Attempts at CDS portfolio margining in regulatory limbo

Central counterparties (CCPs) are facing regulatory delays in efforts to provide margin efficiency between single-name and index credit default swaps (CDSs). This is an issue that could cause liquidity in the CDS market to evaporate unless it is resolved, dealers claim.

“The market is very concerned about this, because it could significantly diminish liquidity on both index and single-name CDSs if clients aren’t able to get margin offsets between the two,” says Mariam Rafi, Americas head of over-the-counter clearing at Citi in New York.

Under the Dodd-Frank framework, the US Commodity Futures Trading Commission (CFTC) has the power to regulate swaps, including broad-based index CDSs, while the Securities and Exchange Commission (SEC) has jurisdiction over security-based swaps, which include CDS trades linked to narrow-based indexes and single names.

On January 30, Ice Clear Credit announced it had received approval from the agencies to offer margin offsets between single-name and index CDSs for proprietary positions held by clearing members. But extending this to buy-side clients has proven more difficult. For one thing, client positions in swaps or security-based swaps are required to be held in separate account classes regulated independently by the CFTC or SEC. They are also subject to different bankruptcy regimes, says Rafi. “In a bankruptcy, the CFTC account class would be governed by regulation part 190, while the SEC account class would fall under a Securities Investor Protection Corporation trustee. So it is quite possible the two account classes could be liquidated at different times,” she says.

Ice Clear Credit has been waiting since October 2011 for the two agencies to respond to a petition that would allow security-based swaps to be held in a swap account regulated by the CFTC, says Peter Barsoom, New York-based chief operating officer at the clearing house. “We petitioned the CFTC and SEC to allow security-based swaps to be held in a CFTC account and thereby get capital efficiency under our margining regime. Unfortunately, it’s one of those things that doesn’t have a statutory timeline, but we’re optimistic we can get it done before the end of the year,” he says.

The CFTC sought public comment on the Ice Clear Credit proposal during November and December last year. The nine comment letters received by the agency included letters in support of the proposal from several industry associations, as well as a submission from London-based law firm Allen & Overy representing 12 major dealers. They also included a letter of support from Chicago-based hedge fund Citadel. “The benefits of portfolio margining should be made available to all market participants. Accordingly, we urge the commission to work together with the SEC to approve portfolio margining as soon as possible,” said the letter.

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