Sangil Min


In September 2019, the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Farm Credit Administration, and Federal Housing Finance Agency proposed rules amending current swap margin requirements for covered swap entities (“CSE”), and have since gathered comments from industry stakeholders.[1] The proposed rule seeks to exempt CSEs from collecting initial margin for non-centrally cleared swaps with their affiliates.[2]

The five agencies recognized that initial margin requirements for inter-affiliate swaps are inconsistent among global jurisdictions and that many CSEs are banking organizations operating in multiple jurisdictions, some of which do not impose initial margin requirements between affiliate counterparties.[3] The agencies believed that the initial margin requirement provides only limited systemic risk benefits and unnecessarily places U.S. banking firms at a competitive disadvantage.[4]

In its margin requirement comparability reports, the Commodity Futures Trading Commission (“CFTC”) also recognized the same problem. Noting that “many authorities . . . were not expected to require initial margin for inter-affiliate swaps, the [CFTC] recognized that requiring the posting and collection of initial margin for inter-affiliate swaps generally would be likely to put CSEs at a competitive disadvantage to firms in those other jurisdictions.”[5]

Current CFTC Margin Rule and Rules under Foreign Jurisdictions

Under the current CFTC margin rule, a covered swap entity must collect initial margin from a margin affiliate unless it meets both of the following conditions: “(i) The swaps are subject to a centralized risk management program that is reasonably designed to monitor and to manage the risks associated with the inter-affiliate swaps; and (ii) the CSE exchanges variation margin with the margin affiliate.”[6] Even if the two conditions are met, the CFTC still requires CSEs to collect initial margin if they are transacting with “non-U.S. affiliates that are financial end users that are not subject to initial margin collection requirements on their own outward-facing swaps with financial end users that are not comparable in outcome to [the CFTC rule].”[7] The CFTC explains that such a rule is “designed to prevent the potential use of affiliates to avoid collecting initial margin from third parties.”[8]

On the other hand, the European Union rule has no margin requirements for inter-affiliate transactions between counterparties established in the same Member State, “as long as there is no legal impediment to the prompt transfer of own funds or repayment of liabilities between counterparties.”[9] For inter-affiliate transactions between counterparties in different Member States, the EU rule adds the following conditions to be met: that the counterparties (i) have appropriate risk management procedures; (ii) comply with certain notification requirements; and (iii) disclose necessary information.

Similarly, the Australian Prudential Regulation Authority (“APRA”) also does not require an exchange of initial margin for inter-affiliate transactions between two APRA-covered entities.[10] For transactions between a covered entity and its non-covered affiliate, APRA uses its discretionary authority based upon “the impact on prudential safety, financial stability, procyclicality, competition, and other factors.”[11]

The Japanese Financial Services Agency (“JFSA”) exempts inter-affiliate transactions from both initial and variation margin requirements.[12]  Instead, the JFSA mitigates such credit risk with capital requirements and risk management standards imposed upon parent companies and financial holding companies.[13] The required capital amount for the consolidated entity executing uncleared swaps between its affiliates is presumably enough to cover exposures that the swap entity puts upon their affiliate counterparties with uncollateralized non-cleared OTC derivatives transactions.[14] And if there is any initial margin voluntarily agreed upon between two affiliate counterparties, then such capital requirement can be reduced accordingly.[15]

What the Amendment Means for U.S. Banking Organizations

Compared to the current U.S. margin rule, other jurisdictions do seem to take a more lenient approach to inter-affiliate initial margin. Inter-affiliate swaps are typically used by banking organizations for internal risk management purposes.[16] Requiring initial margin for swaps between their affiliated counterparties, therefore, can freeze up the banks’ liquidity and interrupt their prudent risk management.[17] Under the current rule, swap entities in the U.S. would need to borrow and lock up more cash to fund collateral for initial margin, compared to competing foreign banking organizations.[18] Although substituted compliance to margin rules in other jurisdictions can often be allowed for some transactions involving foreign counterparties, maintaining a more stringent margin requirement would inevitably shrink the liquidity of U.S. banking organizations and discourage active optimization of overall risk to the conglomerate. Therefore, the proposal to remove the initial margin would definitely boost their international competitiveness. While there could be some possible loss in systemic risk protection by its removal, more flexible and optimized risk management by individual banks is likely to compensate for such loss and can potentially reduce overall risk in the system even further. It will be interesting to see how the prudential regulators’ final decision comes out on this amendment proposal.



[1] Margin and Capital Requirements for Covered Swap Entities, 84 Fed. Reg. 59970 (proposed Nov. 7, 2019).
[2] Id. at 59,982.
[3] Id. at 59,976.
[4] Id.
[5] Comparability Determination for Australia: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 84 Fed. Reg. 12,908, 12,914 (Apr. 3, 2019).
[6] Comparability Determination for the European Union: Margin Requirements for Uncleared Swap s for Swap Dealers and Major Swap Participants, 82 Fed. Reg. 48,394, 48,399 (Oct. 18, 2017).
[7] Id.
[8] Id.
[9] Id. at 48,400.  Such legal impediments include (a) currency and exchange controls; (b) a regulatory, administrative, legal or contractual framework that prevents mutual financial support or significantly affects the transfer of funds within the group; (c) any of the conditions on the early intervention, recovery and resolution as referred to in Directive 2014/59/EU of the European Parliament and of the Council (1) are met, as a result of which the competent authority foresees an impediment to the prompt transfer of own funds or repayment of liabilities; (d) the existence of minority interests that limit decision-making power within entities that form the group; (e) the nature of the legal structure of the counterparty, as defined in its statutes, instruments of incorporation and internal rules. Commission Delegated Regulation 2016/2251, art. 33, 2016 O.J. (L340) 9, 36.
[10] Comparability Determination for Australia: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 84 Fed. Reg. at 12,914.
[11] Id.
[12] Amendment to Comparability Determination for Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 84 Fed. Reg. 12,074, 12,079 (Apr. 1, 2019).
[13] The risk management standards above refer to the JFSA’s “Guideline for Financial Conglomerates Supervision” and “Inspection Manual for Financial Holding Companies.” The former mandates parent companies and financial holding companies to measure, monitor, and manage the risks from relevant inter-affiliate derivatives transactions, and the latter mandates a governance framework and risk management system at a centralized group level that deal with inter-affiliate transaction risks. Id.
[14] Id.
[15] Id.
[16] Margin and Capital Requirements for Covered Swap Entities, 84 Fed. Reg. at 59,976.
[17] Id.
[18] Id.