The CFTC proposed amendments to Rules 23.700-704 regarding the rights of counterparties to elect to segregate initial margin in transactions with swap dealers. According to the CFTC, the proposed amendments are intended to mitigate burdens placed on registrants and market participants by simplifying the notification requirement and other aspects of the rules.

The proposal would make the following changes, among others:

  • The notification would not need to be provided to counterparties subject to initial margin segregation requirements under CFTC or prudential regulator margin requirements.
  • The notification could be made once, at the initiation of a trading relationship, rather than at initiation and annually thereafter.
  • The notification would not be required to be made to a particular person at the counterparty, unlike the existing hierarchy of persons in Rule 23.701(c).
  • Requirements as to the terms of the segregation agreement would be lessened, including by the removal of a requirement that margin be withdrawn only pursuant to a statement "under penalty of perjury."
  • Segregated margin could be reinvested in any agreed assets, not solely those specified in CFTC Rule 1.25.
  • The quarterly report under Rule 23.704 would not need to be provided by the chief compliance officer of the swap dealer.

Comments on the proposal must be submitted within 60 days of publication in the Federal Register.

A comparison of the draft text of the proposed rule against the existing rules is available here.

Commentary / Nihal Patel

Title VII of Dodd-Frank contains a number of provisions that have been subject to heavy criticism. While many of the criticisms reflect disagreements as to regulatory policy, the knocks on Section 4s(l) (the "Statute") (i.e., the counterparty notification requirement) tend to be less about policy and more about whether the provision is a minor nuisance or a significant waste of time and resources. The proposed revisions to Rules 23.700-704 would significantly reduce the burdens associated with the rules, within the confines of the statutory requirements; that is, the direction of the CFTC seems to be to make the Statute more in the way of a nuisance as opposed to a significant burden.

The Statute essentially requires swap dealers ("SDs") to inform their counterparties of their "right" to purchase a service at an unspecified cost. As such, it functions less as a notification and more as a requirement that a swap dealer provides, as a business matter, an additional menu item to its customers.

In adopting Rules 23.700-704, the CFTC took this statutorily-required notification and somehow made it more administratively burdensome and even less useful. First, the notice cannot be provided to the usual address for communications to the counterparty. The regulations require an SD to provide the notice to a person at the counterparty with a specific title (often a title that was not used at the counterparty), thus requiring a second notice and response to determine who the right person is to receive and respond to the notice required under the statute.

Second, the CFTC made the option into an election for an off-market segregation structure by requiring terms (such as the penalty of perjury and limited reinvestment options) that are not commonly included in tri-party margin segregation arrangements. To continue the "menu" analogy, this is like requiring a restaurant to tell their customers they can get a side salad instead of fries and then requiring that if they say yes to the side salad, it has to include beets and ranch dressing. Even counterparties that actually desire segregation of initial margin generally decline the option in the notice, instead opting to negotiate bespoke terms. It is not surprising that the CFTC found that "for nearly every SD examined, fewer than five counterparties elected segregation . . . [and] [f]or some SDs, not a single counterparty [elected segregation]."

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