The U.S. Commodity Futures Trading Commission has ordered futures brokers to tighten up their record-keeping on omnibus accounts, in which customer funds are pooled.
In a letter from the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO) to futures commission merchants (FCMs), the CFTC said that an FCM must maintain separate omnibus accounts with a carrying FCM for segregated and secured customer trading and assets.
These accounts must be clearly titled as segregated or secured funds held for the benefit of customers. Further, account acknowledgment letters must be obtained for each account.
The DSIO oversees the registration and compliance of intermediaries and futures industry self-regulatory organizations (SROs), including U.S. derivatives exchanges and the National Futures Association.
Under the Dodd-Frank Wall Street reforms, the DSIO is also responsible for developing and monitoring compliance with regulations addressing registration, business conduct standards, capital adequacy and margin requirements for swap dealers and major swap participants.
Market participants are facing up to a mountain of record-keeping requirements related to swaps and collateral.
“Among the major pain points is the need to build technology and overhaul existing systems and processes to move from bilateral trades to centrally cleared transactions,” said Alberto Corvo, managing principal for financial services at eClerx, a financial services outsourcing firm.
“Closely allied with this is the complexity of monitoring counterparty risk across cleared and uncleared [bilateral] trades, across different brokers with different systems,” Corvo said.
The introduction of central clearing from Dodd-Frank is expected to result in lower margins, increased collateral requirements and a general increase in the cost of doing business in areas such as OTC derivatives, according to the fourth annual survey by the Professional Risk Managers’ Association, a trade body.
Around 64% of respondents felt that less than half of OTC contracts will be cleared via central counterparties (CCPs), suggesting that bilateral clearing will still have a significant role to play. Among sell-side respondents, who are more closely involved in the clearing process, only 43% agreed, whereas 84% of buy-side respondents hold this view.
Also, 25% of the respondents to the survey have withdrawn from capital-intensive businesses, while 58% admit that they are more selective when undertaking such business. Meanwhile, 18% say they would pass on extra capital costs to clients.
A spirited discussion is taking place among regulators and market participants over collateral protection for cleared swaps customers under the Dodd-Frank Act.
In January, the CFTC adopted final rules regarding the protection of cleared swaps collateral, which impose requirements on FCMs and derivatives clearing organizations (DCOs) regarding the treatment of cleared swaps collateral.
The CFTC adopted what’s known as the Complete Legal Segregation Model (CLSM), under which both the FCM and the DCO are required to segregate the cleared swaps collateral relating to each customer.
The futures industry has proposed as an alternative a Physical Segregation Model as a means of protecting collateral. By establishing separate customer accounts, the ability of an FCM to improperly access or otherwise fail to segregate customer collateral, whether by mere oversight of overt act, would be greatly diminished, participants say.
Under the CFTC’s rules, clearing houses have to collect margin on a gross basis. This means that FCMs will no longer be able to offset one customer’s collateral against another and then send only the net to the clearinghouse.
“As swaps become more regulated and move from an over-the-counter to an exchange-traded model on swap execution facilities, there will be more changes in the market structure and liquidity,” said Philippe Buhannic, chief executive of TradingScreen, a buy-side focused technology provider.
“Even fairly established OTC markets not affected directly by regulatory changes, such as government and corporate bond markets, are facing significant market structure evolution as well,” Buhannic said.
