The Commodity Futures Trading Commission (“CFTC”) adopted final rules (the “LSOC Rules”) on January 11, 2012 that implement a new client margin segregation model for cleared swaps. This new model is intended to provide greater protection than the existing futures segregation model. The LSOC Rules apply to all registered futures commission merchants (“FCMs”) and derivatives clearing organizations (“DCOs”) that clear swaps for customers. The LSOC Rules result from a debate among regulators, clearing organizations, FCMs and other market participants about the appropriate level of protection for customer assets in cleared swaps and, conversely, the appropriate level of mutualization of risk across customers. They also represent a key step toward implementing a mandatory clearing framework for swaps under the Dodd-Frank Act. In their final form, the LSOC Rules are intended to reduce or eliminate “fellow-customer risk,” that is, the risk that margin posted by one customer of an FCM will be used to cover a loss caused by a different customer of that FCM if the carrying FCM fails. The LSOC Rules accomplish this principally by limiting the ability of a DCO to use customer margin posted by non-defaulting customers to satisfy losses caused by defaulting customers. Nonetheless, the LSOC Rules permit the commingling of margin of different cleared swaps customers at the DCO, and the rules do not limit the mutualization of customer losses from investment losses, custodial failures, fraud or other causes. Compliance with the LSOC Rules, which is expected to involve considerable implementation work by DCOs, FCMs and other market participants, will be required by November 8, 2012.
View full memo, "CFTC Adopts Final Rules on Protection of Cleared Swaps Customer Collateral"