On March 20, 2012, the Commodity Futures Trading Commission ("CFTC" or the "Commission") issued final rules ("Final Rules") governing the activities of clearing members of derivatives clearing organizations ("DCOs"). The Final Rules address customer clearing documentation, the timing of acceptance of swaps for clearing by DCOs and clearing members, and clearing member risk management protocols.
Customer Clearing Documentation
The Final Rules prohibit futures commission merchants ("FCMs") who clear customer trades, and swap dealers and major swap participants who enter into cleared swaps, from entering into arrangements that:
- disclose to the FCM or any swap dealer or major swap participant the identity of a customer's original executing counterparty;
- limit the number of counterparties with whom a customer may enter into a trade;
- restrict the size of the position a customer may take with any individual counterparty;
- impair a customer's access to execution of a trade on terms that have a reasonable relationship to the best terms available; or
- prevent trades from being accepted for clearing within the time frames specified in the Final Rules.
The prohibitions were developed in response to template documentation promulgated by industry groups for use by participants in the cleared swaps market ("trilateral agreements"). Optional annexes to the trilateral agreements enabled each party's clearing member to set credit limits for the party's transactions with that particular counterparty and to accept for clearing only those transactions that fell within the limits. The CFTC determined that such arrangements could have potential anticompetitive effects, impair a customer's access to the best price as well as general market liquidity, and hinder the acceptance of trades for clearance. In the Commission's view, the risks the trilateral agreements were designed to address could be mitigated by the processing and risk management rules described below without incurring such negative consequences.
Time Frames for Acceptance into Clearing
The Final Rules require clearing members and DCOs to accept or reject swaps for clearing "as quickly as would be technologically practicable if fully automated systems were used." Swap execution facilities ("SEFs"), designated contract markets ("DCMs"), and swap dealers and major swap participants must comply with the following timing requirements for submitting swaps to DCOs for clearing:
- Where the swap is subject to mandatory clearing, as soon as technologically practicable following execution of the swap, but no later than the close of business on the day of execution.
- For swaps not subject to a clearing mandate, but for which both counterparties have elected to clear the swap, not later than the next business day after execution of the swap, or the agreement to clear, if later than execution.
Clearing Member Risk Management
Clearing members that are FCMs, swap dealers or major swap participants must:
- establish credit and market limits based on position size, order size, margin requirements or similar factors;
- use automated means to screen orders for compliance with the risk-based limits;
- monitor for adherence to the risk-based limits intra-day and overnight;
- in the case of FCM clearing members, conduct stress tests of all of the positions in the proprietary account and all positions in any customer account that could pose material risk to the FCM at least once per week. In the case of swap dealer and major swap participant clearing members, conduct stress tests under extreme but plausible conditions of all positions at least once per week;
- evaluate, at least once a week, its ability to meet initial margin requirements;
- evaluate, at least once a week, its ability to meet variation margin requirements in cash;
- evaluate its ability to liquidate the positions it clears in an orderly manner, and estimate the cost of liquidation at least once per month;
- test all lines of credit at least once per quarter.
The Commission does not prescribe particular means of fulfilling these obligations. Each clearing member may determine the appropriate systems, protocols and processes appropriate to its customer base and business model.
Effective Dates
The Final Rules become effective on October 1, 2012 for FCMs, DCMs and DCOs. For swap dealers and major swap participants, the rules become effective on the later of October 1, 2012 or the date that the Dodd-Frank registration rules for swap dealers and major swap participants become effective. For SEFs, the rules become effective on the later of October 1, 2012 or the date that Dodd-Frank rules implementing the core principles for SEFs take effect.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
