On July 22, the Commodity Futures Trading Commission adopted rules (Final Rules) that set minimum financial capital requirements for swap dealers (SDs) and major swap participants (MSPs) that are not subject to prudential regulation (each, a “Covered Swap Entity” or CSE). The capital requirements were originally proposed in 2016, as explained in more detail here.

The core financial requirement is capital equal to the greatest of $20 million or 8 percent (and in some cases, 2 percent) of the initial margin required on the CSE’s cleared and uncleared swaps, security-based swaps, futures and foreign futures, but the rules permit or require different types of CSEs to adopt different approaches to meeting these requirements.

  1. A CSE can generally elect one of three approaches to computing its regulatory capital:
    1. the “Bank-Based Approach,” which is based on maintaining minimum levels of common equity tier 1 capital, as defined under the rules for bank holding companies, or tier 2 capital (subject to certain limitations);
    2. the “Net Liquid Assets Approach,” which is based on having minimum net capital computed in accordance with the rules for futures commissions merchants (FCMs), registered broker-dealers, and security-based swap dealers; or
    3. the “Tangible Net Worth Capital Approach,” which is available to CSEs predominantly engaged in non-financial activities that are subsidiaries of parent entities that are commercial enterprises.
  2. A CSE that is an FCM must meet existing FCM net capital requirements (as amended by the Final Rules).
  3. An SD organized and domiciled outside the United States may follow the capital adequacy requirements of its home jurisdiction if the CFTC has made a capital comparability determination with respect to those non-US rules.
  4. An SD that is also a broker-dealer registered with the Securities and Exchange Commission and approved as an alternative net capital firm may simply comply with its existing SEC capital requirements.
  5. The only requirement applicable to a major swap participant is that the MSP must maintain a positive tangible net worth.

The Final Rules specify that a CSE must always meet any greater regulatory capital requirements imposed on it by any registered futures association of which it is a member, but the only such association currently in existence is the National Futures Association (NFA), which does not currently set capital requirements for SDs or MSPs. The specific eligibility and capital requirements are explained in further detail in the chart below.

Approaches SD Entities Equity Type The greatest of the following:

Net Liquid Assets Capital

 

Regulation 1.17


FCM Approach

SD – FCM Net Liquid Assets (Assets – Liabilities – Market Risk – Credit Risk) $20 million or $100 million if approved to use capital models
8% of the total customer and noncustomer cleared margin, plus an additional 2% of the total amount of a swap dealer’s initial margin on uncleared swaps
Amount of capital required by the NFA

Alternative Net Capital (ANC)

 

Regulation 1.17 and SEC Rule 15c3-1

SD- FCM- ANC Approved Firm Net Liquid Assets (Assets – Liabilities – Market Risk – Credit Risk) $5 billion tentative net capital (not discounted)
$6 billion early warning net capital (not discounted)
$1 billion Net Discounted Assets
8% of the total customer and noncustomer cleared margin, plus an additional 2% of the total amount of a swap dealer’s initial margin on uncleared swaps
Amount of capital required by the NFA

Net Liquid Assets Capital

 

SEC Rule 15c3-1 or 18a-1

SD – BDs

 

SD- BDs (OTC Derivatives Dealers)

 

SD – Non-Bank Subsidiaries of BHC

 

SD

Net Liquid Assets (Assets – Liabilities Market Risk – Credit Risk) $20 million
2% of the total
amount of a swap dealer’s initial margin on uncleared swaps
Amount of capital required by the NFA
Bank-Based Capital

SD – Non-Bank Subsidiaries of BHC

 

SD

Common Tier 1 Equity, Tier 1 or Tier 2, subject to limits $20 million
8% of risk-weighted-assets
8% of the total amount of a swap dealer’s initial margin on uncleared swaps
Amount of capital required by the NFA

Tangible Net Worth


Capital Approach

SDs – Non-financial Entities (15% test) Basic Equity (Assets-Liabilities- Goodwill) $20 million plus market and credit risk charges
8% of the total amount of a swap dealer’s initial margin on uncleared swaps
Amount of capital required by the NFA
MSPs MSP Equity ≥$0
Amount of capital required by the NFA

Note that this table is a modified version of a table that appears in the Final Rules.

The Final Rules also amend capital requirements for dually registered SDs and FCMs to provide specific capital deductions for market risk and credit risk for swaps and security-based swaps entered into by an FCM. The Final Rules also incorporate additional amendments, such as rules (1) permitting certain entities dually-registered with the SEC to file a Financial and Operational Combined Uniform Single Report (an SEC FOCUS Report) in lieu of CFTC financial reports; (2) requiring certain CFTC registrants to file notices of certain defined events; and (3) requiring notices of bulk transfers to be electronically filed with the CFTC within a defined period of time.

The rules take effect 60 days after publication in the Federal Register.

More information on the Final Rules is available here.

Katten is planning to publish an advisory providing more detailed coverage of the Final Rules.