On July 13, the Federal Reserve Bank of New York (FRBNY) issued a press release to acknowledge the publication by a group of 8 dealers and 8 buy-side market participants of a “cross-jurisdictional analysis of legal and regulatory issues facing credit default swap central counterparties (CDS CCPs) with respect to customer access to central clearing platforms.” In a letter to FRBNY President William Dudley, the dealer and buy-side market participants stated that the full report, along with a “distilled” summary report, “sets forth a statement of the industry’s analysis of the specific issues of segregation of margin and the portability of margin in the event of clearing member default.” In its letter to the FRBNY in early June, the Operation Management Group committed to prepare and deliver the report. The report addresses risks to market participants who clear through a clearing member of a CCP due to default of the clearing member. It does not address risks to market participants that themselves become clearing members of a CCP.
In preparing this report, the dealer and buy-side market participants solicited responses from CME Clearing, Eurex Clearing AG, ICE Clear Europe, ICE Trust U.S. LLC, LCH.Clearnet Limited/NYSE Liffe and LCH.Clearnet SA on several matters related to protection of customer positions and related margin in the event of a clearing member default. The report sets forth a segregation analysis, which identifies “the manner in which margin is provided and held, and particularly, the extent to which margin is segregated from the [clearing member’s] assets and recoverable by the customers” upon clearing member default, and a portability analysis, which identifies “the effectiveness of the CCP’s procedures for the transfer or novation of customer positions and related margin.” Both analyses considered the following factors: the manner by which customers post margin; whether a CCP collects margin from clearing members on a gross or net margin basis; the type of property posted as margin; where the margin is held, and the extent to which it is commingled with other assets in the same account; what relationship exists between the CCP, clearing member and any custodians or customers; whether the margin is subject to any liens or setoff rights; and whether the margin is subject to rehypothecation or on-transfer.
The report also identified which legislative and regulatory reforms would enhance protection of customer margin, including rules clarifying the treatment of CDS upon insolvency of a clearing member, rules relating to timely access by customers to their margin after the insolvency of a clearing member and rules enhancing the ability of CCPs to transfer or novate a customer’s positions, among several others. With the move towards central clearing of many derivatives, as would be mandated by various legislative proposals, this report is an important communication from market participants.