The November 1 letter headed 'Staff Interpretation Regarding Part 22' seeks to clarify rules published by the CFTC on February 7. Those rules implement Dodd-Frank provisions that require the legal segregation, but allow operational commingling, of cleared swaps customers' margin collateral - referred to as the LSOC model.
The rules' compliance date was November 8, and the CFTC was asked to clarify a number of issues in advance of this date. This included guidance on the definition of cleared swaps customer collateral, said David Pentlow, partner at Herrick Feinstein in New York.
But observers criticise the rules and letter for seeking to fulfill a Dodd-Frank regulatory master plan without offering credible protection to cleared swaps customers.
The November 1 letter allows commingling of the collateral of more than one customer for operational purposes while, theoretically at least, mandating a requirement to keep customers' collateral separate.
The letter, which takes a Q&A format, prohibits futures commission merchants from posting the cleared swaps collateral of one customer to meet a margin call for another customer's cleared swaps. It also bans the use of one customer's excess to secure or guarantee the cleared swaps of another customer.
In theory, such safeguards would prevent situations where an unforeseen disaster or trading error, of the kind experienced by MF Global, would cause one innocent customer's collateral to get sucked into the maelstrom of a second customer's trading losses.
Whether or not the safeguards are effective, they are likely to spur negative reactions from futures commission merchants and cleared swaps customers alike, observers said.
"I see the CFTC trying to stay true to its mandate, not trying to loosen things or liberalise anything," said Pentlow.
"People will disagree as to whether this is appropriate. The industry is going to complain that the interpretation limits flexibility, which may be true - flexibility that might, if things go well, improve the profitability or functioning of certain markets," he added.
The CFTC rules clearly don't anticipate a situation where cleared swaps customers have willingly opted to allow their excess margins to breathe fungibility into the market.
There are concerns about how effective the protections are that legally separate different customers' collateral. Apart from market participants' negative reaction, there is a very real question as to whether the CFTC's rules allow the right degree of flexibility, and will ultimately protect collateral.
Practical pressures
Jonathan Schwartz, a former Securities and Exchange Commission and Federal Trade Commission lawyer who now represents clients in CFTC enforcement matters, expressed doubts about the utility of existing CFTC rules.
As a practical matter, an operational staff member at a futures commission merchant faced with a sudden collapse of collateral, and pressure to immediately stop the leak, may take advantage of access to other customers' money, he said.
"If the other customers' collateral is locked away and buried underground, that's very nice, but in reality that collateral has a role to play in the financial health of the company," Schwartz noted.
The CFTC is not above being influenced in the wrong ways by some of the major players in the industry it regulates, he added.
"I would like to know what 'operational' means in this context, because it suggests to me that in the broker-dealer situation, the MF Globals of this world can write a check on my collateral," he commented.
Those looking to the November 1 letter for clarification are likely to come away disappointed.
For example, the CFTC's answer to question 4 states that futures commission merchants are permitted to keep firm money, securities, and other property in cleared swap customer accounts at the derivatives clearing organizations. This appears to create a situation where the merchants may legally make withdrawals from the same accounts where customers have been depositing their collateral.