SEC Issues Exemptive Order in Connection with Portfolio Margining of Cleared Swaps and Security-Based Swaps

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Provisions of the Securities Exchange Act of 1934 (Exchange Act) and the Commodity Exchange Act (CEA) preclude market participants from portfolio margining collateral and other property that is required by the Exchange Act and the CEA to be held in accounts for securities and commodity customers, respectively. The Dodd-Frank Wall Street Reform and Consumer Protection Act amended the Exchange Act and the CEA to facilitate the use of portfolio margining. In general, the Dodd-Frank Act instructs the Securities and Exchange Commission and the Commodity Futures Trading Commission to issue rules or exemptive orders as necessary to permit customers that hold qualifying positions at a firm that is registered as a broker-dealer (BD) and futures commission merchant (FCM) to choose whether such positions will be carried in a futures account or a securities account, similar to the treatment afforded customers that engage in single stock futures transactions. The Dodd-Frank Act further provides that a person that holds portfolio margin positions in a securities account at a joint BD/FCM should receive the benefit of the protections that are available to customers under the Securities Investor Protection Act of 1970, and directs the CFTC to ensure that portfolio margin positions held in a futures account are subject to the same customer protection regime that applies to futures contracts.

The SEC has now issued an order granting conditional exemptive relief from compliance with certain provisions of the Exchange Act in order to facilitate portfolio margining treatment for customer-related positions in cleared credit default swaps (CDS). In particular, the SEC order permits cleared broad-based index CDS (which are swaps under the CEA) and cleared single name and narrow-based index CDS (which are security-based swaps under the Exchange Act) to be held in segregated accounts established and maintained in accordance with Section 4d(f) of the CEA.

The SEC order conditionally exempts dually registered securities clearing agencies/derivatives clearing organizations (clearing agencies/DCOs) from relevant provisions of the Exchange Act and SEC rules thereunder. The clearing agency/DCO exemption is subject to five conditions, including a requirement that the clearing agency/DCO take steps to obtain relief from the CFTC. The order notes the SEC’s anticipation that the CFTC will consider appropriate regulatory action to facilitate portfolio margining.

The SEC order conditionally exempts BDs/FCMs that elect to commingle and portfolio margin customer positions in CDS in customer accounts maintained in accordance with Section 4d(f) of the CEA. The BD/FCM exemption is subject to six conditions which, in part, seek to preserve customers’ ability to select between the segregation requirements and customer protections afforded a securities account under the Exchange Act versus those afforded a swap account under the CEA.

The SEC order is effective on December 19, 2012. The SEC has requested comment on all aspects of the exemptions. Comments must be received on or before February 19, 2013.

Click here for the Exemptive Order.