CME Group is issuing this Audit Information Bulletin (“AIB”) to provide an update on its implementation of its cleared OTC derivatives sequestration rules and to provide clarification on issues which have recently been raised. This AIB updates CME Clearing House Advisory Notice #10-256 issued June 17, 2010 and AIB #10-07 issued July 16, 2010.
First, CME has changed the planned effective date of its cleared OTC derivatives sequestration rules from September 13, 2010 to October 4, 2010. After consultation with clearing member firms and bookkeeping/service bureaus, it was determined that moving the effective date back was prudent to ensure that sufficient time was allocated for system development and testing. Therefore, it is anticipated that CME’s cleared OTC derivatives sequestration rules will become effective and CME Clearing will transfer all customer cleared OTC derivative positions and related performance bond collateral currently held in the Secured Part 30.7 origin (CNSEG) to the new cleared OTC derivatives sequestered origin (COTC) on October 4, 2010.
CME has also received several questions related to its cleared OTC derivatives sequestration rules. Below is a summary of those questions and clarification. Please keep in mind that the below treatment and guidance provided by CME relates to its rules for cleared OTC derivatives and may be different than the treatment and guidance provided by the CFTC upon adoption by the CFTC of substantive, pre-bankruptcy regulations for the cleared OTC derivatives account class.
Financial Statement Reporting
As the planned launch date of the new account class has been moved to October 4, 2010, the monthly Sequestration Statement as of October 29, 2010 (last business day of October) will be required to be filed with the October Form 1-FR or FOCUS in Winjammer.
FCM-only clearing member firms which prepare a monthly Form 1-FR should reflect the sequestered assets and liabilities as Other Assets, Line 19, and Other Liabilities, Line 27.J., respectively, on the Statement of Financial Condition in the Form 1-FR. An itemization of these financial statement lines should continue to be prepared and include the total sequestered assets and liabilities (including the debit/deficit "gross-up") as well as any other items included on these lines.
Acknowledgement Letters and Investment of Sequestered Funds
As previously communicated, CME’s cleared OTC derivatives sequestration rules will provide that an FCM may invest funds of cleared OTC derivative customers in instruments that are allowable pursuant to CFTC Reg. 1.25. Such investments must be held in bank and safekeeping accounts of the FCM which are properly titled and for which the FCM has obtained satisfactory acknowledgement letters from the depository.
Based on suggestions received from clearing member firms, an updated Suggested Sequestration Acknowledgement letter is attached to this AIB. Please note that this letter is provided as a suggested (not required) format. In addition, bank and safekeeping accounts may be titled “Cust OTC Seq” as an abbreviation of the “Customer Cleared OTC Derivatives Sequestered Account” title where character space is limited (e.g. daily account statements). However, the account documents should reflect the full title of the account. Please note the sequestration acknowledgement letters may have to be amended once the CFTC adopts its regulations for the cleared OTC derivatives account class.
The CFTC has issued certain no-action letters regarding customer segregated accounts and acceptable investments of customer segregated funds pursuant to CFTC Regulations 1.20 and 1.25. Provided that such no-action letters remain in effect, and that the terms and conditions therein are complied with by the relevant firm(s), CME will deem the investments and/or accounts that are the subject of such CFTC no-action letters to be acceptable investments and/or accounts for funds of cleared OTC derivatives customers.
Non-Clearing FCMs and CME’s Cleared OTC Derivatives Rules
Clearing member firms recently raised the issue of the applicability of CME’s cleared OTC derivatives sequestration rules on non-clearing FCMs that may carry CME-cleared OTC derivatives products with a clearing member firm on an omnibus basis.
CME has had discussions with the NFA on this issue and the NFA has indicated that it will adopt rules requiring non-clearing FCMs to comply with the CFTC and/or CME rules for the cleared OTC derivatives sequestered origin. In addition, subject to Clearing House Risk Committee approval, CME plans to adopt a rule which will require any clearing member firm that carries a customer omnibus account containing CME-cleared OTC derivatives for a non-clearing FCM to include in its agreement with the non-clearing FCM language sufficient to require the non-clearing FCM to comply with CME rules relating to Cleared OTC Derivatives Customer Sequestered Accounts.
CME will not require a clearing member firm to have a new and separate agreement with any non-clearing FCM for this purpose. Rather, it will be sufficient if language in a clearing member firm’s existing agreement with a non-clearing FCM requires compliance with applicable Clearing rules.
Transfer of Collateral
In order to efficiently facilitate the transfer of collateral currently held at CME Clearing in the clearing member firm’s Secured Part 30.7 account to its new cleared OTC derivatives sequestered account, CME Clearing will require specific authorization.
Clearing member firms holding performance bond collateral in the Secured Part 30.7 origin must specifically authorize and direct CME Clearing to transfer this collateral to the cleared OTC derivatives sequestered account upon the effectiveness of CME’s cleared OTC derivatives sequestration rules. This written authorization should also specifically acknowledge that all collateral being transferred is owned by or held for the benefit of cleared OTC derivative sequestered customers and be forwarded to CME Clearing’s Financial Unit prior to the planned effective date of October 4th.
Collateral which is currently held in CME Clearing’s Secured Part 30.7 origin which may belong to foreign futures and options customers may not be held in the cleared OTC derivatives sequestered account.
Operational Issues related to CDS
Clearing member firms and bookkeeping/service bureaus have also raised the issue of the difficulty of margining CME-cleared Credit Default Swaps (“CDS”) with other cleared OTC derivative positions in the customer cleared OTC derivatives account origin due to the SEC requiring that a proprietary capital charge be taken on customer and affiliate CDS positions if a margin call is not met on T+1.
In order to calculate this capital treatment, clearing member firms have indicated that it is necessary to treat the CDS positions and other cleared OTC derivative positions as separate regulatory categories within the cleared OTC derivatives sequestered origin and utilize manual procedures for the movement of money between accounts in the same origin and the calculation of capital charges.
CME intends to raise this issue with the SEC so that they may reconsider this treatment. This issue is pending.
If you have any questions, please call the Audit Department at (312) 930-3230 or (212) 299-2120.
Suggested Sequestration Acknowledgement Letter
Bank, Trust Company or FCM Depository Account
(TO BE TYPED ON FCM’S LETTERHEAD)
[NAME AND ADDRESS OF BANK, TRUST COMPANY or FCM]
Re: Our Customer Cleared OTC Derivatives Sequestered Account No. XXXXXXXXX
We propose to open [or have opened] an account with you for the purpose of depositing money, securities and other property (“funds”) belonging or accruing to our Cleared OTC Derivative Customers (capitalized terms as defined in relevant Exchange rules referencing the requirements of CFTC Regulation 190.01).
Please be advised that all funds held by or hereafter deposited with you to the credit of this account are funds of our Cleared OTC Derivative Customers which are required to be sequestered and kept apart from our own funds under the rules of Chicago Mercantile Exchange Inc., a derivatives clearing organization, and/or the regulations of the Commodity Futures Trading Commission (CFTC) and must be treated in accordance with the provisions of these rules and/or regulations. All funds held or deposited in this account may not be commingled with our own funds or with the funds of any proprietary, CFTC segregated or CFTC secured/Part 30.7 account we carry on your books and may not be used by you or by us to secure or guarantee any obligation we may have owing to you or used by us to secure credit from you.
Further, the funds in the account shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you.
This letter agreement constitutes the entire understanding of the parties with respect to its subject matter, and supersedes and replaces any prior acknowledgement letters between the parties covering sequestered account treatment. In the event of a conflict between the terms of any prior writings between the parties, including applicable Account(s) agreement(s) and the terms of this letter agreement, the terms of this letter agreement shall supersede and replace such terms of any prior writing.
Please acknowledge that you understand the nature of the funds held or hereafter deposited in this account, and agree that you will treat such funds as belonging to Cleared OTC Derivative Customers in accordance with the provisions of CME rules and/or CFTC regulations, by signing and returning a copy of this letter to us.
[NAME OF FCM]
[NAME OF BANK or CARRYING BROKER]