The Commodity Futures Trading Commission (CFTC) continues to issue regulations implementing the OTC derivatives provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The CFTC recently released an advanced notice of proposed rulemaking and a proposed rule that together address safeguarding customer margin for swaps, both cleared and uncleared.
Clients active in OTC derivatives markets will want to follow these rules closely, because they will directly affect the protection of their margin for cleared and uncleared derivatives, as well as the costs that will be incurred entering into derivatives under the new legislation.
CFTC Seeks Buy-Side Input on Segregation of Customer Margin for Cleared Swaps
By releasing the advanced notice, the CFTC has signaled its desire for more information about a critical industry issue: the protection of customer margin for cleared swaps. The CFTC’s first effort to study this issue was a CFTC Staff Roundtable held on October 22, 2010 (transcript available here). This roundtable revealed a divide on this issue between the derivatives clearing organizations (DCOs) and futures commission merchants (FCMs) on the one hand and non-dealer OTC swap market participants on the other. DCOs and FCMs have built margin systems based on the futures model that allows customer margin to be commingled in an omnibus account. Once a defaulting customer’s margin has been exhausted and the FCM has failed to make the clearinghouse whole, margin of other customers of the FCM may be used to meet the FCM’s obligations to the clearinghouse. Margin of non-defaulting customers held in such omnibus account therefore insulates non-defaulting FCMs and the DCO from the failure of an FCM resulting from a customer default (what the CFTC has termed “fellow-customer risk”). By contrast, buy-side customers want at least the option to choose a segregated account for margin, to protect their margin from this fellow-customer risk.
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