United States: SEC And CFTC Intend To Explore Portfolio Margining

Last Updated: July 11 2019
Article by Steven D. Lofchie and Nihal S. Patel

Most Read Contributor in United States, August 2019

SEC Chair Jay Clayton and CFTC Chair J. Christopher Giancarlo stated their intention to explore whether portfolio margining would be an area where SEC-CFTC "harmonization" would be beneficial.

In a joint statement, Mr. Clayton and Mr. Giancarlo said they were committed to working together to "ensure robust investor protection and market integrity" through (i) assessing the portfolio margining of uncleared CFTC-regulated swaps with SEC-regulated security-based swaps, (ii) expanding joint margining of cleared swaps and security-based swaps and (iii) exploring the possibility of expanding portfolio margining to futures and cash equity positions.

The SEC and the CFTC plan to seek public comment on this in the near future.

Commentary / Steven Lofchie

There are numerous ways in which the arbitrary separation of financial products into those that are SEC-regulated and those that are CFTC-regulated is economically wasteful. To take a simple example, a long position in a basket of S&P stocks and a short position in a futures contract relating to those stocks are hedged, and the margin required of the position should be lowered to reflect the hedge. Instead, because they are subject to two different regulatory schemes, each is margined independently of the other, needlessly raising the cost of holding the positions, and thus making it more likely that related positions will diverge in value. While any single example may be trivial in itself, hundreds of such examples involve real money.

Of course the necessity of two sets of books, two sets of custodial requirements, and so on, adds to the expense and operational difficulties.

There is a certain amount that the regulators can do independently to fix the issues, but a more comprehensive solution would require some legislative action. That said, for the regulators to take the first steps is a great way to spur legislative action.

Commentary / Nihal Patel

I did a "ctrl+f" in the statement and did not find any of the following words: "insolvency," "bankruptcy," "SIPC," "SIPA," "Part 190," "segregation," "15c3-3." In other words, while the statement is a good message to the markets that the CFTC and SEC would like to accomplish goals of permitting broad portfolio margining, it is not clear how the agencies intend to address issues under custody and insolvency rules applicable to CFTC- and SEC-regulated products and market intermediaries.

A number of questions about portfolio margining were asked by the SEC in its request for comment on its SBS margin and capital rules last year. However, in adopting rules, the SEC indicated that it is not quite there as to SBS and swaps and gave little indication as to where it stands on futures and cash market securities.

SBS and Swaps

The SEC rules provide for non-broker-dealer SBSDs to use models to calculate IM for equity SBS and that the model could "potentially" be used for swaps, if portfolio margining is implemented by the SEC and CFTC. Elsewhere, the SEC noted that it would also need to address in its coordination efforts how to incorporate portfolio margin accounts into the SEC and CFTC net capital rules.

Cash Products and Futures

The SBS margin release contains little discussion of how the SEC and CFTC would accomplish this goal. The entity types are an obvious hurdle. Broker-dealer SBSDs would not be permitted to use models to calculate IM for equity SBS and equity swaps. Non-broker-dealer SBSDs would be permitted to use models for equity SBS and equity swaps, but the relevant account could not include cash equity positions (including options). This essentially means that the firms primarily in the business of financing cash market securities positions and futures - joint BD/FCMs - cannot use models to calculate margin for equity SBS and swap positions. The firms that can use models cannot (and do not have the authority to) run a business financing cash securities and futures.

Of course, the commissioner's statement strikes a hopeful note - market participants should continue to monitor developments in this space - any movement could potentially have significant benefits for firms getting financing through a variety of financial products.

Finally, even if the SEC and CFTC were to accomplish whatever they can, it's not obvious that full derivatives and cash market portfolio margining can be accomplished without an act of Congress to clarify the bankruptcy treatment. Bankruptcy treatment, once clarified, would make it easier for the SEC and CFTC to address relevant margin segregation requirements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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