CFTC Issues No-Action Relief Permitting Swap Dealer to Use Certain Counterparty Initial Margin (IM) Models for IM Calculations | Practical Law

CFTC Issues No-Action Relief Permitting Swap Dealer to Use Certain Counterparty Initial Margin (IM) Models for IM Calculations | Practical Law

The CFTC issued No-Action Letter 19-29, permitting Cargill Incorporated, a limited-purpose swap dealer (SD) registered with the CFTC, to use the risk-based model calculations of its SD counterparties to determine the initial margin (IM) amount that must be collected by Cargill from these SD counterparties, as well as to determine whether the counterparties' $50 million IM threshold has been exceeded.

CFTC Issues No-Action Relief Permitting Swap Dealer to Use Certain Counterparty Initial Margin (IM) Models for IM Calculations

by Practical Law Finance
Published on 23 Jan 2020 • USA (National/Federal)
The CFTC issued No-Action Letter 19-29, permitting Cargill Incorporated, a limited-purpose swap dealer (SD) registered with the CFTC, to use the risk-based model calculations of its SD counterparties to determine the initial margin (IM) amount that must be collected by Cargill from these SD counterparties, as well as to determine whether the counterparties' $50 million IM threshold has been exceeded.
On December 19, 2019, the CFTC issued No-Action Letter 19-29 (No-Action 19-29), permitting Cargill Incorporated, a limited-purpose swap dealer (SD) registered with the CFTC and subject to the CFTC's margin requirements for uncleared swaps, to use the risk-based model calculations of its SD counterparties, instead of its own method, to determine both:
  • The initial margin (IM) amount that must be collected by Cargill from these SD counterparties.
  • Whether the $50 million IM threshold, above which registered SDs and major swap participants (MSPs) (collectively, covered swap entities, or CSEs) are required to post or collect IM and to satisfy certain documentation requirements relating to collection, posting, and custody of IM, has been exceeded.
Cargill engages in swap dealing activities through Cargill Risk Management (CRM), a limited-purpose SD registered with the CFTC pursuant to a limited purpose designation order.
CFTC rules require that CSEs collect and post IM with SDs, MSPs, and financial end users with material swaps exposure (MSE). CSEs have the option to calculate the IM amount by using either a risk-based model, after receiving written approval from the CFTC or registered futures association, or the standardized table provided for in CFTC Regulation 23.154(c)(1) (see Practice Note, US Derivatives Regulation: Margin Collection and Exchange Requirements for Uncleared Swaps: Initial Margin (IM) Under the Final CFTC Margin Rules).
According to Cargill in its request for relief, it intends to use the standardized table method for most of its swaps, which mostly involve non-SD counterparties. Cargill states, however, that large SDs generally calculate IM using the ISDA® Standard Initial Margin Model (SIMM™) (see Practice Note, Global Margin Compliance for Uncleared Swaps: The ISDA Standard Initial Margin Model (SIMM™)). According to Cargill, this poses the following issues:
  • Using the standardized tables to calculate IM could require Cargill's SD counterparties to post a higher amount of IM than would be required by the SIMM, and such SD counterparties may choose not to trade with Cargill.
  • The higher amount of IM could also cause the $50 million IM threshold to be reached sooner.
  • Though Cargill could develop a risk-based model for swaps with SD counterparties, this would impose a "disproportionate burden" on Cargill since its swaps business is highly specialized and focuses mainly on commodities.
The CFTC notes that it is expected that Cargill will begin exchanging IM in the what is currently the last phase (current Phase Five) of the compliance schedule for the IM requirements (see Practice Note, US Derivatives Regulation: Margin Collection and Exchange Requirements for Uncleared Swaps: Compliance Dates for Initial Margin Requirements).
No-Action 19-29 states that the Division of Swap Dealer and Intermediary Oversight (DSIO) will not recommend that the CFTC take an enforcement action against Cargill if either:
  • Cargill collects IM from an SD counterparty as calculated by the SD counterparty.
  • Cargill uses the SD counterparty's IM calculations to determine whether the $50 million IM threshold amount has been exceeded.
The no-action relief is subject to the following conditions:
  • Cargill may only use an SD counterparty's IM calculation if the calculation was computed using a risk-based IM model that has been approved by either the CFTC, the National Futures Association (NFA), or a US bank prudential regulator (referred to as an approved IM calculation method).
  • Cargill and the SD counterparty must have a written agreement that the approved IM calculation method:
    • will be used to determine the amount of IM to be collected from such SD counterparty;
    • will be used to determine whether the $50 million IM threshold has been exceeded; and
    • will be provided to Cargill in such manner and time frame that will allow Cargill to comply with applicable CFTC regulations.
  • Cargill may only use an SD counterparty's IM calculation if the swaps entered into between Cargill and the SD counterparty are for the purposes of hedging Cargill's exposure to non-SD counterparties.
  • To the extent Cargill uses an SD counterparty's approved IM calculation method, Cargill:
    • must monitor the approved IM calculation method's output to ensure sufficiency of the calculated IM amounts;
    • must keep track of "exceedances" or price movements above the amounts of IM generated by the approved IM calculation method;
    • if the exceedances indicate the approved IM calculation method is not meeting relevant regulatory standards, Cargill must take steps to ensure compliance with its risk-management obligations and address the exceedances with the SD counterparty;
    • must provide written notice to the National Futures Association (NFA) and CFTC of any adjustments or enhancements that are applied to the amount of IM calculated pursuant to the approved IM calculation method;
    • must have an independent risk-management unit perform an annual review of the approved IM calculation method's output; and
    • must produce, upon request, records relating to the monitoring of the approved IM calculation method's output and any other records demonstrating Cargill's ongoing monitoring.
  • As part of its required internal risk-management procedures (see Practice Note, US Derivatives Regulation: Internal Business Conduct (IBC) Rules for Swap Dealers and MSPs: Internal Compliance Duties for SDs and MSPs), Cargill must independently monitor on an ongoing basis credit risk, including potential future exposure associated with uncleared swaps subject to the CFTC margin rules, to determine, among other things, whether Cargill is approaching the $50 million IM threshold with respect to a counterparty.