The Financial Industry Regulatory Authority (FINRA) recently filed proposed FINRA Rule 4240 with the Securities and Exchange Commission to adopt margin requirements for broker-dealers that carry positions in credit default swaps (CDS) for the accounts of customers and other broker-dealers. Rule 4240 would apply both to cleared CDS and non-cleared CDS.
For Chicago Mercantile Exchange (CME) cleared CDS, Rule 4240 would require customers to deposit margin which is not less than the margin required to be deposited by the FINRA member at CME with respect to these positions. For other cleared CDS and over-the-counter CDS, sellers of protection would be required to post a percentage of the 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 of the same CDS. Under the proposed Rule, 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.
The proposed Rule would require FINRA members to take a concentration haircut. 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 customers.