Wednesday, September 30, 2015

CFTC Chairman Massad Expects Cybersecurity Proposal, Uncleared Swaps Margin Final Rule by Year End

By Lene Powell, J.D.

In remarks at a derivatives industry conference, CFTC Chairman Timothy Massad discussed issues relating to market infrastructure stability, saying he expects the CFTC to propose risk management and cybersecurity requirements for core infrastructure sometime this fall. Massad also anticipates that the CFTC will finalize a proposed rule on margin for uncleared swaps by the end of the year. In addition, Massad does not believe that derivatives should be exempt from the Supplemental Leverage Ratio but said there are questions as to how customer collateral should be treated for purposes of capital requirements.

Cybersecurity. Mandatory clearing requirements put in place by the Dodd-Frank Act have increased the ability of the CFTC to monitor and mitigate risk, with 75 percent of swap transactions now being cleared, compared to 15 percent in 2007. However, mandatory clearing is not a panacea, and the CFTC is working on measures to enhance system stability. In addition to looking at recovery and resolution planning for clearinghouses, the CFTC is stepping up efforts to protect against cyber threats, as well as technological and operational risk generally, said Massad.

System safeguards are already part of the core principles and regulations for clearinghouses, exchanges, and other institutions. Massad said the CFTC is focusing on these issues in its examinations, to determine if institutions are following good practices and paying enough attention from the board level on down. The CFTC is working on a proposal to make sure that institutions are doing adequate testing of risks and their protective measures against cyberattacks and other technological disruptions. Massad expects that the proposal will incorporate principles-based standards on testing and that it will be issued this fall.

Capital and margin. Massad discussed a number of issues related to capital and margin requirements. First, regarding differences in margin methodologies between the E.U. and U.S. and resulting tension over “equivalence,” Massad noted that the E.U. has granted equivalence to many jurisdictions with margin practices similar to the U.S. Dialogue is continuing, and he hopes that equivalence can be granted soon. 

Also related to clearinghouse resiliency is the issue of the supplemental leverage ratio, which imposes extra capital requirements on the largest banks. One question is whether customer collateral held by a bank should be treated as an asset of the bank, since it cannot be used by the bank. On this point, Massad said one possible solution is that under GAAP, cash will not be treated as an asset of the bank if certain conditions are met, like the bank agreeing to waive any investment income. Another question is how to measure the exposure arising from a clearing member’s guarantee of the customer trade. If the clearinghouse rules require it to use the collateral first, before seeking recourse against the clearing member, should that not be taken into account in deciding how to measure the exposure?

Turning to swap dealers, Massad observed that margin for uncleared swaps is critical because there will always be a large part of the swaps market that is not centrally cleared. A CFTC proposed rule currently under consideration requires swap dealers to post and collect margin on uncleared swaps with one another, and with certain financial counterparties. The CFTC has been working closely with U.S. banking regulators as well as European and Japanese regulators, and the goal is to ensure that the respective rules are similar. Massad said he expects that the CFTC final rule will come out before the end of the year, and will use the same overall threshold as E.U. and Japan for defining material swaps exposure and follow the same implementation schedule. Regulators are continuing to work on requirements for margin models, lists of eligible collateral, and collateral haircuts.