MFA Letter to SEC on Proposed Capital, Margin, and Segregation Rules

MFA submitted a comment letter to the SEC on its proposed rules on “Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers”.  MFA emphasized the following recommendations to the SEC:

(i) the desirability of an internationally uniform set of margin requirements;

(ii) MFA’s preference for a single compliance date for imposition of margin requirements;

(iii) that the SEC mandate that security-based swap dealers (“dealers”) transfer variation margin to clients;

(iv) that dealers be permitted to use their internal models for determining risk under cross-product master netting agreements;

(v) that dealers be required to provide customers with the “basic functionality” of their internal margining models; 

(vi) that margin be tailored to the risk of specific products; and

(vii) that customers be able to hold their initial margin either at a tri-party custodian without the dealer suffering a capital penalty for permitting that and that customers have access to a segregation regime that permits customer-by-customer segregation of collateral.

Lofchie Comment:  What this letter implicitly makes clear is that many customers were better off in the pre-Dodd-Frank regime than they will be with the “protections” afforded by Dodd-Frank.  For example, the pre-Dodd-Frank regime allowed customers to (i) negotiate margin levels across a broad range of products, (ii) hold their initial margin at a third-party custodian without the swap dealer suffering a penalty, and (iii) negotiate for margin tied to the risk of specific products. 

Among the other problems pointed out by the letter are that the demands of the rules for high quality collateral may lead to a collateral squeeze and the swaps markets may lose their economic viability because of the high demands of the regulatory system. 

The the trigger that will expose many of the major problems in the regulation of swaps under Dodd-Frank is statutory not regulatory.  The “Lincoln Amendment” (Section 716 of Dodd-Frank) involves the push-out of swaps activities from banks.  Dealing in swaps is largely a credit activity, and when Congress requires that credit activity, which logically belongs in banks, to be done outside of banks, major problems follow.  One of these problems is that margin and capital requirements may be set at a level that is too high relative to ordinary risk (damaging customers and the economy) because, as the SEC pointed out in its capital proposals, non-bank dealers are more vulnerable to runs on liquidity.

View letter in full here (links externally to MFA website).

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