Monday, January 04, 2016

SEC Extends Swaps Margin Requirements No-Action Position for Two Years

By John Filar Atwood

The staff of the SEC’s Division of Investment Management has extended until December 31, 2017 its no-action position to three derivatives clearing organizations in connection with their clearance of credit default swaps (CDS). The staff initially issued the no-action assurance in 2011, and has extended it several times since.

No-action position. The staff announced the extension in letters to ICE Clear Credit LLC, LCH.Clearnet Ltd. and Chicago Mercantile Exchange (CME). The staff agreed not to not recommend action under Investment Company Act Section 17(f) against any registered investment company (a Fund) if the Fund or its custodian places and maintains cash and/or certain securities in the custody of ICE, LCH, or CME; a derivatives clearing organization registered with the CFTC; or a clearing member that is a futures commission merchant registered with the CFTC (FCM) for purposes of meeting ICE’s, LCH’s, or CME’s margin requirements for certain CDS that are cleared by them.

In reaching its position, the staff noted that each clearing member that holds assets for an unaffiliated Fund customer wishing to clear CDS transactions on ICE, LCH, or CME will address each of the requirements of Rule 17f-6. In addition, the manner in which a clearing member will maintain a Fund’s assets will be governed by a written contract between the Fund and the clearing member.

Contract provisions. The contract provides that the clearing member will comply with the requirements relating to the separate treatment of customer funds and property of ICE, LCH, and CME, and the CFTC segregation rules for swap collateral under Part 22 of the CFTC’s regulations, specifying the substantive requirements for the treatment of cleared over-the-counter derivatives in the cleared swaps customer account and the cleared swaps account class prior to any bankruptcy.

Under the contract, the clearing member may place and maintain the Fund’s assets as appropriate to effect the Fund’s cleared CDS transactions through ICE, LCH, and CME and in accordance with the Commodity Exchange Act and the CFTC’s rules. The clearing member will obtain an acknowledgement, to the extent required under CFTC Rules 22.5 and 1.20(a), that the assets are held on behalf of the clearing member’s customers. The clearing member must furnish promptly copies of or extracts from its records or such other information pertaining to the Fund’s assets as the Commission through its employees or agents may request.

Any gains on the Fund’s transactions, other than de minimis amounts, may be maintained with the clearing member only until the next business day following receipt, according to the staff. In addition, the staff noted that the Fund may withdraw its assets from the clearing member as soon as reasonably practicable if the custodial arrangement no longer meets the requirements of Rule 17f-6.

Risk warning. The staff advised that maintaining assets in an FCM’s custody is not without risk, and encouraged Funds to weigh carefully the risks and benefits of maintaining assets to effect transactions in CDS with ICE, LCH, CME, or a clearing member.