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To segregate or not- that’s now the question

Today marks the effective date for compliance with CFTC final rules on notification of IM segregation for SDs/MSPs. The Final Rules on the Protection of Collateral of Counterparties to Uncleared Swaps more or less does what it says on the tin:

Client Notification: SD/MSPs will notify the client of their right to require segregation of initial margin prior to the execution of each uncleared swap transaction.  Receipt of notification and consequent client election must be obtained prior to the confirmation of the trade. Notification will include the following elements:

  • Custodian: SD/MSPs will choose and identify at least one credit-worthy, non-affiliated (to either party) custodian
  • Pricing: SD/MSPs will inform the counterparty of the price of the custodian service

Who to:  SD/MSPs will send notification to “the officer in the counterparty responsible for the management of collateral”. Failing this, to the CRO, CEO etc.

Timing: prior to each new trade; in the absence of new trades, notification must be sent at least once per calendar year

Election: may be made via the CFTC Initial Margin Segregation module on Markit’s ISDA Amend website or direct to the relevant SD/MSP. Election to segregate will require the negotiation of custody agreements and setting up the designated account at the custodian.

Election Change: the counterparty may change their segregation choice by written notice to the SD/MSP, such change will only affect trades after delivery of the election change

Non-segregated margin: the chief compliance officer of the SD/MSP must provide the counterparty a quarterly report detailing any variance from their agreement over the preceding 90 days.

SD/MSPs must be in compliance from today with the Final Rules for any counterparty that entered into a new agreement with them after 6th January 2014. Agreements that pre-date the 6th January 2014 will be subject to full compliance by 3rd November 2014.

It should be noted that the rules impose requirements that are atypical of the majority of triparty agreements. Turnover of control (as opposed to mere withdrawal by mutual agreement) can be effected by either party, by prompt submission to the custodian of a written statement “made under oath or penalty of perjury” that they are entitled to control of the margin. Account funds may only be invested by the SD/MSP consistently with CFTC Rule S1.25- in highly liquid securities. Aside from these slightly anomalous features, buy-side choice will be determined by cost vs. credit concern alleviation. The new rules will be unlikely to affect existing triparty custodian agreements; those who are happy with existing arrangements can simply choose not to segregate. Either way, when notification is received, an election must be made or trade will be disrupted.

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