CFTC changes rules for swap dealers

Following the adoption of final regulations in 2020, the Commodity Futures Trading Commission (CFTC) adopted changes to capital and financial reporting requirements for swap (SD) dealers that relied largely on prior no-action letters and interpretive guidance issued by CFTC employees.( 1)

Section 4s(e) of the Commodity Exchange Act (CEA) requires the CFTC to adopt minimum capital and margin requirements for SDs, and to that end, the CFTC issued final rules on September 15, 2020. These rules, adopted in Section 23 of the Act CFTC regulations, impose capital requirements on SDs that are not subject to the prudential regulator’s capital requirements (non-bank SDs) and detailed financial reporting, recordkeeping and notification requirements, including limited reporting requirements for SDs that are subject to the capital requirements of the Prudential Authority (bank SDs).

However, due to confusion surrounding these new requirements, the CFTC issued eight no-action and clarification letters in 2021 to help SDs better understand their reporting obligations. The policy rationale for the CFTC’s adoption of the amendments almost three years later, on April 30, 2024, was largely to codify CFTC Staff Letters 21-15 and 21-18, on which certain SDs were based, while adding clarity and detail so that the SDs could clearly demonstrate compliance with capital and financial reporting requirements.

These changes will primarily impact SDs that choose to demonstrate compliance with net capital requirements through a net tangible capital approach, and SDs for non-US banks.(2) Other SDs may be impacted by further clarification.

Changes for 2024

• Method based on tangible net capital — The CFTC has codified the guidance contained in CFTC Staff Letter 21-15, which clarifies that a non-bank SD may demonstrate that it has been “primarily engaged in non-financial activities” (using the two tests described below) either at the non-bank SD level or at the level SD non-bank consolidated level of the parent company.
• Non-bank SD reporting requirements and record keeping standards — The CFTC clarified that SD companies may use International Financial Reporting Standards (IFRS) instead of U.S. Generally Accepted Accounting Principles (US GAAP) when calculating net worth. The CFTC has also harmonized the deadlines for filing both general financial reports and supplemental disclosures for non-bank SDs that use the net tangible capital approach.
• SD Bank reporting — A CFTC-codified exemption from CFTC Staff Letter 21-18 that allows a bank’s SD to provide the CFTC with copies of financial statements required by and filed with an SD bank’s applicable prudential regulator in lieu of CFTC requirements. Foreign-based bank SDs may also file balance sheets and regulatory capital statements that meet their parent company’s requirements or, if dual-registered with the SEC, their SEC filings.
• Other issues — The CFTC adopted various other amendments clarifying reporting and financial requirements for SD. These include, but are not limited to, clarifications on certain reporting requirements, updates to forms and how certain instruments can be used to calculate net capital.

Each of these changes is described in more detail below.

Method based on tangible net capital

Nonbank SDs can demonstrate compliance with the CFTC capital requirements through a “net tangible capital approach” under CFTC Regulation 23.101, but only if the SD “is ​​primarily engaged in nonfinancial activities.” To “engage primarily in non-financial activities” within the meaning of CFTC Regulation 23.100, an SD corporation must have demonstrated that in either of the two most recently ended fiscal years (1), its consolidated annual gross financial revenues were less than 15 percent of SD’s consolidated gross revenues in that year tax purposes (the “15 percent of revenue test”) and (2) SD’s consolidated total financial assets represented less than 15 percent of SD’s consolidated total assets (the “15 percent of assets test”). However, it was unclear whether SD, or SD’s parent entity, would have to demonstrate compliance with these tests.

CFTC Staff Letter 21-15 explains that in order to meet the 15 percent revenue and asset tests, a non-bank SD may demonstrate compliance with these tests at or the non-bank SD level or the final consolidated SD level of the non-bank parent entity. In its staff letter, the CFTC clarified that many entities may create non-bank SDs to “segregate” certain financial activities, such as swaps, from the entity’s other commercial activities. However, the definition of “principally engaged in non-financial activities” in CFTC Regulation 23.100 does not clearly explain at what levels the 15 percent revenue and asset tests may apply.

The 2024 CFTC Amendments codified this guidance by expressly allowing both the revenue and asset tests to be met at the consolidated parent level of a nonbank SD.

Non-bank SD reporting requirements and record keeping standards

There was also uncertainty as to what accounting standards non-bank SD companies would be able to use when calculating their measurable net worth. Regulation 23.100 referred to US GAAP only when calculating net measurable value, but many non-bank SD companies use IFRS instead of US GAAP. In Staff Letter 21-15, the CFTC acknowledged that the new regulations did not address the inconsistency that could result from maintaining current books and records and filing financial statements in accordance with IFRS while still requiring the use of US GAAP to calculate quantifiable net worth. As a result, the CFTC clarified that non-bank SD companies that use IFRS to calculate measurable net worth, provided that they also maintain books and records and file financial statements in accordance with IFRS.

The CFTC initially required nonbank SD companies that used the net tangible capital approach to file certain financial disclosures monthly and only required general financial reporting quarterly. In the April 2024 amendments, the CFTC codified the guidance contained in CFTC Staff Letter 21-15, which clarified that “nonbank SD companies using the net tangible capital approach may submit the financial information required under Appendix B to Subpart E of Part 23 on a quarterly basis, not monthly.” This amendment harmonized the deadlines for filing both general financial statements and additional information required by the CFTC.

SD Bank reporting

Numerous SD banks requested an exemption from CFTC 23.105(p), which required SD banks to report financial information within 30 calendar days of the end of a quarter and was contrary to the requirements of applicable prudential regulators. As a result, the CFTC clarified in Staff Letter 21-18 (later expanded by CFTC Staff Letter 23-11) that it will not take enforcement actions against SD banks that provide the CFTC with copies of financial statements required by the SDs filed with the bank, the appropriate authority prudential supervision, instead of complying with CFTC Regulation 23.105(p). The CFTC also provided no-action relief for:

• SD of banks domiciled abroad that file balance sheets and regulatory capital information statements in accordance with applicable home country requirements; AND
• SDs of foreign-domiciled banks that are dual-registered with the SEC and file comparable SEC-required financial statements and schedules with the CFTC.

The CFTC has largely codified all of the above non-action waivers contained in Staff Letter 21-18, but has amended requiring any bank SD cards dually registered with the SEC as a securities-based swap dealer (SBSD) in order to file a Form X-17A-5 FOCUS Report Part IIC with the SEC in lieu of the CFTC-required tender report. Commissioner Caroline Pham, however, noted that the CFTC “extended the deadline to 35 days to allow dual registrants to file reports on the same day as the SEC, (but) the Commission should have set the deadline on the date of Form X-17A-5 Part IIC FOCUS Report is to be filed with the (SEC)” to avoid a potential conflict in the future if the SEC changes its FOCUS Report filing deadlines.

Other issues

As part of its efforts to update capital and financial reporting requirements for SD, the CFTC also adopted the following changes:

• It is clarified that additional Annexures 1-4 included in Annexure B are to be provided by all non-bank SD Cards and must be submitted on a monthly or quarterly basis, as applicable.
• Clarified that net equity subordinated debt is subject to eligibility assessment by the Commission or the National Futures Association.
• References in the 2020 Final Rule have been edited to provide clarity on applicable market and credit risk charges, both for SDs using internal models that elect the bank-based capital approach in accordance with Commission Regulation 23.102 and SDs that do not choose the bank-based capital method and do not decide to use it as internal models in Commission Regulation 23.103.
• Clarified that SDs that are also registered with the SEC as broker-dealers, or SBSDs, must file the financial reports required to be filed with the SEC, and SDs also registered as futures traders must file Form 1-FR-FCM.
  • SDs that are also registered as FCMs must include an additional accountant’s report on material irregularities.
• Amended the applicable public disclosure of unaudited financial condition information in Commission Regulation 23.105(i)(1)(i) to include footnote disclosures and clarified that the amounts of regulatory capital and required minimum regulatory capital must be publicly disclosed in both Commission Regulations 23.205(i)(1) and (2) do not need to be attached as an attachment or in any particular format.
• Amended Form 1-FR-FCM to comply with changes adopted in the 2020 Final Rules regarding net FCM capital requirements, including the addition of reporting lines for market charges and credit risk charges for swaps and a 2 percent margin amount risks in the required net capital for FCM, which are also SD.

Effective date and compliance date

Although the rule’s effective date is 30 days after publication in the Federal Register, its compliance date is September 30, 2024. This additional deadline is intended to allow SD time to make corrections and will apply to all financial statements with an “as of” reporting date. September 30, 2024 or later.

(1) Although the changes also apply to major swap participants (MSPs), there are currently no such MSPs. As a result, this article focuses on SD.

(2) A complete list of provisionally registered swap dealers can be found at https://www.cftc.gov/IndustryOversight/Intermediaries/SDs/index.htm.