The CFTC has issued a proposed rule concerning the rights of counterparties of swap dealers (“SDs”) and major swap participants (“MSPs”) with respect to the segregation of collateral supplied for margining, guaranteeing, or securing uncleared swaps. Under the proposed rule:
- An SD or MSP must notify each counterparty at the beginning of a swap transaction that the counterparty has the right to require segregation of the funds or other property that it supplies to margin, guarantee, or secure its obligations; and - At the request of the counterparty, the SD or MSP must segregate such funds or other property with an independent third party.
The right to segregation applies only to initial margin (defined as “an amount calculated based on anticipated exposure to future changes in the value of a swap”), not variation margin (defined as “an amount calculated 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”).
The notification must be made to certain senior decisionmakers, i.e. the Chief Risk Officer, CEO, or highest level decisionmaker for the counterparty, in that order of preference. The SD or MSP must obtain confirmation of receipt of its notification and the election to require segregation or not, before the terms of the swap are confirmed, and maintain records of such confirmation and election. An SD or MSP is required to notify a particular counterparty of its segregation right only once in any calendar year. A counterparty’s election to require segregation, or not, may be changed at its discretion upon written notice.
Turnover of control of segregated margin by the custodian, shall be made promptly to either party upon presentation of a statement in writing, made under oath or penalty of perjury, stating that such party is entitled to such control pursuant to an agreement between the parties. The other party shall be immediately notified of the turnover. Any other withdrawal of such margin shall only be made pursuant to an agreement between the parties, with immediate notification given to the non-withdrawing party. Initial margin may only be invested consistent with the CFTC’s rule 1.25 governing exchange-traded futures, though the parties have flexibility to structure the investment within the confines of the rule. The SD or MSP must report to a counterparty quarterly regarding its compliance with the agreement’s collateral requirements with respect to unsegregated margin.
The rules also clarify that securities held in a portfolio margining account carried as a futures account are customer property and that owners of those accounts are customers for purposes of the commodity broker provisions of the Bankruptcy Code. Finally, the rules change the time period in CFTC regulations during which the Commission can approve a transfer of customer funds in a commodity broker bankruptcy from five business days to seven calendar days.