CME Group recently expanded its clearing of OTC derivatives to include Interest Rate Swaps. In addition, the CFTC recently issued an Order allowing customer funds used to margin, guarantee or secure trading activity for CBOT Ethanol Swaps listed in the Order to be included in customer segregated accounts.
Questions have arisen regarding the regulatory treatment and financial reporting of these positions by clearing members.
Regulatory Treatment of Cleared Ethanol Swaps
The CFTC recently issued an Order allowing customer funds used to margin, guarantee or secure transactions in CBOT Ethanol Swaps listed in the Order cleared by CME Clearing to be included with other customer segregated assets. On Monday, October 13th, CME Clearing will begin to process these customer trades in its customer segregated origin.
The accounts of customers trading Ethanol Swaps must be included in the customer segregated origin in the firm’s bookkeeping system. All cash and collateral received from customers to margin, guarantee or secure these positions must be deposited in customer segregated bank and safekeeping accounts. Mark-to-market/variation to/from and collateral held in the customer segregated origin at CME Clearing must be reflected as a segregated asset on the Segregation Statement.
As these customer positions are now required to be included in segregation, they are treated similar to futures for regulatory purposes. SPAN will calculate performance bond requirements for these positions and broker-dealers/FCMs are required to call for performance bond collateral, if necessary, from their customers. In addition, the risk performance bond requirement of these positions must be included in its calculation of CFTC risk based capital requirements.
Proprietary positions of the broker-dealer/FCM and its noncustomer affiliates should continue to be reflected in the house origin of the firm’s bookkeeping system and cleared through the house origin at CME Clearing.
Regulatory Treatment of Cleared Interest Rate Swaps
CME Group has also asked the CFTC to allow FCMs to hold funds, securities and other property of customers used to margin, guarantee or secure transactions in CME cleared Interest Rate Swaps with customer segregated assets. This request has not yet been approved by the CFTC.
In the meantime, the CFTC allows customer non-regulated transactions to be included in the CFTC Part 30.7 Secured Calculation. CME Group has confirmed with the CFTC that this treatment is acceptable as it pertains to CME cleared Interest Rate Swaps while they consider the above request.
CME Clearing has established a third origin titled “CFTC Customer Secured” for the clearing of customer positions in Interest Rate Swaps. CME Clearing will calculate a performance bond requirement and hold collateral on customer positions in this origin. If the clearing firm obtains a “secured acknowledgement” letter from CME Clearing, it must include cash and collateral held in this origin as a Part 30.7 secured asset when preparing its Secured Calculation.
The accounts of customers trading Interest Rate Swaps must be included in the customer secured origin of the firm’s bookkeeping system and included in the requirement of the Secured Calculation.
For further information on the CFTC Secured Calculation, please refer to the CFTC 1-FR Instruction Manual and the Joint Audit Committee’s (“JAC”) Foreign Futures and Options Guide on the JAC’s Web Site at www.wjammer.jac
As the positions are non-regulated, the broker-dealer/FCM need not call for performance bond collateral. However, if the broker-dealer/FCM does elect to require its customers to deposit performance bond collateral with it for prudent risk management purposes, it need not include the risk performance bond requirement of these positions in its calculation of CFTC risk based capital requirements.
Generally, broker-dealers must include customer accounts containing non-regulated transactions in their SEC Rule 15c3-3 customer reserve calculation. However, SEC interpretations provide that customer accounts which are included in the CFTC customer segregation or secured calculations need not be included in the reserve calculation.
These positions are non-regulated and a broker-dealer/FCM is not required to call its noncustomer affiliates for performance bond collateral. It is does elect to do so, it need not include the risk performance bond requirement in its calculation of CFTC risk based capital requirements.
In the computation of net capital, broker-dealer/FCMs are required to take a haircut on its proprietary positions. The following haircut treatment applies for proprietary positions in interest rate swaps of a broker-dealer/FCM:
· Where the interest rate swap is maturing in 10 years or less and is matched with offsetting interest rate swaps with corresponding terms and maturities or are hedged with U.S. Treasury obligations – 1% of the notional amount;
· Where the interest rate swap is maturing in more than 10 years and is matched with offsetting interest rate swaps with corresponding terms and maturities or are hedged with US Treasury obligations – 3% of the notional amount; and
· Where the interest rate swaps is not matched or hedged (i.e. naked), the haircut is calculated per SEC Rule 15c3-1(c)(2)(vi)(A)(1) (i.e. the haircut for US government obligations) on the notional amount.
If you have any questions, please contact the Audit Department at 312.930.3230.