Prudential Regulators Are First to Finalize Uncleared Swap Margin Rules

While the rules provide some clarity, the global market still awaits the finalization of the CFTC and the European margin rules.

With the clock ticking on the countdown to finalization of uncleared swap margin rules mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), the Prudential Regulators1 were the first to issue final rules at the end of October,2 establishing minimum margin requirements for uncleared swaps and uncleared security-based swaps (the PR Margin Rules).3 The PR Margin Rules apply to swap dealers, security-based swap dealers, major swap participants and major security-based swap participants that are subject to supervision by the Prudential Regulators, such as bank holding companies and insured depository institutions (collectively referred to herein as PR Covered Swap Entities). In an effort to address industry concerns, the Prudential Regulators eased certain aspects of their 2014 proposed rules (the PR Proposed Margin Rules),4 for example lessening collateral requirements, expanding the collateral eligible to be posted for variation margin in transactions with financial end-users, narrowing the cross-border reach of the rules, raising the initial margin threshold amount and providing some accommodations for inter-affiliate uncleared swaps. These changes bring the rules (including the compliance period) into closer alignment with the recommended international guidelines for uncleared margin published by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) in September 2013.5 Compliance with the rules will be phased in over a period of time beginning in September 2016. Though the finalization of the PR Margin Rules is a key piece of the puzzle with respect to the margin framework for uncleared swaps and uncleared security-based swaps, market participants are still waiting for the US Commodity Futures Trading Commission (the CFTC), the US Securities and Exchange Commission (the SEC) and the European regulators to finalize their respective margin rules for uncleared derivatives.

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Latham & Watkins Financial Institutions Group November 20, 2015 | Number 1896

Prudential Regulators Are First to Finalize Uncleared Swap
Margin Rules
While the rules provide some clarity, the global market still awaits the finalization of the
CFTC and the European margin rules.
With the clock ticking on the countdown to finalization of uncleared swap margin rules mandated under
the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), the Prudential
Regulators1 were the first to issue final rules at the end of October,2 establishing minimum margin
requirements for uncleared swaps and uncleared security-based swaps (the PR Margin Rules).3 The PR
Margin Rules apply to swap dealers, security-based swap dealers, major swap participants and major
security-based swap participants that are subject to supervision by the Prudential Regulators, such as
bank holding companies and insured depository institutions (collectively referred to herein as PR Covered
Swap Entities). In an effort to address industry concerns, the Prudential Regulators eased certain aspects
of their 2014 proposed rules (the PR Proposed Margin Rules),4 for example lessening collateral
requirements, expanding the collateral eligible to be posted for variation margin in transactions with
financial end-users, narrowing the cross-border reach of the rules, raising the initial margin threshold
amount and providing some accommodations for inter-affiliate uncleared swaps. These changes bring the
rules (including the compliance period) into closer alignment with the recommended international
guidelines for uncleared margin published by the Basel Committee on Banking Supervision (BCBS) and
the International Organization of Securities Commissions (IOSCO) in September 2013.5 Compliance with
the rules will be phased in over a period of time beginning in September 2016. Though the finalization of
the PR Margin Rules is a key piece of the puzzle with respect to the margin framework for uncleared
swaps and uncleared security-based swaps, market participants are still waiting for the US Commodity
Futures Trading Commission (the CFTC), the US Securities and Exchange Commission (the SEC) and
the European regulators to finalize their respective margin rules for uncleared derivatives.
Overview
I. Summary
A. PR Margin Rules
B. Exempted End-Users
II. Margin Requirements
A. Minimum Transfer Amount
B. Initial Margin Requirements
1. Posting and Collecting Initial Margin
2. Calculating Initial Margint
C. Variation Margin Requirements
D. Collecting Margin from End-Users
III. Collateral
A. Market Value and Eligibility of Collateral
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B. Collateral Segregation
C. Collateral Valuation
IV. Netting Arrangements and Retroactive Application
A. Eligible Master Netting Agreements
B. No Retroactive Application to Previously Executed Uncleared Swaps
V. Documentation
A. Swap Documentation
B. Approved Proprietary Margin Models
VI. Cross-Border Application
A. Relevant Definitions
B. Substituted Compliance
VII. Phased-in Compliance Period
A. Calculating Average Daily Aggregate Notional Amount
B. Ongoing Compliance Obligations
VIII. EU Margin Rules and Cross-Border Issues
I. Summary
A. PR Margin Rules
The Prudential Regulators first proposed their margin rules in 2011. They then reproposed the rules in
September 2014, following the publication by BCBS and IOSCO, at the direction of the Group of Twenty
(G-20), of international standards for margin requirements for non-centrally cleared derivatives (the
International Standards). The International Standards were intended to reduce the opportunity for
regulatory arbitrage by creating an international framework for uncleared swaps that regulators could use
as a guide to frame their respective margin rules.6 European regulators also reproposed their respective
margin requirements for uncleared derivatives (the EMIR Proposed Margin Rules).7 Prompted by market
demand for more time and given the lack of finalized rules in both the US and abroad, in March 2015
BCBS and IOSCO revised the compliance timeline under the International Standards to recommend
delaying effectiveness of margin rules by nine months.8
Following the recommended timeline of BCBS and IOSCO, the PR Margin Rules will be phased in
beginning in September 2016, with the highest-volume dealers that are PR Covered Swap Entities
becoming subject to initial margin (IM) and variation margin (VM) requirements first. All market
participants, other than commercial end-users and certain exempted small financial institutions, will be
required to post VM by March 2017. Market participants subject to IM requirements will become subject to
the rules in phases, with the final phase requiring the posting of IM by all such market participants by
September 1, 2020.
The PR Margin Rules generally provide that:
• PR Covered Swap Entities entering into uncleared swaps with a person registered (i) with the
CFTC as a swap dealer (SD) or a major swap participant (MSP) or (ii) with the SEC as a security-
based swap dealer (SBSD) or major security-based swap participant (MSBSP) (SDs, MSPs,
SBSDs and MSBSPs collectively referred to herein as Swap Entities),9 or with Financial End-
Users10 with Material Swaps Exposure (defined below), must collect and post IM11 and VM12 on a
daily basis.
• PR Covered Swap Entities entering into uncleared swaps with Financial End-Users which do not
have Material Swaps Exposure must collect and post daily VM, but will not be required to post or
collect IM.
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• PR Covered Swap Entities are not required to post or collect IM or VM with respect to uncleared
swap transactions entered into with commercial end-users and certain small financial institutions.
• For purposes of portfolio margining, counterparties may enter into master netting arrangements
that separately account for pre- and post-compliance date positions.
• A more limited cross-border reach than under the PR Proposed Margin Rules.
• PR Covered Swap Entities must collect IM from their affiliates, but do not have to post IM unless
the affiliate is also a PR Covered Swap Entity. VM must be both collected and posted for inter-
affiliate swaps.
• For purposes of these rules, “Affiliate” is defined with a bright-line test, which provides greater
legal certainty than under the PR Proposed Margin Rules, in particular for purposes of
determining Material Swaps Exposure and IM Threshold Amount (defined below).
• IM must be segregated with independent, non-affiliate custodians.
• For purposes of calculating IM, PR Covered Swap Entities may use approved proprietary margin
models instead of the standardized margin schedules provided by the Prudential Regulators in
the PR Margin Rules.
The PR Margin Rules will ultimately need to work together with the CFTC13 and SEC margin rules, which
have not yet been adopted, and with the rules of foreign regulators. The CFTC margin rules will apply to
registered SDs and MSPs that are not subject to prudential banking regulation, and the SEC margin rules
will apply to registered SBSDs and MSBSPs that are not subject to prudential banking regulation, such as
foreign banks without a presence in the United States (CFTC Covered Swap Entities and SEC Covered
Swap Entities, respectively, and, together with PR Covered Swap Entities, Covered Swap Entities). The
CFTC has recently stated that it will adopt final rules in the near future. We expect the final rules to be
substantially similar to the PR Margin Rules and, like the PR Margin Rules, generally to align with the
International Standards. As a practical matter, the application of the PR Margin Rules or the CFTC margin
rules in transactions with financial and non-financial end-users will turn on the regulated status of the
bank/financial institution counterparty. Note that the SEC likewise has not yet finalized its uncleared
security-based swap margin rules, which have been in proposed form since November 2012.14
Except where otherwise noted, we have used the term “uncleared swaps” herein to encompass both (i)
swaps15 that are not cleared by either a derivatives clearing organization16 registered with the CFTC or by
a clearing organization exempted from registration pursuant to the Commodity Exchange Act17 and (ii)
security-based swaps18 that are not, directly or indirectly, submitted to and cleared by a clearing agency19
that is either registered with the SEC or that is exempted from registration pursuant to the Securities
Exchange Act of 1934.20
B. Exempted End-Users
On January 12, 2015, the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA) was
signed into law.21 Title III of TRIPRA amends certain provisions of the Dodd-Frank Act to exempt certain
counterparties from the IM and VM requirements for uncleared swaps. Specifically, TRIPRA prohibits
applying any margin requirements promulgated under the Dodd-Frank Act to uncleared swaps with any of
the following counterparties (collectively referred to herein as Exempted End-Users), so long as such
counterparty is using the uncleared swaps to hedge commercial risk:
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• Commercial end-users, including treasury affiliates acting as agent
• Financial institutions (i.e., small banks, savings associations, Farm Credit System institutions, credit
unions) with total assets of US$10 billion or less and certain financial cooperatives hedging the risks
associated with originating loans for their members22
Pursuant to TRIPRA, the Prudential Regulators published, concurrently with the PR Margin Rules, an
interim final rule (the Interim Final Rule) exempting from the PR Margin Rules certain uncleared swaps
and uncleared security-based swaps entered into with Exempted End-Users. The Interim Final Rule is
scheduled to go into effect on April 1, 2016. The Prudential Regulators have requested comment on the
Interim Final Rule by January 31, 2016.23 We would expect the Interim Final Rule to be finalized in
substantially similar form.
II. Margin Requirements
A. Minimum Transfer Amount
The minimum transfer amount below which a PR Covered Swap Entity need not collect or post margin
pursuant to the PR Margin Rules with respect to a particular counterparty has been set at US$500,000
(calculated in the aggregate taking into account all IM and VM required under the PR Margin Rules with
respect to such counterparty). This amount has been lowered from US$650,000, the original amount
proposed by the Prudential Regulators in September 2014.24
B. Initial Margin Requirements
1. Posting and Collecting Initial Margin
The PR Margin Rules require that a PR Covered Swap Entity collect IM, with respect to any uncleared
swap from a counterparty that is either (i) a Financial End-User with Material Swaps Exposure or (ii) a
Swap Entity, in an amount that is no less than the greater of either:
• Zero, and
• The IM collection amount (discussed further below) for such uncleared swap, less the IM Threshold
Amount (defined below) (not including any portion of the IM Threshold Amount already applied by the
PR Covered Swap Entity or its Affiliates to other uncleared swaps with the applicable counterparty or
its Affiliates), as applicable.
Further, the PR Margin Rules require that a PR Covered Swap Entity post IM with respect to any
uncleared swap to a counterparty that is a Financial End-User with Material Swaps Exposure, in an
amount that is at least as large as what the PR Covered Swap Entity would be required to collect under
the PR Margin Rules.25 The PR Covered Swap Entity will also be required to post margin to CFTC
Covered Swap Entities and SEC Covered Swap Entities. However, the amount to be posted to these non-
prudentially regulated Swap Entities by PR Covered Swap Entities will be determined under the CFTC or
SEC margin requirements (as applicable) which will govern the collection of margin by CFTC Covered
Swap Entities and SEC Covered Swap Entities, respectively, in instances when they are facing PR
Covered Swap Entities.
Material Swaps Exposure. Under the PR Margin Rules, a Financial End-User has “Material Swaps
Exposure” if such entity and its Affiliates (defined below), in the aggregate, have an average daily
aggregate notional amount of uncleared swaps, uncleared security-based swaps, foreign exchange (FX)
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forwards26 and FX swaps27 with all counterparties for June, July and August of the previous calendar year
that exceeds US$8 billion (calculated only for business days). The PR Proposed Margin Rules originally
provided for an exposure calculation in excess of US$3 billion. The increase in the exposure amount
further aligns with the recommended amount of €8 billion under the International Standards.28 The PR
Margin Rules provide for the following adjustments in calculating a Financial End-User’s Material Swaps
Exposure:
• Inter-affiliate transactions need only be counted once.
• Swaps exempt from the PR Margin Rules by virtue of the Interim Final Rule (i.e., uncleared swaps
entered into with Exempted End-Users) should not be included in the calculation.29
Initial Margin Threshold Amount. Rather than the US$65 million proposed in the PR Proposed Margin
Rules, the Prudential Regulators have lowered the IM Threshold Amount under the PR Margin Rules to
mean an aggregate credit exposure of US$50 million resulting from all uncleared swaps and uncleared
security-based swaps between (i) a PR Covered Swap Entity or any of its Affiliates (defined below) and
(ii) a counterparty or any of its Affiliates. The Interim Final Rule would exclude from this calculation any
uncleared swap entered into with Exempted End-Users. The reduction in the IM Threshold Amount is
consistent with the International Standards. The IM Threshold Amount may be allocated among entities
within a consolidated group at the agreement of the PR Covered Swap Entity and the counterparties, but
the total must remain below US$50 million on a combined basis.30
Inter-affiliate Swaps. The PR Margin Rules require a PR Covered Swap Entity to collect IM from its
Affiliates (defined below) with respect to any inter-affiliate uncleared swap, but do not require such PR
Covered Swap Entity to post IM to its Affiliates (other than Affiliate counterparties that are also PR
Covered Swap Entities). A PR Covered Swap Entity will, however, still be required to calculate the
amount that it would have been required to post to an Affiliate in respect of its inter-affiliate uncleared
swaps with such Affiliate, and provide that information to such Affiliate on a daily basis.31 Precisely how
the CFTC and the SEC finalize their respective margin rules will determine the scope of this inter-affiliate
relief. If the inter-affiliate relief under the to-be-finalized CFTC and SEC margin rules is similar, then the
resulting inter-affiliate exemption would be limited to relief from the posting of IM by any Swap Entity to an
Affiliate Financial End-User counterparty with Material Swaps Exposure.
• IM Threshold Amount. With respect to uncleared swaps entered into by a PR Covered Swap Entity
and its Affiliate, the IM Threshold Amount is equal to an aggregate credit exposure of US$20 million
resulting from all uncleared swaps between such PR Covered Swap Entity and such Affiliate. Any
uncleared swaps entered into with an Affiliate that qualifies under the Interim Final Rule would be
excluded from this calculation.32
Affiliates. In an important revision to the PR Proposed Margin Rules, the Prudential Regulators
abandoned the control-based approach taken under the proposal, and instead apply a bright-line test to
the definition of “Affiliate,” whereby a company is considered an “Affiliate” of another company under any
of the following conditions:
• Either company consolidates the other on financial statements prepared in accordance with US
Generally Accepted Accounting Principles, the International Financial Reporting Standards or other
similar standards (referred to collectively herein as Accounting Standards).
• Both companies are consolidated with a third company on a financial statement prepared in
accordance with Accounting Standards.
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• For a company that is not subject to Accounting Standards, such consolidation would have occurred if
such Accounting Standards had applied.
• The applicable Prudential Regulator has determined that such company is an Affiliate of such other
company, based on such Prudential Regulator’s conclusion that either company provides significant
support to, or is materially subject to the risks or losses of, the other company.33
The “Affiliate” concept is present throughout the PR Margin Rules, including with respect to IM Threshold
Amount, Material Swaps Exposure and special considerations for inter-affiliate uncleared swaps.
Abandoning the proposed control test for this bright-line accounting-based approach eliminates legal
uncertainty regarding calculating IM Threshold Amount and Material Swaps Exposure on an aggregate
basis under the PR Margin Rules.34 Moreover, as a practical effect, the move away from a control
standard creates an objective standard for funds and other investment structures which were potentially
going to be subject to IM posting requirements due to the uncertainties in the proposed control-based
approach.
2. Calculating Initial Margin
A PR Covered Swap Entity may calculate its minimum IM amount under the PR Margin Rules in one of
two ways: (i) by using a standardized margin schedule (as set out in Appendix A of the PR Margin Rules
and reproduced below), which allows for certain types of netting and offsetting of exposures; or (ii) using
an internal margin model that satisfies the PR Margin Rules criteria and that has been approved by the
Prudential Regulator for such PR Covered Swap Entity (an approved proprietary margin model).
Standardized Margin Schedule. The Prudential Regulators have adopted as proposed the following
standardized minimum gross IM requirements for uncleared swaps, as divided by swap asset class:35
Asset Class Gross IM (% of Notional Exposure)
Credit
0-2 year duration 2
2-5 year duration 5
5+ year duration 10
Commodity 15
Equity 15
FX/Currency 6
Cross-Currency Swaps36
0-2 year duration 1
2-5 year duration 2
5+ year duration 4
Interest Rate
0-2 year duration 1
2-5 year duration 2
5+ year duration 4
Other 15

• Eligible Master Netting Agreements. If the standardized margin schedule is being used to calculate IM
for multiple uncleared swaps that are subject to an Eligible Master Netting Agreement (defined
below), the amount of IM that must be collected or posted (as applicable) by the PR Covered Swap
Entity under the PR Margin Rules is determined according to the following calculation:
IM = ( 0.4 x Gross IM ) + ( 0.6 x Net-to-Gross Ratio x Gross IM )37
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Approved Proprietary Margin Models. The PR Margin Rules permit a PR Covered Swap Entity to
calculate IM using a proprietary margin model, so long as the applicable Prudential Regulator has granted
prior written approval to use the model. . Such approval (which may be revoked) is premised on the
model satisfying certain qualitative criteria and minimum control, oversight and validation mechanisms
(which the Prudential Regulators adopted substantially as proposed in the PR Proposed Margin Rule)
including, inter alia:
• The model must determine the potential future exposure of an uncleared swap (or applicable netting
portfolio (as discussed further below)), where “potential future exposure” is an estimate of the one-
tailed 99% confidence interval for an increase in the value of such uncleared swap (or applicable
netting portfolio) over a period equal to the shorter of (i) 10 business days or (ii) the maturity of such
uncleared swap (or applicable netting portfolio) (referred to as a holding period). Note that (i) this 10-
day holding period is longer than the holding period (i.e., three to five days) which central
counterparties typically require and, (ii) unlike under the Prudential Regulators’ capital rules, the PR
Margin Rules do not permit, under any circumstances, a PR Covered Swap Entity using an approved
proprietary margin model to indirectly compute the 10-day horizon by making an IM calculation over a
shorter horizon and then scaling such IM calculation to the required 10-day horizon. The PR Margin
Rules instead require that such PR Covered Swap Entity’s IM calculation be performed directly over
the 10-day close-out period.38
• If the model reflects offsetting exposures, diversification and other hedging benefits for uncleared
swaps that are governed by an Eligible Master Netting Agreement, the PR Covered Swap Entity must
demonstrate the reasonableness for modeling and measuring such hedging benefits.
• With respect to an uncleared cross-currency swap, the model need not recognize risks or risk factors
associated with the embedded FX swap (i.e., the fixed, physically-settled exchange of principal), but
must recognize all material risks associated with all other payments and cash flows under such
uncleared cross-currency swap.39
The PR Covered Swap Entity must review, at least annually, (i) the data used to calibrate the approved
proprietary margin model, to reflect the appropriate period of significant financial stress, (ii) the approved
proprietary margin model itself, in light of market development and modeling technologies and also to
ensure compliance with the PR Margin Rules and (iii) the internal audit report produced in accordance
with the PR Margin Rules.40
Risk Categories. The PR Margin Rules require that an approved proprietary margin model assign each
derivative contract to a single asset class or broad risk category (i.e., FX or interest rate, commodity,
credit, equity) and that the IM calculations for derivatives in each broad risk category be performed
separately. An approved proprietary margin model is not permitted to reflect offsetting exposures,
diversification or other hedging benefits across these broad risk categories.41 Note that FX and interest
rate contracts are considered together as a single asset class for purposes of IM modeling under the PR
Margin Rules.42
Eligible Master Netting Agreements. A PR Covered Swap Entity that uses an approved proprietary
margin model to calculate IM under an Eligible Master Netting Agreement may only offset an uncleared
swap against other uncleared swaps within the same asset class under such Eligible Master Netting
Agreement when calculating IM.43
Inter-affiliate Swaps. With respect to any uncleared swap entered into with an Affiliate that would have
been subject to the clearing requirement but for the inter-affiliate exemption to clearing, a PR Covered
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Swap Entity using an approved proprietary margin model may calculate IM by using a holding period
equal to the shorter of (i) five business days or (ii) the maturity of such inter-affiliate uncleared swap or
the applicable netting portfolio. Netting portfolios for inter-affiliate uncleared swaps that have a holding
period calculated in accordance with the foregoing, must be identified and separated from any other
netting portfolio for purposes of calculating and complying with the IM requirements under the PR Margin
Rules.44
Further, to the extent that a PR Covered Swap Entity uses an internal margin model that does not
conform with the requirements of the PR Margin Rules, such PR Covered Swap Entity shall calculate (on
a daily basis) the IM amount to be collected with respect to uncleared swaps entered into with a given
Affiliate, by using the standardized margin schedule and multiplying the Gross IM by 0.7.45
C. Variation Margin Requirements
The PR Margin Rules require that a PR Covered Swap Entity collect and post (as applicable) VM in
accordance with the PR Margin Rules after such PR Covered Swap Entity has entered into an uncleared
swap with a Swap Entity or a Financial End-User (including any Affiliates of such PR Covered Swap
Entity46 and regardless of whether such Financial End-User has Material Swaps Exposure).47
Calculating Variation Margin
The amount of VM which a PR Covered Swap Entity must post or collect (as applicable) with respect to
an uncleared swap under the PR Margin Rules is calculated as follows:
• The uncleared swap’s cumulative mark-to-market change in value to a PR Covered Swap Entity, as
measured from the date such uncleared swap is entered into (or, in the case of an uncleared swap
that has a positive or negative value to a PR Covered Swap Entity on the date it is entered into, such
positive or negative value plus the uncleared swap’s cumulative mark-to-market change in value to
the PR Covered Swap Entity after such date), less
• The value of all VM previously collected, plus
• The value of all VM previously posted with respect to such uncleared swap.48
A PR Covered Swap Entity must post and/or collect (as applicable) IM and VM daily, for the life of the
uncleared swap.49
D. Collecting Margin from End-Users
The Interim Final Rule exempts from the PR Margin Rules those uncleared swaps entered into with
Exempted End-Users. For uncleared swaps entered into with counterparties that are not Exempted End-
Users but that are, nonetheless, (i) for IM, neither a Swap Entity nor a Financial End-User with Material
Swaps Exposure, or (ii) for VM, neither a Swap Entity nor a Financial End-User, the PR Covered Swap
Entity must collect IM and VM at such times, in such forms and in such amounts (if any) that the PR
Covered Swap Entity determines appropriately addresses the credit risk posed by each such counterparty
and the risks of any such uncleared swaps.50
III. Collateral
A. Market Value and Eligibility of Collateral
The PR Margin Rules require a PR Covered Swap Entity to monitor the market value and eligibility of all
collateral collected and posted to satisfy the IM and VM requirements under the PR Margin Rules. Only
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certain types of assets satisfy these requirements, and the eligibility of the collateral differs based on the
type of margin (IM or VM) being posted and/or collected and, with respect to VM, the identity of the PR
Covered Swap Entity’s counterparty. To the extent that either (i) the market value of such collateral has
declined or (ii) such collateral no longer qualifies as Eligible Collateral, PR Covered Swap Entities are
required to collect or post sufficient collateral to remain compliant with the PR Margin Rules.51
Eligible Collateral
The final rules expand the scope of collateral that PR Covered Swap Entities may post or collect (Eligible
Collateral) beyond the original proposal.
• Initial Margin. PR Covered Swap Entities may post and collect the following types of collateral to
satisfy their IM obligations under the PR Margin Rules:
– Immediately available cash funds denominated in US Dollars or another major currency,52 or the
currency of settlement53 under the uncleared swap (referred to herein as the settlement currency)
(unless noted otherwise, such funds are referred to herein as cash collateral)54
– Securities issued or guaranteed by a US government agency, the European Central Bank (ECB)
or certain sovereign entities55
– Certain debt securities and asset-backed securities issued by US government-sponsored
enterprises (GSEs)56
– Interests in pooled investment funds that invest in US government securities or securities issued
by the ECB or certain sovereign entities (referred to herein as Eligible Investment Fund
Interests)57
– Certain corporate debt securities58
– Securities issued or guaranteed by the Bank for International Settlements, the International
Monetary Fund or a multilateral development bank59
– Certain listed equities60
– Gold61
Many of these types of collateral are subject to significant Haircuts to reflect their liquidity and market
valuation risk. We discuss these Haircuts later in this Client Alert.
• Variation Margin. As noted above, the scope of Eligible Collateral for VM under the PR Margin Rules
varies depending on the identity of such PR Covered Swap Entity’s counterparty:
– Swap Entity: A PR Covered Swap Entity may only post and collect cash collateral for purposes of
satisfying VM requirements for uncleared swaps entered into with a Swap Entity.
– Financial End-User with Material Swap Exposure: A PR Covered Swap Entity may post and
collect the following forms of collateral to satisfy VM requirements for uncleared swaps entered
into with a Financial End-User with Material Swaps Exposure:
o Cash collateral
o Non-cash collateral that is eligible to satisfy the above IM requirements62
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• Ineligible Securities. The following securities are specifically excluded from the definition of Eligible
Collateral under the PR Margin Rules:
– Securities issued by (i) the party pledging such collateral (the posting counterparty) or (ii) an
Affiliate of the posting counterparty
– Securities issued by a wide range of US and non-US financial entities and market intermediaries,
including banks, bank holding companies, brokers, dealers, SDs and futures commission
merchants, in an effort to avoid the wrong-way risk that may depress the value of such securities
in a financial crisis63
B. Collateral Segregation
The PR Margin Rules require that IM posted or collected by a PR Covered Swap Entity (including
collateral in excess of that required by the PR Margin Rules) be segregated at one or more custodians
that are not Affiliates of either the PR Covered Swap Entity or its counterparty (such custodian is referred
to as a third-party custodian).64
Custodial Agreement
The IM must be posted subject to a custodial agreement that satisfies the following conditions:
• The custodial agreement prohibits the third-party custodian from rehypothecating, repledging, reusing
or otherwise transferring any of the collateral it holds, except that cash collateral may be held in a
general deposit account with the third-party custodian if (i) the funds in the account are used to
purchase an asset qualifying as Eligible Collateral, (ii) such Eligible Collateral is not otherwise
rehypothecated, repledged or reused and (iii) such purchase takes place within a time period
reasonably necessary to consummate such purchase after the cash collateral is posted as IM.
• If the custodial agreement permits the posting party to substitute or direct any reinvestment of
collateral held by the third-party custodian pursuant to the PR Margin Rules, the custodial agreement
may only permit the substitution or reinvestment of such collateral in assets (i) that would qualify as
Eligible Collateral or (ii) for which the amount net of applicable Haircuts would be sufficient to meet
the IM requirements under the PR Margin Rules.65
Unavailability of Segregation Under an Applicable Foreign Jurisdiction
Under certain circumstances where segregation of margin is unavailable, the PR Margin Rules provide an
exception to the IM posting requirement with respect to uncleared swaps involving certain non-US
counterparties. This exception only applies to uncleared swaps entered into by either (i) a foreign branch
of a PR Covered Swap Entity that is a depository institution66 or (ii) a PR Covered Swap Entity that is not
organized under the laws of the United States or any State67 and that is a subsidiary (defined below) of a
depository institution, Edge corporation68 or Agreement corporation.69 To qualify for this exception, all of
the following conditions must be present with respect to the uncleared swap(s) in question:
• Limitations in the legal or operational structure of the applicable foreign jurisdiction would not
practically allow the PR Covered Swap Entity and its counterparty to post any form of IM in
compliance with the segregation requirements under the PR Margin Rules.
• The PR Covered Swap Entity is subject to foreign regulatory restrictions that (i) require such PR
Covered Swap Entity to transact in uncleared swaps through an establishment within the applicable
foreign jurisdiction and (ii) do not accommodate the posting of collateral outside such foreign
jurisdiction.
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• The counterparty to the uncleared swap is not, and the counterparty’s obligations under the uncleared
swap are not, guaranteed by either (i) an entity organized under the laws of the United States or any
State (such entity referred to herein as a US entity), including a US branch, agency or subsidiary of a
foreign bank, (ii) a natural person who is a US resident or (iii) a branch or office of a US entity.
• Such PR Covered Swap Entity, as required by the PR Margin Rules, both collects IM and posts and
collects VM, in each case in the form of cash collateral.
In order to rely on this exception, the PR Covered Swap Entity must have received the applicable
Prudential Regulator’s prior written approval.70
Custody Arrangements for Inter-affiliate Swaps
To the extent that a PR Covered Swap Entity collects non-cash collateral from an Affiliate to satisfy its IM
collection requirements under the PR Margin Rules, the custodian for such non-cash collateral may be
such PR Covered Swap Entity or an Affiliate thereof.71
C. Collateral Valuation
The value of any Eligible Collateral is calculated as follows:
Collateral Value = Eligible Collateral Market Value x (1 – Applicable Haircut),
with such value expressed in percentage terms (referred to herein as Collateral Value). The total value of
all IM or VM collateral collected or posted pursuant to the PR Margin Rules is calculated as the sum of
the Collateral Values of each item of Eligible Collateral.72
Haircuts
The value of any Eligible Collateral collected or posted to satisfy the PR Margin Rules is subject to the
sum of the following discounts (such discounts referred to herein as Haircuts):
Asset Class Discount (%)
VM collateral denominated in a currency that is not the settlement currency
(except for immediately available cash funds denominated in US Dollars or
another major currency)
8.0
IM collateral denominated in a currency that is not the settlement currency
(except for Eligible Collateral denominated in a single termination currency
designated as payable to the collecting counterparty under an Eligible Master
Netting Agreement)
8.0
Eligible government and related debt
Residual maturity <1 year 0.5
Residual maturity 1-5 years 2.0
Residual maturity >5 years 4.0
Certain eligible GSE debt securities and other
eligible publicly traded debt
Residual maturity <1 year 1.0
Residual maturity 1-5 years 4.0
Residual maturity >5 years 8.0
Equity included in the S&P 500 or a related index 15.0
Equity included in the S&P 1500 Composite or a related index (but not the S&P
500 or related index) 25.0
Gold 15.0

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• Haircuts for Eligible Investment Fund Interests. The Haircut for any Eligible Investment Fund
Interests under the PR Margin Rules is the weighted average Haircut on all assets within the relevant
eligible investment fund at the end of the prior month, with the weights applied in the weighted
average calculated as a fraction of the fund’s total market value that is invested in each asset with a
given Haircut.73
IV. Netting Arrangements and Retroactive Application
The PR Margin Rules permit a PR Covered Swap Entity to net multiple uncleared swaps with a
counterparty that is a Swap Entity or a Financial End-User for purposes of calculating IM and VM
amounts and of posting or collecting margin, so long as all uncleared swaps netted against each other
have been executed pursuant to an Eligible Master Netting Agreement entered into as between such PR
Covered Swap Entity and such counterparty.74 Note that IM amounts may not be netted against VM
amounts (and vice versa) under the PR Margin Rules.75
A. Eligible Master Netting Agreements
In response to industry market concerns, the PR Margin Rules have aligned the definition of “Eligible
Master Netting Agreement” with that of the definition of “qualified master netting agreement” as used in
the Prudential Regulators’ risk-based capital rules. 76 An “Eligible Master Netting Agreement” means a
legally enforceable agreement for which the following conditions are satisfied:
• Upon an event of default following any permitted stay (discussed below), the agreement creates a
single legal obligation for all transactions entered into under such agreement.
• The agreement provides the PR Covered Swap Entity the right (i) to accelerate, terminate and close-
out on a net basis all transactions under such agreement and (ii) to liquidate or set-off collateral
promptly upon an event of default, including upon an event of receivership, conservatorship,
insolvency, liquidation or similar proceeding, of the counterparty. Upon the occurrence of any such
proceeding, the agreement shall provide that any exercise of rights under such agreement will not be
stayed or avoided under applicable law in the relevant jurisdictions, except under either of the
following circumstances:
– In receivership, conservatorship or resolution under the Federal Deposit Insurance Act, Title II of
the Dodd-Frank Act, the Federal Housing Enterprises Financial Safety and Soundness Act of
1992, as amended, or the Farm Credit Act of 1971, as amended, or laws of foreign jurisdictions
that are substantially similar to the foregoing in order to facilitate the orderly resolution of the
defaulting counterparty
– The agreement is subject by its terms to, or incorporates, any of the laws referenced above (any
such stay referred to herein as a permitted stay)
• The agreement does not contain a walkaway clause (i.e., a provision that permits a non-defaulting
counterparty to make a lower payment than it otherwise would make under the agreement, or no
payment at all, to a defaulter or the estate of a defaulter, even if the defaulter or the estate of the
defaulter is a net creditor under the agreement).
The Prudential Regulators have removed the condition in the PR Proposed Margin Rules that the master
netting agreement could not contain a clause which allowed the suspension or conditioning of payment.
This proposed clause had previously caused much concern among market participants, as it would have
precluded the ISDA Master Agreement from qualifying as an Eligible Master Netting Agreement, given
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Section 2(a)(iii) of the ISDA Master Agreement which allows for suspending payments under a default
scenario.77
A PR Covered Swap Entity that relies on an Eligible Master Netting Agreement to calculate the margin
required under the PR Margin Rules must:
• Conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written
documentation of that legal review) that each of the following conditions has been met:
– The agreement satisfies the requirements of the “Eligible Master Netting Agreement” definition
– In the event of a legal challenge (including one resulting from default or from receivership,
conservatorship, insolvency, liquidation or similar proceeding), the relevant court and
administrative authorities would find the agreement to be legal, valid, binding and enforceable
under the law of the relevant jurisdictions
• Establish and maintain written procedures to monitor possible changes in relevant law and to ensure
that the agreement continues to satisfy the requirements of the “Eligible Master Netting Agreement”
definition78
B. No Retroactive Application to Previously Executed Uncleared Swaps
The PR Margin Rules permit a PR Covered Swap Entity to identify separate netting portfolios (i.e., there
can be multiple groups of uncleared swaps that are netted only against the other uncleared swaps in their
respective group, even if two or more groups of uncleared swaps were executed pursuant to the same
Eligible Master Netting Agreement) in a way that precludes the retroactive application of the PR Margin
Rules to uncleared swaps entered into before the applicable compliance date for the PR Covered Swap
Entity in respect of its counterparty under the Eligible Master Netting Agreement at issue. For example, if
the uncleared swaps under a particular Eligible Master Netting Agreement entered into between a PR
Covered Swap Entity and a counterparty (that is a Swap Entity or a Financial End-User) is divided into
two netting portfolios — (1) uncleared swaps entered into before the compliance date applicable to such
PR Covered Swap Entity in respect of such counterparty (the pre-compliance portfolio) and (2) uncleared
swaps entered into on or after the applicable compliance date (the post-compliance portfolio) — the PR
Covered Swap Entity is permitted to only net the uncleared swaps in the post-compliance portfolio against
other post-compliance uncleared swaps, and the uncleared swaps in the pre-compliance portfolio against
other pre-compliance uncleared swaps. Thus, PR Covered Swap Entities can continue to use an existing
Eligible Master Netting Agreement after the applicable compliance date(s) without effectively subjecting
the pre-compliance trades thereunder to the PR Margin Rules.79
Legacy Swaps
The Prudential Regulators expressly declined to exempt new swap transactions arising from amendments
to and novations or compressions of uncleared swaps entered into prior to the applicable compliance
date (legacy swaps) from the PR Margin Rules; as such, the following transactions will be subject to the
PR Margin Rules beginning on the applicable compliance date, despite their relationship to any legacy
swap, to the extent such transactions give rise to a new swap transaction (note the list below is not
necessarily exhaustive):
• Amendments to legacy swaps
• Novations of legacy swaps
• New derivatives resulting from portfolio compression of legacy swaps80
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V. Documentation
A. Swap Documentation
Consistent with documentation standards under the Dodd-Frank Act, the PR Margin Rules require a PR
Covered Swap Entity to document margin-related matters. Such documentation must satisfy the following
requirements:
• Provide such PR Covered Swap Entity and its counterparty with the contractual right to collect and
post IM and VM in such amounts, in such form and under such circumstances as are required by the
PR Margin Rules
• Specify the methods, procedures, rules and inputs used for determining the value of each uncleared
swap for purposes of calculating IM and VM
• Specify the procedures by which any disputes concerning uncleared swap valuation or margin
amounts may be resolved81
B. Approved Proprietary Margin Models
If a PR Covered Swap Entity calculates IM under the PR Margin Rules by using an approved proprietary
margin model, then such PR Covered Swap Entity must adequately document the following additional
items with respect to such model:
• All material aspects of such approved proprietary margin model, including (i) the management and
valuation of the uncleared swaps to which the model applies, (ii) the control, oversight and validation
of such model and (iii) any review processes and the results of such processes
• Internal authorization procedures (including escalation procedures) that require review and approval
of any change to the IM calculation under such approved proprietary margin model, demonstrable
analysis that any basis for any such change is consistent with the PR Margin Rules and independent
review of such demonstrable analysis and approval82
VI. Cross-Border Application
As proposed in September 2014, the Prudential Regulators have expressly exempted Foreign Uncleared
Swaps (defined below) from the PR Margin Rules.83 Cross-border swaps that do not qualify for this
exemption may otherwise qualify for substituted compliance (but only with respect to posting IM) under
the PR Margin Rules, as further discussed below.
A. Relevant Definitions
Foreign Uncleared Swaps
A foreign uncleared swap or foreign uncleared security-based swap (referred to collectively herein as
Foreign Uncleared Swaps) means any uncleared swap with respect to which neither the counterparty nor
the Foreign Covered Swap Entity (defined below) nor any party providing a guarantee of either party’s
relevant uncleared swap obligations falls under the following categories:
• A US entity (including a US branch, agency or subsidiary of a foreign bank)84
• A natural person who is a US resident
• A branch or office of a US entity
• A Swap Entity that is a subsidiary of a US entity85
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Foreign Covered Swap Entity
A Foreign Covered Swap Entity means a PR Covered Swap Entity that is not:
• A US entity (including a US branch, agency or subsidiary of a foreign bank)
• A branch or office of a US entity
• An entity that is a Subsidiary of US entity86
The final rules adopt a definition of Foreign Uncleared Swap and Foreign Covered Swap Entity nearly
identical to the definitions proposed in September 2014, except that the final rules remove the concept of
“control” in the last prong and replace it with a “subsidiary” concept. The practical effect of this is that
certain entities organized outside of the United States and managed or controlled by a US entity, but that
are not consolidated on the balance sheets of the US entity, will qualify as a Foreign Covered Swap
Entity. The changes to these definitions could create substantial benefits to funds organized outside of
the United States but managed by US managers. However, the Prudential Regulators do leave
themselves some flexibility to make discretionary decisions regarding the definition of “Subsidiary” in the
third prong.
Subsidiary
A company is considered a “Subsidiary” of another company under the PR Margin Rules if any of the
following is true:
• Such company is consolidated by the other company on financial statements prepared in accordance
with Accounting Standards.
• For a company that is not subject to Accounting Standards, such consolidation would have occurred if
such Accounting Standards had applied.
• The applicable Prudential Regulator has determined that such company is a subsidiary of the other
company, based on such Prudential Regulator’s conclusion that either company provides significant
support to, or is materially subject to the risks of loss of, the other company.87
Guarantee
The PR Margin Rules include a definition of “guarantee” that the Prudential Regulators had not previously
proposed. For purposes of Foreign Uncleared Swaps and other cross-border applications of the PR
Margin Rules, the Prudential Regulators have defined “guarantee” to mean an arrangement pursuant to
which one party to an uncleared swap has rights of recourse, with respect to its counterparty’s obligations
under the applicable uncleared swap (referred to herein as relevant swap obligations), against a third-
party guarantor of such relevant swap obligations, provided that:
• A party to an uncleared swap has “rights of recourse” against such guarantor if such party has a
conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in
part, payments from the guarantor with respect to its counterparty’s relevant swap obligations.
• If such guarantor has a conditional or unconditional legally enforceable right to receive or otherwise
collect, in whole or in part, payments from any other third-party guarantor with respect to such
counterparty’s relevant swap obligations under another arrangement, such other arrangement will
also be deemed a “guarantee” (and such other guarantor will also be deemed a “guarantor”) of such
counterparty’s relevant swap obligations.88
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This definition of “guarantee” is limited and would not capture liquidity puts or credit backstops that do not
expressly provide a counterparty with a right of recourse.89
B. Substituted Compliance
The PR Margin Rules permit a PR Covered Swap Entity to request a joint determination from the
Prudential Regulators that such PR Covered Swap Entity’s obligations to post (but not collect) IM under
the PR Margin Rules would be satisfied by complying with the margin requirements of a foreign
jurisdiction relevant to an uncleared swap entered into by such PR Covered Swap Entity (i.e., substituted
compliance) (such margin requirements referred to herein as the applicable foreign margin rules).90 A PR
Covered Swap Entity would be deemed to have posted IM to satisfy its obligations under the PR Margin
Rules if the following requirements are met:
• Such PR Covered Swap Entity posts to its counterparty IM in the form and amount, and at such
times, that such counterparty is required to collect IM pursuant to the applicable foreign margin rules
(provided that such counterparty is subject to the applicable foreign margin rules and the Prudential
Regulators have made a substituted compliance determination under the PR Margin Rules, unless
otherwise stated in such determination).
• Such counterparty’s obligations under the uncleared swap are not guaranteed by either (i) a US entity
(including a US branch, agency or subsidiary of a foreign bank), (ii) a natural person who is a US
resident or (iii) a branch or office of a US entity.91
As finalized, the PR Margin Rules do not provide for substituted compliance determinations with respect
to a PR Covered Swap Entity’s margin collection obligations. The Prudential Regulators have stated that
they will take a holistic view of the applicable foreign margin rules in making their joint substituted
compliance determination and will consider the following factors on a case-by-case basis for each foreign
jurisdiction in question:
• Whether the outcomes achieved by the applicable foreign margin rules are comparable to those
achieved by the PR Margin Rules
• The scope, objectives and specific provisions of the applicable foreign margin rules
• The effectiveness of the supervisory compliance program administered and of the enforcement
authority which the applicable foreign regulatory authorities exercise92
Eligible PR Covered Swap Entities (as discussed below) can request a substituted compliance
determination under the PR Margin Rules only if the uncleared swap activities of such PR Covered Swap
Entity are directly supervised by the foreign regulatory authorities administering the applicable foreign
margin rules.93
The practical cross-border application of the PR Margin Rules will need to consider the overlay of the
CFTC’s finalized margin rules for uncleared swaps (the cross-border approach to uncleared swap margin
rules which the CFTC proposed earlier this year was notably different than the approach that the
Prudential Regulators have finalized in the PR Margin Rules)94 as well as the finalized rules for uncleared
derivatives under EMIR.
Requests for Determination
In requesting a substituted compliance determination under the PR Margin Rules, a PR Covered Swap
Entity must submit the following information to the Prudential Regulators:
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• The scope and objectives of the applicable foreign margin rules
• The specific provisions of the applicable foreign margin rules that govern (i) the scope of transactions
covered, (ii) the determination of the amount of IM and VM required and how such amount is
calculated, (iii) the timing of margin requirements, (iv) any documentation requirements, (v) the forms
of eligible collateral, (vi) any segregation and rehypothecation requirements and (vii) the approval
process and standards for models used in calculating IM and VM
• The supervisory compliance program and enforcement authority exercised by the applicable foreign
financial regulatory authority (or authorities) in such system to support oversight of the application of
the applicable foreign margin rules and how such applicable foreign margin rules apply to the PR
Covered Swap Entity’s uncleared swaps
• Any other description and documentation that the Prudential Regulators determine are appropriate95
Eligible PR Covered Swap Entities
A PR Covered Swap Entity is eligible to request a substituted compliance determination pursuant to the
PR Margin Rules only if it satisfies the following conditions:
• The PR Covered Swap Entity’s obligations under the uncleared swap are not guaranteed by either (i)
a US entity (other than a US branch or agency of a foreign bank), (ii) a natural person who is a US
resident or (iii) a branch or office of a US entity.
• The PR Covered Swap Entity is either (i) a Foreign Covered Swap Entity, (ii) a US branch or agency
of a foreign bank or (iii) an entity that (a) is not a US entity and (b) is a subsidiary of a depository
institution, Edge corporation or Agreement corporation.96
VII. Phased-in Compliance Period
Consistent with the International Standards, the phased-in compliance schedule reproposed by the
Prudential Regulators in September 2014 has been extended under the PR Margin Rules. The
compliance dates for the IM and VM requirements under the PR Margin Rules will be based on the
average daily notional amount of uncleared swaps, uncleared security-based swaps, FX forwards and FX
swaps (computed for business days only) for each counterparty (aggregated with its respective Affiliates),
as set out below:97
Variation Margin Compliance Date
Initial Margin
Compliance Date
AVERAGE DAILY AGGREGATE NOTIONAL AMOUNT
Exceeding US$3 trilliona Sept. 1, 2016 Sept. 1, 2016
Exceeding US$2.25 trillionb
March 1, 2017
Sept. 1, 2017
Exceeding US$1.5 trillionc Sept. 1, 2018
Exceeding US$750 billiond Sept. 1, 2019
Any amount Sept. 1, 2020

a Calculated for March, April and May 2016 c Calculated for March, April and May 2018
b Calculated for March, April and May 2017 d Calculated for March, April and May 2019
A. Calculating Average Daily Aggregate Notional Amount
For purposes of determining the applicable compliance date, a PR Covered Swap Entity would take into
account the average daily aggregate notional amounts of the following transactions:
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• Uncleared swaps
• Uncleared security-based swaps
• FX forwards
• FX swaps
Additionally, the PR Margin Rules provide for the following adjustments in calculating the average daily
aggregate notional amounts:
• Inter-affiliate transactions need only be counted once.
• Swaps exempt from the PR Margin Rules by virtue of the Interim Final Rule (i.e., uncleared swaps
entered into with Exempted End-Users) would not be included in the calculation.
Divergence from International Standards
Note that the applicable compliance date under the PR Margin Rules is determined based on the average
daily aggregate notional amount of uncleared swaps, whereas the International Standards proposed
compliance dates determined by the aggregate month-end average notional amount of non-centrally
cleared derivatives.
B. Ongoing Compliance Obligations
Once a PR Covered Swap Entity is subject to the PR Margin Rules with respect to a particular
counterparty by virtue of the above compliance schedule, such PR Covered Swap Entity will remain
subject to the PR Margin Rules with respect to such counterparty, regardless of the average daily
aggregate notional amount with respect to that particular counterparty or the PR Covered Swap Entity
itself. However, in the event that a counterparty’s status changes in a way that would subject any
uncleared swaps entered into by the PR Covered Swap Entity with such counterparty to “less strict”
margin requirements under the PR Margin Rules (e.g., the counterparty is a Financial End-User that
previously had, but no longer has, Material Swaps Exposure), then the PR Covered Swap Entity may
comply with the “less strict” margin requirements for: (i) any uncleared swaps entered into after such
counterparty’s status change and (ii) any outstanding uncleared swaps entered into after the applicable
compliance date and before such counterparty changed its status.98
VIII. EU Margin Rules and Cross-Border Issues
EU regulators have not yet issued the finalized margin requirements for uncleared derivatives under
EMIR, despite having published two public consultations and having originally indicated that they
expected to submit the final draft of the EMIR margin rules to the European Commission in September or
October of this year.99 Given the international pressure posed by the finalization of the PR Margin Rules
and the International Standards themselves setting a phased-in compliance schedule beginning in
September 2016, we expect these rules to be finalized by early 2016.
Globally, regulators have been working together to impose comparable margin requirements in respect of
uncleared swaps in their respective jurisdictions. In each case, the International Standards serve as a
guide and a regulatory framework on which to base local jurisdiction rules. To date, the EU and Japan
have each proposed uncleared swap margin requirements.100 Many other jurisdictions are expected to
follow suit in light of the G-20 commitments.101
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Market participants who operate internationally will need to understand the interplay among the margin
rules at a global level, which regimes such counterparties may be subject to and what, if any, differential
treatment may exist between a hedging strategy that faces, for instance, an EU bank, on the one hand,
and a US bank, on the other, depending on the location of their uncleared swap counterparties. While
both US and non-US regulators seek to establish comparable rules, largely following the International
Standards in an effort to reduce duplication and the possibilities of regulatory arbitrage and competitive
advantage, harmonizing margin regulation across the globe has proven to be a very difficult task.
Moreover, market participants have raised concerns regarding the effective application of uncleared swap
margin rules globally within the envisaged timeframe, in the absence of harmonization and substituted
compliance.
In fact, the PR Margin Rules, the CFTC Proposed Margin Rules and the EMIR Proposed Margin Rules
each have material differences. For instance, under the PR Margin Rules, an exemption from the margin
requirements will apply to swaps between PR Covered Swap Entities and foreign counterparties,
provided that no US entity guarantees either party’s relevant swap obligations. As a practical matter, then,
certain offshore funds possibly would not be required to post margin when trading with certain non-US
banks, because the EMIR Proposed Margin Rules currently would not require certain investment funds to
post IM or VM. However, the EU regulators have recently stated that they are revisiting the treatment of
certain entities currently classified as non-financial counterparties (including some investment funds and
securitization vehicles), which may eventually close this potential gap in the rules. Further, in the EU,
physically-settled FX swaps and forwards are subject to the margin requirements, while in the US such
instruments would not require posting of margin; this is only one of several discrepancies among the
various uncleared swap margin regimes. Moreover, until rules are finalized in the EU and other foreign
jurisdictions and the US regulators have determined whether compliance with such rules would satisfy US
margin rules, we will not have clarity on which jurisdiction’s rules apply in cross-border circumstances.
Further, even within the United States, the finalized cross-border application of the PR Margin Rules differ
from the CFTC’s proposal with respect to the cross-border reach of the CFTC Proposed Margin Rules.
The market will need to wait for the finalized CFTC and SEC margin rules in order to understand the
extraterritorial application of the US margin rules as a whole, the availability of substituted compliance
and whether the US regulators (i.e., the CFTC, the SEC and the Prudential Regulators) are aligned in
their approach.
The imposition of margin requirements on uncleared swaps is one of the most, if not the most important
regulation affecting the uncleared swaps market since the passage of the Dodd-Frank Act. While the
market gears up for compliance with uncleared swap margin rules there is still a bit of a “wait and see”
approach in the cross-border context as we wait for the global framework to be finalized.

If you have questions about this Client Alert, please contact one of the authors listed below or the Latham
lawyer with whom you normally consult:
Carlos Alvarez
carlos.alvarez@lw.com
+1.212.906.1269
New York

Alan W. Avery
alan.avery@lw.com
+1.212.906.1301
New York
Latham & Watkins November 20, 2015 | Number 1896 | Page 20

Loren N. Finegold
loren.finegold@lw.com
+1.212.906.1327
New York

Ellen L. Marks
ellen.marks@lw.com
+1.312.876.7626
Chicago

Yvette D. Valdez
yvette.valdez@lw.com
+1.212.906.1797
New York

Brett M. Ackerman
brett.ackerman@lw.com
+1.202.637.2109
Washington, DC

J. Ashley Weeks
ashley.weeks@lw.com
+1.212.906.4630
New York

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SEC Proposed Rules: Recordkeeping and Reporting for SBSDs, MSBSPs and BDs; Capital Rules for
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Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends.
The information contained in this publication should not be construed as legal advice. Should further
analysis or explanation of the subject matter be required, please contact the lawyer with whom you
normally consult. The invitation to contact is not a solicitation for legal work under the laws of any
jurisdiction in which Latham lawyers are not authorized to practice. A complete list of Latham’s Client
Alerts can be found at www.lw.com. If you wish to update your contact details or customize the
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Endnotes

1 The term “Prudential Regulators” as used herein means the Office of the Comptroller of the Currency (Department of Treasury)
(the OCC), the Board of Governors of the Federal Reserve System (the FRB), the Federal Deposit Insurance Corporation (the
FDIC), the Farm Credit Administration (the FCA) and the Federal Housing Finance Agency (the FHFA). 12 C.F.R. § __.2 (citing
7 U.S.C. § 1a(39)).
2 The FDIC, the OCC and the FCA approved the final rule establishing margin for uncleared swaps on October 22, 2015 and the
FRB and the FHFA followed suit on October 30, 2015. See Joint Press Release: Agencies Finalize Swap Margin Rule (Oct. 30,
2015), available at http://www.federalreserve.gov/newsevents/press/bcreg/20151030b.htm.
3 At publication, the Prudential Regulators’ uncleared swap margin rules have not yet been published in the Federal Register. A
copy of the final rules as approved by the Prudential Regulators can be found in the Prudential Regulators’ joint press release:
Margin and Capital Requirements for Covered Swap Entities (approved Oct. 30, 2015) (to be codified at 12 C.F.R. pts. 45, 237,
349, 624, 1221), available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20151030b1.pdf (PR Margin Rules).
4 Margin and Capital Requirements for Covered Swap Entities, 79 Fed. Reg. 57348 (proposed Sept. 24, 2014) (proposing
amendment of 12 C.F.R. pts. 45, 237, 349, 624, 1221), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-
22001.pdf (PR Proposed Margin Rules). For further discussion, please refer to our Client Alert on the reproposed uncleared
swap margin rules. UPDATE: Swap Dealers Will Face Significant Challenges from Reproposed Margin Rules for Uncleared
Swaps, Client Alert No. 1792 (Jan. 26, 2015), available at http://www.lw.com/thoughtLeadership/lw-dealers-margin-rules-for-
uncleared-swaps.
5 See PR Margin Rules at 41.
6 Margin Requirements for Non-Centrally Cleared Derivatives (updated March 2015), available at
http://www.bis.org/bcbs/publ/d317.pdf (International Standards).
7 Draft Regulatory Technical Standards on Risk-Mitigation Techniques for OTC-Derivative Contracts Not Cleared by a CCP Under
Article 11(15) of Regulation (EU) No 648/2012 (proposed April 14, 2014), available at
https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.
pdf; Second Consultation Paper: Draft Regulatory Technical Standards on Risk-Mitigation Techniques for OTC-Derivative
Contracts Not Cleared by a CCP Under Article 11(15) of Regulation (EU) No 648/2012 (proposed June 10, 2015), available at
https://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015-
002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf (EMIR Proposed Margin Rules).
8 See International Standards.
9 12 C.F.R. § __.2; see PR Margin Rules at 48-49.
10 The PR Margin Rules define “Financial End-User” to include the following counterparties:
• Bank holding companies (or Affiliates thereof)
• Savings and loan holding companies
• Certain US intermediate holding companies
• Certain nonbank financial institutions supervised by the FRB
• Depository institutions
• Foreign banks
• Federal or state credit unions
• Certain institutions functioning solely in a trust or fiduciary capacity
• Industrial loan companies, industrial banks or similar institutions
• State-licensed or registered credit or lending entities
• State-licensed or registered money services businesses
• Entities regulated by the FHFA
• Institutions regulated by the FCA
• Securities holding companies
• Brokers or dealers
• Investment advisers
• Registered investment companies, certain securitization vehicles or certain private real estate investment entities
• Business development companies
• Private funds relying on Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act; mortgage-related funds
(including some REITs) relying on Section 3(c)(5)(C) of the Investment Company Act; and issuers of asset-backed
securities relying on Rule 3a-7 under the Investment Company Act.
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• Commodity pools, commodity pool operators or commodity trading advisors
• Floor brokers, floor traders or introducing brokers
• Futures commission merchants
• Employee benefit plans
• Insurance companies or other entities primarily engaged in writing insurance or reinsuring risks underwritten by insurance
companies or that are otherwise subject to supervision as an insurance company by an insurance regulator
• Entities, persons or arrangements that are, or hold themselves out as being, an entity, person or arrangement that raises
money from investors, accepts money from clients or uses its own money primarily for the purpose of investing or trading
or facilitating the investing or trading in loans, securities, swaps, funds or other assets for resale or other disposition, or
otherwise trading in loans, securities, swaps, funds or other assets
• Foreign entities that would be considered Financial End-Users or Swap Entities if they were organized in the United
States
The term Financial End-User expressly excludes any counterparty that is:
• A sovereign entity
• A multilateral development bank
• The Bank for International Settlements
• An entity that is exempt from the definition of “financial entity” under the Commodity Exchange Act
• An Affiliate that qualifies for the inter-affiliate exemption from clearing
12 C.F.R. § __.2; see PR Margin Rules at 49-64; 7 U.S.C. §§ 1a(10)-(12), (22), (23), (28), (31), 2(h)(7)(C)(iii), 2(h)(7)(D); 12
U.S.C. §§ 1467a(n), 1752(1), 1752(6), 1813(c), 1841, 1850a, 2001 et seq., 4502(20), 5323; 15 U.S.C. §§ 78c(a)(4)-(5), 78c-
3(g)(4), 80a-1 et seq., 80a-3(c)(5)(C), 80a-53(a), 80b-2(a); 29 U.S.C. §§ 1002(3)(3), (3)(32); 12 C.F.R. § 252.153; 17 C.F.R. §
270.3a-7.
11 “Initial margin” is defined in the PR Margin Rules to mean collateral as calculated in accordance with a permitted IM margin
model that is posted or collected in connection with an uncleared swap. 12 C.F.R. § __.2.
12 “Variation margin” is defined in the PR Margin Rules to mean collateral provided by one party to its counterparty to meet the
performance of its obligations under one or more uncleared swaps between the parties as a result of a change in value of such
obligations since the last time such collateral was provided. 12 C.F.R. § __.2.
13 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 79 Fed. Reg. 59898 (proposed
Oct. 3, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-10-03/pdf/2014-22962.pdf (CFTC Proposed Margin Rules).
14 Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants
and Capital Requirements for Broker-Dealers, 77 Fed. Reg. 70214 (proposed Nov. 23, 2012) (proposing amendment of 17
C.F.R. pt. 240), available at http://www.gpo.gov/fdsys/pkg/FR-2012-11-23/pdf/2012-26164.pdf (SEC Proposed Margin Rules).
15 See 7 U.S.C. § 1a(47).
16 See 7 U.S.C. § 1a(15).
17 12 C.F.R. § __.2; see 7 U.S.C. §§ 7a-1(a), (h).
18 See 15 U.S.C. § 78c(a)(68).
19 See 15 U.S.C. § 78c(a)(23).
20 12 C.F.R. § __.2; see PR Margin Rules at 71-73; 15 U.S.C. §§ 78q-1(b)(1), (k).
21 Terrorism Risk Insurance Program Reauthorization Act of 2015, Pub. L. No. 114-1, § 302 (2015).
22 See PR Margin Rules at 18-19; see also 7 U.S.C. §§ 2(h)(7)(A), (D), 6(c)(1); 15 U.S.C. § 78c-3(g); 17 C.F.R. § 50.51.
23 At publication, the Prudential Regulators’ uncleared swap margin rules have not yet been published in the Federal Register. A
copy of the interim final rule as approved by the Prudential Regulators can be found in the Prudential Regulators’ joint press
release: Margin and Capital Requirements for Covered Swap Entities (approved Oct. 30, 2015) (to be codified at 12 C.F.R. pts.
45, 237, 349, 624, 1221), available at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20151030b2.pdf (Interim
Final Rule); see PR Margin Rules at 32-35.
24 12 C.F.R. § __.5(b); PR Margin Rules at 109-110.
25 12 C.F.R. § __.3(b); see 12 C.F.R. §§ __.3(d), __.9(d)(4); PR Margin Rules at 86-88.
26 See 7 U.S.C. § 1a(24).
27 See 7 U.S.C. § 1a(25).
28 See International Standards at 10, 25.
29 12 C.F.R. § __.2; see PR Margin Rules at 64-71.
30 12 C.F.R. § __.2; see 12 C.F.R. § __.1(d); PR Margin Rules at 88-92, 97-99.
31 12 C.F.R. § __.11(b); see PR Margin Rules at 179-187.
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32 12 C.F.R. § __.11(b)(2).
33 12 C.F.R. § __.2.
34 See PR Margin Rules at 74-79.
35 See PR Margin Rules at 154-161.
36 “Cross-currency swap” is defined in the PR Margin Rules to mean a swap in which one party exchanges with another party
principal and interest rate payments in one currency for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with a reversal of the exchange of principal at a later date that
is agreed upon when the swap is entered into. 12 C.F.R. § __.2; see PR Margin Rules at 79.
37 “Gross IM” is equal to the sum of the product of each uncleared swap’s effective notional amount and the gross IM requirement
for all uncleared swaps subject to the Eligible Master Netting Agreement; “Net-to-Gross Ratio” is the ratio of the net current
replacement cost to the gross current replacement cost, where “net current replacement cost” equals the total replacement cost
for all uncleared swaps subject to the Eligible Master Netting Agreement and “gross current replacement cost” equals the sum of
the replacement cost for each uncleared swap subject to the Eligible Master Netting Agreement for which the cost is positive
(except if the gross current replacement cost is zero, the NGR should be set to 1.0). 12 C.F.R. pt. __, App. A, n. 1.
38 12 C.F.R. § __.8(d)(1); see PR Margin Rules at 141-142.
39 See PR Margin Rules at 152-153.
40 12 C.F.R. § __.8(b)-(f); see PR Margin Rules at 135-154.
41 12 C.F.R. § __.8(d)(3); see PR Margin Rules at 143-150.
42 See PR Margin Rules at 135, 143.
43 12 C.F.R. § __.8(d)(3); see PR Margin Rules at 143.
44 12 C.F.R. § __.11(e); see PR Margin Rules at 181-182, n. 154.
45 12 C.F.R. § __.11(f).
46 See 12 C.F.R. § __.11(c).
47 See PR Margin Rules at 99-101.
48 12 C.F.R. § __.2 (definition of “variation margin amount”); see PR Margin Rules at 101-103.
49 12 C.F.R. §§ __.3(c), __.4(b).
50 12 C.F.R. §§ __.3(d), __.4(c); see 12 C.F.R. § __.6(f); PR Margin Rules at 103-105, 124-125.
51 12 C.F.R. § __.6(e).
52 “Major currency” is defined in the PR Margin Rules to mean the US Dollar (USD), the Canadian Dollar (CAD), the Euro (EUR),
the UK Pound (GBP), the Japanese Yen (JPY), the Swiss Franc (CHF), the New Zealand Dollar (NZD), the Australian Dollar
(AUD), the Swedish Kroner (SEK), the Danish Kroner (the DKK), the Norwegian Krone (NOK) or any other currency as
determined by the PR Covered Swap Entity’s applicable Prudential Regulator. 12 C.F.R. § __.2; see PR Margin Rules at 79-80.
53 “Currency of settlement” is defined in the PR Margin Rules to mean a currency in which a party has agreed to discharge
payment obligations related to an uncleared swap or a group of uncleared swaps subject to a master agreement at the regularly
occurring dates on which such payments are due in the ordinary course. 12 C.F.R. § __.2.
54 12 C.F.R. §§ __.6(a)(1), (b)(1).
55 12 C.F.R. §§ __.6(a)(2)(i)-(iii), (b)(2)-(4). The PR Margin Rules define “sovereign entity” to mean a central government (including
the US government) or an agency, department, ministry or central bank of a central government. 12 C.F.R. § __.2.
56 12 C.F.R. §§ __.6(a)(2)(iv)-(v), (b)(5)-(6). The PR Margin Rules define “US government-sponsored enterprise” to mean an entity
established or chartered by the US government to serve public purposes specified by federal statute but whose debt obligations
are not explicitly guaranteed by the full faith and credit of the US government. 12 C.F.R. § __.2; see PR Margin Rules at 85.
57 12 C.F.R. §§ __.6(a)(2)(viii), (b)(9).
58 12 C.F.R. §§ __.6(a)(2)(vii)(A), (b)(8)(i).
59 12 C.F.R. §§ __.6(a)(2)(vi), (b)(7). “Multilateral development bank” is defined in the PR Margin Rules to mean the International
Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance
Corporation, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the
European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the
Nordic Investment Bank, the Caribbean Development Bank, the Islamic Development Bank, the Council of Europe Development
Bank and any other entity that provides financing for national or regional development in which the US government is a
shareholder or contributing member or which the PR Covered Swap Entity’s applicable Prudential Regulator determines poses
comparable credit risk. 12 C.F.R. § __.2.
60 12 C.F.R. §§ __.6(a)(2)(vii)(B), (b)(8)(ii).
61 12 C.F.R. §§ __.6(a)(2)(ix), (b)(10); see PR Margin Rules at 113-120.
62 See 12 C.F.R. § __.6(b); PR Margin Rules at 111-113.
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63 12 C.F.R. § __.6(d). Securities issued by the following entities are excluded from the scope of Eligible Collateral under the PR
Margin Rules: (i) bank holding companies, (ii) savings and loan holding companies, (iii) US intermediate holding companies
established or designated for purposes of compliance with 12 C.F.R. § 252.153, (iv) foreign banks, (v) depository institutions,
(vi) market intermediaries, (vii) companies that would be fall under the foregoing categories if organized under the laws of the
United States or any State, (viii) Affiliates of any of the foregoing institutions or (ix) nonbank financial institutions supervised by
the FRB under 12 U.S.C. § 5323. 12 C.F.R. § __.6(d)(2)-(3).
64 12 C.F.R. § __.7(a)-(b); see PR Margin Rules at 125-135.
65 12 C.F.R. § __.7(c)-(d).
66 See 12 U.S.C. § 1813(c).
67 “State” is defined in the PR Margin Rules to mean any State, commonwealth, territory or possession of the United States, the
District of Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, American Samoa,
Guam or the US Virgin Islands. 12 C.F.R. § __.2; see PR Margin Rules at 85.
68 An “Edge corporation” is an organization operating under Section 25A of the Federal Reserve Act. See PR Margin Rules at n. 4.
69 An “Agreement corporation” is an organization having an agreement with the FRB under Section 25 of the Federal Reserve Act.
See PR Margin Rules at n. 4.
70 12 C.F.R. § __.9(f); see PR Margin Rules at 174-176.
71 12 C.F.R. § __.11(d).
72 12 C.F.R. § __.6(c)(2); see PR Margin Rules at 120-124.
73 The PR Margin Rules provide the following example of calculating the Haircut for Eligible Investment Fund Interests: for an
eligible investment fund comprised solely of US$100 of 91-day Treasury bills and US$100 of 3-year US Treasury bonds,
Haircut = [ (100 / 200 ) x 0.5 ] + [ (100 / 200 ) x 2.0 ] = ( 0.5 x 0.5 ) + ( 0.5 x 2.0 ) = 1.25 percent
12 C.F.R. pt. __, App. B, n. 1.
74 12 C.F.R. § __.5(a)-(b); see PR Margin Rules at 105-109.
75 See PR Margin Rules at n. 152.
76 See PR Margin Rules at 81; see 12 C.F.R. pts. 3.2, 217.2, 324.2; Regulatory Capital Rules, Liquidity Coverage Ratio: Interim
Final Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 79 Fed. Reg. 78287 (Dec. 30,
2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-12-30/pdf/2014-30218.pdf; Regulatory Capital Rules, Liquidity
Coverage Ratio: Proposed Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 80 Fed.
Reg. 5063 (proposed Jan. 30, 2015), available at http://www.gpo.gov/fdsys/pkg/FR-2015-01-30/pdf/2015-01324.pdf.
77 See PR Margin Rules at 82-83, n. 125.
78 12 C.F.R. § __.2 (citing 12 U.S.C. §§ 1811 et seq., 2183, 2279cc, 4617, 5381 et seq.); see PR Margin Rules at 80-84.
79 12 C.F.R. § __.5(3); see PR Margin Rules at 44-45.
80 See PR Margin Rules at 41-42.
81 12 C.F.R. § __.10; see PR Margin Rules at 176-179.
82 12 C.F.R. § __.8(g)-(h).
83 See PR Margin Rules at 162-165.
84 The PR Margin Rules define “foreign bank” to mean an organization that is organized under the laws of a foreign country and
that engages directly in the business of banking outside the United States. 12 C.F.R. § __.2; see PR Margin Rules at 73-74.
85 12 C.F.R. § __.9(b).
86 12 C.F.R. § __.9(c).
87 12 C.F.R. § __.2; see PR Margin Rules at 74-79.
88 12 C.F.R. § __.9(g).
89 See PR Margin Rules at 165-167.
90 12 C.F.R. § __.9(a); see PR Margin Rules at 168-174.
91 12 C.F.R. § __.9(d)(4).
92 See PR Margin Rules at 173-174; 12 C.F.R. § __.9(d)(2).
93 12 C.F.R. § __.9(e)(2).
94 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants–Cross-Border Application of the
Margin Requirements (proposed July 14, 2015), available at http://www.gpo.gov/fdsys/pkg/FR-2015-07-14/pdf/2015-16718.pdf.
For further discussion, please refer to our Client Alert regarding the CFTC’s proposed cross-border application of the margin
rules. CFTC Proposes Cross-Border Application of Margin Requirements for Uncleared Swaps, Client Alert No. 1865 (Aug. 13,
2015), available at https://www.lw.com/thoughtLeadership/lw-CFTC-Cross-Border-Application-Uncleared-Swaps.
95 12 C.F.R. § __.9(e)(1).
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96 12 C.F.R. § __.9(d)(3).
97 See PR Margin Rules at 35-46.
98 See PR Margin Rules at 42-44.
99 See Presentation given by the European Supervisory Authorities at the Public Hearing on EMIR – Risk mitigation techniques for
non-centrally cleared OTC derivatives, Slide 5 (June 18, 2015), available at http://www.eba.europa.eu/news-
press/calendar?p_p_auth=GQqZ0Umj&p_p_id=8&p_p_lifecycle=0&p_p_state=normal&p_p_mode=view&_8_struts_action=%2F
calendar%2Fview_event&_8_eventId=1106183.
100 See EMIR Proposed Margin Rules; draft amendments to the “Cabinet Office Ordinance on Financial Instruments Business” and
“Comprehensive Guidelines for Supervision” with regard to margin requirements for non-centrally cleared derivatives (July 3,
2014), available in Japanese at http://www.fsa.go.jp/news/26/syouken/20140703-3.html.
101 G-20 Cannes Summit Final Declaration (Nov. 2011), available at https://g20.org/wp-
content/uploads/2014/12/Declaration_eng_Cannes.pdf.

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