CFTC Proposes Revisions to Clarify Capital and Financial Reporting Requirements for Bank and Non-Bank Swap Dealers

On December 15, 2023, the Commodity Futures Trading Commission (Commission or CFTC) published a notice of proposed rulemaking (NPRM)^[1]that would amend capital requirements for non-bank swap dealers and financial reporting requirements for bank and nonbank swap dealers (SDs).^[2]  The proposed amendments have several objectives:

• Clarify existing capital and financial reporting requirements (CFTC Capital Rule).[3]
• Codify relief provided in CFTC Letters No. 21-15 and 23-11 (applicable to bank SDs).
• Revise Form 1-FR-FCM.
• Introduce other changes to financial reporting requirements.

Comments must be submitted by February 13, 2024.

Overview

The NPRM attempts to further respond to compliance inquiries from market participants and to clarify several uncertainties related to the CFTC Capital Rule, in addition to codifying existing interpretative and no-action relief from the rule. For example, CFTC Letters 21-15 and CFTC No-Action Letter 21-18, issued by the Market Participants Division (MPD), clarify the CFTC Capital Rule’s applicability to Tangible Net Worth (TNW) Approach firms and simplify financial reporting requirements for bank SDs subject to alternative domestic or foreign capital and reporting requirements, respectively.   

Title VII of the Dodd-Frank Act divided capital and margin requirements for SDs and security-based swap dealers (SBSDs) between prudential regulators, the CFTC and the Securities and Exchange Commission (SEC).  As a result, bank SDs and SBSDs are subject to prudential regulator capital and financial reporting requirements. In contrast, nonbank SDs and SBSDs are subject to the CFTC and SEC versions of the requirements.  Further, under the CFTC Capital Rule, SD registrants must choose from three methodologies to comply with its requirements: the Net Liquid Asset, Bank-Based, and TNW capital approaches. 

We summarize the proposed revisions of the NPRM according to SD bank affiliate status and, for nonbank SDs, their relevant capital approach.

Impact of CFTC Capital Rule on Various SD Registrants

The following amendments proposed in the NPRM would apply to all nonbank SD registrants:

• Schedules 2-4 of Appendix B, referenced in CFTC Rule 23.105(k), would need to be completed and filed monthly (or quarterly, for TNW Approach firms) by all nonbank SDs. Currently, these schedules provide that SDs “authorized to use models” must submit the schedules, which require the submission of credit exposures on a concentration and internal credit rating basis, as well as jurisdictional exposure reporting. The amendment is most impactful to nonbank SDs taking a standardized (i.e., non-model) approach that was not required to submit Schedules 2-4 previously.
• Nonbank SDs would have two business days after the occurrence of a substantial reduction in capital held (defined as a minimum 30% decrease from a previous filing) to notify the CFTC. Previously, a timing requirement did not apply to CFTC Rule 23.105(c)(4). The proposal aligns with current FCM capital reduction timing requirements.
• The NPRM would require firms to make a publicly disclosed statement that no material differences occurred between annual audited and unaudited financial reports. If adopted, the amendment would replace the current requirement under CFTC Rule 23.105(e)(4), which requires, among other things, a reconciliation of material differences between the statements.
• The term “statement” would be replaced with “amount” under CFTC Rule 23.105(i)(1)(ii) and (2)(ii). In effect, the CFTC is taking the view that publicly disclosed audited and unaudited information, including the minimum regulatory capital requirement and actual capital held, does not need to be provided in a standalone statement or form.
• Footnotes to an SDs unaudited Statement of Financial Condition would be mandated for inclusion in publicly disclosed financials.

In addition, nonbank SDs electing or considering the Tangible Net Worth capital approach should note the following:

• The NPRM aims to clarify the Tangible Net Worth eligibility test, effectively codifying CFTC Letter 21-15, by:
  • Confirming that the revenue and asset eligibility tests can be satisfied at the registrant consolidated parent level, in addition to the SD entity-level, and
  • Enabling certain firms to calculate their eligibility for the TNW approach by using International Financial Reporting Standards (IFRS) accounting standards.
• Position and counterparty financial reporting requirements, including exposures, would be required to be filed quarterly. If adopted, the change would codify the interpretation of the filing’s frequency in Letter 21-15.
• The NPRM proposes to clarify that TNW approach firms would be required to compute standardized credit risk charges under SEC Rule 18a-1 or CFTC regulation 1.17, as applicable. This would standardize market and credit risk charge computations for all nonbank SDs.

Nonbank SDs electing the Net Liquid Assets capital approach should note the following with respect to the NPRM:

• The National Futures Association (NFA) would have authority to review and approve subordinated debt computed as regulatory capital. The approach is technically applied to firms under NFA Financial Requirements Rule 18(d).

Nonbank SDs electing the Bank-based capital approach should note the following with respect to the NPRM:

• The NFA would have the authority to review and approve subordinated debt computed as regulatory capital. The approach is technically applied to firms under NFA Financial Requirements Rule 18(d).
• A cross-reference in CFTC Rule 23.102(d) would be corrected to make clear that Bank-Based approach firms can calculate their capital risk charges in accordance with 12 CFR Part 217.

Further, for SDs dually registered as futures commission merchants (FCM, together SD-FCMs):

• On Form 1-FR-FCM, an SD-FCM would be required to compute and report:
  • 2% of uncleared margin on swap transactions.
  • A swap and security-based swap haircut to net capital computation, including market risk charges.

Finally, bank SDs should note the following with respect to the NPRM:

• CFTC no-action letter 21-18, as extended by letter 23-11, would be largely codified to provide relief to US and non-US bank SDs from certain financial reporting requirements.
• In summary, codifying the relief would enable bank SDs to comply with domestic, prudential and foreign financial reporting requirements in lieu of CFTC requirements, provided the firm timely submits alternative reports or statements timely to the CFTC.
• The NPRM would remove the restriction presented in Letter 21-18 that a non-US bank SD must be subject to G-20 capital standards to substitute compliance with its local requirements.

Takeaways

While the NPRM primarily focuses on codifying and clarifying several ambiguities within the CFTC Capital Rule, SDs should consider whether the rulemaking presents an opportunity for further adjustments to be contemplated by the Commission.

The NPRM does not, for example, codify all no-action or interpretative letters related to the CFTC Capital Rule. Firm-specific relief letters, such as CFTC Letter 22-03, which granted relief from certain public financial reporting requirements to a privately held SD, would not be extended to other similarly situated SDs under the proposal. The NPRM also needs to clarify whether non-model, nonbank SDs electing the Bank-based approach can calculate risk-weighted assets using standardized market risk charges. The prudential regulators recently proposed to establish standardized market risk charges for the first time as part of its broader Basel III rulemaking. 

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[1] https://www.cftc.gov/media/10051/federalregister122223/download.

[2] The NPRM would also apply to major swap participant registrants (“MSPs”).  However, as the MSP registration has been rarely utilized, this alert addresses Swap Dealer registrants only.

[3] Capital Requirements of Swap Dealers and Major Swap Participants, 84 Fed. Reg. 69,664 (Dec. 19, 2019).