The Securities and Exchange Commission has approved new Financial Industry Regulatory Authority Rule 4240, which establishes an interim pilot program with respect to margin requirements for certain transactions in credit default swaps (CDS) and requires members to adopt related risk monitoring procedures and guidelines. The Interim Pilot Program’s requirements generally apply to any CDS transactions which are executed by a member, regardless of the type of account in which the transaction is booked and regardless of whether the transactions are subject to individual negotiation.  

The Interim Pilot Program requires that any member that desires to clear CDS through a clearing agency must notify FINRA in advance in writing. For Chicago Mercantile Exchange (CME) cleared CDS that offset CDS transactions between the member and its counterparties, Rule 4240 requires the member to collect margin which is not less than the margin required to be deposited by the member at CME with respect to such transactions. For other cleared CDS and over-the-counter CDS, sellers of protection would be required to post a percentage of notional amount of the CDS, which percentage would vary depending on the size of the coupon payments required to be made under, and the maturity date of, the CDS. For buyers of protection, the margin required would be equal to 50% of the amount of margin that would be required from a seller of protection on the same CDS. Under Rule 4240, the percentages of the notional amount required to be deposited as margin for CDS index transactions would be lower than the percentages required for single name CDS transactions.  

Rule 4240 also requires members to take a concentration haircut as follows. First, the member would identify its most concentrated CDS position and calculate its current and potential exposure with respect to this position. If this amount exceeds the member’s tentative net capital, the member would be required to take a capital charge equal to the margin required for this position under Rule 4240. The member could reduce the amount of this charge by the amount of any excess margin that it holds with respect to its counterparties. The new rule also requires members to monitor the risk of any accounts that engage in CDS transactions and to maintain a comprehensive written risk analysis methodology for assessing the potential risk to the member’s capital over a specified range of possible market movements over a specified time period.  

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