ISDA comments on Protection of Collateral of Counterparties to Uncleared Swaps

03 February 2011

The comments reflect the consensus of SIFMA and an ISDA working group comprised of firms representing both buy-side and sell-side perspectives regarding considerations relevant to the proposed rules.

  Given that the bilateral OTC derivatives markets are limited to entities that qualify as “eligible contract participants” that meet defined size or sophistication criteria and exclude retail investors, ISDA submits that the final rules relating to the segregation of collateral of counterparties to uncleared swaps (the Final Rules) (i) should permit bilateral contract negotiation in place of formalistic rules where appropriate (as discussed in greater detail below) and (ii) should strike a balance between the burden presented and the need to protect the interests of counterparties who are, by definition, deemed to be able to protect their own interests.

Definitions of “Initial Margin” and “Variation Margin” 

ISDA is concerned that the definitions of “Initial Margin” and “Variation Margin” in the Proposed Rules are more appropriate to the futures markets and less readily applicable in the uncleared OTC derivatives context. It also believes that if these terms are to be used in other Commission rules that reference cleared transactions (whether futures or swaps), their use will create confusion with the equivalent concepts used in the uncleared OTC derivatives markets, which are distinguishable for the reasons noted below.

Specifically, ISDA proposes the following definition of “Exposure Collateral” as a replacement to the Proposed Rules’ definition of “Variation Margin”: 
“Exposure Collateral” means money, securities or property posted by a party to secure its obligations pursuant to the terms of a swap agreement, the amount of which is based on an estimate of the net mark-to-market exposure of all transactions under the master swap agreement. 
Since Independent Amount is an amount that is defined by the parties and calculated on a basis that is distinct from the Exposure Collateral calculation, ISDA proposes the following definition of “Independent Amount” as a replacement to the Proposed Rules’ definition of “Initial Margin”: 
“Independent Amount” means money, securities or property posted by a party to secure its obligations pursuant to the terms of a swap agreement and that is either (i) specified as an “Independent Amount” in the relevant agreement of the parties or (ii) calculated based upon terms agreed between the parties (in either case, in addition to and separately from any Exposure Collateral requirement).

Disclosure of Segregation Costs

The Commission asks whether the Final Rules should require a swap dealer (SD) or major swap participant (MSP) to disclose costs associated with segregation to its counterparties at the time that such SD/MSP provides notice to such counterparty of its right to require segregation of the Independent Amount it posts. ISDA and SIFMA do not believe that mandating disclosure is necessary or desirable for two main reasons.

Notification of Segregation Right

A. Frequency of Notification; Confirmation/Election 
The proposed required annual notification to a counterparty of its right to elect to segregate and the corresponding requirement to obtain each year not only confirmation of receipt of such notice but also a counterparty’s affirmative election as to its segregation right are unnecessary and unduly burdensome. These requirements are inappropriate to markets that are limited to entities that qualify as eligible contract participants. Moreover, these requirements would potentially lead to trading disruptions (e.g., the need to track and confirm receipt of notice acknowledgements and segregation elections by Chief Executive Officers or Chief Risk Officers could prevent parties from entering into swap transactions in a timely manner). Therefore, ISDA proposes that an SD/MSP should only be required to deliver a single notification of the right to segregate, and the counterparty should be deemed to have elected not to require segregation of its Independent Amount until such time as the counterparty duly notifies the SD/MSP of its election to require segregation. Such single notification should be delivered (i) with respect to new counterparties, prior to the trade date of the parties’ first swap transaction entered into after the date that is six months after promulgation of the Final Rules (e.g., as part of a master agreement) and (ii) with respect to existing counterparties, within one year of promulgation of the Final Rules.

B. Authorized Representative 
Requiring notice to and acknowledgement from a Chief Risk Officer or Chief Executive Officer of a counterparty, per the Proposed Rules, is not necessary. The parties to a swap should be able to satisfy any notice requirement contained in the Final Rules if an SD/MSP provides a written notice to a counterparty (or an investment manager that is authorized to act on behalf of a party) in accordance with notice terms mutually agreed between the parties (or, absent such terms, to a person reasonably believed to be authorized to accept notices on behalf of such a counterparty). Counterparties should be able to receive and direct the notice to the appropriate decision-makers. 

Full letter

© ISDA - International Swaps and Derivatives Association