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Better Markets Comment Letter on Margin and Capital Requirements for Covered Swap Entities

Better Markets filed a comment letter on a proposed rulemaking to eliminate initial margin requirements on interaffiliate derivatives transactions between derivatives dealing banks and their affiliates.  The proposal was issued by the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Federal Housing Finance Agency. 

In its letter to the agencies, Better Markets explains that the proposal would do each of the following:  

  1. Facilitate avoidance or evasion of U.S. statutory requirements in violation of a critical Congressional mandate;
  2. Reverse the Agencies’ own longstanding legal and policy views; and
  3. Implement unsupported regulatory changes with significant implications for the safety and soundness of U.S. financial institutions and the U.S. financial system. 

The 2008 financial crisis revealed systematic risk management failures at Wall Street’s largest financial institutions, especially failures to manage counterparty credit risks in the over-the-counter derivatives markets.  The consequence was exemplified by the near-failure of American International Group, Inc., where the spillover effects on other financial institutions—including every systemically important investment bank—essentially extorted the Agencies, other U.S. policymakers, and U.S. taxpayers to directly and indirectly spend, lend, commit, guarantee, pledge, assume, or otherwise put at risk tens of trillions of dollars in bailouts, facilities, and other extraordinary programs to benefit the very institutions that precipitated the worst economic downturn in generations.  Counterparty credit risk management has since become one of the most critical concerns of global regulators, motivating the 2009 G20 commitments to encourage and mandate central clearing of standardized derivatives and impose higher capital requirements on non-cleared derivatives. 

In 2011, the G20 added margin requirements for non-centrally cleared derivatives as a third pillar for managing counterparty credit risk.  By then, the Dodd-Frank Wall Street Reform and Consumer Protection Act already had implemented that commitment by requiring the Agencies to jointly adopt variation and initial margin requirements for all swaps and security-based swaps booked into prudentially regulated swap dealers and security-based swap dealers, if they are not cleared by a derivatives clearing organization or a clearing agency.  This proposal undermines that law and global commitment in a critical respect, which we also explained in our OpEd in the American Banker

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