CFTC Eases Collateral Segregation Requirements for Swap Dealers and MSPs

Practical Law Legal Update w-019-8545 (Approx. 5 pages)

CFTC Eases Collateral Segregation Requirements for Swap Dealers and MSPs

by Practical Law Finance

Published on 04 Apr 2019 • USA (National/Federal)

The CFTC approved a final rule easing certain Dodd-Frank collateral segregation requirements for swap dealers (SDs) and major swap participants (MSPs) as part of the CFTC's Project KISS initiative to simplify rules and reduce regulatory burden. This Update includes a table comparing the original segregation rules with the amended segregation rules.

On March 28, 2019, the CFTC approved a final rule amending certain CFTC regulations, introduced under the Dodd-Frank Act, governing the segregation of assets held as collateral in connection with uncleared swap transactions entered into by swap dealers (SDs) and major swap participants (MSPs).

The final rule is part of the CFTC's Project KISS initiative, which seeks to simplify CFTC rules and regulations to reduce costs and regulatory burden (see Legal Update, CFTC Requests Public Input as Part of Project KISS Initiative to Simplify Rules).

Under CFTC customer initial margin (IM) segregation rules in Part 23 of the CFTC Regulations, SDs and MSPs are required to notify their uncleared swap counterparties of the counterparty's right to have the IM collateral the counterparty posts with the SD or MSP in connection with the uncleared swap transaction between them segregated with an independent third-party custodian (see Practice Note, The Dodd-Frank Act: Derivatives Margin Collateral Rules: Optional Segregation of Uncleared Swaps Initial Margin).

In July 2018, the CFTC proposed a rule (July 2018 proposal) that would ease these notification requirements (see Legal Update, CFTC Proposes Easing Collateral Segregation Notice Requirements for Swap Dealers), as well as a number of other requirements related to this optional collateral segregation rule introduced under Title VII of the Dodd-Frank Act. The final rule adopts the changes to CFTC Regulations 23.700 through 23.704 as proposed in the July 2018 proposal.

The final rule:

Amends Regulation 23.700 by eliminating the definition of "margin," and where the term is used elsewhere in subpart L of Part 23, replacing it with the term "initial margin." As amended, subpart L therefore no longer refers collectively to IM and variation margin (VM) by using only the term "margin," but rather only to IM, because the right to require segregation applies only to IM and not to VM.
Amends Regulation 23.701 by:
- requiring notification of the counterparty of the counterparty's right to segregate prior to the execution of the first uncleared swap transaction that provides for posting of IM by the counterparty, not prior to each transaction as is currently required;
- eliminating the annual notification requirement;
- eliminating the notification requirement where segregation is mandatory under the CFTC margin rules as well as where it is mandatory under the prudential margin rules, in which case the swaps would be subject to the requirements of the applicable regulator (see Practice Note, The Dodd-Frank Act: Margin Collection and Exchange Rules for Uncleared Swaps: Final CFTC Margin Rules and Final Prudential Margin Rules);
- eliminating the requirement to identify one or more creditworthy custodians and to provide information regarding the cost for segregation for each named custodian;
- eliminating the requirement to provide the notification to a person with a specific job title at the counterparty;
- requiring that the terms of segregation are to be established by written agreement with the counterparty; and
- eliminating the requirement to obtain from the counterparty and maintain written confirmation of receipt of the notification.
Amends Regulation 23.702 by replacing the specific requirements regarding the withdrawal or turnover of control of IM with a provision that specifies that:
- the segregation agreement provide written instructions regarding withdrawal of IM; and
- that IM withdrawal notifications be given immediately upon turnover of control of the IM collateral to the non-withdrawing party.
Amends Regulation 23.703 by eliminating the requirement that margin that is segregated pursuant to an election under Regulation 23.701 may only be invested in a manner consistent with Regulation 1.25, which governs the investment and rehypothecation of customer funds held by FCMs and derivatives clearing organizations (DCOs) (see Practice Note, The Dodd-Frank Act: Derivatives Margin Collateral Rules: Investment of Customer Funds and Cleared Swaps Customer Collateral).
Amends Regulation 23.704 by requiring the SD or MSP to report on a quarterly basis to counterparties that do not elect to require segregation of IM, instead of specifically requiring the SD's or MSP's chief compliance office (CCO) to report.

Changes to CFTC Margin Segregation Rules for Uncleared Swaps

	Original segregation rules	Amendments to segregation rules (effective May 3, 2019)
Definitions	Defines "margin" as both "initial margin and "variation margin."	The definition of "margin" is eliminated and conforming changes are made throughout by replacing the term "margin" with "initial margin."
Frequency of notification	Prior to each swap transaction or no less than annually.	At the beginning of the swap trading relationship (there is no annual notification requirement).
Exceptions to the notification requirement	Notification is not required in cases where segregation is mandatory under the CFTC margin rules.	Notification is not required in cases where segregation is mandatory under the final prudential margin rules, as well as the CFTC margin rules.
Custodian identification	An SD or MSP must identify in the notification one or more creditworthy custodians and provide information regarding the cost for segregation for each named custodian.	No requirement to identify custodians or to provide information regarding the cost for segregation.
Specified persons	The notification is required to be provided to a person with a specific title at the counterparty.	No requirement to provide the notification to a person with a specific title at the counterparty.
Segregation agreement	Provides for specific requirements regarding the segregation agreement.	Provides for the general requirement that the terms of segregation are to be established by written agreement with the counterparty.
Confirmation of receipt of notification	The SD or MSP must obtain and maintain from the counterparty written confirmation of receipt of the notification.	No requirement to obtain and maintain written confirmation of receipt of the notification.
Withdrawal or turnover requirements	Provides for specific requirements regarding the withdrawal or turnover of control.	Replaces specific requirements regarding the withdrawal or turnover of control with a general provision that the segregation agreement provide that instructions to withdraw IM must be in writing and that the withdrawal notification be given immediately to the non-withdrawing party
Restriction on investments	Restricts investment of segregated margin to investments permitted under CFTC Regulation 1.25.	No restriction on investment of segregated margin.
Reporting to counterparties that do not segregate	The SD's or MSP's CCO must report quarterly to each counterparty that does not elect segregation.	Provides for a general requirement that the SD or MSP report to counterparties that do not elect segregation, and that the report must state that the SD's or MSP's back office procedures were in compliance with the agreement of the counterparties.

CFTC Eases Collateral Segregation Requirements for Swap Dealers and MSPs | Practical Law