On December 2, 2016, the Commodity Futures Trading Commission (“CFTC”) proposed rules establishing capital requirements for swap dealers (“SDs”) and major swap participants (“MSPs”). The CFTC’s proposed capital rules would cover those swap dealers and major swap participants that are not subject to prudential regulation. Chairman Timothy Massad noted in his attached statement that the proposed rule attempts to recognize the different types of firms that act as SDs and allow for those differences in setting the capital requirements for each. Commissioner J. Christopher Giancarlo stated that his support of the proposed rule was predicated on the inclusion of several questions that he hopes market participants will specifically address in their comments on the rule. Commissioner Giancarlo’s questions relate to his ongoing concern that capital requirements imposed on financial institutions have worked to constrain markets instead of supporting market strength and stability. His questions also address the scope of the proposed rule and the appropriateness of the proposed capital model review and approval process. Market participants seeking to comment on the rule should focus on responding to the questions raised by Commissioner Giancarlo, as comments addressing these points likely will have a significant impact in shaping the final rule.

Under the CFTC’s proposal, the capital requirements applicable to an entity would depend on the characteristics of that entity. An SD that is also a futures commission merchant (“FCM”) would be required to meet the capital requirements applicable to FCMs.

SDs that are not also FCMs could elect to use the “bank-based approach” or the “net liquid assets approach” to determine minimum capital requirements. SDs that are “not predominantly engaged in financial activities,” i.e., SDs with financial assets that are not more than 15% of its consolidated assets and with revenues from financial activities that are not more than 15% of its consolidated revenues, would have the option of using a “tangible net worth approach.”

In conjunction with the proposal, Commissioner J. Christopher Giancarlo issued a statement requesting comment and raising concerns about several specific aspects of the proposal:

• Bank-based approach: SD required to maintain a minimum level of capital at least equal to the greatest of: (1) $20 million of common equity tier 1 capital; (2) common equity tier 1 capital equal to or in excess of 8% its risk-weighted assets; (3) common equity tier 1 capital equal to or greater than 8% of the margin required on the SD’s cleared and uncleared swaps, security-based swaps, futures and foreign futures positions; or (4) the amount of capital required by the National Futures Association (“NFA”).

• Net liquid asset approach: SD required to maintain a minimum level of capital at least equal to the greatest of: (1) $20 million; (2) 8% of the margin required on the SD’s cleared and uncleared swaps, security-based swaps, futures and foreign futures positions; or (3) the amount of capital required by the NFA.

• Tangible net worth approach: SD required to maintain a minimum level of capital at least equal to the greatest of: (1) $20 million plus market and credit risk charges on its swaps positions that are related to its dealing activities; (2) 8% of the margin required on the SD’s cleared and uncleared swaps, security-based swaps, futures and foreign futures positions; or (3) the amount of capital required by the NFA.
  The CFTC further proposes allowing SDs to use internal models to calculate their regulatory capital, subject to prior approval by either the CFTC or the NFA. Finally, MSPs would be required to maintain a positive tangible net worth, or the minimum amount of capital required by the NFA.

Commissioner Giancarlo’s statement is especially significant because, as the sole Republican currently on the Commission, he likely will be named the Acting Chair either after Chairman Massad’s term expires in April 2017 or if Chairman Massad steps down earlier upon the Inauguration of President-elect Trump.

• Smaller swap dealers: Commissioner Giancarlo is “particularly interested how the proposed capital requirements will affect smaller swap dealers and how much additional capital they may have to raise to comply with the proposal.” Commissioner Giancarlo also is requesting comment on the impact of the proposal on potential new registrants if the swap dealer de minimis falls to $3 billion.

• Scope: Commissioner Giancarlo raises several questions about the “broad scope” of the proposal. For example, the proposed capital minimum requirements are based upon 8% of the margin on the SD’s cleared and uncleared swaps, security-based swaps, futures and foreign futures positions. However, the Commodity Exchange Act only cites the risk of uncleared swaps in setting standards for capital.

• Model approval: Commissioner Giancarlo raises concerns about the proposal that the NFA review and approve the internal models of SD’s. Specifically, Commissioner Giancarlo worries that, given “the large number of models that will need to be reviewed, the complexity of those models and the practical resource constraints at the NFA, I am concerned that the proposed process will be unworkable.”