Clearinghouses to Offer Collateral Choices

Terry Flanagan

Clearinghouses are enabling customers to choose whether or not to have their collateral kept separate from that of other customers.

The CFTC has proposed that futures commission merchants (FCMs) and derivatives clearing organizations (DCOs) be required to segregate the cleared swaps of each individual customer and relevant collateral, while permitting FCMs and DCOs to operationally commingle all relevant collateral in one account, known as the legally-separate and operationally-commingled (LSOC) model.

Some DCOs, such as CME Group, contend that the LSOC model will raise operating costs, and recommend instead that the CFTC permit DCOs to use the omnibus model employed in the futures industry, whereby property is treated separately from the property of the FCM, but futures customers are treated as a group, rather than individually.

However, CME also favors permitting cleared swaps customers that desire or require full physical segregation of their contracts and associated collateral to opt out of the commingled customer account of their FCM.

CME Clearing has engaged in initial customer discussions concerning the structure of an opt-out model. One possible approach would be the use of multiparty agreements among the DCO, a settlement bank designated as custodian, the customer and the customer’s sponsoring FCM clearing member.

“We recognize that swaps customers are accustomed to very different practices as relates to the pricing, structuring collateralization, risk management, mark-to-market and settlement of swaps products as compared to traditional exchange-traded futures products,” said CME chief Craig Donohue.

A separate account at the settlement bank would be established for each opt-pit customer pursuant to the rules of the DCO and the multiparty agreement. Operationally, the account would be managed in the same way at the clearing level as a commingled FCM customer account, except that it would be designate din the name of the customer or the DCO, and not the FCM, according to Donohue.

While the requirements to support such accounts would still inject additional risk and operational costs into the system, such costs would be substantially lower than that for a full physical segregation model, and the optional nature of the program would permit many of the costs to be allocated only to those parties choosing to participate, according to CME.

By requiring clearing members to offer full segregation to their clients, European Market Infrastructure Regulation (EMIR) may impose higher operating costs by requiring clearing members to ensure that the assets of each client are identifiable at any given point in time on the clearing member’s books.

“As the CCPs could potentialyl pose a large centralized systemic risk to the system, I am not surprised that [EMIR] is requiring segregated accounts,” Jacqui Hatfield, partner in the financial services regulation practice at Reed Smith, told Markets Media. “Segregated accounts are more protected, being ring fenced from other customer accounts, but they are expensive. Omnibus client accounts are used more frequently in the U.K. for this reason.”

Eurex Clearing’s Individual Clearing model enables full legal and operational segregation of all assets (positions and margin collateral) for its non-clearing members (clients with trading admission) at the clearing house level.

Through the service, Eurex Clearing aims to fulfill the planned regulatory requirements as specified in the published draft versions of EMIR.

The Eurex service will be offered in addition to the existing Eurex Clearing model. Eurex Clearing will also launch an Omnibus Model, offering segregation of client assets in an omnibus account with higher operational efficiency and flexibility for the clearing member.

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