CFTC Approves Rule Expanding Access to Swaps Clearinghouses

Swaps clearinghouses will be required to open access to companies with at least $50 million in capital under Dodd-Frank Act rules completed by the U.S. Commodity Futures Trading Commission.

CFTC commissioners voted 3-2 today to implement governance of member-funded clearinghouses that will guarantee trades between buyers and sellers in the $601 trillion swaps market. Dodd-Frank, the financial-regulation overhaul enacted last year, included the rulemaking in the agency’s mandate after largely unregulated trades helped fuel the 2008 credit crisis.

“This is one of the most significant rulemakings to lower risk in the financial system,” CFTC Chairman Gary Gensler said at the meeting in Washington.

The rules will govern clearinghouses that develop plans to cover a default by their largest member. The CFTC and other regulators may adopt separate rules for clearinghouses deemed systemically important, which would have to create plans to cover the possible default of the two largest members.

Clearinghouses would still be able to scale a member’s participation depending on how much capital a company holds above $50 million, according to a CFTC briefing yesterday.

Hedge-funds, banks and firms including MF Global Holdings Ltd. and Jefferies Group Inc. have supported lowering the capital requirements to allow more participants.

“We have argued vehemently that you can’t set the bar irrationally high because the purpose then is to exclude,” Gary DeWaal, general counsel at futures broker Newedge USA LLC, said in an Oct. 11 interview.


Wall Street’s largest dealer banks have said members need experience and adequate resources to manage defaults.

“When you have members of a clearinghouse come together, they have to share in the risk of the default,” Terrence Duffy, executive chairman of CME Group Inc., said Oct. 12 at a Futures Industry Association conference in Chicago. “And when you have 10 members that have $50 million and you have the rest of the members that have several billion, we know where the default is going to land: it’s going to land in the big players. I can understand why some of the larger participants are a little bit nervous.”

The CFTC would also review a clearinghouse if it adopts membership policies based on requirements other than net capital that may limit participation, according to the briefing.

ICE Clear Credit

IntercontinentalExchange Inc.’s ICE Clear Credit, the world’s largest credit default swap clearinghouse, in July reduced to $100 million from $5 billion the amount of adjusted net capital needed by a broker-dealer or futures commission merchant that wants to be a member. It also required 5 percent of customer funds to be on hand as excess net capital, a standard that most smaller brokers don’t meet, according to CFTC data.

Newedge, the largest futures commission merchant that isn’t part of a bank, and MF Global don’t meet the clearing member standards based on customer segregated amounts, an analysis of CFTC data shows.

“We will look very poorly upon that practice,” Ananda Radhakrishnan, director of the CFTC’s division of clearing and risk, said at the meeting.

ICE adopted membership requirements before CFTC’s rule “that are more open than those of any other clearinghouse,” Lee Underwood, a spokesman for Atlanta-based Intercontinental Exchange, said in an e-mail statement. “We’ll continue to work with the CFTC to increase membership while ensuring that clearing participants have sufficient capital to backstop the risks they bring to the clearinghouse, given the unique features of the CDS market,” Underwood said.

‘Insufficient Discretion’

The rules give clearinghouses “insufficient discretion to take legitimate actions to manage the risks that they confront,” Commissioner Scott O’Malia, one of the CFTC’s two Republican members, said at the meeting. “Such an approach may result in substantial costs to the futures and swaps market, which are not detailed or explored.”

The lack of a full description of the costs may open the rule to a legal challenge, O’Malia said. “These rules are needlessly prescriptive and go beyond what is required by the statute,” said Commissioner Jill E. Sommers, the panel’s other Republican. Both she and O’Malia voted against the rule.

LCH.Clearnet Group Ltd., the world’s largest clearinghouse for interest-rate swaps, previously opposed the lowered capital requirement that was part of a December proposal.

“We are at peace with that now,” Susan Milligan, head of U.S. public affairs at the London-based company, said in an Oct. 11 interview. “It will change our business, but we’re confident we can do it with strong risk-management principles.”

Five Days

The CFTC rule would require clearinghouses to have plans to liquidate positions in futures markets and for swaps on agricultural, energy and metals products within one day, according to yesterday’s briefing. Swaps on financial products would have to be liquidated within five days, the CFTC said.

Investors will have to post five days’ worth of collateral at a minimum to ensure there is enough to unwind any defaulted swaps contracts, compared with one days’ worth of margin to cover futures trades.

The capital requirement would take effect six months after the final rule is published in the Federal Register.

Letters of credit, which typically come from a bank as a promise to provide collateral if needed for an investor, won’t be allowed as initial margin for cleared swaps under the CFTC rule. Such letters could be used as initial margin for clearinghouses that handle futures contracts.

“Letters of credit have proven to be an especially useful and flexible form of collateral for clearing members to post as collateral for late-day margin calls,” CME Group, which operates clearinghouses for energy, interest rate, credit and other derivatives, said in a March 21 comment letter. “We urge the CFTC to strike the prohibition.”

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