Alert December 26, 2012

SEC Grants Conditional Exemptions under the Exchange Act in Connection with Portfolio Margining of Swaps and Security-Based Swaps

The SEC issued an exemptive order granting conditional relief from compliance with certain provisions of the Securities Exchange Act of 1934 (the “Exchange Act”) in connection with a program to commingle and portfolio margin customer positions in cleared credit default swaps (“CDS”), including both swaps and security-based swaps, in a segregated account.  Portfolio margining permits margin to be established based on the overall value and risks of a portfolio of assets, rather than position by position.  The Dodd-Frank Act provided the SEC and CFTC with the authority to facilitate portfolio margining by allowing cash and securities to be held in a futures account, and futures and options on futures and related collateral to be held in a securities account, subject to some conditions.  The exemptive relief provided in the SEC order applies primarily to Sections 3E(b), 3E(d), and 3E(e) of the Exchange Act, which generally require brokers, dealers, and security-based swap dealers to treat security-based swap customer money, securities, and property as belonging to the customer and to separately account for such customer assets, restrict the ability to invest such assets of the security-based swap customer and impose certain prohibitions on the disposition and use of such assets.

The order provides exemptions for two classes of persons.  One exemption is for a clearing agency registered under the Exchange Act and registered as a derivatives clearing organization (“DCO”) under the Commodity Exchange Act (the “CEA”) to perform the functions of a clearing agency for CDS under a program to commingle and portfolio margin CDS for customer positions.  Although this exemption was requested by ICE Clear Credit, LLC, it is available to any other DCO that can satisfy its conditions.  The second exemption is for dual-registered broker-dealers and futures commission merchants (“FCMs”) that elect to offer a program to commingle and portfolio margin customer positions in CDS in customer accounts maintained in accordance with certain provisions of the CEA and related regulations.  Certain conditions apply, and are intended to preserve the ability of customers to select between the segregation requirements and customer protections afforded under the Exchange Act and the CEA, to help ensure that broker-dealers and FCMs collect sufficient margin, and to help ensure that customers receive relevant disclosures.

The order explains that the SEC believes that providing the relief is necessary and appropriate, in the public interest and consistent with the protection of investors, because it will promote a more accurate measure of the risk of the total position of the customer based on off-setting positions, and would also increase efficiency and reduce costs by more closely aligning the costs of maintaining a cleared CDS portfolio to the risks of the portfolio.

Finally, the order requests comments on the exemption generally, and specifically requests comment on whether additional conditions should apply and, if so, what those additional conditions should be and why.

The relief became effective on December 19, 2012.  Comments are due no later than February 19, 2013.