The Commodity Futures Trading Commission recently issued a staff interpretation of the rules requiring end users to be informed they have the right to require swap dealers to segregate their initial margin on uncleared swaps. CFTC Regulation 23.701 requires that such notification be made before a transaction takes place. The dealer must identify an independent custodian to hold the margin and tell the end-user about the cost of segregation.
However, end-users and dealers requested clarification on a number of points, such as whether the option for segregation has to be offered on an ongoing basis if it has been declined in the past, and what the dealers’ responsibility is if the end user does not respond to the notification.
According to a memo by James M. Cain and Meltem F. Kodaman of Sutherland Asbill & Brennan LLP, the CFTC made the following clarifications:
- The swap dealer (SD) or major swap participant (MSP) must continue to provide annual notice of the right to require segregation of initial margin to the counterparty even if there has been no revocation of a prior election, unless the parties have not entered into an uncleared swap transaction since the initial election was made;
- In the absence of a contractual or regulatory requirement for a counterparty to post initial margin to the SD or MSP (e.g., if no initial margin is specified in an ISDA Credit Support Annex or confirmation to an uncleared swap transaction), the SD or MSP is not required to provide the annual notice under Regulation 23.701 or provide the quarterly reports under Regulation 23.704; and
- In the event an SD or MSP does not receive a response from a counterparty after providing notice to an appropriate representative of the counterparty, the SD or MSP may assume that the counterparty has not elected segregation of initial margin; provided, however, that the notice must have included a provision relating to negative consent (i.e., that a lack of response can be interpreted as an election not to require segregation of initial margin).