With (not unanimous) FDIC vote, all regulators now on board with swap margin rule

With its vote Thursday – on a split vote (again) – the federal insurer of bank deposits jumped on board changes by federal banking and securities regulators to swap margin rules aimed at what they said would facilitate “implementation of prudent risk management strategies at banks and other entities with significant swap activities.”

The Federal Deposit Insurance Corp. (FDIC) Board voted to approve the rule, with Board Member Martin Gruenberg dissenting. The rule had previously been approved by the three federal banking agencies, and the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

The FDIC Board had approved another rule, making changes to provisions of the Volcker rule, also on a split vote Thursday (with Gruenberg dissenting).

According to the Federal Reserve, the final rule makes changes so that entities that are part of the same banking organization generally will no longer be required to hold a specific amount of initial margin for uncleared swaps with each other, known as inter-affiliate swaps. “Inter-affiliate swaps typically are used for internal risk management purposes by transferring risk to a centralized risk management function within the firm. The final rule will give firms additional flexibility to allocate collateral internally and support prudent risk management and safety and soundness.

Inter-affiliate swaps will remain subject to variation margin requirements, the Fed said, and initial margin will still be required if a depository institution’s total exposure to all affiliates exceeds 15% of its Tier 1 capital.

In his dissent, Gruenberg said the changes to the rule would remove “critical prudential protection” for banks.

“It would expose the bank to one of the most significant risks identified in the 2008 financial crisis at a time of extraordinary economic and financial uncertainty as a result of COVID-19,” Gruenberg said. “Now is not the time, with the economic and financial uncertainty caused by COVID-19, to eliminate this requirement. For that reason, I will vote against this Final Rule.”

According to a fact sheet issued by the FDIC, since 2015 (when the rule originated), the regulatory agencies have found that banking organizations use inter-affiliate swaps for internal risk management purposes by transferring derivatives exposures to a centralized risk management function. “In addition, after the rule was finalized, the largest firms have made significant progress implementing resolution strategies designed to recapitalize subsidiaries as protection against the types of affiliate failures envisioned under the rule,” the agency stated.

Key portions of the revisions, the FDIC said, include that it:

  • Facilitates prudent risk management by modifying the requirement that a covered swap entity collect initial margin from affiliates. Under the rule, a covered swap entity is not required to collect initial margin from affiliates when the aggregate amount of such initial margin is less than 15% of the covered swap entity’s tier 1 capital.
  • Protects insured depository institutions by preventing banking organizations from transferring significant levels of risk to insured depository institution subsidiaries. Specifically, the FDIC said, the rule requires that, if the aggregate amount of initial margin for inter-affiliate swaps exceeds 15% of a covered swap entity’s tier 1 capital, the covered swap entity would be required to collect initial margin on all new contracts with affiliates.
  • Maintains key safeguards to protect safety and soundness by requiring covered swap entities to exchange variation margin with affiliates to reflect the change in value of each party’s obligations over the life of each contract. In addition, the rule does not amend the requirement that a covered swap entity exchange initial and variation margin with unaffiliated counterparties.

The FDIC also said the rule amends the requirements for covered swap entities by, first, facilitating the transition away from interbank offered rates (IBORs) and other interest rates that are expected to be discontinued or that are determined to have lost their relevance as a reliable benchmark due to significant impairment; second, by adding an additional initial margin compliance period for certain smaller counterparties.

The banking regulators also issued for comment an interim final rule that extends the compliance date of the initial margin requirements of the swap margin rules to Sept. 1, 2021, for swap entities and counterparties with average annual notional swap portfolios of $50 billion to $750 billion. This interim final rule also extends the initial margin compliance date to Sept. 1, 2022, for counterparties with average annual notional swap portfolios of $8 billion to $50 billion.

Agencies finalize amendments to swap margin rule

Interim final rule

FDIC fact sheet