Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 6336-6409 [2012-1033]
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Federal Register / Vol. 77, No. 25 / Tuesday, February 7, 2012 / Rules and Regulations
Table of Contents
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Parts 22 and 190
RIN Number 3038–AC99
Protection of Cleared Swaps Customer
Contracts and Collateral; Conforming
Amendments to the Commodity Broker
Bankruptcy Provisions
Commodity Futures Trading
Commission.
AGENCY:
ACTION:
Final rule.
The Commodity Futures
Trading Commission (the
‘‘Commission’’) is adopting final
regulations to implement new statutory
provisions enacted by Title VII of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act (the ‘‘DoddFrank Act’’). Specifically, these
regulations impose requirements on
futures commission merchants
(‘‘FCMs’’) and derivatives clearing
organizations (‘‘DCOs’’) regarding the
treatment of cleared swaps customer
contracts (and related collateral), and
make conforming amendments to
bankruptcy provisions applicable to
commodity brokers under the
Commodity Exchange Act (the ‘‘CEA’’).
SUMMARY:
The rules will become effective
April 9, 2012. All parties must comply
with the Part 22 rules by November 8,
2012. All parties must comply with the
Part 190 rules by April 9, 2012. Prior to
the compliance date for the Part 22
rules, the definition of 190.01(pp)
(‘‘Cleared Swap’’) shall be limited to
transactions where the rules or bylaws
of a derivatives clearing organization
require that such transactions, along
with the money, securities, and other
property margining, guaranteeing or
securing such transactions, be held in a
separate account for Cleared Swaps
only.
DATES:
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FOR FURTHER INFORMATION CONTACT:
Robert B. Wasserman, Chief Counsel,
Division of Clearing and Risk (DCR), at
202–418–5092 or rwasserman@cftc.gov;
M. Laura Astrada, Associate Chief
Counsel, DCR, at 202–418–7622 or
lastrada@cftc.gov; Alicia Lewis, Special
Counsel, DCR, at 202–418–5862 or
alewis@cftc.gov; or Martin White,
Assistant General Counsel, Office of the
General Counsel, at 202–418–5129 or
mwhite@cftc.gov, in each case, at the
Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street, NW., Washington, DC
20581.
SUPPLEMENTARY INFORMATION:
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I. Background
A. Segregation Requirements.
B. Overview of the Clearing Process as it
Relates to the Segregation Requirements.
C. Segregation Alternatives.
D. Operation of the Segregation Models in
an FCM Bankruptcy.
E. Solicitation of Public Input.
F. Clarification of the Application of
Financial and Segregation Interpretation
No. 10 to Cleared Swaps.
II. The Final Rules
III. Segregation Model for Cleared Swaps
Customer Collateral
A. Summary of the Comments.
B. Discussion of the Comments.
IV. Section by Section Analysis: Regulation
Part 22
A. Regulation 22.1: Definitions.
B. Regulation 22.2—Futures Commission
Merchants: Treatment of Cleared Swaps
Customer Collateral.
C. Regulation 22.3—Derivatives Clearing
Organizations: Treatment of Cleared
Swaps Customer Collateral.
D. Regulation 22.4—Futures Commission
Merchants and Derivatives Clearing
Organizations: Permitted Depositories.
E. Regulation 22.5—Futures Commission
Merchants and Derivatives Clearing
Organizations: Written
Acknowledgment.
F. Regulation 22.6—Futures Commission
Merchants and Derivatives Clearing
Organizations: Naming of Cleared Swaps
Customer Accounts.
G. Regulation 22.7—Permitted
Depositories: Treatment of Cleared
Swaps Customer Collateral.
H. Regulation 22.8—Situs of Cleared
Swaps Customer Accounts.
I. Regulation 22.9—Denomination of
Cleared Swaps Customer Collateral and
Location of Depositories.
J. Regulation 22.10—Application of other
Regulatory Provisions.
K. Regulation 22.11—Information to be
Provided Regarding Customers and Their
Cleared Swaps.
L. Regulation 22.12—Information to be
Maintained Regarding Cleared Swaps
Customer Collateral.
M. Regulation 22.13—Additions to Cleared
Swaps Customer Collateral.
N. Regulation 22.14—Futures Commission
Merchant Failure to Meet a Customer
Margin Call in Full.
O. Regulation 22.15—Treatment of Cleared
Swaps Customer Collateral on an
Individual Basis.
P. Regulation 22.16—Disclosures to
Customers.
V. Section by Section Analysis: Amendments
to Regulation Part 190
A. Background.
B. Definitions.
C. Amendments to Regulation 190.02—
Operation of the Debtor’s Estate
Subsequent to the Filing Date and Prior
to the Primary Liquidation Date.
D. Amendments to Regulation 190.03—
Operation of the Debtor’s Estate
Subsequent to the Primary Liquidation
Date.
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E. Amendments to Regulation 190.04—
Operation of the Debtor’s Estate—
General.
F. Amendments to Regulation 190.05—
Making and Taking Delivery on
Commodity Contracts.
G. Amendments to Regulation 190.06—
Transfers.
H. Amendments to Regulation 190.07—
Calculation of Allowed Net Equity.
I. Amendments to Regulation 190.09—
Member Property.
J. Amendments to Regulation 190.10—
General.
K. Amendments to Appendix A to Part
190—Bankruptcy Forms, Bankruptcy.
L. Amendments to Appendix B to Part
190—Special Bankruptcy Distributions.
VI. Effective Date
VII. Consideration of Costs and Benefits
A. Introduction.
B. Benefits and Costs of Complete Legal
Segregation Model Relative to Futures
Model.
C. Conclusion.
VIII. Related Matters.
A. Paperwork Reduction Act.
B. Regulatory Flexibility Act.
IX. Text of Proposed Rules
I. Background
A. Segregation Requirements
On July 21, 2010, President Obama
signed the Dodd-Frank Act.1 Title VII of
the Dodd-Frank Act 2 amended the
CEA 3 to establish a comprehensive new
regulatory framework for swaps and
certain security-based swaps. The
legislation was enacted to reduce risk,
increase transparency, and promote
market integrity within the financial
system by, among other things: (1)
Providing for the registration and
comprehensive regulation of swap
dealers and major swap participants; 4
(2) imposing mandatory clearing and
trade execution requirements on
clearable swap contracts; (3) creating
rigorous recordkeeping and real-time
reporting regimes; and (4) enhancing the
Commission’s rulemaking and
enforcement authorities with respect to,
among others, all registered entities and
intermediaries subject to the
Commission’s oversight.
Section 724 of the Dodd-Frank Act
prescribes the manner in which Cleared
1 See Dodd-Frank Act, Public Law 111–203, 124
Stat. 1376 (2010). The text of the Dodd-Frank Act
may be accessed at https://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
2 Pursuant to section 701 of the Dodd-Frank Act,
Title VII may be cited as the ‘‘Wall Street
Transparency and Accountability Act of 2010.’’
3 7 U.S.C. 1 et seq.
4 In this release, the terms ‘‘swap dealer’’ and
‘‘major swap participant’’ shall have the meanings
set forth in section 721(a) of the Dodd-Frank Act,
which added sections 1a(49) and (33) of the CEA.
However, as directed by section 721(c) of the DoddFrank Act, the Commission is in the process of
promulgating rules to further define, among other
terms, ‘‘swap dealer’’ and ‘‘major swap participant.’’
See 75 FR 80173, Dec. 21, 2010.
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Swaps (and related collateral) 5 must be
treated prior to and after bankruptcy.
Section 724(a) of the Dodd-Frank Act
amends section 4d of the CEA to add a
new paragraph (f), which imposes the
following requirements on an FCM, as
well as any depository thereof
(including, without limitation, a DCO):
1. The FCM must treat and deal with
all collateral (including accruals
thereon) deposited by a customer 6 to
margin its Cleared Swaps as belonging
to such customer;
2. The FCM must separately account
for and may not commingle such
collateral with its own property and
may not, with certain exceptions, use
such collateral to margin the Cleared
Swaps of any person other than the
customer depositing such collateral;
3. A DCO may not hold or dispose of
the collateral that an FCM receives from
a customer to margin Cleared Swaps in
any manner that would indicate that
such collateral belonged to the FCM or
any person other than the customer; and
4. The FCM and the DCO may only
invest such collateral in enumerated
investments.
In other words, the FCM and the DCO
(i) must hold such customer collateral in
an account (or location) that is separate
from the property belonging to the FCM
or DCO, and (ii) must not use the
collateral of one customer to (A) cover
the obligations of another customer or
(B) the obligations of the FCM or DCO.
These basic requirements that Cleared
Swaps Customer Collateral be treated as
the property of customers and
maintained in segregated accounts (or
locations) are imposed by the statute
and have the force of law regardless of
the Commission’s particular
implementing regulations. Moreover, by
the terms of the statute, these
requirements would apply even if the
Commission promulgated no
implementing regulations.
Section 724(b) of the Dodd-Frank Act
governs bankruptcy treatment of Cleared
Swaps by clarifying that Cleared Swaps
are ‘‘commodity contracts’’ within the
meaning of section 761(4)(F) of the
Bankruptcy Code.7 Therefore, in the
event of an FCM or DCO insolvency,
Cleared Swaps Customers may invoke
the protections of Subchapter IV of
Chapter 7 of the Bankruptcy Code
(‘‘Subchapter IV’’). Such protections
include: (i) protected transfers of
Cleared Swaps and related collateral; 8
and (ii) if Cleared Swaps are subject to
5 Regulation 22.1 defines ‘‘Cleared Swap’’ and
‘‘Cleared Swaps Customer Collateral.’’
6 Regulation 22.1 defines ‘‘Cleared Swaps
Customer.’’
7 11 U.S.C. 761(4)(F).
8 See, e.g., 11 U.S.C. 764.
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liquidation, preferential distribution of
remaining collateral.9 However, section
766(h) of the Bankruptcy Code (‘‘Section
766(h)’’) subjects customers to
mutualized risk by requiring that
customer property be distributed
‘‘ratably to customers on the basis and
to the extent of such customers’ allowed
net equity claims.’’ This requirement, in
turn, limits the Commission’s flexibility
in designing a model for the protection
of customer collateral.
B. Overview of the Clearing Process as
It Relates to the Segregation
Requirements
1. Central Counterparties/Derivatives
Clearing Organizations
One of the primary objectives of the
Dodd-Frank Act was to promote the
central clearing of swaps and to
establish the regulatory infrastructure
for the clearing of swaps.10 Clearing is
the process by which transactions in
derivatives are processed, guaranteed,
and settled by a central counterparty,
also known as a DCO. In accordance
with this overall Congressional purpose,
section 724 of the Dodd-Frank Act
amends the CEA to provide the statutory
foundation for the protection of Cleared
Swaps Customer Collateral.
A DCO has members (‘‘Clearing
Members’’) who clear derivatives
transactions (e.g., swaps) through the
DCO and who are subject to the DCO’s
rules. Clearing Members may clear
transactions on their own behalf (i.e.,
‘‘proprietary transactions’’) or on behalf
of customers (i.e., ‘‘customer
transactions’’). Clearing members that
clear swaps for customers must be
registered as futures commission
merchants (‘‘FCMs’’).11
The term ‘‘central counterparty’’
means, conceptually, that the DCO
becomes the seller to every buyer, and
the buyer to every seller. More
specifically, the DCO novates swap
transactions initially entered into
between various market participants,
such as swaps users, dealers, or end
users, and cleared either directly (if the
market participant is itself a Clearing
Member) or indirectly (through an FCM
that is a Clearing Member) . The
contractual obligations between the
9 See,
e.g., 11 U.S.C. 766(h) and (i).
supra n. 1; S. Rep. No. 111–176, at 33
(2010) (‘‘[w]ith appropriate collateral and margin
requirements, a central clearing organization can
substantially reduce counterparty risk and provide
an organized mechanism for clearing transactions’’);
Process for Review of Swaps for Mandatory
Clearing, 76 FR 44464, July 26, 2011 (final rule);
Derivatives Clearing Organizations General
Provisions and Core Principles, 76 FR 69334, Nov.
8, 2011 (final rule).
11 Section 4d(f)(1) of the CEA, 7 U.S.C. 6d(f)(1).
10 See
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original parties (‘‘A’’ and ‘‘B’’) 12 are
replaced by sets of equivalent
obligations: between the Clearing
Member FCMs acting for the original
parties and the DCO and between the
Clearing Member FCMs and their
individual customers. Thus, if the
original swap agreement would require
a certain payment from A to B, as a
result of the clearing process this
obligation becomes (1) a duty by A’s
clearing FCM to pay the DCO, (2) a
corresponding claim by A’s FCM to
recompense from A, (3) a duty by the
DCO to pay B’s clearing FCM, and (4)
a corresponding duty by B’s FCM to pay
B.
In economic effect, the DCO serves as
a guarantor that every Clearing Member
party to a cleared swap receives
performance according to the terms of
the swap, while the clearing FCM serves
as a guarantor of its customers’ swaps
obligations to the DCO.
2. Variation
To avoid the accumulation of large
obligations, the DCO conducts a
variation payment and collection cycle
at least once a day, and in the case of
many DCOs, twice a day. The DCO will
first calculate the gain (and
corresponding loss) on each contract
through a process known as ‘‘marking to
market,’’ using reported market prices
where available, or other means (such as
surveys of Clearing Members). The DCO
will then aggregate and net the gains
and losses for each Clearing Member
(separately for proprietary and customer
accounts), collect from those Clearing
Members with net losses, and pay those
Clearing Members with net gains. This
process is highly time sensitive: The
Clearing Member typically has only one
or a few hours between the demand for
payment and the time payment is due.
Similarly, the Clearing Member FCMs
will debit the accounts of those
customers who have losses on their
transactions, and credit the accounts of
those customers who have gained.
3. Margin (Collateral)
To secure the prompt payment of
variation obligations, the DCO will
require each Clearing Member to post
collateral (often referred to as ‘‘margin’’)
for the transactions it clears (separately
for customer positions and proprietary
positions). If the Clearing Member does
not promptly make a variation payment
to the DCO—referred to as a default—
the collateral may immediately be
liquidated and applied to the obligation.
Margin may only be used to meet the
12 For purposes of this example, neither A nor B
is a Clearing Member.
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default of the Clearing Member posting
that margin. While proprietary margin
may be used to meet obligations in
either the Clearing Member’s
proprietary account or customer
account, the reverse is not true: A
Clearing Member’s customer margin
may not be used to meet a default in the
Clearing Member’s proprietary account.
Similarly, FCMs will—indeed, are
required to—collect collateral from each
of their customers, based on each
customer’s portfolio of positions, to
secure the prompt payment of the
customer’s variation obligations.13 If a
customer fails to fulfill an obligation to
the FCM arising out of a swap
agreement the FCM clears for the
customer, the FCM may use some or all
of the value of the collateral that
customer has posted to meet that
obligation—that is the purpose of the
collateral.
The DCO will generally set minimum
collateral levels for each type of swap,
and will prescribe a ‘‘margin
methodology’’ to determine the
minimum margin level for portfolios of
swaps. The DCO’s margin methodology
will be designed to estimate the amount
of loss a portfolio of swap positions may
incur, calculated at a statistical
confidence level no less than 99%, over
a holding period generally between one
and ten days, depending on the time it
is estimated to take to liquidate the
swaps in the portfolio.14 The FCM will,
in turn, use the same or similar
methodology in determining the
minimum level of collateral it must
collect from each customer.15
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4. Default Resources
As noted above, the margin collateral
collected by a DCO is designed to cover
most (e.g., 99%), but not all, potential
13 See regulation 39.13(g)(8)(ii) (stating that ‘‘[a]
derivatives clearing organization shall require its
clearing members to collect customer initial margin,
as defined in § 1.3 of this chapter, from their
customers, for nonhedge positions, at a level that
is greater than 100 percent of the derivatives
clearing organization’s initial margin requirements
with respect to each product and swap portfolio.’’).
76 FR at 69439.
The purpose of this rulemaking is to protect
Cleared Swaps Customer Collateral in the event that
an FCM defaults to a DCO due to ‘‘Fellow-Customer
Risk’’ (as such term is defined in section I(B)(6)
herein). However, as section III(B) explores in
greater detail, the segregation model selected in this
rulemaking provides limited protection from
operational and investment risks.
14 See generally, 76 FR 69334. See specifically
regulation 39.13(g)(2)(ii) (setting forth a one-day
minimum liquidation time for agricultural, energy,
and metals swaps, and a five-day minimum
liquidation time for all other swaps). 76 FR 69438.
15 The FCM is required to collect a higher level
of collateral from its customers than that prescribed
for Clearing Members (see id.) and may, in its
discretion, collect a yet higher level. See regulation
22.13(a)(1).
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losses incurred by a Clearing Member.
DCOs cover the ‘‘tail risk’’ (i.e., the risk
that a Clearing Member will incur, and
default on, a loss in excess of the margin
collected) by means of what is
sometimes referred to as a default
resources package, or ‘‘waterfall.’’
Elements of the waterfall may include a
contribution of a specified amount of
the DCO’s own capital, pre-funded
contributions from Clearing Members (a
‘‘guaranty fund’’),16 or (to a limited
extent), a power by the DCO to assess
additional contributions from Clearing
Members. Unlike margin, a Clearing
Member’s contribution to the guaranty
fund will generally be usable to meet
the default of another Clearing Member.
In other words, the guaranty fund is
‘‘mutualized.’’ Elements of the waterfall
are applied in an order pre-determined
by the DCO’s rules. Such rules will
often apply the guaranty fund
contribution of the defaulter before the
DCO’s own capital, and the remainder
of the guaranty fund (i.e., the guaranty
fund contributions of the non-defaulting
Clearing Members) thereafter.
Though seemingly complex,
centralized clearing has important
advantages in terms of transparency,
risk management, netting out of
countervailing obligations, and reduced
exposure of market participants to each
other’s credit risk (by effectively
substituting the DCO’s credit risk).
5. Customer Accounts
Generally, a clearing FCM will have
two different types of Cleared Swaps
Customer Accounts in connection with
collateral provided to it by Cleared
Swaps Customers. One account is
maintained (generally at a bank) by the
FCM on behalf of its Cleared Swaps
Customers (the ‘‘FCM Customer
Account’’). The FCM Customer Account
holds assets provided by customers, or
other assets of equivalent value, that are
not currently posted with the DCO to
support swaps positions cleared by the
FCM on behalf of its Cleared Swaps
Customers. The other account is
maintained by the DCO for the FCM on
behalf of the FCM’s Cleared Swaps
Customers (the ‘‘DCO Customer
Account’’). The DCO Customer Account
holds customer assets, or assets of
equivalent value, that the FCM has
posted to the DCO as collateral for
swaps positions that have been
established and cleared by the FCM for
its Cleared Swaps Customers.
The collateral posted by each Cleared
Swaps Customer is, however,
potentially exposed to risks that do not
arise out of the obligations that a
16 See
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Cleared Swaps Customer has directly
incurred by assuming his or her swaps
position. 17 The most important impact
of such risks would occur in the case of
an insolvency on the part of the FCM
through which the Cleared Swaps
Customer clears. As discussed in more
detail below, the new CEA section 4d(f),
and the Commission’s implementing
regulations, are designed to provide
protection for Cleared Swaps Customer
Collateral against certain risks that may
arise during an insolvency on the part
of the FCM through which the Cleared
Swaps Customer clears.
6. Fellow-Customer Risk
‘‘Fellow-Customer Risk’’ is the risk
that a DCO would need to access the
collateral of non-defaulting Cleared
Swaps Customers to cure an FCM
default. Fellow-Customer Risk arises in
circumstances in which a Cleared
Swaps Customer (the ‘‘defaulting
customer’’) of a clearing FCM suffers a
(significant) loss in connection with a
cleared swap.18 The loss will result in
a call by the DCO for a variation
payment from the clearing FCM that
carries that Cleared Swaps Customer’s
Cleared Swaps.19 The clearing FCM may
demand expedited payment from the
defaulting Cleared Swaps Customer, but
is in any event directly obligated
promptly to meet the payment
obligation to the DCO.
If the loss is great enough, it may
exceed the sum of the FCM’s available
liquid assets, the swaps collateral
posted by the Cleared Swaps Customer,
and any additional payments
immediately available from the Cleared
Swaps Customer. In this situation,
sometimes called a ‘‘double default,’’
the defaulting Cleared Swaps Customer
will have defaulted on its obligation to
the clearing FCM which, in turn, will
default on its obligation to the DCO. In
such circumstances, the FCM will likely
have to file for protection in bankruptcy.
Meanwhile, the defaulting Cleared
Swaps Customer’s loss will translate to
a gain by one or more other market
participants. Notwithstanding the
default by the clearing FCM, the DCO,
in its capacity as central counterparty, is
required to pay out these gains. The
DCO will thus be faced with a
potentially significant loss.
A potential resource for the DCO to
apply to this loss in a double default
17 Examples of other risks include the possibility
of misuse or misallocation of a Cleared Swaps
Customer’s assets by a dishonest or negligent FCM.
18 See also supra n. 13.
19 As noted above, the amount the DCO will call
for or pay to the FCM in respect of its Cleared
Swaps Customers is the net of the gains and losses
computed on a customer-by-customer basis.
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situation is the collateral held in the
Cleared Swaps Customer Account
maintained by the DCO for the
defaulting FCM on behalf of the FCM’s
Cleared Swaps Customers. Under the
current rules applicable to futures
clearing, a DCO is permitted to use all
of the collateral in the Clearing
Member’s customer account to meet a
loss in that account, without regard to
which customer(s) in fact supplied that
collateral. Thus, in this case, the nondefaulting customers of the defaulting
FCM clearing member would be
exposed to loss due to ‘‘FellowCustomer Risk.’’
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C. Segregation Alternatives
In implementing new CEA section
4d(f), the Commission considered five
alternative segregation models for
Cleared Swaps Customer Collateral in
the notice of proposed rulemaking issue
by the Commission on June 9, 2011 (the
‘‘NPRM’’).20
1. Legal Segregation With Operational
Commingling Model
The first alternative explored by the
Commission was legal segregation with
operational commingling (the ‘‘LSOC
Model’’ or ‘‘Complete Legal Segregation
Model’’). Under the LSOC Model, each
FCM and DCO would enter (or
‘‘segregate’’), in its books and records,
the Cleared Swaps of each individual
customer and relevant collateral. Each
FCM and DCO would ensure that such
entries are separate from entries
indicating (i) FCM or DCO obligations,
or (ii) the obligations of non-cleared
swaps customers. Operationally,
however, each FCM and DCO would be
permitted to hold (or ‘‘commingle’’) the
relevant collateral in one account. Each
FCM and DCO would ensure that such
account is separate from any account
holding FCM or DCO property or
holding property belonging to noncleared swaps customers.
Prior to the simultaneous default of an
FCM and one of its Cleared Swaps
Customers (as discussed above, a
‘‘double default’’), the FCM would
ensure that the DCO does not use the
collateral of one Cleared Swaps
Customer to support the obligations of
another customer by making certain that
the value of the Cleared Swaps
Customer Collateral that the DCO holds
equals or exceeds the value of all
Cleared Swaps Customer Collateral that
it has received to secure the contracts of
the FCM’s customers. Following a
20 See Notice of Proposed Rulemaking on the
Protection of Cleared Swaps Customer Contracts
and Collateral; Conforming Amendments to the
Commodity Broker Bankruptcy Provisions, 76 FR
33818, 33822, June 9, 2011.
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double default, the DCO would be
permitted to access the collateral of the
defaulting Cleared Swaps Customers,
but not the collateral of the nondefaulting Cleared Swaps Customers.
Thus while, even under the LSOC
Model, Section 766(h) requires the pro
rata distribution of customer property,
the collateral attributable to the nondefaulting Cleared Swaps Customers
would be available to be distributed.
2. Legal Segregation With Recourse
Model
Second, the Commission
contemplated the Legal Segregation
with Recourse Model (together with the
LSOC Model, the ‘‘Legal Segregation
Models’’). As with the LSOC Model,
under the Legal Segregation with
Recourse Model, each FCM and DCO
would segregate the Cleared Swaps of
each individual customer and relevant
collateral in its books and records.
However, each FCM and DCO would be
permitted to commingle the relevant
collateral in one account, provided that
such account is separate from any
proprietary accounts or accounts
property belonging to non-cleared
swaps customers.
Again, as with the LSOC Model, prior
to a double default, the FCM would
ensure that the DCO does not use the
collateral of one Cleared Swaps
Customer to support the obligations of
another customer by making certain that
the value of the Cleared Swaps
Collateral that the DCO holds equals or
exceeds the value of all Cleared Swaps
Collateral that it has received to secure
the contracts of the FCM’s customers.
However, unlike the LSOC Model,
following a double default, the Legal
Segregation with Recourse Model would
not prohibit a DCO from accessing the
collateral of the non-defaulting Cleared
Swaps Customers, after the DCO applies
its own capital to cure the default, as
well as the guaranty fund contributions
of its non-defaulting FCM members.
3. Physical Segregation Model
The Commission also explored the
possibility of full physical segregation
(the ‘‘Physical Segregation Model’’) for
Cleared Swaps Customer Collateral. The
Physical Segregation Model primarily
differs from the Legal Segregation
Models operationally. In the ordinary
course of business (i.e., prior to a double
default), as with the Legal Segregation
Models, each FCM and DCO would
enter (or ‘‘segregate’’), in its books and
records, the Cleared Swaps of each
individual customer and relevant
collateral. However, unlike the Legal
Segregation Models, each FCM and DCO
would maintain separate individual
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6339
accounts for the relevant collateral.
Hence, the FCM would ensure that the
DCO does not use the collateral of one
Cleared Swaps Customer to support the
obligations of another customer by
making certain that the DCO does not
mistakenly transfer collateral in (i) the
account belonging to the former to (ii)
the account belonging to the latter.
Following a double default, the
Physical Segregation Model would lead
to the same result as the Complete Legal
Segregation Model. Specifically, the
DCO would be permitted to access the
collateral of the defaulting Cleared
Swaps Customers, but not the collateral
of the non-defaulting customers.
As discussed above, one important
limitation on the effectiveness of the
Physical Segregation Model is section
766(h) of the Bankruptcy Code, which
requires that customer property be
distributed ratably. Thus, if because of
Physical Segregation, certain Cleared
Swaps Customer Collateral was better
protected than the property of other
Cleared Swaps Customers, it would not
be permissible to pay Cleared Swaps
Customers in the first group a higher
proportion (i.e., a higher cents-on-thedollar distribution) of their net equity
claims than Cleared Swaps Customers
in the second group. Rather, Cleared
Swaps Customers in both groups would
receive the same proportion of their
allowed net equity claims. In other
words, in spite of incurring greater cost
under the Physical Segregation Model, a
Cleared Swaps Customer would
essentially receive the same level of
protection for its Cleared Swaps
Customer Collateral under the Physical
Segregation Model as it would under the
LSOC Model.
4. Futures Model
The Commission also considered
replicating the segregation requirement
currently applicable to futures (the
‘‘Futures Model’’). Under this model,
DCOs treat each FCM’s customer
account on an omnibus basis, that is, as
belonging to an undifferentiated group
of customers.
Prior to a double default, the Futures
Model shares certain similarities with
the Legal Segregation Models.
Specifically, each FCM would enter (or
‘‘segregate’’), in its books and records,
the Cleared Swaps of each individual
customer and relevant collateral. Each
DCO, however, would recognize, in its
books and records, the Cleared Swaps
that an FCM intermediates on a
collective (or ‘‘omnibus’’) basis. Each
FCM and DCO would be permitted to
hold (or ‘‘commingle’’) all Cleared
Swaps Customer Collateral in one
account.
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Following a double default, the
Futures Model shares certain
similarities with the Legal Segregation
with Recourse Model. Specifically, the
Futures Model would not prohibit a
DCO from accessing the collateral of the
non-defaulting Cleared Swaps
Customers. However, unlike the Legal
Segregation with Recourse Model, under
the Futures Model the DCO would be
permitted to access such collateral
before applying its own capital or the
guaranty fund contributions of nondefaulting FCM members.21
5. Optionality
Finally, the Commission explored
permitting a DCO to choose between (i)
the Legal Segregation Models (whether
Complete or with Recourse), (ii) the
Physical Segregation Model, and (iii) the
Futures Model, rather than mandating
any particular alternative.
D. Operation of the Segregation Models
in an FCM Bankruptcy
When discussing the issues
surrounding an FCM bankruptcy under
the Bankruptcy Code, analytically there
are several scenarios to consider: (1) The
bankruptcy is unrelated to the loss of
customer funds, and there is no such
loss; (2) The bankruptcy involves
shortfalls in customer funds due to
operational risks; (3) The bankruptcy
involves losses due to customer risk
(i.e., a customer incurs a loss in excess
of the FCM’s financial ability to cover);
or (4) the bankruptcy involves shortfalls
in customer funds due to operational
risk and losses due to customer risk.
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1. Bankruptcy Unrelated to Loss of
Customer Funds
An FCM bankruptcy that is unrelated
to the loss of customer funds may arise
because of financial difficulties in the
FCM, financial difficulties in the
proprietary accounts, or because of the
impact of difficulties at a corporate
parent or affiliate. Under this scenario,
all models share important
characteristics: Customer positions and
related collateral, whether at a DCO or
at the FCM, can be transferred to one or
more willing transferee FCMs, or may be
liquidated and returned to the trustee.
With respect to fostering transfer,
however, the Legal Segregation Models
(whether Complete or with Recourse)
and the Physical Segregation Model do
have a significant advantage compared
to the Futures Model: In each of them,
information about the customers as a
whole, and about each individual
21 For
a more detailed discussion regarding the
operation of the segregation models in an FCM
bankruptcy, see section I.D.
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customer’s positions, are transmitted to
the DCO every day, an information flow
(and store) that is not present in the
Futures Model. Thus, each DCO will
have important customer information on
a customer by customer basis that can
be used to facilitate and implement
transfers, and is thus less reliant upon
the FCM for that information.
2. Bankruptcy With Shortfalls Due to
Operational Risks or Investment Risks
An FCM bankruptcy with shortfalls
due to operational risks would arise
because of a shortfall in segregated
funds due to, e.g., negligence, theft or
other mishap. An FCM may also have
shortfalls due to investment risks
resulting from extraordinary losses on
the set of investments permitted under
regulation 1.25 (as included in new
regulation 22.2(e)(3)). Under this
scenario, all models again share
important characteristics: Customer
positions and related collateral at a DCO
may be delivered to the Trustee, or may
transferred by the DCO, but only to the
extent of each customer’s pro rata share.
Under all of the segregation models, to
the extent there is a shortfall, each
customer will ultimately receive the
same cents-on-the-dollar proportion of
the value of the customer’s account.
However, with respect to fostering
transfer, the other models again have a
significant advantage compared to the
Futures Model: In each of them,
information about the customers as a
whole, and about each individual
customer’s positions, are transmitted to
the DCO every day, an information flow
(and store) that is not present in the
Futures Model. Thus, each DCO will
have important customer information on
a customer by customer basis that can
be used to facilitate and implement
transfers, and accordingly is less reliant
upon the FCM for that information.
3. Bankruptcy With Shortfalls Due to
Customer Risk
An FCM bankruptcy with shortfalls
due to customer risk would arise
because a customer incurs a loss that
exceeds both the customer’s collateral
and the FCM’s ability to pay.
Under the Futures Model, the DCO
could use the entirety of the FCM’s
customer account (or as much of it as
necessary) to meet the entire loss
created by the default. Transfer of
customer positions would be difficult,
in that the DCO would lack information
as to which customers were in default,
and which positions belonged to
defaulting customers (and, presumably,
would not be transferred) and which did
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not.22 The DCO would be permitted to
liquidate customer positions, a process
that might take between one and ten
days.23 Once the loss was crystalized,
the DCO would be able to turn over the
collateral (less that used to meet the
default) to the Trustee for use in the pro
rata distribution.
Under the LSOC Model, the DCO
could only use the collateral attributable
to defaulting customers (those whose
positions suffered losses) to meet the
loss. Thus, all collateral attributable to
customers whose net positions gained or
were ‘‘flat’’ (neither gained nor lost),
and much of the collateral attributable
to customers whose net positions lost,
would be immediately available for
transfer. Moreover, the DCO would have
information that is no more than one
business day old tying customers to
portfolios of positions, and the DCO
itself would maintain the margining
methodology that would tie such
portfolios of positions to the collateral
requirement associated with such
portfolios. Even if the DCO decided to
liquidate all customer positions, the
collateral of non-defaulting customers
would be exposed to less loss than
under the Futures Model because the
DCO would not have the right to access
it.
The Physical Segregation Model
would work in a manner similar to the
LSOC Model. Again, all collateral
attributable to customers whose net
positions gained or were ‘‘flat’’ (neither
gained nor lost), and the remaining
collateral attributable to customers
whose net positions lost, would be
immediately available for transfer. The
DCO would have specific information
on how much collateral was, in fact,
attributable to each customer. However,
because of the ratable distribution
requirement, any losses that did exist
would be shared ratably among all
customers.
Under the Legal Segregation with
Recourse, the DCO could only use the
collateral attributable to defaulting
customers (those whose positions
suffered losses) to meet the loss—at
first. It would also use the defaulting
clearing member FCM’s own
contribution to the guaranty fund, its
own contribution to the guaranty fund,
as well as the contributions of nondefaulting clearing members. However,
if those resources were insufficient to
cover the default, the DCO would have
‘‘recourse’’ to the collateral of nondefaulting customers. While such
22 See generally, CME Group, Inc. (‘‘CME’’) at 14–
15 (discussing information deficits at bankrupt
FCM).
23 See 76 FR at 69366–68.
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recourse is much less likely under the
Legal Segregation with Recourse Model
than under the Futures Model—because
the fellow-customer collateral would
not be reached unless the loss was great
enough to consume the entire guaranty
fund—until the amount of loss from the
default was crystalized (through
liquidation or transfer), the DCO might
be reluctant or unable to release the
collateral of non-defaulting customers.
Accordingly, while Legal Segregation
with Recourse would (in most cases)
provide customers superior recovery in
a liquidation, it would be much less
well-suited to a prompt transfer of
positions.
E. Solicitation of Public Input
The Commission sought public
comment on the segregation alternatives
mentioned above, and on the
advisability of permitting the DCO to
choose between alternatives. First, the
Commission, through its staff, held
extensive external meetings with three
segments of stakeholders (i.e., DCOs,
FCMs, and swaps customers).24 Second,
on October 22, 2010, the Commission,
through its staff, held a roundtable (the
‘‘First Roundtable’’).25 Third, on
November 19, 2010, the Commission
issued an Advance Notice of Proposed
Rulemaking for Protection of Cleared
Swaps Customers Before and After
Commodity Broker Bankruptcies (the
‘‘ANPR’’). Fourth, on June 3, 2011, the
Commission, through its staff, held a
second roundtable (the ‘‘Second
Roundtable’’).26 Fifth, after careful
consideration of the comments the
Commission received on the ANPR, the
Commission issued the NPRM.
1. First Roundtable
srobinson on DSK4SPTVN1PROD with RULES3
As the ANPR describes, the First
Roundtable revealed that stakeholders
had countervailing concerns regarding
the alternative segregation models that
the Commission set forth. On the one
hand, a number of swaps customers
argued that the Commission should
focus on effectively eliminating Fellow24 A list of external meetings is available at:
https://www.cftc.gov/LawRegulation/DoddFrankAct/
Rulemakings/DF_6_SegBankruptcy/index.htm.
25 The transcript from the First Roundtable (the
‘‘First Roundtable Tr.’’) is available at: https://www.
cftc.gov/ucm/groups/public/@swaps/documents/
dfsubmission/dfsubmission6_102210-transcrip.pdf.
26 The transcript from the Second Roundtable (the
‘‘Second Roundtable Tr.’’) is available at: https://
www.cftc.gov/ucm/groups/public/@swaps/
documents/dfsubmission/dfsubmission6_060311transcri.pdf.
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Customer Risk 27 and Investment Risk.28
Such swaps customers emphasized that
(i) They currently transact in uncleared
swaps, (ii) they are able to negotiate for
individual segregation at independent
third parties for collateral supporting
such uncleared swaps, and therefore
(iii) they are currently subject to neither
Fellow-Customer Risk nor Investment
Risk. Such customers found it
inappropriate that, under certain
alternatives set forth by the
Commission, they should be subject to
Fellow-Customer Risk and Investment
Risk when they transact in Cleared
Swaps.
On the other hand, a number of FCMs
and DCOs argued that the benefits of
effectively eliminating Fellow-Customer
Risk and Investment Risk are
outweighed by the costs. With respect to
benefits, these FCMs and DCOs noted
27 As noted in section I.B.1, an FCM functions as
a guarantor of customer transactions with a DCO.
Section 4d(f) of the CEA prohibits an FCM from
using the collateral deposited by one Cleared Swaps
Customer to support the swap transactions of
another Cleared Swaps Customer. Therefore, if one
Cleared Swaps Customer owes money to the FCM
(i.e., the Cleared Swaps Customer has a debit
balance), the FCM, acting as guarantor, must
deposit its own capital with the DCO to settle
obligations attributable to such customer. If the
Cleared Swaps Customer defaults to the FCM, and
the Cleared Swaps Customer’s obligations are so
significant that the FCM does not have sufficient
capital to meet them, then the FCM would default
to the DCO.
As discussed in Section I.B.4, the financial
resources DCOs maintain to cover Clearing Member
defaults with respect to customer positions in
excess of collateral provided by the Clearing
Member include property of the defaulting Clearing
Member (i.e., collateral deposited to support FCM
proprietary transactions and contributions to the
DCO guaranty fund). Other elements of such
packages may include: (i) The collateral that the
FCM deposited to support the transactions of nondefaulting customers; (ii) a portion of the capital of
the DCO; and (iii) contributions to the guaranty
fund from other DCO Clearing Members. Typically,
a DCO would exhaust one element before moving
onto the next element. Therefore, the risk that the
DCO would use any one element depends on the
position of that element in the package.
28 ‘‘Investment Risk’’ is the risk that each Cleared
Swaps Customer would share pro rata in any
decline in the value of FCM or DCO investments of
Cleared Swaps Customer Collateral. Section 4d(f) of
the CEA permits an FCM to invest Cleared Swaps
Customer Collateral in certain enumerated
instruments. The Commission is proposing to
expand such instruments to include those
referenced in regulation 1.25 (as it may be amended
from time to time). Even though (i) such
investments are ‘‘consistent with the objectives of
preserving principal and maintaining liquidity,’’
and (ii) both the FCM, as well as the DCO, value
such investments conservatively (by, e.g., applying
haircuts), the value of such investments may
decline to less than the value of the collateral
originally deposited. See regulation 1.25(b) (as
amended in Investment of Customer Funds and
Funds Held in an Account for Foreign Futures and
Foreign Options Transactions, 76 FR 78776,
December 19, 2011). In such a situation, all
customers would share in the decline pro rata, even
if the invested collateral belonged to certain
customers and not others.
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6341
that the Futures Model has served the
futures industry well for many decades.
With respect to costs, these FCMs and
DCOs described two potential sources.
First, FCMs and DCOs stated that,
depending on the manner in which the
Commission proposes to eliminate or
mitigate Fellow-Customer Risk and
Investment Risk, they may experience
substantial increases to operational
costs (e.g., costs associated with
transaction fees, reconciliations,
recordkeeping, reporting). Second, and
more significantly, FCMs and DCOs
stated that they may incur additional
risk costs due to proposed financial
resources requirements.29
In addition, some DCOs may have
anticipated including collateral from
non-defaulting Cleared Swaps
Customers as an element in their
financial resources packages. If DCOs no
longer have access to such collateral,
then those DCOs would need to obtain
additional financial resources to meet
proposed Commission requirements.
Both FCMs and DCOs averred that the
costs associated with obtaining such
additional financial resources may be
substantial, and would ultimately be
borne by Cleared Swaps Customers.30
2. ANPR
Given the concerns that stakeholders
expressed at the First Roundtable, the
Commission decided to seek further
comment through the ANPR on the
potential benefits and costs of (i) The
Legal Segregation Models (whether
Complete or with Recourse), (ii) the
Physical Segregation Model, and (iii) the
Futures Model. As the ANPR explicitly
stated, ‘‘[t]he Commission [was] seeking
to achieve two basic goals: Protection of
customers and their collateral, and
minimization of costs imposed on
customers and on the industry as a
whole.’’ 31 In addition, the Commission
requested comment on the impact of
each model on behavior, as well as
whether Congress evinced intent for the
Commission to adopt any one or more
of these models.
29 As described below, the term ‘‘Risks Costs’’
refers to the costs associated with the allocation of
loss in the event of a default under the Complete
Legal Segregation Model relative to the Futures
Model. For a more detailed explanation of these
costs, see the discussion in section VII.B.2.b., under
the heading titled ‘‘‘Risk Costs’ and potential effects
on margin levels and DCO guaranty fund levels in
response to complete legal segregation.’’
30 75 FR at 75163. For example, one DCO
estimated that it would have to increase the amount
of collateral that each Cleared Swaps Customer
must provide by 60 percent, if it could no longer
access the collateral of non-defaulting Cleared
Swaps Customers to cure certain defaults. See infra
n. 258.
31 Id.
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As described in the NPRM, the
Commission received thirty-one
comments from twenty-nine
commenters.32 The comments were
generally divided by the nature of the
commenter: Most (though not all) of the
comments from current or potential
Cleared Swaps Customers favored either
the Legal Segregation Models (whether
Complete or with Recourse) or the
Physical Segregation Model, manifesting
a willingness to bear the added costs.33
Most of the FCMs and DCOs favored the
Futures Model, though one commenter
favored the Complete Legal Segregation
Model.34 Finally, another commenter, in
its supplemental comment, opined that
the most important factor that the
Commission should consider is the
extent to which a model fostered the
portability 35 of Cleared Swaps
belonging to non-defaulting
customers.36 This commenter noted that
the Physical Segregation Model and
what is now referred to as the Complete
Legal Segregation Model were most
conducive to that goal.37
After careful consideration of the First
Roundtable discussion and the
comments received in response to the
ANPR, the Commission issued the
NPRM on June 9, 2011.
srobinson on DSK4SPTVN1PROD with RULES3
3. Second Roundtable
Discussions during the Second
Roundtable generally reflected the
conflicting concerns expressed by
market participants regarding the
alternative segregation models set forth
by the Commission. Swaps customers
continued to state that the Commission
should focus on mitigating FellowCustomer Risk, with some also
advocating for the elimination of
Investment Risk, while FCMs and DCOs
reiterated that the Commission should
select the Futures Model as the
segregation model for Cleared Swaps
Customer Collateral because the Futures
Model has served the futures industry
well for many decades. Pension funds,
and a few investment managers,
remained concerned about their
potential exposure to Fellow-Customer
Risk and Investment Risk and continued
to press the Commission to adopt the
32 All comment letters are available through the
Commission’s Web site at: https://www.cftc.gov/
LawRegulation/FederalRegister/ProposedRules/
2010-29836.
33 See id.
34 See id.
35 The terms ‘‘portability,’’ ‘‘port,’’ and ‘‘porting’’
refer to the ability to reliably transfer the swaps
(and related collateral) of a non-defaulting customer
from an insolvent FCM to a solvent FCM, without
the necessity of liquidating and re-establishing the
swaps.
36 See ISDA comment letters on ANPR.
37 See id.
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Physical Segregation Model either
outright or on an optional basis.
In addition, participants discussed
various cost and benefits issues arising
in relation to the Futures and the Legal
Segregation Models. Specifically,
several participants believed that the
operational costs would not be
significantly different between the
Futures Model and the Complete Legal
Segregation Model.38 Moreover,
although some participants projected
that risk costs would significantly
increase if the Commission were to
select the Complete Legal Segregation
Model,39 one participant argued that
these risk costs would not be
incremental risk costs; rather they are
risk costs that exist in the Futures
Model that would most likely ultimately
be borne by customers.40 Finally, one
participant argued that any model that
facilitates the ability to port ‘‘is superior
to one that doesn’t’’ because ‘‘the
38 See Second Roundtable Tr. at 250, l.2 (In
response to whether the Complete Legal Segregation
Model would impose operational costs over the
Futures Model, Ms. Bregasi stated that ‘‘[t]here is no
additional cost between LSOC and the futures
model;’’ Mr. Prager stated that ‘‘[w]e don’t see them
incurring other than the start-up costs, the one time
that everyone will have to incur to set up, the
running cost. We don’t see any incremental cost;’’
and Mr. MacFarlane stated that ‘‘I would agree there
are no additional operational costs.’’). See also,
Second Roundtable Tr. at 239, l.8 (Mr. Frankel
explaining that operational costs resulting from
passing ‘‘the client identity and * * * some other
multiplier that explains how much excess there is
in the seg account for the client * * * [is] a small
build.’’); Second Roundtable Tr. at 243, l.22 (Mr.
Kahn stating that ‘‘in terms of the cost, the fact is
OTC is a little different than futures because there
is a tremendous build that everyone is doing in the
case of OTC so if we need to build LSOC which in
essence we’ve done in the LCH European model,
there is a cost of that but I can’t really define what
it is. It’s relatively small and not material.’’).
39 See Second Roundtable Tr. at 255, l.12 (Mr.
Frankel arguing that ‘‘Moving to a 99.9 percent
confidence of coverage we think will increase
margins by about 60 percent [for rates] * * * I
think for CDS it could be more than double.’’). See
also Second Roundtable Tr. at 262, l.2 (Mr. Diplas
arguing that ‘‘not having the additional pool of
funds that are associated with the fellow customers
means that we definitely need to actually margin
from a CCP perspective, the higher confidence
interval. That will differ depending on the asset
class we’re looking at. Some of them, at least based
on the existing pool of trades, it could be
manageable like at 60, 70 percent in rates. We’ll talk
about three to four times the amount that—in
credit—and the more we get to instruments with
fatter tails the higher the number is going to be. I
think that is something that clients need to be
cognizant of.’’).
40 See, e.g., Second Roundtable Tr. at 257, l.6 (Mr.
MacFarlane stating that ‘‘what’s being said, if our
transactions had to be margined on an individual
basis it would require that we put up 60 to 70
percent more, which says that then the real risk of
that transaction is 75 percent more than what we’re
collateralizing. So in the event of a default, not by
us but by another counterparty potentially, they
will be under-collateralized relative to what their
individual transaction would require, and then that
potentially could work its way back to us.’’).
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closeout cost in the future’s model was
the most expensive,’’ meaning that
‘‘closing out a client account and rates
could be extremely devastating to the
market, and * * * be really significant
losses * * * [and] any way [the losses]
can be avoided would be beneficial to
every participant in the market.’’ 41
4. NPRM
After carefully considering all
comments to the ANPR and statements
made during the First Roundtable
discussion, the Commission proposed in
the NPRM the Complete Legal
Segregation Model as the segregation
model for Cleared Swaps Collateral
because the Complete Legal Segregation
Model provided the best balance
between benefits and costs in order to
protect market participants and the
public. Nonetheless, due in part to the
strong opposing views expressed by
market participants, the NPRM made
clear that the Commission was still
considering whether to adopt, in the
alternative, the Legal Segregation with
Recourse Model, and was continuing to
assess the feasibility of an optional
approach and the Futures Model.
Commenters to the ANPR generally
observed that customers ultimately
would bear the costs of implementing
whatever segregation model was
selected by the Commission.
Nonetheless, most (though not all) of the
buy-side commenters favored individual
protection for Cleared Swaps Customer
Collateral. These commenters generally
viewed the Complete Legal Segregation
Model as the minimum level of
protection necessary for Cleared Swaps
Customer Collateral. Because it was
largely recognized that customers would
ultimately bear the costs of
implementing the selected segregation
model, the Commission believed it
appropriate to give weight to the views
of market participants who would bear
those costs, and found it compelling
that most buy-side commenters favored
adoption of either the LSOC Model or
the Physical Segregation Model. The
Commission noted that the Legal
Segregation Models and the Physical
Segregation Model would provide
greater individualized protection to
Cleared Swaps Customer Collateral than
the Futures Model, and was in
accordance with section 4d(f) of the
CEA. In addition, the Commission noted
that the LSOC Model and the Physical
Segregation Model may provide
substantial benefits in the form of (i)
41 See, e.g., Second Roundtable Tr. at 259, l.6
(quoting Mr. Frankel). For a more detailed
discussion of cost and benefit considerations,
please see discussion below in section VII.
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Decreased Fellow-Customer Risk, (ii)
increased likelihood of portability, (iii)
decreased systemic risk, and (iv)
positive impact on portfolio margining,
and asked for comment as to whether
and why commenters favor or oppose
adoption of the Futures Model.
In choosing between the Legal
Segregation Models and the Physical
Segregation Model, the Commission
noted that the operational costs for the
Physical Segregation Model would be
substantially higher than the operational
costs for the Legal Segregation Models
(whether Complete or with Recourse).
With respect to benefits, the
Commission believed that the Physical
Segregation Model would provide only
incremental advantages over the
Complete Legal Segregation Model with
respect to the mitigation of FellowCustomer Risk. In addition, the
Commission noted that while the
Physical Segregation Model does
eliminate Investment Risk, (i) the
Commission was in the process of
further addressing Investment Risk by
proposing amendments to regulation
1.25, and (ii) each FCM and DCO
already values investments
conservatively. Finally, the Commission
observed that the Physical Segregation
Model would generally enhance
portability to the same extent as the
Complete Legal Segregation Model, and
therefore would have similar effects on
systemic risk. In addition, the
Commission stated that the Physical
Segregation Model and the Complete
Legal Segregation Model would likely
enhance portfolio margining to the same
extent. Therefore, the Commission
chose not to propose the Physical
Segregation Model in the NPRM.
In choosing between the Complete
Legal Segregation Model and the Legal
Segregation with Recourse Model, the
Commission noted that commenters
argued that implementing the former
would result in significant Risk Costs,42
whereas implementing the latter would
result in no Risk Costs. In addition, the
Commission believes that comments to
the ANPR that question the assumptions
underlying the upper estimates of Risk
Costs for the Complete Legal
Segregation Model have raised credible
issues regarding the accuracy of those
estimates. Nevertheless, the
Commission recognized that such
assumptions formed an area of
divergence between commenters, and
therefore asked for additional comment
on the Risk Costs for the Complete Legal
Segregation Model. The Commission
also observed that operational costs for
42 For a more detailed discussion regarding risk
costs, see section VII.B.2.b., infra.
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the Complete Legal Segregation Model
and the Legal Segregation with Recourse
Model were approximately the same.
With respect to benefits, the
Commission noted that the Complete
Legal Segregation Model would (i)
Mitigate Fellow-Customer Risk even in
extreme FCM defaults, unlike the Legal
Segregation with Recourse Model, (ii)
enhance portability (and therefore
mitigate systemic risk) to a significantly
greater extent than the Legal Segregation
with Recourse Model, and (iii) have an
incremental advantage over the Legal
Segregation with Recourse Model with
respect to impact on portfolio
margining.43 Consequently, the
Commission chose not to propose the
Legal Segregation with Recourse Model
in the NPRM, but stated that it was still
considering this model as an alternative.
F. Clarification of the Application of
Financial and Segregation
Interpretation No. 10 to Cleared Swaps
In response to the Commission’s
NPRM, clarification was requested 44
regarding the applicability to the cleared
swaps market of the Commission’s 2005
Amendment to Financial and
Segregation Interpretation No. 10 on the
Treatment of Funds Deposited in
Safekeeping Accounts (‘‘Segregation
Interpretation 10–1’’).45 The commenter
noted that ‘‘[u]ntil 2005, the CFTC
permitted the use of third-party
custodial accounts for futures margin by
pension plans and investment
companies registered under the 1940
Act * * *. In 1984, the CFTC issued
Financial and Segregation Interpretation
No. 10 * * *, permitting the use of
third party custodial accounts for the
holding of customer property subject to
certain conditions ensuring that an FCM
would have immediate and unfettered
access to customer funds.’’ 46 However,
Segregation Interpretation 10–1 made it
clear that, with limited exceptions,
FCMs would not be in compliance with
the requirements of section 4d(a)(2) of
the CEA if they hold customer funds in
a third-party custodial account.
The Commission agrees that
Segregation Interpretation 10–1 does not
apply to Cleared Swaps. Accordingly,
and subject to the conditions described
below, Cleared Swaps Customer
Collateral may be deposited at a bank in
43 See
33818 FR at 33828.
Committee on Investment of Employee
Benefit Assets (‘‘CIEBA’’) December 22, 2011 letter
(‘‘CIEBA Supplemental’’) at 2.
45 Amendment of Interpretation, 70 FR 24768,
May 11, 2005 (Notice) The underlying Financial
and Segregation Interpretation No. 10 (‘‘Segregation
Interpretation 10’’) was issued on May 23, 1984,
and can be found at Comm. Fut. L. Rep. (CCH)
¶7120.
46 CIEBA Supplemental at 4.
44 See
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a third-party safekeeping account, in
lieu of posting such collateral directly to
the FCM, without the FCM being
deemed in violation of section 4d(f) of
the CEA, and FCMs are permitted to
allowed Cleared Swaps Customers to
elect to have their Cleared Swaps
Customer Collateral held in such
accounts.
However, if an FCM uses, or allows
the use of, a third-party safekeeping
account, that FCM must comply with all
of the conditions for such accounts set
forth in Segregation Interpretation 10 as
originally issued in 1984.47 In addition,
as noted in Segregation Interpretation
10, though the use of third-party
safekeeping accounts is not prohibited,
such collateral constitutes customer
property within the meaning of the
Bankruptcy Code. As such, positions
and collateral held in third-party
custodial accounts are subject to the
U.S. Bankruptcy Code and applicable
provisions in the CEA, which provide
for the pro rata share of available
customer property.
The commenter also requested that
the Commission revise or repeal
Segregation Interpretation 10–1 to allow
futures and options customers to have
their collateral held in third-party
safekeeping accounts.48 However, while
the Commission does not believe it
would be appropriate to address this
request at this time, as it is beyond the
scope of this rulemaking, the
Commission may address this concern
in the future.
The Commission also notes that a
number of commenters49 have proposed
alternative arrangements that would
provide individual protection for
collateral belonging to cleared swaps
market participants (and, in some cases,
futures customers) that are willing and
able to bear the associated costs.
However, these proposals raise
important risk management and cost
externality issues, particularly with
respect to ensuring that collateral is
promptly available to DCOs in the event
of a default, ensuring proper capital
treatment for the relevant market
participants, and protecting all
customers.
The Commission has directed staff to
carefully analyze these proposals with
the goal of developing proposed rules
that provide additional protection for
47 These conditions include limitations regarding
the titling and location of the third-party
safekeeping account, and requirements concerning
the FCM’s rights to promptly liquidate positions
and access collateral.
48 See CIEBA Supplemental at 12
49 See generally CIEBA August 8, 2011 letter
(‘‘CIEBA Original’’) at 1–5; Salzman at 1–9; CME at
18; State Street at 2–4.
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II. The Final Rules
In determining the scope and content
of the final rules, the Commission has
taken into account issues raised by
commenters, including those issues
with respect to the costs and benefits
associated with the proposed
segregation model for Cleared Swaps
Customer Collateral. The Commission
received twenty-eight (28) comment
letters on the proposed rules,52 twentyfive (25) of which addressed the issue of
which segregation model the
Commission should adopt for Cleared
Swaps Customer Collateral. Of these
twenty-five (25), the strong weight of the
commenters rested in favor of
individual protection for Cleared Swaps
Customer Collateral, with twenty (20)
comment letters supporting
implementation of the Complete Legal
Segregation Model, the Physical
Segregation Model or some combination
thereof.53 Four (4) comment letters
supported adoption of the current
Futures Model,54 with one (1) comment
letter, from the FIA, showing support for
both the Complete Legal Segregation
Model and the Futures Model.
After carefully considering all
comments, the Commission has selected
the Complete Legal Segregation Model
as the most appropriate segregation
model for Cleared Swaps Customer
Collateral under section 4d(f) of the
CEA. The Commission believes this
model provides the best balance
between benefits and costs in order to
protect market participants and the
public. The Commission has adopted a
number of clarifications and corrections
suggested in the comment letters. In
other cases the final rules are adopted
as proposed. The discussion below
provides a more detailed analysis of the
issues raised by the comment letters.
III. Segregation Model for Cleared
Swaps Customer Collateral
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collateral belonging to market
participants.50
The Commission agrees with the
comment that ‘‘swap margin is not
meant to enhance the swap dealers’
bottom line, but to protect the system
against counterparty failure,’’ 51 and
remains committed to protecting the
market and market participants.
50 The Commission also notes that any market
participant may become a clearing member of a
DCO, consistent with the DCO’s membership
eligibility requirements and the CEA and
Commission regulations, with all the rights and
responsibilities associated therewith.
51 See CIEBA Supplemental at 14.
52 All comment letters are available through the
Commission’s Web site at: https://comments.cftc.
gov/PublicComments/CommentList.aspx?id=1038.
Comments addressing the proposed rules were
received from: APG Algemene Pensioen Groep N.V.
and the European Federation Retirement Provision
(‘‘APG/EFRP’’), American Council of Life Insurers
(‘‘ACLI’’), Association of Institutional Investors
(‘‘AII’’), Bank of America, N.A., BlackRock, Inc.
(‘‘BlackRock’’), Chris Barnard, CME, CIEBA, Federal
Home Loan Banks (‘‘FHLB’’), Fidelity Management
& Research Co. (‘‘Fidelity’’), Freddie Mac, Futures
Industry Association (‘‘FIA’’),
IntercontinentalExchange, Inc. (‘‘ICE’’), Investment
Company Institute (‘‘ICI’’), International Swaps and
Derivatives Association, Inc. (‘‘ISDA’’),
LCH.Clearnet Group Limited (‘‘LCH’’), Managed
Funds Association (‘‘MFA’’), Natural Gas Exchange,
Inc. (‘‘NGX’’), Newedge USA, LLC (‘‘Newedge’’),
Och-Ziff Capital Management Group (‘‘Och-Ziff’’),
Jerrold E. Salzman, Securities Industry and
Financial Markets Association (‘‘SIFMA’’), Tudor
Investment Corporation (‘‘Tudor’’), and Vanguard.
Note, CIEBA, Fidelity and the MFA each submitted
two comment letters.
53 The following commenters support the
Complete Legal Segregation Model outright: ACLI,
AII, BlackRock, Mr. Barnard, Freddie Mac, ICI,
ISDA, LCH, SIFMA, and Vanguard. APG/EFRP,
CIEBA, Fidelity, MFA, Tudor and FHLB support
implementation of the Physical Segregation Model.
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In the NPRM, the Commission
proposed the Complete Legal
Segregation Model but made clear that,
because the costs and benefits
associated with the Complete Legal
Segregation Model were still being
evaluated, the Commission was
considering whether to adopt the Legal
Segregation with Recourse Model as an
alternative, and was continuing to
assess the feasibility of the Futures
Model and a clearinghouse-byclearinghouse Optional Approach.
Below is a summary of the comments
the Commission received regarding the
alternative segregation models for
Cleared Swaps Customer Collateral.
A. Summary of the Comments
1. Complete Legal Segregation Model
As mentioned above, the majority of
the comment letters supported adoption
of the Complete Legal Segregation
Model either outright or as a viable
alternative to the Physical Segregation
Model, with most arguing that the
Complete Legal Segregation Model
presents the best balance between costs
and adequacy of collateral protections,55
and several calling it a ‘‘significant
improvement over the’’ Futures
Model.56 Several commenters also
opined that the Complete Legal
Segregation Model is supported by the
54 The commenters in favor of adoption of the
Futures Model were CME, ICE, Newedge, and Mr.
Salzman.
55 See ACLI at 2; AII at 1; BlackRock at 1; Barnard
at 2; Fidelity at 2; Freddie Mac at 2; LCH at 1–2;
SIFMA at 3; Vanguard at 8.
56 CIEBA at 1; and FHLB at 1.
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statutory language and purposes of the
Dodd-Frank Act.57
In addition, many of the comment
letters asserted that the Complete Legal
Segregation Model largely mitigates
Fellow-Customer Risk and enhances the
portability of cleared swap positions
and associated collateral.58 One
commenter stated that the Complete
Legal Segregation Model is ‘‘the most
cost effective framework to adequately
protect the margin customers post to
cleared swap transactions’’ because it
effectively mitigates Fellow-Customer
Risk, avoids the costs associated with
establishing the Physical Segregation
Model by allowing margin to be held in
an omnibus account, and enhances the
portability of cleared swap positions
and related margin.59 Another
commenter stated that the Complete
Legal Segregation Model ‘‘provides the
most operationally efficient framework
to manage risk on a daily basis or port
portfolios especially in periods of
stress.’’ 60 And yet other commenters
argued that there has been little
substantiation of the ‘‘increased costs’’
that would arise from implementation of
the Complete Legal Segregation Model,
especially with respect to costs
surrounding the reporting requirements
associated with maintaining separate
legal accounts given that ‘‘other
regulatory rulemakings that require
similar reporting will likely result in
many of these incremental operational
costs being incurred regardless of which
model is chosen.’’ 61
57 See BlackRock at 3; Fidelity at 5–6; FIA at 3,
n. 10; ICI at 2; Mr. Barnard at 1; and SIFMA at 3,
n. 7.
58 See, e.g., AII at 3 (stating that the Complete
Legal Segregation Model effectively eliminates
Fellow-Customer Risk, enhances portability of
positions and related margin, and largely avoids the
costs associated with establishing individually
segregated accounts); BlackRock at 2 (arguing that
the Complete Legal Segregation Model ‘‘eliminates
Fellow-Customer Risk and facilitates ‘immediate’
portability of customer positions if required’’);
CIEBA Original at 5 (acknowledging that the
Complete Legal Segregation Model could eliminate
Fellow-Customer Risk); FHLB at 3 (agreeing that the
Complete Legal Segregation Model greatly reduces
Fellow-Customer Risk); ICI at 3 (stating that the
Complete Legal Segregation Model mitigates
Fellow-Customer Risk); ISDA at 1–2 (agreeing that
Complete Legal Segregation Model facilitates postdefault portability); MFA at 3–4 (stating that the
Complete Legal Segregation Model eliminates
Fellow-Customer Risk and enhances the portability
of customer positions); Vanguard at 4–6 (arguing
that the Complete Legal Segregation Model
addresses counterparty risk and Fellow-Customer
Risk); and SIFMA at 5 (stating that Complete Legal
Segregation Model minimizes Fellow-Customer
Risk and facilitates the ability of Cleared Swaps
Customers to port their positions to a nondefaulting FCM).
59 AII at 1.
60 BlackRock at 6.
61 Fidelity at 6. See also LCH at 2–3. The
Commission has adopted a gross margining
requirement. See 76 FR at 69374–76.
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Several commenters also argued that,
in selecting a segregation model for
Cleared Swaps Customer Collateral, the
Commission should take into account
the differences between the risk profiles
of futures and over the counter (‘‘OTC’’)
swaps.62
Furthermore, commenters argued that,
unlike the Futures Model, the Complete
Legal Segregation Model would not
degrade the collateral protections that
currently exist in the OTC swaps
market.63 In addition, one commenter
indicated that the Complete Legal
Segregation Model is ‘‘the model that
most closely parallels the protections
that [LCH] understand[s] will be
required in Europe under the European
Commission’s proposal for a European
Market Infrastructure Regulation
(‘‘EMIR’’).’’ 64
Commenters who did not support
adoption of the Complete Legal
Segregation Model largely argued that
(1) The costs of implementing the
Complete Legal Segregation Model
outweigh any of the purported benefits
of such model; 65 (2) the Complete Legal
Segregation Model would, in the view of
the commenter, fail to work
operationally or legally,66 and does not
take into account the operational
complexities of multi-tiered and multiDCO clearing; 67 (3) individualized
segregation potentially introduces
systemic costs because it impedes
timely market settlements during
periods of market stress; 68 (4) since the
Futures Model has served the industry
well during times of stress in the futures
market, it should be the segregation
model for Cleared Swaps Customer
Collateral; 69 (5) the Complete Legal
Segregation Model introduces moral
hazard; 70 or (6) the Complete Legal
62 BlackRock at 2–4; Fidelity at 4; SIFMA at 2;
Vanguard at 3–4.
63 See Fidelity at 2–4; Freddie Mac at 1; and LCH
at 1. See also Tudor at 2 (arguing that the
segregation model selected by the Commission
should not provide a lesser degree of protection for
Cleared Swaps Customer Collateral).
64 LCH at 1.
65 See, e.g., ICE at 11.
66 See CME at 5 (stating that ‘‘the framework
established by the [Complete Legal Segregation
Model] concept and the proposed regulations will
be wholly inadequate to achieve the Commission’s
desired objectives: Namely, in an FCM default, the
preservation of non-defaulting cleared swaps
customers’ collateral and the ability to port their
positions and collateral to another FCM.’’).
67 See, e.g., CME at 6–8. See also Mr. Salzman at
7 (stating that ‘‘the benefits promised by the
proponents of the [Complete Legal Segregation
Model] are illusory,’’ and arguing that the
Commission’s authority to adopt, and a bankruptcy
court’s willingness to respect, such model are
questionable).
68 See ICE at 3.
69 See, e.g., Newedge at 8; and CME at 23.
70 See, e.g., Newedge at 4–5.
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Segregation Model does not provide
enough protection of Cleared Swaps
Customer Collateral because there is
some residual Fellow-Customer Risk,71
and it does not protect against fraudrelated risks,72 record-keeping/
operational risk, and Investment
Risks.73 Moreover, several commenters
disagreed with the Commission’s
interpretation of the statutory language
in the Dodd-Frank Act, and argued that
the statutory language cited by the
Commission does not indicate
Congressional intent for individual
protection for Cleared Swaps Customer
Collateral.74
2. Physical Segregation Model
Comments with respect to the
Physical Segregation Model were mixed,
with some commenters advocating the
adoption of the Physical Segregation
Model outright,75 others advocating for
its adoption on an optional basis,76 and
others arguing that the Physical
Segregation Model should not be
adopted because the increased costs and
operational burdens associated with
adoption of the Physical Segregation
Model outweigh the benefits.77
Two commenters requested that the
Commission reconsider adoption of the
Physical Segregation Model on the basis
that (i) Customer collateral should be
individually segregated at both the FCM
and the DCO to provide the same level
of customer collateral protection that
currently exists in the OTC swaps
market, (ii) none of the other models are
sufficient to fully protect customer
collateral from recordkeeping/
operational, investment and fraudrelated risks, (iii) the Physical
Segregation Model facilitates porting
more than the other models, and (iv) the
commenters would be willing to bear
any increased costs associated with the
71 See,
e.g., CME at 7.
risks are risks associated to an
FCM’s fraudulent activity with respect to the
cleared swap margin account.
73 See, e.g., Tudor at 4; CIEBA Original at 1; and
FHLB at 3–6 (each advocating for the adoption and
implementation, either outright or on an optional
basis, of the Physical Segregation Model, though
acknowledging that the Complete Legal Segregation
Model is preferable to the Futures Model).
74 See CME at 21–22 (arguing that if Congress
intended to change the framework for the protection
of customer collateral it would have explicitly done
so); FIA at 3, n. 10 (agreeing that the complete legal
segregation model is permitted by the language of
section 4d(f), but arguing that Commission reliance
on the differences between sections 4d(a) and 4d(b)
are misplaced); and ICE at 5 (arguing that the
Commission should not rely on the language in
section 4d(f) because there is no legislative history
interpreting the statutory language).
75 FHLB at 1; Tudor at 1–2.
76 ACLI at 2; CIEBA at 2; MFA at 2; Mr. Salzman
at 8.
77 BlackRock at 6; Vanguard at 6.
72 Fraud-related
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6345
adoption of the Physical Segregation
Model.78
In addition, though several
commenters supported the Complete
Legal Segregation Model as the best
alternative under consideration, these
commenters urged the Commission to
develop a framework for the adoption of
the Physical Segregation Model because
(i) The protections offered by the
Physical Segregation Model are greater
than those offered by the Complete
Legal Segregation Model, (ii) the
Physical Segregation Model facilitates
porting more than the other models, and
(iii) the costs assertions resulting from
implementing the Physical Segregation
Model have either not been
substantiated or are costs that the
commenters are willing to bear.79
Commenters that opposed adoption of
the Physical Segregation Model
generally did so on the basis that
implementation of the model would
give rise to substantial increased costs
with little increased benefit, as
compared with the Complete Legal
Segregation Model.80
3. Futures Model
As mentioned above, four comment
letters supported adoption of the
Futures Model, with one commenter
supporting adoption of both the
Complete Legal Segregation Model and
the Futures Model.
CME argued that the Futures Model
provides the best balance of costs versus
industry risk as a whole and is ‘‘the only
approach that provides both legal and
operational certainty to all parties in the
event of an FCM default.’’ 81 According
to CME, the Complete Legal Segregation
Model imperfectly protects customer
collateral and thus, ‘‘the Commission
[should] not rush [sic] to implement a
‘solution’ that gives superficial comfort,
but may not work either operationally or
legally in the event of an actual
default.’’ 82 CME encouraged the
Commission to ‘‘engage in further study,
and establish a review process that
includes a representative group of
interested parties with expertise in the
area, in order to evaluate alternative
approaches.’’ 83 Because the Futures
Model has effectively protected
customer interests in the futures market,
CME recommended that, in the interim,
the Commission implement swaps
clearing employing the Futures
78 See,
e.g., ICI at 2 and 9.
e.g., ACLI at 2; BlackRock at 5.
80 See, e.g., AII at 2; ICE at 9; FIA at 6; SIFMA
at 4 n. 9; and Vanguard at 6.
81 CME at 23.
82 Id. at 2.
83 Id.
79 See,
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Federal Register / Vol. 77, No. 25 / Tuesday, February 7, 2012 / Rules and Regulations
Model.84 Moreover, CME suggests that
the Commission support a new industry
effort to, at some point in the future,
develop and implement a guaranteed
clearing participant relationship that
would allow a client, on an optional
basis, to have a direct relationship with
a DCO, with the client’s positions
guaranteed by a guaranteeing clearing
member of the DCO and the client’s
Cleared Swaps Customer Collateral held
in an outside account by a third party
custodian.
Mr. Salzman supported adoption of
the Futures Model with optional full
physical segregation of Cleared Swaps
Customer Collateral.
ICE advocated adoption of the Futures
Model, arguing against fundamentally
changing a clearinghouse’s existing
operations, and positing that customers
that wish to avoid Fellow-Customer
Risk might explore becoming direct
clearing participants once they ‘‘fully
appreciate[e] the substantial costs * * *
associated with implementing and
maintaining [the Complete Legal
Segregation Model].’’ 85 However, ICE
also proposed, as a middle ground, a
model that appears to be based on the
Futures Model but that provides some
protection against Fellow-Customer
Risk. ICE explained that its ICE Clear
Credit affiliate had adopted a model
under which, ‘‘customers are exposed to
‘fellow-customer risk’ only with respect
to the customer’s pro-rata share of the
net customer-related margin
requirement of its clearing member.’’ 86
ICE Clear Credit considers ‘‘the
difference between a customer’s gross
margin requirement and the customer’s
net margin requirement’’ to be ‘‘Excess
Margin.’’ 87 ICE stated that a customer’s
Excess Margin is segregated and held by
ICE Clear Credit on a custodial basis and
is therefore not exposed to FellowCustomer Risk. ICE argued that this
model would provide some protection
against Fellow-Customer Risk but would
be more cost-effective than the proposed
Complete Legal Segregation Model. In
addition, ICE stated that individual
segregation should be offered to
customers at the option of a DCO, and
also advanced the notion that the
Commission should ‘‘carefully consider
and weigh the costs and benefits of
potential customer-related OTC clearing
models by asset class * * *.’’ 88
Newedge, which submitted a
comment on behalf of itself, DRW
Trading Group and nine ‘‘Customers,’’
84 See
85 ICE
id. at 23.
at 3.
86 Id.
87 Id.
at 3, n. 3.
at 1–2.
88 ICE
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supported adoption of the Futures
Model on the basis that the Futures
Model ‘‘is the model most consistent
with the general purposes of Title VII of
Dodd-Frank as well as least likely to add
moral hazard to the industry.’’ 89
Newedge argued that Title VII is about
the reduction of systemic risk through
the mutualization of risk, and that by
mutualizing credit risk the Futures
Model promotes the purpose of the
Dodd-Frank Act because such
mutualization encourages the creation
and maintenance of well-capitalized
FCMs. In addition, Newedge argued that
the loss of customer off-sets would
increase moral hazard because it would
encourage FCMs to maintain less excess
capital. Furthermore, Newedge
suggested that, as an alternative to the
adoption of the Complete Legal
Segregation Model, the Commission
should require greater FCM disclosure
to allow customers to better assess
Fellow-Customer Risk.90
Comment letters supporting
individual protection for customer
collateral over the Futures Model
generally did so on the basis that the
Futures Model (i) does not protect
Cleared Swaps Customer Collateral from
Fellow-Customer Risk, Investment Risk,
operational risk or fraud-related risk,
and (ii) does not facilitate the portability
of customer positions and associated
89 Newedge
at 2.
argues that such disclosure be
provided in ‘‘plain English’’ on an annual basis, and
include the following data:
The FCM’s total equity, regulatory capital and net
worth;
The dollar value of the FCM’s proprietary margin
requirements as a percentage of its segregated and
secured customer margin requirements;
What number of the FCM’s customers comprise
an agreed significant percentage of its customer
segregated funds;
The aggregate notional value of non-hedged,
principal OTC transactions into which the FCM has
entered;
The amount, generic source and purpose of any
unsecured and uncommitted short-term funding the
FCM is using;
The aggregate amount of financing the FCM
provides for customer transactions involving
illiquid financial products for which it is difficult
to obtain timely and accurate prices;
The percentage of customer ‘‘bad debts’’ the FCM
had during the prior year compared to its year-end
segregated and secured customer funds; and
A summary of the FCM’s current risk practices,
controls and procedures.
Newedge at 7. See also FHLB at 7, n. 14
(encouraging the Commission, in response to a
question in the NPRM regarding additional
disclosure of FCM financial information, to make
such information publicly available on a real time
basis); and MFA at 5 (arguing that ‘‘if the
Commission mandates the disclosure by FCMs of
certain financial information, customers will be in
a better position than they are today to evaluate the
financial strength of their FCM.’’).
90 Newedge
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collateral in the event of an FCM’s
default.91
BlackRock argued that not only does
the Futures Model fail to address the
core risk differences between futures
and OTC swaps, but because of the
buffer created by the mutualized risk
provided by the customer collateral, the
Futures Model may result in less
stringent selection and oversight of
customers by FCMs.92 In addition,
BlackRock argued that the moral hazard
argument advocated by proponents of
the Futures Model presumes that futures
customers have access to information
that allows them to make informed
decisions regarding their fellow
customers. However, BlackRock stated
that access to such information is
currently lacking, there are no
requirements or incentives for a DCO or
FCM to inform a customer when a
fellow customer is in a stress or
potential default situation and, as a
result, customers are forced to rely on
DCOs and regulators for protection.93
Freddie Mac argued that by allowing
DCOs to access the collateral of nondefaulting customers to cover the losses
of defaulting customers, the Futures
Model provides a ‘‘subsidy to DCOs,
FCMs and their riskiest customers at the
expense of customers that present less
risk[, and] this non-transparent shifting
of risk would create moral hazard and
inefficient credit decisions.’’ 94
Similarly, FHLB argued that DCOs
and FCMs should bear all FellowCustomer Risk as they are in a superior
position to conduct analyses of other
cleared swap customers.95 In addition,
FHLB indicated that if the Commission
adopts the Futures Model as the
segregation model for Cleared Swaps
Customer Collateral, it would be
anomalous for market participants to
have the initial margin they post for
Cleared Swaps face greater risk than the
initial margin they post for uncleared
swaps.96 Moreover, the Futures Model
would impede portability because the
collateral posted for Cleared Swaps
‘‘could be tied up in the omnibus
account indefinitely.’’ 97
SIFMA stated that avoiding FellowCustomer Risk presented by the Futures
Model should be the most important
91 See, e.g., AII at 1–2; BlackRock at 2, 7–8; CIEBA
Original at 5; FHLB at 6–7; Fidelity at 3; Freddie
Mac at 1–2; SIFMA at 5; and Vanguard at 4–5.
92 Blackrock at 8.
93 Id.
94 Freddie Mac at 2.
95 FHLB at 6–7.
96 FHLB at 7. FHLB also states that market
participants have a statutory right to segregate
initial margin they post for uncleared swaps with
an independent custodian. Id. at 6.
97 FHLB at 7.
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objective in selecting a segregation
model for Cleared Swaps Customer
Collateral and, as such, none of the
members of the Asset Management
Group supports the Futures Model.98 In
addition, SIFMA argued that the Futures
Model does not facilitate portability to
the same extent as the Complete Legal
Segregation Model and, therefore, is not
as effective at reducing systemic risk.99
Vanguard asserted that the Futures
Model exposes market participants to
Fellow-Customer Risk and because this
risk is not a factor in the OTC swaps
markets, the magnitude of such risk is
not something that a customer could
ever assess, especially given the
‘‘complete lack of transparency with
respect to [an] FCM’s other customers
and their trading positions.’’ 100
Furthermore, Vanguard stated that
mutualization of customer losses
effectively allows ‘‘less sophisticated
analysis of the risk presented by
individual customers and their trading
portfolios as such individual risk can
ultimately be covered by the overall
pool of margin posted by all of the
FCM’s customers,’’ with the result that
‘‘riskier customers (and trading
portfolios) [are] likely to be under
margined and safer clients (and trading
portfolios) [are] likely to be over
margined relative to their actual level of
risk presented to the system.’’ 101 In
sum, Vanguard stated that, given the
differences between the swaps and
futures markets, the Futures Model
could expose a Cleared Swaps Customer
to significantly greater and potentially
unlimited risk.102
4. Legal Segregation With Recourse
Model
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None of the comment letters received
by the Commission appeared to support
the Legal Segregation with Recourse
Model. Commenters that discussed this
model generally stated that the
Commission should not adopt the Legal
Segregation with Recourse Model
because either (1) by failing to mitigate
Fellow-Customer Risk, it is substantially
inferior to the Complete Legal
Segregation Model 103 or (2) it suffers
from the same shortcomings as the
Complete Legal Segregation Model since
it is costly to implement and fails to
mitigate investment and operational
risks.104
98 SIFMA
at 3.
SIFMA at 4–6.
100 Vanguard at 5.
101 Id.
102 Id.
103 See BlackRock at 7; FHLB at 7; Freddie Mac
at 2; FIA at 6–7; MFA at 2; and Vanguard at 4.
104 See, e.g., CME at 16.
99 See
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5. Optional Approach
Though some commenters expressed
a desire to have optional full physical
segregation of Cleared Swaps Customer
Collateral, none of the commenters
supported the Optional Approach
outlined by the Commission.105 Under
this approach, each DCO would choose
the level of customer collateral
protection it chooses to offer.106 The
Commission noted that this approach
might be reconciled with section 766(h)
of the Bankruptcy Code by permitting
DCOs to require that FCMs establish
separate legal entities, each of which is
limited to clearing at DCOs that use only
the same customer collateral protection
model.107
One commenter stated that it is
‘‘likely that the benefits of creating such
a regulatory structure would be
illusory,’’ 108 while another argued that
‘‘[o]ptionality will produce complexity
and expense that might be tolerable
when the cleared swaps market is well
established, but that will be burdensome
to a developing market.’’ 109 In addition,
one commenter expressed concern
regarding the appropriateness of the
Commission adopting a segregation
regime ‘‘that provides protection to
customers based on their ability and
willingness to pay.’’ 110
B. Discussion of the Comments
After careful analysis of the issues
raised by the comment letters with
respect to the selection of a segregation
model for Cleared Swaps Customer
Collateral, the Commission is adopting
the Complete Legal Segregation Model.
105 See, e.g., MFA at 3 n. 11 (stating ‘‘[t]he
Commission should allow market participants to
elect the Physical Segregation Model but only to the
extent that it is compatible with the Complete Legal
Segregation Model. We are not advocating that the
Commission adopt the ‘‘Optional Approach’’ set
forth in the Proposing Release, because we believe
that approach would be very difficult to
implement.’’); ACLI at 2 (supporting the option to
negotiate and select the Physical Segregation
Model); BlackRock at 5 (stating that BlackRock
would support an optional approach if the
Commission believes such an approach would be
prudent, but cautions that optionality may present
implementation challenges and result in portability
delays); CIEBA Original at 1 (promoting optional
individual segregation of Cleared Swaps Customer
Collateral); CME at 17–20 (arguing that the
Commission should support efforts to establish
programs that would permit individuals to
physically segregate the collateral associated with
their Cleared Swaps positions on an optional basis);
and Tudor at 6 (arguing that if the Commission does
not adopt the Physical Segregation Model, the
Commission should ‘‘require DCOs to offer various
segregation models to their cleared swaps
customers, including full physical segregation.’’).
106 See 76 FR at 33825.
107 See 76 FR at 33829.
108 CME at 20.
109 ISDA at 2.
110 FIA at 6.
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As described above, the majority of
market participants supported adoption
of either the Complete Legal Segregation
Model or the Physical Segregation
Model. In addition, while certain
technical corrections/clarifications were
requested, none of the commenters
identified material new information
with respect to costs or benefits
associated with the adoption of the
Complete Legal Segregation Model or
any other model under consideration.
Some commenters did, however, reiterate their view that their business
model depended upon receiving
stronger protection for their Cleared
Swaps Customer Collateral than what
exists under the Futures Model. These
commenters are accustomed to paying
for the higher costs implicit in separate
accounting in the current bilateral
market.
On the other hand, CME, ICE, and Mr.
Salzman identified a number of issues
with the Complete Legal Segregation
Model, including a number of
limitations on the protection it provides
to customers. They did not, however,
provide reason to reject the conclusion
that the Complete Legal Segregation
Model provides substantially greater
protection against Fellow-Customer Risk
than the Futures Model.
CME notes 111 that a portion of the
Cleared Swaps Customer Collateral will
be held at the FCM, not the DCO, and
that this collateral will not be protected
by Complete Legal Segregation in the
event that an FCM becomes insolvent.
This proposition is true 112 but is of
little or no relevance to the comparison
of Complete Legal Segregation with the
Futures Model favored by these
commenters. Complete Legal
Segregation is intended to protect
against Fellow-Customer Risk. As
discussed in the NPRM and above,113
Fellow-Customer Risk is the risk that
the collateral of one customer will be
used to compensate a DCO for market
losses resulting from the swaps of
another customer.114 In other words,
Fellow-Customer Risk arises in
connection with collateral maintained
in an FCM’s customer account posted
with a DCO because, under the Futures
Model, the DCO is potentially entitled
to take all of the collateral in this
account to cover losses created by the
swaps of any customer. However,
Cleared Swaps Customer Collateral held
at the FCM (or at a location other than
at the DCO, such as a bank) is not
accessible to the DCO. Thus, such
111 CME
at 6.
supra note 13.
113 See supra at Section 1.B.6.
114 76 FR at 33821 n. 21.
112 See
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collateral is not subject to FellowCustomer Risk.115 While Cleared Swaps
Customer Collateral in the customer
account at the FCM is available to meet
customers’ swaps-related obligations to
the FCM, the FCM is prohibited by
statute from using one customer’s
Cleared Swaps Customer Collateral as
margin or security for another
customer’s swaps.116
To be sure, Cleared Swaps Customer
Collateral is subject to operational risk—
the risk that, due to fraud,
incompetence, or other mishap,
customer funds that are required to be
segregated are lost. Operational risk,
however, is common to all of the
segregation models for Cleared Swaps
Customer Collateral, including the
Physical Segregation Model.117
Collateral at the FCM is also subject to
a modicum of Investment Risk. But
Commission regulation 1.25, upon
which regulation 22.2(e)(1) is based, is
designed to ensure that customer
segregated funds are invested in a
manner that minimizes their exposure
to credit, liquidity, and market risks
both to preserve their availability to
customers and DCOs and to enable
investments to be quickly converted to
cash at a predictable value in order to
avoid systemic risk. Towards these
ends, regulation 1.25 establishes a
general prudential standard by requiring
that all permitted investments be
‘‘consistent with the objectives of
preserving principal and maintaining
liquidity.’’ 118
CME also provides a detailed
description of how, due to the ‘‘the
extended operational timeline for
derivatives clearing and the netting of
payments,’’ a customer could default on
a payment on Tuesday, but the DCO
would, due to a countervailing gain by
a different customer or customers of the
same clearing member, not see such a
default until after Wednesday’s clearing
cycle (payments for which may not be
due until Thursday morning).119 This
analysis elides the fact that, pursuant to
the calculations required under
115 As explained above, FCMs typically maintain
two separate Cleared Swaps Customer Accounts.
One is maintained at the DCO and contains
collateral required by the DCO to secure current
swaps positions. The second is maintained by the
FCM itself, typically at a bank, and contains
collateral provided to the FCM by customers but not
currently posted to the account at the DCO.
116 Section 4d(f)(2)(B) of the CEA, 7 U.S.C.
6d(f)(2)(B).
117 Moreover, as noted above (see supra section
I.D.2), while the LSOC Model does not protect
against operational risk any more than the Futures
Model, it is superior in that it enhances the ability
to transfer collateral after an insolvency caused by
operational risk.
118 See regulation 1.25(b).
119 CME at 9.
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regulation 22.2(f), an FCM with a
customer who incurred a loss in excess
of that customer’s Cleared Swaps
Customer Collateral would, unless and
until that customer posted additional
collateral, be required to have covered
such loss with the FCM’s own capital
deposited into the Cleared Swaps
Customer Account. If, at any moment,
such customer loss was not covered by
the FCM’s own capital, then the FCM
would be in violation of its segregation
requirements. Pursuant to Commission
regulation 1.12(h),
[w]henever a person registered as a futures
commission merchant knows or should know
that the total amount of its funds on deposit
in segregated accounts on behalf of customers
* * * is less than the total amount of such
funds required by the Act and the
Commission’s rules to be on deposit in
segregated * * * accounts on behalf of such
customers, the registrant must report such
deficiency immediately by telephonic notice
* * * to the registrant’s designated selfregulatory organization and the principal
office of the Commission in Washington, DC
* * *.120
Thus, an FCM whose customer suffers
such a loss which is not covered by the
FCM’s own capital on deposit in the
Cleared Swaps Customer Account will
certainly know of such deficiency no
later than noon the next day
(Wednesday in CME’s example), when it
will be required, pursuant to regulation
22.2(g), to compute its segregated funds
requirements and the amount of
segregated funds it has on deposit to
meet such requirements. Moreover, the
Commission believes that an FCM
carrying a customer account that suffers
losses in excess of that firm’s ability to
cover ‘‘should know’’ of such losses by
the end of that trading day (Tuesday in
CME’s example).
Such notice will permit the
Commission to act to notify the relevant
clearing organizations and to ensure that
prompt action is taken to either bring
capital in to enable the FCM to meet its
segregated funds requirements or to
otherwise act to minimize customer
losses.
CME implies that a successful porting
of customer accounts requires
information that is ‘‘100% accurate,’’ 121
and that an FCM is unlikely to meet that
standard each day. CME also notes that
there may be portfolio changes in
customer accounts on the day of
default.122 Moreover, CME notes that a
defaulting FCM may have systems that
fail.123 CME notes that in the case of
120 Commission regulation 1.12(h) emphasis
added.
121 CME at 13.
122 Id. at 12.
123 Id. at 14.
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Lehman Brothers,124 there was a
‘‘rushed, confused, uncertain and nearpanic atmosphere,’’ as described in the
report of the SIPA Trustee.125
Recent experience demonstrates,
however, that transfers can occur
despite less than perfect information.
For example, in the case of the
bankruptcy of Lehman Brothers the
commodity customer accounts were
effectively transferred to Barclays over
the weekend of September 20–21, 2008,
immediately following the
commencement of the liquidation of the
firm,126 and any discrepancies were
resolved, despite the difficulties
described. Indeed, the key issue will be
to identify the collateral attributable to
the defaulting customer, as
distinguished from the collateral
attributable to all other customers, as
discrepancies between non-defaulting
customers can be resolved either as
transferred accounts are reconciled, or
through the claims process.
Thus, while CME is correct in stating
that ‘‘the risk of ultimate financial loss
to customers due to a fellow-customer
default is reduced but certainly not
eliminated under CLSM,’’ 127 the
Commission concludes, based on its
experience with its rules in general and
with FCM bankruptcies in particular,
that the probability and probable
amount of such loss is far less than CME
implies.
Moreover, the swift portability of
collateral associated with customer
positions in the event of an FCM’s
default remains problematic under the
Futures Model where there is a
customer default. Furthermore, many of
the imperfections of the Complete Legal
Segregation Model and the residual
Fellow-Customer Risk associated
therewith that were highlighted by CME
arise from the ‘‘last-day risk’’ that
results from the fact that information
about each customer’s positions is only
provided once each day. However, the
NPRM made clear in relevant portions
of sections 22.11 and 22.12, and the
Commission reiterates herein, that
information must be provided and
calculations must be made at least once
a business day. In other words, many of
the imperfections discussed by CME are
not inherent to the Complete Legal
Segregation Model. Rather, each DCO is
free to make improvements to that
124 The Lehman Brothers FCM was placed into a
Securities Investor Protection Corporation
liquidation on Friday, September 19, 2008.
125 CME at 14 (citation omitted).
126 This transfer was authorized in the hours
immediately following the commencement of
Lehman’s liquidation, and was implemented in the
hours immediately thereafter.
127 CME at 15.
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minimum regulatory standard if the
DCO finds such improvements to be
technologically feasible and
economically justifiable. For example, a
DCO could require its clearing members
to identify the customer associated with
each swap as it is cleared, and the DCO
could use this information to associate
gains and losses more tightly with each
customer, thereby minimizing ‘‘last-day
risk.’’ The NPRM and this final rule
simply set a minimum threshold for
daily tracking.
With respect to costs associated with
evaluating the credit risks of individual
customers, CME noted that it calculates,
‘‘at the end of each trading day * * *
for each FCM’s cleared swaps customer
account * * * the net position of each
customer in the account [and] the net
margin requirement for each customer
in the account.’’ 128 Thus, based on
CME’s description of its current clearing
practices, it would appear that CME
already undertakes an individualized
evaluation of the sufficiency of the
collateral posted by each customer of an
FCM.129 In addition, as CME notes,
‘‘FCMs are subject to compliance audits
that are conducted for each FCM by the
DCO serving as its ‘‘designated selfregulatory organization.’’ 130 It would
therefore seem that at least some of the
costs associated with evaluating the
credit risk of individual customers are
already being incurred by DCOs.
With respect to ICE’s proposal, the
Commission notes that it would provide
less Fellow-Customer Risk protection
than the Complete Legal Segregation
Model. The fact that swap customers
seem to overwhelmingly favor at least as
much Fellow-Customer Risk protection
as afforded to them under the Complete
Legal Segregation Model,
notwithstanding the potential costs,
weighs in favor of the Complete Legal
Segregation Model rather than ICE’s
proposal.
With respect to Newedge’s suggestion
for increased disclosure of FCM
information, additional disclosure is
often beneficial, and the Commission
will consider additional disclosure
requirements as a means of enhancing
protection for collateral belonging to
128 Id.
at 9 (emphasis supplied).
addition, during the Second Roundtable,
Ms. Taylor of CME stated that with respect to risk
management, CME is ‘‘set up to do it in the overthe-counter business at the individual customer
level.’’ See Second Roundtable Tr. at168, l. 10.
130 See also Second Roundtable Tr. at 171, l. 18
(Ms. Taylor stating that ‘‘on a day-to-day basis we
don’t see the collateral that’s in the account of a
customer at an FCM, but we do have transparency
into the efficacy of the practices of holding margin
and holding it in segregated accounts through the
financial supervision and audit functions so that
there is ongoing monitoring of that * * *’’).
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129 In
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market participants. However, because
of confidentiality concerns, any feasible
enhanced disclosure is insufficient for
quantifying risk exposure to FellowCustomer Risk and, thus, insufficient for
providing Cleared Swaps Customers
with the ability to effectively manage
such exposure.131 Moreover, even if it
were practical to provide Cleared Swaps
Customers with information sufficient
to assess Fellow-Customer Risk, that
task is better left to the DCO since (1)
DCOs have a concentrated ability to
ensure adequate risk mitigation, and (2)
having each Cleared Swaps Customer
effectively risk-manage each FCM
would likely entail duplication with
resulting cost.
Thus, after careful analysis of the
comments, the Commission believes
that the Complete Legal Segregation
Model provides the most appropriate
framework for the protection of Cleared
Swaps Customer Collateral at this time.
None of the segregation models the
Commission considered provides
perfect protection for Cleared Swaps
Customer Collateral, and the degree of
imperfection of any of the models is
influenced by ‘‘the facts and
circumstances’’ of an FCM default.
However, as CME notes, the Complete
Legal Segregation Model ‘‘would, on its
face, lead to greater protection of cleared
swaps customer collateral against
Fellow-Customer Risk than the Futures
Model’’ 132 and is ‘‘more likely to
facilitate portability of cleared swaps
customer positions than the Futures
Model, in the event of an FCM default
in its cleared swaps customer account
* * *.’’ 133 Furthermore, the Complete
Legal Segregation Model provides the
131 See Second Roundtable at p. 183, 1.12–p. 184,
1.10 (In reference to the disclosure of additional
FCM information, Mr. Kahn stating ‘‘Barclays does
agree and would be willing to show our riskmanagement procedures and policies, and we do
talk to our buy side clients about that * * * [but]
if Barclays is providing clearing services for any of
the individual firms on the other side of the table,
we do not say that, nor would we ever give out any
position level information. It is very important to
us that in whatever paradigm it’s set up and how
you evaluate from a risk-management standpoint
that the buy side and their trades that they’ve put
on that we are serving remains confidential and
does not leak to the market in any side.’’); and
Second Roundtable at p. 185, 1.6 (Ms. Taylor stating
that ‘‘when we know when people clear, that’s very
confidential information and I’m very sympathetic
to the fear about fellow customer risk, but I’m also
very sympathetic to the fact that none of you would
want your information disclosed so that there is a
balance on the other side * * *’’). See also In re
Stotler and Co., 144 B.R. 385, 393 (Bankr.N.D.Ill.
1992) (‘‘[T]he legislative history of 11 U.S.C. 766
emphasizes that the risk of a broker’s bankruptcy
is not to be borne by the customer * * *.’’
Individual customers ‘‘face a formidable task in
researching the relative solvency, reputation, and
success of competing FCMs.’’).
132 CME at 16.
133 Id.
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6349
best balance between benefits and costs
in order to protect market participants
and the public.
Finally, while the Complete Legal
Segregation Model is a critical step in
the efforts to protect customers and their
collateral, as noted above, the
Commission is actively considering
seeking notice and comment on a
proposal to allow individual protection
of client assets. In addition, the
Commission is directing staff to look
into the possibility of adopting the
Complete Legal Segregation Model for
the futures market. The Commission
remains committed to protecting market
participants.
IV. Section by Section Analysis:
Regulation Part 22
A. Regulation 22.1: Definitions
Proposed regulation 22.1 established
definitions for, inter alia, the following
terms: ‘‘cleared swap,’’ ‘‘cleared swaps
customer,’’ ‘‘cleared swaps customer
account,’’ ‘‘cleared swaps customer
collateral,’’ ‘‘cleared swaps proprietary
account,’’ ‘‘clearing member,’’ 134
‘‘collecting futures commission
merchant,’’ ‘‘commingle,’’ ‘‘customer,’’
‘‘depositing futures commission
merchant,’’ ‘‘permitted depository,’’ 135
and ‘‘segregate.’’
1. ‘‘Segregate’’ and ‘‘Commingle’’
Regulation 22.1 proposed definitions
for the terms ‘‘segregate’’ and
‘‘commingle’’ that are intended to codify
the common meaning of such terms
under the part 1 of the Commission’s
regulations (the ‘‘Part 1 Provisions’’).
Pursuant to the proposal, to ‘‘segregate’’
two or more items means to keep them
in separate accounts and to avoid
combining them in the same transfer
between accounts. In contrast,
‘‘commingle’’ means to hold two or
more items in the same account, or to
combine such items in a transfer
between accounts. The Commission did
not receive comments on these
134 Under the Commission’s proposal, the term
‘‘clearing member’’ means ‘‘any person that has
clearing privileges such that it can process, clear
and settle trades through a derivatives clearing
organization on behalf of itself or others. The
derivatives clearing organization need not be
organized as a membership organization.’’
135 The Commission proposed to define
‘‘permitted depository’’ as a depository that is a
bank located in the United States, a trust company
located in the United States, a Collecting Futures
Commission Merchant registered with the
Commission (but only with respect to a Depositing
Futures Commission Merchant providing Cleared
Swaps Customer Collateral), or a derivatives
clearing organization registered with the
Commission. In addition, the FCM or the DCO must
hold a written acknowledgment letter from the
depository as required by proposed regulation 22.5.
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proposed definitions and is, therefore,
adopting them as proposed.
2. ‘‘Cleared Swap’’
Regulation 22.1 proposed a definition
of the term ‘‘Cleared Swap’’ that (i)
excludes, for purposes of Part 22 only,
cleared swaps (and related collateral)
that, pursuant either to a Commission
rule, regulation, or order (including an
order under section 4d(a) of the CEA) or
to a DCO rule approved in accordance
with regulation 39.15(b)(2),136 are
commingled with futures contracts (and
related collateral) in a customer account
established for the futures contracts, but
(ii) includes, for purposes of Part 22
only, futures contracts or foreign futures
contracts (and, in each case, related
collateral) that, pursuant to either a
Commission rule, regulation, or order
(including an order under section 4d(f)
of the CEA) or to a DCO rule approved
in accordance with regulation
39.15(b)(2),137 are commingled with
cleared swaps (and related collateral) in
a customer account established for the
cleared swaps. The Commission did not
receive comments on the proposed
definition of ‘‘Cleared Swap’’ and is
adopting it as proposed with one
change. The Commission finalized
regulation 39.15 on October 18, 2011.138
That final regulation requires a DCO
seeking to commingle Cleared Swaps
(and related collateral) with futures
contracts (and related collateral) in a
futures account to petition for a
Commission order under section 4d(a)
of the CEA. Thus, the final definition of
‘‘Cleared Swap’’ in this rulemaking
removes the reference to DCO rule
approval procedures relevant to such
commingling.
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3. ‘‘Cleared Swaps Customer’’ and
‘‘Customer’’
Regulation 22.1 proposed definitions
of ‘‘Cleared Swaps Customer’’ and
‘‘Customer.’’ The Commission is
adopting the definitions of ‘‘Cleared
Swaps Customer’’ and ‘‘Customer’’
essentially as proposed, except that a
technical amendment is made to the
definition of Cleared Swaps Customer to
clarify that a clearing member of a DCO
is not a Cleared Swaps Customer with
respect to Cleared Swaps cleared on that
DCO.
4. ‘‘Cleared Swaps Customer Collateral’’
Proposed regulation 22.1 defined
Cleared Swaps Customer Collateral to
include (i) money, securities, or other
property that an FCM or a DCO receives,
136 Section
4d(a) of the CEA, 7 U.S.C. 6d(a).
4d(f) of the CEA, 7 U.S.C. 6d(f).
138 76 FR 69441.
137 Section
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from, for, or on behalf of a Cleared
Swaps Customer that is intended to or
does margin, guarantee, or secure a
Cleared Swap 139 or, if the Cleared Swap
is in the form or nature of an option,
constitutes the settlement value of such
option and (ii) ‘‘accruals,’’ which are the
money, securities, or other property that
an FCM or DCO receives, either directly
or indirectly, as incident to or resulting
from a Cleared Swap that the FCM
intermediates for a Cleared Swaps
Customer. The proposed definition
explicitly included a Cleared Swap in
the form or nature of an option as
Cleared Swaps Customer Collateral, but
did not explicitly include option
premiums as Cleared Swaps Customer
Collateral. The proposed definition also
explicitly included in ‘‘accruals’’ the
money, securities, or other property that
a DCO may receive relating to the
Cleared Swap that an FCM
intermediates for a Cleared Swap
Customer.
FIA suggested that the Commission
confirm that the term Cleared Swaps
Customer Collateral includes all assets
provided by a Cleared Swaps Customer,
including any sums required by an FCM
to margin a Cleared Swap, even if that
sum is in excess of the amount required
by the relevant DCO, as well as
collateral ‘‘voluntarily’’ deposited by a
Cleared Swaps Customer in a Cleared
Swaps Customer Account.140 In
response, the Commission is clarifying
that the definition of Cleared Swaps
Customer Collateral includes any sums
required by an FCM that is intended to,
or does, margin a Cleared Swap as well
as collateral ‘‘voluntarily’’ deposited by,
or on behalf of, a Cleared Swaps
Customer in a Cleared Swaps Customer
Account. Moreover, in response to this
comment, the Commission is adding a
new section 22.13(c), which states that
collateral posted by a Cleared Swaps
Customer in excess of the amount
required by a DCO (the ‘‘excess
collateral’’) may be transmitted by the
Cleared Swaps Customer’s FCM to the
DCO if, but only if, (i) the FCM is
permitted to do so by DCO rule and (ii)
the DCO provides a mechanism by
139 Proposed regulation 22.1 provides that
‘‘Cleared Swaps Customer Collateral’’ includes
collateral that an FCM or a DCO receives from, for,
or on behalf of a Cleared Swaps Customer that
either (i) is actually margining, guaranteeing, or
securing a Cleared Swap or (ii) is intended to
margin, guarantee, or secure a Cleared Swap. This
provision is a clarification of ‘‘customer funds’’ as
defined in regulation 1.3, which includes ‘‘all
money, securities, and property received by a
futures commission merchant or by a clearing
organization from, for, or on behalf of, customers or
option customers * * * to margin, guarantee, or
secure futures contracts.’’
140 See FIA at 7–8.
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which the FCM can identify the amount
of such excess collateral attributable to
each Cleared Swaps Customer, and such
mechanism is employed effectively to
accomplish that goal.
5. ‘‘Cleared Swaps Customer Account’’
and ‘‘Cleared Swaps Proprietary
Account’’
As proposed, regulation 22.1 defined
a ‘‘Cleared Swaps Customer Account’’
as (i) an account that an FCM maintains
at a Permitted Depository for the
Cleared Swaps (and related collateral) of
its Cleared Swaps Customers, or (ii) an
account that a DCO maintains at a
Permitted Depository for collateral
related to Cleared Swaps that the FCM
members intermediate for their Cleared
Swaps Customers. Regulation 22.1 also
proposed a definition for ‘‘Cleared
Swaps Proprietary Account’’ that is
substantially similar to regulation 1.3,
which defines ‘‘Proprietary Account’’
for futures contracts. The Commission
requested comment on whether the
proviso in paragraph (b)(8), which states
that ‘‘an account owned by any
shareholder or member of a cooperative
association of producers, within the
meaning of section 6a of the Act, which
association is registered as an FCM and
carries such account on its records, shall
be deemed to be a Cleared Swaps
Customer Account and not a Cleared
Swaps Proprietary Account of such
association, unless the shareholder or
member is an officer, director, or
manager of the association,’’ remains
relevant, particularly with respect to
Cleared Swaps. The Commission did
not receive comments on these
proposed definitions and is, therefore,
adopting the definitions of ‘‘Cleared
Swaps Customer Account’’ and
‘‘Cleared Swaps Proprietary Account’’
as proposed.
6. ‘‘Clearing Member’’
Regulation 22.1 proposed a definition
of ‘‘Clearing Member.’’ The Commission
did not receive comments on this
proposed definition. Therefore, the
Commission is adopting the definition
of ‘‘Clearing Member’’ as proposed.
7. ‘‘Collecting Futures Commission
Merchant’’ and ‘‘Depositing Futures
Commission Merchant’’
Proposed regulation 22.1 defined a
‘‘Collecting Futures Commission
Merchant’’ or ‘‘Collecting FCM’’ as one
that carries Cleared Swaps on behalf of
another FCM and the Cleared Swaps
Customers of that other FCM and, as
part of doing so, collects Cleared Swaps
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Customer Collateral.141 In contrast, a
‘‘Depositing Futures Commission
Merchant’’ or ‘‘Depositing FCM’’ was
defined as one that carries Cleared
Swaps on behalf of its Cleared Swaps
Customers through a Collecting FCM,
and, as part of doing so, deposits
Cleared Swaps Customer Collateral with
such Collecting FCM. The Commission
did not receive comments on these
proposed definitions and is adopting the
definitions of ‘‘Collecting Futures
Commission Merchant’’ and
‘‘Depositing Futures Commission
Merchant’’ as proposed.
8. ‘‘Permitted Depository’’
Regulation 22.1 proposed a definition
of ‘‘Permitted Depository.’’ The
Commission did not receive comments
on this proposed definition and is,
therefore, adopting the definition of
‘‘Permitted Depository’’ as proposed.
B. Regulation 22.2—Futures
Commission Merchants: Treatment of
Cleared Swaps Customer Collateral
Regulation 22.2 proposed
requirements for an FCM’s treatment of
Cleared Swaps Customer Collateral, as
well as the associated Cleared Swaps.
1. In General
Proposed regulation 22.2(a) required
an FCM to treat and deal with the
Cleared Swaps of Cleared Swaps
Customers, as well as associated Cleared
Swaps Customer Collateral, as belonging
to the Cleared Swaps Customers. The
Commission did not receive any
comments on regulation 22.2(a) and is
therefore adopting regulation 22.2(a) as
proposed.
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2. Location of Collateral
Proposed regulation 22.2(b) required
that an FCM segregate all Cleared Swaps
Customer Collateral that it receives.
Additionally, proposed regulation
22.2(b) required that an FCM adopt one
of two methods to hold segregated
Cleared Swaps Customer Collateral,
which parallel either implicit
assumptions or explicit provisions of
regulation 1.20(a).
The Commission did not receive any
comments on regulation 22.2(b) and is
therefore adopting regulation 22.2(b) as
proposed.
3. Commingling
Proposed regulation 22.2(c) permitted
an FCM to commingle the Cleared
141 For the avoidance of doubt, an FCM does not
become a Collecting FCM simply by intermediating
the proprietary transactions of another FCM. An
FCM only becomes a Collecting FCM by
intermediating, on behalf of another FCM, Cleared
Swaps belonging to Cleared Swaps Customers (and
the relevant collateral).
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Swaps Customer Collateral of multiple
Cleared Swaps Customers, while
prohibiting the FCM from commingling
Cleared Swaps Customer Collateral
with:
• FCM property, except as permitted
under proposed regulation 22.2(e) (as
discussed below); or
• ‘‘customer funds’’ (as regulation 1.3
defines such term) for futures contracts
or the ‘‘foreign futures or foreign options
secured amount’’ (as regulation 1.3
defines such term), except as permitted
by a Commission rule, regulation or
order (or a derivatives clearing
organization rule approved pursuant to
regulation 39.15(b)(2)).142
The Commission did not receive any
comments on regulation 22.2(c) and is
therefore adopting regulation 22.2(c) as
proposed.
4. Limitations on Use
Proposed regulation 22.2(d)
prohibited an FCM from (i) using, or
permitting the use of, the Cleared Swaps
Customer Collateral of one Cleared
Swaps Customer to purchase, margin, or
settle the Cleared Swaps, or any other
transaction, of a person other than the
Cleared Swaps Customer; (ii) using
Cleared Swaps Customer Collateral to
margin, guarantee, or secure the nonCleared Swap contracts (e.g., futures or
foreign futures contracts) of the entity
constituting the Cleared Swaps
Customer; 143 (iii) imposing, or
permitting the imposition of, a lien on
Cleared Swaps Customer Collateral,
including on any FCM residual financial
interest therein; and (iv) claiming that
any of the following constitutes Cleared
Swaps Customer Collateral:
• Money invested in the securities,
memberships, or obligations of any
DCO, designated contract market
142 As the discussion on the proposed definition
of ‘‘Cleared Swaps’’ highlights, if the Commission
adopts a rule or regulation or issues an order
pursuant to section 4d(a) of the CEA, or if the
Commission approves DCO rules pursuant to
regulation 39.15(b)(2) permitting such
commingling, the Commission would apply the
corresponding provisions and Part 190 to the
Cleared Swap (and related collateral) as if the swap
constituted a futures contract (and related
collateral).
In contrast, if the Commission adopts a rule or
regulation or issues an order pursuant to section
4d(f) of the CEA, or if the Commission approves
DCO rules pursuant to regulation 39.15(b)(2)
permitting such commingling, the proposed
definition of ‘‘Cleared Swap’’ would operate to
apply Part 22 and Part 190 to (i) the futures contract
(and related collateral) or (ii) the foreign futures
contract (and related collateral) as if such contracts
constituted Cleared Swaps (and related collateral).
143 As mentioned above, an entity may
simultaneously transact (i) Futures contracts, (ii)
foreign futures contracts, (iii) Cleared Swaps, and
(iv) uncleared swaps. Such entity would constitute
a Cleared Swaps Customer only with respect to its
Cleared Swaps.
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6351
(‘‘DCM’’), swap execution facility
(‘‘SEF’’), or swap data repository
(‘‘SDR’’); or
• Money, securities, or other property
that any DCO holds and may use for a
purpose other than to margin, guarantee,
secure, transfer, adjust or settle the
obligations incurred by the FCM on
behalf of its Cleared Swaps Customers.
ISDA argued that these proposed rules
could prevent or inhibit portfolio
margining, even where netting itself is
legally enforceable, and stated that the
Commission should ‘‘acknowledge in
rule that excess collateral may be
managed and applied so as to facilitate
portfolio based-margining (including to
the benefit of uncleared swaps).’’ 144 FIA
requested that the Commission confirm
that regulation 22.2(d) will permit FCMs
to take security interests in their Cleared
Swaps Customers’ Cleared Swaps
Customer Accounts in support of other
positions held by such customers at the
FCM, or for other entities (including
affiliates of FCMs) to take such security
interests in support of financing the
Cleared Swaps Customer’s margin
obligations. MFA asked the Commission
to ensure that Cleared Swaps Customers
are able to grant liens on Cleared Swaps
Customer Collateral (subordinate to a
DCO’s rights) to be able to continue
entering into cross-product, and other
multilateral, netting agreements. MFA
also argued that the Commission should
either (i) modify proposed regulation
22.2(d)(2) to limit application of the rule
to ‘‘prohibiting an FCM’s creditors from
obtaining a lien on [Cleared Swaps
Customer Collateral]’’ or (ii) clarify in
the final rule release or in interpretive
guidance that the language of proposed
regulation 22.2(d) is not intended to
limit a Cleared Swaps Customer’s ability
‘‘to grant liens on entitlements to
cleared swap positions and related
collateral as contemplated by UCC 9–
102(14), 102(15), 9–102(16), 9–102(17),
9–102(49);’’ provided such lien does not
impair a DCO’s first priority interests to
such collateral.145
As explained above, ‘‘excess’’
collateral refers to the collateral that a
Cleared Swaps Customer deposits with
an FCM or DCO that is more than the
amount required by the FCM or DCO to
margin such customer’s Cleared Swaps
portfolio. Since the ‘‘excess’’ collateral
belongs to the Cleared Swaps Customer,
and is not required by the FCM or DCO,
it is entirely proper for the Cleared
Swaps Customer to manage the
collateral. The Cleared Swaps Customer
may manage ‘‘excess’’ collateral by
giving instructions to the FCM to,
144 ISDA
145 See
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MFA at 5–6.
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among other things, transfer such
collateral from one account (e.g., a
Cleared Swaps Customer Account) to
another account (e.g., a futures
account).146 However, it is less clear
how collateral that is not ‘‘excess’’—
namely, collateral margining cleared
positions (for which the counterparty is
the DCO, through the FCM)—can also be
used to margin uncleared positions (for
which the counterparty is, by definition,
other than a DCO). Accordingly, while
the Commission supports the benefits of
portfolio margining, the Commission
does not believe it would be prudent to
permit collateral margining cleared
positions to simultaneously be used to
margin uncleared positions.
In addition, the Commission clarifies
that an FCM may not, under any
circumstances, grant a lien to any
person (other than to a DCO) on its
Cleared Swaps Customer Account, or on
the FCM’s residual interest in its
Cleared Swaps Customer Account. On
the other hand, a Cleared Swaps
Customer may grant a lien on the
Cleared Swaps Customer’s individual
cleared swaps account (an ‘‘FCM
customer account’’) that is held and
maintained at the Cleared Swaps
Customer’s FCM.147 The Commission
notes that by permitting a Cleared
Swaps Customer to grant a lien on that
Cleared Swaps Customer’s FCM
customer account, an FCM is not
permitting the grant of a lien on Cleared
Swaps Customer Collateral.
Furthermore, the Commission confirms
that regulation 22.2(d) permits (i) FCMs
to take a security interest in a Cleared
Swaps Customer’s FCM customer
account in support of other positions
held by such customer at the FCM, and
(ii) other entities (including affiliates of
FCMs) to take a security interest in a
Cleared Swaps Customer’s FCM
customer account in support of
financing the Cleared Swaps Customer’s
margin obligations.
146 Regulation Part 22 creates the presumption
that all money, securities, and other property
deposited in a Cleared Swaps Customer Account
constitutes Cleared Swaps Customer Collateral.
Therefore, in order for a Cleared Swaps Customer
to use ‘‘excess’’ collateral to margin, e.g., uncleared
swaps, such customer must direct the transfer of
such collateral from the Cleared Swaps Customer
Account.
147 An FCM customer account is an account
maintained by the FCM on behalf of a specific
Cleared Swaps Customer that holds assets provided
by that Cleared Swaps Customer, or other assets of
equivalent value, that are not currently posted with
the DCO to support swaps positions cleared by the
FCM on behalf of such Cleared Swaps Customer.
Typically, an FCM customer account constitutes a
notation in the books and records of the FCM, and
not a separate account at a depository. For a more
detailed discussion of FCM customer accounts, see
the discussion in section I.B.5.
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5. Exceptions
Regulation 22.2(e) proposed certain
exceptions to the abovementioned
requirements and limitations.
Specifically, proposed regulation
22.2(e)(1) allowed an FCM to invest
Cleared Swaps Customer Collateral in
accordance with regulation 1.25, as such
regulation may be amended from time to
time. Proposed regulation 22.2(e)(2)
permitted an FCM to withdraw Cleared
Swaps Customer Collateral for such
purposes as meeting margin calls at a
DCO or a Collecting FCM, or to meet
charges lawfully accruing in connection
with a cleared swap, such as brokerage
or storage charges. Proposed regulation
22.2(e)(3) permitted an FCM (i) to place
its own property in an FCM Physical
Location or (ii) to deposit its own
property in a Cleared Swaps Customer
Account.148 Finally, as proposed,
regulation 22.2(e)(4) clarified that, if an
FCM places or deposits its own property
in an FCM Physical Location or a
Cleared Swaps Customer Account, as
applicable, then that property becomes
Cleared Swaps Customer Collateral.
However, an FCM would be permitted
to retain a residual financial interest in
property in excess of that necessary.
SIFMA and Vanguard argued that the
Commission should require an FCM to
identify when it has used its own
capital to meet a Cleared Swap
Customer’s margin obligation and
whether such capital can be used by a
DCO to cure a defaulting Cleared Swap
Customer’s margin obligations.149 To
address this comment, the Commission
is amending regulation 22.2(e)(3) to
distinguish between (a) cases where an
FCM uses its own capital to cure a
Cleared Swaps Customer’s
undermargined or deficit account and
(b) cases where an FCM uses its own
capital to create a ‘‘buffer’’ in the
Cleared Swaps Customer Account. The
Commission notes that in case (a), the
FCM has, in essence, provided an
advance to the Cleared Swaps Customer,
and the DCO should be able to use such
collateral to meet a default by that
Cleared Swaps Customer to the same
extent as if that Cleared Swaps
Customer provided the collateral.
However, in case (b) the FCM has
provided collateral that does not belong
to any specific Cleared Swaps Customer,
148 Regulation 22.2(e)(3) proposes to permit an
FCM to deposit only those securities that are
unencumbered and are of the types specified in
regulation 1.25. Such proposal accords with
regulation 1.23. See regulation 1.23. The
Commission notes, however, that this proposal does
not, and is not meant to, require a DCO to accept
all of the types of securities or other property
specified in regulation 1.25.
149 See SIFMA at 10; and Vanguard at 7.
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and thus there is no reason to restrict
the use of that collateral to any specific
Cleared Swaps Customer. The
Commission also notes that, to the
extent the DCO permits the FCM to post
‘‘excess’’ collateral, the DCO must,
through its own rules, require that the
FCM separately account for the
separately identified ‘‘buffer collateral’’
(which originated from the FCM’s own
capital) and the collateral attributed (at
the DCO) to the FCM’s Cleared Swaps
Customers (which belongs to those
customers).
ISDA noted that the use of ‘‘such’’ in
regulation 22.2(e)(4)(ii) is ambiguous
and could imply that an FCM has a
residual interest only in the particular
account (i.e., cash versus securities) into
which it has deposited property. ISDA
argued that this might cause unintended
consequences if the customer deposits a
security and the FCM, faced with a need
to advance variation margin on behalf
such customer in cash, does not
liquidate the security but rather deposits
cash secured by that security. ISDA
suggested that the Commission clarify
the language by making clear that the
FCM has a residual interest in all
property in Cleared Swaps Customer
Accounts in excess of that required by
the regulation 22.2(f)(4) segregation
requirement.150 In response, the
Commission clarifies that an FCM has a
residual interest in all property in
Cleared Swaps Customer Accounts in
excess of that required by the regulation
22.2(f)(4) segregation requirements.
e. Requirements As to Amount
As proposed, regulation 22.2(f) set
forth an explicit calculation for the
amount of Cleared Swaps Customer
Collateral that an FCM must maintain in
segregation, which did not materially
differ in the Form 1–FR–FCM from the
calculation for ‘‘customer funds’’ of
futures customers. First, proposed
regulation 22.2(f) defined ‘‘account’’ to
reference an FCM’s books and records
pertaining to the Cleared Swaps
Customer Collateral of a particular
Cleared Swaps Customer. Second,
proposed regulation 22.2(f) required an
FCM to reflect in its account for each
Cleared Swaps Customer the market
value of any Cleared Swaps Collateral
that it receives from such customer, as
adjusted for:
• Any uses that proposed regulation
22.2(d) permits;
• Any accruals or losses on
investments permitted by proposed
regulation 22.2(e) that, pursuant to the
applicable FCM customer agreement,
150 See
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are creditable or chargeable to such
Cleared Swaps Customer;
• Any charges lawfully accruing to
the Cleared Swaps Customer, including
any commission, brokerage fee, interest,
tax, or storage fee; and
• Any appropriately authorized
distribution or transfer of the Cleared
Swaps Collateral.
Third, proposed regulation 22.2(f)
categorized accounts of Cleared Swaps
Customers as having credit or debit
balances. Accounts where the market
value of Cleared Swaps Customer
Collateral is positive after adjustments
have credit balances. Conversely,
accounts where the market value of
Cleared Swaps Customer Collateral is
negative after adjustments have debit
balances. Fourth, proposed regulation
22.2(f) required an FCM to maintain in
segregation, in its FCM Physical
Location and/or its Cleared Swaps
Customer Accounts at Permitted
Depositories, an amount equal to the
sum of any credit balances that Cleared
Swaps Customers have in their
accounts, excluding from such sum any
debit balances that Cleared Swaps
Customers have in their accounts (the
‘‘Collateral Requirement’’). Finally,
regulation 22.2(f) proposed an exception
to the exclusion of debit balances.
Specifically, to the extent that a Cleared
Swaps Customer deposited ‘‘readily
marketable securities’’ with the FCM to
secure a debit balance in its account,
then the FCM must include such
balance in the Collateral Requirement.
‘‘Readily marketable’’ was defined as
having a ‘‘ready market’’ as such latter
term is defined in rule 15c3–1(c)(11) of
the Securities and Exchange
Commission (§ 241.15c3–1(c)(11) of this
title). Proposed regulation 22.2(f)
deemed a debit balance ‘‘secured’’ only
if the FCM maintains a security interest
in the ‘‘readily marketable securities,’’
and holds a written authorization to
liquidate such securities in its
discretion. To determine the amount of
the debit balance that the FCM must
include in the Collateral Requirement,
proposed regulation 22.2(f) required the
FCM (i) to determine the market value
of such securities, and (ii) to reduce
such market value by applicable
percentage deductions (i.e., ‘‘securities
haircuts’’) as set forth in rule 15c3–
1(c)(2)(vi) of the Securities and
Exchange Commission. The FCM would
include in the Collateral Requirement
that portion of the debit balance, not
exceeding 100 percent, which is secured
by such reduced market value. The
Commission requested comment on the
Collateral Requirement proposed in
regulation 22.2(f). Specifically, the
Commission requested comment on
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whether the explicit calculation of such
Collateral Requirement materially
differs from the implicit calculation in
the Part 1 Provisions for segregated
‘‘customer funds’’ of futures customers.
ISDA expressed concern that the
definition of Cleared Swaps Customer
Collateral may sweep in investment
returns, which may be inconsistent with
regulation 22.10 that allows DCOs and
FCMs to keep investment returns unless
otherwise agreed and regulation
22.2(f)(2)(ii) that refers to investment
returns creditable to a customer by
agreement.151 FIA asked the
Commission to clarify whether the
definition of Cleared Swaps Customer
Collateral included the interest earned
on investments of customer funds,
which FCMs have traditionally been
permitted to retain.152 In addition, FIA
stated that because an FCM is required
to include accruals or losses on
investments of customer collateral
under proposed regulation 22.3, the
provision appears to state that
customers can agree to assume all or a
portion of the losses incurred in
connection with the investment of
customer collateral. FIA ‘‘does not
believe that a customer may agree to
share in losses incurred in connection
with investments under Rule 1.25.’’ 153
The Commission confirms that
investment returns are includable in
Cleared Swaps Customer Collateral only
to the extent creditable pursuant to the
customer agreement. As such, the
Commission is deleting the words ‘‘or
losses’’ and ‘‘or chargeable,’’ from
regulation § 22.2(f)(2)(ii). To be clear,
Cleared Swaps Customers are not
responsible for losses on investments
made pursuant to, and in accordance
with, regulation 1.25.
AII requested that the Commission
‘‘ensure that swaps customers may
direct the investments in which initial
margin is invested, as is done today
through bilateral agreements with dealer
counterparties.’’ 154 While Cleared
151 ISDA
at 6–7.
FIA at 7–8 & nn. 25–30.
153 The FIA cited to a number of cases where
courts have stated that ‘‘Congress intended that
futures commission merchants be entitled to any
and all interest on their investment of customer
margin funds.’’ See id. at n. 29 (citing Marchese v.
Shearson Hayden Stone, Inc. 644 F.Supp. 1381
(C.D. Cal. 1986), aff’d, 822 F.2d 876 (9th Cir. 1987);
Craig v. Refco, 624 F.Supp 944 (N.D. Ill. 1983),
aff’d. 816 F.2d 347 (7th Cir. 1987) (confirming that
‘‘the FCM, not the customer, bears the risk of any
decline in the value of investments purchased with
customer funds’’); and Bibbo v. Dean Witter
Reynolds, Inc., 151 F.3d 559 (6th Cir. 1998). See
also id. at 8–9 & n. 31.
154 AII at 4. The term ‘‘initial margin’’ is defined
in regulation 1.3(ccc) and means ‘‘money,
securities, or property posted by a party to a futures,
option, or swap as performance bond to cover
152 See
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6353
Swaps Customers in the Cleared Swaps
Customer Account Class would share in
Investment Risk, the Commission notes
that these comments are beyond the
limited scope of these regulations, and
it will consider how to address them
outside of this rulemaking. However,
nothing contained herein would limit
an FCM from adopting as a policy—and
commit itself by contract with its
customers—to further limit its
investments of customer funds for all
customers of one or more account
classes (i.e., futures, foreign futures,
Cleared Swaps).155
FIA argued that the calculation
requirements set forth in regulation 22.2
pose an excessive burden because an
FCM cannot offset negative and positive
balances in different currencies. Thus, if
a Cleared Swaps Customer has a
positive balance in USD but a negative
balance in Euro, the FCM would need
to deposit its own capital to cover the
negative balance in Euro without
respect to the Cleared Swaps Customer’s
positive balance in USD. FIA noted that
though proposed regulation 22.2(g)
mirrors existing regulation 1.32(a), there
is an important difference in
circumstances that warrants different
treatment of the two cases: while
relatively few futures contracts traded
on U.S. DCMs are denominated in a
foreign currency, a significant number
of Cleared Swaps are expected to be
denominated in foreign currencies.156 In
response, the Commission recognizes
the concerns expressed by the FIA.
However, efforts to provide that an FCM
may, in making its segregation
calculations, include a debit balance to
the extent such balance is secured by
funds in other currencies, subject to
appropriate haircuts, are beyond the
limited scope of this rulemaking. The
Commission will, therefore, consider
how to address these issues outside of
this rulemaking.
f. Segregated Account; Daily
Computation and Record
Proposed regulation 22.2(g) required
an FCM to compute, as of the close of
potential future exposures arising from changes in
the market value of the position.’’ The term
‘‘variation margin’’ is defined in regulation 1.3(fff)
and means ‘‘a payment made by a party to a futures,
option, or swap to cover the current exposure
arising from changes in the market value of the
position since the trade was executed or the
previous time the position was marked to market.’’
155 Because of pro rata distribution, limiting the
investments of customer funds attributable to
individual customers would be insufficient to
protect such customers from Investment Risk
attributable to the investment of customer funds
attributable to other customers within the same
account class.
156 See FIA at 10–11.
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each business day, on a currency-bycurrency basis:
• The aggregate market value of the
Cleared Swaps Customer Collateral in
all FCM Physical Locations and all
Cleared Swaps Customer Accounts at
Permitted Depositories (the ‘‘Collateral
Value’’);
• The Collateral Requirement; and
• The amount of the residual
financial interest that the FCM holds in
such Cleared Swaps Customer Collateral
(i.e., the difference between the
Collateral Value and the Collateral
Requirement).
Proposed regulation 22.2(g) also
required the FCM to complete the
abovementioned computation prior to
noon157 on the next business day, and
to keep all computations, together with
supporting data, in accordance with
regulation 1.31.
The Commission did not receive any
comments on regulation 22.2(g) and is
therefore adopting regulation 22.2(g) as
proposed.
C. Regulation 22.3—Derivatives Clearing
Organizations: Treatment of Cleared
Swaps Customer Collateral
Regulation 22.3 proposed
requirements for DCO treatment of
Cleared Swaps Customer Collateral from
FCMs, as well as the associated Cleared
Swaps. Specifically, regulation 22.3(a)
required a DCO to treat Cleared Swaps
Customer Collateral deposited by an
FCM as belonging to the Cleared Swaps
Customers of that FCM and not other
persons. Moreover, regulation 22.3(b)
required DCOs to segregate all Cleared
Swaps Customer Collateral either with
itself or a Permitted Depository.
Proposed regulation 22.3(c) allowed a
DCO to commingle the Cleared Swaps
Customer Collateral that it receives from
multiple FCMs on behalf of their
Cleared Swaps Customers, while
prohibiting the DCO from commingling
Cleared Swaps Customer Collateral with
(i) The money, securities, or other
property belonging to the DCO, (ii) the
money, securities, or other property
belonging to any FCM, or (iii) other
categories of funds that it receives from
an FCM on behalf of Customers,
including ‘‘customer funds’’ (as
regulation 1.3 defines such term) for
futures contracts or the ‘‘foreign futures
or foreign options secured amount’’ (as
regulation 1.3 defines such term), except
as permitted by a Commission rule,
regulation or order (or by a derivatives
clearing organization rule approved
pursuant to regulation 39.15(b)(2)).158
157 ‘‘Noon’’ refers to noon in the time zone where
the FCM’s principal office is located.
158 See 76 FR at 69390–92.
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Regulations 22.3(d) and (e), on the other
hand, proposed certain exceptions to
the abovementioned requirements and
limitations. Regulation 22.3(d) as
proposed (i) allowed a DCO to place
money, securities, or other property
belonging to an FCM in a DCO Physical
Location, or deposit such money,
securities, or other property in the
relevant Cleared Swaps Customer
Account, pursuant to an instruction
from the FCM, and (ii) to permit FCM
withdrawals of money, securities, or
other property from a DCO Physical
Location or Cleared Swaps Customer
Account. Proposed regulation 22.3(d) is
being deleted consistent with the
changes to regulation 22.2(e)(3), which
require delineation between cases where
an FCM posts collateral on behalf of a
particular customer and cases where an
FCM posts collateral on behalf of its
customer account in general. Proposed
regulation 22.3(e) (now, regulation
22.3(d)) allowed a DCO to invest
Cleared Swaps Customer Collateral in
accordance with regulation 1.25, as such
regulation may be amended from time to
time.
The Commission requested comment
on what, if any, changes to proposed
regulation 22.3 may be appropriate to
accommodate the possibility that a
depository registered with either
domestic or foreign banking regulators
may seek to become a DCO, and that
such depository may seek to hold
Cleared Swaps Customer Collateral, as
well as other forms of customer
property. Specifically, the Commission
requested comment on (i) whether a
DCO that is also a registered depository
should be permitted to hold both
tangible and intangible forms of Cleared
Swaps Customer Collateral from FCMs
itself, (ii) the challenges that a DCO
holding tangible and intangible forms of
Cleared Swaps Customer Collateral pose
to the protection (including effective
segregation) of Cleared Swaps Customer
Collateral (as well as other forms of
customer property), and (iii) how any
challenges identified in (ii) might be
addressed.
ISDA stated that the definition of
Cleared Swaps Customer Collateral does
not distinguish between initial and
variation margin. Both FIA and ISDA
expressed concerns that, if variation
margin is considered as collateral,
regulations 22.3(a) and 22.3(b) would
prevent a DCO from taking Cleared
Swaps Customer Collateral received
from one FCM as variation margin ‘‘and
transferring it to an FCM whose
customers are on the opposite side of
the relevant trades.’’ 159 FIA asked the
159 ISDA
PO 00000
at 5. See FIA at 9.
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Commission to confirm that a DCO may
pass variation margin to the receiving
party ‘‘if such variation is characterized
as collateral and not as a settlement
payment by the parties to the swap.’’ 160
Similarly, ICE requested clarification
that a DCO that has received ‘‘variation
or mark-to-market margin (as opposed to
initial margin)’’ may be used to settle
variation for offsetting swaps. ICE
argues that without an amendment
permitting DCOs to treat ‘‘variation or
mark-to-market’’ margin as a passthrough, ‘‘clearinghouses could
effectively be prohibited from clearing
much of the OTC swaps market as it
transacts today.’’ 161 The Commission is
adopting regulation 22.3 as proposed.
The Commission recognizes the
concerns expressed by commenters and
confirms that regulation 22.3 is
intended to permit DCOs to use
variation margin collected from Cleared
Swaps Customers to pay variation
margin to, among others, Cleared Swaps
Customers.
ISDA also observed that a variation
margin payment ‘‘may be considered as
a settlement payment—a realized profit/
loss—as in the case of listed futures; or
as collateralizing current exposure, a
payment representing unrealized profit/
loss, as in the case of bilateral
(uncleared) swap contracts.’’ 162 ISDA
argued that Cleared Swaps Customers
would be subject to a ‘‘mark-to-market’’
tax regime, paying ordinary income on
swap returns, if a DCO were to treat as
a contract settlement, a variation margin
payment made with respect to a Cleared
Swap.163 Accordingly, ISDA noted that
recording daily mark-to-market income
on swaps would poorly match the
periodic realized coupon income on the
bonds hedged by such swaps.164
Similarly, FIA noted that it has ‘‘been
advised that, because cleared swaps are
not subject to section 1256 of the
Internal Revenue Code, the
characterization of such payments as
settlement payments may have tax
consequences that may impair the
ability of certain financial end-users
* * * to enter into cleared swaps
transactions.’’ 165 ISDA suggested that
Congress did not intend to change the
tax treatment of swaps, because section
1601 of the Dodd-Frank Act explicitly
exempts Cleared Swaps from being
treated as ‘‘section 1256 contracts.’’ 166
As such, ISDA requested that the
160 FIA
at 9 (emphasis supplied).
at 10.
162 ISDA at 5.
163 Id.
164 Id. at 6.
165 FIA at 9, n. 33.
166 ISDA at 6.
161 ICE
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Commission clarify that DCOs can treat
variation margin as collateral rather
than settlement payments.167 These
comments are beyond the limited scope
of these regulations and outside the
scope of the Commission’s authority.
The Commission does not take any view
on the proper treatment of variation
margin associated with swaps for tax
purposes. Rather, the Commission
believes that the Internal Revenue
Service is the regulatory body best
equipped to address the identified
taxation issue.
D. Regulation 22.4—Futures
Commission Merchants and Derivatives
Clearing Organizations: Permitted
Depositories
Proposed regulation 22.4 listed
depositories permitted to hold Cleared
Swaps Customer Collateral (the
‘‘Permitted Depositories’’),168 and noted
that an FCM could serve as a Permitted
Depository, but only if it is a Collecting
FCM carrying the Cleared Swaps (and
related Cleared Swaps Customer
Collateral) of a Depositing FCM. The
Commission sought public comment
regarding the appropriateness of
allowing an FCM to serve as a Permitted
Depository only if the FCM is a
‘‘Collecting FCM.’’ The Commission did
not receive any comments in response
thereto or on regulation 22.4 generally.
The Commission is, therefore, adopting
regulation 22.4 as proposed.
E. Regulation 22.5—Futures
Commission Merchants and Derivatives
Clearing Organizations: Written
Acknowledgement
As proposed, regulation 22.5 required
a DCO or FCM to obtain written
acknowledgement letters from
depositories (including, by implication,
depositories located outside the United
States) before opening a Cleared Swaps
Customer Account.169 Proposed
regulation 22.5 also set forth substantive
requirements for such acknowledgement
letter. The Commission requested
comment on the appropriateness of the
following: (i) the addition of regulation
1.20 (as the Commission may choose to
amend such regulation) in proposed
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167 Id.
168 As proposed, for a DCO or an FCM, a
Permitted Depository must (subject to regulation
22.9) be: (i) A bank located in the United States; (ii)
a trust company located in the United States; or (iii)
a DCO.
169 The function of a written acknowledgment
letter is to ensure and provide evidence that a
potential Permitted Depository is aware that (i) The
FCM or DCO is opening a Cleared Swaps Customer
Account, (ii) the funds deposited in such account
constitute Cleared Swaps Customer Collateral, and
(iii) such Cleared Swaps Customer Collateral is
subject to the requirements of section 4d(f) of the
CEA and Part 22 (when finalized).
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regulation 22.5, and (ii) the adaptation
of any form letter that the Commission
may choose to promulgate under
regulation 1.20 to accommodate Cleared
Swaps Customer Collateral under
regulation 22.5.
ISDA stated that an acknowledgement
letter from a foreign depository ‘‘may be
difficult to get and of little purpose, if
obtained’’ because the letter would not
alter the fact that the foreign depository
would be subject to local bankruptcy
jurisdiction.170 The Commission is
adopting regulation 22.5 as proposed.
The Commission notes that under
regulation 1.49(d)(1) depositories in the
futures market must provide the
depositing FCM or DCO with the
appropriate written acknowledgements
required under regulations 1.20 and
1.26. The requirements set forth in
regulation 22.5 parallel the
requirements set forth under regulations
1.20 and 1.26. The Commission has no
reason to believe that written
acknowledgements from foreign
depositories would be any more
difficult to obtain in the swaps market
than they would be in the futures
market. Moreover, the written
acknowledgment is intended to clearly
establish the commercial expectations of
the parties before a bankruptcy or
insolvency event. In addition, the
written acknowledgements could aid a
bankruptcy judge’s or trustee’s
allocation of assets to the extent a
bankruptcy court or other insolvency
regime finds the commercial
expectations of the parties to be helpful
information.
F. Regulation 22.6—Futures
Commission Merchants and Derivatives
Clearing Organizations: Naming of
Cleared Swaps Customer Accounts
Proposed regulation 22.6 required an
FCM or DCO to ensure that the name of
each Cleared Swaps Customer Account
that it maintains with a Permitted
Depository (i) clearly identifies the
account as a ‘‘Cleared Swaps Customer
Account,’’ and (ii) clearly indicates that
the collateral therein is ‘‘Cleared Swaps
Customer Collateral’’ subject to
segregation in accordance with section
4d(f) of the CEA and Part 22. The
Commission did not receive any
comments on this regulation and is,
therefore, adopting regulation 22.6 as
proposed.
G. Regulation 22.7—Permitted
Depositories: Treatment of Cleared
Swaps Customer Collateral
As proposed, under regulation 22.7 a
Permitted Depository is (i) required to
170 ISDA
PO 00000
at 8.
Frm 00021
treat all funds in a Cleared Swaps
Customer Account as Cleared Swaps
Customer Collateral and (ii) prohibited
from holding, disposing of, or using any
Cleared Swaps Customer Collateral as
belonging to any person other than the
Cleared Swaps Customers of the FCM
maintaining such Cleared Swaps
Customer Account or the Cleared Swaps
Customers of the FCMs for which the
DCO maintains such Cleared Swaps
Customer Account. The Commission
did not receive any comments on this
proposed rule and is adopting
regulation 22.7 as proposed.
H. Regulation 22.8—Situs of Cleared
Swaps Customer Accounts
1. Proposed Requirements
Proposed regulation 22.8 required (i)
each FCM to designate the United States
as the site (i.e., the legal situs) of the
FCM Physical Location and the
‘‘account’’ (as regulation 22.2(f)(1)
defines such term) that the FCM
maintains for each Cleared Swaps
Customer, and (ii) each DCO to
designate the United States as the site
(i.e., the legal situs) of the DCO Physical
Location and the Cleared Swaps
Customer Account that the DCO
maintains on its books and records for
the Cleared Swaps Customers of each
FCM. The Commission sought comment
on whether, as proposed, regulation
22.8 ensured that Cleared Swaps
Customer Collateral be treated in
accordance with the U.S. Bankruptcy
Code, to the extent possible, and if it did
not achieve this purpose, what
alternatives the Commission should
consider to achieve such purpose.
Additionally, the Commission requested
comment on the benefits and costs of
proposed regulation 22.8, as well as any
alternatives.
NGX states that the requirement of
U.S. situs for a customer account may
increase legal uncertainty with respect
to the insolvency regime that would
apply to a bankruptcy, and such
uncertainty may slow down resolution
of a clearing participant’s default and
bankruptcy. Moreover, NGX argues that
‘‘it is unclear how the U.S. account situs
requirement will interact with the
choice of law provision’’ 171 of a nonU.S. DCO that chooses to apply its home
country insolvency regime. In light of
this uncertainty, NGX recommends that
the Commission adopt the approach it
proposed for foreign non-U.S.
clearinghouses seeking DCO
registration; namely, that the DCO
registration application include a
‘‘memorandum of local law analyzing
171 NGX
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insolvency issues in the [relevant]
foreign jurisdiction * * * and
describing how the applicant has
addressed any conflict of law issues,
which jurisdiction’s law is intended to
apply to each aspect of the applicant’s
clearing house’s operations, and the
enforceability of the choice of law in the
relevant jurisdictions.’’ 172 However,
NGX requested that the Commission
provide greater guidance regarding the
operation of the proposed rule if it opts
to retain the account situs requirements,
specifically making clear that ‘‘a DCO
choice of law rule should be able to
include both choice of forum as well as
the substantive law to be applied’’ with
respect to a clearinghouse’s insolvency
and the remedies available to a
clearinghouse in the event of a clearing
member’s default or insolvency.173
The Commission notes that, in the
event of an FCM’s bankruptcy, the legal
situs provision is intended to make clear
that the insolvency regime that will
apply to the customers of the FCM is the
U.S. insolvency regime embodied in
Subchapter IV of Chapter 7 of the U.S.
Bankruptcy Code and Part 190 of the
Commission’s regulations.174 While a
DCO is free to make the choice that local
law applies to all other aspects of a
DCO’s relationships with its members,
the Commission has historically
required, and intends to continue
requiring, that customers of FCMs in
bankruptcy be treated in accordance
with U.S. bankruptcy law.
srobinson on DSK4SPTVN1PROD with RULES3
I. Regulation 22.9—Denomination of
Cleared Swaps Customer Collateral and
Location of Depositories
Proposed regulation 22.9 applies
regulation 1.49 to Cleared Swaps
Customer Collateral. Regulation 1.49
sets forth rules determining the
permitted denominations of customer
funds (i.e., permitted currencies and
172 Id. at 5 (citing to the ‘‘Risk Management
Requirements for Derivative Clearing
Organizations,’’ 76 FR. 3698, 3742, Jan. 20, 2011).
173 Id. at 4–5.
174 As discussed in the NPRM, the Commission
does not intend for regulation 22.8 to affect the
actual location in which an FCM or DCO may keep
Cleared Swaps Customer Collateral. Though the
legal situs of an ‘‘account’’ (as regulation 22.2(f)(1)
defines the term) and a Cleared Swaps Customer
Account must be in the United States, the
Commission recognizes that Cleared Swaps
Customer Collateral may, in actuality, be kept
outside the United States in certain circumstances.
However, the Commission notes that regulation
22.8 does not override other Commission
regulations regarding the location of customer
funds. Specifically, regulation 22.9, which applies
regulation 1.49 to Cleared Swaps, requires, among
other things, FCMs and DCOs to hold, in a
segregated account on behalf of Cleared Swaps
Customers, sufficient United States dollars in the
United States to meet all United States dollar
obligations.
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amounts in each currency), permitted
locations of customer funds (i.e.,
permitted countries and amounts in
each country), and qualifications that
entities outside of the United States
must meet to become Permitted
Depositories (e.g., minimum regulatory
capital). Specifically, regulation
1.49(b)(1)(iii) permits an FCM’s
obligations to a customer to be
denominated in ‘‘a currency in which
funds have accrued to the customer as
a result of trading conducted on a
designated contract market or registered
derivatives transaction execution
facility,’’ while regulation 1.49(d)(3)
requires depositories that are located
outside the United States to be (i) A
bank or trust company that meets
certain financial requirements, (ii) an
FCM, or (iii) a DCO. In addition,
regulation 22.9 proposed to allow an
FCM to serve as a Permitted Depository
only if the FCM was a Collecting FCM
carrying the Cleared Swaps, and
associated Cleared Swaps Customer
Collateral, for the Cleared Swaps
Customers of a Depositing FCM.
ISDA stated that regulation
1.49(b)(1)(iii) should be amended to
reflect the wider scope of execution
methods available for Cleared Swaps.175
In response, the Commission is
amending regulation 22.9 to allow the
FCM’s obligations to a Cleared Swaps
Customer to be denominated in the
currency in which funds have accrued
to the Cleared Swaps Customer as a
result of a Cleared Swap carried through
such FCM, to the extent of such
accruals. However, the Commission
notes that it cannot amend regulation
1.49(b)(1)(iii) at this time because such
an amendment was not part of the
NPRM.
ISDA also requested that the
Commission make plain that central
securities depositories are acceptable
depositories.176 Similarly, FIA argued
that Euroclear, a central securities
depository for Euro-denominated
securities, should be permitted to act as
a depository under Commission
regulations.177 The Commission notes
that although the notion of a central
securities depository as an acceptable
depository for securities has
considerable intuitive appeal, CEA
§ 4d(f)(3)(A)(i) limits acceptable
depositories for commingled funds to
‘‘any bank or trust company or * * * a
derivatives clearing organization.’’ 178
175 ISDA
at 8.
176 Id.
177 See
FIA at 11.
4d(f)(3)(A)(ii) of the CEA permits
customer property to be used to margin a cleared
swap with a member of a DCO, i.e., a collecting
178 Section
PO 00000
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Because these comments are beyond the
limited scope of these regulations, the
Commission will consider how to
address them outside of this
rulemaking.
Finally, FHLB argued that ‘‘customer
collateral should only be held in banks
or trust companies located in the United
States.’’ 179 The Commission does not
believe it would be appropriate to
address this comment at this time, as it
is beyond the scope of this rulemaking.
J. Regulation 22.10—Application of
Other Regulatory Provisions
Proposed regulation 22.10 applies
1.27 (Record of investments),180 1.28
(Appraisal of obligations purchased
with customer funds),181 1.29
(Increment or interest resulting from
investment of customer funds),182 and
1.30 (Loans by futures commission
merchants; treatment of proceeds) 183 to
Cleared Swaps Customers and Cleared
Swaps Customer Collateral.
While several commenters cited
regulation 22.10, they did so in the
context of discussion of other
regulations. Because the Commission
did not receive any comments regarding
the substance of regulation 22.10, it is
adopting regulation 22.10 as proposed.
K. Regulation 22.11—Information To Be
Provided Regarding Customers and
Their Cleared Swaps
Proposed regulation 22.11 required
that (i) each Depositing FCM provide to
its Collecting FCM and (ii) each FCM
member provide to its DCO, in each
case, information sufficient to identify
Cleared Swaps Customers on a one-time
basis, and information sufficient to
identify the portfolio of rights and
obligations belonging to such customers
with respect to their Cleared Swaps ‘‘at
least once each business day.’’ If a
Depositing FCM or FCM member also
serves as a Collecting FCM, then it must
FCM. However, the Commission notes that a foreign
bank that meets the requirements of regulation
1.49(d)(3)(i) is a good depository, and such a foreign
bank may itself hold foreign securities in an
account at a foreign central securities depository.
179 FHLB at 9.
180 Regulation 1.27 requires FCMs and DCOs
investing customer funds to maintain specified
records concerning such investments.
181 Regulation 1.28 requires FCMs investing
customer funds to record and report such
investment at no greater than market value.
182 Regulation 1.29 permits FCMs and DCOs
investing customer funds to receive and retain any
increment or interest thereon.
183 Regulation 1.30 permits FCMs to loan their
own funds to customers on a secured basis, and to
repledge or sell such security pursuant to agreement
with such customers. However, regulation 1.30 does
make clear that the proceeds of such loans, when
used to purchase, margin, guarantee, or secure
futures contracts, shall be treated as customer
funds.
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provide the specified information with
respect to each individual Cleared
Swaps Customer for which it acts (on
behalf of a Depositing FCM) as a
Collecting FCM. As proposed,
regulation 22.11 also held the DCO
responsible for taking appropriate steps
to confirm that the information that it
receives is accurate and complete, and
ensure that the information is being
produced on a timely basis. However,
because the DCO may not have a direct
relationship with, e.g., a Depositing
FCM, the regulation required the DCO to
take ‘‘appropriate steps’’ to ensure that
its FCM members enter into suitable
arrangements with, e.g., a Depositing
FCM to verify the accuracy and
timeliness of information. The
Commission requested comment on
whether (i) The proposed requirement
in regulation 22.11 for a Depositing
FCM to provide a Collecting FCM with
information sufficient to identify its
Cleared Swaps Customers raises any
competitive concerns, (ii) such
concerns, if any, could be resolved if the
identities of the Cleared Swaps
Customers are coded, with the DCO, but
not the Collecting FCM, receiving a
copy of such code, and (iii) other
methods were available to resolve any
such concerns.
ISDA requested that the Commission
further clarify the language of regulation
22.11 to make explicit that an FCM must
provide identifying information to the
DCO or to the Collecting FCM the first
time the FCM intermediates a swap for
a Cleared Swaps Customer with the
particular relevant DCO or collecting
FCM.184 In response, the Commission is
amending the language of regulation
22.11 to make clear that an FCM must
provide identifying information to a
DCO or Collecting FCM the first time it
intermediates a Cleared Swap with that
DCO or Collecting FCM.
In addition, a number of commenters
raised concerns regarding the need for
specific recordkeeping and reporting
requirements.185 These commenters
requested that the Commission mandate
reporting and recordkeeping
requirements for DCOs and require
DCOs to implement rules requiring their
clearing members to comply with such
reporting and recordkeeping
requirements. FHLB argued that, at a
minimum, an FCM should have to
identify (i) collateral posted by an
individual customer as cash or
securities and (ii) with respect to
identifiable securities, which customer
184 See
ISDA at 9.
e.g., ICI at 5; SIFMA at 8; and FHLB at
185 See,
4.
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posted such securities.186 CME, by
contrast, stated that auditing for
accuracy of ‘‘a full breakdown of all
forms of collateral at all levels of
clearing for each end customer,
allocated specifically to each DCO
* * * will increase costs
exponentially.’’ 187 CIEBA, CME, ICE,
FHLB, SIFMA, BlackRock, and
Vanguard stated that it is important to
be able to ensure that an FCM’s books
and records are accurate in order to
support implementation of Cleared
Swaps Customer Collateral in
bankruptcy. The preferred means of
addressing this problem ranged from
increasing recordkeeping and
monitoring burdens on FCMs and DCOs
to abandoning the Complete Legal
Segregation Model. On the other hand,
CME complained that the phrase
‘‘portfolio of rights and obligations
arising from the Cleared Swaps that
such futures commission merchant
intermediates for such customer’’ is
unclear as to whether it covers the
collateral supporting such positions.188
CME stated that it ‘‘read[s] the proposed
regulations as requiring a DCO to
allocate to each non-defaulting customer
its specific required margin only
* * *,’’ and that it intends to ‘‘allocate
to any defaulting customer the
difference between its specific required
margin and the collateral within the
DCO’s access and control * * * .’’189
AII, SIFMA, and Vanguard requested
that the Commission require DCOs to
carefully monitor clearing member
compliance with DCO rules, including
through periodic audits, by amending
regulation 22.11(e) to provide specific
and concrete examples of the steps a
DCO must take to confirm that
information from an FCM is accurate,
complete and timely. In addition, AII,
SIFMA, and Vanguard requested that
the words ‘‘appropriate steps’’ in
regulation 22.11(e) be replaced with ‘‘all
steps necessary.’’ 190 CME argued that
regulation 22.11 should specify the
contents of the daily FCM report to the
DCO,191 and that the Commission
should clarify the intent behind the
language ‘‘take additional steps,’’
186 FHLB also argues that this information should
be provided to Cleared Swaps Customers on a daily
basis so that they can correct any discrepancies in
the records, which would, in turn, reduce
operational risk. See FHLB at 4.
187 CME at 15, n. 30. Cf. FHLB at 3, n. 2 (stating
FHLB’s understanding that LCH has the technology
necessary to track individual customer collateral on
a real-time basis, but acknowledging that it is ‘‘not
in a position to calculate the costs associated with
such technology.’’).
188 CME at 6–7.
189 Id. at 7 (emphasis in original).
190 See AII at 3; SIFMA at 8; and Vanguard at 6.
191 See CME at 3–4, and 13–15.
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specifically with respect to what the
Commission ‘‘intends each DCO to
accomplish under the verification
requirement.’’ 192
FIA noted that the proposed rule does
not require the information to be
provided by any specific time each
business day, and recommended that
the Commission specify such a
deadline.193 Vanguard, SIFMA and AII
also suggested that the Commission
consider requiring information to be
provided ‘‘as frequently as necessary’’
rather than ‘‘at least once each business
day.’’ 194 Finally, CME stated that it
‘‘presume[d] that the Commission’s
intention is to continue to treat omnibus
accounts of a foreign broker clearing
through an FCM as a single ‘customer’
for purposes of the requirements of Part
22.’’195
The Commission notes that under the
Complete Legal Segregation Model,
DCOs must, in the event of the
insolvency of a clearing member
carrying Cleared Swaps Customer
positions, either return to the Trustee, or
transfer to another FCM, the value of the
collateral associated with each Cleared
Swaps Customer’s positions (as adjusted
in accordance with Commission
regulations). This requirement
corresponds to the margin required for
the Cleared Swaps Customer’s swaps
cleared through that DCO, including any
individualized surcharge or voluntary
contribution.196 Thus, a DCO has no
responsibility to monitor the nature or
amount of collateral each Cleared Swaps
Customer actually posts with the FCM,
or the provenance of the specific items
of collateral the DCO receives from the
FCM. Rather, the DCO should take the
steps appropriate, in the professional
judgment of its staff, to verify that FCM
members have and are using systems
and appropriate procedures to track
accurately, and to provide to the DCO
accurately, the positions of each
customer. Furthermore, the Commission
is clarifying that the responsibilities of
a DCO under Part 22 are analogous to
the responsibilities of a DCM under
regulation 1.52 with respect to margin
(the calculation of which requires an
accurate accounting of the customer’s
positions). As noted by one commenter,
FCMs are already subject to DSRO
192 CME
at 15.
FIA at 12. FIA cites to ‘‘Proposed Rule
22.12,’’ but it is regulation § 22.11 that requires
FCMs to provide information to a clearing FCM or
DCO.
194 AII at 3; SIFMA at 8; and Vanguard at 6–7.
195 CME at 8, n. 20.
196 See regulation 22.13(a)(1)(C).
193 See
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audits on an approximately annual
basis.197
At this time, the Commission is not
requiring that information be provided
‘‘as frequently as necessary’’ or by a
specific time. Regulation 22.11 requires
information to be provided ‘‘at least
once a day,’’ thereby permitting DCOs to
require by rule the collection of this
information more frequently. If more
frequent collection of such information
becomes an industry standard at a later
point in time, the Commission might
then consider increasing the frequency
of this reporting requirement. In
addition, the Commission notes that a
DCO may set, by rule, the time or times
by which such information must be
provided.
Finally, the Commission confirms the
presumption ‘‘that the Commission’s
intention is to continue to treat omnibus
accounts of a foreign broker clearing
through an FCM as a single ‘customer’
for purposes of the requirements of Part
22.’’ 198 However, to the extent a foreign
broker is required to provide individual
protection for swaps customer collateral
under the laws of another jurisdiction,
the Commission intends that the
regulations under Part 22 foster
compliance with such other laws.
L. Regulation 22.12—Information To Be
Maintained Regarding Cleared Swaps
Customer Collateral
As proposed, regulation 22.12
required DCOs and Collecting FCMs to
use the information provided pursuant
to proposed regulation 22.11 to
calculate and record, no less frequently
than once each business day, the
amount of collateral required (i) for each
relevant Cleared Swaps Customer
(including each such customer of a
Depositing FCM), based on the portfolio
of rights and obligations arising from its
Cleared Swaps; and (ii) for all relevant
Cleared Swaps Customers.
SIFMA argued that DCOs and FCMs
should be required to perform the
calculations specified in regulation
22.12 ‘‘as frequently as technologically
possible’’ rather than ‘‘no less frequently
than once each business day.’’ 199 The
Commission is adopting regulation
22.12 as proposed. The calculations
required by regulation 22.12 are based
on information provided under
regulation 22.11, which is sent to the
DCOs and FCMs ‘‘at least once each
business day.’’ It would be anomalous
for the Commission to require a more
frequent calculation of collateral
requirements when the information on
197 See
CME at 15.
id. at 8, n. 20.
199 SIFMA at 9. See also AII at 3.
which such calculation is based is only
required to be provided once each
business day. However, if more frequent
collection of such information becomes
an industry standard at a later point in
time, the Commission might then
consider requiring more frequent
calculation of collateral requirements by
regulation.
FIA and ISDA observed that the
reference in the NPRM in the discussion
of regulation 22.12 to an advance by the
FCM to a Cleared Swaps Customer as a
‘‘loan’’ combined with regulation 22.10,
which, among other things, prohibits an
FCM from granting unsecured loans to
customers, could be read to prohibit
unsecured short-term advances of
margin funds to Cleared Swaps
Customers by FCMs. They asked that
the Commission clarify that unsecured
short term advances of margin are
permissible.200 The Commission
clarifies that, consistent with current
practice, unsecured short term advances
of margin are not considered ‘‘loans’’ for
purposes of existing regulation 1.30, or
new regulation 22.10. The Commission
notes, however, that such advances
should be either promptly repaid or
promptly replaced with a secured loan.
M. Regulation 22.13—Additions to
Cleared Swaps Customer Collateral
Regulation 22.13 proposed two tools
that DCOs or Collecting FCMs may use
to manage the risk they incur with
respect to individual Cleared Swaps
Customers. Because the proposed tools
were not intended to be mandatory or
exclusive, the Commission sought
comment on how it could enable DCOs
or Collecting FCMs to use other tools to
manage such risk. In addition, proposed
regulation 22.13(a) clarified that a DCO
or Collecting FCM could increase the
collateral required of a particular
Cleared Swaps Customer or group of
such customers, based on an evaluation
of the credit risk posed by such
customer(s). The proposed clarification
was not intended to interfere with the
right of any FCM to increase the
collateral requirements with respect to
any of its customers, and the
Commission requested comment
regarding whether a DCO or a Collecting
FCM wished to increase the collateral
required for any reason other than credit
risk. Similarly, proposed regulation
22.13(b) provided that collateral
deposited by an FCM that is identified
as collateral in which such FCM has a
residual financial interest (i.e., the
FCM’s own funds) may, to the extent of
such residual financial interest, be used
by the DCO or Collecting FCM to secure
198 See
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the Cleared Swaps of any or all Cleared
Swaps Customers.
ISDA suggests that the final rule
attribute the collateral deposited by an
FCM that is identified as collateral in
which such FCM has a residual
financial interest to individual Cleared
Swaps Customers to determine which
Cleared Swaps Customers have a credit
balance and which have a debit
balance.201 The Commission notes that
collateral attributable to an FCM’s
residual financial interest is, by
definition, not the property of any
Cleared Swaps Customer. Accordingly,
there is no customer-protection-based
reason to deny a DCO or Collecting FCM
the ability to use such collateral to meet
the default of any Cleared Swaps
Customer. In addition, as mentioned
above, the Commission is adding a new
section 22.13(c), which states that,
subject to certain requirements,
collateral posted by a Cleared Swaps
Customer in excess of the amount
required by a DCO (the ‘‘excess
collateral’’) may be transmitted by the
Cleared Swaps Customer’s FCM to the
DCO.202
N. Regulation 22.14—Futures
Commission Merchant Failure To Meet
a Customer Margin Call in Full
Proposed regulation 22.14 required a
defaulting FCM to transmit to the DCO
or Collecting FCM, as applicable,
Cleared Swaps Customer Collateral on
deposit at the FCM for each Cleared
Swaps Customer whose swaps
contributed to the call, and the identity
and the amount transmitted on behalf
of, each such customer. Regulation
22.14 also proposed a detailed sequence
of events following an FCM’s default.
Specifically, proposed regulations
22.14(e) and (f) addressed the issue of
allocation of the loss of value of
collateral (also known as Investment
Risk) 203 despite the application of
haircuts. The Commission sought
comment on the proposed allocation of
Investment Risk.
FIA suggested that the regulations
make clear that the DCO or Collecting
FCM may reasonably rely on the
information provided by the defaulting
FCM (or on information previously
provided if the defaulting FCM does not
promptly provide information on the
day of the default).204 In response, the
Commission is amending regulation
22.14 to add subsection (2) to
specifically permit such reliance on
201 See
ISDA at 9–10.
further detail, see the discussion above in
section IV.A.4. under the definition of ‘‘Cleared
Swaps Customer Collateral.’’
203 See supra at n. 28.
204 See FIA at 12; SIFMA at 10.
202 For
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information provided by a defaulting
FCM.
Vanguard and SIFMA requested
clarification regarding how a DCO
should handle simultaneous defaults in
a futures and Cleared Swaps Customer
Account, and how the FCM and DCO
resources should be allocated between
the two accounts.205 The Commission
notes that defaults in multiple accounts
are already addressed in the
Commission’s regulations and, in
particular, Part 190, which treats
account classes separately. For example,
in the event of a default in a futures
customer account, the default would be
treated in accordance with the Futures
Model, and the FCM would be
permitted to apply all customer
collateral to meet that default and
would, after liquidation of positions,
return any remaining customer
collateral to the Trustee for distribution
as above. A default in the Cleared
Swaps Customer Account, on the other
hand, would be treated in accordance
with the Complete Legal Segregation
Model, with remaining positions and
collateral either transferred to another
FCM or returned to the Trustee. Thus,
swaps customer accounts and futures
customer accounts are treated separately
by the DCO, with balances that are not
transferred being returned to the Trustee
for distribution.206 The Trustee would
distribute customer property, including
collateral received from a DCO, pari
passu within each account class. Any
surplus in any account class would be
re-distributed in accordance with
regulation 190.08. In addition, the
Commission notes that a separate
proprietary account for swaps is not
required under Commission regulations.
Thus, a clearing member’s own swaps
and futures (and related collateral) may
be held together in a proprietary
account and a default in such account
should proceed in accordance with
existing Commission regulations. For
example, if there is a default only in the
proprietary account, property in either
customer account will not be liable for
that default, and such customer
property will either be transferred along
with customer positions to another FCM
or, after the liquidation of customer
positions, would be returned to the
Trustee for distribution as part of the
appropriate account classes pursuant to
regulation 190.08.
With respect to the application of
DCO resources, the Commission notes
205 See
Vanguard at 7.
to regulation 190.06(b)(3)(iii), for a
particular customer, a negative equity balance in
one account class must be offset against a positive
equity balance in any other account class.
206 Pursuant
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that if there is a shortfall in more than
one account class, after the application
of collateral as permitted in the
proposed and existing rules, the DCO
would apply its default resources to the
remaining shortfalls in each account in
accordance with its then-existing rules.
O. Regulation 22.15: Treatment of
Cleared Swaps Customer Collateral on
an Individual Basis
As proposed, regulation 22.15 set
forth the basic principle of individual
collateral protection. It required each
DCO and each Collecting FCM to treat
the amount of collateral required with
respect to the portfolio of rights and
obligations arising out of the Cleared
Swaps intermediated for each Cleared
Swaps Customer as belonging to that
customer, which amount could not be
used to margin, guarantee or secure the
Cleared Swaps, or any other obligations,
of an FCM, or of any other customer.
FIA urged the Commission to confirm
that, in the event of an FCM default,
clearing FCMs and DCOs have
flexibility to liquidate all positions in an
omnibus account (with the restriction
that proceeds of positions of nondefaulting customers may not be used to
offset sums owed by defaulting
customers to the FCM or by the clearing
FCM to the DCO).207 SIFMA stated that
proposed regulation 22.15 required that
‘‘any temporary misallocation of nondefaulting customer property due to
[intra-day price movements on the day
of a default] * * * be rectified as
promptly as possible so that the
property of non-defaulting customers is
fully restored.’’ 208 ICI argued that if at
the time of an FCM default there is a
misallocation of Cleared Swaps
Customer Collateral, the Commission
should require such misallocation to be
corrected as soon as practicable.209
Similarly, Vanguard requested that the
Commission clarify that any initial
misallocation related to delayed
recordkeeping be rectified as promptly
as possible such that the property of the
non-defaulting parties is fully
restored.210 CME cautioned that errors
in the § 22.11 information from an FCM
could heighten the risk of misallocating
Cleared Swaps Customer Collateral in a
default scenario, because a DCO will not
have the time or legal ability to resolve
discrepancies in a portfolio.211 CME
asked the Commission to clarify the
allocation of this risk among Cleared
FIA at 12–13.
at 10.
209 See ICI at 5.
210 See Vanguard at 7.
211 See CME at 14.
Swaps Customers.212 In addition, CME
questioned how to allocate excess
collateral that is posted to a DCO for
purposes of daily reporting and in
response to customer default, 213 and
sought confirmation that the
Commission intended to preserve the
finality of the clearing cycle.214
The Commission has amended
regulation 22.15 to make clear that
clearing FCMs and DCOs have the
flexibility to liquidate all positions in an
omnibus account in the event of the
default of a depositing FCM or clearing
member respectively. In addition, the
Commission notes that there will not be
any unallocated excess collateral
because such collateral is either
collateral in which the FCM has a
residual interest and does not belong to
a customer, or collateral that must be
attributed to individual Cleared Swaps
Customers. Furthermore, any temporary
misallocation of non-defaulting Cleared
Swaps Customer property or excess
collateral would be resolved by the
Trustee, in computing the claims by
such customers against the estate (or,
where appropriate, by the estate against
such customers). In addition, these
discrepancies would not be the
responsibility of the DCO, even if the
DCO transferred an amount on behalf of
a Cleared Swaps Customer that was later
found to be too much, nor would such
a transfer be subject to avoidance.215
Finally, it is not the Commission’s
intent to disrupt or unwind a complete
and final settlement cycle, and northing
in these regulations should be construed
to do so.
P. Regulation 22.16—Disclosures to
Customers
As proposed, regulation 22.16
requires each FCM to disclose, to each
of its Cleared Swaps Customers, the
governing provisions of each DCO (or
the provisions of the customer
agreement with respect to a Collecting
FCM) relating to use of Cleared Swaps
Customer Collateral and related matters.
The FIA advocated that these FCM
disclosures be the subject of a uniform
disclosure document prepared by the
industry, subject to Commission
approval.216 Given the diversity of
industry practice in the swaps market,
the Commission is reluctant to mandate
the use of a uniform disclosure
document. Nonetheless, the
Commission sees no reason to object to
an FCM’s use of a document prepared
207 See
212 See
208 SIFMA
213 See
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id. at 7–8.
214 See id. at 9.
215 Cf. 11 U.S.C. 764(b).
216 See FIA at 12.
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by a committee, so long as the document
accurately provides the required
information for each DCO on which the
customer’s positions are cleared.
V. Section by Section Analysis:
Amendments to Regulation Part 190
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A. Background
In April of 2010, prior to the
enactment of the Dodd-Frank Act, the
Commission promulgated rules to
establish an account class for cleared
OTC derivatives (and related
collateral).217 At that time, there were
questions concerning the Commission’s
authority to require the segregation of
cleared OTC derivatives (and related
collateral) or to establish a separate
account class for cleared OTC
derivatives in a DCO insolvency. As a
result, protection for cleared OTC
derivatives (and related) collateral was
limited to those cases where such
derivatives and collateral were required
to be segregated pursuant to the rules of
a DCO, and the reach of the account
class was limited to cases of the
bankruptcy of a commodity broker that
is an FCM. Moreover, while section
4d(a)(2) of the CEA permitted the
inclusion in the domestic futures
account class of transactions and related
collateral from outside that class, there
was no similar provision permitting the
inclusion in the cleared OTC account
class of transactions and related
collateral from outside that latter class.
Section 724 of the Dodd-Frank Act
has resolved these questions. As
mentioned above, section 4d(f) of the
CEA, as amended by the Dodd-Frank
Act, requires, among other things,
segregation of Cleared Swaps and
Cleared Swaps Customer Collateral.
Section 4d(f)(3)(B) of the CEA permits
the inclusion of positions in other
contracts (such as exchange-traded
futures) and related collateral with
Cleared Swaps and Cleared Swaps
Customer Collateral. Section 724(b) of
the Dodd-Frank Act amends the
Bankruptcy Code to include in the
definition of ‘‘commodity contracts’’
Cleared Swaps with respect to both
FCMs and DCOs. Thus, this section V
proposes amendments to regulation Part
190, pursuant to Commission authority
under section 20 of the CEA, in order to
give effect to section 724 of the DoddFrank Act, to implement Public Law
111–16, the Statutory Time-Periods
Technical Amendments Act of 2009,
and to provide technical clarifications.
Such amendments conform to proposed
Part 22.
217 See
Account Class, 75 FR 17297, Apr. 6, 2010.
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B. Definitions
1. Proposed Amendment to Regulation
190.01(a)—Account Class
The Commission proposed
amendments to regulation 190.01(a) to
change the definition of account class to
include a class for cleared swaps
accounts, delete commodity option
accounts from the definition, make clear
that options on futures and options on
commodities should not be grouped into
one account class, clarify that
Commission orders putting futures
contracts and related collateral in the
cleared swaps account class (pursuant
to new section 4d(f)(3)(B) of the CEA)
are treated, for bankruptcy purposes, in
a manner analogous to orders putting
Cleared Swaps and related collateral in
the futures account class (pursuant to
CEA section 4d(a)(2)), and clarify that if,
pursuant to a Commission rule,
regulation or order (or a DCO rule
approved pursuant to regulation
39.15(b)(2)), positions or transactions
that would otherwise belong to one
class are associated with positions and
related collateral in commodity
contracts in another account class, then
the former positions and related
collateral shall be treated as part of the
latter account class. The Commission
did not receive any comments on
proposed regulation 190.01(a) and is
adopting regulation 190.01(a) as
proposed.
2. Proposed New Regulation 190.01(e)—
Calendar Day
The Commission proposed defining
the term ‘‘calendar day’’ to include the
time from midnight to midnight. The
Commission did not receive any
comments on proposed regulation
190.01(e) and is adopting regulation
190.01(e) as proposed.
3. Proposed Amendment to Regulation
190.01(f)—Clearing Organization
The Commission proposed to amend
the definition of clearing organization to
remove, as unnecessary, the reference to
commodity options traded on or subject
to the rules of a contract market or board
of trade. The Commission did not
receive any comments on proposed
regulation 190.01(f) and is adopting
regulation 190.01(f) as proposed.
4. Proposed Amendment to Regulation
190.01(cc)—Non-Public Customer
The Commission proposed to amend
the definition of non-public customer to
include references to non-public
customers under regulation 30.1(c)
(with respect to foreign futures and
options customers) and in the definition
of Cleared Swaps Proprietary Aaccount.
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The Commission did not receive any
comments on proposed regulation
190.01(cc) and is adopting regulation
190.01(cc) as proposed.
5. Proposed Amendment to Regulation
190.01(hh)—Principal Contract
The Commission proposed to amend
the definition of principal contract to
include an exclusion for cleared swaps
contracts. The Commission did not
receive any comments on proposed
regulation 190.01(hh) and is adopting
regulation 190.01(hh) as proposed.
6. Proposed Amendment to Regulation
190.01(ll)—Specifically Identifiable
Property
The Commission proposed to amend
the definition of specifically identifiable
property to update references and
change terms to conform to other
proposed changes to Part 190 and other
business practices. The Commission did
not receive any comments on proposed
regulation 190.01(ll) and is adopting
regulation 190.01(ll) as proposed.
7. Proposed Amendment to Regulation
190.01 (pp)—Cleared Swap
Proposed regulation 190.01(pp)
replaced the definition of ‘‘Cleared OTC
Derivative’’ that the Commission
previously adopted with a definition of
cleared swap that includes the
definition of that term in regulation
22.1. The Commission did not receive
any comments on proposed regulation
190.01(pp) and is adopting regulation
190.01(pp) as proposed.
C. Proposed Amendments to Regulation
190.02—Operation of the Debtor’s
Estate Subsequent to the Filing Date and
Prior to the Primary Liquidation Date
The Commission proposed certain
clarifications as well as technical
amendments to § 190.02 to (1) expand
the regulation to apply to Cleared Swaps
(and related collateral) and (2) change
references to ‘‘business days’’ to
‘‘calendar days,’’ and require transfer
instructions by the sixth calendar day
after the order for relief and instruct
transfers to be completed by the seventh
calendar day after the order for relief, in
order to fall within the protection of
section 764(b) of the U.S. Bankruptcy
Code. The Commission did not receive
any comments on proposed regulation
190.02. However, in light of a recent
demonstration of the efficiency of
transfer arrangements, it appears that a
full calendar day may not be necessary
to execute such instructions.
Accordingly, the Commission is
changing the amendment to require
transfer instructions to be provided by
the seventh calendar day after the order
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for relief, at an hour to be specified by
the trustee.
D. Proposed Amendments to Regulation
190.03—Operation of the Debtor’s
Estate Subsequent to the Primary
Liquidation Date
The Commission proposed certain
technical amendments to regulation
190.03 to clarify that maintenance
margin refers to the maintenance margin
requirements of the applicable
designated contract market or swap
execution facility. The Commission did
not receive any comments on proposed
regulation 190.03 and is adopting
regulation 190.03 as proposed.
E. Proposed Amendments to Regulation
190.04—Operation of the Debtor’s
Estate—General
Proposed amendments to regulation
190.04 would extend the liquidation of
open commodity contracts to
commodity contracts traded on swap
execution facilities.218 These
commodity contracts would be
liquidated in accordance with the rules
of the relevant SEF or DCM. Open
commodity contracts that are liquidated
by book entry may also be offset using
the settlement price as calculated by the
relevant clearing organization pursuant
to its rules, which rules are required to
be submitted to the Commission for
approval pursuant to section 5c(c) of the
CEA, or approved by the Commission
(or its delegate) pursuant to regulation
190.10(d). The Commission did not
receive any comments on proposed
regulation 190.04 and is adopting
regulation 190.04 as proposed.
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F. Proposed Amendments to Regulation
190.05—Making and Taking Delivery on
Commodity Contracts
The Commission proposed technical
amendments to regulation 190.05 to
change a reference to ‘‘contract market’’
to ‘‘designated contract market, swap
execution facility, or clearing
organization,’’ and require the
submission of rules for approval subject
to section 5c(c) of the CEA. The
Commission did not receive any
comments on proposed regulation
190.05 and is adopting regulation
190.05 as proposed.
G. Proposed Amendments to Regulation
190.06—Transfers
The Commission proposed
amendments to regulation 190.06 to (i)
Clarify that nothing in subparagraph (a)
would constrain the contractual right of
218 Open commodity contracts traded on a
designated contract market would continue to be
liquidated in accordance with the rules of the
relevant designated contract market.
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the DCO to liquidate open commodity
contracts, (ii) permit the trustee to
transfer accounts with no open
commodity contracts, as the
Commission has permitted in a number
of recent FCM bankruptcies, (iii)
prohibit the trustee from avoiding prepetition transfers made by a clearing
organization as long as the money,
securities, or other property
accompanying such transfer would not
exceed the funded balance of accounts
held for or on behalf of customers based
on information available as of the close
of business on the calendar day
immediately preceding such transfer
minus the value on the date of return or
transfer of any property previously
returned or transferred thereto, and (iv)
change ‘‘business day’’ to ‘‘calendar
day.’’ The Commission did not receive
any comments on proposed regulation
190.06 and is adopting regulation
190.06 as proposed.
H. Proposed Amendments to Regulation
190.07—Calculation of Allowed Net
Equity
Proposed amendments to regulation
190.07 clarify that individual Cleared
Swaps Customer Accounts within an
omnibus account are to be treated
individually, correct a typographical
error, change the valuation of an open
commodity contract so that the value of
the commodity contract would be
derived from the settlement price as
calculated by the relevant clearing
organization pursuant to its rules, and
change references to securities traded
over-the-counter pursuant to the
National Association of Securities
Dealers Automated Quotation System to
securities not traded on an exchange.
The Commission did not receive any
comments on proposed regulation
190.07. However, the Commission is
adding ‘‘paragraph (c)’’ before ‘‘(1)(ii)’’
in regulation 190.7(c)(1)(i)(A) to clarify
the cross reference.
I. Proposed Amendments to Regulation
190.09—Member Property
The Commission proposed
amendments to regulation 190.09 to
include references to an account
excluded pursuant to the proviso in
regulation 30.1(c) (referring to
proprietary accounts in the context of
foreign futures and options) and to the
Cleared Swaps Proprietary Account.
The Commission did not receive any
comments on proposed regulation
190.09 and is adopting regulation
190.09 as proposed.
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J. Proposed Amendments to Regulation
190.10—General
Proposed amendments to regulation
190.10 have been made to require notice
by email and overnight mail. The
Commission did not receive any
comments on proposed regulation
190.10. However, the Commission is
changing the reference to the ‘‘Division
of Clearing and Intermediary Oversight’’
to the ‘‘Division of Clearing and Risk’’
in regulation 190.10(a) to reflect changes
based on a structural reorganization
within the Commission.
K. Proposed Amendments to Appendix
A to Part 190—Bankruptcy Forms,
Bankruptcy
The Commission proposed changes to
appendix A, form 1 to include
references to ‘‘transfers’’ generally, and
to make certain technical amendments
to (i) Reflect the addition of section 4d(f)
of the CEA by section 724 of the DoddFrank Act, (ii) clarify that Commission
approval with respect to the rules of a
registered entity that require
Commission approval means
Commission approval under section
5c(c) of the CEA, and (iii) conform
certain time periods to the proposed
changes made by the Commission to
implement Public Law 111–16, the
Statutory Time-Periods Technical
Amendments Act of 2009. The
Commission did not receive any
comments on the proposed amendments
to appendix A and is adopting appendix
A as proposed.
L. Proposed Amendments to Appendix
B to Part 190—Special Bankruptcy
Distributions
The Commission proposed
amendments to Framework 1 of
Appendix B to clarify that the cross
margining program is intended to apply
only to futures customers and customer
funds for futures contracts, and to
Framework 2 of Appendix B to address
shortfalls in Cleared Swaps Customer
Collateral. The Commission did not
receive any comments on the proposed
amendments to appendix B. However,
the Commission is making certain
technical corrections to bring the
language of the appendix in line with
current statutory language.
VI. Effective Date
The Commission asked for comment,
in the NPRM and at the Second
Roundtable, on the appropriate timing
of effectiveness for the final rules, and
whether six months after the
promulgation of final rules would be
sufficient.
At the Second Roundtable, several
panelists stated that it would take
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approximately 18 months to 2 years
after finalization of the segregation rules
to complete all of the documentation
and other infrastructure work that
would be necessary to implement the
segregation regime selected by the
Commission.219 These commenters
indicated that this lead time would be
the same for the Legal Segregation
Models and the Full Physical
Segregation Model, but may be longer if
the Commission were to select the
Futures Model.220 In other words, this
18 month to 2 year time period is ‘‘a
cost of moving to the cleared world
regardless of how it’s done.’’ Another
panelist, however, did state that six
months did not seem to provide
sufficient time to complete all of the
work that would need to be
completed,221 though this commenter
acknowledged that ‘‘the real
constraining factor * * * is getting that
final documentation with the
clients.’’ 222
Comments to the NPRM generally
reinforced the need for additional time.
ISDA recommended that there be a
minimum of 18 months between final
promulgation of the rules and
effectiveness.223 In addition, FIA stated
that, according to certain representatives
from investment management firms, it
would take one to two years to
implement whatever model is chosen by
the Commission.224 ICE requested that,
if a model other than the Futures Model
is adopted, the Commission provide
sufficient time to FCMs and DCOs to
allow them ‘‘to analyze, develop and
implement the necessary systems and
processes relating to’’ the selected
segregation model.225 In addition, ICI
stated that market participants need
time to develop ‘‘the operational and
systems infrastructure necessary to
facilitate a smooth transition to
clearing.’’ 226
As acknowledged by some
commenters, the 18 month to 2 year
time period is the time period needed to
transition to clearing. It is not the time
period necessary to implement the
219 Second
Roundtable Tr. at 58, 1.14 to 61, 1.17.
220 Id.
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221 Second
Roundtable Tr. at 62, 1.11 to 62, 1.19
(Mr. Diplas stating that six months ‘‘seems to live
within the low side from the standpoint in terms
of the work, the IT work that needs to take place
between, like, FCMs and DCOs, the testing, et
cetera, and also even the agreements that we might
have to do in terms of consistency, of how these
reports should look, and how the client IDs should
be done, et cetera, so that we don’t have—each DCO
have a different methodology in that respect.’’).
222 Second Roundtable Tr. at 63, 1.2 to 63, 1.4.
223 See ISDA at 11.
224 See FIA at 6.
225 ICE at 11.
226 ICI at 2.
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Complete Legal Segregation Model.
Because the Commission did not receive
any specific comments regarding the
time period needed to implement the
Complete Legal Segregation model, the
Commission considered adopting the
effective date that was proposed in the
NPRM. However, given representations
from market participants regarding the
amount and tenor of the work that
would need to be completed to
implement clearing, the Commission is
extending the compliance date for the
Part 22 rules to November 8, 2012, the
compliance date set forth in the rules
implementing DCO Core Principles for
the gross margining requirement of
Regulation 39.13(g)(8)(i).
Given the importance of
implementing the time period changes
in Part 190 as soon as possible, and
because the implementation issues
raised by Part 22 do not apply to Part
190, which imposes obligations
primarily on bankruptcy trustees, the
compliance date for the Part 190 rules
is the effective date of these rules.
However, during the period between the
compliance date for Part 190 and the
compliance date for Part 22,
Commission rules will not require
segregation of Cleared Swaps or Cleared
Swaps Collateral. Accordingly,
consistent with the approach applicable
under current Part 190, where
protection for cleared OTC derivatives
(and related) collateral is limited to
those cases where such derivatives and
collateral are required to be segregated
pursuant to the rules of a DCO, during
that period, the definition of 190.01(pp)
(‘‘Cleared Swap’’) shall be limited to
transactions where the rules or bylaws
of a derivatives clearing organization
require that such transactions, along
with the money, securities, and other
property margining, guaranteeing or
securing such transactions, be held in a
separate account for Cleared Swaps
only.
VII. Consideration of Costs and Benefits
A. Introduction
Section 15(a) of the CEA 227 requires
the Commission to consider the costs
and benefits of its actions before issuing
a rulemaking under the CEA. Section
15(a) further specifies that the costs and
benefits shall be evaluated in light of
five broad areas of market and public
concern: (1) Protection of market
participants and the public; (2)
efficiency, competitiveness, and
financial integrity of futures markets; (3)
price discovery; (4) sound risk
management practices; and (5) other
227 7
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public interest considerations. To the
extent that these new rules reflect the
statutory requirements of the DoddFrank Act, they will not create costs and
benefits beyond those mandated by
Congress in passing the legislation.
However, the rules may generate costs
and benefits attributable to the
Commission’s determinations regarding
implementation of the Dodd-Frank Act’s
statutory requirements. The costs and
benefits of the Commission’s
determinations are considered in light
of the five factors set forth in CEA
section 15(a).
1. Business and Legal Context of the
Segregation Requirement for Cleared
Swaps Customer Collateral
The Commission’s Part 22 rules are
one component of the regulatory
infrastructure for clearing 228 swaps
transactions mandated by the DoddFrank Act. Though a significant fraction
of swaps transactions may be required
to be cleared through DCOs, many
swaps transactions may voluntarily be
cleared though DCOs. Swaps users and
some swap dealers transact with the
DCO through FCMs that the DCO admits
as ‘‘clearing members’’ and who are
subject to DCO rules. As described
above in detail, for every transaction
received by or matched through its
facilities, a DCO acts as the buyer to
every seller and the seller to every
buyer, essentially guaranteeing financial
performance.229
2. Overview of the Statute and
Regulation
Proposed Part 22 implements the
requirement of the newly enacted CEA
section 4d(f) that property provided by
Cleared Swaps Customers to FCMs to
serve as collateral for Cleared Swaps
transactions be treated as the property of
the customers, not the FCM or DCO; and
that such property be maintained in
accounts separate from the property of
the FCM or DCO, although such
accounts can hold the commingled
collateral of more than one Cleared
Swaps Customer ‘‘for convenience.’’ 230
These basic requirements that Cleared
228 As described above, clearing is the process by
which transactions in derivatives are processed,
guaranteed, and settled by a central clearing
organization, the DCO. See section I.B.
229 For a detailed discussion of clearing as it
pertains to swap transactions, see section I.B.
230 Though treating futures customer collateral on
a collective basis may, at one time, have been
practically necessary ‘‘for convenience,’’ such
practice is not standard in the current swaps market
nor is it as critical in an era where account
information is stored and processed on an
automated basis. For example, and as noted above,
DCOs are already assessing risks posed by clearing
members’ customers at the individual customer
level. See supra n.122.
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Swaps Customer Collateral be treated as
the property of customers and
maintained in segregated accounts are
imposed by the statute independently of
the Commission’s particular
implementing regulations and, by the
terms of the statute, would apply even
if the Commission promulgated no
implementing regulations. Generally,
the core statutory segregation
requirements serve two functions: (1)
They help ensure that FCMs, DCOs, and
other depositories of assets deposited by
swaps customers to serve as collateral
for their Cleared Swaps transactions
treat such customer collateral as the
property of the customers and not use
it for their own proprietary business
purposes; and (2) in conjunction with
Subchapter IV of Chapter 7 of the
Bankruptcy Code, they provide
protection of Cleared Swaps Customer
Collateral from the claims of other
creditors in the event of the bankruptcy
of an FCM.
Sections 22.2 through 22.10
implement the basic architecture of a
system of segregation for swaps
customer funds roughly comparable to
the system used for customer funds for
futures contracts under CEA sections
4d(a)(2) and 4d(b) and Commission
regulations 1.20 through 1.30 and
1.49.231 Some provisions of sections
22.2 through 22.10 essentially restate
the statutory requirements. Other
provisions of these sections set forth
requirements intended to (a) ensure that
the objectives of the statute are met and
(b) clarify FCMs’ and DCOs’ duties
under the statute and facilitate carrying
out those duties in an efficient
manner.232 The basic architecture
established by sections 22.2 through
22.10 is supplemented by section 22.16,
a disclosure requirement designed to
inform swaps customers of DCO and
FCM policies regarding the handling of
their collateral in case of default and by
amendments to part 190 of the
Commission’s rules intended to ensure
that cleared swaps customer accounts of
the sort required by Part 22 are treated
as a separate account class under
bankruptcy law in the event the relevant
FCM files for bankruptcy.233
Proposed sections 22.11 through
22.15 add to this basic segregation
architecture provisions designed to
implement the Complete Legal
Segregation Model for protecting swaps
customer funds against Fellow231 See
discussion in sections IV.B through IV.J.
id.
233 See discussion above in section IV.P and
section V.B.1.
232 See
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Customer Risk.234 Proposed sections
22.11, 22.12, and 22.14 are intended to
ensure that DCOs have available
information that will enable them to
attribute the value of assets in an FCM’s
customer account to individual
customers in the event of an FCM’s
default on obligations to the DCO
arising in connection with swaps
transactions cleared for customers.235
Section 22.14 also requires certain
transfers of customer collateral among
FCMs in response to margin calls.236
Section 22.5 prohibits the DCO from
using asset value in an FCM’s customer
account attributable to one customer to
margin, guarantee, or secure the Cleared
Swaps or other obligations of the
relevant FCM or of other customers.237
Section 22.13 clarifies that DCO’s have
the right, at their election, to require (on
the grounds of risk management) larger
amounts of collateral from selected
customers.238
3. Organization and Focus of the
Consideration of Costs and Benefits
Section VII.B presents the
Commission’s considerations regarding
the costs and benefits arising from the
Commission’s choice of the Complete
Legal Segregation Model as set forth in
sections 22.11 through 22.15.239 The
costs and benefits of the Commission’s
choice of model for addressing FellowCustomer Risk are, in the view of the
Commission, the most significant costbenefit issues in this final rulemaking,
as is reflected in the fact that
discussions of cost-benefit issues in
comments to the NPRM focused almost
exclusively on the choice of model. This
section of the discussion employs the
Futures Model—in essence, the rule
without sections 22.11 through 22.15—
as a baseline for comparison because
this model was favored by several
234 See discussion above in section IV.K through
section IV.O.
235 See discussion above in sections IV.K., IV.L.
and IV.N. Having such information at the DCO can
be quite valuable in a situation where the FCM is
bankrupt.
236 See discussion above in section IV.N.
237 See discussion above in section IV.E.
238 See discussion above in section IV.M.
239 As discussed above, in addition to the Futures
Model and the Complete Legal Segregation Model,
the Commission gave consideration to other
alternatives: the Legal Segregation with Recourse
Model and the Physical Segregation Model. No
commenters supported the Legal Segregation with
Recourse Model on grounds that it involved the
same costs as the Legal Segregation Model, but with
fewer benefits. Accordingly, its costs and benefits
are not considered further in this analysis. Several
commenters did support the Physical Segregation
Model; however, as noted above, the effectiveness
of the Physical Segregation Model is limited due to
the application of the ratable distribution
requirements of section 766(h) of the Bankruptcy
Code. As such, these limitations were disqualifying.
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commenters and because comparison
with this model provides a useful and
appropriate methodology for isolating,
to the extent possible, the relative costs
and benefits of the alternative models
presented by the commenters and
considered by the Commission.240
Notably, this comparative analysis
pivots, in the first instance, on who
bears the cost of the most significant
cost driver—Fellow-Customer Risk.
Where the risk is assigned to one
constituency (e.g., swap users in the
Futures Model baseline) a virtually
mirror image risk mitigation benefit is
conferred on others (e.g., DCOs and
clearing members in the Futures Model
baseline).
Under any model, however, once such
risks are initially assigned, the affected
entities and market participants, may
then attempt to re-allocate or shift such
assigned risks or costs to other entities
or market participants. The LSOC
Model, in the first instance places
fellow risk on DCOs and clearing
members with corresponding mitigation
of risk to swaps users. However, as
explained in detail below, market
participants can be expected to adapt to
the direct allocation of risk associated
with one or another of the models in a
variety of ways, and the ultimate costs
and benefits of the rule will reflect both
its direct allocation of risk and the effect
of adaptations to that allocation.
For example, as described below,
some, though not all, DCOs commented
that they would be likely to adapt to the
LSOC Model by increasing margin
levels. To the extent that this occurs, the
rule would have the effect of reducing
the risks of losses to the DCO and the
FCM because there would be a reduced
240 CIEBA, FHLB, SIFMA, and Fidelity argue that
the correct baseline for making cost and benefit
comparisons should be the current practice in the
uncleared swaps markets rather than the Futures
Model (See CIEBA Original at 12; FHLB at 9;
SIFMA at 7; and Fidelity at 7). In principle, using
this benchmark rather than the Futures Model
would change the absolute level of costs and
benefits of the alternatives under consideration but
would not change the relative ranking of those
alternatives so long as comparisons to the
benchmark were made in a consistent fashion.
There are, however, practical advantages to using
the Futures Model as a benchmark because current
practice with regard to protection of collateral in
the uncleared swaps market is unregulated and the
level of protection provided varies considerably
across transactions. Moreover, CEA, as amended by
the Dodd-Frank Act, does not permit the
Commission to retain the current practice regarding
uncleared swaps. Because the appropriate baseline
for the consideration of costs and benefits is the
Futures Model rather than the uncleared swaps
model, the costs and benefits of the basic
requirement that swaps customer collateral be kept
in segregated accounts and treated as the property
of customers rather than the property of FCMs or
DCOs are included within the baseline and not
evaluated separately.
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likelihood of any given customer
incurring losses that exceed the margin
posted by that customer. In return for
the benefit of reduced fellow customer
risk and legal allocation of the residual
risk to DCOs and their members, swaps
users would incur the opportunity cost
of having to use more capital as
collateral for their Cleared Swaps. Thus,
to the extent that DCOs adapt to the
LSOC Model in this fashion, the rule
would function in a manner analogous
to insurance, with swaps users incurring
somewhat higher costs in their routine
use of swaps in return for a lower risk
of wholesale loss of collateral as a result
of some other swaps user’s market
losses. As also described below, the
LSOC Model is expected to alter
behavioral incentives for market
participants relative to the Futures
Model in variety of other ways that will
create costs and benefits but that the
Commission believes will lead to a net
increase in monitoring of risky behavior
by FCMs and that, on balance, will
facilitate transfer of customer positions
and collateral in the event of the
simultaneous default of an FCM and one
or more customers.
B. Benefits and Costs of Complete Legal
Segregation Model Relative to Futures
Model
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1. Introduction
As noted above, the Complete Legal
Segregation Model is intended to
provide swaps customers with
protection against Fellow-Customer
Risk.241
The basic difference between the
Complete Legal Segregation Model and
the Futures Model thus relates to a
difference in the allocation of loss
arising out of a double default of both
a customer and the customer’s FCM.
Under the Futures Model, this risk is
borne by customers in the form of
‘‘Fellow-Customer Risk’’— the risk that
a customer will lose some or all of the
value of its collateral due to the default
of some other swaps customer or
customers of the clearing FCM. Under
the LSOC Model, this risk to customers
is substantially, though not completely,
eliminated. However, the corresponding
loss, in the event of a double default,
falls on the DCO and, through the
guaranty fund, its non-defaulting
members. In practice, under the LSOC
Model, DCOs can be expected to take
measures to protect themselves against
the risk of loss from a double default,
and some of the material benefits and
241 For a discussion of Fellow-Customer Risk, see
supra section I.B.6.
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costs are likely to flow from a DCO’s
adaptations to the rule.
The next section reviews,
respectively, the material benefits and
costs that the Commission believes will
arise from the Commission’s selection of
the LSOC Model.
2. Material Benefits and Costs Arising
From the Complete Legal Segregation
Model
a. Benefits to Customers of Protection
Against Fellow-Customer Risk
The primary benefit of the Complete
Legal Segregation Model to customers is
the protection of non-defaulting Cleared
Swaps Customers against loss of the
value of their collateral due to the use
of such value by the relevant DCO in the
event of a double default.242 The
associated cost to those customers is the
payment they will be required to make
for protection against this risk, where
this payment will likely originate from
some combination of the capital cost of
posting higher initial margins and/or
higher fees for swaps transactions (see
subsection b below).
Comments regarding this rulemaking
have indicated that, as a result of the
statutory clearing requirements in the
Dodd-Frank Act, once the cleared swaps
market has matured, Cleared Swaps
Customers would be posting upwards of
$500 billion in collateral to secure their
Cleared Swaps positions.243 The
Commission notes that the precise
amount will depend on how the market
evolves and can be expected to change
over time.244 Under the Futures Model,
the value of this collateral will be
exposed to greater Fellow-Customer
Risk than under the other models
considered. In addition, it does not
appear possible to reliably quantify the
probability of the actual loss of value of
collateral by a given customer due to
Fellow-Customer Risk for a number of
reasons. By their nature, double defaults
are rare events, though potentially
important if they involve major FCMs.
Because the mandatory clearing of
swaps under the Dodd-Frank Act has
242 According to comments on the ANPR, the
direct benefit to customers in the form of reduced
risk of loss of collateral stemming from the
activities of fellow customers may generate indirect
benefits. For example, commenters indicated that
increased security for collateral could increase their
ability to use swaps for business purposes, although
this effect could be counterbalanced by increased
dollar costs. Commenters also stated that the
increased protection against Fellow-Customer Risk
would reduce their need to incur costs to protect
against the effects of loss of Cleared Swaps
Customer Collateral.
243 CME Comment on ANPR at 7 (estimated $500
billion in collateral for swaps expected to be cleared
by CME); ISDA February 16, 2011 Comment on
ANPR at 2 (estimated $833 billion industry-wide).
244 Id.
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not yet gone into effect, there is, as yet
no body of experience with such
clearing in practice, and a fortiori no
experience with FCM defaults under the
Dodd-Frank clearing regime.245 There
has been experience with FCM default
in the futures industry, but the numbers
are too small to permit reliable
extrapolation.246 In addition, a number
of commenters suggested that FellowCustomer Risk may be greater in the
cleared swaps market than in the futures
market because swaps are less liquid
than exchange-traded futures (thereby
resulting in greater volatility of prices,
particularly in times of financial stress)
and because the aggregate value of
transactions in the swaps market is
many times greater than the aggregate
value of transactions in the futures
market.247 The Commission notes these
commenters requested increased
protection for their funds to guard
against Fellow-Customer Risk.
Notwithstanding its inability to
reasonably quantify the value of benefits
associated with Fellow-Customer Risk
elimination, the Commission, in light of
comments received in response to both
the ANPR and NPRM, believes that the
Complete Legal Segregation Model
confers benefits to swaps users. In fact,
buy-side commenters represented that
they desired the protection afforded
through the Complete Legal Segregation
Model, notwithstanding the costs
associated with that protection.248 The
245 Several clearing houses do, however, have
experience clearing swaps on a voluntary basis. For
example, LCH has been clearing interest rate swaps
for over a decade, and ICE actively clears credit
default swaps. In addition, while there are
examples of FCM defaults related to clearing futures
(e.g., Griffin Trading Co., Klein Futures, Inc. and
Lehman Brothers, Inc.), there have been no FCM
failures related to the clearing of swaps
transactions.
246 In the past two decades, there have been only
two cases of double defaults in the futures markets:
Griffin Trading Co. and Klein Futures, Inc. See
Trustee v. Griffin, 440 B.R. 148 (2010); CFTC
Division of Trading and Markets, Report on Lessons
Learned from the Failure of Klein & Co. Futures,
Inc., July 2001, available at https://www.cftc.gov/
files/tm/tmklein_report071101.pdf. With respect to
FCM defaults generally in the futures markets, one
commenter observed, ‘‘The United States,
fortunately has seen only a handful of FCM failures
in recent decades. As a result, the FCM liquidation
process, including the availability of porting, has
not been tested under a wide variety of
circumstances.’’ ISDA at 3.
247 See, e.g., Second Roundtable Tr. at 165, 283–
84 (characteristics of swaps may make it more
difficult to liquidate or transfer customer positions
in case of an FCM insolvency than for futures).
248 E.g. MFA at 7–8; BlackRock at 7; Fidelity at
6; LCH at 2. The numerical estimates of higher
margin and guaranty fund levels for Complete Legal
Segregation relative to the Futures Model described
in the text below were also described in the NPRM
so swaps users who commented in response to the
NPRM presumably were aware of them. However,
some commenters who supported Complete Legal
Segregation indicated that they did not give full
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ability of a swaps customer to determine
Fellow-Customer Risk at a particular
FCM is limited, because confidentiality
restraints inherently limit the amount of
information that an FCM can provide
customers with respect to the
creditworthiness, swaps positions, and,
in some cases, even identity of its other
customers.249 This, in turn, impairs (if
not completely precludes) the
customer’s ability to evaluate FellowCustomer Risk, hindering their ability to
manage it, insure against it, or
appropriately account for it in business
decision-making.250
Both the benefit to customers of
greater protection for their collateral
provided under the Complete Legal
Segregation Model as well as the
associated costs depends, to an extent,
on customer behavior in advance of a
double default. Prior to an FCM
insolvency, customers have the right to
find another FCM to carry their
accounts, and to have their existing
FCM transfer their positions and
collateral to that clearing FCM.251 Under
the extreme assumption that all
customers costlessly anticipate the
default and move their positions to
another FCM before the default occurs,
the Complete Legal Segregation Model
offers no apparent greater benefit to
customers over the Futures Model.
However, on this assumption the
Complete Legal Segregation model also
imposes no additional losses to the DCO
compared with the Futures Model since,
in this instance, under neither model is
the collateral of non-defaulting
customers available to the DCO to cure
the default. As a result, the extent to
which customers can anticipate a
fellow-customer default will tend to
decrease both the benefits and the costs
of the Complete Legal Segregation
Model.
b. ‘‘Risk Costs’’ and Potential Effects on
Margin Levels and DCO Guaranty Fund
Levels in Response To Complete Legal
Segregation.
Risk Costs refer to the costs associated
with the allocation of loss in the event
of a default under the Complete Legal
Segregation Model relative to the
Futures Model. This can usefully be
divided into direct and indirect costs
(and associated benefits). The direct cost
of the Complete Legal Segregation
Model is the increased risk the DCO will
face when a Cleared Swaps Customer
credence to the higher of the cost estimates. E.g.,
MFA at 7–8.
249 Id. See also Second Roundtable Tr. at 183–
185.
250 E.g., Tudor at 2; Fidelity at 3; MFA at 3–8. See
also supra at 50–51.
251 See 76 FR at 69442.
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and its FCM default, which equals the
probability of a default by a Cleared
Swaps Customer and its FCM,
multiplied by the expected contribution
that fellow customers would have
provided toward the uncovered loss. (As
discussed in the previous section, there
is a corresponding gain to Cleared
Swaps Customers which is the value
they place on avoiding this same cost,
i.e., the value of having the equivalent
of insurance against Fellow-Customer
Risk.) 252 Thus, the Complete Legal
Segregation Model will potentially
result in a decrease in the financial
resources package available to the DCO
in the event of default. Maintaining the
same assurance of performance of the
DCO’s function as central counterparty
in the circumstances of a double default
may require the DCO to, therefore, raise
additional financial resources.253 The
comments submitted to the Commission
by DCOs and others have suggested two
possible ways by which DCO’s default
resource structure under the Complete
Legal Segregation Model might differ
from the Futures Model: Either through
higher initial customer margins or by
increasing the size of the DCO’s
guaranty fund.254 Of course, actual
252 In addition, as discussed in section
VII.B.3.b.iv., there are efficiency gains in
centralizing FCM monitoring in a small number of
parties. Moreover, because of confidentiality
considerations, among other things, DCOs have
greater access to information from their Clearing
Members than Cleared Swaps Customers do. As a
result of this greater access to information and
because of the increased incentive on DCOs to
actively monitor the risks posed by their Clearing
Member FCMs and Cleared Swaps Customers, the
overall effectiveness of risk management may be
increased.
253 Section 725(c)(2)(B)(ii) of the Dodd-Frank Act
requires that a DCO possess financial resources that,
at a minimum, would allow the DCO to meet its
financial obligations notwithstanding a default by
the member or participant creating the largest
financial exposure for that organization in extreme
but plausible market conditions. See also 76 FR at
69344–45. In determining what financial resources
are needed to comply with section 725(c)(2)(B)(ii)
and its implementing regulations, a DCO will need
to evaluate and take into consideration the effect of
Complete Legal Segregation. However, within
limits, the statute and regulations permit the
exercise of judgment by the DCO as to the methods
it will use to do this. As is indicated in the
discussion in the text below, in comments to the
proposed rulemaking, different DCOs have
suggested that they may differ in their evaluation
of the practical effects of Complete Legal
Segregation, in the value they ascribe to fellowcustomer collateral as a resource, and in the steps
they will take to maintain adequate financial
resources in light of their evaluation.
254 A guaranty fund is a fund created by a DCO
to which the clearing members contribute, in
proportion generally set by DCO rule. See supra
section I.B.4 and n. 27. The assets in the fund are
then available to cover losses resulting from
defaults by one or more clearing members, whether
in their proprietary capacity or due to customer
accounts, to the extent those losses are not covered
by available collateral provided by the defaulting
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DCOs could use a mixture of
adjustments to margins and guaranty
funds. Commenters who estimated
higher costs resulting from Complete
Legal Segregation therefore estimated
potential effects on margins and
guaranty funds in isolation, while
generally recognizing that this is a
simplification of what actual practice is
likely to be.255
Assuming no change in guaranty fund
levels, ISDA suggested that the
Complete Legal Segregation Model
would require an increase of roughly
60% in initial margins relative to the
Futures Model.256 A number of other
participants in the Commission’s
roundtables thought that the method
used to arrive at the estimate was a
reasonable way to roughly model the
effect of Complete Legal Segregation on
margin levels.257
CME estimated that Complete Legal
Segregation would require an increase
in margin in the range of 60% to
90%.258 CME did not specify the
quantitative assumptions underlying its
estimate.259 To illustrate effects on
margin in dollar terms, CME made the
assumption that, in a mature swaps
market, it might expect to clear interest
rate swaps with a notional value of $200
trillion. On this assumption, CME
projected required margin from
Clearing Member (limited to proprietary collateral
for a default in the clearing member’s proprietary
account, or including customer collateral for a
customer default). In addition, a DCO may retain by
rule the right to call upon the members to
contribute additional assets, up to a defined
amount, if the pre-funded default resources are
insufficient (referred to as an ‘‘assessment power’’).
255 ICE contends that DCOs will choose to adjust
to Complete Legal Segregation entirely by
increasing margins rather than guaranty funds
because Complete Legal Segregation increases the
risk that assets in guaranty funds will actually be
used to cover losses in the event of a double default.
According to ICE, excessive reliance on margin is
undesirable because guaranty funds offer the DCO
more flexibility in responding to defaults and may
be more liquid than assets used as margin. See ICE
at 6–7. However, while ICE may be correct that
clearing member FCMs, all other things being equal,
would prefer less risk of loss of assets contributed
to guaranty funds, there may be counterbalancing
factors. For example, clearing customers may prefer
a DCO with a larger guaranty fund and lower
margin levels. Similarly, if a structure of default
resources with an excessive ratio of margin to
guaranty fund is, in fact, less effective or efficient
for dealing with FCM defaults, a DCO that employs
such a structure might be at a competitive
disadvantage.
256 ISDA January 18, 2011 Comment on ANPR at
9. The assumption that DCOs would use a 99.9%
confidence level under Complete Legal Segregation
was based on ‘‘suggestions’’ made at the
Commission’s First Roundtable. See First
Roundtable Tr. at 110–111.
257 See, e.g., First Roundtable Tr. at 110–114;
Second Roundtable Tr. at 255–57.
258 CME Comment on ANPR at 7–8.
259 See CME Comment on ANPR at 8 (describing
methodology used in general terms).
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customers clearing through CME of $500
billion under the Futures Model and
$800–900 billion under Complete Legal
Segregation.260 ISDA estimated that,
industry-wide, Complete Legal
Segregation would require $581 billion
more margin than the Futures Model (a
69.75% increase over a baseline, for the
Futures Modal, of $833 billion). ISDA
made clear that this estimate was based
on a number of assumptions about
future market activity and on data
obtained from only four FCMs.
Therefore, this figure is best construed
as an estimate of the general magnitude
of the effects expected by ISDA and not
as a precise predicted dollar figure.261
Nonetheless and notwithstanding this
estimate of higher initial margin, ISDA
concluded that Complete Legal
Segregation was ‘‘the most appropriate
choice of holding model for cleared
swaps collateral’’ of the models
proposed in the NPRM and supported
this approach because it facilitated
porting of customer positions in the
event of an FCM default.262
Although the above estimates were
based on data for interest rate swaps,
commenters and participants in
roundtable discussions indicated that
somewhat higher margin levels might be
needed to maintain adequate default
resources in connection with credit
default swaps because of the high
volatility and idiosyncratic risks
associated with this type of swap.263
Using data concerning credit default
swaps it currently clears, albeit not
under the Dodd-Frank legal regime, ICE
estimated that the required initial
margin increases would range from 40%
to 371%.
These estimates assume that the entire
default resource shortfall resulting from
the DCO’s lost reliance on collateral
posted as margin by non-defaulting
customers is reflected in higher initial
margins. To illustrate the other extreme,
CME estimated the cost of responding to
Complete Legal Segregation purely by
means of an increase in its guaranty
fund. According to CME, it would be
necessary to double the size of the
guaranty fund using this approach,
although their comment indicates that
this should be taken as a rough estimate
likely to be adjusted based on
experience in the future.264 Under its
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260 CME
261 ISDA
Comment on ANPR at 7–8.
January 18, 2011 Comment on ANPR at
10.
262 ISDA at 1. For a more detailed discussion of
the benefits of Complete Legal Segregation for
porting, see section VII.B.3.b.ii.
263 Second Roundtable Tr. at 255.
264 CME Comment on ANPR at 7–8. The comment
states that under Complete Legal Segregation CME,
in determining the size of the guaranty fund ‘‘would
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assumption that in the future it might
clear a notional value of $200 trillion in
interest rate swaps, CME estimates that
it would require a guaranty fund of $50
billion under the Futures Model and
$100 billion under Complete Legal
Segregation. CME also stated that it
might prove possible to adapt to
Complete Legal Segregation using ‘‘what
is traditionally called ‘concentration’
margin whereby the DCO sets a level of
risk at which it would begin to charge
higher margins based on indicative
stress-test levels.’’ According to CME, if
it proved possible to implement such a
system, likely ‘‘concentration charges’’
would fall in the range of $50-$250
billion.265 However, CME stated that it
currently lacked sufficient information
to precisely assess an appropriate
methodology using this approach and
that this approach could have
disadvantages which would need to be
addressed before it was considered as a
practical approach.266 ISDA estimated
that industry-wide guaranty funds
under the Futures Model would come to
$128 billion.267 ISDA apparently did not
independently estimate the effect of
Complete Legal Segregation on guaranty
funds, but, relying upon DCO estimates
that they would approximately double,
estimated an increment of an additional
$128 billion for Complete Legal
Segregation industry-wide.268 If
guaranty funds are larger as a result of
Complete Legal Segregation, it is likely
that some or all of the cost would be
passed on by FCMs to their customers
in the form of higher fees. However, in
the absence of more information about
future competitive conditions in the
cleared swaps market and similar
matters, it is not possible to reliably
estimate the extent to which this would
occur.
By contrast to CME, ICE, and ISDA,
LCH stated that it is not appropriate to
attribute higher margins and/or guaranty
funds to the Complete Legal Segregation
likely change [from an approach treating customer
margin accounts as diversified unitary pools] to an
approach geared toward assessing the largest loss
associated with a certain number of the largest
individual customer accounts. Currently, we
presume that five such customer accounts would be
our target, although experience and prudence
would be our guide. In any event, our stress-test
loss profile of the largest customer accounts would
almost certainly generate larger ‘worst loss’ results
[under Complete Legal Segregation] than under [the
Futures Model].’’ Id.
265 Id. at 8–9.
266 Id.
267 ISDA January 18, 2011 Comment on ANPR at
10. ISDA stated that this estimate referred to the
funded component of guaranty funds and did not
include DCO’s right to call for more assets from
member FCMs when needed.
268 ISDA January 18, 2011 Comment on ANPR at
9–10 and n.8 (referring to CME estimate).
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Model than to the Futures Model and
that the appropriate level of default
resources for DCOs, is the same under
both models.269 LCH has a more than a
decade’s worth of experience clearing
OTC swaps. LCH states that a
methodology in which no
diversification of customer collateral is
assumed represents their current
practice, and is appropriately
‘‘conservative’’ in terms of capital
adequacy.270 LCH maintains that, even
if it is legally permissible for a DCO to
take advantage of fellow customer
collateral, it is imprudent to assume that
any funds in the omnibus Cleared
Swaps Customer Account will remain at
the time of default.271 In the event that
default occurs not as a sudden shock,
but rather, as the end of a process of
credit deterioration taking place over a
number of days (potentially a number of
weeks), the Cleared Swaps Customers
may have time (and, if subject to
Fellow-Customer Risk, strong incentive)
to port (i.e., transfer) their Cleared
Swaps Contracts and associated
collateral away from the defaulting
FCM.272 CME also has noted that an
FCM default is likely to be preceded by
a period of financial turmoil: ‘‘In a
situation where an FCM has defaulted
on its obligations to one or more DCOs,
it is entirely possible that the FCM or its
parent company has been under severe
financial stress for some period of
time.’’ 273
Thus, according to the logic of LCH’s
approach, the size of the guaranty fund
and/or initial margin levels would need
to be as high under the Futures Model
as under the Complete Legal Segregation
Model.274
The divergence in the approaches of
LCH and the other two clearinghouse
commenters is due in part to different
implicit assumptions about fellow
customer behavior, and how such
behavior should affect a DCO’s design of
default resources. Under Complete Legal
Segregation, such an approach likely
requires an assessment of the largest
stressed loss on a small (or
concentrated) number of the largest
customers of the given FCM since, in
this instance, the DCO would not have
access to the collateral of non-defaulting
customers. Under the Futures Model, by
contrast, consideration of the largest
269 Evaluating the Costs of Complete Legal
Segregation, Aug. 2011, at 6–11 (‘‘LCH White
Paper’’).
270 76 FR at 33847, n. 177.
271 LCH White Paper at 8.
272 LCH at 3.
273 CME at 14. See also id. (describing a situation
where ‘‘an increasing number of customers were
removing their assets and accounts.’’).
274 LCH White Paper at 8.
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stressed loss might occur over an
expanded (and, to a degree, more
diversified) pool of customers because
the DCO is permitted to use the
mutualized pool of customer collateral.
Hence, the Complete Legal Segregation
Model effectively prohibits the DCO
from using the mutualized pool of
customer deposits as a resource in the
event of double default. It follows that
the extent to which the Complete Legal
Segregation Model actually affects the
DCO’s resources relative to the Futures
Model depends upon the degree to
which non-defaulting Cleared Swaps
Customers collateral will be present
following a default. If all Cleared Swaps
Customer Contracts remained with the
defaulting FCM through the default,
then the DCO could potentially measure
the adequacy of guaranty funds based
on a fully diversified pool of customer
positions. Conversely, if all customers
would transfer their positions to a
different FCM in anticipation of the
default, then the diversification (and its
consequence for the DCO’s financial
resources package) would be eliminated.
More generally, the extent to which
the Complete Legal Segregation Model
leads to a higher guaranty fund or
higher levels of margin per customer
than the Futures Model depends on the
extent to which Cleared Swaps
Customer Contracts can be expected to
remain with the defaulting FCM during
the period immediately preceding a
default. Since the circumstances of
particular FCM defaults will vary,
DCOs, in determining their financial
resources package, should be expected
to take into consideration the possibility
that, at least for some FCM defaults,
there will be warning signs, resulting in
a portion of Cleared Swaps Customer
Collateral being transferred out of the
Cleared Swaps Customer Account
maintained by the defaulting FCM.
While determining the appropriate
assumptions regarding customer
behavior under the Futures Model is
central to the issue of the adequacy of
a DCO’s default resources, it may prove
less central to the consideration of
relative costs and benefits under this
rule, since both of those costs and
benefits depend on the extent to which
Cleared Swaps Customers will transfer
their Cleared Swaps Contracts. In
general, the greater the extent to which
customers will move their positions, the
lower the benefits of the Complete Legal
Segregation Model over the Futures
Model. However, this benefit afforded
the customer needs to be balanced
against the cost to the DCO of insuring
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against the uncertainty.275 Both the
capital costs and associated benefits of
the LSOC Model relative to the Futures
Model will tend to be lower to the
extent customers are likely to move
their positions in advance of an FCM
default and higher to the extent
customers are unlikely to be able to do
so. Differing assumptions about
customer mobility in advance of default
are, therefore, likely to have smaller
implications for the relative costs and
benefits between approaches than they
do for the Risk Costs considered in
isolation.
A distinct question in evaluating Risk
Cost is how to translate a margin or
guaranty fund increase into a cost
increase. A customer that is required to
post an additional $100 of margin is not
adversely affected in the amount of
$100. Moreover, the cost to the customer
is, at least in part, offset by the benefit
to the DCO. The cost to a customer of
a margin increase of $100 is the
difference between the gain he or she
would have received by retaining that
$100, and the return he or she will
receive on the asset while it is on
deposit with the FCM or DCO. For
example, the customer might invest the
$100 in buying and holding grain over
the pendency of the swap if the initial
margin were not increased, while he or
she is limited to the return on assets the
DCO will accept as margin payment
(e.g., the T-bill rate) under the new,
higher margins. The exact difference in
rate of returns is dependent on the
individual customer’s investment
options as well as his/her risk tolerance,
and hence is difficult to calculate
precisely. Offsetting this cost are the
statutory goal of protecting customer
funds and the gain to the DCO of having
additional assets available in the event
of a combined Cleared Swaps Customer
and FCM default, which may enable it
to obtain a higher rate of return on some
of its other assets.276 Similarly, the cost
to an FCM of a guaranty fund
contribution increase is equal to the
difference in return between acceptable
instruments for deposit to the guaranty
fund and the FCM’s potential return on
those additional funds if they were not
deposited to the guaranty fund.277
275 In addition, and as discussed above, section
724(a) of the Dodd-Frank Act added a new
paragraph (f) to section 4(d) of the CEA, which
requires that neither an FCM nor a DCO may not
use the collateral of one customer to cover the
obligations of another customer or the obligations
of the FCM or the DCO.
276 An additional offset to this cost is the value
that customers assign to the increased safety of their
collateral from Fellow-Customer Risk, as discussed
in section VII.B.2.
277 There will also be an implicit cost to the FCM
reflecting the risk that the contributed assets will
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6367
c. Effects on Likelihood That Customer
Swaps Positions Will Be ‘‘Ported’’ to
New FCMs Rather Than Liquidated in
the Event of an FCM Default
According to several commenters, a
central issue to consider when
designing a customer collateral
protection regime is the ability of
customers to ‘‘port,’’ i.e., transfer, their
swaps positions to a solvent FCM in the
event that their current FCM defaults.278
Following a default by an FCM, the
swaps positions of the FCM’s customers
either have to be moved to another
FCM, or closed. Moving a position to
another FCM allows the DCO to
maintain its net position in that contract
at zero, which is generally a goal of a
DCO. It also relieves the customer of the
necessity of reestablishing a position,
which potentially can be costly,
especially in a stressed economic
state.279 Finally, according to
commenters, the ability to port rather
than liquidate customer positions can
have important systematic benefits for
the market at large, because the forced
liquidation of the swaps cleared by a
major FCM could have severe disruptive
effects on prices and market
conditions.280
Rules governing customer collateral
accounts have an indirect, but
potentially important, effect on the
likelihood of successful porting in the
event of an FCM default. If swaps
positions are transferred to a new FCM,
the new FCM will have to add to its
customer account with the DCO enough
collateral to secure the ‘‘ported’’ swaps.
The most ready source of such collateral
is the customer account of the
defaulting FCM, which already contains
collateral securing the relevant swaps.
However, if collateral from the
defaulting FCM’s customer account
cannot be transferred, then porting of
market positions requires customers to,
at least temporarily, provide the new
FCM with new collateral. This is, at
best, a burden, and may, in some cases,
make porting infeasible—particularly
the prompt porting of numerous
customers with varied financial
resources and liquidity.
From the perspective of porting, the
Complete Legal Segregation Model has
several related advantages over the
Futures Model in circumstances of a
double default. As discussed above,
under the Futures Model, if even a
need to be used by the DCO to cover losses in a
default situation.
278 Black Rock at 2; Fidelity at 5; FIA at 4; MFA
at 4.
279 See ISDA February 16, 2011 Comment on
ANPR at 2.
280 See, e.g., id. at 2–4; and MFA at 4.
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single customer is in default, the DCO
is entitled to as much of the customer
account as is necessary to make up its
loss. As a result, the DCO has incentives
to postpone transfer of the customer
account until the full ramifications of
the customer default—and thus the size
of the DCO’s claim against the
account—are resolved. By contrast,
under Complete Legal Segregation, the
DCOs claim against the customer
account is limited by law to that portion
of the account attributable to individual
customers in default. The DCO will
therefore have little or no incentive to
resist transfer of that portion of the
account attributable to other customers.
At the same time, the Complete Legal
Segregation Model, unlike the Futures
Model, provides a legal framework for
attributing the value of the customer
account to individual customers.
Further, it requires that FCMs provide
DCOs with the necessary information
and that DCOs make the attribution at
least once daily, so as to be prepared for
a possible FCM default. As a result, the
Complete Legal Segregation Model, has
clear advantages over the Futures Model
in terms of facilitating the transfer of the
collateral of non-defaulting customers in
circumstances where one or more
customers have defaulted.281
Because of the infrequent occurrence
of double default situations it is not
possible to predict how frequently
Complete Legal Segregation will permit
porting in circumstances where porting
would not be possible, or would be
delayed, under the Futures Model.
Nevertheless, the structural advantages
of Complete Legal Segregation for
purposes of facilitating porting, and the
analysis in ISDA’s comment, imply that
this is an important benefit of this
model.
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d. Effects on Incentives for DCOs and
Customers to Monitor and Control Risky
Behavior by FCMs
CME and other commenters have
argued that the Complete Legal
Segregation Model could potentially
reduce the incentives of individual
customers to carefully evaluate clearing
FCMs and only do business with the
least risky.282 In effect, they argue that
because the financial condition of the
FCM, and of the FCM’s other customers,
will be less relevant to the customer’s
exposure to loss in the event of a fellow
customer’s default than under the
Futures Model, the customer will devote
281 For a more detailed discussion of the
operation of the segregation models in an FCM
bankruptcy, see supra section I.D.
282 Second Roundtable Tr. at 253, l.17; FIA at 5;
Newedge at 4. Cf. MFA at 4–5; BlackRock at 8.
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less effort to monitoring the FCM and its
other customers.
However, while it is possible that the
protection against Fellow-Customer Risk
provided by the Complete Legal
Segregation Model may cause
customers, on average, to devote less
effort to monitoring the activities of
their respective FCMs than under the
Futures Model, that incentive is not
removed. For example, customers
remain exposed to Operational Risk.
Moreover, the Complete Legal
Segregation Model creates offsetting
increased monitoring incentives on the
DCO and its member FCMs, to the
benefit of customers. Because of the
increased likelihood that a customer
default would impact the guaranty fund
under the Complete Legal Segregation
Model, increased incentives exist to
protect that fund through more careful
monitoring by the suppliers of the
guaranty fund and their agent (the
DCO). Indeed, commenters observe that
the availability of fellow-customer
collateral as a buffer reduces the
incentives of DCOs to provide vigorous
oversight.283 The net effect of these
incentive changes on the incentive to
monitor is difficult to quantify.
However, the basic economics of
monitoring suggest that there are
efficiency gains to centralizing
monitoring in a small number of
parties.284 This is because of ‘‘free
rider’’ effects associated with diffuse
exposure to risk of loss. When the risk
of loss from the activities of a firm, such
as an FCM, is spread over a large
number of agents, each individual agent
gains little from devoting resources to
monitoring the firm relative to the total
potential benefit of monitoring to the
affected agents as a group.285 This effect
is compounded by an information effect;
even if the incentive exists, it is difficult
for individual customers to gain access
to real-time information about the
financial condition of the FCM, and
even more so to gain real-time
information about the financial
condition of their fellow customers. In
contrast, the DCO is in a position to
obtain good information about the
financial condition of FCMs and
customers since, via its rules, it can
require FCMs to provide such
information as a condition for becoming
283 Blackrock
at 8; Freddie Mac at 2; Vanguard at
5.
284 See e.g., Kevin Dowd, Re-Examining the Case
for Government Deposit Insurance, 59 S. Econ. J.
363, 370 (1993).
285 See, e.g., Andrei Shleifer and Robert W.
Vishny, A Survey of Corporate Governance, 52 J.
Fin. 737, 753 (1997) (discussing effect of ‘‘free
rider’’ issues on monitoring in context of corporate
governance).
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and remaining clearing members. Based
on these considerations, there is reason
to believe that, while Complete Legal
Segregation may reduce incentives for
customers to monitor their FCMs, it will
increase incentives for monitoring of
FCMs by DCOs and, on balance is likely
to increase the effectiveness and
efficiency with which risk taking by
clearing FCMs is monitored.
e. Operational Costs
As discussed above, in order for the
Complete Legal Segregation Model to
work better than the Futures Model in
the event of a double default, the DCO
must have information that will enable
it to attribute the assets in the defaulting
FCM’s customer account to individual
customers of the FCM.286 Moreover,
because the occurrence of a double
default is rare, and because an FCM in
the process of default may not (despite
its regulatory obligations) be able to
provide a DCO with accurate and timely
information on its customers, section
22.11 requires clearing FCMs to provide
the necessary information to DCOs on at
least a daily basis. The Commission
notes that section 22.12 similarly
requires DCOs to use this information to
calculate and record the amount of
collateral required to support each
customer’s Cleared Swaps transactions
on at least a daily basis. This daily
information processing is not provided
under the Futures Model and will add
to the operational costs of clearing.
The NPRM discussed the likely
magnitude of increased operational
costs associated with the more extensive
information requirement.287 The
Commission noted there that one
estimate suggested the operational costs
of the Complete Legal Segregation
Model (relative to the Futures Model)
were likely to be slightly less than $1
million per year per FCM, with one-time
costs of about $700,000.288 A DCO’s cost
of accommodating this additional
information was estimated to be of the
same general magnitude. Another
comment observed that the operational
costs would be the same across all
models being considered given a
requirement for DCOs to collect margin
on a gross basis.289 The Commission
286 See
discussion at section VII.A.2; supra n.224.
FR at 33845–33846.
288 Id. (citing ISDA estimates for operational costs
received in response to the ANPR).
289 LCH at 2 (‘‘If the Commission adopts [the gross
margining requirement for DCOs], any DCO offering
any swaps clearing service under any of the models
outlined by the Commission in the Proposed
Rulemaking will be required to track margin on an
individual client basis and FCMs will be required
to do the same.’’). See also 76 FR at 69374–76. In
addition, some individual customer information
already resides at the DCO. See CME at 9 (‘‘At the
287 76
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received no alternative quantitative
estimates in response to the NPRM,290
although Fidelity suggested that some of
the operational costs associated with
Complete Legal Segregation will be
incurred regardless of the segregation
model that is chosen because other
CFTC rulemakings (i.e., the real time
reporting rulemaking and the reporting
of certain post-enactment swap
transactions rulemaking) require similar
reporting.291
Based on estimates by CME and ISDA
described above, the expected scale of
the cleared swaps market will require
hundreds of billions of dollars of
collateral to adequately secure swaps
positions under any segregation model,
and will thus potentially expose this
collateral to some degree of FellowCustomer Risk. In light of the projected
magnitude of the customer funds at
stake, the Commission believes that
operational costs of the Complete Legal
Segregation Model are a relatively minor
factor in choosing a model that would
protect customer funds consistent with
section 4d(f) of the CEA, and that this
would be true even if operational costs
proved to be considerably higher than
the estimate described in the NPRM.
f. Additional Potential Sources of Costs
and Benefits Arising From Complete
Legal Segregation
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As discussed in section I.D.1 above,
the Complete Legal Segregation Model
provides a significant advantage
compared to the Futures Model with
respect to fostering transfer.
Specifically, under the Complete Legal
Segregation Model, information about
the Cleared Swaps Customers as a
whole, and about each individual
Cleared Swaps Customer’s positions, are
transmitted to the DCO every day, an
information flow (and store) that is not
present in the Futures Model. Thus, in
the event of an FCM bankruptcy, each
DCO will have important information
on a customer by customer basis that
can be used to facilitate and implement
transfers, thereby making the DCO less
reliant upon the FCM for that
information.
end of each trading day, CME Clearing calculates,
for each FCM’s cleared swaps customer
account* * * the net margin requirement for each
customer in the account.’’).
290 In fact, FHLB states that the costs and risks
associated with the additional operational
complexity ‘‘may be difficult to quantify.’’ FHLB at
4.
291 Fidelity at 6.
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3. Application to CEA Section 15(a)
Considerations
a. Protection of Market Participants
As discussed above, the primary
benefit of the Complete Legal
Segregation Model is the protection of
Cleared Swaps Customers from the risk
of losing the value of their collateral as
a result of a double default. Based on
estimates by CME and ISDA, the cleared
swaps market is likely to require
upwards of $500 billion in customer
collateral regardless of the segregation
model chosen by the Commission.292
These assets will be potentially exposed
to Fellow-Customer Risk. It is not
possible to reliably quantify the
likelihood of fellow customer losses in
the absence of Complete Legal
Segregation for reasons discussed in
section VII.B.2.a. above. In addition, the
magnitude of Fellow-Customer Risk in
particular default situations will be
affected by the extent to which
customers foresee or anticipate a default
and accordingly move their accounts to
other FCMs; and the extent to which a
default is foreseeable or anticipated will
vary in different defaults. The risk cost
imposed on DCOs and their members by
Complete Legal Segregation will be
affected by the foreseeability of default
in a roughly parallel way.
Notwithstanding these uncertainties,
swaps users who participated in this
rulemaking process, with only limited
exceptions, consistently placed great
value on protection against FellowCustomer Risk and supported either
Complete Legal Segregation or stronger
measures to provide such protection
despite estimates of high dollar costs in
the form of the capital cost of higher
margins or guaranty funds.293 Since
swaps users most likely ultimately will
bear, directly or indirectly, most of the
dollar costs of protection against
Fellow-Customer Risk, the Commission
places substantial weight on their
valuation of such protection.
b. Efficiency, Competitiveness, and
Financial Integrity of Markets
i. Dollar Costs and Swaps Usage
Complete Legal Segregation could add
materially to the dollar cost of clearing
swaps, affecting competitiveness in
particular.294 Moreover, there were
292 See
supra n. 243.
e.g., Second Roundtable Tr. at 245–249;
Second Roundtable Tr. at 140, l.12 (Mr. MacFarlane
stating that ‘‘Tudor would happily pay the
incremental costs, both in terms of collateral and
operational costs [for greater protection].’’).
294 This analysis is also informed by the extent to
which clearing certain types of swaps is mandatory,
as well as by the cost already incurred in the
uncleared swaps market.
293 See,
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6369
estimates (albeit somewhat speculative
estimates) that Complete Legal
Segregation might require on the order
of 70% higher margins, 100% higher
DCO guaranty funds, or some
combination of smaller increases in
both. In light of the expected large scale
of the cleared swaps market, these
estimates imply industry wide
increments in margin on the order of
$500 billion or more, increments in
guaranty funds of over $100 billion, or
a combination of smaller increments of
both.295 The cost of these measures
would not be the dollar amount of
margin or guaranty fund contributions,
but, rather, the opportunity cost of using
capital for these purposes rather than
other business purposes. Considerable
uncertainty is added to the evaluation of
these estimates of the dollar cost of
Complete Legal Segregation by the fact
that DCOs do not yet have experience
clearing under the Dodd-Frank regime
(although they do currently clear swaps
pursuant to the rules of the exchanges)
and by LCH’s observation that, under
the method it uses to determine needed
financial resources to protect against
default, the same level of resources is
required under both Complete Legal
Segregation and the Futures Model.296
If Complete Legal Segregation results
in higher dollar costs to swaps users,
this may discourage some use of swaps
for hedging or other beneficial economic
uses. The Commission does not have
precise information about the price
responsiveness of swaps usage that
would make it possible to quantify this
effect. A countervailing consideration is
that comments to this rulemaking
indicate that customers are already
transacting in uncleared swaps, and are
paying for full segregation of the
collateral they are posting because of the
importance to them of protection of that
collateral against the defaults of others.
Moreover, as some commenters noted,
concern over exposure to FellowCustomer Risk that they currently pay
for and receive could discourage swaps
usage in the absence of Complete Legal
Segregation or other protection against
such risk.297 Comments by swaps users
indicated that such effects would occur
though they did not provide
quantitative estimates. The evidence
from the comments, specifically the
statements of swap users regarding their
willingness to pay for legal segregation,
suggests that the demand-enhancing
295 See
supra n. 243.
supra n. 269.
297 See e.g., Second Roundtable at 141, l.3 (Mr.
MacFarlane stating’’the uncertainty that’s created
by not knowing who we’re sharing risk in the
omnibus pool would cause us to pull our capital
back from the market.’’).
296 See
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effects of the increased safety associated
with Complete Legal Segregation are
larger than the demand-reducing effects
of higher margins and/or fees associated
with it.298
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ii. Financial Integrity of Markets
Complete Legal Segregation is likely
to have several effects on the financial
integrity of markets, the specifics of
which are discussed in more detail
under other headings.299 As explained
above, Complete Legal Segregation is
expected to lead to a net improvement
in the monitoring of risky behavior by
FCMs, with the effects of increased
incentives for such monitoring by DCOs
outweighing the effects of reduced
incentives for such monitoring by
customers. This net improvement in
monitoring of FCMs can be expected to
enhance the financial integrity of the
markets in which clearing FCMs
participate.
By facilitating porting, Complete
Legal Segregation is expected to
enhance the financial integrity of
cleared swaps markets in financial
stress situations involving FCMs by
reducing the likelihood that a double
default will result in the need to
liquidate large volumes of swaps
positions with resulting costs to
customers and the DCO and the
potential to seriously disrupt the market
at large.
By prohibiting DCOs from using the
collateral of non-defaulting customers in
a double default situation, Complete
Legal Segregation potentially could have
a negative effect on the financial
integrity of DCOs by reducing the
financial resources available to apply to
losses arising from double defaults.
However, the record indicates that
DCOs would substitute additional
resources in the form of higher margin
levels, larger guaranty funds, or a
combination of both as need to maintain
the ability to cover losses from FCM and
customer defaults.300 Importantly,
prohibiting DCOs from using the
collateral of non-defaulting customers to
protect a DCO from risks within a DCO’s
control is consistent with the statute’s
goal of protecting customer funds. As a
result, the loss of the ability to rely on
the collateral of non-defaulting
customers would be expected to
translate to higher dollar costs than
298 See e.g., Second Roundtable Tr. at 245 (Mr.
Thum stating that ‘‘we’re prepared to bear the cost
to provide for the margin protection that our clients
need.’’).
299 See discussion at sections VII.B.2.b, VII.B.2.c,
VII.B.2.d, and VII.B.3.b.i.
300 See supra n. 255.
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under the Futures Model rather than
reduced financial integrity.
c. Price Discovery
Complete Legal Segregation is not
expected to have a significant effect on
price discovery under normal market
conditions. In circumstances of a double
default involving a large FCM, Complete
Legal Segregation may help protect
price discovery in the swaps markets by
reducing the likelihood of the need for
a large scale liquidation of swaps
positions that would disrupt normal
pricing.
d. Sound Risk Management Practices
As discussed above,301 Complete
Legal Segregation is expected to
produce a net improvement in the
monitoring of risky behavior by FCMs.
While there may be some reduction in
the incentives to Cleared Swaps
Customers to monitor their FCMs, there
is a corresponding increase in the
incentives by DCOs to do so. There are
efficiency gains in centralizing this
responsibility in a small number of
parties, and the DCOs (as membership
organizations) have greater access to
information from their Clearing
Members, in contrast to Cleared Swaps
Customers, who (due to considerations
of confidentiality) may have little ability
to obtain information about an FCM’s
activities with respect to fellowcustomers.
e. Other Public Interest Considerations
By better protecting Cleared Swaps
Customer Collateral against fellowcustomer risk, the LSOC Model will
enhance compliance with the values of
CEA Section 4d(f), which requires that
the property of each individual
customer be protected.
C. Conclusion
The Commission has carefully
considered the available evidence
regarding the costs and benefits of
Complete Legal Segregation Model and
has concluded that the Complete Legal
Segregation Model best accomplishes
the statutory objective of protecting
customer deposits. In terms of benefits,
customers have much greater assurance
of the safety of their margin deposits
against Fellow-Customer Risk under the
Complete Legal Segregation Model than
under the Futures Model. In addition,
Complete Legal Segregation will
facilitate porting rather than liquidation
of customer positions in double default
situations with associated benefits to
customers and, for defaults of large
FCMs, reduced risk of disruption of
301 See
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markets as a result of large volumes of
customer positions. Complete Legal
Segregation also will increase incentives
for DCOs to monitor risky behavior by
member FCMs and that this effect can
be expected to outweigh reduced
incentives for customers to monitor
their FCMs. In determining that
Complete Legal Segregation is the
appropriate model, the Commission has
placed weight on, among other
considerations, the comments of many
swaps users that they place great value
on assurance of their margins and their
positions and are willing to incur
substantial costs to achieve such
assurance and on comments by a range
of market participants placing great
importance on porting of customer
positions as a response to FCM defaults.
On the cost side, several DCOs that
employ the Futures Model for the
futures-side of their business and other
commenters argued that Complete Legal
Segregation will require some
combination of substantially higher
margin levels and guaranty fund
contributions than the Futures Model.
However, one major DCO reported that,
under the approach it uses to establish
margin and guaranty fund level, these
levels would be the same under
Complete Legal Segregation and the
Futures Model. Complete Legal
Segregation will impose some
operational costs but such costs are
small enough to be a minor
consideration relative to the other
aspects of cost; e.g., the potential
increases in margins and guaranty
funds.
The Commission notes that, as
discussed above, there are a number of
sources of uncertainty in evaluating the
costs and benefits of Complete Legal
Segregation, such as market participants
not yet having experience clearing
swaps under the Dodd-Frank legal
regime and the infrequency of double
defaults. However, the costs and
benefits of all the models considered by
the Commission are subject to similar
uncertainties as to the probability of
double defaults and customer behavior
in anticipation of such defaults.
Accordingly, such uncertainties do not
militate against the selection of the
Complete Legal Segregation Model as
the preferred alternative.
VIII. Related Matters
A. Paperwork Reduction Act
1. Introduction
Sections 22.2(g), 22.5(a), 22.11, 22.12,
and 22.16 of these rules impose new
information disclosure and
recordkeeping requirements that
constitute the collection of information
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within the meaning of the Paperwork
Reduction Act of 1995 (‘‘PRA’’).302
Under the PRA, an agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a
currently valid control number.303 The
Commission therefore has requested
that the Office of Management and
Budget (‘‘OMB’’) assign a control
number for this collection of
information. The Commission has also
submitted the NPRM, this final rule
release, and supporting documentation
to OMB for review in accordance with
44 U.S.C. 3507(d) and 5 CFR 1320.11.
The title for this collection of
information is ‘‘Disclosure and
Retention of Certain Information
Relating to Cleared Swaps Customer
Collateral,’’ OMB Control Number
3038–0091. This collection of
information will be mandatory. The
information in question will be held by
private entities and, to the extent it
involves consumer financial
information, may be protected under
Title V of the Gramm-Leach-Bliley Act
as amended by the Dodd-Frank Act.304
OMB has not yet approved the
collection of this information.
2. Comments Received on Collection of
Information Proposed in NPRM
Sections 22.2(g), 22.5(a), 22.11, 22.12,
and 22.16 and estimates of the expected
information collection burden were
published for comment in the NPRM.
The collection of information required
by the final versions of these rules and
the associated information collection
burden is identical to that of the rules
as proposed. Comments were received
regarding proposed sections 22.5(a),
22.11, 22.12, and 22.16. The substance
of these comments and the
Commission’s response to them is set
forth above in sections IV.E, IV.K, IV.L.,
and IV.P of this preamble.
In addition, in response to a comment
on the definition of ‘‘Cleared Swaps
Customer Collateral’’ by the FIA
requesting that the Commission confirm
that the term ‘‘Cleared Swaps Customer
Collateral’’ includes all assets provided
to an FCM by a Cleared Swaps
Customer, including amounts in excess
of the amount required to margin a
Cleared Swap by the relevant DCO, the
Commission has included in the final
rule a new permissive provision,
subsection 22.13(c)(2). Subsection
22.13(c)(2) provides that an FCM may
302 44
U.S.C. 3501 et seq.
transmit to a DCO collateral posted by
a Cleared Swaps Customer in excess of
the amount required by the DCO if (1)
the rules of the DCO permit such
transmission; and (2) the DCO provides
a mechanism by which the FCM is able
to, and maintains rules requiring the
FCM to, identify each business day, for
each Cleared Swaps Customer, the
amount of collateral posted in excess of
the amount required by the DCO. This
rule subsection may have the effect of
causing some FCMs to perform a daily
computation of the amount of collateral
posted in excess of the amount required
by the relevant DCO. In the view of the
Commission, this provision does not
materially change, or add to the burden
of, the information collection required
by the Part 22 rules as proposed. This
is so because the computation of the
amount of collateral posted in excess of
the amount required by the relevant
DCO will be performed using same data
sources that would be used for the
information collections required by
subsections 22.2(g), 22.11, and 22.12.
Moreover, this burden would only be
imposed (and enforced) by voluntary
action of the DCO in permitting, and the
FCM in transmitting, such additional
collateral.
There were no comments specifically
addressing the Commission’s numerical
estimates of information collection
burden in section VII.B.2 of the NPRM.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act
(‘‘RFA’’) 305 requires that agencies
consider whether their rules will have a
significant economic impact on a
substantial number of small entities
and, if so, provide a regulatory
flexibility analysis of that impact. These
Part 22 rules and amendments to Part
190 apply to DCOs and FCMs. In the
NPRM, the Chairman, pursuant to
section 605(b) of the RFA, 5 U.S.C.
605(b), certified on behalf of the
Commission that these rules and
amendments will not have a significant
economic impact on a substantial
number of small entities based on
previous determinations by the
Commission that DCOs and FCMs are
not small entities for purposes of the
RFA.306
List of Subjects
17 CFR Part 22
Brokers, Clearing, Consumer
protection, Reporting and recordkeeping
requirements, Swaps.
303 Id.
304 See generally, Notice of Proposed Rulemaking,
Privacy of Consumer Financial Information;
Conforming Amendments Under Dodd-Frank Act,
75 FR 66014, Oct. 27, 2010.
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305 5
U.S.C. 601 et seq.
66 FR 45605, 45609 (Aug. 29, 2001)
(DCOs); 47 FR 18618, 18619–20 (April 30, 1982)
(FCMs).
306 See
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6371
17 CFR Part 190
Bankruptcy, Brokers, Commodity
futures, Reporting and recordkeeping
requirements, Swaps.
IX. Text of Final Rules
For the reasons stated in this release,
the Commission hereby amends Chapter
17 as follows:
■ 1. Add Part 22 to read as follows:
PART 22—CLEARED SWAPS
Sec.
22.1
22.2
Definitions.
Futures Commission Merchants:
Treatment of Cleared Swaps Customer
Collateral.
22.3 Derivatives Clearing Organizations:
Treatment of Cleared Swaps Customer
Collateral.
22.4 Futures Commission Merchants and
Derivatives Clearing Organizations:
Permitted Depositories.
22.5 Futures Commission Merchants and
Derivatives Clearing Organizations:
Written Acknowledgement.
22.6 Futures Commission Merchants and
Derivatives Clearing Organizations:
Naming of Cleared Swaps Customer
Accounts.
22.7 Permitted Depositories: Treatment of
Cleared Swaps Customer Collateral.
22.8 Situs of Cleared Swaps Customer
Accounts.
22.9 Denomination of Cleared Swaps
Customer Collateral and Location of
Depositories.
22.10 Application of other Regulatory
Provisions.
22.11 Information to be Provided
Regarding Customers and their Cleared
Swaps.
22.12 Information to be Maintained
Regarding Cleared Swaps Customer
Collateral.
22.13 Additions to Cleared Swaps
Customer Collateral.
22.14 Futures Commission Merchant
Failure to Meet a Customer Margin Call
in Full.
22.15 Treatment of Cleared Swaps
Customer Collateral on an Individual
Basis.
22.16 Disclosures to Customers.
Authority: 7 U.S.C. 1a, 6d, 7a–1 as
amended by Pub. L. 111–203, 124 Stat. 1376.
§ 22.1
Definitions.
For the purposes of this part:
Cleared Swap. This term refers to a
transaction constituting a ‘‘cleared
swap’’ within the meaning of section
1a(7) of the Act.
(1) This term shall exclude any swap
(along with money, securities, or other
property received to margin, guarantee,
or secure such a swap) that, pursuant to
a Commission rule, regulation, or order,
is (along with such money, securities, or
other property) commingled with a
commodity future or option (along with
money, securities, or other property
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received to margin, guarantee, or secure
such a future or option) that is
segregated pursuant to section 4d(a) of
the Act.
(2) This term shall include any trade
or contract (along with money,
securities or other property received to
margin, guarantee, or secure such a
trade or contract), that
(i) Would be required to be segregated
pursuant to section 4d(a) of the Act, or
(ii) Would be subject to § 30.7 of this
chapter, but which is, in either case,
pursuant to a Commission rule,
regulation, or order (or a derivatives
clearing organization rule approved in
accordance with § 39.15(b)(2) of this
chapter), commingled with a swap
(along with money, securities, or other
property received to margin, guarantee,
or secure such a swap) in an account
segregated pursuant to section 4d(f) of
the Act.
Cleared Swaps Customer. This term
refers to any person entering into a
Cleared Swap, but shall exclude:
(1) Any owner or holder of a Cleared
Swaps Proprietary Account with respect
to the Cleared Swaps in such account;
and
(2) A clearing member of a derivatives
clearing organization with respect to
Cleared Swaps cleared on that
derivatives clearing organization. A
person shall be a Cleared Swaps
Customer only with respect to its
Cleared Swaps.
Cleared Swaps Customer Account.
This term refers to any account for the
Cleared Swaps of Cleared Swaps
Customers and associated Cleared
Swaps Customer Collateral that:
(1) A futures commission merchant
maintains on behalf of Cleared Swaps
Customers (including, in the case of a
Collecting Futures Commission
Merchant, the Cleared Swaps Customers
of a Depositing Futures Commission
Merchant) or
(2) A derivatives clearing organization
maintains for futures commission
merchants on behalf of Cleared Swaps
Customers thereof.
Cleared Swaps Customer Collateral.
(1) This term means all money,
securities, or other property received by
a futures commission merchant or by a
derivatives clearing organization from,
for, or on behalf of a Cleared Swaps
Customer, which money, securities, or
other property:
(i) Is intended to or does margin,
guarantee, or secure a Cleared Swap; or
(ii) Constitutes, if a Cleared Swap is
in the form or nature of an option, the
settlement value of such option.
(2) This term shall also include
accruals, i.e., all money, securities, or
other property that a futures
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commission merchant or derivatives
clearing organization receives, directly
or indirectly, which is incident to or
results from a Cleared Swap that a
futures commission merchant
intermediates for a Cleared Swaps
Customer.
Cleared Swaps Proprietary Account.
(1) This term means an account for
Cleared Swaps and associated collateral
that is carried on the books and records
of a futures commission merchant for
persons with certain relationships with
that futures commission merchant,
specifically:
(i) Where such account is carried for
a person falling within one of the
categories specified in paragraph (2) of
this definition, or
(ii) Where ten percent or more of such
account is owned by a person falling
within one of the categories specified in
paragraph (2) of this definition, or
(iii) Where an aggregate of ten percent
or more of such account is owned by
more than one person falling within one
or more of the categories specified in
paragraph (2) of this definition.
(2) The relationships to the futures
commission merchant referred to in
paragraph (1) of this definition are as
follows:
(i) Such individual himself, or such
partnership, corporation or association
itself;
(ii) In the case of a partnership, a
general partner in such partnership;
(iii) In the case of a limited
partnership, a limited or special partner
in such partnership whose duties
include:
(A) The management of the
partnership business or any part thereof;
(B) The handling, on behalf of such
partnership, of:
(1) The Cleared Swaps of Cleared
Swaps Customers or
(2) The Cleared Swaps Customer
Collateral;
(C) The keeping, on behalf of such
partnership, of records pertaining to
(1) the Cleared Swaps of Cleared
Swaps Customers or
(2) the Cleared Swaps Customer
Collateral; or
(D) The signing or co-signing of
checks or drafts on behalf of such
partnership;
(iv) In the case of a corporation or
association, an officer, director, or
owner of ten percent or more of the
capital stock of such organization;
(v) An employee of such individual,
partnership, corporation or association
whose duties include:
(A) The management of the business
of such individual, partnership,
corporation or association or any part
thereof;
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(B) The handling, on behalf of such
individual, partnership, corporation, or
association, of the Cleared Swaps of
Cleared Swaps Customers or the Cleared
Swaps Customer Collateral;
(C) The keeping of records, on behalf
of such individual, partnership,
corporation, or association, pertaining to
the Cleared Swaps of Cleared Swaps
Customers or the Cleared Swaps
Customer Collateral; or
(D) The signing or co-signing of
checks or drafts on behalf of such
individual, partnership, corporation, or
association;
(vi) A spouse or minor dependent
living in the same household of any of
the foregoing persons;
(vii) A business affiliate that, directly
or indirectly, controls such individual,
partnership, corporation, or association;
or
(viii) A business affiliate that, directly
or indirectly, is controlled by or is
under common control with, such
individual, partnership, corporation or
association. Provided, however, that an
account owned by any shareholder or
member of a cooperative association of
producers, within the meaning of
section 6a of the Act, which association
is registered as a futures commission
merchant and carries such account on
its records, shall be deemed to be a
Cleared Swaps Customer Account and
not a Cleared Swaps Proprietary
Account of such association, unless the
shareholder or member is an officer,
director, or manager of the association.
Clearing Member. This term means
any person that has clearing privileges
such that it can process, clear and settle
trades through a derivatives clearing
organization on behalf of itself or others.
The derivatives clearing organization
need not be organized as a membership
organization.
Collecting Futures Commission
Merchant. A futures commission
merchant that carries Cleared Swaps on
behalf of another futures commission
merchant and the Cleared Swaps
Customers of the latter futures
commission merchant, and as part of
carrying such Cleared Swaps, collects
Cleared Swaps Customer Collateral.
Commingle. To commingle two or
more items means to hold such items in
the same account, or to combine such
items in a transfer between accounts.
Customer. This term means any
customer of a futures commission
merchant, other than a Cleared Swaps
Customer, including, without limitation:
(1) Any ‘‘customer’’ or ‘‘commodity
customer’’ within the meaning of § 1.3
of this chapter; and
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(2) Any ‘‘foreign futures or foreign
options customer’’ within the meaning
of § 30.1(c) of this chapter.
Depositing Futures Commission
Merchant. A futures commission
merchant that carries Cleared Swaps on
behalf of its Cleared Swaps Customers
through another futures commission
merchant and, as part of carrying such
Cleared Swaps, deposits Cleared Swaps
Customer Collateral with such futures
commission merchant.
Permitted Depository. This term shall
have the meaning set forth in § 22.4 of
this part.
Segregate. To segregate two or more
items is to keep them in separate
accounts, and to avoid combining them
in the same transfer between two
accounts.
srobinson on DSK4SPTVN1PROD with RULES3
§ 22.2 Futures Commission Merchants:
Treatment of Cleared Swaps and
Associated Cleared Swaps Customer
Collateral.
(a) General. A futures commission
merchant shall treat and deal with the
Cleared Swaps of Cleared Swaps
Customers and associated Cleared
Swaps Customer Collateral as belonging
to Cleared Swaps Customers.
(b) Location of Cleared Swaps
Customer Collateral. (1) A futures
commission merchant must segregate all
Cleared Swaps Customer Collateral that
it receives, and must either hold such
Cleared Swaps Customer Collateral
itself as set forth in paragraph (b)(2) of
this section, or deposit such collateral
into one or more Cleared Swaps
Customer Accounts held at a Permitted
Depository, as set forth in paragraph
(b)(3) of this section.
(2) If a futures commission merchant
holds Cleared Swaps Customer
Collateral itself, then the futures
commission merchant must:
(i) Physically separate such collateral
from its own property;
(ii) Clearly identify each physical
location in which it holds such
collateral as a ‘‘Location of Cleared
Swaps Customer Collateral’’ (the ‘‘FCM
Physical Location’’);
(iii) Ensure that the FCM Physical
Location provides appropriate
protection for such collateral; and
(iv) Record in its books and records
the amount of such Cleared Swaps
Customer Collateral separately from its
own funds.
(3) If a futures commission merchant
holds Cleared Swaps Customer
Collateral in a Permitted Depository,
then:
(i) The Permitted Depository must
qualify pursuant to the requirements set
forth in § 22.4 of this part, and
(ii) The futures commission merchant
must maintain a Cleared Swaps
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Customer Account with each such
Permitted Depository.
(c) Commingling. (1) A futures
commission merchant may commingle
the Cleared Swaps Customer Collateral
that it receives from, for, or on behalf of
multiple Cleared Swaps Customers.
(2) A futures commission merchant
shall not commingle Cleared Swaps
Customer Collateral with either of the
following:
(i) Funds belonging to the futures
commission merchant, except as
expressly permitted in paragraph (e)(3)
of this section; or
(ii) Other categories of funds
belonging to Customers of the futures
commission merchant, including
customer funds (as § 1.3 of this chapter
defines such term) and the foreign
futures or foreign options secured
amount (as § 1.3 of this chapter defines
such term), except as expressly
permitted by Commission rule,
regulation, or order, or by a derivatives
clearing organization rule approved in
accordance with § 39.15(b)(2) of this
chapter.
(d) Limitations on Use. (1) No futures
commission merchant shall use, or
permit the use of, the Cleared Swaps
Customer Collateral of one Cleared
Swaps Customer to purchase, margin, or
settle the Cleared Swaps or any other
trade or contract of, or to secure or
extend the credit of, any person other
than such Cleared Swaps Customer.
Cleared Swaps Customer Collateral shall
not be used to margin, guarantee, or
secure trades or contracts of the entity
constituting a Cleared Swaps Customer
other than in Cleared Swaps, except to
the extent permitted by a Commission
rule, regulation or order.
(2) A futures commission merchant
may not impose or permit the
imposition of a lien on Cleared Swaps
Customer Collateral, including any
residual financial interest of the futures
commission merchant in such collateral,
as described in paragraph (e)(4) of this
section.
(3) A futures commission merchant
may not include, as Cleared Swaps
Customer Collateral,
(i) Money invested in the securities,
memberships, or obligations of any
derivatives clearing organization,
designated contract market, swap
execution facility, or swap data
repository, or
(ii) Money, securities, or other
property that any derivatives clearing
organization holds and may use for a
purpose other than those set forth in
§ 22.3 of this part.
(e) Exceptions. Notwithstanding the
foregoing:
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(1) Permitted Investments. A futures
commission merchant may invest
money, securities, or other property
constituting Cleared Swaps Customer
Collateral in accordance with § 1.25 of
this chapter, which section shall apply
to such money, securities, or other
property as if they comprised customer
funds or customer money subject to
segregation pursuant to section 4d(a) of
the Act and the regulations thereunder.
(2) Permitted Withdrawals. Such
share of Cleared Swaps Customer
Collateral as in the normal course of
business shall be necessary to margin,
guarantee, secure, transfer, adjust, or
settle a Cleared Swaps Customer’s
Cleared Swaps with a derivatives
clearing organization, or with a
Collecting Futures Commission
Merchant, may be withdrawn and
applied to such purposes, including the
payment of commissions, brokerage,
interest, taxes, storage, and other
charges, lawfully accruing in connection
with such Cleared Swaps.
(3) Deposits of Own Money,
Securities, or Other Property.
(i) In order to ensure that it is always
in compliance with paragraph (f) of this
section, a futures commission merchant
may place in an FCM Physical Location
or deposit in a Cleared Swaps Customer
Account its own money, securities, or
other property (provided, that such
securities or other property are
unencumbered and are of the types
specified in § 1.25 of this chapter).
(ii) Money, securities, or other
property deposited by a futures
commission merchant pursuant to
22.13(b) and available to a derivatives
clearing organization or Collecting
Futures Commission Merchant to meet
the obligations of the futures
commission merchant’s Cleared Swaps
Customers collectively, shall be
maintained in an account separate from
the Cleared Swaps Customer Account.
(4) Residual Financial Interest. (i) If,
in accordance with paragraph (e)(3)(i) of
this section, a futures commission
merchant places in an FCM Physical
Location or deposits in a Cleared Swaps
Customer Account its own money,
securities, or other property, then such
money, securities, or other property
(including accruals thereon) shall
constitute Cleared Swaps Customer
Collateral.
(ii) The futures commission merchant
shall have a residual financial interest
in any portion of such money,
securities, or other property in excess of
that necessary for compliance with
paragraph (f)(4) of this section.
(iii) The futures commission merchant
may withdraw money, securities, or
other property from the FCM Physical
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Location or Cleared Swaps Customer
Account, to the extent of its residual
financial interest therein. At the time of
such withdrawal, the futures
commission merchant shall ensure that
the withdrawal does not cause its
residual financial interest to become
less than zero.
(f) Requirements as to Amount. (1) For
purposes of this § 22.2(f), the term
‘‘account’’ shall reference the entries on
the books and records of a futures
commission merchant pertaining to the
Cleared Swaps Customer Collateral of a
particular Cleared Swaps Customer.
(2) The futures commission merchant
must reflect in the account that it
maintains for each Cleared Swaps
Customer the market value of any
Cleared Swaps Customer Collateral that
it receives from such customer, as
adjusted by:
(i) Any uses permitted under § 22.2(d)
of this part;
(ii) Any accruals on permitted
investments of such collateral under
§ 22.2(e) of this part that, pursuant to
the futures commission merchant’s
customer agreement with that customer,
are creditable to such customer;
(iii) Any charges lawfully accruing to
the Cleared Swaps Customer, including
any commission, brokerage fee, interest,
tax, or storage fee; and
(iv) Any appropriately authorized
distribution or transfer of such
collateral.
(3) If the market value of Cleared
Swaps Customer Collateral in the
account of a Cleared Swaps Customer is
positive after adjustments, then that
account has a credit balance. If the
market value of Cleared Swaps
Customer Collateral in the account of a
Cleared Swaps Customer is negative
after adjustments, then that account has
a debit balance.
(4) The futures commission merchant
must maintain in segregation, in its
FCM Physical Locations and/or its
Cleared Swaps Customer Accounts at
Permitted Depositories, an amount
equal to the sum of any credit balances
that the Cleared Swaps Customers of the
futures commission merchant have in
their accounts, excluding from such
sum any debit balances that the Cleared
Swaps Customers of the futures
commission merchant have in their
accounts.
(5) Notwithstanding the foregoing, the
futures commission merchant must
include, in calculating the sum
referenced in paragraph (f)(4) of this
section, any debit balance that a Cleared
Swaps Customer may have in its
account, to the extent that such balance
is secured by ‘‘readily marketable
securities’’ that the Cleared Swaps
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Customer deposited with the futures
commission merchant.
(i) For purposes of this section,
‘‘readily marketable’’ shall be defined as
having a ‘‘ready market’’ as such latter
term is defined in Rule 15c3–1(c)(11) of
the Securities and Exchange
Commission (§ 241.15c3–1(c)(11) of this
title).
(ii) In order for a debit balance to be
deemed secured by ‘‘readily marketable
securities,’’ the futures commission
merchant must maintain a security
interest in such securities, and must
hold a written authorization to liquidate
the securities at the discretion of the
futures commission merchant.
(iii) To determine the amount secured
by ‘‘readily marketable securities,’’ the
futures commission merchant shall:
(A) Determine the market value of
such securities; and
(B) Reduce such market value by
applicable percentage deductions (i.e.,
‘‘securities haircuts’’) as set forth in
Rule 15c3–1(c)(2)(vi) of the Securities
and Exchange Commission (§ 240.15c3–
1(c)(2)(vi) of this title). The portion of
the debit balance, not exceeding 100 per
cent, that is secured by the reduced
market value of such readily marketable
securities shall be included in
calculating the sum referred to in
paragraph (f)(4) of this section.
(g) Segregated Account; Daily
Computation and Record. (1) Each
futures commission merchant must
compute as of the close of each business
day, on a currency-by-currency basis:
(i) The aggregate market value of the
Cleared Swaps Customer Collateral in
all FCM Physical Locations and all
Cleared Swaps Customer Accounts held
at Permitted Depositories (the
‘‘Collateral Value’’);
(ii) The sum referenced in paragraph
(f)(4) of this section (the ‘‘Collateral
Requirement’’); and
(iii) The amount of the residual
financial interest that the futures
commission merchant holds in such
Cleared Swaps Customer Collateral,
which shall equal the difference
between the Collateral Value and the
Collateral Requirement.
(2) The futures commission merchant
must complete the daily computations
required by this section prior to noon on
the next business day and must keep
such computations, together with all
supporting data, in accordance with the
requirements of § 1.31 of this chapter.
§ 22.3 Derivatives Clearing Organizations:
Treatment of Cleared Swaps Customer
Collateral.
(a) General. A derivatives clearing
organization shall treat and deal with
the Cleared Swaps Customer Collateral
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deposited by a futures commission
merchant as belonging to the Cleared
Swaps Customers of such futures
commission merchant and not other
persons, including, without limitation,
the futures commission merchant.
(b) Location of Cleared Swaps
Customer Collateral. (1) The derivatives
clearing organization must segregate all
Cleared Swaps Customer Collateral that
it receives from futures commission
merchants, and must either hold such
Cleared Swaps Customer Collateral
itself as set forth in paragraph (b)(2) of
this section, or deposit such collateral
into one or more Cleared Swaps
Customer Accounts held at a Permitted
Depository, as set forth in paragraph
(b)(3) of this section.
(2) If a derivatives clearing
organization holds Cleared Swaps
Customer Collateral itself, then the
derivatives clearing organization must:
(i) Physically separate such collateral
from its own property, the property of
any futures commission merchant, and
the property of any other person that is
not a Cleared Swaps Customer of a
futures commission merchant;
(ii) Clearly identify each physical
location in which it holds such
collateral as ‘‘Location of Cleared Swaps
Customer Collateral’’ (the ‘‘DCO
Physical Location’’);
(iii) Ensure that the DCO Physical
Location provides appropriate
protection for such collateral; and
(iv) Record in its books and records
the amount of such Cleared Swaps
Customer Collateral separately from its
own funds, the funds of any futures
commission merchant, and the funds of
any other person that is not a Cleared
Swaps Customer of a futures
commission merchant.
(3) If a derivatives clearing
organization holds Cleared Swaps
Customer Collateral in a Permitted
Depository, then:
(i) The Permitted Depository must
qualify pursuant to the requirements set
forth in § 22.4 of this part; and
(ii) The derivatives clearing
organization must maintain a Cleared
Swaps Customer Account with each
such Permitted Depository.
(c) Commingling. (1) A derivatives
clearing organization may commingle
the Cleared Swaps Customer Collateral
that it receives from multiple futures
commission merchants on behalf of
their Cleared Swaps Customers.
(2) A derivatives clearing organization
shall not commingle the Cleared Swaps
Customer Collateral that it receives from
a futures commission merchant on
behalf of Cleared Swaps Customers with
any of the following:
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(i) The money, securities, or other
property belonging to the derivatives
clearing organization;
(ii) The money, securities, or other
property belonging to any futures
commission merchant; or
(iii) Other categories of funds that it
receives from a futures commission
merchant on behalf of Customers,
including customer funds (as § 1.3 of
this chapter defines such term) and the
foreign futures or foreign options
secured amount (as § 1.3 of this chapter
defines such term), except as expressly
permitted by Commission rule,
regulation or order, (or a derivatives
clearing organization rule approved in
accordance with § 39.15(b)(2) of this
chapter).
(d) Exceptions; Permitted
Investments. Notwithstanding the
foregoing and § 22.15 of this part, a
derivatives clearing organization may
invest the money, securities, or other
property constituting Cleared Swaps
Customer Collateral in accordance with
§ 1.25 of this chapter, which section
shall apply to such money, securities, or
other property as if they comprised
customer funds or customer money
subject to segregation pursuant to
section 4d(a) of the Act and the
regulations thereunder.
§ 22.4 Futures Commission Merchants and
Derivatives Clearing Organizations:
Permitted Depositories.
srobinson on DSK4SPTVN1PROD with RULES3
In order for a depository to be a
Permitted Depository:
(a) The depository must (subject to
§ 22.9) be one of the following types of
entities:
(1) A bank located in the United
States;
(2) A trust company located in the
United States;
(3) A Collecting Futures Commission
Merchant registered with the
Commission (but only with respect to a
Depositing Futures Commission
Merchant providing Cleared Swaps
Customer Collateral); or
(4) A derivatives clearing organization
registered with the Commission; and
(b) The futures commission merchant
or the derivatives clearing organization
must hold a written acknowledgment
letter from the depository as required by
§ 22.5 of this part.
§ 22.5 Futures Commission Merchants and
Derivatives Clearing Organizations: Written
Acknowledgement.
(a) Before depositing Cleared Swaps
Customer Collateral, the futures
commission merchant or derivatives
clearing organization shall obtain and
retain in its files a separate written
acknowledgment letter from each
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depository in accordance with §§ 1.20
and 1.26 of this chapter, with all
references to ‘‘customer funds’’
modified to apply to Cleared Swaps
Customer Collateral, and with all
references to section 4d(a) or 4d(b) of
the Act and the regulations thereunder
modified to apply to section 4d(f) of the
Act and the regulations thereunder.
(b) The futures commission merchant
or derivatives clearing organization
shall adhere to all requirements
specified in §§ 1.20 and 1.26 of this
chapter regarding retaining, permitting
access to, filing, or amending the
written acknowledgment letter, in all
cases as if the Cleared Swaps Customer
Collateral comprised customer funds
subject to segregation pursuant to
section 4d(a) or 4d(b) of the Act and the
regulations thereunder.
(c) Notwithstanding paragraph (a) of
this section, an acknowledgement letter
need not be obtained from a derivatives
clearing organization that has made
effective, pursuant to section 5c(c) of the
Act and the regulations thereunder,
rules that provide for the segregation of
Cleared Swaps Customer Collateral, in
accordance with all relevant provisions
of the Act and the regulations
thereunder.
§ 22.6 Futures Commission Merchants and
Derivatives Clearing Organizations: Naming
of Cleared Swaps Customer Accounts.
The name of each Cleared Swaps
Customer Account that a futures
commission merchant or a derivatives
clearing organization maintains with a
Permitted Depository shall:
(a) Clearly identify the account as a
‘‘Cleared Swaps Customer Account’’
and
(b) Clearly indicate that the collateral
therein is ‘‘Cleared Swaps Customer
Collateral’’ subject to segregation in
accordance with the Act and this part.
§ 22.7 Permitted Depositories: Treatment
of Cleared Swaps Customer Collateral.
A Permitted Depository shall treat all
funds in a Cleared Swaps Customer
Account as Cleared Swaps Customer
Collateral. A Permitted Depository shall
not hold, dispose of, or use any such
Cleared Swaps Customer Collateral as
belonging to any person other than:
(a) The Cleared Swaps Customers of
the futures commission merchant
maintaining such Cleared Swaps
Customer Account or;
(b) The Cleared Swaps Customers of
the futures commission merchants for
which the derivatives clearing
organization maintains such Cleared
Swaps Customer Account.
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§ 22.8 Situs of Cleared Swaps Customer
Accounts.
The situs of each of the following
shall be located in the United States:
(a) Each FCM Physical Location or
DCO Physical Location;
(b) Each ‘‘account,’’ within the
meaning of § 22.2(f)(1), that a futures
commission merchant maintains for
each Cleared Swaps Customer; and
(c) Each Cleared Swaps Customer
Account on the books and records of a
derivatives clearing organization with
respect to the Cleared Swaps Customers
of a futures commission merchant.
§ 22.9 Denomination of Cleared Swaps
Customer Collateral and Location of
Depositories.
(a) Subject to paragraph (b) of this
section, futures commission merchants
and derivatives clearing organizations
may hold Cleared Swaps Customer
Collateral in the denominations, at the
locations and depositories, and subject
to the same segregation requirements
specified in § 1.49 of this chapter, which
section shall apply to such Cleared
Swaps Customer Collateral as if it
comprised customer funds subject to
segregation pursuant to section 4d(a) of
the Act.
(b) Notwithstanding the requirements
set forth in § 1.49 of this chapter, a
futures commission merchant’s
obligations to a Cleared Swaps
Customer may be denominated in a
currency in which funds have accrued
to the customer as a result of a Cleared
Swap carried through such futures
commission merchant, to the extent of
such accruals.
(c) Each depository referenced in
paragraph (a) of this section shall be
considered a Permitted Depository for
purposes of this part. Provided,
however, that a futures commission
merchant shall only be considered a
Permitted Depository to the extent that
it is acting as a Collecting Futures
Commission Merchant (as § 22.1 of this
part defines such term).
§ 22.10 Application of other Regulatory
Provisions.
Sections 1.27, 1.28, 1.29, and 1.30 of
this chapter shall apply to the Cleared
Swaps Customer Collateral held by
futures commission merchants and
derivatives clearing organizations to the
same extent as if such sections referred
to:
(a) ‘‘Cleared Swaps Customer
Collateral’’ in place of ‘‘customer
funds;’’
(b) ‘‘Cleared Swaps Customers’’
instead of ‘‘commodity or option
customers’’ or ‘‘customers or option
customers;’’
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(c) ‘‘Cleared Swaps Contracts’’ instead
of ‘‘trades, contracts, or commodity
options;’’ and
(d) ‘‘Section 4d(f) of the Act’’ instead
of ‘‘section 4d(a)(2) of the Act.’’
srobinson on DSK4SPTVN1PROD with RULES3
§ 22.11 Information To Be Provided
Regarding Customers and Their Cleared
Swaps.
(a) Each Depositing Futures
Commission Merchant shall:
(1) The first time that the Depositing
Futures Commission Merchant
intermediates a Cleared Swap for a
Cleared Swaps Customer with a
Collecting Futures Commission
Merchant, provide information
sufficient to identify such customer to
the relevant Collecting Futures
Commission Merchant; and
(2) At least once each business day
thereafter, provide information to the
relevant Collecting Futures Commission
Merchant sufficient to identify, for each
Cleared Swaps Customer, the portfolio
of rights and obligations arising from the
Cleared Swaps that the Depositing
Futures Commission Merchant
intermediates for such customer.
(b) If an entity serves as both a
Depositing Futures Commission
Merchant and a Collecting Futures
Commission Merchant, then:
(1) The information that such entity
must provide to its Collecting Futures
Commission Merchant pursuant to
paragraph (a)(1) of this section shall also
include information sufficient to
identify each Cleared Swaps Customer
of the Depositing Futures Commission
Merchant for which such entity serves
as a Collecting Futures Commission
Merchant; and
(2) The information that such entity
must provide to its Collecting Futures
Commission Merchant pursuant to
paragraph (a)(2) of this section shall also
include information sufficient to
identify, for each Cleared Swaps
Customer referenced in paragraph (b)(1)
of this section, the portfolio of rights
and obligations arising from the Cleared
Swaps that such entity intermediates as
a Collecting Futures Commission
Merchant, on behalf of its Depositing
Futures Commission Merchant, for such
customer.
(c) Each futures commission merchant
that intermediates a Cleared Swap for a
Cleared Swaps Customer, on or subject
to the rules of a derivatives clearing
organization, directly as a Clearing
Member shall:
(1) The first time that such futures
commission merchant intermediates a
Cleared Swap for a Cleared Swaps
Customer, provide information to the
relevant derivatives clearing
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organization sufficient to identify such
customer; and
(2) At least once each business day
thereafter, provide information to the
relevant derivatives clearing
organization sufficient to identify, for
each Cleared Swaps Customer, the
portfolio of rights and obligations
arising from the Cleared Swaps that
such futures commission merchant
intermediates for such customer.
(d) If the futures commission
merchant referenced in paragraph (c) of
this section is a Collecting Futures
Commission Merchant, then:
(1) The information that it must
provide to the derivatives clearing
organization pursuant to paragraph
(c)(1) of this section shall also include
information sufficient to identify each
Cleared Swaps Customer of any entity
that acts as a Depositing Futures
Commission Merchant in relation to the
Collecting Futures Commission
Merchant (including, without
limitation, each Cleared Swaps
Customer of any Depositing Futures
Commission Merchant for which such
entity also serves as a Collecting Futures
Commission Merchant); and
(2) The information that it must
provide to the derivatives clearing
organization pursuant to paragraph
(c)(2) of this section shall also include
information sufficient to identify, for
each Cleared Swaps Customer
referenced in paragraph (d)(1) of this
section, the portfolio of rights and
obligations arising from the Cleared
Swaps that the Collecting Futures
Commission Merchant intermediates, on
behalf of the Depositing Futures
Commission Merchant, for such
customer.
(e) Each derivatives clearing
organization shall:
(1) Take appropriate steps to confirm
that the information it receives pursuant
to paragraphs (c)(1) or (c)(2) of this
section is accurate and complete, and
(2) Ensure that the futures
commission merchant is providing the
derivatives clearing organization the
information required by paragraphs
(c)(1) or (c)(2) of this section on a timely
basis.
§ 22.12 Information To Be Maintained
Regarding Cleared Swaps Customer
Collateral.
(a) Each Collecting Futures
Commission Merchant receiving Cleared
Swaps Customer Funds from an entity
serving as a Depositing Futures
Commission Merchant shall, no less
frequently than once each business day,
calculate and record:
(1) the amount of collateral required
at such Collecting Futures Commission
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Merchant for each Cleared Swaps
Customer of the entity acting as
Depositing Futures Commission
Merchant (including, without
limitation, each Cleared Swaps
Customer of any Depositing Futures
Commission Merchant for which such
entity also serves as a Collecting Futures
Commission Merchant); and
(2) the sum of the individual
collateral amounts referenced in
paragraph (a)(1) of this section.
(b) Each Collecting Futures
Commission Merchant shall calculate
the collateral amounts referenced in
paragraph (a) of this section with
respect to the portfolio of rights and
obligations arising from the Cleared
Swaps that the Collecting Futures
Commission Merchant intermediates, on
behalf of the Depositing Futures
Commission Merchant, for each Cleared
Swaps Customer referenced in
paragraph (a)(1) of this section.
(c) Each derivatives clearing
organization receiving Cleared Swaps
Customer Funds from a futures
commission merchant shall, no less
frequently than once each business day,
calculate and record:
(1) the amount of collateral required
at such derivatives clearing organization
for each Cleared Swaps Customer of the
futures commission merchant; and
(2) the sum of the individual
collateral amounts referenced in
paragraph (c)(1) of this section.
(d) If the futures commission
merchant referenced in paragraph (c) of
this section is a Collecting Futures
Commission Merchant, then the
derivatives clearing organization shall
also perform and record the results of
the calculation required in paragraph (c)
of this section for each Cleared Swaps
Customer of an entity acting as a
Depositing Futures Commission
Merchant in relation to the Collecting
Futures Commission Merchant
(including, without limitation, any
Cleared Swaps Customer for which such
entity is also acting as a Collecting
Futures Commission Merchant).
(e) Each futures commission merchant
shall calculate the collateral amounts
referenced in paragraph (c) of this
section with respect to the portfolio of
rights and obligations arising from the
Cleared Swaps that the futures
commission merchant intermediates
(including, without limitation, as a
Collecting Futures Commission
Merchant on behalf of a Depositing
Futures Commission Merchant), for
each Cleared Swaps Customer
referenced in paragraphs (c)(1) and (d)
of this section.
(f) The collateral requirement
referenced in paragraph (a) of this
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section with respect to a Collecting
Futures Commission Merchant shall be
no less than that imposed by the
relevant derivatives clearing
organization with respect to the same
portfolio of rights and obligations for
each relevant Cleared Swaps Customer.
srobinson on DSK4SPTVN1PROD with RULES3
§ 22.13 Additions to Cleared Swaps
Customer Collateral.
(a)(1) At the election of the derivatives
clearing organization or Collecting
Futures Commission Merchant, the
collateral requirement referred to in
§§ 22.12(a), (c), and (d) of this part
applicable to a particular Cleared Swaps
Customer or group of Cleared Swaps
Customers may be increased based on
an evaluation of the credit risk posed by
such customer or group, in which case
the derivatives clearing organization or
Collecting Futures Commission
Merchant shall collect and record such
higher amount as provided in § 22.12 of
this part.
(2) Nothing in paragraph (a)(1) of this
section is intended to interfere with the
right of a futures commission merchant
to increase the collateral requirements at
such futures commission merchant with
respect to any of its Cleared Swaps
Customers or Customers.
(b) Any collateral deposited by a
futures commission merchant
(including a Depositing Futures
Commission Merchant) pursuant to
§ 22.2(e)(3)(ii) of this part, which
collateral is identified as such futures
commission merchant’s own property
may be used by the derivatives clearing
organization or Collecting Futures
Commission Merchant, as applicable, to
margin, guarantee or secure the Cleared
Swaps of any or all of such Cleared
Swaps Customers.
(c) A futures commission merchant
may transmit to a derivatives clearing
organization any collateral posted by a
Cleared Swaps Customer in excess of
the amount required by the derivatives
clearing organization if:
(1) the rules of the derivatives clearing
organization expressly permit the
futures commission merchant to
transmit collateral in excess of the
amount required by the derivatives
clearing organization; and
(2) the derivatives clearing
organization provides a mechanism by
which the futures commission merchant
is able to, and maintains rules pursuant
to which the futures commission
merchant is required to, identify each
Business Day, for each Cleared Swaps
Customer, the amount of collateral
posted in excess of the amount required
by the derivatives clearing organization.
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§ 22.14 Futures Commission Merchant
Failure To Meet a Customer Margin Call in
Full.
(a) A Depositing Futures Commission
Merchant which receives a call for
either initial margin or variation margin
with respect to a Cleared Swaps
Customer Account from a Collecting
Futures Commission Merchant, which
call such Depositing Futures
Commission Merchant does not meet in
full, shall, with respect to each Cleared
Swaps Customer of such Depositing
Futures Commission Merchant whose
Cleared Swaps contribute to such
margin call,
(1) Transmit to the Collecting Futures
Commission Merchant an amount equal
to the lesser of
(i) The amount called for; or
(ii) The remaining Cleared Swaps
Collateral on deposit at such Depositing
Futures Commission Merchant for that
Cleared Swaps Customer; and
(2) Advise the Collecting Futures
Commission Merchant of the identity of
each such Cleared Swaps Customer, and
the amount transmitted on behalf of
each such customer.
(b) If the entity acting as Depositing
Futures Commission Merchant
referenced in paragraph (a) of this
section is also a Collecting Futures
Commission Merchant, then:
(1) Such entity shall include in the
transmission required in paragraph
(a)(1) of this section any amount that it
receives, pursuant to paragraph (a)(1) of
this section, from a Depositing Futures
Commission Merchant for which such
entity acts as a Collecting Futures
Commission Merchant; and
(2) Such entity shall present its
Collecting Futures Commission
Merchant with the information that it
receives, pursuant to paragraph (a)(2) of
this section, from a Depositing Futures
Commission Merchant for which such
entity acts as a Collecting Futures
Commission Merchant.
(c) A futures commission merchant
which receives a call for either initial or
variation margin with respect to a
Cleared Swaps Customer Account from
a derivatives clearing organization,
which call such futures commission
merchant does not meet in full, shall,
with respect to each Cleared Swaps
Customer of such futures commission
merchant whose Cleared Swaps
contribute to such margin call:
(1) Transmit to the derivatives
clearing organization an amount equal
to the lesser of
(i) The amount called for; or
(ii) The remaining Cleared Swaps
Collateral on deposit at such futures
commission merchant for each such
Cleared Swaps Customer; and
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(2) Advise the derivatives clearing
organization of the identity of each such
Cleared Swaps Customer, and the
amount transmitted on behalf of each
such customer.
(d) If the futures commission
merchant referenced in paragraph (c) is
a Collecting Futures Commission
Merchant, then:
(1) Such Collecting Futures
Commission Merchant shall include in
the transmission required in paragraph
(c)(1) of this section any amount that it
receives from a Depositing Futures
Commission Merchant pursuant to
paragraph (a)(1) of this section; and
(2) Such Collecting Futures
Commission shall present the
derivatives clearing organization with
the information that it receives from a
Depositing Futures Commission
Merchant pursuant to paragraph (a)(2) of
this section.
(e) If,
(1) On the business day prior to the
business day on which the Depositing
Futures Commission Merchant fails to
meet a margin call with respect to a
Cleared Swaps Customer Account, such
Collecting Futures Commission
Merchant referenced in paragraph (a) of
this section held, with respect to such
account, Cleared Swaps Collateral of a
value no less than the amount specified
in § 22.12(a)(2) of this part, after the
application of haircuts specified by
policies applied by such Collecting
Futures Commission Merchant in its
relationship with the Depositing Futures
Commission Merchant, and
(2) As of the close of business on the
business day on which the margin call
is not met, the market value of the
Cleared Swaps Collateral held by the
derivatives clearing organization or
Collecting Futures Commission
Merchant is, due to changes in such
market value, less than the amount
specified in § 22.12(a)(2) of this part,
then the amount of such collateral
attributable to each Cleared Swaps
Customer pursuant to § 22.12(a)(1) of
this part shall be reduced by the
percentage difference between the
amount specified in § 22.12(a)(2) of this
part and such market value.
(f) If:
(1) On the business day prior to the
business day on which the futures
commission merchant fails to meet a
margin call with respect to a Cleared
Swaps Customer Account, the
derivatives clearing organization
referenced in paragraph (c) of this
section held, with respect to such
account, Cleared Swaps Collateral of a
value no less than the amount specified
in § 22.12(c)(2) of this part, after the
application of haircuts specified by the
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rules and procedures of such derivatives
clearing organization, and
(2) As of the close of business on the
business day on which the margin call
is not met, the market value of the
Cleared Swaps Collateral held by the
derivatives clearing organization is, due
to changes in such market value, less
than the amount specified in
§ 22.12(c)(2) of this part, then the
amount of collateral attributable to each
Cleared Swaps Customer pursuant to
§ 22.12(c)(1) of this part shall be
reduced by the percentage difference
between the amount specified in
§ 22.12(c)(2) and such market value.
(g) A derivatives clearing organization
or Collecting Futures Commission
Merchant is entitled to reasonably rely
upon any information provided by a
defaulting futures commission merchant
under § 22.14. If the defaulting futures
commission merchant does not provide
such information on the date of the
futures commission merchant’s default,
a derivatives clearing organization or
Collecting Futures Commission
Merchant may rely on the information
previously provided to it by the
defaulting futures commission
merchant.
§ 22.15 Treatment of Cleared Swaps
Customer Collateral on an Individual Basis.
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Subject to § 22.3(d) of this part, each
derivatives clearing organization and
each Collecting Futures Commission
Merchant receiving Cleared Swaps
Customer Collateral from a futures
commission merchant shall treat the
value of collateral required with respect
to the portfolio of rights and obligations
arising out of the Cleared Swaps
intermediated for each Cleared Swaps
Customer, and collected from the
futures commission merchant, as
belonging to such customer, and such
amount shall not be used to margin,
guarantee, or secure the Cleared Swaps
or other obligations of the futures
commission merchant or of any other
Cleared Swaps Customer or Customer.
Nothing contained herein shall be
construed to limit, in any way, the right
of a derivatives clearing organization or
Collecting Futures Commission
Merchant to liquidate any or all
positions in a Cleared Swaps Customer
Account in the event of default of a
clearing member or Depositing Futures
Commission Merchant.
§ 22.16
Disclosures to Customers.
(a) A futures commission merchant
shall disclose, to each of its Cleared
Swaps Customers, the governing
provisions, as described in paragraph (c)
of this section, relating to use of Cleared
Swaps Customer Collateral, transfer,
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neutralization of the risks, or liquidation
of Cleared Swaps in the event of a
default by the futures commission
merchant relating to the Cleared Swaps
Customer Account, as well as any
change in such governing provisions.
(b) If the futures commission
merchant referenced in paragraph (a) of
this section is a Depositing Futures
Commission Merchant, then such
futures commission merchant shall
disclose, to each of its Cleared Swaps
Customers, the governing provisions, as
described in paragraph (c) of this
section, relating to use of Cleared Swaps
Customer Collateral, transfer,
neutralization of the risks, or liquidation
of Cleared Swaps in the event of a
default by:
(1) Such futures commission
merchant or
(2) Any relevant Collecting Futures
Commission Merchant relating to the
Cleared Swaps Customer Account, as
well as any change in such governing
provisions.
(c) The governing provisions referred
to in paragraphs (a) and (b) of this
section are the rules of each derivatives
clearing organization, or the provisions
of the customer agreement between the
Collecting Futures Commission
Merchant and the Depositing Futures
Commission Merchant, on or through
which the Depositing Futures
Commission Merchant will intermediate
Cleared Swaps for such Cleared Swaps
Customer.
PART 190—BANKRUPTCY
2. The authority citation for part 190
continues to read as follows:
■
Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g,
7a, 12, 19, and 24, and 11 U.S.C. 362, 546,
548, 556, and 761–766, unless otherwise
noted.
§§ 190.01, 190.02, 190.03, 190.05, 190.06,
190.07, 190.10 [Amended]
3. In 17 CFR part 190:
a. Remove the words ‘‘commodity
account’’ and add, in their place, the
words ‘‘commodity contract account’’
in:
■ i. Sections 190.01(w), (y), and (kk)(6);
■ ii. Sections 190.02(d)(1), (6), and (7);
■ iii. Section 190.06(g)(3); and
■ iv. Section 190.10(d)(1).
■ b. Remove the words ‘‘commodity
futures account’’ and add, in their place,
the words ‘‘commodity contract
account’’ in:
■ i. Section 190.03(a)(2); and
■ ii. Section 190.10(h).
■ c. Remove the words ‘‘commodity
transactions’’ and add, in their place,
the words ‘‘commodity contract
transactions’’ in § 190.02(d)(3).
■
■
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d. Remove the words ‘‘commodity
futures contract’’ and add, in their
place, the words ‘‘commodity contract’’
in § 190.05(a)(1) and (b)(1).
■ e. Remove the words ‘‘commodity
accounts’’ and add, in their place, the
words ‘‘commodity contract accounts’’
in § 190.06(g)(1)(i) and (ii).
■ f. Remove the words ‘‘board of trade’’
and add, in their place, the words
‘‘designated contract market’’ in
§ 190.07(e)(1).
■ g. Remove the words ‘‘contract
market’’ and add, in their place, the
words ‘‘designated contract market’’ in
§ 190.07(e)(2)(ii)(B).
■ 4. In § 190.01,
■ a. Redesignate paragraphs (e) through
(oo) as (f) through (pp);
■ b. Add a new paragraph (e); and
■ c. Revise paragraphs (a), and newly
redesignated paragraphs (f), (cc), (hh),
(ll)(2)(ii), (ll)(4), (ll)(5), and (pp) to read
as follows:
■
§ 190.01
Definitions.
*
*
*
*
*
(a)(1) Account class means each of the
following types of customer accounts
which must be recognized as a separate
class of account by the trustee: futures
accounts, foreign futures accounts,
leverage accounts, delivery accounts as
defined in § 190.05(a)(2) of this part,
and cleared swaps accounts.
(2)(i) To the extent that the equity
balance, as defined in § 190.07 of this
part, of a customer in a commodity
option, as defined in § 1.3 of this
chapter, may be commingled with the
equity balance of such customer in any
domestic commodity futures contract
pursuant to regulations under the Act,
the aggregate shall be treated for
purposes of this part as being held in a
futures account.
(ii) To the extent that such equity
balance of a customer in a commodity
option may be commingled with the
equity balance of such customer in any
cleared swaps account pursuant to
regulations under this act, the aggregate
shall be treated for purposes of this part
as being held in a cleared swaps
account.
(iii) If positions or transactions in
commodity contracts that would
otherwise belong to one account class
(and the money, securities, or other
property margining, guaranteeing, or
securing such positions or transactions),
are, pursuant to a Commission rule,
regulation, or order (or a derivatives
clearing organization rule approved in
accordance with § 39.15(b)(2) of this
chapter), held separately from other
positions and transactions in that
account class, and are commingled with
positions or transactions in commodity
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contracts of another account class (and
the money, securities, or other property
margining, guaranteeing, or securing
such positions or transactions), then the
former positions (and the relevant
money, securities, or other property)
shall be treated, for purposes of this
part, as being held in an account of the
latter account class.
*
*
*
*
*
(e) Calendar day. A calendar day
includes the time from midnight to
midnight.
(f) Clearing organization shall have
the same meaning as that set forth in
section 761(2) of the Bankruptcy Code.
*
*
*
*
*
(cc) Non-public customer means any
person enumerated in the definition of
Proprietary Account in § 1.3 or § 31.4(e)
of this chapter, any person excluded
from the definition of ‘‘foreign futures or
foreign options customer’’ in the proviso
to section 30.1(c) of this chapter, or any
person enumerated in the definition of
Cleared Swaps Proprietary Account in
§ 22.1 of this chapter, in each case, if
such person is defined as a ‘‘customer’’
under paragraph (k) of this section.
*
*
*
*
*
(hh) Principal contract means a
contract which is not traded on a
designated contract market, and
includes leverage contracts and dealer
options, but does not include:
(1) Transactions executed off the floor
of a designated contract market
pursuant to rules approved by the
Commission or rules which the
designated contract market is required
to enforce, or pursuant to rules of a
foreign board of trade located outside
the United States, its territories or
possessions; or
(2) Cleared swaps contracts.
*
*
*
*
*
(ll) * * *
(2) * * *
(ii) Is a bona fide hedging position or
transaction as defined in § 1.3 of this
chapter or is a commodity option
transaction which has been determined
by the registered entity to be
economically appropriate to the
reduction of risks in the conduct and
management of a commercial enterprise
pursuant to rules which have been
approved by the Commission pursuant
to section 5c(c) of the Commodity
Exchange Act; and
*
*
*
*
*
(4) Any cash or other property
deposited prior to the entry of the order
for relief to pay for the taking of
physical delivery on a long commodity
contract or for payment of the strike
price upon exercise of a short put or a
long call option contract on a physical
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commodity, which cannot be settled in
cash, in excess of the amount necessary
to margin such commodity contract
prior to the notice date or exercise date,
which cash or other property is
identified on the books and records of
the debtor as received from or for the
account of a particular customer on or
after three calendar days before the first
notice date or three calendar days before
the exercise date specifically for the
purpose of payment of the notice price
upon taking delivery or the strike price
upon exercise, respectively, and such
customer takes delivery or exercises the
option in accordance with the
applicable designated contract market
rules.
(5) The cash price tendered for any
property deposited prior to the entry of
the order for relief to make physical
delivery on a short commodity contract
or for exercise of a long put or a short
call option contract on a physical
commodity, which cannot be settled in
cash, to the extent it exceeds the amount
necessary to margin such contract prior
to the notice date or exercise date,
which property is identified on the
books and records of the debtor as
received from or for the account of a
particular customer on or after three
calendar days before the first notice date
or three calendar days before the
exercise date specifically for the
purpose of a delivery or exercise,
respectively, and such customer makes
delivery or exercises the option in
accordance with the applicable contract
market rules.
*
*
*
*
*
(pp) Cleared Swap. This term shall
have the same meaning as set forth in
§ 22.1 of this chapter.
■ 5. In § 190.02, revise paragraphs (a),
(b)(1), (b)(2), (d)(11), (e), (f)(1)(i), (f)(1(ii)
and (g)(2)(i) to read as follows:
§ 190.02 Operation of the debtor’s estate
subsequent to the filing date and prior to
the primary liquidation date.
*
*
*
*
*
(a) Notices to the Commission and
Designated Self-Regulatory
Organizations.
(1) General. Each commodity broker
which files a petition in bankruptcy
shall, at or before the time of such filing,
and each commodity broker against
which such a petition is filed shall, as
soon as possible, but no later than one
calendar day after the receipt of notice
of such filing, notify the Commission
and such broker’s designated selfregulatory organization, if any, in
accordance with § 190.10(a) of the filing
date, the court in which the proceeding
has been filed, and the docket number
assigned to that proceeding by the court.
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(2) Of transfers under section 764(b)
of the Bankruptcy Code. As soon as
possible, but in no event later than the
close of business on third calendar day
after the order for relief, the trustee, the
applicable self-regulatory organization,
or the commodity broker must notify the
Commission in accordance with
§ 190.10(a) whether such entity or
organization intends to transfer or to
apply to transfer open commodity
contracts on behalf of the commodity
broker in accordance with section
764(b) of the Bankruptcy Code and
§ 190.06 (e) or (f).
(b) Notices to customers. (1)
Specifically identifiable property other
than commodity contracts. The trustee
must use its best efforts to promptly, but
in no event later than two calendar days
after entry of the order for relief,
commence to publish in a daily
newspaper or newspapers of general
circulation approved by the court
serving the location of each branch
office of the commodity broker, for two
consecutive days a notice to customers
stating that all specifically identifiable
property of customers other than open
commodity contracts which has not
otherwise been liquidated will be
liquidated commencing on the sixth
calendar day after the second
publication date if the customer has not
instructed the trustee in writing on or
before the fifth calendar day after the
second publication date to return such
property pursuant to the terms for
distribution of specifically identifiable
property contained in § 190.08(d)(1)
and, on the seventh calendar day after
such second publication date, if such
property has not been returned in
accordance with such terms on or prior
to that date. Such notice must describe
specifically identifiable property in
accordance with the definition in this
part and must specify the terms upon
which that property may be returned.
Publication of the form of notice set
forth in the appendix to this part will
constitute sufficient notice for purposes
of this paragraph (b)(1).
(2) Request for instructions regarding
transfer of open commodity contracts.
The trustee must use its best efforts to
request promptly, but in no event later
than two calendar days after entry of an
order for relief, customer instructions
concerning the transfer or liquidation of
the specifically identifiable open
commodity contracts, if any, not
required to be liquidated under
paragraph (f)(1) of this section. The
request for customer instructions
required by this paragraph (b)(2) must
state that the trustee is required to
liquidate any such commodity contract
for which transfer instructions have not
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been received on or before the seventh
calendar day after entry of the order for
relief, at an hour specified by the
trustee, and any such commodity
contract for which instructions have
been received which has not been
transferred in accordance with
§ 190.08(d)(2) on or before the seventh
calendar day after entry of the order for
relief. A form of notice is set forth in the
appendix to this part.
*
*
*
*
*
(d) * * *
(11) Whether the claimant’s positions
in security futures products are held in
a futures account or a securities
account, as these terms are defined in
§ 1.3 of this chapter;
*
*
*
*
*
(e) Transfers—(1) All cases. The
trustee for a commodity broker must
immediately use its best efforts to effect
a transfer in accordance with § 190.06
(e) and (f) no later than the seventh
calendar day after the order for relief of
the open commodity contracts and
equity held by the commodity broker for
or on behalf of its customers.
(2) Involuntary cases. A commodity
broker against which an involuntary
petition in bankruptcy is filed, or the
trustee if a trustee has been appointed
in such case, must use its best efforts to
effect a transfer in accordance with
§ 190.06 (e) and (f) of all open
commodity contracts and equity held by
the commodity broker for or on behalf
of its customers and such other property
as the Commission in its discretion may
authorize, on or before the seventh
calendar day after the filing date, and
immediately cease doing business:
Provided, however, That the commodity
broker may trade for liquidation only,
unless otherwise directed by the
Commission, by any applicable selfregulatory organization or by the court:
And, Provided further, That if the
commodity broker demonstrates to the
Commission within such period that it
was in compliance with the segregation
and financial requirements of this
chapter on the filing date, and the
Commission determines, in its sole
discretion, that such transfer or
liquidation is neither appropriate nor in
the public interest, the commodity
broker may continue in business subject
to applicable provisions of the
Bankruptcy Code and of this chapter.
(f) * * *
(1) * * *
(i) Dealer option contracts, if the
dealer option grantor is not the debtor,
which cannot be transferred on or before
the seventh calendar day after the order
for relief; and
(ii) Specifically identifiable
commodity contracts as defined in
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§ 190.01(kk)(2) for which an instruction
prohibiting liquidation is noted
prominently in the accounting records
of the debtor and timely received under
paragraph (b)(2) of this section.
Notwithstanding the foregoing, an open
commodity contract must be offset if:
such contract is a futures contract or a
Cleared Swaps contract which cannot be
settled in cash and which would
otherwise remain open either beyond
the last day of trading (if applicable), or
the first day on which notice of intent
to deliver may be tendered with respect
thereto, whichever occurs first; such
contract is a long option on a physical
commodity which cannot be settled in
cash and would be automatically
exercised, has value and would remain
open beyond the last day for exercise;
such contract is a short option on a
physical commodity which cannot be
settled in cash; or, as otherwise
specified in these rules.
*
*
*
*
*
(g) * * *
(2) * * *
(i) 100% of the maintenance margin
requirements of the applicable
designated contact market or swap
execution facility, if any, with respect to
the open commodity contracts in such
account; or
*
*
*
*
*
■ 6. In § 190.03, revise paragraphs (a)(3),
(b)(3), (b)(4), (b)(5), and (c) to read as
follows:
§ 190.03 Operation of the debtor’s estate
subsequent to the primary liquidation date.
*
*
*
*
*
(a) * * *
(3) Margin calls. The trustee must
promptly issue margin calls with
respect to any account referred to under
paragraph (a)(1) of this section in which
the balance does not equal or exceed
100% of the maintenance margin
requirements of the applicable
designated contact market or swap
execution facility, if any, with respect to
the open commodity contracts in such
account, or if there are no such
maintenance margin requirements,
100% of the clearing organization’s
initial margin requirements applicable
to the open commodity contracts in
such account, or if there are no such
maintenance margin requirements or
clearing organization initial margin
requirements, then 50% of the customer
initial margin applicable to the
commodity contracts in such account:
Provided, That no margin calls need be
made to restore customer initial margin.
*
*
*
*
*
(b) * * *
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(3) The trustee has received no
customer instructions with respect to
such contract by the sixth calendar day
after entry of the order for relief;
(4) The commodity contract has not
been transferred in accordance with
§ 190.08(d)(2) on or before the seventh
calendar day after entry of the order for
relief; or
(5) The commodity contract would
otherwise remain open (e.g., because it
cannot be settled in cash) beyond the
last day of trading in such contract (if
applicable) or the first day on which
notice of delivery may be tendered with
respect to such contract, whichever
occurs first.
(c) Liquidation of specifically
identifiable property other than open
commodity contracts. All specifically
identifiable property other than open
commodity contracts which have not
been liquidated prior to the primary
liquidation date, and for which no
customer instructions have been timely
received must be liquidated, to the
extent reasonably possible, no later than
the sixth calendar day after final
publication of the notice referred to in
§ 190.02(b)(1). All other specifically
identifiable property must be liquidated
or returned, to the extent reasonably
possible, no later than the seventh
calendar day after final publication of
such notice.
■ 7. In § 190.04, revise paragraph (d)(1)
to read as follows:
§ 190.04 Operation of the debtor’s estate—
general.
*
*
*
*
*
(d) Liquidation — (1) Order of
Liquidation. (i) In the Market.
Liquidation of open commodity
contracts held for a house account or
customer account by or on behalf of a
commodity broker which is a debtor
shall be accomplished pursuant to the
rules of a clearing organization, a
designated contract market, or a swap
execution facility, as applicable. Such
rules shall ensure that the process for
liquidating open commodity contracts,
whether for the house account or the
customer account, results in competitive
pricing, to the extent feasible under
market conditions at the time of
liquidation. Such rules must be
submitted to the Commission for
approval, pursuant to section 5c(c) of
the Act, and be approved by the
Commission. Alternatively, such rules
must otherwise be submitted to and
approved by the Commission (or its
delegate pursuant to § 190.10(d) of this
part) prior to their application.
(ii) Book entry. Notwithstanding
paragraph (d)(1) of this section, in
appropriate cases, upon application by
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the trustee or the affected clearing
organization, the Commission may
permit open commodity contracts to be
liquidated, or settlement on such
contracts to be made, by book entry.
Such book entry shall offset open
commodity contracts, whether matched
or not matched on the books of the
commodity broker, using the settlement
price for such commodity contracts as
determined by the clearing organization.
Such settlement price shall be
determined by the rules of the clearing
organization, which shall ensure that
such settlement price is established in a
competitive manner, to the extent
feasible under market conditions at the
time of liquidation. Such rules must be
submitted to the Commission for
approval pursuant to section 5c(c) of the
Act, and be approved by the
Commission. Alternatively, such rules
must otherwise be approved by the
Commission (or its delegate pursuant to
§ 190.10(d) of this part) prior to their
application.
*
*
*
*
*
■ 8. In § 190.05, revise paragraph (b)
introductory text to read as follows:
§ 190.05 Making and taking delivery on
commodity contracts.
*
*
*
*
*
(b) Rules for deliveries on behalf of a
customer of a debtor. Except in the case
of a commodity contract which is
settled in cash, each designated contract
market, swap execution facility, or
clearing organization shall adopt,
maintain in effect and enforce rules
which have been submitted in
accordance with section 5c(c) of the Act
for approval by the Commission, which:
*
*
*
*
*
■ 9. In § 190.06,
■ a. Remove paragraph (e)(1)(iv) and
redesignate paragraph (e)(1)(v) as
(e)(1)(iv);
■ b. Revise paragraphs (a), (e)(1)(iii),
(e)(2), (f)(3)(i), (g)(2) and
■ c. Add paragraph (g)(1)(iii) to read as
follows:
srobinson on DSK4SPTVN1PROD with RULES3
§ 190.06
Transfers.
(a) Transfer rules. No clearing
organization or other self-regulatory
organization may adopt, maintain in
effect or enforce rules which:
(1) Are inconsistent with the
provisions of this part;
(2) Interfere with the acceptance by its
members of open commodity contracts
and the equity margining or securing
such contracts from futures commission
merchants, or persons which are
required to be registered as futures commission merchants, which are required
to transfer accounts pursuant to
§ 1.17(a)(4) of this chapter; or
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(3) Prevent the acceptance by its
members of transfers of open
commodity contracts and the equity
margining or securing such contracts
from futures commission merchants
with respect to which a petition in
bankruptcy has been filed, if such
transfers have been approved by the
Commission. Provided, however, that
this paragraph shall not limit the
exercise of any contractual right of a
clearing organization or other registered
entity to liquidate open commodity
contracts.
*
*
*
*
*
(e) * * *
(1) * * *
(iii) Dealer option accounts, if the
debtor is the dealer option grantor with
respect to such accounts; or
*
*
*
*
*
(2) Amount of equity which may be
transferred. In no case may money,
securities or property be transferred in
respect of any eligible account if the
value of such money, securities or
property would exceed the funded
balance of such account based on
available information as of the calendar
day immediately preceding transfer less
the value on the date of return or
transfer of any property previously
returned or transferred with respect
thereto.
(f) * * *
(3) * * *
(i) Of the customer estate. If all
eligible customer accounts held by a
debtor cannot be transferred under this
section, a partial transfer may
nonetheless be made. The Commission
will not disapprove such a transfer for
the sole reason that it was a partial
transfer if it would prefer the transfer of
accounts, the liquidation of which could
adversely affect the market or the
bankrupt estate. Any dealer option
contract held by or for the account of a
debtor which is a futures commission
merchant from or for the account of a
customer which has not previously been
transferred, and is eligible for transfer,
must be transferred on or before the
seventh calendar day after entry of the
order for relief.
*
*
*
*
*
(g) * * *
(1) * * *
(iii) The transfer prior to the order for
relief by a clearing organization of one
or more accounts held for or on behalf
of customers of the debtor, provided
that (I) the money, securities, or other
property accompanying such transfer
did not exceed the funded balance of
each account based on available
information as of the close of business
on the business day immediately
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preceding such transfer less the value
on the date of return or transfer of any
property previously returned or
transferred thereto, and (II) the transfer
is not disapproved by the Commission.
(2) Post-relief transfers. On or after the
entry of the order for relief, the
following transfers to one or more
transferees may not be avoided by the
trustee:
(i) The transfer of a customer account
eligible to be transferred under
paragraph (e) or (f) of this section made
by the trustee of the commodity broker
or by any self-regulatory organization of
the commodity broker:
(A) On or before the seventh calendar
day after the entry of the order for relief;
and
(B) The Commission is notified in
accordance with § 190.02(a)(2) prior to
the transfer and does not disapprove the
transfer; or
(ii) The transfer of a customer account
at the direction of the Commission on or
before the seventh calendar day after the
order for relief upon such terms and
conditions as the Commission may
deem appropriate and in the public
interest.
*
*
*
*
*
■ 10. In § 190.07,
■ a. Redesignate paragraph (b)(2)(xiii) as
paragraph (b)(2)(xiv);
■ b. Add a new paragraph (b)(2)(xiii);
and
■ c. Revise paragraphs (b)(2)(viii),
(b)(2)(ix), (b)(3)(v), (c)(1)(i), (e)
introductory text, (e)(1) and (e)(4) to
read as follows:
§ 190.07
Calculation of allowed net equity.
*
*
*
*
*
(b) * * *
(2) * * *
(viii) Subject to paragraph (b)(2)(ix) of
this section, the futures accounts,
leverage accounts, options accounts,
foreign futures accounts, delivery
accounts (as defined in § 190.05(a)(2)),
and cleared swaps accounts of the same
person shall not be deemed to be held
in separate capacities: Provided,
however, that such accounts may be
aggregated only in accordance with
paragraph (b)(3) of this section.
(ix) An omnibus customer account of
a futures commission merchant
maintained with a debtor shall be
deemed to be held in a separate capacity
from the house account and any other
omnibus customer account of such
futures commission merchant.
*
*
*
*
*
(xiii) With respect to the cleared
swaps account class, each individual
customer account within each omnibus
customer account referred to in
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paragraph (ix) of this section shall be
deemed to be held in a separate capacity
from each other such individual
customer account; subject to the
provisions of paragraphs (b)(2)(i)
through (xii) of this paragraph (b)(2).
*
*
*
*
*
(3) * * *
(v) The rules pertaining to separate
capacities and permitted setoffs
contained in this section must be
applied subsequent to the entry of an
order for relief; prior to the filing date,
the provisions of § 1.22 of this chapter
and of sections 4d(a)(2) and 4d(f) of the
Act (and, in each case, the regulations
promulgated thereunder) shall govern
what setoffs are permitted.
*
*
*
*
*
(c) * * *
(1) * * *
(i) Multiplying the ratio of the amount
of the net equity claim less the amounts
referred to in paragraph (c)(1)(ii) of this
section of such customer for any
account class bears to the sum of the net
equity claims less the amounts referred
to in paragraph (c)(1)(ii) of this section
of all customers for accounts of that
class by the sum of:
(A) The value of the money, securities
or property segregated on behalf of all
accounts of the same class less the
amounts referred to in paragraph
(c)(1)(ii) of this section;
(B) The value of any money, securities
or property which must be allocated
under § 190.08 to customer accounts of
the same class; and
(C) The amount of any add-back
required under paragraph (b)(4) of this
section; and
*
*
*
*
*
(e) Valuation. In computing net
equity, commodity contracts and other
property held by or for a commodity
broker must be valued as provided in
this paragraph (e): Provided, however,
that for all commodity contracts other
than those listed in paragraph (e)(1) of
this section, if identical commodity
contracts, securities, or other property
are liquidated on the same date, but
cannot be liquidated at the same price,
the trustee may use the weighted
average of the liquidation prices in
computing the net equity of each
customer holding such contracts,
securities, or property.
(1) Commodity Contracts. Unless
otherwise specified in this paragraph
(e), the value of an open commodity
contract shall be equal to the settlement
price as calculated by the clearing
organization pursuant to its rules:
Provided, that such rules must either be
submitted to the Commission, pursuant
to section 5c(c)(4) of the Act and be
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approved by the Commission, or such
rules must be otherwise approved by the
Commission (or its delegate pursuant to
§ 190.10(d) of this part) prior to their
application; Provided, further, that if
such contract is transferred its value
shall be determined as of the end of the
settlement cycle in which it is
transferred; and Provided, finally, that if
such contract is liquidated, its value
shall be equal to the net proceeds of
liquidation.
*
*
*
*
*
(4) Securities. The value of a listed
security shall be equal to the closing
price for such security on the exchange
upon which it is traded. The value of all
securities not traded on an exchange
shall be equal in the case of a long
position, to the average of the bid prices
for long positions, and in the case of a
short position, to the average of the
asking prices for the short positions. If
liquidated prior to the primary
liquidation date, the value of such
security shall be equal to the net
proceeds of its liquidation. Securities
which are not publicly traded shall be
valued by the trustee, subject to
approval of the court, using such
professional assistance as the trustee
deems necessary in its sole discretion
under the circumstances.
*
*
*
*
*
11. In § 190.09, revise paragraph (b) to
read as follows:
■
§ 190.09
Member property.
*
*
*
*
*
(b) Scope of Member Property.
Member property shall include all
money, securities and property
received, acquired, or held by a clearing
organization to margin, guarantee or
secure, on behalf of a clearing member,
the proprietary account, as defined in
§ 1.3 of this chapter, any account not
belonging to a foreign futures or foreign
options customer pursuant to the
proviso in § 30.1(c), and any Cleared
Swaps Proprietary Account, as defined
in § 22.1: Provided, however, that any
guaranty deposit or similar payment or
deposit made by such member and any
capital stock, or membership of such
member in the clearing organization
shall also be included in member
property after payment in full of that
portion of the net equity claim of the
member based on its customer account
and of any obligations due to the
clearing organization which may be
paid therefrom in accordance with the
by-laws or rules of the clearing
organization, including obligations due
from the clearing organization to
customers or other members.
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12. In § 190.10, revise paragraph (a) to
read as follows:
■
§ 190.10
General.
(a) Notices. Unless instructed
otherwise by the Commission, all
mandatory or discretionary notices to be
given to the Commission under this part
shall be directed by electronic mail to
bankruptcyfilings@cftc.gov, with a copy
sent by overnight mail to Director,
Division of Clearing and Risk,
Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street NW., Washington, DC
20581. For purposes of this part, notice
to the Commission shall be deemed to
be given only upon actual receipt.
*
*
*
*
*
■ 13. Revise appendix A to part 190 to
read as follows:
Appendix A to Part 190—Bankruptcy
Forms
Bankruptcy Appendix Form 1—Operation of
the Debtor’s Estate—Schedule of Trustee’s
Duties
For the convenience of a prospective
trustee, the Commission has constructed an
approximate schedule of important duties
which the trustee should perform during the
early stages of a commodity broker
bankruptcy proceeding. The schedule
includes duties required by this part,
subchapter IV of chapter 7 of the Bankruptcy
Code as well as certain practical suggestions,
but it is only intended to highlight the more
significant duties and is not an exhaustive
description of all the trustee’s
responsibilities. It also assumes that the
commodity broker being liquidated is an
FCM. Moreover, it is important to note that
the operating facts in a particular bankruptcy
proceeding may vary the schedule or obviate
the need for any of the particular activities.
All Cases
Date of Order for Relief
1. Assure that the commodity broker has
notified the Commission, its designated selfregulatory organization (‘‘DSRO’’) (if any),
and all applicable clearing organizations of
which it is a member that a petition or order
for relief has been filed (§ 190.02(a)(1)).
2. Attempt to effectuate the transfer of
entire customer accounts wherein the
commodity contracts are transferred together
with the money, securities, or other property
margining, guaranteeing, or securing the
commodity contracts (hereinafter the
‘‘transfer’’).
3. Attempt to estimate shortfall of customer
funds segregated pursuant to sections 4d(a)
and (b) of the Act; customer funds segregated
pursuant to section 4f of the Act; and the
foreign futures or foreign options secured
amount, as defined in § 1.3 of this chapter.
a. The trustee should:
i. Contact the DSRO (if any) and the
clearing organizations and attempt to
effectuate a transfer with such shortfall under
section 764(b) of the Code; notify the
Commission for assistance (§ 190.02(a)(2) and
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(e)(1), § 190.06(b)(2), (e), (f)(3), (g)(2), and (h))
but recognize that if there is a substantial
shortfall, a transfer of such funds or amounts
is highly unlikely.
ii. If a transfer cannot be effectuated,
liquidate all customer commodity contracts
that are margined, guaranteed, or secured by
funds or amounts with such shortfall, except
dealer options and specifically identifiable
commodity contracts which are bona fide
hedging positions (as defined in
§ 190.01(kk)(2)) with instructions not to be
liquidated. (See §§ 190.02(f) and
190.06(d)(1)). (In this connection, depending
upon the size of the debtor and other
complications of liquidation, the trustee
should be aware of special liquidation rules,
and in particular the availability under
certain circumstances of book-entry
liquidation (§ 190.04(d)(1)(ii)).
b. If there is a small shortfall in any of the
funds or amounts listed in paragraph 2,
negotiate with the clearing organization to
effect a transfer; notify the Commission
(§§ 190.02(a)(2) and (e)(1), 190.06(b)(2), (e),
(f)(3), (g)(2), and (h)).
4. Whether or not a transfer has occurred,
liquidate or offset open commodity contracts
not eligible for transfer (e.g., deficit accounts)
(§ 190.06(e)(1)).
5. Offset all futures contracts and Cleared
Swaps contracts which cannot be settled in
cash and which would otherwise remain
open either beyond the last day of trading (if
applicable) or the first day on which notice
of intent to deliver may be tendered with
respect thereto, whichever occurs first; offset
all long options on a physical commodity
which cannot be settled in cash, have value
and would be automatically exercised or
would remain open beyond the last day of
exercise; and offset all short options on a
physical commodity which cannot be settled
in cash (§ 190.02(f)(1)).
6. Compute estimated funded balance for
each customer commodity contract account
containing open commodity contracts
(§ 190.04(b)) (daily thereafter).
7. Make margin calls if necessary
(§ 190.02(g)(1)) (daily thereafter).
8. Liquidate or offset any open commodity
contact account for which a customer has
failed to meet a margin call (§ 190.02(f)(1))
(daily thereafter).
9. Commence liquidation or offset of
specifically identifiable property described in
§ 190.02(f)(2)(i) (property which has lost 10%
or more of value) (and as appropriate
thereafter).
10. Commence liquidation or offset of
property described in § 190.02(f)(3) (‘‘all
other property’’).
11. Be aware of any contracts in delivery
position and rules pertaining to such
contracts (§ 190.05).
First Calendar Day After the Entry of an
Order for Relief
1. If a transfer occurred on the date of entry
of the order for relief:
a. Liquidate any remaining open
commodity contracts, except any dealer
option or specifically identifiable commodity
contract [hedge] (See § 190.01(kk)(2) and
§ 190.02(f)(1)), and not otherwise transferred
in the transfer.
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b. Primary liquidation date for transferred
or liquidated commodity contracts
(§ 190.01(ff)).
2. If no transfer has yet been effected,
continue attempt to negotiate transfer of open
commodity contracts and dealer options
(§ 190.02(c)(1)).
3. Provide the clearing organization or
Collecting Futures Commission Merchant (as
such term is defined in § 22.1) with
assurances to prevent liquidation of open
commodity contract accounts available for
transfer at the customer’s instruction or
liquidate all open commodity contracts
except those available for transfer at a
customer’s instruction and dealer options.
Second Calendar Day After the Entry of an
Order for Relief
If no transfer has yet been effected, request
directly customer instructions regarding
transfer of open commodity contracts and
publish notice for customer instructions
regarding the return of specifically
identifiable property other than commodity
contracts (§§ 190.02(b) (1) and (2)).
Third Calendar Day After the Entry of an
Order for Relief
1. Second publication date for customer
instructions (§ 190.02(b)(1)) (publication is to
be made on two consecutive days, whether
or not the second day is a business day).
2. Last day on which to notify the
Commission with regard to whether a
transfer in accordance with section 764(b) of
the Bankruptcy Code will take place
(§ 190.02(a)(2) and § 190.06(e)).
Sixth Calendar Day After the Entry of an
Order for Relief
Last day for customers to instruct the
trustee concerning open commodity contracts
(§ 190.02(b)(2)).
Seventh Calendar Day After the Entry of an
Order for Relief
1. If not previously concluded, conclude
transfers under § 190.06(e) and (f). (See
§ 190.02(e)(1) and § 190.06(g)(2)(i)(A)).
2. Transfer all open dealer option contracts
which have not previously been transferred
(§ 190.06(f)(3)(i)).
3. Primary liquidation date (§ 190.01(ff))
(assuming no transfers and liquidation
effected for all open commodity contracts for
which no customer instructions were
received by the sixth calendar day).
4. Establishment of transfer accounts
(§ 190.03(a)(1)) (assuming this is the primary
liquidation date); mark such accounts to
market (§ 190.03(a)(2)) (daily thereafter until
closed).
5. Liquidate or offset all remaining open
commodity contracts (§ 190.02(b)(2)).
6. If not done previously, notify customers
of bankruptcy and request customer proof of
claim (§ 190.02(b)(4)).
Eighth Calendar Day After the Entry of an
Order for Relief
Customer instructions due to trustee
concerning specifically identifiable property
(§ 190.02(b)(1)).
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Ninth Calendar Day After the Entry of an
Order for Relief
Commence liquidation of specifically
identifiable property for which no
arrangements for return have been made in
accordance with customer instructions
(§§ 190.02(b)(1), 190.03(c)).
Tenth Calendar Day After the Entry of an
Order for Relief
Complete liquidation to the extent
reasonably possible of specifically
identifiable property which has yet to be
liquidated and for which no customer
instructions have been received (§ 190.03(c)).
Separate Procedures for Involuntary Petitions
for Bankruptcy
1. Within one calendar day after notice of
receipt of filing of the petition in bankruptcy,
the trustee should assure that proper
notification has been given to the
Commission, the commodity broker’s
designated self-regulatory organization
(§ 190.02(a)(1)) (if any), and all applicable
clearing organizations; margin calls should
be issued if necessary (§ 190.02(g)(2)).
2. On or before the seventh calendar day
after the filing of a petition in bankruptcy,
the trustee should use his best efforts to effect
a transfer in accordance with § 190.06(e) and
(f) of all open commodity contracts and
equity held for or on behalf of customers of
the commodity broker (§ 190.02(e)(2)) unless
the debtor can provide certain assurances to
the trustee.
Bankruptcy Appendix Form 2— Request for
Instructions Concerning Non-Cash Property
Deposited With (Commodity Broker)
Please take notice: On (date), a petition in
bankruptcy was filed by [against]
(commodity broker). Those customers of
(commodity broker) who deposited certain
kinds of non-cash property (see below) with
(commodity broker) may instruct the trustee
of the estate to return their property to them
as provided below.
As no customer may obtain more than his
or her proportionate share of the property
available to satisfy customer claims, if you
instruct the trustee to return your property to
you, you will be required to pay the estate,
as a condition to the return of your property,
an amount determined by the trustee. If your
property is not margining an open contract,
this amount will approximate the difference
between the market value of your property
and your pro rata share of the estate, as
estimated by the trustee. If your property is
margining an open commodity contract, this
amount will be approximately the full fair
market value of the property on the date of
its return.
Kinds of Property to Which This Notice
Applies
1. Any security deposited as margin which,
as of (date petition was filed), was securing
an open commodity contract and is:
—registered in your name,
—not transferrable by delivery, and
—not a short-term obligation.
2. Any fully-paid, non-exempt security
held for your account in which there were no
open commodity contracts as of (date
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petition was filed). (Rather than the return,
at this time, of the specific securities you
deposited with (commodity broker), you may
instead request now, or at any later time, that
the trustee purchase ‘‘like-kind’’ securities of
a fair market value which does not exceed
your proportionate share of the estate).
3. Any warehouse receipt, bill of lading or
other document of title deposited as margin
which, as of (date petition was filed), was
securing an open commodity contract and—
can be identified in (commodity broker)’s
records as being held for your account, and—
is neither in bearer form nor otherwise
transferable by delivery.
4. Any warehouse receipt bill of lading or
other document of title, or any commodity
received, acquired or held by (commodity
broker) to make or take delivery or exercise
from or for your account and which—can be
identified in (commodity broker)’s records as
received from or for your account as held
specifically for the purpose of delivery or
exercise.
5. Any cash or other property deposited to
make or take delivery on a commodity
contract may be eligible to be returned. The
trustee should be contacted directly for
further information if you have deposited
such property with (commodity broker) and
desire its return.
Instructions must be received by (the 5th
calendar day after 2d publication date) or the
trustee will liquidate your property. (If you
own such property but fail to provide the
trustee with instructions, you will still have
a claim against (commodity broker) but you
will not be able to have your specific
property returned to you).
Note: Prior to receipt of your instructions,
circumstances may require the trustee to
liquidate your property, or transfer your
property to another broker if it is margining
open commodity contracts. If your property
is transferred and your instructions were
received within the required time, your
instructions will be forwarded to the new
broker.
Instructions should be directed to:
(Trustee’s name, address, and/or telephone).
Even if you request the return of your
property, you must also pay the trustee the
amount he specifies and provide the trustee
with proof of your claim before (the 7th
calendar day after 2d publication date) or
your property will be liquidated. (Upon
receipt of customer instructions to return
property, the trustee will mail the sender a
form which describes the information he
must provide to substantiate his claim).
Note: The trustee is required to liquidate
your property despite the timely receipt of
your instructions, money, and proof of claim
if, for any reason, your property cannot be
returned by (close of business on the 7th
calendar day after 2d publication date).
Bankruptcy Appendix Form 3—Request for
Instructions Concerning Transfer of Your
Hedge Contracts Held by (Commodity
Broker)
United States Bankruptcy Court llDistrict
of llIn re ll, Debtor, No. ll.
Please take notice: On (date), a petition in
bankruptcy was filed by [against]
(commodity broker).
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You indicated when your hedge account
was opened that the commodity contracts in
your hedge account should not be liquidated
automatically in the event of the bankruptcy
of (commodity broker), and that you wished
to provide instructions at this time
concerning their disposition.
Instructions to transfer your commodity
contracts and a cash deposit (as described
below) must be received by the trustee by (the
6th calendar day after entry of order for
relief) or your commodity contracts will be
liquidated.
If you request the transfer of your
commodity contracts, prior to their transfer,
you must pay the trustee in cash an amount
determined by the trustee which will
approximate the difference between the value
of the equity margining your commodity
contracts and your pro rata share of the estate
plus an amount constituting security for the
nonrecovery of any overpayments. In your
instructions, you should specify the broker to
which you wish your commodity contracts
transferred.
Be further advised that prior to receipt of
your instructions, circumstances may, in any
event, require the trustee to liquidate or
transfer your commodity contracts. If your
commodity contracts are so transferred and
your instructions are received, your
instructions will be forwarded to the new
broker.
Note also that the trustee is required to
liquidate your positions despite the timely
receipt of your instructions and money if, for
any reason, you have not made arrangements
to transfer and/or your contracts are not
transferred by (7 calendar days after entry of
order for relief).
Instructions should be sent to: (Trustee’s or
designee’s name, address, and/or telephone).
[Instructions may also be provided by
phone].
Bankruptcy Appendix Form 4—Proof of
Claim
[Note to trustee: As indicated in § 190.02(d),
this form is provided as a guide to the
trustee and should be modified as
necessary depending upon the information
which the trustee needs at the time a proof
of claim is requested and the time provided
for a response.]
Proof of Claim
United States Bankruptcy Court llDistrict
of llIn re ll, Debtor, No. ll.
Return this form by ll or your claim will
be barred (unless extended, for good cause
only).
I. [If claimant is an individual claiming for
himself] The undersigned, who is the
claimant herein, resides at ll.
[If claimant is a partnership claiming
through a member] The undersigned, who
resides at ll, is a member of ll, a
partnership, composed of the undersigned
and ll, of ll, and doing business at ll,
and is duly authorized to make this proof of
claim on behalf of the partnership.
[If claimant is a corporation claiming
though a duly authorized officer] The
undersigned, who resides at ll is the ll
of ll, a corporation organized under the
laws of ll and doing business at ll, and
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is duly authorized to make this proof of claim
on behalf of the corporation.
[If claim is made by agent] The
undersigned, who resides at ll, is the agent
of ll, and is duly authorized to make this
proof of claim on behalf of the claimant.
II. The debtor was, at the time of the filing
of the petition initiating this case, and still
is, indebted to this claimant for the total sum
of $ ll.
III. List EACH account on behalf of which
a claim is being made by number and name
of account holder[s], and for EACH account,
specify the following information:
a. Whether the account is a futures, foreign
futures, leverage, option (if an option
account, specify whether exchange-traded,
dealer or cleared swap), ‘‘delivery’’ account,
or a cleared swaps account. A ‘‘delivery’’
account is one which contains only
documents of title, commodities, cash, or
other property identified to the claimant and
deposited for the purposes of making or
taking delivery on a commodity underlying
a commodity contract or for payment of the
strike price upon exercise of an option.
b. The capacity in which the account is
held, as follows (and if more than one is
applicable, so state):
1. [The account is held in the name of the
undersigned in his individual capacity];
2. [The account is held by the undersigned
as guardian, custodian, or conservator for the
benefit of a ward or a minor under the
Uniform Gift to Minors Act];
3. [The account is held by the undersigned
as executor or administrator of an estate];
4. [The account is held by the undersigned
as trustee for the trust beneficiary];
5. [The account is held by the undersigned
in the name of a corporation, partnership, or
unincorporated association];
6. [The account is held as an omnibus
customer account of the undersigned futures
commission merchant];
7. [The account is held by the undersigned
as part owner of a joint account];
8. [The account is held by the undersigned
in the name of a plan which, on the date the
petition in bankruptcy was filed, had in
effect a registration statement in accordance
with the requirements of § 1031 of the
Employee Retirement Income Security Act of
1974 and the regulations thereunder]; or
9. [The account is held by the undersigned
as agent or nominee for a principal or
beneficial owner (and not described above in
items 1–8 of this II, b)].
10. [The account is held in any other
capacity not described above in items 1–9 of
this II, b. Specify the capacity].
c. The equity, as of the date the petition in
bankruptcy was filed, based on the
commodity contracts in the account.
d. Whether the person[s] (including a
general partnership, limited partnership,
corporation, or other type of association) on
whose behalf the account is held is one of the
following persons OR whether one of the
following persons, alone or jointly, owns
10% or more of the account:
1. [If the debtor is an individual—
A. Such individual;
B. Relative (as defined below in item 8 of
this III.d) of the debtor or of a general partner
of the debtor;
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C. Partnership in which the debtor is a
general partner;
D. General partner of the debtor; or
E. Corporation of which the debtor is a
director, officer, or person in control];
2. [If the debtor is a partnership—
A. Such partnership;
B. General partner in the debtor;
C. Relative (as defined in item 8 of this
III.d) of a general partner in, general partner
of, or person in control of the debtor;
D. Partnership in which the debtor is a
general partner;
E. General partner of the debtor; or
F. Person in control of the debtor];
3. [If the debtor is a limited partnership—
A. Such limited partnership;
B. A limited or special partner in such
partnership whose duties include:
i. The management of the partnership
business or any part thereof;
ii. The handling of the trades or customer
funds of customers of such partnership;
iii. The keeping of records pertaining to the
trades or customer funds of customers of
such partnership; or
iv. The signing or co-signing of checks or
drafts on behalf of such partnership];
4. [If the debtor is a corporation or
association (except a debtor which is a
futures commission merchant and is also a
cooperative association of producers)—
A. Such corporation or association;
B. Director of the debtor;
C. Officer of the debtor;
D. Person in control of the debtor;
E. Partnership in which the debtor is a
general partner;
F. General partner of the debtor;
G. Relative (as defined in item 8 of this
III.d) of a general partner, director, officer, or
person in control of the debtor;
H. An officer, director or owner of ten
percent or more of the capital stock of such
organization];
5. [If the debtor is a futures commission
merchant which is a cooperative association
of producers—
Shareholder or member of the debtor
which is an officer, director or manager];
6. [An employee of such individual,
partnership, limited partnership, corporation
or association whose duties include:
A. The management of the business of such
individual, partnership, limited partnership,
corporation or association or any part thereof;
B. The handling of the trades or customer
funds of customers of such individual,
partnership, limited partnership, corporation
or association;
C. The keeping of records pertaining to the
trades or funds of customers of such
individual, partnership, limited partnership,
corporation or association; or
D. The signing or co-signing of checks or
drafts on behalf of such individual,
partnership, limited partnership, corporation
or association];
7. [Managing agent of the debtor];
8. [A spouse or minor dependent living in
the same household of ANY OF THE
FOREGOING PERSONS, or any other
relative, regardless of residency, (unless
previously described in items 1–B, 2–C, or 4–
G of this III.d) defined as an individual
related by affinity or consanguinity within
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the third degree as determined by the
common law, or individual in a step or
adoptive relationship within such degree];
9. [‘‘Affiliate’’ of the debtor, defined as:
A. Entity that directly or indirectly owns,
controls, or holds with power to vote, 20
percent or more of the out-standing voting
securities of the debtor, other than an entity
that holds such securities—
i. In a fiduciary or agency capacity without
sole discretionary power to vote such
securities; or
ii. Solely to secure a debt, if such entity has
not in fact exercised such power to vote;
B. Corporation 20 percent or more of
whose outstanding voting securities are
directly or indirectly owned, con-trolled, or
held with power to vote, by the debtor, or by
an entity that directly or indirectly owns,
controls, or holds with power to vote, 20
percent or more of the outstanding voting
securities of the debtor, other than an entity
that holds such securities—
i. In a fiduciary or agency capacity without
sole discretionary power to vote such
securities; or
ii. Solely to secure a debt, if such entity has
not in fact exercised such power to vote;
C. Person whose business is operated
under a lease or operating agreement by the
debtor, or person substantially all of whose
property is operated under an operating
agreement with the debtor;
D. Entity that otherwise, directly or
indirectly, is controlled by or is under
common control with the debtor];
E. Entity that operates the business or all
or substantially all of the property of the
debtor under a lease or operating agreement;
or
F. Entity that otherwise, directly or
indirectly, controls the debtor; or
10. [Any of the persons listed in items 1–
7 above of this III.d if such person is
associated with an affiliate (see item 9 above)
of the debtor as if the affiliate were the
debtor].
e. Whether the account is a discretionary
account. (If it is, the name in which the
‘‘attorney in fact’’ is held).
f. If the account is a joint account, the
amount of the claimant’s percentage interest
in the account. (Also specify whether
participants in a joint account are claiming
separately or jointly).
g. Whether the claimant’s positions in
security futures products are held in a futures
account or securities account, as those terms
are defined in § 1.3 of this chapter.
IV. Describe all claims against the debtor
not based upon a commodity contract
account of the claimant (e.g., if landlord, for
rent; if customer, for misrepresentation or
fraud).
V. Describe all claims of the DEBTOR
against the CLAIMANT not already included
in the equity of a commodity contract
account[s] of the claimant (see III.c above).
VI. Describe any deposits of money,
securities or other property held by or for the
debtor from or for the claimant, and indicate
if any of this property was included in your
answer to III.c above.
VII. Of the money, securities, or other
property described in VI above, identify any
which consists of the following:
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6385
a. With respect to property received,
acquired, or held by or for the account of the
debtor from or for the account of the claimant
to margin, guarantee or secure an open
commodity contract, the following:
1. Any security which as of the filing date
is:
A. Held for the claimant’s account;
B. Registered in the claimant’s name;
C. Not transferable by delivery; and
D. Not a short term obligation; or
2. Any warehouse receipt, bill of lading or
other document of title which as of the filing
date:
A. Can be identified on the books and
records of the debtor as held for the account
of the claimant; and
B. Is not in bearer form and is not
otherwise transferable by delivery.
b. With respect to open commodity
contracts, and except as otherwise provided
below in item g of this VII, any such contract
which:
1. As of the date the petition in bankruptcy
was filed, is identified on the books and
records of the debtor as held for the account
of the claimant;
2. Is a bona fide hedging position or
transaction as defined in Rule 1.3 of the
Commodity Futures Trading Commission
(‘‘CFTC’’) or is a commodity option
transaction which has been determined by a
registered entity to be economically
appropriate to the reduction of risks in the
conduct and management of a commercial
enterprise pursuant to rules which have been
approved by the CFTC pursuant to section
5c(c) of the Commodity Exchange Act;
3. Is in an account designated in the
accounting records of the debtor as a hedging
account.
c. With respect to warehouse receipts, bills
of lading or other documents of title, or
physical commodities received, acquired, or
held by or for the account of the debtor for
the purpose of making or taking delivery or
exercise from or for the claimant’s account,
any such document of title or commodity
which as of the filing date can be identified
on the books and records of the debtor as
received from or for the account of the
claimant specifically for the purpose of
delivery or exercise.
d. Any cash or other property deposited
prior to bankruptcy to pay for the taking of
physical delivery on a long commodity
contract or for payment of the strike price
upon exercise of a short put or a long call
option contract on a physical commodity,
which cannot be settled in cash, in excess of
the amount necessary to margin such
commodity contract prior to the notice date
or exercise date which cash or other property
is identified on the books and records of the
debtor as received from or for the account of
the claimant within three or less days of the
notice date or three or less days of the
exercise date specifically for the purpose of
payment of the notice price upon taking
delivery or the strike price upon exercise.
e. The cash price tendered for any property
deposited prior to bankruptcy to make
physical delivery on a short commodity
contract or for exercise of a long put or a
short call option contract on a physical
commodity, which cannot be settled in cash,
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to the extent it exceeds the amount necessary
to margin such contract prior to the notice
exercise date which property is identified on
the books and records of the debtor as
received from or for the account of the
claimant within three or less days of the
notice date or of the exercise date specifically
for the purpose of a delivery or exercise.
f. Fully paid, non-exempt securities
identified on the books and records of the
debtor as held by the debtor for or on behalf
of the commodity contract account of the
claimant for which, according to such books
and records as of the filing date, no open
commodity contracts were held in the same
capacity.
g. Open commodity contracts transferred to
another futures commission merchant by the
trustee.
VIII. Specify whether the claimant wishes
to receive payment in kind, to the extent
possible, for any claim for securities.
IX. Attach copies of any documents which
support the information provided in this
proof of claim, including but not limited to
customer confirmations, account statements,
and statements of purchase or sale.
This proof of claim must be filed with the
trustee no later than __, or your claim will
be barred unless an extension has been
granted, available only for good cause.
Return this form to:
(Trustee’s name (or designee’s) and address)
llllllllllllllllllll
Dated: lllllllllllllllll
(Signed) llllllllllllllll
Penalty for Presenting Fraudulent Claim.
Fine of not more than $5,000 or
imprisonment for not more than five years
or both—Title 18, U.S.C. 152.
(Approved by the Office of Management and
Budget under control number 3038–0021)
14. Revise appendix B to part 190 to
read as follows:
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Appendix B to Part 190—Special
Bankruptcy Distributions
Framework 1—Special Distribution of
Customer Funds for Futures Contracts When
FCM Participated in Cross-Margining
The Commission has established the
following distributional convention with
respect to ‘‘customer funds’’ (as § 1.3 of this
chapter defines such term) for futures
contracts held by a futures commission
merchant (FCM) that participated in a crossmargining (XM) program which shall apply
if participating market professionals sign an
agreement that makes reference to this
distributional rule and the form of such
agreement has been approved by the
Commission by rule, regulation or order:
All customer funds for futures contracts
held in respect of XM accounts, regardless of
the product that customers holding such
accounts are trading, are required by
Commission order to be segregated separately
from all other customer segregated funds. For
purposes of this distributional rule, XM
accounts will be deemed to be commodity
interest accounts and securities held in XM
accounts will be deemed to be received by
the FCM to margin, guarantee or secure
commodity interest contracts. The
maintenance of property in an XM account
will result in subordination of the claim for
such property to certain non-XM customer
claims and thereby will operate to cause such
XM claim not to be treated as a customer
claim for purposes of the Securities Investors
Protection Act and the XM securities to be
excluded from the securities estate. This
creates subclasses of futures customer
accounts, an XM account and a non-XM
account (a person could hold each type of
account), and results in two pools of
segregated funds belonging to futures
customers: An XM pool and a non-XM pool.
In the event that there is a shortfall in the
non-XM pool of customer class segregated
funds and there is no shortfall in the XM
pool of customer segregated funds, all futures
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customer net equity claims, whether or not
they arise out of the XM subclass of accounts,
will be combined and will be paid pro rata
out of the total pool of available XM and nonXM customer funds for futures contracts. In
the event that there is a shortfall in the XM
pool of customer segregated funds and there
is no shortfall in the non-XM pool of
customer segregated funds, then futures
customer net equity claims arising from the
XM subclass of accounts shall be satisfied
first from the XM pool of customer segregated
funds, and futures customer net equity
claims arising from the non-XM subclass of
accounts shall be satisfied first from the nonXM customer segregated funds. Furthermore,
in the event that there is a shortfall in both
the non-XM and XM pools of customer
segregated funds: (1) If the non-XM shortfall
as a percentage of the segregation
requirement in the non-XM pool is greater
than or equal to the XM shortfall as a
percentage of the segregation requirement in
the XM pool, all futures customer net equity
claims will be paid pro rata; and (2) if the
XM shortfall as a percentage of the
segregation requirement in the XM pool is
greater than the non-XM shortfall as a
percentage of the segregation requirement of
the non-XM pool, non-XM futures customer
net equity claims will be paid pro rata out
of the available non-XM segregated funds,
and XM futures customer net equity claims
will be paid pro rata out of the available XM
segregated funds. In this way, non-XM
customers will never be adversely affected by
an XM shortfall.
The following examples illustrate the
operation of this convention. The examples
assume that the FCM has two customers, one
with exclusively XM accounts and one with
exclusively non-XM accounts. However, the
examples would apply equally if there were
only one customer, with both an XM account
and a non-XM account.
BILLING CODE 6351–01–P
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Issued in Washington, DC on January 11,
2012, by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Protection of Cleared
Swaps Customer Contracts and
Collateral; Conforming Amendments to
the Commodity Broker Bankruptcy
Provisions—Commission Voting
Summary and Statements of
Commissioners
Note: The following appendices will not
appear in the Code of Federal Regulations
Appendix 1—Commission Voting
Summary
On this matter, Chairman Gensler and
Commissioners Chilton, O’Malia and Wetjen
voted in the affirmative; Commissioner
Sommers voted in the negative
Appendix 2—Statement of Chairman
Gary Gensler
I support the final rules on segregation of
customer funds for cleared swaps. These
rules are an important step forward in
protecting customers and reducing the risk of
swaps trading. The rules carry out the DoddFrank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) mandate
that futures commission merchants (FCMs)
and derivatives clearing organizations (DCOs)
segregate customer collateral supporting
cleared swaps. FCMs and DCOs must hold
customer collateral in a separate account
from that belonging to the FCM or DCO. It
prohibits clearing organizations from using
the collateral of non-defaulting, innocent
customers to protect themselves and their
clearing members. For the first time,
customer money must be protected
individually all the way to the clearinghouse.
We received a tremendous amount of
public input on this rule, including through
two roundtables, as well as through
comments on an advanced notice of
proposed rulemaking and a proposal. This
rule builds on customer protections included
in the clearinghouse core principles rule we
finalized in October requiring DCOs to
collect initial margin on a gross basis for their
clearing members’ customer accounts.
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Appendix 3—Statement of
Commissioner Scott D. O’Malia
Today, the Commodity Futures Trading
Commission (the ‘‘Commission’’) is voting to
finalize a rulemaking on protection of cleared
swaps customer collateral.307 Whereas I
support this rulemaking, I believe that it is
important to detail its limitations, so that we
do not offer market participants a misleading
sense of comfort in light of the collapse of
MF Global, Inc. (‘‘MF Global’’). As I will
explain further, the Commission has much
307 Protection of Cleared Swaps Customer
Contracts and Collateral; Conforming Amendments
to the Commodity Broker Bankruptcy Provisions (to
be codified at 17 CFR parts 22 and 190) (referenced
herein as the ‘‘rulemaking’’), available at: https://
www.cftc.gov/PressRoom/Events/opaevent_
cftcdoddfrank011112.
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more work to do to increase confidence in
the customer protections that our regulations
offer.
This rulemaking does not address MF
Global.
First, this rulemaking does not address MF
Global. The rulemaking is entitled, in part,
Protection of Cleared Swaps Customer
Contracts and Collateral. Therefore, it
benefits cleared swaps customers, and not
futures customers (who are bearing the brunt
of MF Global). This rulemaking would not
have prevented a shortfall in the customer
funds of the ranchers and farmers that
transact daily in the futures market. Nor
would it have expedited the transfer of
positions and collateral belonging to such
customers in the event of a collapse similar
to that of MF Global.
This rulemaking may expose swaps
customers to more risk.
Second, this rulemaking only addresses
one of three categories of risk that an
intermediary—like MF Global—can pose to
its customers. The three categories of risk are
(i) ‘‘fellow-customer’’ risk, (ii) operational
risk, and (iii) investment risk. By its own
admission, this rulemaking only protects
against ‘‘fellow-customer’’ risk. It does not
protect against operational risk—namely, the
risk that an intermediary improperly
segregates cleared swaps customer
collateral.308 Moreover, it does not protect
against investment risk—namely, the risk
that an intermediary experiences losses on its
investment of cleared swaps customer
collateral, which it cannot cover using its
capital.309 To be plain, I support limiting
intermediaries from investing customer
collateral in risky instruments—regardless of
whether such collateral margins futures or
¨
swaps contracts.310 However, I am not naıve
enough to believe that such limitations—
without additional Commission oversight or
action—would be sufficient. I have warned
against complacency in the past.311 I reiterate
such warning here.
Under this rulemaking, what happens if an
intermediary—like MF Global—becomes
insolvent as operational or investment
irregularities are revealed? Basically, under
the Bankruptcy Code,312 cleared swaps
customers would share pro rata in any
shortfall. A shortfall would complicate the
porting of cleared swaps customer contracts
and associated collateral, notwithstanding
the enhanced recordkeeping and reporting
requirements of this rulemaking.
By not protecting against operational and
investment risk, this rulemaking may have
the effect of exposing some swaps customers
to more risk than they currently bear in the
308 See section I(D)(2) of the preamble to this
rulemaking.
309 Id.
310 See sections 22.2(e)(1) and 22.3(d) of the rule
text to this rulemaking (to be codified at 17 CFR
22.2(e)(1) and 22.3(d)) (limiting an FCM and a DCO
to investing cleared swaps customer collateral in
instruments enumerated in regulation 1.25).
311 See ‘‘Opening Statement of Commissioner
Scott D. O’Malia’’, dated December 5, 2011,
available at: https://www.cftc.gov/PressRoom/
SpeechesTestimony/omaliastatement120511.
312 See section 766(h) of the Bankruptcy Code, 11
U.S.C. 766(h).
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6407
over-the-counter markets. Since December 2,
2011, we have received eight comment letters
from end-users, many of which explicitly
asked the Commission to not finalize this
rulemaking until it explores other
alternatives that may provide greater
protection.313 These end-users include
Fidelity Investments, the Committee on
Investment of Employee Benefit Assets
(‘‘CIEBA’’), and the Federal Home Loan
Banks. According to many of these comment
letters, swaps customers in the over-thecounter markets currently have the option to
enter into tri-party custody agreements. In
general, these agreements may provide
superior protection to this rulemaking against
not only fellow-customer risk, but also
operational and investment risk.314
I understand that staff has been directed to
‘‘carefully analyze’’ various proposals that
commenters have advanced ‘‘with the goal of
developing proposed rules that provide
additional protection for collateral belonging
to market participants.’’ 315 This is a laudable
goal. I only hope that we achieve this goal
before mandatory clearing becomes
effective.316 Otherwise, we may be subjecting
313 See comment letters from (i) Managed Funds
Association, dated December 2, 2011; (ii) Fidelity
Investments, dated December 8, 2011; (iii) Och-Ziff
Capital Management Group, dated circa December
12, 2011; (iv) State Street Corporation, dated
December 14, 2011; (v) the Committee on
Investment of Employee Benefit Assets, dated
December 22, 2011; (vi) the European Federation for
Retirement Provision (‘‘EFRP’’) and APG Algemene
Pensioen Groep, N.V. (‘‘APG’’), dated December 23,
2011; (vii) the Federal Home Loan Banks, dated
January 9, 2012; and (viii) BlueMountain Capital
Management, LLC, Elliot Management Corporation,
Moore Capital Management, LP, Paulson & Co. Inc.,
and Tudor Investment Corporation, dated January 9,
2012 (the ‘‘Moore et. al. letter’’). In each case, the
comment letters were filed in answer to the notice
of proposed rulemaking on the Protection of
Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker
Bankruptcy Provisions, 76 FR 33818, Jun. 9, 2011.
All comment letters to such notice are available at:
https://www.cftc.gov/ucm/groups/public/@
lrfederalregister/documents/file/2011-10737a.pdf.
314 See, e.g., comment letters from (i) Fidelity
Investments, dated December 8, 2011; (ii) Och-Ziff
Capital Management Group, dated circa December
12, 2011; and (iii) CIEBA, dated December 22, 2011.
315 Section I(F) of the preamble to this
rulemaking.
316 See comment letter from CIEBA, dated
December 22, 2011 (stating that ‘‘* * * the
Commission should not permit mandatory clearing
of swaps to become effective until a physical
segregation option, such as the individual
settlement account * * * or another satisfactory
structure, has been made available to swaps
customers.’’ [emphasis original]).
This rulemaking does attempt to resolve one
request repeated in the comment letters filed since
December 2, 2011. In section I(F) of the preamble,
the rulemaking makes clear that the Commission’s
2005 Amendment to Financial and Segregation
Interpretation No. 10, 70 FR 24768, May 11, 2005
(‘‘Segregation Interpretation 10–1’’), does not apply
to cleared swaps. Therefore, Segregation
Interpretation 10–1 would not prohibit an
intermediary from entering into a tri-party custody
agreement with a cleared swaps customer.
However, this rulemaking similarly makes clear that
Segregation Interpretation No. 10, which the
Commission issued in 1984, would continue to
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srobinson on DSK4SPTVN1PROD with RULES3
a substantial portion of cleared swaps
customer collateral to operational risk and
investment risk. To provide some context,
such collateral—in the aggregate—may
amount to anywhere from $500 billion to
$833 billion.317 As one commenter stated,
‘‘[i]t would seem to be a perverse result that,
because of rulemaking promulgated under
the Dodd-Frank * * * Act, which was * * *
meant to enhance the safety of the over-thecounter markets by reducing systemic and
counterparty risks, market participants were
to be placed [in] [sic] a worse position with
regard to risk than they are currently.’’ 318
Other commenters supported this
statement.319
This rulemaking may imperfectly address
fellow-customer risk.
Let me now say a few words on ‘‘fellowcustomer’’ risk. Preliminarily, what is it?
According to this rulemaking, it is the risk
that a derivatives clearing organization
(‘‘DCO’’) will access the collateral of nondefaulting cleared swaps customers to cure
the default of an intermediary.320 Under what
circumstances could a DCO access such
collateral? Under this rulemaking, there are
two circumstances and they have to occur
simultaneously. First, a swaps customer
would need to default to an intermediary.
Second, as a result of such default, the
intermediary must be unable to meet its DCO
obligations. In short, swaps customer losses
must exceed the capitalization of the
intermediary.321 As this rulemaking
acknowledges, ‘‘fellow-customer’’ risk is
rare.322 In comparison, according to notices
received by the Commission, operational risk
is far more prevalent.323
apply to collateral segregated according to a triparty custody agreement. In other words, cleared
swaps customers could not avoid the pro rata
distribution provisions of the Bankruptcy Code (as
well as regulation Part 190). Therefore, the
resolution in this rulemaking may provide
commenters with cold comfort.
317 Section VII(B)(2) of the preamble to this
rulemaking (citing estimates provided by CME
Group, Inc. and the International Swaps and
Derivatives Association, Inc.).
318 Comment letter from Och-Ziff Capital
Management Group, dated circa December 12, 2011.
319 See the Moore et. al. letter (stating ‘‘[g]iven the
crucial role that central clearing will play in
reducing systemic risk in the swaps market, we see
no valid argument to suggest that customers to
cleared swaps should be subject to weaker
regulatory protections than those afforded
counterparties to uncleared swaps.’’); and comment
letter from EFRP and APG, dated December 23,
2011 (stating ‘‘EFRP and APG support the CFTC’s
efforts to reduce risk, enhance transparency, and
promote market integrity, as the U.S. Congress
intended by enacting Title VII of the Dodd-Frank
* * * Act. It should be clear though that such
reform will only improve financial stability, if it is
prudent from the perspective of end users, such as
pension funds. However, as currently framed the
Proposed Rules subject us to increased risks.’’).
320 Section I(B)(6) of the preamble to this
rulemaking.
321 Id.
322 Section VII(B)(2) of the preamble to this
rulemaking (stating that ‘‘double defaults are rare
events.’’).
323 Regulation 1.12(h) requires an intermediary
that knows or should know that it is undersegregated to report to the Commission and its
designated self-regulatory organization. Usually,
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Of course, just because a risk is rare does
not mean that the Commission should not
protect against it. But let us take a closer look
at the protection that this rulemaking is
offering. First, although it is close to 230
pages, with nearly 100 pages in rule text,
only a couple of the provisions of this
rulemaking address ‘‘fellow-customer’’ risk.
They are regulations 22.11 to 22.16.324 The
remainder of regulation Part 22, as well as
the majority of changes to regulation Part 190
(Bankruptcy), simply aligns the cleared
swaps segregation regime with the existing
futures segregation regime.325 As MF Global
reveals, the futures segregation regime may
have some vulnerabilities. In this
rulemaking, the Commission is unthinkingly
replicating these vulnerabilities.
Second, this rulemaking only offers
protection to a portion of the cleared swaps
customer collateral that an intermediary
holds. In general, cleared swaps customer
collateral may fall within two categories: (i)
collateral needed to support contracts; and
(ii) collateral in excess of that needed to
support contracts (‘‘Excess Collateral’’). The
Commission, in its final rulemaking on
Derivatives Clearing Organization General
Provisions and Core Principles, states that a
DCO must require its clearing members to
collect Excess Collateral.326 However, as
certain commenters have astutely observed,
and as this rulemaking readily admits, this
rulemaking does not protect Excess Collateral
deposited outside of the DCO.327 So, the
Commission has required cleared swaps
customers to provide collateral that it then
does not protect.
Third, this rulemaking cites, as a major
benefit, the possibility of enhanced
portability of cleared swaps customer
contracts, as well as associated collateral,
after an intermediary defaults due to ‘‘fellowcustomer’’ risk.328 The rulemaking sets forth
under-segregation results from minor operational
failure, and does not lead to the collapse of an
intermediary. However, a pattern of operational
failure would draw greater attention and inquiry.
324 Sections 22.11 to 22.16 of the rule text to this
rulemaking (to be codified at 17 CFR 22.11
(Information to be Provided Regarding Customers
and Their Cleared Swaps), 22.12 (Information to be
Maintained Regarding Cleared Swaps Customer
Collateral), 22.13 (Additions to Cleared Swaps
Customer Collateral), 22.14 (Futures Commission
Merchant Failure to Meet a Customer Margin Call
in Full), 22.15 (Treatment of Cleared Swaps
Collateral on an Individual Basis), 22.16
(Disclosures to Customers)).
325 See, e.g., section 22.10 to the rule text of this
rulemaking (to be codified at 17 CFR 22.10
Application of other Regulatory Provisions).
326 See Derivatives Clearing Organization General
Provisions and Core Principles, 76 FR 69334,
69438, Nov. 8, 2011 (to be codified at 17 CFR
39.13(g)(8)).
327 See section III(B) of the preamble to this
rulemaking (stating ‘‘CME notes that a portion of
the Cleared Swaps Customer Collateral will be held
at the FCM, not the DCO, and that this collateral
will not be protected by Complete Legal Segregation
in the event that an FCM becomes insolvent. This
proposition is true but is of little or no relevance
to the comparison of Complete Legal Segregation
with the Futures Model favored by these
commenters.’’).
328 Section I(D)(2) of the preamble to this
rulemaking. To be fair, this rulemaking does make
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more stringent recordkeeping and reporting
requirements as a foundation for enhanced
portability. As commenters have identified,
these requirements have two significant
weaknesses.
Preliminarily, to maximize portability,
each intermediary must (i) keep complete
and accurate records and (ii) comply with
reporting requirements. As MF Global and
earlier intermediary collapses have
demonstrated, a distressed intermediary may
not prioritize recordkeeping and reporting.329
Secondarily, despite requests from various
commenters (including the Association of
Institutional Investors and Vanguard), this
rulemaking does not provide guidance on the
concrete steps that a DCO should take to
ensure that an intermediary is providing
accurate and complete information. Instead,
the rulemaking states: ‘‘* * * the DCO
should take the steps appropriate, in the
professional judgment of its staff, to verify
that [intermediaries] have and are using
systems and appropriate procedures to track
accurately, and to provide to the DCO
accurately, the positions of each
customer.’’ 330 In light of MF Global, the
Commission should give this provision—and
the requests of commenters—more thought.
Finally, this rulemaking is silent on one
important factor that may affect the
portability of cleared swaps customer
contracts, as well as associated collateral—
namely, whether the intermediary is both a
futures commission merchant and a
securities broker-dealer. I am touching on
this issue in the interest of full disclosure.
A comprehensive solution is needed.
Despite its limitations, I ultimately support
this rulemaking. As I have stated previously,
the Commission must immediately take
action to renew public confidence in our
customer protection regime.331 Although this
rulemaking largely replicates futures
segregation, this rulemaking—if it works as
promised in an intermediary bankruptcy—
may enhance portability for cleared swaps
customers in the event of ‘‘fellow-customer’’
risk. Even the possibility of such
enhancement is non-negligible—especially in
the volatile economic environment that exists
today.
However, this rulemaking also vividly
illustrates some of my concerns regarding our
Dodd-Frank rulemaking process. First, the
Commission has a duty to regulate the swaps
market. It also owes a duty to futures
customers. Right now, it is unclear from this
rulemaking how the Commission means to
address futures customer concerns. I
understand that the investigation into the MF
Global collapse is ongoing. However, the
Commission could examine the manner in
the point that enhanced recordkeeping and
reporting requirements may also foster portability
in the event of operational or investment risk.
329 See, e.g., comment letters from (i) the Federal
Home Loan Banks, dated January 9, 2012 and (ii)
CIEBA, dated December 22, 2011. See also the
Moore et. al. letter.
330 Section IV(K) of the preamble to this
rulemaking.
331 See Statement on MF Global: Next Steps,
dated November 16, 2011, available at: https://www.
cftc.gov/PressRoom/SpeechesTestimony/
omaliastatement111611.
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which operational and investment risks
contribute to undersegregation. Our
undersegregation reports would help us with
such an examination, as well as the detection
of potential causal patterns for
undersegregation.332
Second, instead of rushing to complete this
rulemaking, I would have preferred that the
Commission focus on providing a more
comprehensive solution to operational,
srobinson on DSK4SPTVN1PROD with RULES3
332 See
supra note 17.
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investment, and ‘‘fellow-customer’’ risk.
Moreover, I would have preferred that the
Commission more fully explore the
alternatives that various commenters have
advanced, which may provide greater
protection for futures, as well as cleared
swaps customer, collateral. Further, it would
have been helpful for the Commission to
have weighed, in one analysis, the benefits
and costs of offering a combination of (i) this
rulemaking and (ii) one or more alternatives.
Finally, the Commission needs to
contemplate whether any alternative would
PO 00000
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6409
be workable in light of the pro rata
distribution provisions of the Bankruptcy
Code. If not, the Commission should
contemplate recommending to Congress
changes to the Bankruptcy Code.
After MF Global, the Commission needs to
provide market participants with real, fully
developed reforms. I look forward to the
Commission taking such action.
[FR Doc. 2012–1033 Filed 2–6–12; 8:45 am]
BILLING CODE 6351–01–P
E:\FR\FM\07FER3.SGM
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Agencies
[Federal Register Volume 77, Number 25 (Tuesday, February 7, 2012)]
[Rules and Regulations]
[Pages 6336-6409]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-1033]
[[Page 6335]]
Vol. 77
Tuesday,
No. 25
February 7, 2012
Part III
Commodity Futures Trading Commission
-----------------------------------------------------------------------
17 CFR Parts 22 and 190
Protection of Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker Bankruptcy Provisions;
Final Rule
Federal Register / Vol. 77 , No. 25 / Tuesday, February 7, 2012 /
Rules and Regulations
[[Page 6336]]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 22 and 190
RIN Number 3038-AC99
Protection of Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker Bankruptcy Provisions
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')
is adopting final regulations to implement new statutory provisions
enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the ``Dodd-Frank Act''). Specifically, these
regulations impose requirements on futures commission merchants
(``FCMs'') and derivatives clearing organizations (``DCOs'') regarding
the treatment of cleared swaps customer contracts (and related
collateral), and make conforming amendments to bankruptcy provisions
applicable to commodity brokers under the Commodity Exchange Act (the
``CEA'').
DATES: The rules will become effective April 9, 2012. All parties must
comply with the Part 22 rules by November 8, 2012. All parties must
comply with the Part 190 rules by April 9, 2012. Prior to the
compliance date for the Part 22 rules, the definition of 190.01(pp)
(``Cleared Swap'') shall be limited to transactions where the rules or
bylaws of a derivatives clearing organization require that such
transactions, along with the money, securities, and other property
margining, guaranteeing or securing such transactions, be held in a
separate account for Cleared Swaps only.
FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel,
Division of Clearing and Risk (DCR), at 202-418-5092 or
rwasserman@cftc.gov; M. Laura Astrada, Associate Chief Counsel, DCR, at
202-418-7622 or lastrada@cftc.gov; Alicia Lewis, Special Counsel, DCR,
at 202-418-5862 or alewis@cftc.gov; or Martin White, Assistant General
Counsel, Office of the General Counsel, at 202-418-5129 or
mwhite@cftc.gov, in each case, at the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,
DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Segregation Requirements.
B. Overview of the Clearing Process as it Relates to the
Segregation Requirements.
C. Segregation Alternatives.
D. Operation of the Segregation Models in an FCM Bankruptcy.
E. Solicitation of Public Input.
F. Clarification of the Application of Financial and Segregation
Interpretation No. 10 to Cleared Swaps.
II. The Final Rules
III. Segregation Model for Cleared Swaps Customer Collateral
A. Summary of the Comments.
B. Discussion of the Comments.
IV. Section by Section Analysis: Regulation Part 22
A. Regulation 22.1: Definitions.
B. Regulation 22.2--Futures Commission Merchants: Treatment of
Cleared Swaps Customer Collateral.
C. Regulation 22.3--Derivatives Clearing Organizations:
Treatment of Cleared Swaps Customer Collateral.
D. Regulation 22.4--Futures Commission Merchants and Derivatives
Clearing Organizations: Permitted Depositories.
E. Regulation 22.5--Futures Commission Merchants and Derivatives
Clearing Organizations: Written Acknowledgment.
F. Regulation 22.6--Futures Commission Merchants and Derivatives
Clearing Organizations: Naming of Cleared Swaps Customer Accounts.
G. Regulation 22.7--Permitted Depositories: Treatment of Cleared
Swaps Customer Collateral.
H. Regulation 22.8--Situs of Cleared Swaps Customer Accounts.
I. Regulation 22.9--Denomination of Cleared Swaps Customer
Collateral and Location of Depositories.
J. Regulation 22.10--Application of other Regulatory Provisions.
K. Regulation 22.11--Information to be Provided Regarding
Customers and Their Cleared Swaps.
L. Regulation 22.12--Information to be Maintained Regarding
Cleared Swaps Customer Collateral.
M. Regulation 22.13--Additions to Cleared Swaps Customer
Collateral.
N. Regulation 22.14--Futures Commission Merchant Failure to Meet
a Customer Margin Call in Full.
O. Regulation 22.15--Treatment of Cleared Swaps Customer
Collateral on an Individual Basis.
P. Regulation 22.16--Disclosures to Customers.
V. Section by Section Analysis: Amendments to Regulation Part 190
A. Background.
B. Definitions.
C. Amendments to Regulation 190.02--Operation of the Debtor's
Estate Subsequent to the Filing Date and Prior to the Primary
Liquidation Date.
D. Amendments to Regulation 190.03--Operation of the Debtor's
Estate Subsequent to the Primary Liquidation Date.
E. Amendments to Regulation 190.04--Operation of the Debtor's
Estate--General.
F. Amendments to Regulation 190.05--Making and Taking Delivery
on Commodity Contracts.
G. Amendments to Regulation 190.06--Transfers.
H. Amendments to Regulation 190.07--Calculation of Allowed Net
Equity.
I. Amendments to Regulation 190.09--Member Property.
J. Amendments to Regulation 190.10--General.
K. Amendments to Appendix A to Part 190--Bankruptcy Forms,
Bankruptcy.
L. Amendments to Appendix B to Part 190--Special Bankruptcy
Distributions.
VI. Effective Date
VII. Consideration of Costs and Benefits
A. Introduction.
B. Benefits and Costs of Complete Legal Segregation Model
Relative to Futures Model.
C. Conclusion.
VIII. Related Matters.
A. Paperwork Reduction Act.
B. Regulatory Flexibility Act.
IX. Text of Proposed Rules
I. Background
A. Segregation Requirements
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act \2\ amended the CEA \3\ to establish a
comprehensive new regulatory framework for swaps and certain security-
based swaps. The legislation was enacted to reduce risk, increase
transparency, and promote market integrity within the financial system
by, among other things: (1) Providing for the registration and
comprehensive regulation of swap dealers and major swap participants;
\4\ (2) imposing mandatory clearing and trade execution requirements on
clearable swap contracts; (3) creating rigorous recordkeeping and real-
time reporting regimes; and (4) enhancing the Commission's rulemaking
and enforcement authorities with respect to, among others, all
registered entities and intermediaries subject to the Commission's
oversight.
---------------------------------------------------------------------------
\1\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376
(2010). The text of the Dodd-Frank Act may be accessed at https://www.cftc.gov./LawRegulation/OTCDERIVATIVES/index.htm.
\2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 7 U.S.C. 1 et seq.
\4\ In this release, the terms ``swap dealer'' and ``major swap
participant'' shall have the meanings set forth in section 721(a) of
the Dodd-Frank Act, which added sections 1a(49) and (33) of the CEA.
However, as directed by section 721(c) of the Dodd-Frank Act, the
Commission is in the process of promulgating rules to further
define, among other terms, ``swap dealer'' and ``major swap
participant.'' See 75 FR 80173, Dec. 21, 2010.
---------------------------------------------------------------------------
Section 724 of the Dodd-Frank Act prescribes the manner in which
Cleared
[[Page 6337]]
Swaps (and related collateral) \5\ must be treated prior to and after
bankruptcy. Section 724(a) of the Dodd-Frank Act amends section 4d of
the CEA to add a new paragraph (f), which imposes the following
requirements on an FCM, as well as any depository thereof (including,
without limitation, a DCO):
---------------------------------------------------------------------------
\5\ Regulation 22.1 defines ``Cleared Swap'' and ``Cleared Swaps
Customer Collateral.''
---------------------------------------------------------------------------
1. The FCM must treat and deal with all collateral (including
accruals thereon) deposited by a customer \6\ to margin its Cleared
Swaps as belonging to such customer;
---------------------------------------------------------------------------
\6\ Regulation 22.1 defines ``Cleared Swaps Customer.''
---------------------------------------------------------------------------
2. The FCM must separately account for and may not commingle such
collateral with its own property and may not, with certain exceptions,
use such collateral to margin the Cleared Swaps of any person other
than the customer depositing such collateral;
3. A DCO may not hold or dispose of the collateral that an FCM
receives from a customer to margin Cleared Swaps in any manner that
would indicate that such collateral belonged to the FCM or any person
other than the customer; and
4. The FCM and the DCO may only invest such collateral in
enumerated investments.
In other words, the FCM and the DCO (i) must hold such customer
collateral in an account (or location) that is separate from the
property belonging to the FCM or DCO, and (ii) must not use the
collateral of one customer to (A) cover the obligations of another
customer or (B) the obligations of the FCM or DCO. These basic
requirements that Cleared Swaps Customer Collateral be treated as the
property of customers and maintained in segregated accounts (or
locations) are imposed by the statute and have the force of law
regardless of the Commission's particular implementing regulations.
Moreover, by the terms of the statute, these requirements would apply
even if the Commission promulgated no implementing regulations.
Section 724(b) of the Dodd-Frank Act governs bankruptcy treatment
of Cleared Swaps by clarifying that Cleared Swaps are ``commodity
contracts'' within the meaning of section 761(4)(F) of the Bankruptcy
Code.\7\ Therefore, in the event of an FCM or DCO insolvency, Cleared
Swaps Customers may invoke the protections of Subchapter IV of Chapter
7 of the Bankruptcy Code (``Subchapter IV''). Such protections include:
(i) protected transfers of Cleared Swaps and related collateral; \8\
and (ii) if Cleared Swaps are subject to liquidation, preferential
distribution of remaining collateral.\9\ However, section 766(h) of the
Bankruptcy Code (``Section 766(h)'') subjects customers to mutualized
risk by requiring that customer property be distributed ``ratably to
customers on the basis and to the extent of such customers' allowed net
equity claims.'' This requirement, in turn, limits the Commission's
flexibility in designing a model for the protection of customer
collateral.
---------------------------------------------------------------------------
\7\ 11 U.S.C. 761(4)(F).
\8\ See, e.g., 11 U.S.C. 764.
\9\ See, e.g., 11 U.S.C. 766(h) and (i).
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B. Overview of the Clearing Process as It Relates to the Segregation
Requirements
1. Central Counterparties/Derivatives Clearing Organizations
One of the primary objectives of the Dodd-Frank Act was to promote
the central clearing of swaps and to establish the regulatory
infrastructure for the clearing of swaps.\10\ Clearing is the process
by which transactions in derivatives are processed, guaranteed, and
settled by a central counterparty, also known as a DCO. In accordance
with this overall Congressional purpose, section 724 of the Dodd-Frank
Act amends the CEA to provide the statutory foundation for the
protection of Cleared Swaps Customer Collateral.
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\10\ See supra n. 1; S. Rep. No. 111-176, at 33 (2010) (``[w]ith
appropriate collateral and margin requirements, a central clearing
organization can substantially reduce counterparty risk and provide
an organized mechanism for clearing transactions''); Process for
Review of Swaps for Mandatory Clearing, 76 FR 44464, July 26, 2011
(final rule); Derivatives Clearing Organizations General Provisions
and Core Principles, 76 FR 69334, Nov. 8, 2011 (final rule).
---------------------------------------------------------------------------
A DCO has members (``Clearing Members'') who clear derivatives
transactions (e.g., swaps) through the DCO and who are subject to the
DCO's rules. Clearing Members may clear transactions on their own
behalf (i.e., ``proprietary transactions'') or on behalf of customers
(i.e., ``customer transactions''). Clearing members that clear swaps
for customers must be registered as futures commission merchants
(``FCMs'').\11\
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\11\ Section 4d(f)(1) of the CEA, 7 U.S.C. 6d(f)(1).
---------------------------------------------------------------------------
The term ``central counterparty'' means, conceptually, that the DCO
becomes the seller to every buyer, and the buyer to every seller. More
specifically, the DCO novates swap transactions initially entered into
between various market participants, such as swaps users, dealers, or
end users, and cleared either directly (if the market participant is
itself a Clearing Member) or indirectly (through an FCM that is a
Clearing Member) . The contractual obligations between the original
parties (``A'' and ``B'') \12\ are replaced by sets of equivalent
obligations: between the Clearing Member FCMs acting for the original
parties and the DCO and between the Clearing Member FCMs and their
individual customers. Thus, if the original swap agreement would
require a certain payment from A to B, as a result of the clearing
process this obligation becomes (1) a duty by A's clearing FCM to pay
the DCO, (2) a corresponding claim by A's FCM to recompense from A, (3)
a duty by the DCO to pay B's clearing FCM, and (4) a corresponding duty
by B's FCM to pay B.
---------------------------------------------------------------------------
\12\ For purposes of this example, neither A nor B is a Clearing
Member.
---------------------------------------------------------------------------
In economic effect, the DCO serves as a guarantor that every
Clearing Member party to a cleared swap receives performance according
to the terms of the swap, while the clearing FCM serves as a guarantor
of its customers' swaps obligations to the DCO.
2. Variation
To avoid the accumulation of large obligations, the DCO conducts a
variation payment and collection cycle at least once a day, and in the
case of many DCOs, twice a day. The DCO will first calculate the gain
(and corresponding loss) on each contract through a process known as
``marking to market,'' using reported market prices where available, or
other means (such as surveys of Clearing Members). The DCO will then
aggregate and net the gains and losses for each Clearing Member
(separately for proprietary and customer accounts), collect from those
Clearing Members with net losses, and pay those Clearing Members with
net gains. This process is highly time sensitive: The Clearing Member
typically has only one or a few hours between the demand for payment
and the time payment is due. Similarly, the Clearing Member FCMs will
debit the accounts of those customers who have losses on their
transactions, and credit the accounts of those customers who have
gained.
3. Margin (Collateral)
To secure the prompt payment of variation obligations, the DCO will
require each Clearing Member to post collateral (often referred to as
``margin'') for the transactions it clears (separately for customer
positions and proprietary positions). If the Clearing Member does not
promptly make a variation payment to the DCO--referred to as a
default--the collateral may immediately be liquidated and applied to
the obligation. Margin may only be used to meet the
[[Page 6338]]
default of the Clearing Member posting that margin. While proprietary
margin may be used to meet obligations in either the Clearing Member's
proprietary account or customer account, the reverse is not true: A
Clearing Member's customer margin may not be used to meet a default in
the Clearing Member's proprietary account.
Similarly, FCMs will--indeed, are required to--collect collateral
from each of their customers, based on each customer's portfolio of
positions, to secure the prompt payment of the customer's variation
obligations.\13\ If a customer fails to fulfill an obligation to the
FCM arising out of a swap agreement the FCM clears for the customer,
the FCM may use some or all of the value of the collateral that
customer has posted to meet that obligation--that is the purpose of the
collateral.
---------------------------------------------------------------------------
\13\ See regulation 39.13(g)(8)(ii) (stating that ``[a]
derivatives clearing organization shall require its clearing members
to collect customer initial margin, as defined in Sec. 1.3 of this
chapter, from their customers, for nonhedge positions, at a level
that is greater than 100 percent of the derivatives clearing
organization's initial margin requirements with respect to each
product and swap portfolio.''). 76 FR at 69439.
The purpose of this rulemaking is to protect Cleared Swaps
Customer Collateral in the event that an FCM defaults to a DCO due
to ``Fellow-Customer Risk'' (as such term is defined in section
I(B)(6) herein). However, as section III(B) explores in greater
detail, the segregation model selected in this rulemaking provides
limited protection from operational and investment risks.
---------------------------------------------------------------------------
The DCO will generally set minimum collateral levels for each type
of swap, and will prescribe a ``margin methodology'' to determine the
minimum margin level for portfolios of swaps. The DCO's margin
methodology will be designed to estimate the amount of loss a portfolio
of swap positions may incur, calculated at a statistical confidence
level no less than 99%, over a holding period generally between one and
ten days, depending on the time it is estimated to take to liquidate
the swaps in the portfolio.\14\ The FCM will, in turn, use the same or
similar methodology in determining the minimum level of collateral it
must collect from each customer.\15\
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\14\ See generally, 76 FR 69334. See specifically regulation
39.13(g)(2)(ii) (setting forth a one-day minimum liquidation time
for agricultural, energy, and metals swaps, and a five-day minimum
liquidation time for all other swaps). 76 FR 69438.
\15\ The FCM is required to collect a higher level of collateral
from its customers than that prescribed for Clearing Members (see
id.) and may, in its discretion, collect a yet higher level. See
regulation 22.13(a)(1).
---------------------------------------------------------------------------
4. Default Resources
As noted above, the margin collateral collected by a DCO is
designed to cover most (e.g., 99%), but not all, potential losses
incurred by a Clearing Member. DCOs cover the ``tail risk'' (i.e., the
risk that a Clearing Member will incur, and default on, a loss in
excess of the margin collected) by means of what is sometimes referred
to as a default resources package, or ``waterfall.'' Elements of the
waterfall may include a contribution of a specified amount of the DCO's
own capital, pre-funded contributions from Clearing Members (a
``guaranty fund''),\16\ or (to a limited extent), a power by the DCO to
assess additional contributions from Clearing Members. Unlike margin, a
Clearing Member's contribution to the guaranty fund will generally be
usable to meet the default of another Clearing Member. In other words,
the guaranty fund is ``mutualized.'' Elements of the waterfall are
applied in an order pre-determined by the DCO's rules. Such rules will
often apply the guaranty fund contribution of the defaulter before the
DCO's own capital, and the remainder of the guaranty fund (i.e., the
guaranty fund contributions of the non-defaulting Clearing Members)
thereafter.
---------------------------------------------------------------------------
\16\ See also infra at n. 250.
---------------------------------------------------------------------------
Though seemingly complex, centralized clearing has important
advantages in terms of transparency, risk management, netting out of
countervailing obligations, and reduced exposure of market participants
to each other's credit risk (by effectively substituting the DCO's
credit risk).
5. Customer Accounts
Generally, a clearing FCM will have two different types of Cleared
Swaps Customer Accounts in connection with collateral provided to it by
Cleared Swaps Customers. One account is maintained (generally at a
bank) by the FCM on behalf of its Cleared Swaps Customers (the ``FCM
Customer Account''). The FCM Customer Account holds assets provided by
customers, or other assets of equivalent value, that are not currently
posted with the DCO to support swaps positions cleared by the FCM on
behalf of its Cleared Swaps Customers. The other account is maintained
by the DCO for the FCM on behalf of the FCM's Cleared Swaps Customers
(the ``DCO Customer Account''). The DCO Customer Account holds customer
assets, or assets of equivalent value, that the FCM has posted to the
DCO as collateral for swaps positions that have been established and
cleared by the FCM for its Cleared Swaps Customers.
The collateral posted by each Cleared Swaps Customer is, however,
potentially exposed to risks that do not arise out of the obligations
that a Cleared Swaps Customer has directly incurred by assuming his or
her swaps position. \17\ The most important impact of such risks would
occur in the case of an insolvency on the part of the FCM through which
the Cleared Swaps Customer clears. As discussed in more detail below,
the new CEA section 4d(f), and the Commission's implementing
regulations, are designed to provide protection for Cleared Swaps
Customer Collateral against certain risks that may arise during an
insolvency on the part of the FCM through which the Cleared Swaps
Customer clears.
---------------------------------------------------------------------------
\17\ Examples of other risks include the possibility of misuse
or misallocation of a Cleared Swaps Customer's assets by a dishonest
or negligent FCM.
---------------------------------------------------------------------------
6. Fellow-Customer Risk
``Fellow-Customer Risk'' is the risk that a DCO would need to
access the collateral of non-defaulting Cleared Swaps Customers to cure
an FCM default. Fellow-Customer Risk arises in circumstances in which a
Cleared Swaps Customer (the ``defaulting customer'') of a clearing FCM
suffers a (significant) loss in connection with a cleared swap.\18\ The
loss will result in a call by the DCO for a variation payment from the
clearing FCM that carries that Cleared Swaps Customer's Cleared
Swaps.\19\ The clearing FCM may demand expedited payment from the
defaulting Cleared Swaps Customer, but is in any event directly
obligated promptly to meet the payment obligation to the DCO.
---------------------------------------------------------------------------
\18\ See also supra n. 13.
\19\ As noted above, the amount the DCO will call for or pay to
the FCM in respect of its Cleared Swaps Customers is the net of the
gains and losses computed on a customer-by-customer basis.
---------------------------------------------------------------------------
If the loss is great enough, it may exceed the sum of the FCM's
available liquid assets, the swaps collateral posted by the Cleared
Swaps Customer, and any additional payments immediately available from
the Cleared Swaps Customer. In this situation, sometimes called a
``double default,'' the defaulting Cleared Swaps Customer will have
defaulted on its obligation to the clearing FCM which, in turn, will
default on its obligation to the DCO. In such circumstances, the FCM
will likely have to file for protection in bankruptcy. Meanwhile, the
defaulting Cleared Swaps Customer's loss will translate to a gain by
one or more other market participants. Notwithstanding the default by
the clearing FCM, the DCO, in its capacity as central counterparty, is
required to pay out these gains. The DCO will thus be faced with a
potentially significant loss.
A potential resource for the DCO to apply to this loss in a double
default
[[Page 6339]]
situation is the collateral held in the Cleared Swaps Customer Account
maintained by the DCO for the defaulting FCM on behalf of the FCM's
Cleared Swaps Customers. Under the current rules applicable to futures
clearing, a DCO is permitted to use all of the collateral in the
Clearing Member's customer account to meet a loss in that account,
without regard to which customer(s) in fact supplied that collateral.
Thus, in this case, the non-defaulting customers of the defaulting FCM
clearing member would be exposed to loss due to ``Fellow-Customer
Risk.''
C. Segregation Alternatives
In implementing new CEA section 4d(f), the Commission considered
five alternative segregation models for Cleared Swaps Customer
Collateral in the notice of proposed rulemaking issue by the Commission
on June 9, 2011 (the ``NPRM'').\20\
---------------------------------------------------------------------------
\20\ See Notice of Proposed Rulemaking on the Protection of
Cleared Swaps Customer Contracts and Collateral; Conforming
Amendments to the Commodity Broker Bankruptcy Provisions, 76 FR
33818, 33822, June 9, 2011.
---------------------------------------------------------------------------
1. Legal Segregation With Operational Commingling Model
The first alternative explored by the Commission was legal
segregation with operational commingling (the ``LSOC Model'' or
``Complete Legal Segregation Model''). Under the LSOC Model, each FCM
and DCO would enter (or ``segregate''), in its books and records, the
Cleared Swaps of each individual customer and relevant collateral. Each
FCM and DCO would ensure that such entries are separate from entries
indicating (i) FCM or DCO obligations, or (ii) the obligations of non-
cleared swaps customers. Operationally, however, each FCM and DCO would
be permitted to hold (or ``commingle'') the relevant collateral in one
account. Each FCM and DCO would ensure that such account is separate
from any account holding FCM or DCO property or holding property
belonging to non-cleared swaps customers.
Prior to the simultaneous default of an FCM and one of its Cleared
Swaps Customers (as discussed above, a ``double default''), the FCM
would ensure that the DCO does not use the collateral of one Cleared
Swaps Customer to support the obligations of another customer by making
certain that the value of the Cleared Swaps Customer Collateral that
the DCO holds equals or exceeds the value of all Cleared Swaps Customer
Collateral that it has received to secure the contracts of the FCM's
customers. Following a double default, the DCO would be permitted to
access the collateral of the defaulting Cleared Swaps Customers, but
not the collateral of the non-defaulting Cleared Swaps Customers. Thus
while, even under the LSOC Model, Section 766(h) requires the pro rata
distribution of customer property, the collateral attributable to the
non-defaulting Cleared Swaps Customers would be available to be
distributed.
2. Legal Segregation With Recourse Model
Second, the Commission contemplated the Legal Segregation with
Recourse Model (together with the LSOC Model, the ``Legal Segregation
Models''). As with the LSOC Model, under the Legal Segregation with
Recourse Model, each FCM and DCO would segregate the Cleared Swaps of
each individual customer and relevant collateral in its books and
records. However, each FCM and DCO would be permitted to commingle the
relevant collateral in one account, provided that such account is
separate from any proprietary accounts or accounts property belonging
to non-cleared swaps customers.
Again, as with the LSOC Model, prior to a double default, the FCM
would ensure that the DCO does not use the collateral of one Cleared
Swaps Customer to support the obligations of another customer by making
certain that the value of the Cleared Swaps Collateral that the DCO
holds equals or exceeds the value of all Cleared Swaps Collateral that
it has received to secure the contracts of the FCM's customers.
However, unlike the LSOC Model, following a double default, the Legal
Segregation with Recourse Model would not prohibit a DCO from accessing
the collateral of the non-defaulting Cleared Swaps Customers, after the
DCO applies its own capital to cure the default, as well as the
guaranty fund contributions of its non-defaulting FCM members.
3. Physical Segregation Model
The Commission also explored the possibility of full physical
segregation (the ``Physical Segregation Model'') for Cleared Swaps
Customer Collateral. The Physical Segregation Model primarily differs
from the Legal Segregation Models operationally. In the ordinary course
of business (i.e., prior to a double default), as with the Legal
Segregation Models, each FCM and DCO would enter (or ``segregate''), in
its books and records, the Cleared Swaps of each individual customer
and relevant collateral. However, unlike the Legal Segregation Models,
each FCM and DCO would maintain separate individual accounts for the
relevant collateral. Hence, the FCM would ensure that the DCO does not
use the collateral of one Cleared Swaps Customer to support the
obligations of another customer by making certain that the DCO does not
mistakenly transfer collateral in (i) the account belonging to the
former to (ii) the account belonging to the latter.
Following a double default, the Physical Segregation Model would
lead to the same result as the Complete Legal Segregation Model.
Specifically, the DCO would be permitted to access the collateral of
the defaulting Cleared Swaps Customers, but not the collateral of the
non-defaulting customers.
As discussed above, one important limitation on the effectiveness
of the Physical Segregation Model is section 766(h) of the Bankruptcy
Code, which requires that customer property be distributed ratably.
Thus, if because of Physical Segregation, certain Cleared Swaps
Customer Collateral was better protected than the property of other
Cleared Swaps Customers, it would not be permissible to pay Cleared
Swaps Customers in the first group a higher proportion (i.e., a higher
cents-on-the-dollar distribution) of their net equity claims than
Cleared Swaps Customers in the second group. Rather, Cleared Swaps
Customers in both groups would receive the same proportion of their
allowed net equity claims. In other words, in spite of incurring
greater cost under the Physical Segregation Model, a Cleared Swaps
Customer would essentially receive the same level of protection for its
Cleared Swaps Customer Collateral under the Physical Segregation Model
as it would under the LSOC Model.
4. Futures Model
The Commission also considered replicating the segregation
requirement currently applicable to futures (the ``Futures Model'').
Under this model, DCOs treat each FCM's customer account on an omnibus
basis, that is, as belonging to an undifferentiated group of customers.
Prior to a double default, the Futures Model shares certain
similarities with the Legal Segregation Models. Specifically, each FCM
would enter (or ``segregate''), in its books and records, the Cleared
Swaps of each individual customer and relevant collateral. Each DCO,
however, would recognize, in its books and records, the Cleared Swaps
that an FCM intermediates on a collective (or ``omnibus'') basis. Each
FCM and DCO would be permitted to hold (or ``commingle'') all Cleared
Swaps Customer Collateral in one account.
[[Page 6340]]
Following a double default, the Futures Model shares certain
similarities with the Legal Segregation with Recourse Model.
Specifically, the Futures Model would not prohibit a DCO from accessing
the collateral of the non-defaulting Cleared Swaps Customers. However,
unlike the Legal Segregation with Recourse Model, under the Futures
Model the DCO would be permitted to access such collateral before
applying its own capital or the guaranty fund contributions of non-
defaulting FCM members.\21\
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\21\ For a more detailed discussion regarding the operation of
the segregation models in an FCM bankruptcy, see section I.D.
---------------------------------------------------------------------------
5. Optionality
Finally, the Commission explored permitting a DCO to choose between
(i) the Legal Segregation Models (whether Complete or with Recourse),
(ii) the Physical Segregation Model, and (iii) the Futures Model,
rather than mandating any particular alternative.
D. Operation of the Segregation Models in an FCM Bankruptcy
When discussing the issues surrounding an FCM bankruptcy under the
Bankruptcy Code, analytically there are several scenarios to consider:
(1) The bankruptcy is unrelated to the loss of customer funds, and
there is no such loss; (2) The bankruptcy involves shortfalls in
customer funds due to operational risks; (3) The bankruptcy involves
losses due to customer risk (i.e., a customer incurs a loss in excess
of the FCM's financial ability to cover); or (4) the bankruptcy
involves shortfalls in customer funds due to operational risk and
losses due to customer risk.
1. Bankruptcy Unrelated to Loss of Customer Funds
An FCM bankruptcy that is unrelated to the loss of customer funds
may arise because of financial difficulties in the FCM, financial
difficulties in the proprietary accounts, or because of the impact of
difficulties at a corporate parent or affiliate. Under this scenario,
all models share important characteristics: Customer positions and
related collateral, whether at a DCO or at the FCM, can be transferred
to one or more willing transferee FCMs, or may be liquidated and
returned to the trustee. With respect to fostering transfer, however,
the Legal Segregation Models (whether Complete or with Recourse) and
the Physical Segregation Model do have a significant advantage compared
to the Futures Model: In each of them, information about the customers
as a whole, and about each individual customer's positions, are
transmitted to the DCO every day, an information flow (and store) that
is not present in the Futures Model. Thus, each DCO will have important
customer information on a customer by customer basis that can be used
to facilitate and implement transfers, and is thus less reliant upon
the FCM for that information.
2. Bankruptcy With Shortfalls Due to Operational Risks or Investment
Risks
An FCM bankruptcy with shortfalls due to operational risks would
arise because of a shortfall in segregated funds due to, e.g.,
negligence, theft or other mishap. An FCM may also have shortfalls due
to investment risks resulting from extraordinary losses on the set of
investments permitted under regulation 1.25 (as included in new
regulation 22.2(e)(3)). Under this scenario, all models again share
important characteristics: Customer positions and related collateral at
a DCO may be delivered to the Trustee, or may transferred by the DCO,
but only to the extent of each customer's pro rata share. Under all of
the segregation models, to the extent there is a shortfall, each
customer will ultimately receive the same cents-on-the-dollar
proportion of the value of the customer's account.
However, with respect to fostering transfer, the other models again
have a significant advantage compared to the Futures Model: In each of
them, information about the customers as a whole, and about each
individual customer's positions, are transmitted to the DCO every day,
an information flow (and store) that is not present in the Futures
Model. Thus, each DCO will have important customer information on a
customer by customer basis that can be used to facilitate and implement
transfers, and accordingly is less reliant upon the FCM for that
information.
3. Bankruptcy With Shortfalls Due to Customer Risk
An FCM bankruptcy with shortfalls due to customer risk would arise
because a customer incurs a loss that exceeds both the customer's
collateral and the FCM's ability to pay.
Under the Futures Model, the DCO could use the entirety of the
FCM's customer account (or as much of it as necessary) to meet the
entire loss created by the default. Transfer of customer positions
would be difficult, in that the DCO would lack information as to which
customers were in default, and which positions belonged to defaulting
customers (and, presumably, would not be transferred) and which did
not.\22\ The DCO would be permitted to liquidate customer positions, a
process that might take between one and ten days.\23\ Once the loss was
crystalized, the DCO would be able to turn over the collateral (less
that used to meet the default) to the Trustee for use in the pro rata
distribution.
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\22\ See generally, CME Group, Inc. (``CME'') at 14-15
(discussing information deficits at bankrupt FCM).
\23\ See 76 FR at 69366-68.
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Under the LSOC Model, the DCO could only use the collateral
attributable to defaulting customers (those whose positions suffered
losses) to meet the loss. Thus, all collateral attributable to
customers whose net positions gained or were ``flat'' (neither gained
nor lost), and much of the collateral attributable to customers whose
net positions lost, would be immediately available for transfer.
Moreover, the DCO would have information that is no more than one
business day old tying customers to portfolios of positions, and the
DCO itself would maintain the margining methodology that would tie such
portfolios of positions to the collateral requirement associated with
such portfolios. Even if the DCO decided to liquidate all customer
positions, the collateral of non-defaulting customers would be exposed
to less loss than under the Futures Model because the DCO would not
have the right to access it.
The Physical Segregation Model would work in a manner similar to
the LSOC Model. Again, all collateral attributable to customers whose
net positions gained or were ``flat'' (neither gained nor lost), and
the remaining collateral attributable to customers whose net positions
lost, would be immediately available for transfer. The DCO would have
specific information on how much collateral was, in fact, attributable
to each customer. However, because of the ratable distribution
requirement, any losses that did exist would be shared ratably among
all customers.
Under the Legal Segregation with Recourse, the DCO could only use
the collateral attributable to defaulting customers (those whose
positions suffered losses) to meet the loss--at first. It would also
use the defaulting clearing member FCM's own contribution to the
guaranty fund, its own contribution to the guaranty fund, as well as
the contributions of non-defaulting clearing members. However, if those
resources were insufficient to cover the default, the DCO would have
``recourse'' to the collateral of non-defaulting customers. While such
[[Page 6341]]
recourse is much less likely under the Legal Segregation with Recourse
Model than under the Futures Model--because the fellow-customer
collateral would not be reached unless the loss was great enough to
consume the entire guaranty fund--until the amount of loss from the
default was crystalized (through liquidation or transfer), the DCO
might be reluctant or unable to release the collateral of non-
defaulting customers. Accordingly, while Legal Segregation with
Recourse would (in most cases) provide customers superior recovery in a
liquidation, it would be much less well-suited to a prompt transfer of
positions.
E. Solicitation of Public Input
The Commission sought public comment on the segregation
alternatives mentioned above, and on the advisability of permitting the
DCO to choose between alternatives. First, the Commission, through its
staff, held extensive external meetings with three segments of
stakeholders (i.e., DCOs, FCMs, and swaps customers).\24\ Second, on
October 22, 2010, the Commission, through its staff, held a roundtable
(the ``First Roundtable'').\25\ Third, on November 19, 2010, the
Commission issued an Advance Notice of Proposed Rulemaking for
Protection of Cleared Swaps Customers Before and After Commodity Broker
Bankruptcies (the ``ANPR''). Fourth, on June 3, 2011, the Commission,
through its staff, held a second roundtable (the ``Second
Roundtable'').\26\ Fifth, after careful consideration of the comments
the Commission received on the ANPR, the Commission issued the NPRM.
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\24\ A list of external meetings is available at: https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_6_SegBankruptcy/index.htm.
\25\ The transcript from the First Roundtable (the ``First
Roundtable Tr.'') is available at: https://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission6_102210-transcrip.pdf.
\26\ The transcript from the Second Roundtable (the ``Second
Roundtable Tr.'') is available at: https://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission6_060311-transcri.pdf.
---------------------------------------------------------------------------
1. First Roundtable
As the ANPR describes, the First Roundtable revealed that
stakeholders had countervailing concerns regarding the alternative
segregation models that the Commission set forth. On the one hand, a
number of swaps customers argued that the Commission should focus on
effectively eliminating Fellow-Customer Risk \27\ and Investment
Risk.\28\ Such swaps customers emphasized that (i) They currently
transact in uncleared swaps, (ii) they are able to negotiate for
individual segregation at independent third parties for collateral
supporting such uncleared swaps, and therefore (iii) they are currently
subject to neither Fellow-Customer Risk nor Investment Risk. Such
customers found it inappropriate that, under certain alternatives set
forth by the Commission, they should be subject to Fellow-Customer Risk
and Investment Risk when they transact in Cleared Swaps.
---------------------------------------------------------------------------
\27\ As noted in section I.B.1, an FCM functions as a guarantor
of customer transactions with a DCO. Section 4d(f) of the CEA
prohibits an FCM from using the collateral deposited by one Cleared
Swaps Customer to support the swap transactions of another Cleared
Swaps Customer. Therefore, if one Cleared Swaps Customer owes money
to the FCM (i.e., the Cleared Swaps Customer has a debit balance),
the FCM, acting as guarantor, must deposit its own capital with the
DCO to settle obligations attributable to such customer. If the
Cleared Swaps Customer defaults to the FCM, and the Cleared Swaps
Customer's obligations are so significant that the FCM does not have
sufficient capital to meet them, then the FCM would default to the
DCO.
As discussed in Section I.B.4, the financial resources DCOs
maintain to cover Clearing Member defaults with respect to customer
positions in excess of collateral provided by the Clearing Member
include property of the defaulting Clearing Member (i.e., collateral
deposited to support FCM proprietary transactions and contributions
to the DCO guaranty fund). Other elements of such packages may
include: (i) The collateral that the FCM deposited to support the
transactions of non-defaulting customers; (ii) a portion of the
capital of the DCO; and (iii) contributions to the guaranty fund
from other DCO Clearing Members. Typically, a DCO would exhaust one
element before moving onto the next element. Therefore, the risk
that the DCO would use any one element depends on the position of
that element in the package.
\28\ ``Investment Risk'' is the risk that each Cleared Swaps
Customer would share pro rata in any decline in the value of FCM or
DCO investments of Cleared Swaps Customer Collateral. Section 4d(f)
of the CEA permits an FCM to invest Cleared Swaps Customer
Collateral in certain enumerated instruments. The Commission is
proposing to expand such instruments to include those referenced in
regulation 1.25 (as it may be amended from time to time). Even
though (i) such investments are ``consistent with the objectives of
preserving principal and maintaining liquidity,'' and (ii) both the
FCM, as well as the DCO, value such investments conservatively (by,
e.g., applying haircuts), the value of such investments may decline
to less than the value of the collateral originally deposited. See
regulation 1.25(b) (as amended in Investment of Customer Funds and
Funds Held in an Account for Foreign Futures and Foreign Options
Transactions, 76 FR 78776, December 19, 2011). In such a situation,
all customers would share in the decline pro rata, even if the
invested collateral belonged to certain customers and not others.
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On the other hand, a number of FCMs and DCOs argued that the
benefits of effectively eliminating Fellow-Customer Risk and Investment
Risk are outweighed by the costs. With respect to benefits, these FCMs
and DCOs noted that the Futures Model has served the futures industry
well for many decades. With respect to costs, these FCMs and DCOs
described two potential sources. First, FCMs and DCOs stated that,
depending on the manner in which the Commission proposes to eliminate
or mitigate Fellow-Customer Risk and Investment Risk, they may
experience substantial increases to operational costs (e.g., costs
associated with transaction fees, reconciliations, recordkeeping,
reporting). Second, and more significantly, FCMs and DCOs stated that
they may incur additional risk costs due to proposed financial
resources requirements.\29\
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\29\ As described below, the term ``Risks Costs'' refers to the
costs associated with the allocation of loss in the event of a
default under the Complete Legal Segregation Model relative to the
Futures Model. For a more detailed explanation of these costs, see
the discussion in section VII.B.2.b., under the heading titled
```Risk Costs' and potential effects on margin levels and DCO
guaranty fund levels in response to complete legal segregation.''
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In addition, some DCOs may have anticipated including collateral
from non-defaulting Cleared Swaps Customers as an element in their
financial resources packages. If DCOs no longer have access to such
collateral, then those DCOs would need to obtain additional financial
resources to meet proposed Commission requirements. Both FCMs and DCOs
averred that the costs associated with obtaining such additional
financial resources may be substantial, and would ultimately be borne
by Cleared Swaps Customers.\30\
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\30\ 75 FR at 75163. For example, one DCO estimated that it
would have to increase the amount of collateral that each Cleared
Swaps Customer must provide by 60 percent, if it could no longer
access the collateral of non-defaulting Cleared Swaps Customers to
cure certain defaults. See infra n. 258.
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2. ANPR
Given the concerns that stakeholders expressed at the First
Roundtable, the Commission decided to seek further comment through the
ANPR on the potential benefits and costs of (i) The Legal Segregation
Models (whether Complete or with Recourse), (ii) the Physical
Segregation Model, and (iii) the Futures Model. As the ANPR explicitly
stated, ``[t]he Commission [was] seeking to achieve two basic goals:
Protection of customers and their collateral, and minimization of costs
imposed on customers and on the industry as a whole.'' \31\ In
addition, the Commission requested comment on the impact of each model
on behavior, as well as whether Congress evinced intent for the
Commission to adopt any one or more of these models.
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\31\ Id.
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[[Page 6342]]
As described in the NPRM, the Commission received thirty-one
comments from twenty-nine commenters.\32\ The comments were generally
divided by the nature of the commenter: Most (though not all) of the
comments from current or potential Cleared Swaps Customers favored
either the Legal Segregation Models (whether Complete or with Recourse)
or the Physical Segregation Model, manifesting a willingness to bear
the added costs.\33\ Most of the FCMs and DCOs favored the Futures
Model, though one commenter favored the Complete Legal Segregation
Model.\34\ Finally, another commenter, in its supplemental comment,
opined that the most important factor that the Commission should
consider is the extent to which a model fostered the portability \35\
of Cleared Swaps belonging to non-defaulting customers.\36\ This
commenter noted that the Physical Segregation Model and what is now
referred to as the Complete Legal Segregation Model were most conducive
to that goal.\37\
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\32\ All comment letters are available through the Commission's
Web site at: https://www.cftc.gov/LawRegulation/FederalRegister/ProposedRules/2010-29836.
\33\ See id.
\34\ See id.
\35\ The terms ``portability,'' ``port,'' and ``porting'' refer
to the ability to reliably transfer the swaps (and related
collateral) of a non-defaulting customer from an insolvent FCM to a
solvent FCM, without the necessity of liquidating and re-
establishing the swaps.
\36\ See ISDA comment letters on ANPR.
\37\ See id.
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After careful consideration of the First Roundtable discussion and
the comments received in response to the ANPR, the Commission issued
the NPRM on June 9, 2011.
3. Second Roundtable
Discussions during the Second Roundtable generally reflected the
conflicting concerns expressed by market participants regarding the
alternative segregation models set forth by the Commission. Swaps
customers continued to state that the Commission should focus on
mitigating Fellow-Customer Risk, with some also advocating for the
elimination of Investment Risk, while FCMs and DCOs reiterated that the
Commission should select the Futures Model as the segregation model for
Cleared Swaps Customer Collateral because the Futures Model has served
the futures industry well for many decades. Pension funds, and a few
investment managers, remained concerned about their potential exposure
to Fellow-Customer Risk and Investment Risk and continued to press the
Commission to adopt the Physical Segregation Model either outright or
on an optional basis.
In addition, participants discussed various cost and benefits
issues arising in relation to the Futures and the Legal Segregation
Models. Specifically, several participants believed that the
operational costs would not be significantly different between the
Futures Model and the Complete Legal Segregation Model.\38\ Moreover,
although some participants projected that risk costs would
significantly increase if the Commission were to select the Complete
Legal Segregation Model,\39\ one participant argued that these risk
costs would not be incremental risk costs; rather they are risk costs
that exist in the Futures Model that would most likely ultimately be
borne by customers.\40\ Finally, one participant argued that any model
that facilitates the ability to port ``is superior to one that
doesn't'' because ``the closeout cost in the future's model was the
most expensive,'' meaning that ``closing out a client account and rates
could be extremely devastating to the market, and * * * be really
significant losses * * * [and] any way [the losses] can be avoided
would be beneficial to every participant in the market.'' \41\
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\38\ See Second Roundtable Tr. at 250, l.2 (In response to
whether the Complete Legal Segregation Model would impose
operational costs over the Futures Model, Ms. Bregasi stated that
``[t]here is no additional cost between LSOC and the futures
model;'' Mr. Prager stated that ``[w]e don't see them incurring
other than the start-up costs, the one time that everyone will have
to incur to set up, the running cost. We don't see any incremental
cost;'' and Mr. MacFarlane stated that ``I would agree there are no
additional operational costs.''). See also, Second Roundtable Tr. at
239, l.8 (Mr. Frankel explaining that operational costs resulting
from passing ``the client identity and * * * some other multiplier
that explains how much excess there is in the seg account for the
client * * * [is] a small build.''); Second Roundtable Tr. at 243,
l.22 (Mr. Kahn stating that ``in terms of the cost, the fact is OTC
is a little different than futures because there is a tremendous
build that everyone is doing in the case of OTC so if we need to
build LSOC which in essence we've done in the LCH European model,
there is a cost of that but I can't really define what it is. It's
relatively small and not material.'').
\39\ See Second Roundtable Tr. at 255, l.12 (Mr. Frankel arguing
that ``Moving to a 99.9 percent confidence of coverage we think will
increase margins by about 60 percent [for rates] * * * I think for
CDS it could be more than double.''). See also Second Roundtable Tr.
at 262, l.2 (Mr. Diplas arguing that ``not having the additional
pool of funds that are associated with the fellow customers means
that we definitely need to actually margin from a CCP perspective,
the higher confidence interval. That will differ depending on the
asset class we're looking at. Some of them, at least based on the
existing pool of trades, it could be manageable like at 60, 70
percent in rates. We'll talk about three to four times the amount
that--in credit--and the more we get to instruments with fatter
tails the higher the number is going to be. I think that is
something that clients need to be cognizant of.'').
\40\ See, e.g., Second Roundtable Tr. at 257, l.6 (Mr.
MacFarlane stating that ``what's being said, if our transactions had
to be margined on an individual basis it would require that we put
up 60 to 70 percent more, which says that then the real risk of that
transaction is 75 percent more than what we're collateralizing. So
in the event of a default, not by us but by another counterparty
potentially, they will be under-collateralized relative to what
their individual transaction would require, and then that
potentially could work its way back to us.'').
\41\ See, e.g., Second Roundtable Tr. at 259, l.6 (quoting Mr.
Frankel). For a more detailed discussion of cost and benefit
considerations, please see discussion below in section VII.
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4. NPRM
After carefully considering all comments to the ANPR and statements
made during the First Roundtable discussion, the Commission proposed in
the NPRM the Complete Legal Segregation Model as the segregation model
for Cleared Swaps Collateral because the Complete Legal Segregation
Model provided the best balance between benefits and costs in order to
protect market participants and the public. Nonetheless, due in part to
the strong opposing views expressed by market participants, the NPRM
made clear that the Commission was still considering whether to adopt,
in the alternative, the Legal Segregation with Recourse Model, and was
continuing to assess the feasibility of an optional approach and the
Futures Model.
Commenters to the ANPR generally observed that customers ultimately
would bear the costs of implementing whatever segregation model was
selected by the Commission. Nonetheless, most (though not all) of the
buy-side commenters favored individual protection for Cleared Swaps
Customer Collateral. These commenters generally viewed the Complete
Legal Segregation Model as the minimum level of protection necessary
for Cleared Swaps Customer Collateral. Because it was largely
recognized that customers would ultimately bear the costs of
implementing the selected segregation model, the Commission believed it
appropriate to give weight to the views of market participants who
would bear those costs, and found it compelling that most buy-side
commenters favored adoption of either the LSOC Model or the Physical
Segregation Model. The Commission noted that the Legal Segregation
Models and the Physical Segregation Model would provide greater
individualized protection to Cleared Swaps Customer Collateral than the
Futures Model, and was in accordance with section 4d(f) of the CEA. In
addition, the Commission noted that the LSOC Model and the Physical
Segregation Model may provide substantial benefits in the form of (i)
[[Page 6343]]
Decreased Fellow-Customer Risk, (ii) increased likelihood of
portability, (iii) decreased systemic risk, and (iv) positive impact on
portfolio margining, and asked for comment as to whether and why
commenters favor or oppose adoption of the Futures Model.
In choosing between the Legal Segregation Models and the Physical
Segregation Model, the Commission noted that the operational costs for
the Physical Segregation Model would be substantially higher than the
operational costs for the Legal Segregation Models (whether Complete or
with Recourse). With respect to benefits, the Commission believed that
the Physical Segregation Model would provide only incremental
advantages over the Complete Legal Segregation Model with respect to
the mitigation of Fellow-Customer Risk. In addition, the Commission
noted that while the Physical Segregation Model does eliminate
Investment Risk, (i) the Commission was in the process of further
addressing Investment Risk by proposing amendments to regulation 1.25,
and (ii) each FCM and DCO already values investments conservatively.
Finally, the Commission observed that the Physical Segregation Model
would generally enhance portability to the same extent as the Complete
Legal Segregation Model, and therefore would have similar effects on
systemic risk. In addition, the Commission stated that the Physical
Segregation Model and the Complete Legal Segregation Model would likely
enhance portfolio margining to the same extent. Therefore, the
Commission chose not to propose the Physical Segregation Model in the
NPRM.
In choosing between the Complete Legal Segregation Model and the
Legal Segregation with Recourse Model, the Commission noted that
commenters argued that implementing the former would result in
significant Risk Costs,\42\ whereas implementing the latter would
result in no Risk Costs. In addition, the Commission believes that
comments to the ANPR that question the assumptions underlying the upper
estimates of Risk Costs for the Complete Legal Segregation Model have
raised credible issues regarding the accuracy of those estimates.
Nevertheless, the Commission recognized that such assumptions formed an
area of divergence between commenters, and therefore asked for
additional comment on the Risk Costs for the Complete Legal Segregation
Model. The Commission also observed that operational costs for the
Complete Legal Segregation Model and the Legal Segregation with
Recourse Model were approximately the same. With respect to benefits,
the Commission noted that the Complete Legal Segregation Model would
(i) Mitigate Fellow-Customer Risk even in extreme FCM defaults, unlike
the Legal Segregation with Recourse Model, (ii) enhance portability
(and therefore mitigate systemic risk) to a significantly greater
extent than the Legal Segregation with Recourse Model, and (iii) have
an incremental advantage over the Legal Segregation with Recourse Model
with respect to impact on portfolio margining.\43\ Consequently, the
Commission chose not to propose the Legal Segregation with Recourse
Model in the NPRM, but stated that it was still considering this model
as an alternative.
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\42\ For a more detailed discussion regarding risk costs, see
section VII.B.2.b., infra.
\43\ See 33818 FR at 33828.
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F. Clarification of the Application of Financial and Segregation
Interpretation No. 10 to Cleared Swaps
In response to the Commission's NPRM, clarification was requested
\44\ regarding the applicability to the cleared swaps market of the
Commission's 2005 Amendment to Financial and Segregation Interpretation
No. 10 on the Treatment of Funds Deposited in Safekeeping Accounts
(``Segregation Interpretation 10-1'').\45\ The commenter noted that
``[u]ntil 2005, the CFTC permitted the use of third-party custodial
accounts for futures margin by pension plans and investment companies
registered under the 1940 Act * * *. In 1984, the CFTC issued Financial
and Segregation Interpretation No. 10 * * *, permitting the use of
third party custodial accounts for the holding of customer property
subject to certain conditions ensuring that an FCM would have immediate
and unfettered access to customer funds.'' \46\ However, Segregation
Interpretation 10-1 made it clear that, with limited exceptions, FCMs
would not be in compliance with the requirements of section 4d(a)(2) of
the CEA if they hold customer funds in a third-party custodial account.
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\44\ See Committee on Investment of Employee Benefit Assets
(``CIEBA'') December 22, 2011 letter (``CIEBA Supplemental'') at 2.
\45\ Amendment of Interpretation, 70 FR 24768, May 11, 2005
(Notice) The underlying Financial and Segregation Interpretation No.
10 (``Segregation Interpretation 10'') was issued on May 23, 1984,
and can be found at Comm. Fut. L. Rep. (CCH) ]7120.
\46\ CIEBA Supplemental at 4.
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The Commission agrees that Segregation Interpretation 10-1 does not
apply to Cleared Swaps. Accordingly, and subject to the conditions
described below, Cleared Swaps Customer Collateral may be deposited at
a bank in a third-party safekeeping account, in lieu of posting such
collateral directly to the FCM, without the FCM being deemed in
violation of section 4d(f) of the CEA, and FCMs are permitted to
allowed Cleared