Swap end-users should expect to receive a notice from each of their swap dealers regarding the right to require segregation of initial margin. In November 2013, the Commodity Futures Trading Commission (CFTC) published its final rules requiring swap dealers (SDs) to notify counterparties of their right to require segregation of initial margin for uncleared swaps (the Segregation Notice Requirement). Under the CFTC’s Segregation Notice Requirement, an SD’s notice regarding counterparty initial margin segregation rights (the Segregation Rights Notice) must:
- Be made at least once each calendar year to an officer of the counterparty responsible for the management of collateral identified by the counterparty;
- Identify one or more custodians to hold initial margin (one of which must be a creditworthy nonaffiliate of the SD, and each of which must be a legal entity independent of the SD and the counterparty);
- Provide information regarding the price of segregation for each custodian to the extent that the SD has such information; and
- Obtain counterparty confirmation of receipt of the Segregation Rights Notice and a counterparty election whether to require initial margin segregation or not.
The CFTC’s Segregation Notice Requirement became effective on Jan. 6, 2014. End-users that are new counterparties of an SD — because they entered into a master agreement with the relevant SD after Jan. 6, 2014 — must respond to the Segregation Rights Notice by May 5, 2014.End-users that were existing counterparties on or prior to Jan. 6, 2014, must respond to the Segregation Rights Notice by Nov. 3, 2014. A counterparty’s failure to respond to the Segregation Rights Notice before the applicable deadline may prevent an SD from trading uncleared swaps with such counterparty.
In anticipation of receiving Segregation Rights Notices from SDs, a swap end-user can designate a “responsible officer” for purposes of receiving Segregation Rights Notices and provide the appropriate contact information. An end-user can provide this information directly to its SDs or by adding that information to its profile on Markit’s ISDA Amend website. The Segregation Rights Notice contact should be an officer of the counterparty responsible for the management of collateral. If an end-user does not designate a contact for this purpose, SDs will send Segregation Rights Notices to the end-user’s “chief risk officer,” if there is one, the “chief executive officer,” or the “highest-level decision-maker” for the end-user.
End-users can respond to a Segregation Rights Notice by returning it directly to its SD. In addition, ISDA and Markit have announced that, beginning sometime in April 2014, end-users can use Markit’s ISDA Amend online platform for that purpose. The Segregation Rights Notice will request that an end-user:
- Identify a collateral contact and provide an email address and other contact information for the collateral contact;
- Confirm receipt of the Segregation Rights Notice from the relevant SD; and
- Make an election either to require segregation of initial margin or not require segregation of initial margin.
An end-user may change its segregation election by subsequent written notice to the relevant SD at any time. However, that election will apply only to transactions entered after the notice is given. Segregation of initial margin is not mandatory.
In the event an end-user elects to require segregation of initial margin, it must negotiate a triparty control agreement acceptable to the end-user, SD and custodian that complies with the CFTC’s requirements for segregation of initial margin. Such an agreement must be in place prior to the May 5, 2014, or Nov. 3, 2014, deadline as applicable, if an end-user elects to require segregation of initial margin. Pre-existing triparty control agreements generally do not comply with the CFTC’s requirements for segregated initial margin and investment of segregated initial margin. While the CFTC’s initial margin segregation rules do not apply to variation margin, end-users are not prohibited from including variation margin in any segregation arrangement they negotiate.
Please contact one of the authors or your regular McGuireWoods lawyer if you have any questions regarding the CFTC’s Segregation Notice Requirement or segregation of margin.