The following alert was sent in by our friends at Schulte Roth & Zabel. The publication discusses the CFTC’s final rules, pursuant to Dodd-Frank, and how they require the segregation of collateral posted by customers with respect to cleared swaps by futures commission merchants and derivatives clearing organizations. Here is an excerpt:
The Commodity Futures Trading Commission (the “CFTC”) issued its final rules requiring futures commission merchants (“FCMs”) and derivatives clearing organizations (“DCOs”) to segregate collateral posted by customers with respect to cleared swaps (the “Collateral Rules”) pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The CFTC adopted the legal segregation with operational commingling model (the “LSOC Model”), which (1) requires FCMs and DCOs to segregate cleared swap customers’ collateral on their books and records, and prohibits them from commingling customer collateral with their own funds, but permits FCMs and DCOs to commingle customer collateral in accounts with other cleared swap customers; and (2) restricts a DCO’s ability to use non-defaulting customers’ collateral to cover a defaulting customer’s obligations in the event that a cleared swap customer defaults on its obligations to an FCM which, in turn, defaults on its obligations to the DCO (a “double default”), thereby reducing “fellow-customer risk” (i.e., the risk that a DCO would need to access the collateral of non-defaulting customers to cure an FCM default).
Private investment fund managers, and the funds that they manage, should be aware of the Collateral Rules because they impact the fellow-customer, operational and investment risks to their collateral. In addition, the Collateral Rules affect the costs of entering into cleared swap transactions. The effective date of the Collateral Rules will be April 9, 2012. All parties, including private fund managers, must comply with the Collateral Rules by Nov. 8, 2012. While implementation may involve considerable operational changes at DCOs and FCMs, it is not expected that most fund managers will have to make significant changes to their current practices in order to comply with the Collateral Rules.
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