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Swap Buyers Led by Vanguard Seen Gaining Assurance on Collateral

Sept. 14 (Bloomberg) -- Large swap buyers including Vanguard Group Inc. may get assurance from the U.S. Commodity Futures Trading Commission that Dodd-Frank Act rules protect all of their collateral in a broker default, according to a person briefed on the matter.

The agency is considering publication of additional guidance in the coming weeks to allay the swap buyers’ concerns that rules it completed this year have gaps in their coverage, according to the person, who spoke on condition of anonymity because the guidance hasn’t been released. Swap buyers have urged the agency to act before Nov. 8 when the rules begin to take effect.

“Clarification is urgently needed to reassert the market’s expectation for full margin protection,” William Thum, a derivatives lawyer at Vanguard, based in Valley Forge, Pennsylvania, said in an e-mail.

The CFTC, the main U.S. regulator of futures and swaps, has faced pressure from buyers to better protect their collateral following the collapse of MF Global Holdings Ltd. and Peregrine Financial Group Inc. The agency has completed a series of Dodd-Frank rules designed to have most swaps processed at clearinghouses that guarantee trades by accepting collateral from buyers and sellers.

One of the rules is designed to protect clients’ collateral if their broker defaults, while also allowing it to be pooled before a bankruptcy. The measure is intended to prevent a non-defaulting client’s collateral to be used to resolve another client’s downfall that results in their broker’s default.

Urging Clarification

Clearinghouses operated by CME Group Inc., LCH.Clearnet Group Ltd. and Intercontinental Exchange Inc. have met with buyers, brokers and CFTC staff since the rule was completed in January. The Investment Company Institute, a trade group for mutual funds, a group of buyers represented by the Securities Industry and Financial Markets Association and the Managed Funds Association among others have met with the CFTC in the last two months to urge clarification of the rules.

The groups say that two forms of collateral could be at risk. First, collateral that they post in excess of the amount required might be used to resolve another party’s default. Second, variation margin, collateral typically exchanged daily to account for incremental price movements in a trade, might also be exposed in a default, the groups said in a summary of their concerns presented to the CFTC.

Flanks Covered

“The gaps would expose investors’ placement of margin or the variation margin gains to potential losses or use,” Timothy Cameron, managing director at Sifma, said in a telephone interview on Sept. 10. “To the extent that there is exposure, investment managers want to make sure they’ve covered their flanks and satisfied their obligation as a fiduciary to protect customer assets.”

JPMorgan Chase & Co., Goldman Sachs Group Inc. and other swap dealers, who have until the end of the year to register with regulators, will be among the first companies required to clear credit and interest rate swaps. Investment managers will face clearing requirements later next year.

JPMorgan, Goldman Sachs, Bank of America Corp., Citigroup Inc. and Morgan Stanley controlled 96 percent of cash and derivatives trading for U.S. bank holding companies as of March 31, according to the Office of the Comptroller of the Currency.

To contact the reporter on this story: Silla Brush in Washington at

To contact the editor responsible for this story: Maura Reynolds at

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