Monday, July 27, 2020

CFTC commissioners clash as curtain comes down on agency’s Dodd-Frank rulemaking

By Brad Rosen, J.D.

At the first of two consecutive CFTC open meetings held via teleconference, the CFTC voted 3-2 to approve a final rule regarding new capital requirements for swap dealers (SDs) and major swap participants (MSPs). Chairman Heath Tarbert trumpeted the rule as promoting certainty, customer protection, and reducing systematic risk. Tarbert also noted that the adoption of the rule marked the completion of the CFTC’s required rulemakings under Section 731 of the Dodd-Frank Act.

For his part, Democratic Commissioner Dan Berkovitz noted the CFTC’s progress made under Dodd-Frank was now under threat. Moreover, he vigorously opposed the final rule noting it was not based upon the risks of uncleared swaps, as the law requires, but rather on existing capital requirements for FCMs and banks. Berkovitz also pointed to the Commission’s acknowledgement that there will be little or no need for most affected swap dealers to raise new capital under the rule.

The meeting agenda also included a Division of Swaps and Intermediary Oversight (DSIO) presentation with regard to proposed rules in connection with margin requirements for uncleared swaps for SDs and MSPs. The commissioners did not vote on that proposal at the meeting.

Final rule: capital requirements of swap dealers and major swap participants. The final rule imposes new capital requirements on SDs and MSPs that are not subject to supervision by a banking regulator. According to DSIO analysis, 56 firms, with varying business structures and characteristics, would be subject to the new rules. To accommodate the variety in business operations of impacted firms, SDs will be provided with the option of selecting from one of three alternative methods to establish and meet minimum capital requirements. These include the following:
  • net liquid assets method, which is based primarily on existing capital requirements for FCMs, and on the capital requirements adopted by the Securities and Exchange Commission for security-based swap dealers and major security-based swap participants;
  • bank-based method, which is based primarily on existing capital requirements for bank holding companies under the supervision of the Federal Reserve Board; and
  • tangible net worth method, designed specifically for SDs which are part of a larger commercial enterprise.
Under the rule, MSPs are required to maintain positive tangible net worth. Additionally, the final rule includes 1) a comprehensive model approval process overseen by the National Futures Association; 2) accompanying financial reporting, recordkeeping, and notification requirements; and, 3) a substituted compliance determination process for those SDs which may already be required to maintain capital in accordance with a foreign regulator. This final rule will be effective 60 days after publication in the Federal Register. The rule’s compliance date is October 6, 2021.

Each of the commissioners issued further comments about the rule, which included the following observations:

Chairman Tarbert focuses on flexibility. Highlighting the completion of the CFTC’s required rulemakings under the Dodd-Frank Act, Chairman Tarbert lauded the final capital rule’s flexibility and ability to accommodate the wide array of swap dealers that touch every corner of the Commission’s markets. He also observed, "Capital requirements are the ultimate backstop, ensuring that customers are protected and the financial system remains sound in the event that all other measures fail." Tarbert concluded, "The final rule is also long on customer protection and systemic risk mitigation, advancing the CFTC’s mission of promoting the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation."

Commissioner Quintenz views rule as appropriately calibrated. In his remarks, Commissioner Brian Quintenz observed, " the cost of capital may be the most determinative factor in a firm’s decision to remain, or become, a swap dealer (SD) If capital costs are too expensive, firms will restrict certain business activities, end unprofitable business lines, or, in some cases, exit the swaps or futures markets altogether." In his view, the capital rules are appropriately calibrated to the true risks posed by an SD’s business and ensures these firms will have the capital necessary to support their market activities.

Commissioner Behnam connects Dodd-Frank concerns with the impropriety of adopting the final capital rule. Commissioner Behnam noted," Yesterday marked ten years since Congress passed Wall Street reform, a swift legislative response to the financial crisis and ensuing Great Recession, which wreaked havoc on Main Street America and the global economy in large part because of undercapitalized financial institutions." The commissioner further expressed his opposition to the final rules on both procedural and substantive grounds, stating, "The Commission now jumps from a proposal issued in 2016 to a significantly different final rule nearly four years later, without any intervening reproposal to provide interested market participants clear proposed capital requirements to meaningfully comment upon. In so doing, the Commission undermines both the spirit of the Dodd-Frank Act and the letter of the Administrative Procedure Act."

Commissioner Stump contends re-opening the 2016 comments was appropriate. Commissioner Stump asserted that the CFTC acted appropriately in re-opening the comment period last year to allow for market participants to update their views based on developments since the 2016 CFTC proposal and improve the end product. The commissioner observed, "as a result, the Commission considered the actions taken by our fellow regulators, especially the SEC finalizing their capital and financial reporting rules in the interim, concerning capital and adopting their lessons learned and harmonizing where appropriate." She added, "Re-opening the comment period provided us with an opportunity to rethink our approach to capital and allowed us to be more consistent with what other regulators had accomplished."

Commissioner Berkovitz asserts rule lacks analytical support and contravenes congressional intent. In his remarks, Commissioner Dan Berkovitz asserted that " While the Commission makes conclusory statements that the rule helps "ensure the safety and soundness" of the swap dealers, there is little or no analysis supporting these assertions." In concluding, Berkovitz explains his dissent noting "Unfortunately, the rule the Commission will be adopting today is simply an affirmation of the status quo. This is not what Congress intended when it directed the CFTC to adopt capital requirements "appropriate for the risk" presented by uncleared swap activities of swap dealers."

Proposed rules: margin requirements for uncleared swaps for SDs and MSPs. The DSIO also made a presentation to the Commission in connection with a set of three proposed margin rules for uncleared swaps based on a report submitted to the Commission from the Global Markets Advisory Committee (GMAC). Commissioner Stump commented briefly on the proposals noting that thoughtful consideration should be given to recommendations made in GMAC report.