On January 11, 2012, the CFTC approved final rules designed to protect margin collateral relating to the cleared swaps of customers of futures commission merchants (FCMs). FCMs are broker-dealers that are typically members of swap clearinghouses. The final rules implement Section 724(a) of the Dodd-Frank Act, which imposes the following requirements:

To implement these requirements, the CFTC adopted the "complete legal segregation" model, also known as the "legally segregated operationally commingled" or "LSOC" model, described in the proposed rules issued on April 27, 2011 (see Legal Update, CFTC Proposes Rules Protecting Certain Margin Collateral of FCM Customers). The complete legal segregation model requires that cleared swaps customer collateral be segregated from the FCM's own property, but allows an FCM to keep cleared swaps customer collateral together in a single omnibus customer account if the FCM is not in bankruptcy. However, the rules do not permit FCM customers to segregate their posted collateral with a third-party custodian or other intermediary. In the event of a default of both an FCM and one or more of its cleared swaps customers, a DCO would have recourse against the collateral of defaulting customers, but not against the collateral of non-defaulting customers.

Additionally, the final rules state that cleared swaps customer collateral may only be invested pursuant to Regulation 1.25. To learn more about Regulation 1.25, the CFTC's rules governing the investment of customer collateral, see Legal Update, Final Rules on Investment of Customer Funds under Dodd-Frank Issued by CFTC.

FCMs are often clearing members of swap clearinghouses. FCMs are also futures brokers, however, these rules do not apply to FCMs in that capacity. Though these final rules do not apply to collateral posted in relation to futures contracts, only to collateral relating to cleared swaps, collateral relating to futures contracts is also typically held by FCMs in an omnibus customer account.

Certain CFTC commissioners have expressed concern that some of the other protections extended by the final rules to cleared swap customer collateral, such as the limitations on use of collateral in an FCM's omnibus customer swap collateral account, have not been extended to futures collateral. The CFTC is considering, somewhat controversially, whether to impose similar restrictions on FCM collateral in the futures markets. The issue is particularly timely given the recent collapse of MF Global and its misplacement of hundreds of millions in customer collateral. MF Global is a registered FCM.

The final rules will become effective 60 days after publication in the Federal Register.

For more information on the final rules, see the CFTC's Fact Sheet and Q&A.

To learn about other Dodd-Frank Act regulations on swap margin collateral, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap Margin Collateral Matters under Dodd-Frank.

For tips and information on collateral protection matters, see Practice Note, Practical Guide to Counterparty Collateral Negotiation: Considerations for End Users.

For details on the mechanics of derivatives clearing, including an explanation of the role of clearing members, see Practice Note, Mechanics of Derivatives Clearing.

For information on rulemaking activities implementing the Dodd-Frank Act, see Practice Note, Road Map to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.