Collateral Concerns Weigh on Markets

Terry Flanagan

Complete legal segregation model may not prevent MF Global-type situations.

Market participants are weighing the tradeoffs associated with new collateral protections being put in place by regulators.

In January 2012, the Commodity Futures Trading Commission adopted final rules regarding the protection of cleared swaps collateral, which impose requirements on FCMs and derivatives clearing organizations (DCOs) regard the treatment of cleared swaps collateral.

The CTFC adopted what’s known as the Complete Legal Segregation Model (CLSM), under which both the FCM and the DCO are required to segregate the cleared swaps collateral relating to each customer.

“It’s hard to say whether the CLSM model will fully protect against another MF Global type situation,” Russ Chruschiel, head of Valdi Options U.S., part of SunGard’s capital markets business, told Markets Media.  “Given the magnitude and fallout of the MF Global situation, all industry participants need to be open to experimenting with different safeguards, be it a CLSM model or some other structure.”

Prior to MF Global, the U.S. futures model for customer asset segregation had worked well for many years, and various FCM and DCO segregation processes are deeply ingrained in the futures markets, they note. However, in the aftermath of MF Global, regulatory changes are needed.

“Customer confidence in the existing U.S. futures model for customer asset segregation is certainly shaken, and the CLSM model appears to provide more granularity into specific customer accounts,” Chrusciel said. “That said, the overall costs of implementing and managing the CLSM model could prove to be fairly costly relative to the intended benefit it seeks to provide.”

A group of asset managers—BlueMountain Capital Management, Elliott Management, Moore Capital Management, Paulson & Co., and Tudor Investment Corp.—which collectively manage in excess of $65 billion, said that the CLSM model was deficient in a number of respects.

They instead have proposed a Physical Segregation Model as a means of protecting collateral. By establishing separate customer account, the ability of an FCM to improperly access or otherwise fail to segregate customer collateral, whether by mere oversight of overt act, would be greatly diminished.


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