Revisions to the current swap margin rule in place at federal banking regulators and others that would, among other things, address the expected phase-out of the London Interbank Offered Rate (LIBOR) and ease requirements for initial margin were issued for a 30-day comment period Tuesday by the Federal Deposit Insurance Corp. (FDIC) Board, with Member Martin Gruenberg casting the one dissenting vote.
The proposed rule would revise the 2015 swap margin rule, which provides a phased compliance schedule spanning from 2016 through 2020. Under the 2015 rule, banks are required collect a set amount of collateral (called “initial margin”) in swaps transactions with their affiliates.
Gruenberg said the proposed rule would revise the swap margin rule “to repeal the requirement that a bank that is a dealer in derivatives collect initial margin from its affiliates. This would remove an important prudential protection from the bank and expose the bank to one of the most significant risks identified in the financial crisis.”
Gruenberg cited results of a survey by the International Swaps and Derivatives Association (ISDA) of 20 of the largest firms subject to the rule; he said the amount of initial margin held by those firms to cover inter-affiliate swaps as of year-end 2018 was $39.4 billion, making up 31% of all regulatory initial margin as of that date.
“The argument seems to be that the collateral or margin protection provided for the bank, when it has a derivative contract with an affiliate, should be removed on the assumption that the centralized risk management of the banking organization, including additional flexibility for internal allocation of collateral, will provide better protection to the insured depository institution,” he said in a statement.
“Although there is value in centralized risk management of the banking organization, it is not a substitute for actual loss absorbing collateral held by the bank as a buffer against the risk of an inter-affiliate derivative relationship,” he continued. “Removing the inter-affiliate initial margin requirement would provide an incentive for banking organizations to concentrate risky derivative activity in the insured depository institution because of the subsidy provided by the public safety net. This would defeat one of the principal purposes of the 2015 final rule.”
The proposed rule’s 30-day comment period will begin after the proposal is published in the Federal Register. The FDIC is the one of five agencies that are part of this joint rule making, and all five need to sign off before it runs in the Register. The other four agencies are the Office of the Comptroller of the Currency (OCC), Federal Reserve Board, Farm Credit Administration, and Federal Housing Finance Board.