Alert March 15, 2011

SEC Staff Issues No-Action Letter Providing Relief to Registered Investment Companies Seeking to Place Assets in the Custody of Credit Default Swap Clearinghouse or its Members

The staff of the SEC's Division of Investment Management (the "staff") issued a no-action letter stating that it would not recommend enforcement action under Section 17(f) of the Investment Company Act of 1940 (the “1940 Act”) against a registered investment company (a “Fund”) if the Fund or its custodian places and maintains cash and/or certain securities (“assets”) in the custody of ICE Trust U.S. LLC (“ICE”) or a U.S. ICE clearing member (“ICE Clearing Member”) for purposes of meeting ICE’s or an ICE Clearing Member’s margin requirements for credit default swap contracts (“CDS”) that are cleared by ICE. 

ICE, which had requested the relief, acts as a central clearing party by accepting the rights and obligations under eligible CDS transactions entered into with ICE Clearing Members and submitted to ICE in accordance with its rules (“ICE Rules”). Following acceptance of a CDS transaction for clearing, ICE becomes the seller of credit protection with respect to the CDS purchaser, and the purchaser of credit protection with respect to the CDS seller.

Section 17(f) of the 1940 Act and the rules thereunder govern the safekeeping of Fund assets, and generally provide that a Fund must place and maintain its securities and similar instruments only with certain qualified custodians. Section 17(f)(1)(A) of the 1940 Act permits certain banks to maintain custody of Fund assets subject to SEC rules.  Although ICE, as a New York-chartered limited purpose trust company and member of the Federal Reserve System, is a “bank” as defined by Section 2(a)(5) of the 1940 Act, it would be holding a Fund’s assets at least partially for the benefit of its central clearing operations, rather than in the more pure custody context of a Fund custodian under Section 17(f)(1) of the 1940 Act. 

In its analysis, the staff cited ICE’s claim that a Fund’s deposit of assets with ICE or an ICE Clearing Members would be consistent with the principles of custody established by Congress and the SEC in Section 17(f) of the 1940 Act and the rules thereunder.  The staff relied on the assertion that ICE’s framework (the “Non-Member Framework”) for providing access to ICE’s clearing services to clients (including Funds) of ICE Clearing Members (“Third-Party Clients”), which requires that ICE Clearing Members segregate assets held on behalf of Third-Party Clients from proprietary assets, maintain adequate capital and liquidity and keep certain books and records, protects Third-Party Client assets.

In granting the relief, the staff cited representations from ICE that ICE would comply with certain recordkeeping obligations and supply relevant information to the SEC and that ICE Clearing Members would be in material compliance with ICE Rules, would be in material compliance with applicable laws and regulations with respect to CDS cleared by ICE, would provide disclosure regarding the impact of applicable insolvency law on a Fund’s ability to recover assets, would transfer Fund assets promptly to the custodial client omnibus margin account, would provide ICE with a self-assessment and a report of their independent auditors regarding their compliance with applicable SEC orders and would supply relevant information to the SEC.