Regulators propose easing margin requirements on swaps

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WASHINGTON — Federal regulators are proposing to repeal the requirement that banks collect initial margin from an affiliate engaged in an intracompany swaps deal.

The plan approved by the Federal Deposit Insurance Corp. Tuesday would ease the agencies' 2015 swaps margin rule by only requiring banks to set aside initial funds to cover defaults in deals involving external swaps participants.

“Exchanging initial margin with unaffiliated counterparties is an important protection for [depository institutions] against the risk of counterparty default,” FDIC Chairman Jelena McWilliams said in prepared remarks Tuesday. “However, inter-affiliate transactions, conducted among entities that are part of the same banking organization, are often used by banks for internal risk management purposes.”

McWilliams said initial margin collateral is “locked up, frozen, and available only in the event that the affiliate fails — a scenario that has become much less likely” in intervening years.

The 2015 rule, mandated by the Dodd-Frank Act, required that banks trading derivatives among both affiliates and external parties set aside funds in the event one party defaults. The rules trace back to the aftermath of the 2008 crisis, when unregulated derivatives trading was cited as one of the contributing factors.

Banks have lobbied hard for the rule to be defanged. According to one industry estimate, banks had effectively frozen $39.4 billion in collateral for inter-affiliate derivative trades that could have been used elsewhere by the end of 2018.

Industry groups cheered the proposal Tuesday. (Other regulatory agencies were expected to follow the FDIC board in advancing the plan.)

“While the details must be carefully reviewed, this proposal reflects common-sense reforms that aim to help level the playing field for domestic banks, lower the costs for end-users, and promote safety and soundness within the global financial system,” said Financial Services Forum President and CEO Kevin Fromer in a statement.

The Bank Policy Institute hailed the proposal for encouraging “prudent internal risk management practices,” and the American Bankers Association called the move a “sensible change [that] will ensure that U.S. rules are consistent with international standards.”

But Martin Gruenberg, the former FDIC chairman and current board member, voted against the proposed rule, saying it weakened a key post-crisis requirement.

“This would remove an important prudential protection from the bank and expose the bank to one of the most significant risks identified in the financial crisis,” he said. “Although there is value in centralized risk management of the banking organization, it is not a substitute for actual loss absorbing collateral held by the bank as a buffer against the risk of an inter-affiliate derivative relationship.”

The proposal would still retain the requirement that "variation" margin must be exchanged in affiliate transactions.

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