CFTC Fines FCM for Failure to Hold Segregated Cleared Swaps Margin in US Dollars | Practical Law

CFTC Fines FCM for Failure to Hold Segregated Cleared Swaps Margin in US Dollars | Practical Law

The CFTC's Division of Enforcement issued an order requiring futures commission merchant Morgan Stanley & Co. LLC to pay $300,000 in civil monetary penalties for failing to adhere to Dodd-Frank margin collateral segregation requirements for cleared swaps. The matter is further evidence of a CFTC shift from rulemaking mode to enforcement and active regulation of the swaps markets under the Dodd-Frank Act.

CFTC Fines FCM for Failure to Hold Segregated Cleared Swaps Margin in US Dollars

Practical Law Legal Update 1-618-0706 (Approx. 3 pages)

CFTC Fines FCM for Failure to Hold Segregated Cleared Swaps Margin in US Dollars

by Practical Law Finance
The CFTC's Division of Enforcement issued an order requiring futures commission merchant Morgan Stanley & Co. LLC to pay $300,000 in civil monetary penalties for failing to adhere to Dodd-Frank margin collateral segregation requirements for cleared swaps. The matter is further evidence of a CFTC shift from rulemaking mode to enforcement and active regulation of the swaps markets under the Dodd-Frank Act.
On August 6, 2015, the CFTC's Division of Enforcement issued an order requiring Morgan Stanley & Co. LLC, which is a CFTC-registered futures commission merchant (FCM) and a provisionally registered swap dealer (SD), to pay $300,000 in civil monetary penalties for failing to adhere to Dodd-Frank cleared-swaps customer margin collateral segregation requirements.
Under Section 724 of the Dodd-Frank Act, FCMs are required to hold collateral posted by their cleared swaps customers in a segregated collateral account. Posted collateral must be legally separated but may be operationally commingled (LSOC), which means that while the posted collateral of all of the FCM's cleared-swaps customers may be operationally commingled in an omnibus segregation account, those funds must be legally segregated from the FCM's own funds. Additionally, segregated funds must be held in US dollars (see Practice Note, US Derivatives Regulation: Margin Collateral Rules: Segregation of Cleared Swaps Customer Collateral by FCMs and DCOs).
According to the order, while Morgan Stanley held the correct total value of margin in its omnibus cleared-swaps customer segregation account, it did not do so in US dollars, as required under CFTC Regulation 1.49(b)(1) and (e) (17 CFR 1.49(b) and (e)) and CFTC Regulation 22.9(a) (17 CFR 22.9(a)). At various times between March 2013 and March 2014, the currency deficit in Morgan Stanley's cleared-swaps customer segregation account ranged from $5 million to $265 million, which represented more than 10% of the entire segregation account balance. Additionally, Morgan Stanley did not have adequate procedures in place to ensure that it complied with those regulations, as required by CFTC Regulation 166.3 (17 CFR 166.3).
Notably, according to the order, Morgan Stanley:
  • Held the correct minimum value of collateral, albeit a portion of it in a foreign currency.
  • Promptly reported the US currency deficiencies to the CFTC.
  • Implemented corrective procedures.
  • Cooperated with the CFTC's Division of Enforcement throughout the investigation.
Despite its cooperation, the CFTC levied the civil monetary penalty against Morgan Stanley, and in doing so, demonstrated its willingness to pursue violations for breaches of CFTC regulations, even if promptly reported by the party. In this case, the CFTC imposed the penalty even though there was no actual value deficit in the segregation account. In the absence of forthright reporting by the company, the fine levied would likely have been much higher.
The matter is further evidence of a CFTC shift from rulemaking mode to enforcement and active regulation of the swaps markets under the Dodd-Frank Act.