On November 15, 2013, the CFTC, jointly with the Federal Reserve Board of Governors (FRB), issued final rules establishing standards for systemically important derivatives clearing organizations (SIDCOs), which align with the international Principles for financial market infrastructures (PFMIs) (see Legal Update, CPSS-IOSCO principles for financial market infrastructures).

SIDCOs are large CFTC-registered derivatives clearinghouses that the Financial Stability Oversight Council (FSOC) have designated systemically important. The final SIDCO rules require that sovereign debt, including US Treasuries, used to collateralize swaps and futures cleared by SIDCOs be subject to a committed funding arrangement, such as a credit or liquidity facility, that would allow for immediate conversion by the SIDCO of the sovereign collateral into cash.

The final SIDCO rules, added to Part 39 of the CFTC Regulations, which covers derivatives clearing organizations (DCOs), are applicable only to SIDCOs and DCOs that elect to be treated as SIDCOs (called "Subpart C" SIDCOs). The FRB participated in this rulemaking due to its responsibility for regulation of systemically significant financial institutions (SSFIs), which incudes SIDCOs subject to its jurisdiction.

Under Regulation 39.33 of the final rules, a SIDCO must take appropriate steps to maintain eligible liquidity resources that, at a minimum, will enable it to meet intraday, same-day, and multi-day obligations and to perform settlement of transactions it has cleared with a high degree of confidence under a wide range of stress scenarios that should include, but not be limited to, a default by the clearing member creating the largest aggregate liquidity obligation for the SIDCO in extreme but plausible market conditions.

Under 39.33, the following liquidity resources are eligible for the purpose of meeting these liquidity requirements:

Each such prearranged liquidity arrangement relating to sovereign debt must not include MAC (material adverse change) conditions.

The rule does not prohibit SIDCOs from requiring their clients to obtain the liquidity prearrangement, as long as the SIDCOs maintain the requisite liquidity. As a result, it appears that SIDCOs may either:

Regulators are requiring these liquidity prearrangements in order to avoid unnecessary delays in covering cleared derivatives losses in the event of a financial crisis, which could intensify in less time than it would take to convert posted treasuries to cash on the open market. Additionally, with congressional uncertainty surrounding the federal debt ceiling, US Treasury credit ratings have weakened, potentially decreasing a SIDCO's ability to convert them into cash in a financial crisis, enhancing the need for prearranged liquidity support.

Because US Treasuries are among the most commonly posted types of derivatives collateral, these rules are likely to raise the expense of clearing a transaction through a SIDCO.

However, the rule will enable SIDCOs to qualify as central counterparties for the purposes of international bank capital standards. This permits banks and bank affiliates that are clearing members of SIDCOs, as well as their customers, to benefit from favorable capital treatment for their cleared-derivatives exposure to SIDCOs. A DCO that is subject to the collective obligations contained in Subpart A, Subpart B and Subpart C of the final rules should be a QCCP for purposes of the Basel CCP capital requirements. Therefore, parties are incentivized to clear transactions through a SIDCO, and DCOs not designated as systemically important may want to opt into the SIDCO program.

The rule also addresses various other requirements for SIDCOs, which conform US derivatives clearinghouse requirements to international standards and allow SIDCOs that meet US regulatory requirements to be confident in their compliance with the international PFMIs. The final SIDCO rules address, among other things:

Derivatives clearinghouses, also known as central counterparties or CCPs (including SIDCOs), attempt to minimize counterparty risk by guaranteeing payment on transactions entered into by banks and brokerages that are clearing members of the clearinghouse, collecting margin collateral from either party as needed to cover the other party's exposure under the swap (see Practice Note, Mechanics of Derivatives Clearing).

Compliance dates. The compliance deadlines for these rules are:

Final Dodd-Frank rules on DCOs were issued by the CFTC in 2011 (see CFTC Issues Final Rules for Derivatives Clearing Organizations Under Dodd-Frank).

For further information on DCOs and other Dodd-Frank-regulated derivatives clearinghouses, see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap and SBS Clearinghouses: DCOs and SCAs.