United States: Financial Entity Update - CFTC's Proposed Margin Rules For Uncleared Swaps – Dude, Where's My Collateral?

Last Updated: September 22 2015
Article by Bo Harvey and John S. Servidio

This is the third article in a series on the U.S. Commodity Futures Trading Commission's (CFTC's) proposed margin rules for uncleared swaps, with a particular focus on the rules as they relate to swap market participants that are neither swap dealers nor commercial end users.

In our first installment on the CFTC's proposed margin rules (Margin Rules) for uncleared swaps, we discussed the importance of applying the "financial end user" definition and making related notional calculations. In our second installment we discussed collateral requirements, timing, eligibility and haircuts. In this issue we move on to custody and segregation of initial margin and related documentation requirements.

Custodial Arrangements for Initial Margin

Under the Margin Rules, covered swap entities (CSEs) would be required to exchange initial margin with financial end users that have "material swaps exposure." (For a refresh on the definitions of CSE, financial end user and material swaps exposure, please see our prior update.) In general, the initial margin posted or collected by a CSE must be held by one or more custodians that are unaffiliated with either the CSE or its counterparty. In addition, the agreement among the CSE, its counterparty and the custodian must meet certain requirements. CFTC Rule 23.157 specifies that the custody agreement: (1) must prohibit the custodian from rehypothecating or otherwise transferring the initial margin it holds; (2) may, notwithstanding the prohibition on rehypothecation, permit the posting party to substitute or direct reinvestment of initial margin held by the custodian, provided all assets remain eligible as initial margin and of sufficient value; and (3) must be legal, valid, binding and enforceable under the laws of all relevant jurisdictions, including in the event of bankruptcy, insolvency or a similar proceeding.

While these requirements may appear straightforward, they pose the following important considerations for financial end users.

Mandatory Segregation for Certain Financial End Users

CFTC Rule 23.701 requires that swap dealers notify their counterparties of their right to elect segregation of initial margin at an unaffiliated custodian. The Margin Rules would turn the current election to segregate initial margin into a mandatory requirement for financial end users that have material swaps exposure. As a result, financial end users with material swaps exposure will no longer be able to opt out of initial margin segregation when they trade uncleared swaps with CSEs. CSEs and financial end users subject to this requirement will need to review their custodians and triparty custody agreements to confirm that (1) the custodian is unaffiliated with either party, (2) rehypothecation is prohibited and (3) the custody agreement is enforceable under the laws of all relevant jurisdictions.

Financial end users without material swaps exposure are not required to post initial margin under the Margin Rules. As such, they would still retain the option, but not the requirement, to segregate initial margin under CFTC Rule 23.701. To the extent these financial end users exercise this right, they would not be required to segregate initial margin posted to a CSE because the Margin Rules apply the segregation requirement only to initial margin that is required to be collected by a CSE.

Know Your Custodians

Financial end users that trade with many CSEs or use multiple custodians will need to determine whether any particular transaction is in compliance with the requirement to use an unaffiliated custodian. For instance, asset managers that use global custodial arrangements on behalf of multiple clients may need to take a fresh look at whether existing custodial arrangements can continue to be used or new arrangements for certain client-CSE pairs will need to be implemented. The requirement to use an unaffiliated custodian may also pose a problem for pension plans that use their trustees, or affiliates of their trustees, as custodians. It is also unclear how, or whether, this requirement would apply to sub-custodians. If it does, custodians will need to track and monitor the affiliations of their sub-custodians with respect to specific CSE-financial end user pairs.

More generally, given the limited number of large custodians, there are also concerns that the non-affiliation requirement will serve to further increase market concentration in the custody services industry and will put pressure on custodial capacity.

Standards for Custody Agreements

The condition that the custody agreement must be "legal, valid, binding and enforceable under the laws of all relevant jurisdictions including in the event of bankruptcy, insolvency, or a similar proceeding" gives rise to the following challenges.

First, it may be difficult to identify all the "relevant jurisdictions" for the purpose of the enforceability analysis. The organizational structures through which CSEs, financial end users and custodians (and their sub-custodians) exchange and hold margin may implicate several relevant jurisdictions.

Second, it is unclear what level of review suffices for determining that the agreement is enforceable. If legal opinions are required, what type of qualifications would be permitted? It may not be possible to obtain unqualified opinions in all circumstances or jurisdictions. Obtaining any required opinions – perhaps for multiple jurisdictions – will also add a significant cost and expense to implementing initial margin segregation.

Third, it is not clear what exactly the phrase "including in the event of bankruptcy" refers to. One possible interpretation is that the custodial agreement is generally enforceable notwithstanding the bankruptcy of any party, but that interpretation is dissonant with equitable principles of U.S. bankruptcy law, as contracts are generally subject to the insolvency of a party unless there is a specific exemption under the Bankruptcy Code, such as the safe harbor that protects the netting of qualified financial contracts. It is possible that the CFTC's intention was that "in the event of bankruptcy" referred to the custodian's bankruptcy, but this is not clear from the proposed rule.

Prime Brokerage Transactions

Under the Margin Rules, the custodian is not permitted to rehypothecate initial margin it holds, although the posting party is permitted to substitute or direct reinvestment of initial margin held by the custodian, provided all assets remain eligible as initial margin and of sufficient value. There is some confusion as to how the prohibition on rehypothecation will affect intermediated prime brokerage transactions. In these transactions, a client, typically an asset manager, will enter into a trade with an executing dealer, which then "gives up" the swap to client's prime broker, which may be a CSE. The parties are left with a trade between the client and its prime broker and a substantially equal and offsetting trade between the prime broker and the executing dealer. The prime broker is principal to both legs of the transaction: one facing the client and the other facing the executing dealer. The prime broker effectively transfers initial margin it receives from one party to satisfy the demand for initial margin from the other party. Under the Margin Rules it is unclear whether this would constitute an unpermitted rehypothecation. Without allowing for these arrangements, intermediate prime brokerage transactions may no longer be economically viable for many prime brokers that are also CSEs.

Margin Documentation

The Margin Rules also require that CSEs enter into documentation with counterparties that satisfies the swap trading relationship documentation (STRD) requirements under CFTC Rule 23.504 and provides for the exchange of any margin required by the Margin Rules. While most CSEs and their counterparties have already adhered to the ISDA March 2013 Dodd-Frank Protocol designed to comply with the STRD rules, Rule 23.158 of the Margin Rules may require additional documentation between CSEs and non-financial end users in order to document whether margin is to be exchanged (even if such margin is not required) and, if so, the methodology and data sources for calculating margin, the valuation of positions and margin, dispute resolution and applicable thresholds below which margin is not required.

With respect to valuation and dispute resolution, the Margin Rules contain inconsistencies with other CFTC rules. For instance, CFTC Rule 23.504 requires swap documentation to include "methods, procedures, rules and inputs" for swap valuation and a dispute resolution process, and CFTC Rule 23.431(d)(3) requires disclosure of "the methodology and assumptions used to prepare the daily mark" for each uncleared swap. When the Margin Rules are finalized, CSEs and financial end users will need to review their swap documentation and credit support annexes to determine if they satisfy the proposed documentation requirements.

Next Steps

In our next installment in the series, we will discuss the calculation and netting of margin.

Once the Margin Rules are finalized, they will create a project with economic and operational complexity for many financial end users, to say nothing of particular cross-border differences that will need to be navigated. Please contact one of the authors or your regular McGuireWoods lawyer if you have questions about how margin requirements may apply to your business.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.