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Decade later, CFTC finalizes last Dodd-Frank mandated rule

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Derivatives
Friday, July 24, 2020

It took 10 years and one day, but the Commodity Futures Trading Commission (CFTC) has completed the rulemaking required of the agency by the Dodd-Frank Act.

A day after the 10th anniversary of the signing of the act into law, the CFTC finalized its rule regarding new capital and financial reporting requirements for swap dealers (SDs) and major swap participants (MSPs). That move marks the completion of the CFTC’s required rulemakings under Section 731 of the Dodd-Frank Act.

“Today marks 10 years and a day since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. Much has changed during the past decade — our derivatives markets today are faster, increasingly digital, and more deeply connected to the global economy than they were in 2010,” CFTC Chairman Heath Tarbert said in a statement. “Yet amidst these changes, there has been at least one constant: the absence of capital requirements for swap dealers and major swap participants for which the CFTC is responsible.

“As a response to the credit crisis of 2008, Section 731 of the Dodd-Frank Act amended the Commodity Exchange Act, providing that the CFTC ‘shall adopt’ capital and financial reporting requirements for these entities. It is high time to fulfill this mandate and close the book on our Dodd-Frank Act responsibilities. After all, ‘late’ is always better than ‘too late.’ ”

Tarbert said the finalization of the capital rule would bring certainty to the industry.

“There is another compelling reason to finalize a capital rule that is more than a decade in the making: certainty,” he stated. “One of our strategic goals as an agency is to enhance the regulatory experience for market participants at home and abroad. Certainty is the bedrock of this goal. Our swap dealers cannot effectively plan for compliance without clarity from us about what their capital obligations will look like. Today we lift this cloud of uncertainty by finalizing a capital rule that carefully accounts for the differences among our swap dealers.”

The rule was approved by a 3-2 vote and provides SDs with the option to elect one of three alternative methods to establish and meet minimum capital requirements, depending on the characteristics of their business:

  • A net liquid assets method, which is based primarily on existing capital requirements for futures commission merchants (FCMs), and on the capital requirements adopted by the Securities and Exchange Commission for security-based swap dealers and major security-based swap participants;
  • A bank-based method, which is based primarily on existing capital requirements for bank holding companies under the supervision of the Federal Reserve Board; and
  • A tangible net worth method, designed specifically for SDs which are part of a larger commercial enterprise.

MSPs are required to maintain positive tangible net worth.

The final rule also makes several amendments to existing capital requirements for FCMs to impose specific requirements for swaps and security-based swaps.

In addition, the final rule includes:

  1. A comprehensive model approval process;
  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.

Tarbert expressed his thanks to the CFTC staff for their work on the rule.

“Today we mark a decade and a day following the enactment of the Dodd-Frank Act by completing the CFTC’s required rulemakings under Section 731. The final capital rule is flexible and tailored, to accommodate the wide array of swap dealers that touch every corner of our markets. 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,” he stated. “After 10 years of hard work by CFTC staff, I am pleased to support the final rule and the long-awaited certainty it brings to our markets. Given the current economic crisis the world faces in light of the continuing COVID-19 pandemic, we are fortunate to have a final rule that has come late, but not too late.”

The final rule will be effective 60 days after publication in the Federal Register, and market participants must be compliant by Oct, 6, 2021.

Commissioner Brian Quintenz issued a statement of support for the final rule.

“Ten years and one day ago, the Dodd-Frank Act Wall Street Reform and Consumer Protection Act was enacted. I am proud to vote for today’s final rule which, in my view, is the capstone of the Commodity Futures Trading Commission’s work to appropriately calibrate the post-crisis reforms,” he stated.

Both dissenting commissioners also issued statements, with Dan Berkovitz saying there was “no rational basis” to conclude the minimum capital requirements in the rule meet the standards set forth in Dodd-Frank.

“Notwithstanding my dissent, I want to once again acknowledge the complexity and highly technical nature of the capital requirements,” he stated. “Given these difficulties, I would like to recognize the hard-working staff of the CFTC for their efforts in fashioning the final rule. Some of you spent many a late night addressing comments and questions and revising the rule release. While I cannot support the outcome, I nonetheless appreciate and thank you for the dedication you bring to your work here at the CFTC.”

Commissioner Rostin Benham looked to the creation of the Section 731 rulemaking in writing his dissent.

“Yesterday marked 10 years since Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Congress passed Dodd-Frank as a targeted legislative response to the 2008 financial crisis and the near obsolescence of the U.S. financial regulatory framework. The Great Recession wreaked havoc on Main Street Americans and the global economy,” he stated. “Undercapitalization was at the heart of the 2008 crisis, and the swift response to require financial institutions to hold additional capital mitigated both the blunt economic shock we endured this past March, and the substantial weight we continue to shoulder as a result of the Covid-19 pandemic.

“The capital requirements in Section 731 … clear: ‘…[t]o offset the greater risk to the swap dealer or major swap participant and the financial system arising from the use of swaps that are not cleared,’ the commission’s capital requirements shall ‘help ensure the safety and soundness of the swap dealer or major swap participant’ and ‘be appropriate to the risk associated with the non-cleared swaps held as a swap dealer or major swap participant.’ There can be no doubt that Congress intended to impose significant new requirements that would contribute to the protection from another financial crisis.”

Benham added his thanks to Berkovitz’s to the CFTC staff for their “excellent work on this highly technical and complex rulemaking.”

“While I would have liked to stand with my fellow commissioners today, I cannot justify it under these circumstances,” he stated. “I truly wish that I could support today’s commission action as we mark the 10th anniversary of the Dodd-Frank Act this week. To reiterate sentiments made in my first speech as a CFTC commissioner, capital is a cornerstone financial crisis reform that is critical to protecting our financial institutions and our financial system as a whole from systemic risk and contagion. But it is also critical to protection from unintended consequences if capital (and margin) levels are applied and set without due regard to the uniqueness of our financial markets and market participants.”

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