Under the Dodd-Frank Act and CFTC rules, swap dealers are required to notify their counterparties that they have the right to require segregation with a third-party custodian of any initial margin posted to the swap dealer in connection with uncleared swaps. As a result of these rules, ISDA recently published a form of notification and a series of frequently asked questions regarding the rules. Under the rules, swap dealers are required to, among other things:
- notify each counterparty to any swap transaction that the counterparty has the right to require that any initial margin the counterparty provides in connection with such transaction be segregated with an independent custodian; and
- if the counterparty elects to segregate initial margin in accordance with the rules, execute a tri-party custody agreement or similar agreement with the counterparty that meets the requirements of the rules.
The segregation of initial margin may provide certain benefits to counterparties, such as additional credit protection, but also impose costs, which includes the negotiation of a tri-party custodial agreement and the possible lack of discretion in selecting a custodian.