Canadian Regulators Assess Collateral Options

Terry Flanagan

Canadian securities regulators are recommending that central counterparties, which clear over-the-counter derivatives, be required to maintain customer collateral in legally separate accounts, known as the complete legal segregation model.

The Canadian Securities Administrators has a consultation paper out for comment which deals with segregation and portability in OTC derivatives clearing. The comment period expires on April 10.

Segregation is a method of protecting customer collateral and contractual positions by holding and accounting for them separately from those of their clearing member and fellow customers of their clearing member.

The CSA’s Derivatives Committee recommends that clearing members be required to segregate customer collateral from their own proprietary assets and that for all OTC derivatives, CCPs must employ an account structure that enables efficient identification of positions and collateral belonging to the customers of a clearing member.

Prior to the collapse of MF Global in October last year, the U.S. futures model for customer asset segregation had worked well for many years, and various futures commission merchants and derivatives clearing organizations’ segregation processes are deeply ingrained in the futures markets.

In the U.S., the Commodity Futures Trading Commission has ruled that the CLSM model be adopted as part of its rulemaking under the Dodd-Frank Act, legislation aimed at preventing another financial crisis.

“While the CLSM model is certainly appealing given recent events, it is not yet clear what caused the problems at MF Global and we should be careful not to swing the pendulum too far towards over-regulation in the case of futures,” Alison Crosthwait, an independent market structure analyst, told Markets Media.

“The credit underlying futures and swaps contracts have fundamentally different characteristics and thus the same approach to collateral may not be justified,” added Crosthwait.

The CSA committee also recommends that CCPs provide for segregation of collateral belonging to each individual customer of a clearing member, as opposed to a clearing member’s customers collectively.

The committee examined four potential segregation models for the Canadian market: full physical segregation, complete legal segregation, legal segregation with recourse, and futures.

While potentially not providing the same level of protection as the full physical segregation model, CLSM permits the commingling of customer collateral and is therefore considered more cost-effective.

The CFTC is seeking input through a series of roundtables starting on February 29 on how it might build upon these segregation protections. This review includes further safeguards for client collateral on an individual basis, as well as to possibly consider similar protections for futures to what the CFTC approved for swaps.

Meanwhile, OTC derivatives transactions involving U.S. and Canadian counterparties could be centrally cleared under an arrangement between the Canadian Derivatives Clearing Corp. and New York Portfolio Clearing.

Last year, the two clearinghouses signed a memorandum of understanding to explore the development of a clearing link for the Canadian swap market.

The link would create a one-stop shop for swaps dealers and participants to centrally clear their OTC derivatives transactions. The agreement would also enable Canada to fulfill its G20 commitment to provide central clearing of OTC products by the end of 2012.

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