/20/2022 Letter at p. 21-22.
\89\ Harrington 10/20/2022 Letter at p.3 (noting that the
requirement for SDs to post and collect variation margin for swap
contracts with a securitization or structured debt issuer
``generates the immense benefit of inducing U.S. securitization and
structured debt issuers to forswear all swap contracts, both with
and without a flip clause'').
\90\ Harrington 10/20/2022 Letter at p.3 (arguing that ``non-
U.S. swap margin rules de facto exempt a swap provider from
collecting or posting variation margin under a new contract with
most securitization and structured debt issuers'').
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The Commission recognizes that given some definitional differences
and differences in the activity thresholds with respect to the scope of
application of the CFTC margin requirements and non-U.S. margin
requirements, some transactions that are subject to the CFTC margin
requirements for uncleared swaps may not be subject to margin
requirements in another jurisdiction. In connection with this
Comparability Determination, however, the Commission notes that both
under the CFTC Capital Rules and the Japanese Capital Rules,
uncollateralized exposures from uncleared swap transactions would
generate a higher counterparty credit risk charge than the exposures
resulting from transactions under which the counterparties have posted
collateral.\91\ Accordingly, the Commission does not believe that the
respective sets of rules adopt a conflicting approach or lead to a
disparate outcome with respect to the capital treatment of
uncollateralized uncleared swap exposures that would warrant a finding
of non-comparability of the CFTC Capital Rules and the Japanese Capital
Rules.
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\91\ 12 CFR 217.34 and 12 CFR 217.132 (indicating that nonbank
SDs may recognize the risk-mitigating effects of financial
collateral for collateralized derivatives contracts) and Notice on
Capital, Article 15.5. and 15-2.5 (similarly indicating that
Japanese nonbank SDs are allowed to recognize the risk-mitigating
effect of collateral by deducting the amount of collateral from the
exposure at default amount).
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With regard to Harrington's general recommendations, also included
in a submission by Harrington in connection with the adoption of the
CFTC Capital Rules, that the Commission impose additional capital
charges for swap contracts with a flip clause,\92\ the Commission notes
that any change in its capital requirements and approach, if deemed
appropriate, would be addressed separately from the Comparability
Determination. As the Commission stated in adopting the CFTC Capital
Rules, over time the Commission may consider adjusting the capital
charges applicable to nonbank SDs that engage in bespoke swap
transactions, including contracts involving flip clauses, as a result
of its experience and as market developments may warrant.\93\ If the
Commission proceeds with adjustments to the CFTC Capital Rules, the
Commission may reconsider the comparability between the CFTC Capital
Rules and the Japanese Capital Rules in light of these changes.
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\92\ Harrington 10/20/2022 Letter at p.24.
\93\ 85 FR 57462 at 57475. As stated in the adopting release to
the CFTC Capital Rules, the Commission considered that its rules
were appropriately calibrated to account for a wide variety of
possible uncleared swap transactions, including bespoke transactions
involving flip clauses or other unique features. See id.
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Finally, IBAJ proposed several technical amendments to the 2022
Proposal that were corrective or clarifying in nature.\94\ As further
discussed below, several of the proposed changes have been
incorporated, as appropriate, throughout the final Comparability
Determination and Comparability Order.
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\94\ IBAJ Letter.
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II. Final Capital and Financial Reporting Comparability Determination
and Comparability Order
The following section provides the Commission's comparative
analysis of the Japanese Capital Rules and the Japanese Financial
Reporting Rules with the corresponding CFTC Capital Rules and CFTC
Financial Reporting Rules, as described in the 2022 Proposal, further
modified to address comments received. As emphasized in the 2022
Proposal, the capital and financial reporting regimes are complex
structures comprised of a number of interrelated regulatory
components.\95\ 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
framework.
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\95\ See 2022 Proposal at 48098.
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The Commission performed the analysis by assessing the
comparability of the Japanese Capital Rules for Japanese nonbank SDs as
set forth in the FSA Application and in the English language
translation of certain applicable Japanese laws and regulations with
the Commission's Bank-Based Approach for nonbank SDs.
[[Page 58479]]
The Commission understands that, as of the date of the final
Comparability Determination and Comparability Order, the three Japanese
nonbank SDs registered with the Commission are subject to a bank-based
capital approach under the Japanese Capital Rules. Accordingly, when
the Commission makes its final determination herein about the
comparability of the Japanese Capital Rules with the CFTC Capital
Rules, the determination pertains to the comparability of the Japanese
Capital Rules with the Bank-Based Approach under the CFTC Capital
Rules. The Commission notes that any material changes to the
information submitted in the FSA Application, including, but not
limited to, proposed and final material changes to the Japanese Capital
Rules or Japanese Financial Reporting Rules, as well as any proposed
and final material changes to the FSA's supervisory authority or
supervisory regime, will require notification to the Commission and NFA
pursuant to Condition 22 of the final Comparability Order.\96\
Therefore, if there are subsequent material changes to the Japanese
Capital Rules, Japanese Financial Reporting Rules, or the supervisory
authority or supervisory regime, the Commission will review and assess
the impact of such changes on the final Comparability Determination and
Comparability Order as they are then in effect, and may amend or
supplement the Comparability Order as appropriate.\97\
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\96\ Condition 22 of the final Comparability Order. The
Commission notes that it made certain non-substantive, clarifying
changes to the language of final Condition 22 as compared to the
proposed condition.
\97\ See 2022 Proposal at 48098. As stated in the 2022 Proposal,
the Commission may also amend or supplement the Comparability Order
to address any material changes to the CFTC Capital Rules and CFTC
Financial Reporting Rules, including rule amendments to capital
rules of the Federal Reserve Board that are incorporated into the
CFTC capital Rules' Bank-Based Approach under Commission Regulation
23.101(a)(1)(i), that are adopted after the final Comparability
Order is issued. See id. (fn. 72).
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A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules and Japanese Capital Rules and Japanese Financial
Reporting Rules
1. Preliminary Determination
As reflected in the 2022 Proposal and discussed above, the
Commission preliminarily determined that the overall objectives of the
Japanese Capital Rules and the CFTC Capital Rules are comparable in
that both sets of rules are intended to ensure the safety and soundness
of nonbank SDs by establishing regulatory regimes that require 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.\98\ The Commission further noted that the Japanese
Capital Rules and CFTC Capital Rules are also based on, and consistent
with, the BCBS framework, which was designed to ensure that banking
entities hold sufficient levels of capital to absorb losses and
decreases in the value of firm assets and increases in the value of
firm liabilities without the banks becoming insolvent.\99\
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\98\ See 2022 Proposal at 48099.
\99\ Id.
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The Commission also preliminarily found that the Japanese Capital
Rules are comparable in purpose and effect to the CFTC Capital Rules
given that both regulatory approaches compute the minimum capital
requirements based on the level of a nonbank SD's on-balance sheet and
off-balance sheet exposures, with the objective and purpose of ensuring
that the nonbank SD's capital is adequate to absorb losses or decreases
in the value of firm assets or increases in the value of firm
liabilities resulting from such exposures.\100\ The Commission observed
that the Japanese Capital Rules and CFTC Capital Rules provide for a
comparable approach to the calculation of on-balance sheet and off-
balance sheet risk exposures using standardized or internal model-based
approaches.\101\ In addition, as discussed in the 2022 Proposal, the
Japanese Capital Rules' and CFTC Capital Rules' requirements for
identifying and measuring on-balance sheet and off-balance sheet
exposures under standardized or internal model-based approaches are
also consistent with the requirements set forth under the BCBS
framework for identifying and measuring on-balance sheet and off-
balance sheet exposures.\102\
---------------------------------------------------------------------------
\100\ Id.
\101\ Id.
\102\ Id.
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Finally, the Commission preliminarily noted that the Japanese
Capital Rules and CFTC Capital Rules further achieve comparable
outcomes and are comparable in purpose and effect in that both sets of
rules limit the types of capital instruments that qualify as regulatory
capital to cover the on-balance sheet and off-balance sheet risk
exposures to high quality equity capital and qualifying subordinated
debt instruments that meet conditions designed to ensure that the
holders of the debt have effectively subordinated their claims to other
creditors of the nonbank SD.\103\ As discussed in the 2022 Proposal and
in Section II.B. below, both the Japanese Capital Rules and the CFTC
Capital Rules define high quality capital by the degree to which the
capital represents permanent capital that is contributed, or readily
available to a nonbank SD, on an unrestricted basis to absorb
unexpected losses, including losses from swaps trading and other
activities, without the nonbank SD becoming insolvent.\104\
---------------------------------------------------------------------------
\103\ Id. at 48099-48100.
\104\ Id.
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The Commission further stated that it preliminarily found the
Japanese Financial Reporting Rules to be comparable in purpose and
effect to the CFTC Financial Reporting Rules as both the FSA and CFTC
require nonbank SDs to file 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.\105\ As discussed in the 2022
Proposal, in addition to providing the CFTC and FSA with information
necessary to comprehensively assess the financial condition of a
nonbank SD on an ongoing basis, the financial reports further provide
the CFTC and FSA with information regarding potential changes in a
nonbank SD's risk profile by disclosing changes in account balances
reported over a period of time.\106\ Such changes in account balances
may indicate, among other things, 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.\107\
---------------------------------------------------------------------------
\105\ Id. at 48100.
\106\ Id.
\107\ Id.
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In assessing the comparability between the CFTC Financial Reporting
Rules and the Japanese Financial Reporting Rules, the Commission noted
that 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 FSA in meeting their respective
objectives of ensuring the safety and soundness of nonbank SDs. In this
regard, the Commission stated that the early identification of
potential financial issues provides the Commission and FSA with an
opportunity to address such issues with the nonbank SD before they
develop to a state where the financial condition of the firm is
[[Page 58480]]
impaired such that it may no longer hold a sufficient amount of
qualifying regulatory capital to absorb decreases in the value of firm
assets, absorb increases in the value of firm liabilities, or cover
losses from its business activities, including the firm's swap dealing
activities and obligations to swap counterparties.\108\
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\108\ Id.
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2. Comment Analysis and Final Determination
In response to the Commission's request for comment, Better Markets
identified certain differences between the CFTC Capital Rules and CFTC
Financial Reporting Rules and the Japanese Capital Rules and Japanese
Financial Reporting Rules and stated that the differences mandated
denial of the request for a comparability determination.\109\ Better
Markets further stated that the imposition of conditions to achieve
comparability between the regimes implicitly concedes that the regimes
are not comparable, and is suboptimal and undesirable, as it creates a
set of capital and reporting requirements that Japanese nonbank SDs
must abide by and that the Commission must monitor.\110\
---------------------------------------------------------------------------
\109\ Better Markets Letter at pp. 7-11. For example, Better
Markets asserts that while the CFTC requires non-bank SDs to hold
qualifying capital in an amount equal to at least 8 percent of the
nonbank SDs uncleared swap margin amount, Japan's capital rules are
based on an ``arbitrary percentage'' of a company's operating
expenses. Better Markets also asserted that while the CFTC's capital
rules require nonbank SDs to ``maintain regulatory capital in the
form of common equity tier 1 capital, additional tier 1 capital, and
tier 2 capital, Japan's capital rules require nonbank SDs to
maintain a ``capital adequacy amount'' in the form of ``Basic Items
and Supplemental Items'' and that the Japanese framework has no
dollar minimum capital requirement. These distinctions between the
CFTC Capital Rules and Financial Reporting Rules, and the Japanese
Capital and Financial Reporting Rules are discussed in detail in
sections II.C. and II.B., respectively, below.
\110\ Id.
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As described herein and in the 2022 Proposal, Commission staff has
engaged in a detailed, comprehensive study and evaluation of the
Japanese capital and financial reporting framework and has confirmed
that its understanding of the elements and application of the framework
is accurate. The Commission has also concluded, based on its
evaluation, that the FSA has a comprehensive oversight program for
monitoring Japanese nonbank SD's compliance with relevant Japanese
Capital Rules.
Furthermore, as discussed in Section I.E. above, the conditions set
forth in the Comparability Order are generally intended to ensure that:
(i) only Japanese nonbank SDs that are subject to the laws and
regulations assessed under the Comparability Determination are eligible
for substituted compliance; (ii) the Japanese nonbank SDs are subject
to supervision by the FSA; and (iii) the Japanese nonbank SDs provide
information to the Commission and NFA that is relevant to the ongoing
supervision of their operations and financial condition. Considering
this thorough analysis and the ongoing requirement for Japanese nonbank
SDs to provide information to the Commission and NFA demonstrating
compliance with the Comparability Order, the Commission is confident
that it is capable of effectively conducting, together with NFA,
appropriately tailored oversight of the Japanese nonbank SDs. In light
of the Commission's ultimate conclusion that the Japanese capital and
financial reporting requirements are comparable based on the standards
articulated in Commission Regulation 23.106(a)(3), the Commission
believes that a failure to issue a Comparability Determination and
Comparability Order would in fact be ``suboptimal and undesirable'' as
it would impose duplicative requirements that would result in increased
costs for registrants and market participants without a commensurate
benefit from an oversight perspective.
As discussed in Sections I.B. and E. above, and detailed herein,
the Commission finds that the CFTC Capital Rules and Financial
Reporting Rules and the Japanese Capital Rules and Financial Reporting
Rules are comparable in purpose and effect, and have overall comparable
objectives, notwithstanding the identified differences. In this regard,
the Commission notes that instead of conducting a line-by-line
assessment or comparison of the Japanese Capital and Japanese Financial
Reporting Rules and the CFTC Capital and CFTC Financial Reporting
Rules, it has applied in the assessment set forth in this determination
and order, a principles-based, holistic approach in assessing the
comparability of both regimes, consistent with the standard of review
it adopted in Commission Regulation 23.106(a)(3). Based on that
principles-based, holistic assessment, the individual elements of which
are described in more detail in Sections II.B. through II.F below, the
Commission has determined that both sets of rules are designed to
ensure the safety and soundness of nonbank SDs and achieve comparable
outcomes. As such, the Commission adopts the Comparability
Determination and Comparability Order as proposed with respect to the
analysis of the regulatory objectives of the CFTC Capital Rules and
Financial Reporting Rules and the Japanese Capital and Financial
Reporting Rules.
B. Nonbank Swap Dealer Qualifying Capital
1. Preliminary Determination
As discussed in the 2022 Proposal, the Commission preliminarily
determined that the Japanese Capital Rules are comparable in purpose
and effect to 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.\111\ The Commission
explained that the Japanese Capital Rules and the CFTC Capital Rules
for nonbank SDs both require a nonbank SD to maintain a quantity of
high-quality and permanent capital 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 firm assets and increases
in the value of firm liabilities without resulting in the firm becoming
insolvent.\112\ The Commission observed that the Japanese Capital Rules
and the CFTC Capital Rules permit nonbank SDs to recognize comparable
forms of equity capital and qualifying subordinated debt instruments
toward meeting minimum capital requirements, with both the Japanese
Capital Rules and the CFTC Capital Rules emphasizing high quality
capital instruments.\113\
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\111\ See 2022 Proposal at 48101.
\112\ Id.
\113\ Id.
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In support of its preliminary Comparability Determination, the
Commission noted that 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.\114\ 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 that is last in line to receive distributions in the event of
the entity's insolvency.\115\ Additional tier 1 capital is generally
composed of
[[Page 58481]]
equity instruments such as preferred stock and certain hybrid
securities that may be converted to common stock if triggering events
occur and may have a preference in distributions over common equity
tier 1 capital in the event of an insolvency.\116\ Total tier 1 capital
is composed of common equity tier 1 capital and further includes
additional tier 1 capital. Tier 2 capital includes certain types of
instruments that include both debt and equity characteristics such as
qualifying subordinated debt.\117\ Subordinated debt must meet certain
conditions to qualify as tier 2 capital under the CFTC Capital
Rules.\118\
---------------------------------------------------------------------------
\114\ 17 CFR 23.101(a)(1)(i) and 2022 Proposal at 48100. 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.
\115\ 12 CFR 217.20(b).
\116\ 12 CFR 217.20(c).
\117\ 12 CFR 217.20(d).
\118\ Subordinated debt must meet requirements set forth in SEC
Rule 18a-1d. 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. 17 CFR 23.101(a)(1)(i)(B)
and 17 CFR 240.18a-1d.
---------------------------------------------------------------------------
The preliminary Comparability Determination also noted that the
Japanese Capital Rules require each Japanese nonbank SD to maintain a
``capital adequacy amount'' (i.e., an aggregate of Basic Items and
Supplemental Items, after deducting carrying value of fixed assets,
with Basic Items representing at least 50 percent of the total capital
adequacy amount) \119\ that equals or exceeds 120 percent of the firm's
``risk equivalent amount,'' which is the sum of the firm's market risk,
credit risk, and basic risk.\120\ Basic Items are composed of the
Japanese nonbank SD's balance sheet capital, including: (i) issued and
outstanding shares; (ii) the payment for an application for new shares;
(iii) the capital surplus; (iv) the earned surplus; (v) the negative
valuation difference on available-for-sale securities; and (vi) the
firm's own treasury stock.\121\ Supplemental Items include the positive
valuation difference on available-for-sale securities and certain
subordinated debt instruments.\122\ Subordinated debt instruments also
must meet certain conditions to qualify as Supplemental Items under the
Japanese Capital Rules, including containing appropriate provisions
subordinating the rights of the lender to the payment of principal and
interest to other creditors of the Japanese nonbank SD.\123\ In
addition, any accelerated payment of the subordinated debt may only be
made on a voluntarily basis by the Japanese nonbank SD after obtaining
approval from the FSA.\124\
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\119\ See 2022 Proposal at 48100. The phrase ``after deducting
carrying value of fixed assets'' has been added after ``Supplemental
Items'' in response to a technical comment by IBAJ. IBAJ Letter at
p. 5. As the Commission explained in the 2022 Proposal, the
deduction of the carrying value of fixed assets is a conservative
approach to the computation of a Japanese nonbank SD's capital
adequacy amount as it excludes the value of non-liquid fixed assets
from the firm's total Basic Items. See 2022 Proposal at 48101.
\120\ Article 46-6(2) of the FIEA, Article 176 of the COO and
section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the
Supervisory Guidelines for FIBO.
\121\ Article 176(1)(i) through (vi) of the COO.
\122\ Article 176(1)(vii) of the COO.
\123\ Article 176(2) and (3) of the COO.
\124\ Id.
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Based on its comparative assessment, the Commission preliminarily
found that the types and characteristics of the equity instruments
included in Basic Items under the Japanese Capital Rules are comparable
to the types and characteristics of equity instruments comprising
common equity tier 1 capital and additional tier 1 capital under the
CFTC Capital Rules.\125\ Specifically, the Commission noted that the
Japanese Capital Rules' Basic Items and the CFTC Capital Rules' common
equity tier 1 capital and additional tier 1 capital are comparable in
that these forms of equity capital have similar characteristics (e.g.,
the equity must be in the form of high-quality, committed, and
permanent capital) and represent contributed equity capital that
generally has no priority to the distribution of firm assets or income
with respect to other shareholders or creditors of the firm, which
allows a nonbank SD to use this equity to absorb decreases in the value
of firm assets, absorb increases in the value of firm liabilities, and
cover losses from business activities, including the firm's swap
dealing activities.\126\
---------------------------------------------------------------------------
\125\ See 2022 Proposal at 48101.
\126\ Id.
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The Commission also found the Supplemental Items under the Japanese
Capital Rules to be comparable to tier 2 capital under the CFTC Capital
Rules.\127\ Specifically, the Commission noted that the qualifying
conditions imposed on subordinated debt instruments are comparable
under the Japanese Capital Rules and the CFTC Capital Rules in that
they are designed to ensure that the debt has qualities supporting its
recognition by a nonbank SD as equity for capital purposes, including
by effectively subordinating the lenders' claims for repayment on the
debt, or interest payments on the debt, to the claims of other
creditors of the nonbank SD, and by limiting or restricting repayment
or accelerated payments of the subordinated loans if such repayments or
accelerated prepayments would result in the nonbank SD's equity falling
below certain defined thresholds.\128\ The Commission preliminarily
concluded that the terms and conditions provided assurances that the
subordinated debt was appropriate to be recognized as regulatory
capital available to a nonbank SD to meet its regulatory obligations
and to absorb business losses and decreases in the value of firm assets
and increases in the value of firm liabilities.\129\
---------------------------------------------------------------------------
\127\ Id.
\128\ Id.
\129\ Id.
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The Commission also noted that the Japanese Capital Rules differ
from the CFTC Capital Rules in that the Japanese Capital Rules require
Japanese nonbank SDs to exclude the carrying value of fixed assets from
the sum of the Basic Items and Supplemental Items in computing the
capital adequacy amount, whereas the CFTC Capital Rules do not require
a nonbank SD to exclude the carrying value of fixed assets from the
firm's common equity tier 1 capital or additional tier 1 capital.\130\
As discussed in the 2022 Proposal, the deduction of the carrying value
of fixed assets under the Japanese Capital Rules is a more conservative
standard as it imposes an obligation on Japanese nonbank SDs to meet
minimum regulatory capital requirements with capital that reflects or
represents balance sheet assets that are more liquid than fixed
assets.\131\
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\130\ The IBAJ noted that the Japanese Capital Rules require the
carrying value of fixed assets to be deducted from both Basic Items
and Supplemental Items (and not just Basic Items as stated in the
2022 Proposal). The Commission has incorporated this clarification
into the final Comparability Determination. IBAJ Letter at p. 5.
\131\ See Article 177 of the COO for a breakdown of the fixed
assets to be deducted.
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2. Comment Analysis and Final Determination
In response to the Commission's request for comment on the
qualifying capital analysis, Better Markets objected to the
Commission's determination that the Japanese Capital Rules are
comparable to the CFTC Capital Rules with respect to the type and
characteristics of equity that qualifies as regulatory capital.\132\
Better Markets asserted that the Commission did not adequately analyze
the differences between the two regulatory regimes with respect to the
items of qualifying capital.\133\ More specifically, Better Markets
stated that Basic Items under the Japanese Capital Rules include
treasury stock, whereas, under the CFTC Capital Rules, which are based
on definitions of capital from the Federal
[[Page 58482]]
Reserve Board, common equity tier 1 capital is net of treasury
stock.\134\
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\132\ Better Markets Letter at p. 9.
\133\ Id. at p. 8.
\134\ Id. at p. 9.
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The Commission recognizes that the Japanese Capital Rules list
treasury stock, which represents previously issued shares of stock that
have been repurchased by the firm, as a Basic Item.\135\ In application
of the Japanese Rules of Corporate Accounting, however, treasury stock
must be deducted from the shareholders' equity component of the firms'
balance sheet.\136\ As such, consistent with the treatment received
under the CFTC Capital Rules, the treasury stock is not counted towards
the Japanese nonbank SD's Basic Items or Supplemental Items in meeting
its minimum regulatory capital requirement. Accordingly, the Commission
does not find that the CFTC Capital Rules and the Japanese Capital
Rules diverge with respect to their respective approach to exclude
treasury stock from regulatory capital.
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\135\ Article 176 of the COO.
\136\ Article 76(2) of Rules of Corporate Accounting (Ordinance
of the Ministry of Justice No. 13 of February 7, 2006). To account
for the accurate treatment of treasury stock, the Commission has
revised final Condition 4 of the final Comparability Order to
include Article 76 of the Rules of Corporate Accounting to the list
of laws comprising the Japanese Capital Rules that a Japanese
nonbank SD must comply with under the Comparability Order.
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In addition, upon further analysis, the Commission not only
reiterates its observations that the Japanese Capital Rules' Basic
Items present characteristics that are comparable to the
characteristics of common equity tier 1 and additional tier 1 capital,
but the Commission further concludes that, despite certain definitional
differences, the Japanese Capital Rules' Basic Items are more closely
equated to common equity tier 1 capital. In particular, the Basic
Items' categories of ``issued and outstanding shares,'' ``capital
surplus,'' and ``earned surplus,'' correspond to the CFTC Capital
Rules' common equity tier 1 categories of ``common stock and related
surpluses,'' and ``retained earnings'' as the categories represent
equity contributions and earnings that have been retained by the
nonbank SDs and represent residual ownership interest in the nonbank
SDs. Similarly, whereas the CFTC Capital Rules provide for the
inclusion of unrealized losses and gains on available-for-sale
securities in the common equity tier 1 category of ``accumulated other
comprehensive income,'' the Japanese Capital Rules require that the
positive valuation of available-for-sale securities (i.e., unrealized
gain) be excluded and the negative valuation difference (i.e.,
unrealized loss) of available-for-sale securities be included in Basic
Items, thus mandating a similar, if not more conservative, treatment
for this category of capital items. Finally, as clarified above, the
CFTC Capital Rules and the Japanese Capital Rules treat treasury stock
consistently for purposes of determining qualifying capital. More
generally, the Commission is of the view that the Japanese Capital
Rules' Basic Items are comparable to the CFTC Capital Rules' common
equity tier 1 items in that both categories represent a more
conservative, permanent form of capital that is last in line to receive
distributions in the event of the entity's insolvency.
In conclusion, the Commission finds that the Japanese Capital Rules
and the CFTC Capital Rules, are comparable in purpose and effect, and
achieve comparable regulatory outcomes, with respect to the types of
capital instruments that qualify as regulatory capital. Both the
Japanese Capital Rules and the CFTC Capital Rules limit regulatory
capital to permanent and conservative forms of capital, including
common equity, capital surpluses, retained earnings, and subordinate
debt where debt holders effectively subordinate their claims to
repayment to all other creditors of the nonbank SD in the event of the
firm's insolvency. Limiting regulatory capital to the above categories
of equity and debt instruments promotes the safety and soundness of the
nonbank SD by helping to ensure that the regulatory capital is not
withdrawn or converted to other equity instruments that may have rights
or priority with respect to payments, such as dividends or
distributions in insolvency, over other creditors, including swap
counterparties. The Commission, therefore, is adopting the
Comparability Order as proposed with respect to the types and
characteristics of equity and subordinated debt that qualify as
regulatory capital to meet minimum capital requirements under the
Japanese Capital Rules.
C. Nonbank Swap Dealer Minimum Capital Requirement
1. Introduction to Nonbank Swap Dealer Minimum Capital Requirements
As reflected in the 2022 Proposal, the CFTC Capital Rules require a
nonbank SD electing the Bank-Based Approach to maintain regulatory
capital that satisfies each of the following criteria: (i) an amount of
common equity tier 1 capital of at least $20 million; (ii) an aggregate
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; (iii) 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; \137\ and (iv) the amount of capital
required by NFA.\138\
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\137\ 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. 17 CFR 23.154.
\138\ 17 CFR 23.101(a)(1)(i)(D). See also 2022 Proposal at 48101
and 48104. Commission Regulation 23.101(a)(1)(i) sets forth one of
the minimum thresholds that a nonbank SD must meet as the ``the
amount of capital required by a registered futures association.'' As
previously noted, NFA is currently the only entity that is a
registered futures association. NFA has adopted the Commission's
capital requirements as its own requirements, and has not adopted
any additional or stricter minimum capital requirements. See NFA
rulebook, Financial Requirements section 18 Swap Dealer and Major
Swap Participant Financial Requirements, available at
<a href="http://nfa.futures.org">nfa.futures.org</a>.
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In comparison, the Japanese Capital Rules require each Japanese
nonbank SD to maintain a ``capital adequacy amount'' that equals or
exceeds 120 percent of the firm's ``risk equivalent amount.'' \139\ As
explained in the 2022 Proposal, the ``capital adequacy amount'' is
calculated as the Japanese nonbank SD's qualifying balance sheet equity
capital in the form of Basic Items and Supplemental Items, after
deducting the carrying value of fixed assets from both Basic Items and
Supplemental Items.\140\ The Commission noted that the Japanese Capital
Rules further require that at least 50 percent of the Japanese nonbank
SD's capital used to meet the 120 percent minimum requirement must be
composed of Basic Items, and any subordinated debt included in
Supplemental Items must meet regulatory requirements designed to ensure
that the debt is adequately subordinated to claims of other potential
creditors of the firm.\141\
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\139\ See 2022 Proposal at 48103.
\140\ Id.
\141\ See 2022 Proposal at 48099 and Article 176(1)(vii) of the
COO.
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2. Preliminary Determination and Comment Analysis
While noting certain differences in the minimum capital
requirements and
[[Page 58483]]
calculation of regulatory capital between the Japanese Capital Rules
and the CFTC Capital Rules, the Commission preliminarily found that the
Japanese Capital Rules and CFTC Capital Rules achieve, subject to the
proposed conditions in the proposed Comparability Determination and
proposed Comparability Order, comparable outcomes by requiring a
nonbank SD to maintain a minimum level of qualifying regulatory capital
and subordinated debt to absorb losses from the firm's business
activities, including its swap dealing activities, and decreases in the
value of the firm's assets and increases in the firm's liabilities
without the nonbank SD becoming insolvent.\142\ As further discussed
below, the Commission's preliminary finding of comparability was based
on a principles-based, holistic comparative analysis of the three
minimum capital requirement thresholds of the CFTC Capital Rules' Bank-
Based Approach referenced above and the respective elements of the
Japanese Capital Rules' requirements.
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\142\ See 2022 Proposal at 48104.
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a. Fixed Amount Minimum Capital Requirement
As noted above, 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 Commission'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.\143\ In contrast, the
Japanese Capital Rules do not impose a capital requirement on Japanese
nonbank SDs based on a minimum dollar amount.
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\143\ 85 FR 57462 at 57492.
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The Commission expressed the preliminary view that each CFTC-
registered nonbank SD should maintain a minimum level of regulatory
capital to help ensure that it satisfies its regulatory obligations and
meets its financial commitments to swap counterparties and creditors
without the firm becoming insolvent.\144\ Accordingly, the Commission
proposed to condition the Comparability Order to require each Japanese
nonbank SD to maintain, at all times, a minimum level of regulatory
capital in the form of Basic Items, as defined in Article 176 of the
COO, in an amount denominated in yen that is equivalent to, or greater
than, $20 million in U.S. dollars.\145\
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\144\ See 2022 Proposal at 48106.
\145\ Id. The Commission also proposed to allow a Japanese
nonbank SD to convert the yen-denominated amount of its Basic Items
to the U.S. dollar equivalent based on a commercially reasonable and
observed exchange rate.
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One commenter, Better Markets, argued that the absence of a base
level requirement in the Japanese Capital Rules that is equivalent to
the CFTC Capital Rules' requirement for each nonbank SD to maintain a
minimum of $20 million of common equity tier 1 capital ``demonstrates a
fatal lack of comparability.'' \146\ Better Markets further asserted
that the Commission's proposed condition requiring that Japanese
nonbank SDs maintain a minimum level of regulatory capital of at least
$20 million inadequately compensates for the gap in the Japanese
framework.\147\ Specifically, Better Markets argued that by allowing
Japanese nonbank SD to meet the proposed minimum capital level with
Basic Items, which the Commission preliminarily found to be equivalent
to the combination of common equity tier 1 and additional tier 1
capital, instead of limiting the qualifying items to the higher form of
common equity tier 1 capital, the Commission would impose a materially
weaker capital requirement.\148\
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\146\ Better Markets Letter at p. 9.
\147\ Id.
\148\ Id.
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As noted above, the Commission recognized the difference between
the Japanese Capital Rules and the CFTC Capital Rules with respect to
the $20 million minimum dollar amount of regulatory capital a nonbank
SD is required to maintain. The Commission's proposed condition,
however, effectively addresses this difference by providing that a
Japanese nonbank SD may not avail itself of substituted compliance
unless it maintains a minimum of $20 million of regulatory capital in
the form of Basic Items. The imposition of the condition was consistent
with the Commission authority under Commission Regulation 23.106(a)(5).
Furthermore, as discussed in Section I.E. above, the Commission has
stated that entities relying on substituted compliance may be required
to comply with certain Commission-imposed requirements in situations
where comparable regulations in their home country jurisdiction are
deemed to be lacking.\149\
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\149\ Guidance at 45343.
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As discussed in Section II.B.2. above, the Commission is also of
the view that the Japanese Capital Rules' Basic Items are comparable to
the CFTC Capital Rules' common equity tier 1 items in that both
categories represent a conservative, permanent form of capital that is
last in line to receive distributions in the event of the entity's
insolvency. Specifically, the capital that may be recognized by a
nonbank SD and Japanese nonbank SD to meet its common equity tier 1
capital requirement and Basic Items requirement, respectively, is
generally limited to common stock, related common stock surpluses, and
retained earnings. As such, the Commission concludes that the
requirement for Japanese nonbank SDs to maintain an amount of
regulatory capital in the form of Basic Items equal to or in excess of
the equivalent of $20 million will impose a comparable standard to the
analogue requirement under the CFTC Capital Rules and will
appropriately address the lack of a minimum fixed amount capital
requirement under the Japanese Capital Rules.
In conclusion, the Commission finds that the Japanese Capital Rules
and the CFTC Capital Rules, with the imposition of the condition for
Japanese nonbank SDs to maintain a minimum level of Basic Items in an
amount equivalent to at least $20 million, are comparable in purpose
and effect and achieve comparable regulatory outcomes with respect to
capital requirements based on a minimum dollar amount. The requirement
for a nonbank SD with limited swap dealing or other business activities
to maintain a minimum level of regulatory capital equivalent to $20
million helps to ensure the firm's safety and soundness by allowing it
to absorb decreases in firm assets, absorb increases in firm
liabilities, and meet obligations to swap counterparties, other
creditors, and market participants, without the firm becoming
insolvent.
b. Minimum Capital Requirement Based on Risk-Weighted Assets
Prong (ii) of the CFTC Capital Rules' minimum capital requirements
described above requires each nonbank SD electing the Bank-Based
Approach to maintain an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
greater than 8 percent of the nonbank SD's total risk-weighted assets,
with common equity tier 1 capital comprising at least 6.5 percent of
the 8 percent.\150\ Risk-weighted assets are a nonbank SD's on-balance
sheet and off-balance sheet exposures, including market risk and credit
risk exposures, and include
[[Page 58484]]
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 (ii) are based on
the Federal Reserve Board's capital requirements for bank holding
companies \151\ and are consistent with the BCBS framework.\152\ 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, absorb increases in the value of the firm's liabilities, and
cover unexpected losses resulting from the firm's business activities,
including losses resulting from collateralized and uncollateralized
defaults from swap counterparties, without the nonbank SD becoming
insolvent.\153\
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\150\ 17 CFR 23.101(a)(1)(i)(B).
\151\ 12 CFR 217.10(a)(1). The minimum capital requirement for a
bank holding company under the Federal Reserve Board's rules
requires bank holding companies to satisfy their 8 percent minimum
capital ratio requirement with a minimum of 4.5 percent of common
equity tier 1 capital. The CFTC Capital Rules, however, require a
nonbank SD to meet its minimum 8 percent capital ratio with at least
6.5 percent of common equity tier 1 capital. 17 CFR
23.101(a)(1)(i)(B).
\152\ Risk-based capital requirements RBC20, Calculation of
minimum risk-based capital requirements (Version effective as of 01
January 2023), published by the BCBS and available here: <a href="https://www.bis.org/basel_framework/chapter/RBC/20.htm?inforce=20230101&published=20201126">https://www.bis.org/basel_framework/chapter/RBC/20.htm?inforce=20230101&published=20201126</a>.
\153\ See generally 85 FR 57462 at 57530.
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The Japanese Capital Rules contain capital requirements for
Japanese nonbank SDs that the Commission preliminarily found comparable
in purpose and effect to the requirements in prong (ii) of the CFTC
Capital Requirements.\154\ Specifically, the Japanese Capital Rules
require a Japanese nonbank SD to maintain regulatory capital in an
amount equal to or in excess of 120 percent of the firm's risk ``risk
equivalent amount'' (i.e., the firm's risk-weighted assets).\155\ A
Japanese nonbank SD's ``risk equivalent amount'' is calculated as the
sum of the firm's: (i) market risk equivalent amount (i.e., the amount
equivalent to possible risks which may accrue due to fluctuations in
the prices of securities and other proprietary assets and transactions
held); \156\ (ii) counterparty risk equivalent amount (i.e., the amount
equivalent to possible risks which may accrue due to the default in
performance of contracts by the counterparties to transactions or any
other reason); \157\ and (iii) basic risk equivalent amount (i.e., the
amount equivalent to possible risk which may accrue in the ordinary
course of executing business, such as errors in business
handling).\158\
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\154\ See 2022 Proposal at 48105.
\155\ See discussion in 2022 Proposal at 48105. The Japanese
Capital Rules require a Japanese nonbank SD to maintain a capital
adequacy amount that equals or exceeds 120 percent of its ``risk
equivalent amount.'' Article 46-6(2) of the FIEA, Article 176 of the
COO, and section IV-2-1 (Preciseness of Capital Adequacy Ratio) of
the Supervisory Guidelines for FIBO.
\156\ Article 178(1)(i) of the COO and Articles 10 through 14 of
the Notice on Capital. The ``market risk equivalent amount''
corresponds to ``market risk'' in the CFTC Capital Rules' Bank-Based
Approach and the BCBS framework.
\157\ Article 178(1)(ii) of the COO and Articles 15 through 15-7
of the Notice on Capital. The ``counterparty risk equivalent
amount'' corresponds to ``credit risk'' in the BCBS and Bank-Based
Approach frameworks.
\158\ Article 178(1)(iii) of the COO and Article 16 of the
Notice on Capital.
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The Commission also preliminarily found that the Japanese Capital
Rules and the CFTC Capital Rules are comparable with respect to the
approaches used in the calculation of risk-weighted amounts for market
risk and credit risk in determining the nonbank SD's risk-weighted
assets.\159\ In this connection, the Commission noted that both regimes
require a nonbank SD to use standardized approaches to compute market
risk and credit risk amounts, unless the firm is approved to use
internal models.\160\
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\159\ See 2022 Proposal at 48105.
\160\ Id.
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As the Commission observed, the standardized approaches to
calculating risk-weighted asset amounts for market risk and credit risk
under both the Japanese Capital Rules and the CFTC Capital Rules 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 finally, (vi) for credit risk exposures, multiplying the sum of net
exposures to each counterparty by their corresponding risk factor.\161\
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\161\ Id
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More specifically, with respect to the calculation of standardized
risk-weighted asset amounts for market risk, the Commission explained
that the CFTC Capital Rules incorporate by reference the standardized
market risk charges set forth in Commission Regulation 1.17 for FCMs
and SEC Rule 18a-1 for nonbank security-based swap dealers
(``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 assets,
including 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\ For
example, the CFTC Capital Rules require nonbank SDs to calculate
standardized market risk-weighted asset amounts for uncleared swaps
based on notional values of the swap positions multiplied by
percentages set forth in the applicable rules.\164\ In addition, market
risk-weighted asset amounts for readily marketable equity securities
are calculated by multiplying the fair market value of the securities
by 15 percent.\165\
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\162\ See paragraph (3) of the definition of the term BHC
equivalent risk-weighted assets in 17 CFR 23.100.
\163\ 17 CFR 1.17(c)(5) and 17 CFR 240.18a-1(c)(1).
\164\ 17 CFR 1.17(c)(5)(iii).
\165\ 17 CFR 1.17(c)(5)(v), referencing SEC Rule 15c3-
1(c)(2)(vi) (17 CFR 240.15c3-1(c)(2)(vi)).
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Under the CFTC Capital Rules, the resulting total market risk-
weighted asset 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 under prong (ii) of the rules'
minimum capital requirements described above. As a result, a nonbank SD
is effectively required to hold qualifying regulatory capital equal to
or greater than 100 percent of the amount of its market risk exposure
amount.\166\
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\166\ 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 equals or exceeds 8 percent of its risk-weighted assets. The
regulations, however, require the nonbank SD to effectively maintain
qualifying capital equal to or in excess of 100 percent of its
market risk-weighted assets by requiring the nonbank SD to multiply
its market-risk weighted assets by a factor of 12.5. For example,
the market risk exposure amount for marketable equity securities
with a current fair market value of $250,000 is $37,500 (market
value of $250,000 x .15 standardized market risk factor). The
nonbank SD is required to maintain regulatory capital equal to or in
excess of full market risk exposure amount of $37,500 (risk exposure
amount of $37,500 x 8 percent regulatory capital requirement equals
$3,000; the regulatory capital requirement is then multiplied by a
factor of 12.5, which effectively requires the nonbank SD to hold
regulatory capital in an amount equal to at least 100 percent of the
market risk exposure amount ($3,000 x 12.5 factor equals $37,500)).
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Comparable to the CFTC Capital Rules, the Japanese Capital Rules
[[Page 58485]]
require a Japanese nonbank SD to calculate its standardized market risk
equivalent amount by multiplying specified market risk weights set
forth in the Japanese Capital Rules by the notional or market value of
the relevant assets and positions.\167\ A Japanese nonbank SD is
further required to include the full value of its market risk
equivalent amount in its aggregate risk equivalent amount, which
effectively requires the Japanese nonbank SD to hold qualifying equity
capital and subordinated debt in an amount that equals or exceeds 120
percent of the market risk equivalent amount.\168\
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\167\ See 2022 Proposal at 48103.
\168\ Id. Using the example above, if the market risk exposure
amount for the equity securities under the Japanese Capital Rules
was calculated to be $37,500, the Japanese nonbank SD would be
required to hold an amount of regulatory capital equal to or in
excess of $45,000 (market risk exposure amount of $37,500 x 120
percent).
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With respect to standardized risk-weighted asset amounts for credit
risk from non-derivatives positions, the Commission explained that
under the CFTC Capital Rules, a nonbank SD must compute its on-balance
sheet and off-balance sheet exposures in accordance with the
standardized risk-weighting requirements 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.\169\ Standardized risk-
weighted asset amounts for credit risk are computed by multiplying the
amount of the exposure by defined counterparty credit risk factors that
range from 0 percent to 150 percent.\170\ A nonbank SD with off-balance
sheet exposures is required to calculate a risk-weighted asset amount
for credit risk by multiplying each exposure by a credit conversion
factor that ranges from 0 percent to 100 percent, depending on the type
of exposure.\171\
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\169\ 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. See
also 2022 Proposal at 48102.
\170\ 12 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 percent is applied to exposures to the U.S.
government, the Federal Reserve Bank, and U.S. government agencies
(12 CFR 217.32(a)(1)), and a credit risk factor of 100 percent is
assigned to an exposure to foreign sovereigns that are not members
of the Organization of Economic Co-operation and Development (12 CFR
217.32(a)(2)). See also discussion in 2022 Proposal at 48102.
\171\ 12 CFR 217.33. See also discussion in 2022 Proposal at
48102.
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In comparison, the Commission noted that Japanese Capital Rules
require a Japanese nonbank SD to calculate its standardized
counterparty risk equivalent amount by multiplying its exposure under a
given transaction by the specific risk weight applicable to the
counterparty under the provisions of the Japanese Capital Rules.\172\
In this regard, the Japanese Capital Rules impose risk weights ranging
from 0 percent to 25 percent on exposures to governmental financial
institutions, non-governmental financial institutions, general
corporations, and individuals.\173\ For certain exposures, credit
ratings are used to determine the percentage of the counterparty credit
risk exposure and, if no credit ratings are available, the Japanese
nonbank SD generally applies a 25 percent risk weight.\174\ A Japanese
nonbank SD is required to include the full amount of the counterparty
risk equivalent amount in its aggregate risk equivalent amount.\175\ As
noted above, a Japanese nonbank SD is also required to maintain a
``capital adequacy amount'' that equals or exceeds 120 percent of the
firm's ``risk equivalent amount.'' Therefore, a Japanese nonbank SD is
effectively required to maintain an amount of qualifying capital that
is equal to or in excess of 120 percent of its credit risk equivalent
amount.
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\172\ See 2022 Proposal at 48103-48104.
\173\ Article 15(3) of the Notice on Capital. See also
discussion in 2022 Proposal at 48104.
\174\ Id.
\175\ Id.
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With respect to credit risk for derivatives positions, the
Commission explained that under the CFTC Capital Rules, a nonbank SD
may compute standardized credit risk exposures, using either the
current exposure method (``CEM'') or the standardized approach for
measuring counterparty credit risk (``SA-CCR'').\176\ 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.\177\ 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.\178\
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\176\ 17 CFR 217.34 and 17 CFR 23.100 (defining the term BHC
risk-weighted assets and providing 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 with respect to the use of a
calculation approach under the Federal Reserve Board's capital
rules). See also discussion in 2022 Proposal at 48102.
\177\ 12 CFR 217.34.
\178\ 12 CFR 217.132(c).
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In comparison, the Japanese Capital Rules require a Japanese
nonbank SD that is not approved to use credit risk models to calculate
its exposure using the CEM.\179\ Under the CEM, a Japanese nonbank SD
calculates its exposures for over-the-counter derivatives using a
standardized rules-based approach, and is required to hold an amount of
qualifying capital that equals or exceeds 120 percent of the aggregate
derivatives exposures.
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\179\ See 2022 Proposal at 48104.
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As discussed in the 2022 Proposal, both the CFTC Capital Rules and
the Japanese Capital Rules also provide that, if approved by NFA or the
FSA, respectively, nonbank SDs may also use internal models to
calculate market and/or credit risk exposures.\180\ The Commission
noted that the internal market and credit risk models under the
Japanese Capital Rules and the CFTC Capital Rules are based on the BCBS
framework and preliminarily found that such models must meet comparable
quantitative and qualitative requirements covering the same risks,
including comparable model risk management requirements.\181\ In this
regard, the Commission observed that both rule sets address the same
types of risk, with similar allowed methodologies, calibrated to
similar risk levels and under similar controls.\182\ The Commission
also noted that the Japanese Capital Rules and the CFTC Capital Rules
contain comparable
[[Page 58486]]
requirements for the management of model risk, which depend on a series
of controls, including the independence of validation, ongoing
monitoring and audit.
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\180\ Id. at 48102-48104.
\181\ Id. For a discussion of the qualitative and quantitative
requirements that models must meet under the CFTC Capital Rules and
the Japanese Capital Rules, see 2022 Proposal at 48102-48103 and
48104, respectively. In this context, the Commission notes that, as
emphasized by IBAJ, the expected exposure method is the only
internal model allowed for purposes of calculating credit risk under
the Japanese Capital Rules. IBAJ Letter at pp. 5-6. The Commission
had erroneously indicated, in referring to credit risk models under
the Japanese Capital Rules, that internal credit risk models can
also further include estimation of the likelihood of default of
counterparties and that credit risk models may include internal
ratings based on the estimation of default probabilities, consistent
with the Basel framework and subject to the same model risk
management guidelines. 2022 Proposal at 48098 and 48104. The
Commission hereby rectifies its summary of the relevant Japanese
Capital Rules and specifies that these statements do not apply to
credit risk models under the Japanese Capital Rules. The Commission,
however, maintains its conclusion that model requirements under the
CFTC Capital Rules and the Japanese Capital Rules are comparable.
\182\ See 2022 Proposal at 48105.
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In addition, the Japanese Capital Rules require a Japanese nonbank
SD to calculate a basic risk equivalent amount (i.e., an operational
risk exposure amount) as a component of the firm's risk equivalent
amount. The basic risk equivalent amount is computed as an amount equal
to 25 percent of the Japanese nonbank SD's defined annual operating
expenses, and is intended to provide a capital cushion to cover risks
that may occur in the course of executing ordinary business operations,
such as errors in business transactions.\183\
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\183\ Article 178(1)(iii) of the COO and Article 16 of the
Notice on Capital. See also discussion in 2022 Proposal at 48104.
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One commenter, Better Markets, noted that the CFTC Bank-Based
Approach requires nonbank SDs to maintain 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 non-bank SD's total risk-weighted
assets, provided that common equity tier 1 capital must comprise at
least 6.5 percent of the 8 percent of risk-weighted assets.\184\ Better
Markets stated that, in contrast, the Japanese Capital Rules require
Japanese nonbank SDs to hold capital equal to or greater than 120
percent of their risk-weighted assets, including 50 percent that must
be held in Basic Items.\185\ Better Markets further asserted that in
stating that the 120 percent of risk-weighted assets required by the
Japanese capital rules equates to an ``effective minimum capital
requirement of 9.6 percent of risk-weighted assets,'' the Commission
did not provide an analysis of how the CFTC calculated that effective
minimum and did not disclose how much of the 9.6 percent is held in
Basic Items as opposed to Supplementary Items.\186\ In Better Markets'
view, without this information and analysis, no comparability
determination can be made because U.S. nonbank SDs are required to
maintain 6.5 percent of the total 8 percent of risk-weighted assets in
the highest form of capital, namely common equity tier 1 capital.\187\
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\184\ Better Markets Letter at p 9.
\185\ Id. at p. 10.
\186\ Id.
\187\ Id.
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Another commenter, IBAJ, offered a contrasting view, stating that
Japanese nonbank SDs must maintain capital equal to 120 percent of
market risk, credit risk, and basic risk equivalent amounts and that
such amount of capital translated into an effective capital ratio
requirement of 9.6 percent of risk weighted assets, which is higher
than the 8 percent capital ratio required by the Basel standards or
CFTC Capital Rules.\188\ As discussed immediately below, the Commission
agrees with the IBAJ that the capital ratio required by the Japanese
Capital Rules exceeds the capital ratio required by the CFTC Capital
Rules under the Bank-Based Approach.
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\188\ IBAJ Letter at p. 2.
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In response to the comment asserting that the Commission did not
provide an analysis supporting the statement that the Japanese Capital
Rules impose on Japanese nonbank SDs ``an effective minimum requirement
of 9.6 percent of the risk-weighted assets,'' the Commission notes that
the 9.6 percent figure is intended to express the Japanese minimum
capital as a capital ratio in a manner consistent with the CFTC Capital
Rules for purposes of a comparison. Specifically, the Japanese Capital
Rules require a Japanese nonbank SD to maintain regulatory capital in
an amount that equals or exceeds 120 percent of the aggregate of the
firm's risk-weighted assets. In contrast, the CFTC Capital Rules
require a nonbank SD to maintain a minimum capital ratio to total risk-
weighted assets of 8 percent. Converting the Japanese Capital Rules'
requirement to an equivalent capital ratio under the CFTC Capital Rules
would result in the capital ratio of 8 percent being increased by 20
percent, effectively requiring nonbank SDs to maintain a ratio of total
regulatory capital to risk-weighted assets of 9.6 percent (i.e., 8
percent plus 20 percent of 8 percent).\189\
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\189\ See 2022 Proposal at 48104 and fn. 125.
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In addition, the Japanese Capital Rules' standardized approach to
calculating minimum capital requirements also results in a higher
regulatory capital requirement for counterparty credit risk. Although
the standardized credit risk weights under the Japanese Capital Rules
range from 0 to 25 percent, whereas those applicable under the CFTC
Capital Rules range from 0 to 150 percent, the Japanese Capital Rules'
requirement that Japanese nonbank SDs hold 120 percent of the firm's
risk-weighted assets would yield a higher capital requirement. For
example, for an exposure that is subject to the highest risk weight for
counterparty credit risk, the Japanese Capital Rules would require a
Japanese nonbank SD to hold capital equal to 30 percent of the exposure
amount (i.e., 25 percent risk weight multiplied by 120 percent capital
requirement), whereas the CFTC Capital Rules would require a nonbank SD
to hold capital equal to 12 percent of the exposure amount (i.e., 150
percent risk weight multiplied by 8 percent capital requirement).
Furthermore, the Commission notes that under the Japanese Capital
Rules, the total risk-weighted assets include amounts for operational
and similar risks arising from a Japanese nonbank SD's activities
(i.e., basic risk equivalent amount). These risk-weighted asset amounts
are included in the risk equivalent amount in all circumstances,
whether the nonbank SD uses a standardized approach or a model approach
to calculating risk-weighted assets.\190\ As such, the basic risk
equivalent amount increases the amount of the risk-weighted assets and
thus the amount of regulatory capital that a Japanese nonbank SD is
required to maintain. Taking these factors into account in the
computation of risk-weighted assets and regulatory capital under the
Japanese Capital Rules, the Commission believes that a nonbank SD is
generally required to maintain a higher level of regulatory capital
under the Japanese Capital Rules than it would be under the CFTC
Capital Rules.
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\190\ In contrast, the CFTC Capital Rules do not require nonbank
SDs to include an operational risk charge in the firm's risk-
weighted assets if the firm uses a standardized approach to
calculating risk-weighted asset amounts. An operational risk
component is included in the firm's risk-weighted assets only if the
firm uses a model to calculate risk-weighted asset amounts for
credit risk. See definition of BHC equivalent risk-weighted assets
in Commission Regulation 23.100 (cross referencing subparts E and D
of 12 CFR part 217). 17 CFR 23.100.
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Moreover, to the extent the Japanese Capital Rules might require a
lesser amount of common equity tier 1 capital than the CFTC Capital
Rules, the Commission believes that the difference will be generally
offset and mitigated by the higher amount of regulatory capital
required by the Japanese Capital Rules. Accordingly, the Commission
finds that the Japanese Capital Rules and the CFTC Capital Rules are
comparable in purpose and effect with respect to the minimum amount of
capital and type of capital required by these rules.
In conclusion, the Commission finds that the Japanese Capital Rules
and the CFTC Capital Rules are comparable in purpose and effect with
respect to the computation of minimum capital requirements based on a
nonbank SD's risk-weighted assets. The Commission finds that
notwithstanding the differences discussed above, the Japanese Capital
Rules and the CFTC Capital rules have a comparable approach to the
computation of market
[[Page 58487]]
risk exposure amounts and credit risk exposure amounts for on-balance
sheet and off-balance sheet exposures, which are intended to achieve
comparable regulatory outcomes by ensuring that a nonbank SD maintains
a sufficient level of regulatory capital to absorb decreases in firm
assets, absorb increases in firm liabilities, and meet obligations to
counterparties and creditors, without the firm becoming insolvent.
c. Minimum Capital Requirement Based on the Uncleared Swap Margin
Amount
As noted above, prong (iii) 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.\191\
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\191\ More specifically, 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, the Commission stated that the intent of
the uncleared swap margin amount was to establish a method of
developing a minimum amount of capital for a nonbank SD to meet its
obligations as an SD to market participants, and to cover potential
operational risk, legal risk and liquidity risk, and not just the
risks of its trading portfolio. See 85 FR 57462 at 57485.
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The Japanese Capital Rules differ from the CFTC Capital Rules in
that they do not impose a capital requirement on Japanese nonbank SDs
based on a percentage of the margin for uncleared swap
transactions.\192\ In the 2022 Proposal, the Commission described,
however, how certain Japanese capital and liquidity requirements may
compensate for the lack of direct analogue to the 8 percent uncleared
swap margin amount requirement.\193\ Specifically, the Commission noted
that under the Japanese Capital Rules the risk equivalent amount (i.e.,
the firm's risk-weighted assets) is calculated as the sum of the market
risk equivalent amount, the counterparty risk equivalent amount, and
the basic risk equivalent amount.\194\ As discussed, the basic risk
equivalent amount is computed as an amount equal to 25 percent of the
Japanese nonbank SD's defined annual operating expenses, and is
intended to provide a capital cushion to cover risks that may accrue in
the course of executing ordinary business operations, such as errors in
business transactions.\195\ In addition, the Japanese Capital Rules
require a Japanese nonbank SD to deduct the carrying value of fixed
assets from its Basic Items and Supplemental Items in computing its
regulatory capital, which promotes a degree of liquidity into the
Japanese nonbank SD's regulatory capital by requiring assets that are
more liquid than fixed assets to support the Basic Items and
Supplemental Items that are used to meet the Japanese nonbank SD's
minimum capital requirement. As stated in the 2022 Proposal, the
Commission preliminarily determined that the inclusion of an
operational risk charge as a separate component of the risk equivalent
amount, including by Japanese nonbank SDs that do not use internal
models, and the deduction of the carrying value of fixed assets from
regulatory capital, would 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.\196\
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\192\ See 2022 Proposal at 48104.
\193\ Id. at 48105.
\194\ Article 178(1)(iii) of the COO and Article 16 of the
Notice on Capital. The basic risk equivalent amount is calculated as
25 percent of certain defined operating expenses incurred by the
Japanese nonbank SD over a 12-month period, and includes general
expenses, selling expenses, and financial expenses.
\195\ See 2022 Proposal at 48105.
\196\ Id.
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Focusing on the absence of a capital requirement based on a
percentage of the margin for uncleared swap transactions under the
Japanese Capital Rules, Better Markets asserted that the Japanese
Capital Rules are not only different from the CFTC Capital Rules in
form and substance, but lead to a regulatory outcome that is not
comparable.\197\ In support, Better Markets noted that, whereas the
CFTC relies on an approach that requires nonbank SDs to hold qualifying
capital in an amount equal to at least 8 percent of the nonbank SD's
uncleared swap margin amount, the Japanese Capital Rules are based on
``an arbitrary percentage of a company's operating expenses, which
would be closer in concept to liquidity needs.'' \198\
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\197\ Better Markets Letter at p. 7.
\198\ Id.
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Other commenters agreed with the Commission's preliminary
determination that the Japanese Capital Rules and CFTC Capital Rules
are comparable notwithstanding the absence in the Japanese Capital
Rules of a capital requirement based on uncleared swap margin.\199\ In
this regard, FSA asserted that the Japanese Capital Rules are largely
comparable in outcome even in the absence of the uncleared swap margin
requirement because the Japanese capital adequacy ratio takes into
account operational risk.\200\
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\199\ Associations Letter at p. 2; FSA Letter at p. 1; IBAJ
Letter at p. 2.
\200\ FSA Letter at p. 1.
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The Associations and IBAJ expressed the view that the Japanese
Capital Rules are comparable in purpose and effect to the Commission's
requirements for a nonbank SD to hold regulatory capital equal to or
greater than 8 percent of its uncleared swap margin amount.\201\ The
commenters explained that under the Japanese Capital Rules, liquidity
risk is covered through the deduction of the balance sheet carrying
value of fixed assets, and operational risk and legal risk are covered
by the basic risk equivalent amount, which is a simplified but
conservative approach to calculating a proxy for operational risks
under the Basel standards.\202\ Under the approach, basic risk is
incrementally added to market risk and credit risk, which further
increases the required capital amount under the Japanese Capital
Rules.\203\ The commenters further explained that the Japanese Capital
Rules' basic risk equivalent amount is computed as an amount equal to
25 percent of the Japanese nonbank SD's defined annual operating
expenses, and is intended to provide a capital cushion to cover risk
that may accrue in the course of executing ordinary business
operations, such as errors in business transactions.\204\ According to
the commenters, such amount combined with market risk, credit risk, and
the deduction of the carrying value of fixed assets will broadly
capture obligations to market participants, potential operational risk,
legal risk, and liquidity risk, as well as market risk and credit
risk.\205\ The commenters further noted that the calculation will
capture both the trading portfolio as well as non-trading assets,
whereas the CFTC's requirement to hold 8 percent of nonbank SD's
uncleared swap margin amount will not capture non-trading assets.\206\
As such, the commenters concluded that the Japanese Capital Rules'
basic risk equivalent requirement is sufficiently comparable to the
CFTC Capital Rules' uncleared swap margin requirement.\207\
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\201\ Associations Letter at p. 2; IBAJ Letter at p. 2.
\202\ Id.
\203\ Id.
\204\ Associations Letter at p. 3; IBAJ Letter at p. 3.
\205\ Id.
\206\ Id.
\207\ Id.
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The Commission believes that the Japanese Capital Rules' approach
to calculating the basic risk equivalent amount, which accounts for
operational risk and legal risk, and the deduction of the balance sheet
carrying value of fixed
[[Page 58488]]
assets to reflect liquidity risk, support the comparability of the
Japanese Capital Rules and the CFTC Capital Rules even in the absence
of a separate capital requirement in the Japanese Capital Rules
requiring Japanese nonbank SDs to have qualified capital equal to or
greater than 8 percent of the amount of uncleared swap margin.
In conclusion, the Commission finds that the Japanese Capital Rules
and the CFTC Capital Rules are comparable in purpose and effect with
respect to the requirement that a nonbank SD's minimum level of
regulatory capital reflects potential operational risk exposures in
addition to market risk and credit risk exposures. The Commission
emphasizes that the intent of the minimum capital requirement based on
a percentage of the nonbank SD's uncleared swap margin is to establish
a minimum capital requirement that would help ensure that the nonbank
SD meets its obligations as an 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.\208\ The Commission
further notes that the minimum capital requirement based on a
percentage of the nonbank SD's uncleared swap margin amount was
conceived as a proxy, not an exact measure, for inherent risk in the
SD's positions and operations, including operational risk, legal risk,
and liquidity risk.\209\ As the Commission noted in adopting the CFTC
Capital Rules, although the amount of capital required of a nonbank SD
under the uncleared swap margin calculation is directly related to the
volume, size, complexity, and risk of the covered SD's positions, the
minimum capital requirement is intended to cover a multitude of
potential risks faced by the SD.\210\ The Commission understands that
other jurisdictions may adopt alternative measures to cover the same
risks. In this regard, the Japanese Capital Rules address comparable
risks albeit not through a requirement based on a Japanese nonbank SD's
uncleared swap margin amount. Specifically, Japanese nonbank SDs are
required to maintain a minimum level of regulatory capital based on an
aggregate of the firm's total risk-weighted asset exposure amounts for
market risk, credit risk, and operational risk. The Commission further
notes that a Japanese nonbank SD is required to maintain regulatory
capital in an amount that exceeds 120 percent of the total risk-
weighted assets, which is 20 percent higher than the CFTC Capital
Rules. Accordingly, the Commission has determined that, notwithstanding
the differences in approaches, the Japanese Capital Rules and CFTC
Capital Rules are comparable in purpose and effect, and achieve
comparable regulatory outcomes, by requiring nonbank SDs to maintain a
sufficient minimum level of regulatory capital to addresses potential
market risk, credit risk, and operational risk, and to help ensure the
safety and soundness of the firm by requiring it to hold capital to
absorb decreases in firm assets, absorb increases in firm liabilities,
and meet its obligations to counterparties and creditors, without the
firm becoming insolvent.
---------------------------------------------------------------------------
\208\ See 2022 Proposal at 48102 (referencing 85 FR 57462).
\209\ 85 FR 57462 at 57497.
\210\ 85 FR 57462 at 57485 and 57497.
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3. Final Determination
Based on its analysis of comments and its holistic assessment of
the respective requirements discussed in Section II.C.2.a., b., and c.
above, the Commission adopts the Comparability Determination and
Comparability Order as proposed with respect to the minimum capital
requirements and calculation of regulatory capital, subject to the
condition that Japanese nonbank SDs must maintain a minimum level of
regulatory capital in the form of Basic Items that equals or exceeds
the equivalent of $20 million U.S. dollars.
D. Nonbank Swap Dealer Financial Reporting Requirements
1. Proposed Determination
The Commission detailed the requirements of the CFTC Financial
Reporting Rules in the 2022 Proposal.\211\ Specifically, the 2022
Proposal notes that the CFTC Financial Reporting Rules require nonbank
SDs to file with the Commission and NFA periodic unaudited and annual
audited financial reports.\212\ The unaudited financial reports must
include: (i) a statement of financial condition; (ii) a statement of
income/loss; (iii) a statement demonstrating compliance with, and
calculation of, the applicable regulatory minimum capital requirement;
(iv) a statement of changes in ownership equity; (v) a statement of
changes in liabilities subordinated to claims of general creditors; and
(vi) such further material information necessary to make the required
statements not misleading.\213\ The annual audited financial reports
must include the same financial statements that are required to be
included in the unaudited financial reports, and must further include:
(i) a statement of cash flows; (ii) appropriate footnote disclosures;
and (iii) a reconciliation of any material differences between the
financial statements contained in the annual audited financial reports
and the financial statements contained in the unaudited financial
reports prepared as of the nonbank SD's year-end date.\214\ In
addition, a nonbank SD must attach to each unaudited and audited
financial report an oath or affirmation that to the best knowledge and
belief of the individual making the affirmation the information
contained in the financial report is true and correct.\215\ The
individual making the oath or affirmation must be a duly authorized
officer if the nonbank SD is a corporation, or one of the persons
specified in the regulation for business organizations that are not
corporations.\216\
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\211\ 2022 Proposal at 48106-48107.
\212\ Id. and 17 CFR 23.105(d) and (e).
\213\ Id. and 17 CFR 23.105(d)(2).
\214\ Id. and 17 CFR 23.105(e)(4).
\215\ Id. and 17 CFR 23.105(f).
\216\ Id.
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The CFTC Financial Reporting Rules also require a nonbank SD to
file the following financial information with the Commission and NFA on
a monthly basis: (i) a schedule listing the nonbank SD's financial
positions reported at fair market value; \217\ (ii) schedules showing
the nonbank SD's counterparty credit concentration for the 15 largest
exposures in derivatives, a summary of its derivatives exposures by
internal credit ratings, and the geographic distribution of derivatives
exposures for the 10 largest countries; \218\ and (iii) for nonbank SDs
approved to use internal capital models, certain model metrics, such as
aggregate value-at-risk (``VaR'') and counterparty credit risk
information.\219\
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\217\ Id. and 17 CFR 23.105(l) and Schedule 1 of Appendix B to
Subpart E of part 23 (``Schedule 1''). Schedule 1 includes a nonbank
SD's holding of U.S Treasury securities, U.S. government agency debt
securities, foreign debt and equity securities, money market
instruments, corporate obligations, spot commodities, and cleared
and uncleared swaps, security-based swaps, and mixed swaps in
addition to other position information.
\218\ Id. and schedules 2, 3 and 4, respectively, of Commission
Regulation 23.105(l). 17 CFR 23.105(l).
\219\ Id. and 17 CFR 23.105(k) and (l), and appendix B to
Subpart E of part 23.
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The CFTC Financial Reporting Rules further require a nonbank SD to
provide the Commission and NFA with information regarding the
custodianship of margin for uncleared swap transactions (``Margin
Report'').\220\ The Margin Report must contain: (i) the name and
address of each custodian holding initial margin or variation margin on
behalf of the nonbank SD or
[[Page 58489]]
its swap counterparties; (ii) the amount of initial and variation
margin required by the uncleared margin rules held by each custodian on
behalf of the nonbank SD and on behalf its swap counterparties; and
(iii) the aggregate amount of initial margin that the nonbank SD is
required to collect from, or post with, swap counterparties for
uncleared swap transactions subject to the uncleared margin rules.\221\
---------------------------------------------------------------------------
\220\ Id. and 17 CFR 23.105(m).
\221\ Id.
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A nonbank SD electing the Bank-Based Capital Approach is required
to file the unaudited financial report, Schedule 1, schedules of
counterparty credit exposures, and the Margin Report with the
Commission and NFA no later than 17 business days after the applicable
month end reporting date.\222\ A nonbank SD must file its annual report
with the Commission and NFA no later than 60 calendar days after the
end of its fiscal year.\223\
---------------------------------------------------------------------------
\222\ Id.
\223\ Id.
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The 2022 Proposal also detailed relevant financial reporting
requirements of the Japanese Financial Reporting Rules.\224\ The
Japanese Financial Reporting Rules require a Japanese nonbank SD to
submit monthly monitoring survey reports (``Monthly Monitoring
Report'') to the FSA.\225\ The Monthly Monitoring Report must include
information on the Japanese nonbank SD's capital adequacy ratio, and
the status of the firm's business operations and accounting (including
a balance sheet and profit/loss statement), market risk, counterparty
risk, operational risk, and liquidity risk.\226\ The Monthly Monitoring
Report are typically submitted by a Japanese nonbank SD within two to
three weeks of the end of each month.\227\
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\224\ 2022 Proposal at 48106-48110.
\225\ Id. and section II-1-4 (General Supervisory Process) of
the Supervisory Guidelines for FIBO, which directs the FSA as part
of its offsite monitoring to require FIBOs (including the Japanese
nonbank SDs) to submit a monitoring survey report regarding the
following matters: capital adequacy ratio, status of business
operations and accounting (including a balance sheet and profit and
loss statement), status of segregated management of customer assets,
market risk, counterparty risk, operational risk, and liquidity
risk. The FSA has, pursuant to Article 56-2(1) of the FIEA, ordered
the Japanese nonbank SDs to submit monthly monitoring reports to the
FSA.
\226\ Id.
\227\ The Commission noted that there are various types of
reports which are required of the Japanese nonbank SDs under
``Reporting orders'' issued by the FSA in accordance with Article
56-2(1) of the FIEA. Some of these reports are required to be
submitted on a monthly basis, whereas other reports are required to
be submitted on a quarterly basis, semi-annual basis, or annual
basis. The FSA typically does not set a specific filing deadline and
instead requests all reports to be submitted ``without delay.'' In
case of monthly reports, the normal practice is for firms to submit
such reports within two to three weeks from the prior month-end.
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A Japanese nonbank SD is also required to submit a business report
to the Commissioner of the FSA within three months of the end of the
firm's fiscal year (``Annual Business Report'').\228\ The Annual
Business Report must include a balance sheet, profit/loss statement,
statement of changes in shareholders' equity, balance of subordinated
debt, and a statement of capital adequacy ratio.\229\ Furthermore, a
Japanese nonbank SD is required to prepare financial statements and
business reports every business year pursuant to the Japanese Companies
Act (``Annual Audited Financial Report'').\230\ The Annual Audited
Financial Report includes the firm's balance sheet, profit/loss
statement, and statement of changes in shareholders' equity, and such
statements are required to be audited by an accounting auditor.\231\
The Annual Audited Financial Report must be submitted to, and approved
by, the shareholders at a meeting within three months of the Japanese
nonbank SD's fiscal year-end.\232\
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\228\ 2022 Proposal at 48107 and Article 46-3(1) of the FIEA and
Article 172 of the COO.
\229\ 2022 Proposal at 48107 and Appended Forms No. 12 of the
COO.
\230\ 2022 Proposal at 48107 and Japanese Companies Act (Act No.
86 of 2005).
\231\ 2022 Proposal at 48107 and Article 328(1) and (2), Article
435(2), and 436(2)(i) of the Companies Act, and Article 59 of the
Rules of Corporate Accounting (Ordinance of the Ministry of Justice
No. 13 of 2006). The audit requirement applies to a ``Large
Company,'' which is defined by Article 2(vi) of the Companies Act as
a stock company that satisfies any of the following requirements:
(i) that the amount of stated capital in the balance sheet as of the
end of the firm's most recent business year is JPY 500 million or
more; or (ii) that the total sum of the liabilities section of the
balance sheet as of the end of the firm's most recent business year
is JPY 20 billion or more. The FSA has represented that each of the
current CFTC-registered Japanese nonbank SDs is a Large Company
under the Companies Act, and is subject to the audit requirement for
its financial statements. FSA Application p. 18.
\232\ Id.
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Based on its review of the FSA Application and the relevant
Japanese laws and regulations, the Commission preliminarily determined
that, subject to the conditions specified in the 2022 Proposal and
discussed below, the Japanese Financial Reporting Rules are comparable
to CFTC Financial Reporting Rules in purpose and effect.\233\ The
Commission noted that both sets of rules provide the FSA and the
Commission with financial information necessary to monitor a nonbank
SD's compliance with capital requirements and to assess a nonbank SD's
overall safety and soundness. Specifically, both CFTC Financial
Reporting Rules and the Japanese Financial Reporting Rules require a
nonbank SD to file statements of financial condition, statements of
profit and loss, and statements of regulatory capital that,
collectively, provide information for the FSA, Commission, and NFA to
assess a nonbank SD's overall ability to absorb decreases in the value
of firm assets, absorb increases in the value of firm liabilities, and
cover losses from business activities, including swap dealing
activities, without the firm becoming insolvent.\234\
---------------------------------------------------------------------------
\233\ See 2022 Proposal at 48106-48110.
\234\ Id.
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The proposed conditions in the proposed Comparability Order were
intended to ensure that the Commission and NFA receive appropriate and
timely financial information from Japanese nonbank SDs in order to
monitor the firms' compliance with FSA capital requirements and to
assess the firms' overall safety and soundness. The proposed conditions
would require a Japanese nonbank SD to provide the Commission and NFA
with copies of its Monthly Monitoring Report, Annual Business Report,
and Annual Audited Financial Report.\235\ The proposed conditions would
also require the Monthly Monitoring Report, Annual Business Report, and
Annual Audited Financial Report to be translated into the English
language.\236\ The Monthly Monitoring Report and the Annual Business
Report also must have balances converted from yen to U.S. dollars. The
Commission further recognized that the requirement to translate
balances denominated in yen to U.S. dollars on the audited financial
statements may have an unintended impact on the opinion expressed by
the public accountant on the financial statements. The Commission,
therefore, proposed to accept the Annual Audited Financial Report
denominated in yen, but required the report to be translated into the
English language.\237\
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\235\ See 2022 Proposal at 48107 and Article 46-3(1) of the
FIEA, Article 172 of the COO, and Appended Forms No. 12 of the COO.
\236\ In the 2022 Proposal, the Commission proposed that the
translation of audited financial statements into the English
language would not be required to be subject to the audit of the
public accountants. A Japanese nonbank SD would be required to
report the exchange rate that it used to convert balances from yen
to U.S. dollars to the Commission and NFA as part of the financial
reporting.
\237\ See 2022 Proposal at 48108.
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The proposed conditions also would require a Japanese nonbank SD to
file with the Commission and NFA its: (i) Monthly Monitoring Reports
within 15 business days of the earlier of the date
[[Page 58490]]
the report is filed with the FSA or 35 calendar days after the month-
end reporting date; \238\ (ii) Annual Business Report within 15
business days of the earlier of the date the report is filed with the
FSA or the date that the report is required to be filed with the FSA;
\239\ and (iii) Annual Audited Financial Report within 15 business days
of the approval of the report at the Japanese nonbank SD's shareholder
meeting.\240\ The Commission stated that, in its preliminary view, the
proposed filing dates provided sufficient time for the respective
reports to be translated into the English language with balances
converted from yen to U.S. dollars, as applicable.\241\
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\238\ 2022 Proposal at 48108 and proposed Condition 8. As noted,
the FSA does not set a specific filing date for Monthly Monitoring
Reports, electing to instead require firms to file such reports
``without delay.'' The Commission proposed to establish a due date
that is no later than 35 calendar days from the reporting date to
set a definitive filing date that also provides Japanese nonbank SDs
with sufficient time to translate the reports into English and
convert balances to U.S. dollars.
\239\ 2022 Proposal at 48108 and proposed Condition 9.
\240\ 2022 Proposal at 48108 and proposed Condition 10.
\241\ See 2022 Proposal at 48108.
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The Commission also proposed a condition to require Japanese
nonbank SDs to file with the Commission and NFA, on a monthly basis,
Schedule 1 showing the aggregate securities, commodities, and swap
positions of the firm at fair market value as of the reporting
date.\242\ The Commission explained that Schedule 1 provides the
Commission and NFA with detailed information regarding the fair market
value of the nonbank SD's financial positions as of the end of each
month, including the firm's swaps positions, which allows the
Commission and NFA to monitor the types of investments and other
activities that the firm engages in and would assist the Commission and
NFA in monitoring the safety and soundness of the firm.\243\ The
Commission proposed to require that Schedule 1 be filed by a Japanese
nonbank SD along with the firm's Monthly Monitoring Report. The
Commission also proposed to require that Schedule 1 be prepared in the
English language with balances reported in U.S. dollars.
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\242\ See id. In response to a comment by the IBAJ, the
Commission confirms that its intent was to require that Schedule 1
of Appendix B to Subpart E of part 23 be filed at the same time as
the Monthly Monitoring Report, consistent with Condition (11) of the
Order. IBAJ Letter at p. 6.
\243\ See 2022 Proposal at 48108.
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The Commission also proposed a condition to require a Japanese
nonbank SD to submit a statement by an authorized representative or
representatives of the Japanese nonbank SD that, to the best knowledge
and belief of the person(s), the information contained within each
Monthly Monitoring Report, Schedule 1, Annual Business Report, and
Annual Audited Financial Report, is true and correct, including as it
relates to the translation of the report into the English language and
the conversion of balances to U.S. dollars.\244\ The statement by an
authorized representative or representatives of the Japanese nonbank SD
was intended to be the equivalent of the oath or affirmation required
of nonbank SDs under Commission Regulation 23.105(f),\245\ to ensure
that reports filed with the Commission and NFA were prepared and
submitted by firm personnel with knowledge of the financial reporting
of the firm who can attest to the accuracy of the reporting and
translation.\246\
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\244\ Id. at 48108-48109 and proposed Condition 12.
\245\ 17 CFR 23.105(f). Commission Regulation 23.105(f) requires
a nonbank SD to attach to each unaudited and audited financial
report an oath or affirmation that to the best knowledge and belief
of the individual making the affirmation the information contained
in the financial report is true and correct. The individual making
the oath or affirmation must be a duly authorized officer if the
nonbank SD is a corporation, or one of the persons specified in the
regulation for business organizations that are not corporations.
\246\ See 2022 Proposal at 48109.
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The Commission further proposed a condition that would require a
Japanese nonbank SD to file a Margin Report with the Commission and NFA
on a monthly basis.\247\ The Commission noted that a Margin Report
would assist the Commission and NFA in their assessment of the safety
and soundness of the Japanese nonbank SDs by providing information
regarding the firm's swaps book and the extent to which it has
uncollateralized swap exposures to counterparties or has not met its
margin obligations to swap counterparties. The Commission explained
that this information, along with the list of custodians holding both
the firm's and counterparties' swaps collateral, would assist with
identifying potential financial impacts to the nonbank SD resulting
from defaults on its swap transactions.
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\247\ Id.
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In the Commission's preliminary view, its proposed approach of
requiring Japanese nonbank SDs to provide the Commission and NFA with
copies of the Monthly Monitoring Reports, Annual Business Reports, and
Annual Audited Financial Reports that the firms currently file with the
FSA or otherwise prepare struck an appropriate balance of ensuring that
the Commission and NFA receive the financial reporting necessary for
the effective monitoring of the financial condition of the nonbank SDs,
while also recognizing the appropriateness of providing substituted
compliance based on the existing FSA financial reporting requirements
and regulatory structure.\248\
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\248\ Id.
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The Commission's preliminary determination did not require a
Japanese nonbank SD to file the model metrics and counterparty credit
exposure information required by Commission Regulations 23.105(k) and
(l),\249\ respectively, in recognition that NFA's current SD risk
monitoring program requires all SDs, including Japanese nonbank SDs, to
file with NFA on a monthly basis certain risk metrics that are
comparable with the risk metrics contained in Commission Regulation
23.105(k) and (l) and address the market risk and credit risk of the
SD's positions.\250\ Specifically, the Commission noted that NFA's
monthly risk metric information includes: (i) VaR for interest rates,
credit, foreign exchange, equities, commodities, and total VaR; (ii)
total stressed VaR; (iii) interest rate, credit spread, foreign
exchange market, and commodity sensitivities; (iv) total swaps current
exposure both before and after offsetting against collateral held by
the firm; and (v) a list of the 15 largest swaps counterparty current
exposures.\251\
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\249\ Commission Regulation 23.105(k) requires a nonbank SD that
has obtained approval from the Commission or NFA to use internal
capital models to submit to the Commission and NFA each month
information regarding its risk exposures, including VaR, and
requires certain credit risk exposure information from model and
non-model approved firms. 17 CFR 23.105(k). Commission Regulation
23.105(l) requires each nonbank SD to provide information to the
Commission and NFA regarding its counterparty credit concentration
for the 15 largest exposures in derivatives, a summary of its
derivatives exposures by internal credit ratings, and the geographic
distribution of derivatives exposures for the 10 largest countries
in Schedules 2, 3, and 4, respectively. 17 CFR 23.105(l).
\250\ 2022 Proposal at 48109.
\251\ See 2022 Proposal at 48109 and NFA Financial Requirements,
section 17--Swap Dealer and Major Swap Participant Reporting
Requirements, and Notice to Members--Monthly Risk Data Reporting for
Swap Dealers (May 30, 2017) (``NFA Notice I-17-10''), available
here: <a href="https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4817">https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4817</a>.
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Furthermore, the Commission recognized that although the Japanese
Financial Reporting Rules do not contain an analogue to the CFTC's
requirements for nonbank SDs to file monthly model metric information
and counterparty exposure information, the FSA has access to comparable
[[Page 58491]]
information.\252\ More specifically, the Commission noted that the FSA
would perform the initial approval and ongoing assessment of the
performance of a Japanese nonbank SD's models as part of its oversight
function and may be better positioned to monitor a Japanese nonbank
SD's model metrics and performance and to assess the Japanese nonbank
SD's credit exposures as part of the FSA's overall monitoring of the
financial condition of the firm.\253\ As such, the FSA would have
access to information allowing it to assess the ongoing performance of
risk models and to monitor the Japanese nonbank SD's credit exposures,
which may be comprised of credit exposures to primarily Japanese
counterparties.
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\252\ Under the Japanese Financial Reporting Rules, the FSA has
broad powers to request any information necessary for the exercise
of its functions. FSA Application at p. 16 (referencing Article 56-2
of the FIEA) and discussion in 2022 Proposal at 48113.
\253\ See 2022 Proposal at 48109.
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2. Comment Analysis and Final Determination
The Commission received comments regarding the comparability of
financial reporting and specific comments addressing several of the
financial reporting issues on which the Commission solicited feedback.
Regarding the scope of the financial information that a Japanese
nonbank SD should be required to file, Better Markets stated that the
2022 Proposal does not adequately support the Commission's preliminary
conclusion that the content of the Monthly Monitoring Reports, Annual
Business Reports, and Annual Audited Financial Reports required
pursuant to the Japanese Capital Rules are comparable with the
requirements of the CFTC Financial Reporting Rules.\254\ In contrast,
FSA stated that the Commission should limit the request of financial
information to the extent consistent and sufficient with the purpose of
the Commission's capital requirements to efficiently and effectively
achieve its supervisory and monitoring objectives.\255\ IBAJ stated
that the Commission should limit the financial information required to
be filed to the types of financial information required of nonbank SDs
under Commission Regulation 23.105.\256\ IBAJ further stated that,
consistent with the types of schedules and data nonbank SDs are
required to file under Commission Regulation 23.105, the Commission
should require Japanese nonbank SDs to file the following information
from the Monthly Monitoring Report: (i) Form 1-1 Capital Ratio Summary;
(ii) Form 1-2 Capital Ratio: Deductible Assets; (iii) Form 1-3 Market
Risk; (iv) Form 1-4 Counterparty Risk; (v) Form 2-1 Monthly Financial
Statement (1); and (vi) Form 2-2 Monthly Financial Statement (2). IBAJ
also stated that other financial information contained within the
Monthly Monitoring Report should not be required as the information is
either not submitted by nonbank SDs under Commission Regulation 23.105,
such as client assets segregation status and transaction volume, or the
information is similar to the information contained in the quarterly
risk exposure report and monthly risk data report that Japanese nonbank
SDs already provide to the Commission and NFA.\257\ IBAJ also asserted
that limiting the scope of information to the six items noted above
from the Monthly Monitoring Report would be consistent with the
financial information that Commission staff has required from Japanese
nonbank SDs under CFTC Staff Letter 22-10.\258\
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\254\ Better Markets Letter at p. 10.
\255\ FSA Letter at p. 2.
\256\ IBAJ Letter at p. 4.
\257\ Id.
\258\ Id. and CFTC Staff Letter No. 22-10, Extension of Time-
Limited No-Action Position for Foreign Based Nonbank Swap Dealers
domiciled in Japan, Mexico, the United Kingdom, and the European
Union, issued by the Market Participants Division on August 17,
2022. CFTC Staff Letter No. 22-10, which extended the expiration of
CFTC Staff Letter 21-20, provides that the Market Participants
Division (``MPD'') would not recommend an enforcement action to the
Commission if a non-U.S. nonbank SD covered by the letter (``covered
nonbank SDs''), subject to certain conditions, complied with their
respective home-country capital and financial reporting requirements
in lieu of the Commission's capital and financial reporting
requirements set forth in Commission Regulations 23.100 through
23.106, pending the Commission's determination of whether the
capital and financial reporting requirements of certain foreign
jurisdictions are comparable to the Commission's corresponding
requirements. The relevant conditions include that a covered nonbank
SD domiciled in Japan must: (i) be registered as a Type I FIBO with
the FSA; (ii) submit to MPD financial information required by the
FSA within 15 days of submitting such information to the FSA; and
(iii) submit to the Commission a statement of financial condition,
statement of income/loss, and statement of regulatory capital to the
extent that such financial information is not required by the FSA.
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The Commission has reviewed the comments and believes that the
Japanese Financial Reporting Requirements, subject to the conditions
below, are comparable to the CFTC Financial Reporting Requirements in
purpose and effect in that both the Japanese rules and the CFTC
regulations provide information necessary for the monitoring of the
financial condition of a nonbank SD. In response to the comments, the
Commission is modifying the conditions in the final Comparability Order
to list specific schedules of the Monthly Monitoring Report that each
Japanese nonbank SD is required to file with the Commission and NFA.
Specifically, the Commission agrees that the Comparability Order should
specify the required information that a Japanese nonbank SD must submit
to the Commission and NFA from its Monthly Monitoring Report to be
consistent with the types of capital and general financial statement
information that a nonbank SD is required to file under Commission
Regulation 23.105. This modification would ensure that the Commission
receives the relevant financial information necessary to monitor the
general financial condition and capital compliance of a Japanese
nonbank SD, while eliminating the requirement for Japanese nonbank SDs
to provide other information contained in the Monthly Monitoring Report
that is specific to certain requirements in Japan and beyond the
overall financial condition and capital compliance of the firm.
Therefore, consistent with the statement above, the Commission is
modifying Condition 8 of the Comparability Order to provide that a
Japanese nonbank SD must file Form 1-1 Capital Ratio Summary (``Form 1-
1''), Form 1-2 Capital Ratio: Deductible Assets (``Form 1-2''), Form 1-
3 Market Risk (``Form 1-3''), Form 1-4 Counterparty Risk (``Form 1-
4''), Form 2-1 Monthly Financial Statement (1) (``Form 2-1''), and Form
2-2 Financial Statement (2) (``Form 2-2'') of the Monthly Monitoring
Report with the Commission and with NFA on a monthly basis. Final
Condition 8 will continue to require a Japanese nonbank SD to file such
forms translated into the English language with balances converted to
U.S. dollars,\259\ and, as further discussed below, will require that
such forms be filed with the Commission and NFA within 35 calendar days
after the end of each month.
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\259\ The condition will also specify that Japanese nonbank SDs
must use a commercially reasonable and observable yen/U.S. dollar
spot rate as of the date of the reports.
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The Commission finds that the financial information provided by
Japanese nonbank SDs in the specified forms of the Monthly Monitoring
Report, the Annual Business Report, and the Annual Audited Financial
Report is comparable to the unaudited and audited financial information
provided by nonbank SDs under the relevant provisions of Commission
Regulation 23.105(d) and (e), respectively. With respect to Better
Markets' comment regarding the
[[Page 58492]]
sufficiency of the support for a finding of comparability of the
financial reporting requirements, the Commission believes that the
description of the reporting forms' content demonstrates the similarity
between the required information. In this regard, Form 2-1 and Form 2-2
of the Monthly Monitoring Report present a Japanese nonbank SD's
statement of financial condition and statement of profit/loss,
respectively. Form 2-1 and Form 2-2 provide information that is
necessary for the monitoring of the financial condition of a Japanese
nonbank SD and are comparable to the statement of financial condition
and statement of profit/loss required by the Commission of nonbank SDs
under Commission Regulation 23.105(d)(2).
Form 1-1, Form 1-2, Form 1-3, and Form 1-4 detail the calculation
of a Japanese nonbank SD's capital ratio. Form 1-3 and Form 1-4 provide
details concerning a Japanese nonbank SD's calculation of market risk
and counterparty credit risk, respectively, that is incorporated into
the firm's calculation of its risk-weighted assets. Form 1-3 details
market risk by asset class (e.g., equity, interest rate, foreign
exchange, commodity, and crypto assets) and contract type (e.g., spot
transactions or forward transactions). Form 1-4 details counterparty
credit risk by transaction type (e.g., foreign exchange, interest
rates, and equity). Form 1-2 details the deductions that a Japanese
nonbank SD must take in computing its Basic and Supplemental capital to
reflect illiquid assets (e.g., fixed assets). Form 1-1 summarizes the
Japanese nonbank SD's capital calculation of its Basic and Supplemental
Items and further contains the firm's overall capital ratio to
demonstrate compliance with the Japanese Capital Rules. Forms 1-1
through 1-4 of the Monthly Monitoring Report require a Japanese nonbank
SD to file financial information regarding its capital ratio that is
comparable to the capital ratio reporting requirements under Commission
Regulation 23.105(d)(2), which requires a nonbank SD to submit a
statement of its capital requirement calculation and the firm's
compliance with such capital requirement.
The Commission is also adopting Conditions 9 and 10 of the proposed
Comparability Order substantially as proposed.\260\ Final Conditions 9
and 10 require a Japanese nonbank SD to file a copy of its Annual
Business Report and Annual Audited Financial Report, respectively, with
the Commission and NFA. The Annual Business Report and Annual Audited
Financial Report are comparable to the annual audited financial report
that each nonbank SD is required to file with the Commission and NFA
pursuant to Commission Regulation 23.105(e). Specifically, information
included in the Annual Business Report and Annual Audited Financial
Reports includes the Japanese nonbank SD's statements of financial
condition, statement of income or loss, a statement demonstrating the
firm's capital levels and its compliance with the Japanese Capital
Rules, a statement of changes in ownership equity and a statement of
subordinated debt. This information is comparable
[…truncated; see source link]Indexed from Federal Register on July 18, 2024.
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