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CFTC Final Rules on Protection of Cleared Swaps Customer Contracts and Collateral and Conforming Amendments to the Commodity Broker Bankruptcy Provisions
24 January 2012
On January 11, 2012, the Commodity Futures Trading Commission (the "CFTC") adopted the final rules on the protection of collateral deposited by swap counterparties for cleared swaps to futures commission merchants ("FCM") and derivatives clearing organizations ("DCO"). In the final rules, the CFTC adopted the "legal segregation with operational commingling ("LSOC") model, which is different from the current mechanism for the protection of collateral deposited by futures customers to FCMs.
Under the LSOC model, each FCM and DCO are required to segregate, on their books and records, the cleared swaps of and related collateral posted by a cleared swaps customer from the obligations of the FCM and DCO and the obligations of any person other than such cleared swaps customer. However, the FCM and DCO are permitted to commingle all of the cleared swaps collateral posted by all cleared swaps customers in a single account, so long as such account is separate from any account holding the property of the FCM or DCO or property belonging to any person other than such cleared swaps customers.
In case of a "double default" (a default of a cleared swaps customer in meeting a margin call from its FCM and a resulting default of such FCM in meeting the related margin call from the relevant DCO), under the LSOC model the DCO is permitted to access only the collateral posted by the defaulting customer, but not any collateral belonging to non-defaulting customers, after resorting to other default resources including the DCO's own capital and guaranty fund contributions. The LSOC model thus mitigates the so-called "fellow customer risk" arising from a double default situation under the current mechanism for the protection of futures collateral.
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