Industry Weighs Collateral Protection

Terry Flanagan

CFTC’s Complete Legal Segregation Model is topic of spirited debate.

A spirited discussion is taking place among regulators and market participants over collateral protection for cleared swaps customers under the Dodd-Frank Act.

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) regarding the treatment of cleared swaps collateral.

The CFTC 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.

“While CLSM for clearing and collateral management is costly, the new rule will enact safety measures to prevent misuse of customer funds,” Zohar Hod, vice president and head of the Americas at SuperDerivatives, told Markets Media. “The current track record has been anything but safe for customer funds–case in point is MF Global.”

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.

Under the CFTC’s rules, clearinghouses will have to collect margin on a gross basis. This means that as of this upcoming November, FCMs will no longer be able to offset one customer’s collateral against another and then send only the net to the clearinghouse.

“For the first time, customer money must be protected individually all the way to the clearinghouse,” CFTC chairman Gary Gensler said in a speech last week.

The CFTC is seeking input on how it might build upon these segregation protections, Gensler said.

This review includes further safeguards for client collateral on an individual basis, as well as possibly considering for futures similar protections to what the CFTC approved for swaps. Staff plans roundtables to hear from the public, the first of which will be on February 29.

Futures customers are entitle to receive the same protections as swaps customers, industry participants say.

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.

CME Group recommends 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.

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