Sunday, January 15, 2012

Hedge Fund Industry Asks CFTC to Approve ICE Petition on Portfolio Margining and Calculating Margins for Cleared Swaps

The ICE portfolio margining program will benefit customers and the U.S. credit default market by facilitating systemic risk reduction, providing capital efficiencies, and encouraging greater clearing and facilitating the transition to clearing and should thus be approved by the CFTC, said the hedge fund industry. In a letter to the Commission, the Managed Funds Association also noted that approval of the ICE petition will improve buy-side access to clearing and remove economic barriers to customer clearing, promote competitive equality, and improve risk management. Without the exemptive relief requested in the ICE petitions, the MFA believes that none of these benefits will be realized.

The ICE petition is also supported by the Futures Industry Association. In a letter to the CFTC, the FIA said that a commingled portfolio margining account will allow ICE Clear Credit to offer the greatest benefit to the market and market participants by providing its broker dealer and futures commission merchant clearing members and their customers with greater operational efficiencies and a more comprehensive offering of products that can be cleared.

In particular, continued the FIA, because many market participants hedge index credit default swap positions with a single-name credit default swap, in the absence of portfolio margining, a trader will have to post full margin for both assets, which will require a significant capital outlay that will discourage participation in the US swap market and potentially add to systemic risk during times of stress. Portfolio margining will provide participants in the credit default swap market with the incentive and capital efficiency necessary to make the central clearing of credit default swaps, as contemplated in the Dodd-Frank Act, economically feasible.

Similarly, the MFA strongly believes that by granting the requested exemptive relief in the ICE petitions, the CFTC will provide customers in the credit default swap market with the economic incentives and capital efficiencies necessary to promote clearing of a broader scope of swap contracts. The requested exemptive relief would thus facilitate the achievement of the systemic risk reduction goal of the Dodd-Frank Act. Customers will be able to expend less capital on margin by virtue of the ability to net customers’ offsetting positions in security-based credit default swaps and index credit default swaps in cleared swaps customer accounts under ICE Clear Credit’s margin methodology.

Moreover, without portfolio margin treatment, many customers may determine that clearing their security-based and index credit default swaps will be prohibitively expensive. This would have a limiting effect on both the volume of voluntary clearing prior to the clearing mandate becoming effective, said the MFA, and the breadth of credit default swap clearing after the clearing mandate becomes effective. In the association’s view, these results would be inconsistent with a key Dodd-Frank Act goal to promote greater central clearing of swaps to reduce systemic risk.

Without the exemptive relief requested in the ICE Petitions, noted the MFA, ICE Clear Credit and its broker-dealers and futures commission merchants would be required to maintain separate accounts subject to the different margin rules of the CFTC and SEC to hold customer collateral relating to index and security-based credit default swaps. Separate accounts would make clearing significantly more expensive for customers because they would be required to fully margin both accounts.

For example, a customer that sells single-name credit default swaps to offset the risk of a correlated index credit default swap will, without the ability to net margin under a portfolio margining program, have to post full margin for both assets. The resulting inability of broker-dealers and futures commission merchants clearing such transactions on behalf of customers to net the margin of correlated index and security-based credit default swaps held in separate accounts would eliminate the economic efficiencies that can be gained from portfolio margining and that are inherent in a wide range of hedging strategies.

The MFA believes that these inefficiencies will act as an economic disincentive, not only to customers’ efficient portfolio risk management, but also to moving the US credit default swap marketplace to central clearing. Further, such a significant disincentive would severely undermine a fundamental objective of the Dodd-Frank Act to reduce systemic risk through promotion of greater clearing of swaps and the reduction of systemic risk. In addition, the Dodd-Frank Act encourages portfolio netting for systemic risk management reasons, charging the CFTC and the SEC with issuing exemptive orders under Section 713(a) in support of portfolio margining.

The FIA noted that Section 713 amends the Securities Exchange Act to provide that cash and securities, including security-based swaps, that are carried in a segregated account in accordance with an approved portfolio margining program will be subject to the commodity broker liquidation provisions of Subchapter IV of Chapter 7 of title 11 of the Bankruptcy Code. With this amendment, said the FIA, a major impediment to implementation of portfolio margining has been removed.