SPST-0204 AF08 Margin and Capital Requirements for Covered Swap Entities 2023 Revisions

SUPPORTING STATEMENT

Margin and Capital Requirements for Covered Swap Entities

(OMB Control No. 3064-0204)

INTRODUCTION

The Federal Deposit Insurance Corporation (FDIC) is requesting OMB approval of a three-year extension with revisions of the information collection entitled “Margin and Capital Requirements for Covered Swap Entities” (OMB Control Number 3064-0204). This information collection covers burdens imposed by 12 CFR 349 Subpart A - Margin and Capital Requirements for Covered Swap Entities (349 Subpart A). These regulations establish the minimum capital requirements and initial and variation margin requirements for swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants (swap entities) with respect to all non-cleared swaps and non-cleared security-based swaps (covered swaps). 349 Subpart A implements section 4s of the Commodity Exchange Act and section 15F of the Securities Exchange Act of 1934 by defining terms used in the statutes and related terms, establishing capital and margin requirements, and explaining the statutes' requirements.¹

1. JUSTIFICATION

1. Circumstances that make the collection necessary:

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) established a comprehensive regulatory framework for derivatives, which are generally characterized as swaps and security-based swaps.

Sections 731 and 764 of the Dodd-Frank Act require the registration and regulation of swap dealers and major swap participants and security-based swap dealers and major security-based swap participants, respectively (collectively, “swap entities”). For certain types of swap entities that are prudentially regulated by one of the Agencies,² sections 731 and 764 of the Dodd-Frank Act require the Agencies to jointly adopt rules for swap entities under their respective jurisdictions imposing: capital requirements and initial and variation margin requirements on all non-cleared swaps. Swap entities that are prudentially regulated by the Agencies and therefore subject to the proposed rule are referred to herein as “covered swap entities.”

Sections 731 and 764 of the Dodd-Frank Act require the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) to separately adopt rules imposing capital and margin requirements for swap entities for which there is no prudential regulator. The Dodd-Frank Act requires the CFTC, SEC, and the Agencies to establish and maintain, to the maximum extent practicable, capital and margin requirements that are comparable, and to consult with each other periodically (but no less than annually) regarding these requirements.

The capital and margin standards for swap entities imposed under sections 731 and 764 of the Dodd-Frank Act are intended to offset the greater risk to the swap entity and the financial system arising from the use of swaps and security-based swaps that are not cleared. They require that the capital and margin requirements imposed on swap entities must, to offset the greater risk to the swap entity and the financial system arising from the use of non-cleared swaps, help ensure the safety and soundness of the swap entity and be appropriate for the greater risk associated with the non-cleared swaps and non-cleared security-based swaps held as a swap entity. They also require the Agencies, in establishing capital rules for covered swap entities, to take into account the risks associated with other types of swaps or classes of swaps or categories of swaps engaged in and the other activities conducted by that person that are not otherwise subject to regulation applicable to that person by virtue of the status of the person as a swap dealer or a major swap participant.

The swaps-related provisions are intended to reduce risk, increase transparency, promote market integrity within the financial system, and, in particular, address a number of weaknesses in the regulation and structure of the swaps markets that were revealed during the financial crisis. During the financial crisis, the opacity of swap transactions among dealers and between dealers and their counterparties created uncertainty about whether market participants were significantly exposed to the risk of a default by a swap counterparty. A regulatory margin requirement for non-cleared swaps reduces the uncertainty around the possible exposures arising from non-cleared swaps.

In addition, the financial crisis revealed that a number of significant participants in the swaps markets had taken on excessive risk through the use of swaps without sufficient financial resources to make good on their contracts. By imposing an initial and variation margin requirement on non-cleared swaps, the ability of firms to take on excessive risks through swaps without sufficient financial resources will be reduced. The minimum margin requirement will reduce the amount by which firms can leverage the underlying risk associated with the swap contract.

2. Use of the information:

Twelve CFR 349.2 defines terms referenced in part 349. Under the definition of “eligible master netting agreement,” a covered swap entity that relies on such agreement for purpose of calculating required margin must (1) conduct sufficient legal review of the agreement to conclude with a well-founded basis that the agreement meets specified criteria and maintain sufficient written documentation of that legal review and (2) establish and maintain written procedures for monitoring relevant changes in law and to ensure that the agreement continues to satisfy the requirements of the definition. To demonstrate compliance with this section, records must be retained for as long as the covered swap entity relies on such agreement. The term “eligible master netting agreement” is used elsewhere in the rule to specify instances in which a covered swap entity may (1) calculate variation margin on an aggregate basis across multiple non-cleared swaps and security-based swaps and (2) calculate initial margin requirements under an initial margin model for one or more swaps and security-based swaps.

Section 349.7 generally requires a covered swap entity to ensure that any initial margin collateral that it collects or posts is held at a third-party custodian. Section 349.7(c) requires the custodian to act pursuant to a custody agreement that: (1) prohibits the custodian from rehypothecating, repledging, reusing, or otherwise transferring (through securities lending, securities borrowing, repurchase agreement, reverse repurchase agreement or other means) the collateral held by the custodian, except that cash collateral may be held in a general deposit account with the custodian if the funds in the account are used to purchase certain assets, such assets are held in compliance with § 349.7, and such purchase takes place within a time period reasonably necessary to consummate such purchase after the cash collateral is posted as initial margin; and (2) is a legal, valid, binding, and enforceable agreement under the laws of all relevant jurisdictions, including in the event of bankruptcy, insolvency, or a similar proceeding. A custody agreement may permit the posting party to substitute or direct any reinvestment of posted collateral held by the custodian, provided that, with respect to collateral collected by a covered swap entity pursuant to § 349.3(a) or posted by a covered swap entity pursuant to § 349.3(b), the agreement requires the posting party to substitute only funds or other property that would qualify as eligible collateral under § 349.6, and for which the amount net of applicable discounts described in Appendix B would be sufficient to meet the requirements of § 349.3 and direct reinvestment of funds only in assets that would qualify as eligible collateral under § 349.6, and for which the amount net of applicable discounts described in Appendix B would be sufficient to meet the requirements of § 349.3.

Section 349.8 sets forth standards for the use of initial margin models. These standards include: (1) a requirement that the covered swap entity receive prior approval from the OCC based on demonstration that the initial margin model meets specific requirements (§ 349.8(c)(1)); (2) a requirement that a covered swap entity notify the OCC in writing 60 days before extending use of the model to additional product types, making certain changes to the initial margin model, or making material changes to modeling assumptions (§ 349.8(c)(3)); and (3) a requirement that the covered swap entity demonstrate to the satisfaction of the OCC that the omission of any risk factor from the calculation of its initial margin is appropriate, prior to omitting such risk factor (§ 349.8(d)(10)), and demonstrate to the satisfaction of the OCC that the incorporation of any proxy or approximation used to capture the risks of the covered swap entity’s non-cleared swaps or non-cleared security-based swaps is appropriate prior to incorporating such proxy or approximation (§ 349.8(d)(11)). Also, if the validation process reveals any material problems with the initial margin model, the covered swap entity must promptly notify the OCC of the problems, describe to the OCC any remedial actions being taken, and adjust the initial margin model to ensure an appropriately conservative amount of required initial margin is being calculated (§ 349.8(f)(3)).

Section 349.8 also sets forth requirements for the ongoing review and documentation of initial margin models. These standards include a requirement that the covered swap entity adequately document all material aspects of its initial margin model (§ 349.8(g)) and that the covered swap entity must adequately document internal authorization procedures, including escalation procedures, that require review and approval of any change to the initial margin calculation under the initial margin model, demonstrable analysis that any basis for any such change is consistent with the requirements of § 349.8, and independent review of such demonstrable analysis and approval (§ 349.8(h)).

Section 349.9 addresses the treatment of cross-border transactions and, in certain limited situations, will permit a covered swap entity to comply with a foreign regulatory framework for non-cleared swaps (as a substitute for compliance with the prudential regulators’ rule) if the prudential regulators jointly determine that the foreign regulatory framework is comparable to the requirements in the prudential regulators’ rule. Section 349.9(e) allows a covered swap entity to request that the prudential regulators make a substituted compliance determination and provides that the covered swap entity must provide the reasons therefore and other required supporting documentation. A request for a substituted compliance determination must include a description of the scope and objectives of the foreign regulatory framework for non-cleared swaps and non-cleared security-based swaps; the specific provisions of the foreign regulatory framework for non-cleared swaps and security-based swaps (scope of transactions covered; determination of the amount of initial and variation margin required; timing of margin requirements; documentation requirements; forms of eligible collateral; segregation and re-hypothecation requirements; and approval process and standards for models); the supervisory compliance program and enforcement authority exercised by a foreign financial regulatory authority or authorities in such system to support its oversight of the application of the non-cleared swap and security-based swap regulatory framework; and any other descriptions and documentation that the prudential regulators determine are appropriate. A covered swap entity may make a request under § 349.9 only if it is directly supervised by the authorities administering the foreign regulatory framework for non-cleared swaps and non-cleared security-based swaps.

Section 349.10 requires a covered swap entity to execute trading documentation with each counterparty that is either a swap entity or financial end user regarding credit support arrangements that: (1) provides the contractual right to collect and post initial margin and variation margin in such amounts, in such form, and under such circumstances as are required; and (2) specifies the methods, procedures, rules, and inputs for determining the value of each non-cleared swap or non-cleared security-based swap for purposes of calculating variation margin requirements, and the procedures for resolving any disputes concerning valuation.

3. Consideration of the use of improved information technology:

Any information technology may be used that permits review by FDIC examiners.

4. Efforts to identify duplication:

The information required is unique. It is not duplicated elsewhere.

5. Methods used to minimize burden if the collection has a significant impact on a substantial number of small entities:

The information collection does not have a significant impact on a substantial number of small entities.

6. Consequences to the Federal program if the collection were conducted less frequently:

Conducting the collection less frequently would present safety and soundness risks.

7. Special circumstances necessitating collection inconsistent with 5 CFR Part 1320.5(d)(2):

None. The information collection is conducted in accordance with OMB guidelines in 5 CFR part 1320.

8. Efforts to consult with persons outside the agency:

The FDIC published a notice in the Federal Register seeking comment for a 60-day period on renewal of this information collection on July 24, 2023 (88 FR 47503). No comments were received.

9. Payments or gifts to respondents:

None.

10. Any assurance of confidentiality:

Information will be kept private to the extent allowed by law.

11. Justification for questions of a sensitive nature:

No information of a sensitive nature is requested.

12. Estimate of hour burden including annualized hourly costs:

Estimated Annual Burden

In late 2022 and early 2023, PRA and legal representatives from the FDIC, Federal Reserve Board (FRB) and Office of the Comptroller of Currency (OCC) (together, agencies) reviewed the set of ICs in each agency’s respective ICR.³ Based on this review and the FDIC’s own internal review, the FDIC has determined that only six of the eleven existing ICs continue to capture the PRA burden imposed by 349 Subpart A.⁴ A brief description of the six ICs are as follows:

§ 349.2 Definition of "Eligible Master Netting Agreement," paragraphs (4)(i) and (ii), and § 349.10 Documentation of Margin Matters (Mandatory). Together, these sections impose recordkeeping requirements on covered swap entities by (1) requiring a covered swap entity that relies on an eligible master netting agreement to satisfy the requirements of 349 Subpart A to conduct sufficient legal review of any and all eligible master netting agreements to conclude with a well-founded basis that the agreement meets specified criteria and maintain sufficient written documentation of that legal review⁵,(2) requiring a covered swap entity that relies on an eligible master netting agreement to satisfy the requirements of Part 349 to establish and maintain written procedures for monitoring relevant changes in law and to ensure that the agreement continues to satisfy the requirements of Part 349⁶, and (3) requiring a covered swap entity to execute trading documentation with certain counterparties related to collection of initial and variation margin.⁷

§ 349.7(c) Custody Agreement (Mandatory). This section imposes recordkeeping requirements on a covered swap entity to write custody agreements that prohibit custodians of collateral for covered swaps from rehypothecating, repledging, reusing, or otherwise transferring (through securities lending, securities borrowing, repurchase agreement, reverse repurchase agreement or other means) the collateral held by the custodian.

§ 349.8(c) and (d) Initial Margin Model (Mandatory). Section 349.8 describes the covered swap entities’ requirements for their initial margin models. Section 349.8(c) imposes mandatory reporting requirements for a covered swap entity to obtain prior written approval of the FDIC before using any initial margin model and to notify the FDIC in writing 60 days prior to extending or making changes to its initial margin model. Section 349.8(d) imposes mandatory reporting requirements on the covered swap entity to demonstrate to the satisfaction of the FDIC that the omission of any risk factor from the calculation of its initial margin is appropriate.

§ 349.8(f)(3) Initial Margin Modeling Report (Mandatory). This section imposes a reporting requirement on a covered swap entity to promptly notify the FDIC of any material problems with its initial margin model and describe to the FDIC any remedial actions the entity is taking to address those problems.

§ 349.8(h) Escalation Procedures (Mandatory). This section imposes a recordkeeping requirement on a covered swap entity. It requires a covered swap entity to adequately document internal authorization procedures, including escalation procedures, that require review and approval of any change to the initial margin calculation under the initial margin model, demonstrable analysis that any basis for any such change is consistent with the requirements of 349 Subpart A, and independent review of such demonstrable analysis and approval.

§ 349.9(e) Requests for Determinations (Required to Obtain Benefits). Section 349.9(e) allows a covered swap entity that is subject to the supervisory authority of authorities administering a foreign regulatory framework for the entity’s non-cleared swaps and non-cleared security-based swaps to request that its prudential regulators make a substituted compliance determination.⁸ Under the PRA, a request under this section would be classified as a reporting IC required to obtain benefits.

In the 2020 ICR the requirement associated with 349.8(g) was included in IC 1 above, along with the requirements associated with 349.2 Definition of "Eligible Master Netting Agreement," paragraphs (4)(i) and (ii), and § 349.10 Documentation of Margin Matters. During the review of the PRA burden imposed by 349 Subpart A that the FDIC conducted along with the FRB and the OCC, the agencies made a determination to break out the requirement in 349.8(g) into a separate IC for the 2023 renewal, bringing the total number of ICs in the 2023 renewal to seven. A description of the IC associated with the requirement in 349.8(g) is below.

§ 349.8(g) Documentation (Mandatory). Section 349.8(g) imposes a recordkeeping requirement on a covered swap entity. This section requires a covered swap entity to document all material aspects of its initial margin model.⁹

FDIC estimates the annual hourly burden for each of these seven ICs by finding the product of the estimated number of annual respondents, the estimated annual number of responses per respondent, and the estimated time per response for each IC. It then finds the total annual cost of this ICR as the product of the estimated annual hourly burden and the estimated weighted average hourly compensation rate.

Estimated Number of Respondents and Responses

Potential respondents to OMB No. 3064-0204 are covered swap entities. Covered swap entities include FDIC-institutions registered with the Commodity Futures Trading Commission (CFTC) as swap dealers or major swap participants pursuant to the Commodity Exchange Act of 1936 and persons registered with the Securities and Exchange Commission (SEC) as security-based swap dealers and major security-based swap participants under the Securities Exchange Act of 1934. Using the lists published by these organizations, FDIC identified 111 institutions that are registered as swap entities, as of May 2, 2023.¹⁰

One of these institutions is among the 3,038 insured depository institutions (IDIs) supervised by the FDIC, as of December 31, 2022.¹¹ As a covered swap entity, this institution would incur PRA burdens associated with all of the ICs listed above. Therefore, FDIC estimates an annual respondent count of one for all ICs in this ICR. These respondent counts are unchanged from the 2020 ICR for ICs 1-5. The lone respondent is not a small entity for purposes of the Regulatory Flexibility Act (RFA).¹²

For recordkeeping ICs 1, 2, 5and 7, FDIC believes that the respective activities throughout the year that are performed by the respondent can all be considered as parts of a single annual response. Therefore, FDIC uses one as the number of annual responses per respondent for each of ICs 1, 2, 5 and 7.

For reporting ICs 3, 4 and 6, the FDIC believes that these reporting requirements only arise on the occasion when the respondent must notify the FDIC of a problem with its initial margin model or request a substituted compliance determination. FDIC does not anticipate these occasions to arise more than once, if at all, in the next three years for the lone respondent to this ICR. As such, FDIC uses one as a placeholder for the number of annual responses per respondent for ICs 3, 4, and 6. For IC 6, this estimate is lower than the estimate of three annual responses used for the 2020 ICR.

Table 1. Summary of Estimated Annual Burden (OMB No. 3064-0204)
Information Collection (Obligation to Respond)	Type of Burden (Frequency of Response)	Number of Respondents	Number of Responses per Respondent	Time per Response (HH:MM)	Annual Burden (Hours)
1. § 349.2 Definition of "Eligible Master Netting Agreement," paragraphs (4)(i) and (ii) § 349.8(g) Documentation § 349.10 Documentation of Margin Matters (Mandatory).	Recordkeeping (Annual)	1	1	5:00	5
2. § 349.7(c) Custody Agreement (Mandatory).	Recordkeeping (Annual)	1	1	100:00	100
3. § 349.8(c) and (d) Initial Margin Model (Mandatory).	Reporting (On occasion)	1	1	240:00	240
4. § 349.8(f)(3) Initial Margin Modeling Report (Mandatory).	Reporting (On occasion)	1	1	50:00	50
5. § 349.8(h) Escalation Procedures (Mandatory).	Recordkeeping (Annual)	1	1	20:00	20
6. § 349.9(e) Requests for Determinations (Required to Obtain Benefits).	Reporting (On Occasion)	1	1	10:00	10
7. Documentation, 12 CFR 349.8(g) (Mandatory)	Recordkeeping (Annual)	1	1	80:00	80
Total Annual Burden (Hours):					505
Source: FDIC.
Note: The annual burden estimate for a given collection is calculated in two steps. First, the total number of annual responses is calculated as the whole number closest to the product of the annual number of respondents and the annual number of responses per respondent. Then, the total number of annual responses is multiplied by the time per response and rounded to the nearest hour to obtain the estimated annual burden for that collection. This rounding ensures the annual burden hours in the table are consistent with the values recorded in the OMB’s regulatory tracking system.

Estimated Labor Cost

FDIC allocates labor costs across six occupations to find the estimated hourly cost of complying with this ICR. To estimate the average cost of compensation per hour, FDIC uses the 75th percentile hourly wages reported by the Bureau of Labor Statistics (BLS) National Industry-Specific Occupational Employment and Wage Estimates (OEWS) for the relevant occupations in the Depository Credit Intermediation sector. However, the latest OEWS wage data are as of May 2022 and do not include non-wage compensation. To adjust these wages for use in this estimate, FDIC multiplies the OEWS hourly wages by approximately 1.51 to account for non-wage compensation, using the BLS Employer Cost of Employee Compensation (ECEC) data as of March 2022 (the latest published release prior to the OEWS wage data). It then multiplies the resulting compensation rates by approximately 1.05 to reflect the change in the seasonally adjusted Employment Cost Index for the Credit Intermediation and Related Activities sector (NAICS Code 522) between March 2022 and March 2023. Table 2 shows the results:

Table 2. Summary of Hourly Burden Cost Estimate (OMB No. 3064-0204)
Percentage Shares of Hours Spent by and Hourly Compensation Rates for each Occupation Group						Estimated Hourly Compensation Rate
Exec. & Mgr. ($132.34)	Lawyer ($170.71)	Compl. Ofc. ($65.6)	IT ($104.27)	Fin. Anlst. ($96.78)	Clerical ($37.28)
10	15	15	15	15	30	$90.02
Weighted Average Hourly Compensation Rate:						$90.02
Source: Bureau of Labor Statistics: 'National Industry-Specific Occupational Employment and Wage Estimates: Industry: Credit Intermediation and Related Activities (5221 and 5223 only) (May 2022), Employer Cost of Employee Compensation (March 2022), and Employment Cost Index (March 2022 and March 2023). Standard Occupational Classification (SOC) Codes: Exec. And Mgr = 11-0000 Management Occupations; Lawyer = 23-0000 Legal Occupations; Compl. Ofc. = 13-1040 Compliance Officers; IT = 15-0000 Computer and Mathematical Occupations; Fin. Anlst. = 13-2051 Financial and Investment Analysts; Clerical = 43-0000 Office and Administrative Support Occupations. Note: The estimated hourly compensation rate for a given collection is the average of the hourly compensation rates for the occupations used to comply with that collection, weighted by the share of hours spent by each occupation. The weighted average hourly compensation rate is the average of the estimated hourly compensation rates for all information collections, weighted by the share of hourly burden for each collection. These hourly weights, calculated as the estimated number of annual burden hours in a given collection over the total estimated number of annual burden hours across all collections, are shown in the “Hourly Weight” column of this table.

Total Estimated Labor Cost

FDIC estimate the total annual cost burden for OMB No. 3064-0204 by multiplying the total annual estimated burden hours reported in Table 1 by the corresponding weighted average hourly cost estimate reported in Table 2. The estimated total annual cost burden for this ICR is $45,460 per year¹³ and is considerably less than the corresponding estimate ($169,860 per year) in the 2020 ICR. As discussed above, this decrease is primarily the result of a reduction in the number of ICs in this renewal (seven) relative to the 2020 ICR (eleven). A reduction in the estimated number of annual responses for IC 6 also contributed to the decrease in the estimated annual cost of this ICR.

13. Estimate of start-up costs to respondents:

None.

14. Estimate of annualized costs to the government:

None.

15. Analysis of change in burden:

See discussion in Section 12 above.

16. Information regarding collections whose results are planned to be published for statistical use:

The result of this collection will not be published for statistical use.

17. Display of expiration date:

Not applicable.

18. Exceptions to Certification

Not applicable.

2. Collection of Information Employing Statistical Methods

Not Applicable.

1 12 CFR 349.1(b)

2 The Agencies are the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the Farm Credit Administration.

3 The FRB’s and OCC’s ICRs are OMB No. 7100-0364 for 12 CFR Part 237 and OMB No. 1557-0251 for 12 CFR Part 45, respectively.

4 The IC corresponding to 12 CFR 349.11(b)(1) will be eliminated in this ICR because 12 CFR 349.11(b)(1) was eliminated in a 2020 final rulemaking. See 85 FR 39754.

5 Part 349.2 Definition of “Eligible Master Netting Agreement” paragraph 4(i)

6 Part 349.2 Definition of “Eligible Master Netting Agreement” paragraph 4(ii)

7 Part 349.10

8 Section 349.9(e) states that covered swap entities must include certain information in a request for a substituted compliance determination.

9 Section 349.8(g) states that these material aspects include the management and valuation of the non-cleared swaps and non-cleared security-based swaps to which it applies, the control, oversight, and validation of the initial margin model, any review processes and the results of such processes.

10 FDIC used the list of swap dealers set forth on May 2, 2023 (providing data as of January 30, 2023) at https://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer.html and the list of security-based swap dealers and major security-based swap participants set forth on May 2, 2023 (providing data as of January 4, 2023) at https://www.sec.gov/tm/List-of-SBS-Dealers-and-Major-SBS-Participants. Major swap participants, among others, are required to apply for registration through a filing with the National Futures Association. Accordingly, the FDIC reviewed the National Futures Association https://www.nfa.futures.org/members/sd/index.html to determine whether there were registered major swap participants. As of May 2, 2023, there were no major swap participants listed at this link.

11 FDIC Call Report Data, December 31, 2022. One other identified swap dealer has a name that is similar to both an FRB-supervised and an FDIC-supervised IDI. The FDIC confirmed that this swap dealer is FRB-supervised.

12 Based on FDIC Call Report data, December 2022. The Small Business Administration (SBA) defines a small banking organization as having $850 million or less in assets, where an organization's ''assets are determined by averaging the assets reported on its four quarterly financial statements for the preceding year.'' See 13 CFR 121.201 (as amended by 87 FR 69118, effective December 19, 2022). In its determination, the ''SBA counts the receipts, employees, or other measure of size of the concern whose size is at issue and all of its domestic and foreign affiliates.'' See 13 CFR 121.103. Following these regulations, the FDIC uses an insured depository institution's affiliated and acquired assets, averaged over the preceding four quarters, to determine whether the insured depository institution is ''small'' for the purposes of RFA.

13 $45,460 per year = 505 hours per year x $90.02 per hour.

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