Survey of Portfolio Margining
Survey of Portfolio Margining
Survey of Portfolio Margining
ARTICLE REPRINT
September 2014
Volume 34
A Survey of Portfolio
Margining under
Dodd-Frank
BY JONATHAN CHING AND JOEL TELPNER
Jonathan Ching has significant experience working with derivatives and their practical applications in
trading and capital markets. He is involved in the structuring, negotiation and execution of OTC derivatives
and synthetic financial products, and works regularly with capital markets, litigation, bankruptcy and
finance teams at Jones Day on the derivatives aspects of litigation, acquisitions, financing transactions
and corporate restructurings. His transactional practice includes the financing of various assets through
lending arrangements, repos, derivatives, and other structured solutions. He also advises non-U.S.
corporations and financial firms on compliance with various requirements for OTC derivatives under
Dodd-Frank, foreign exchanges in their U.S. offerings of futures products, and non-financial corporate
entities regarding the commercial end-user exception.
Joel Telpner represents financial institutions, derivative dealers, Fortune 500 corporations, hedge funds,
pension funds, and other end-users in designing, structuring, and negotiating complex derivative and
structured finance transactions. Joel advises clients on a broad variety of financial products and transactions,
including credit, equity, and commodity derivatives; synthetic products; credit and equity-linked products;
hedge fund-linked products; and structured and leveraged finance transactions. In addition, Joel advises
financial institutions and end-users on understanding and complying with the regulatory requirements
arising from the financial reform legislation, as well as new opportunities resulting from the legislation.
Executive Summary: Global regulatory reforms arising from the 2008 financial crisis
resulted in a new market structure for overthe-counter (OTC) derivatives. This new
structure, designed to address the twin goals
of transparency and risk mitigation, has disrupted traditional portfolio margining by
imposing mandatory clearing requirements
for much of the OTC derivatives market. Although many portfolio margining arrangements, such as those employed in securities
and futures markets in the U.S., were specifically permitted by the Dodd-Frank Wall
Street Reform and Consumer Protection Act
(Dodd-Frank), they have taken some time to
develop in practice. In this article we discuss
examples of portfolio margining which have
existed for years in equity and fixed income
CONTINUED ON PAGE 3
Article REPRINT
Reprinted from the Futures & Derivatives Law
Report. Copyright 2014 Thomson Reuters.
For more information about this publication
please visit legalsolutions.thomsonreuters.com
Issue
2014 Thomson Reuters. This publication was created to provide you with accurate and authoritative information
concerning the subject matter covered, however it may not necessarily have been prepared by persons licensed to practice
law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice, and this
publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek
the services of a competent attorney or other professional.
For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA
01923, USA (978) 750-8400; fax (978) 646-8600 or Wests Copyright Services at 610 Opperman Drive, Eagan, MN
55123, fax (651)687-7551. Please outline the specific material involved, the number of copies you wish to distribute and
the purpose or format of the use.
For subscription information, please contact the publisher at: west.legalworkspublications@thomson.com
Editorial Board
STEVEN W. SEEMER
Publisher, West Legal Ed Center
RICHARD A. MILLER
Editor-in-Chief, Prudential Financial
Two Gateway Center, 5th Floor, Newark, NJ
07102
Phone: 973-802-5901 Fax: 973-367-5135
E-mail: richard.a.miller@prudential.com
MICHAEL S. SACKHEIM
Managing Editor, Sidley Austin LLP
787 Seventh Ave., New York, NY 10019
Phone: (212) 839-5503
Fax: (212) 839-5599
E-mail: msackheim@sidley.com
PAUL ARCHITZEL
Wilmer Cutler Pickering Hale and Dorr
Washington, D.C.
CONRAD G. BAHLKE
Strook & Strook & Lavan LLP
New York, NY
ANDREA M. CORCORAN
Align International, LLC
Washington, D.C.
W. IAIN CULLEN
Simmons & Simmons
London, England
IAN CUILLERIER
White & Case LLP
New York
WARREN N. DAVIS
Sutherland Asbill & Brennan
Washington, D.C.
SUSAN C. ERVIN
Davis Polk & Wardwell LLC
Washington, D.C.
RONALD H. FILLER
New York Law School
DENIS M. FORSTER
New York, NY
THOMAS LEE HAZEN
University of North Carolina at Chapel Hill
DONALD L. HORWITZ
North American Derivatives Exchange
Chicago, IL
PHILIP MCBRIDE JOHNSON
Washington, D.C.
DENNIS KLEJNA
New York, NY
PETER Y. MALYSHEV
Latham & Watkins
Washington, D.C., and New York, NY
ROBERT M. MCLAUGHLIN
Fried, Frank, Harris, Shriver & Jacobson LLP
New York, NY
CHARLES R. MILLS
K&L Gates, LLP
Washington, D.C.
DAVID S. MITCHELL
Fried, Frank, Harris, Shriver & Jacobson LLP
New York, NY
RITA MOLESWORTH
Willkie Farr & Gallagher
New York, NY
PAUL J. PANTANO
Cadwalader, Wickersham & Taft LLP
Washington, D.C.
GLEN A. RAE
Banc of America Merrill Lynch
New York, NY
KENNETH M. RAISLER
Sullivan & Cromwell
New York, NY
KENNETH M. ROSENZWEIG
Katten Muchin Rosenman
Chicago, IL
THOMAS A. RUSSO
American International Group, Inc.
New York, NY
HOWARD SCHNEIDER
Charles River Associates
New York, NY
LAUREN TEIGLAND-HUNT
Teigland-Hunt LLP
New York, NY
PAUL UHLENHOP
Lawrence, Kamin, Saunders & Uhlenhop
Chicago, IL
SHERRI VENOKUR
Venokur LLC
New York, NY
For authorization to photocopy, please contact the Copyright Clearance Center at 222 Rosewood Drive, Danvers, MA 01923, USA (978) 750-8400; fax (978) 646-8600
or Wests Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) 687-7551. Please outline the specific material involved, the number of copies you
wish to distribute and the purpose or format of the use.
This publication was created to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily
prepared by persons licensed to practice law in a particular jurisdication. The publisher is not engaged in rendering legal or other professional advice, and this publication
is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional.
Copyright is not claimed as to any part of the original work prepared by a United States Government officer or employee as part of the persons official duties.
September 2014
Volume 34
Issue 8
Reg T generally establishes initial margin requirements for securities-related credit transactions. Reg
T governs the amount of margin a BD must collect
from a customer in connection with purchases and
sales (including short sales) of securities. Reg T does
not, however, determine the amount of margin that
must be maintained by a customer after the initial
purchase or short sale of a security.
Reg T allows securities self regulatory organizations, such as securities exchanges, to establish their
own rules governing the amount of margin that
must be held by BDs in connection with customer
open positions.8 Additionally, in 1998, the Federal
Reserve Board (Fed) opened the way for portfolio
margining by amending Reg T to exclude from its
scope any financial relations between a customer
and a BD that comply with a portfolio margining regime approved by the SEC.9 The 1998 amendment
allows BDs to compute initial and variation margin
requirements pursuant to exchange-approved portfolio margining programs.
September 2014
Volume 34
Issue 8
Building on the work of the CME, the OCC introduced portfolio margining in 1989, recognizing
offsetting hedged positions maintained by firms
at multiple clearinghouses through the use of joint
clearing accounts for the members of those clearinghouses. In the event of a default, the clearinghouses
arrangement provides for the treatment of all assets
and obligations associated with the joint account as
well as the other clearing accounts of the defaulting
member. Trades subject to cross product margining arrangements are executed on the applicable
exchange for which the participating clearing organization clear trades and are then transferred to a
September 2014
Volume 34
Issue 8
As shown by the examples above, a fully functioning marketplace requires portfolio margining across both a broad set of products and legal
structures. Fundamentally, the rationale for offsetting exposures through appropriate risk reduction
strategies does not change whether between asset
classes of swaps, between swaps and other products or between cleared and uncleared swaps. The
same rationale also applies for offsetting exposure
across different regulatory regimes. In other words,
the availability of portfolio margining will encourage parties to use portfolio-based hedging strategies
which will in turn increase market stability and reduce systemic risk.
C. Facilitates clearing
September 2014
3.
4.
IV. Conclusion
NOTES
1.
See OTC Derivatives Market Reforms: Third
Progress Report on Implementation, 15 June
2012, Financial Stability Board, available at
http://www.financialstabilityboard.org/public
ations/r_120615.pdf.
2.
See Adaptation of Regulations to Incorporate Swaps 77 FR 66288 (November 2, 2012),
available at: http://www.cftc.gov/ucm/groups/
5.
6.
7.
8.
9.
10.
11.
12.
Volume 34
Issue 8
public/@lrfederalregister/documents/file/201225764a.pdf.
See Craig Pirrong, The Economics of Central
Clearing: Theory and Practice, ISDA Discussion Papers, May 23, 2011, available at: http://
www2.isda.org/functional-areas/research/discussion-papers/.
Another potential cost arising from the bifurcation of swaps into cleared and uncleared
portfolios is the loss of the collateral netting
which occurs when all swaps are held under a
single ISDA Master Agreement. For example, if
a market participant had bought protection on
a CDS index and sold protection on the single
name CDS which are components of that index, its overall margin requirement would have
been reduced by virtue of the trades occurring
under a single agreement, i.e. the net exposure
is reduced. However, once CDS indices were required to be cleared, the same single name CDS
would be left unhedged, and there would be a
corresponding increase in the margin requirement for these trades with one requirement
imposed by the CCP for the cleared trade, and
another being imposed under the ISDA Master
Agreement for the uncleared leg.
See CEA 4(d) (2012).
Exchange Act Release No. 34-46292 (July 31,
2002), 78 S.E.C. Docket 384, 2002 WL 1769439
(July 31, 2002).
17 C.F.R. Section 1.20.
12 C.F.R. Section 220.1(b)(2).
See C.F.R. Section 220.1(b)(3)(i). The Fed also
encouraged the development of portfolio margining when it delegated authority to set margin requirements for security futures to the SEC
and the CFTC. Letter from the Fed to James E.
Newsome, Acting Chairman, CFTC, and Laura S.
Unger, Acting Chairman, SEC, dated March 6,
2001. See also SEC Rule 400(c)(2)(i) (exempting
from the security futures margin requirements
financial relations between a customer and a
security futures intermediary that comply with
an appropriate portfolio margining system);
CFTC Rule 41.42(c)(2) (comparable exemption).
How SPAN Works CME Group, http://www.
cmegroup.com/clearing/risk-management/ (last
visited August 27, 2014).
SPAN Overview CME Group, http://www.
cmegroup.com/clearing/risk-management/ (last
visited August 27, 2014).
SEC Release No. 34-54918 (Dec. 12, 2006), 71
Fed. Reg. 75790 (Dec. 18, 2006); SEC Release
No. 34-54919 (Dec. 12, 2006), 71 Fed. Reg.
75781 (Dec. 18, 2006). See also NYSE Information Memo 06-86 (Dec. 21, 2006) (IM 06-86);
CBOE Regulatory Circular RG06-128 (Dec. 15,
2006).
13.
14.
15.
16.
17.
18.
10
19.
20.
21.
22.
23.
24.