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Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations
disincentivized from trading uncleared swaps with such SDs since doing so would require large SDs to manage riskbased model calculations with some entities and table-based calculation with smaller SDs.100 Further, this commenter stated that table-based IM calculations, which do not take into account a firms specific portfolio composition, including diversification and hedges, might produce more conservative results requiring the posting and collection of margin that is inappropriately high given the actual level of risk involved in a typical transaction.101
Another commenter representing a group of commercial firms in the energy industry stated that allowing smaller SDs to rely on their SD counterparties approved IM model calculation would allow them to continue to play a crucial role in certain discrete swaps markets, like the energy swaps markets, in an economic and cost effective manner.102
The commenter noted that the use of the table-based method for the calculation of IM by smaller SDs and IM modeling by larger SDs resulted in a mismatch in calculation methods that could lead to worse pricing for smaller SDs, as the table-based method would likely cause their counterparties to post more IM
than they would under a model-based approach, with the cost of that margin being reflected in a higher price provided to the smaller SDs.103
Notwithstanding these expressions of support, many commenters objected to the provision in the Proposal that limits the application of the alternative method of calculation of IM to uncleared swaps entered into by a CSE
and a swap entity counterparty to hedge the risk of customer-facing swaps undertaken by the CSE, namely the hedging limitation.104 A commenter stated that it would be difficult, if not impossible, to ensure that all transactions to which the alternative method of calculation could apply are entered into for hedging purposes given that the concept of hedging is difficult to administer.105 The commenter pointed to questions that may arise, including what standard should be used to determine whether a given swap is in fact a hedge. 106 The commenter asked whether each swap with a large SD must be matched one-by-one with a swap 100 Id.

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101 Id.

at 5.

102 Working
Group 10/22/2020 Letter at 3.
See also STRM 10/23/2020 Letter at 2.
104 Associations 10/22/2020 Letter at 4; BPEC 10/
23/2020 Letter at 2; FIA 10/22/2020 Letter at 6;
Working Group 10/22/2020 Letter at 4.
105 BPEC 10/23/2020 Letter at 5.
106 Id. at 4.
103 Id.

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with a non-swap entity counterparty,107
and whether it would be feasible for an entity to undertake portfolio hedging or dynamic hedging in that context.108 The commenter also asked what would happen if the underlying swap transaction with a non-swap entity counterparty had been terminated, and whether anticipatory hedges could be counted as hedging.109 The commenter noted that because the swaps markets are dynamic, the character of swaps may change over time and tagging a swap as hedging and non-hedging may be impractical.110 The commenter concluded that given the uncertainty as to what constitutes hedging, CSEs may be reluctant to apply the alternative method of calculation.111
Another commenter raised similar concerns regarding difficulties in applying the concept of hedging, illustrated by the position limits rule recently adopted after many attempts by the Commission to implement the Dodd-Frank Act, noting that at the core of the rule lies the concept of hedging.112 The commenter stated that the concept of hedging is difficult to quantify and that there are many instances when hedging is virtually indistinguishable from speculation.113
In the absence of a definition in the Final Rule, the commenter stated, counterparties could be left guessing and may be reluctant to rely on the alternative method of calculation for fear of violating the hedging limitation.114 A commenter also noted that proposed Regulation 23.154a5
does not define the term hedging and suggested replacing the term with the phrase hedge or mitigate commercial risk. 115
Another commenter stated that many CSEs do not separate hedging from dealing on a transaction-by-transaction basis since CSEs often manage hedging on a portfolio basis and, as a result, to implement the hedging limitation, CSEs would need to undertake a significant amount of analysis and legal review to make hedging determinations, making the relief provided by the alternative method of IM calculation 107 Id. See also STRM 10/23/2020 Letter at 4
stating that classifying individual transactions with other SDs as hedges and tying the hedges to particular client-facing transactions would impose a material compliance burden that could nullify any benefit offered by the relief in proposed Regulation 23.154a5.
108 BPEC 10/23/2020 Letter at 4.
109 Id.
110 Id.
111 Id. at 5.
112 FIA 10/22/2020 Letter at 7.
113 Id.
114 Id.
115 STRM 10/23/2020 Letter at 4.

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impracticable.116 Similarly, another commenter stated that if a CSE must be able to demonstrate that each swap is a hedge of a transaction with a non-SD, then the CSE would not be able to engage in portfolio hedging if the portfolio includes risk related to a speculative swap with another SD.117
Consequently, in the commenters view, the hedging limitation would limit the flexibility and efficacy of a CSEs risk management program.118
In line with these comments, another commenter stated that if a commercial CSEs portfolio includes non-hedging transactions, the opportunity to rely on the IM calculations of its SD
counterparty may not be useful since they would need to calculate separately IM for the non-hedging transactions, which would reduce the benefits of netting or diversification offered by the Standardized IM Model SIMM.119
As a result, the commenter noted, the amount of IM is likely to be higher, disadvantaging commercial CSEs and their SD counterparties in a way that would not apply to CSE portfolios with non-SDs.120
Commenters also noted that CSEs and their counterparties typically transact both hedging and dealing swaps under a single ISDA Master Agreement or credit support annex, with many relationships put in place years ago, and calculate IM at the relationship or master contract level rather than the transaction level.121 A commenter stated that if CSEs are required to add additional representations confirming that a given transaction is a hedging transaction, the existing documentation would need to be updated.122 The commenter further stated that IM would also need to be administered on the basis of hedging and non-hedging transactions which would make the 116 BPEC

10/23/2020 Letter at 5.
Group 10/22/2020 Letter at 4.

117 Working 118 Id.

119 Associations 10/22/2020 Letter at 4. This commenter, along with another commenter, also argued that SIMM, whose use must be approved by a regulator prior to its utilization in the calculation of regulatory IM, is a robust framework that obviates the need for a safeguard, such as the hedging limitation, to ensure the calculation of sufficient amounts of IM. See Associations 10/22/2020 Letter at 5; FIA 10/22/2020 Letter at 9. While recognizing the value of standardization, the Commission believes that SIMM on its own does not offer the safeguards necessary to address the concerns raised by the application of the alternative method of IM
calculation. That is because SIMM is a tool that must be tailored to fit each firms portfolio and risk profile, and must be subject to ongoing oversight to ensure adequate calibration.
120 Associations 10/22/2020 Letter at 4.
121 See generally Associations 10/22/20 Letter at 4; BPEC 10/23/2020 Letter at 6; FIA 10/22/2020
Letter at 78.
122 FIA 10/22/2020 Letter at 8.

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