The CFTC has proposed an amendment to the definition of "material swaps exposure" (MSE) in CFTC Regulation 23.151 by replacing "June, July and August of the previous calendar year" with "March, April and May of that year." The result of this change is that the period for calculating average aggregate notional amount (AANA) for determining whether a financial end user (FEU) has MSE would be March, April, and May of the year MSE is calculated for determining whether the CFTC IM requirements apply. (The CFTC notes that the calculation of MSE is precipitated by CFTC Regulation 23.161(a)(7), which requires a CSE to exchange IM with a counterparty that is an FEU with MSE beginning on September 1, 2021, and thereafter.)

The CFTC is proposing to further amend the MSE definition to set “September 1 of any year” as the determination date for MSE. Currently, the MSE for an FEU must be determined beginning on September 1, 2021, and subsequently, after the last phase of compliance, on January 1 of each year. The proposed amendment would change the date of determination of MSE, applicable after the last compliance phase, from January 1 to September 1. Because MSE triggers the applicability of the IM requirements for an FEU, requiring the CSE to post and collect IM with the FEU counterparty, the proposed amendment would effectively set the timing for compliance with the IM requirements at September 1 after the last phase of compliance with respect to uncleared swaps entered into by a CSE and an FEU with MSE.

These proposed amendments to the definition of MSE would have the effect of reducing the time frame that FEUs and their CSE counterparties would have to prepare for compliance with the IM requirements. Under the proposed amendment, for the last phase of compliance in 2021, the CSE and FEU would have only three months, as opposed to 12 under the current rules, because MSE would be determined using the AANA for the March, April, and May period of the current year (2021), as opposed to the June, July, and August period of 2020.

Also, under the proposal, the date for determining MSE for an FEU would be September 1 of each year, and the AANA calculation period for determining whether an FEU has MSE would be March, April, and May of such year. As a result, under the proposed amendment, an FEU with MSE and its CSE counterparty would have three months to prepare in advance of compliance with the IM requirements, whereas under the current rule, such parties have four months because MSE must be determined on January 1 based on the AANA for June, July, and August of the prior year.

This proposed amendment would have greater impact on Phase Six entities, coming into scope in the last phase of compliance, compared to those entities subject to compliance after the end of the last compliance phase. Nevertheless, the GMAC margin subcommittee report supported these changes because they would:

See Legal Update, CFTC Committee Adopts Uncleared Swap Margin Recommendations with Focus on IM for Small End Users and Separately Managed Accounts (SMAs).

The CFTC is proposing to replace the requirement to use daily average AANA during the three-month calculation period for determining MSE (daily AANA calculation method) with the use of average month-end AANA during the three-month calculation period (month-end AANA calculation method). In adopting the CFTC margin rules, the CFTC acknowledged that the use of the month-end AANA calculation method would be consistent with BCBS/IOSCO.

The CFTC expresses its "preliminary" view that switching from daily AANA calculations to month-end calculations for the purpose of determining MSE would likely have a limited impact on the protections provided by the CFTC margin rules and that the benefits of aligning with the BCBS/IOSCO framework and the approach of other major market jurisdictions outweigh concerns that the proposed month-end AANA calculation method may be subject to manipulation by market participants and may not account for certain products that are required to be included in the calculation.

According to the CFTC's Office of the Chief Economist (OCE), all but 22 of the entities that are above MSE under the current methodology would also be above MSE under the proposed methodology. In addition, there are 20 entities that would be in scope under the proposed methodology that would not be in scope under the current methodology. So the aggregate number of Phase Six entities under the current and proposed methodologies would, according to OCE, differ by two.

The CFTC is also proposing to allow CSEs to use the risk-based model IM calculation of a counterparty that is a CFTC-registered SD or MSP, as permitted by the CFTC in No-Action Letter 19-29 (the Cargill letter) subject to the following conditions, consistent with the Cargill letter:

For further details on the Cargill letter, see Legal Update, CFTC Issues No-Action Relief Permitting Swap Dealer to Use Certain Counterparty Initial Margin (IM) Models for IM Calculations.