The Commodity Futures Trading Commission proposed a new rule entitled, "Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap," which contains a section expanding the types of money market funds eligible as collateral (from Treasury only to Government and repo). The summary tells us "The Commodity Futures Trading Commission is proposing to amend the margin requirements for uncleared swaps applicable to swap dealers and major swap participants for which there is no prudential regulator. The proposed amendment would revise the definition of 'margin affiliate' to provide that certain collective investment vehicles that receive all of their start-up capital, or a portion thereof, from a sponsor entity would be deemed not to have any margin affiliates for the purposes of calculating certain thresholds that trigger the requirement to exchange initial margin for uncleared swaps.... The Commission is also proposing to eliminate a provision disqualifying the securities issued by certain pooled investment funds ('money market and similar funds') that transfer their assets through securities lending, securities borrowing, repurchase agreements, reverse repurchase agreements, and similar arrangements from being used as eligible IM [initial margin] collateral, thereby expanding the scope of assets that qualify as eligible collateral ('Money Market Funds Proposal')." (See the press release, entitled, "CFTC Approves Final DCO Reporting and Information Requirement and Three Proposals at the Commission Open Meeting.")
The "Money Market Funds Proposal section (on page 29) says, "The Commission proposes to amend Commission Regulation 23.156(a)(1)(ix) to eliminate the restriction on the use of securities of money market and similar funds that transfer their assets through repurchase or similar arrangement (the asset transfer restriction). The Commission is also proposing an amendment to the haircut schedule set forth in Commission Regulation 23.156(a)(3)(i)(B) to add a footnote that was inadvertently omitted when the rule was originally promulgated."
The CFTC explains, "In adopting the CFTC Margin Rule, the Commission added redeemable securities in money market and similar funds to the list of eligible collateral in response to comments arguing for the inclusion of MMF securities as eligible collateral for IM. The Commission explained that the addition of money market and similar fund securities to the list of eligible collateral would provide flexibility while maintaining a level of safety, noting that to qualify, such fund securities would need to meet the conditions in Commission Regulation 23.156(a)(1)(ix), including the asset transfer restriction in paragraph (C), which has the effect of disqualifying the securities of funds that transfer their assets through repurchase or similar arrangements."
They comment, "As discussed above, market participants, and the GMAC Margin Subcommittee, have urged the Commission to eliminate the asset transfer restriction in paragraph (C), noting that it disqualifies the securities of most MMFs and significantly restricts the ability of swap counterparties to use such form of collateral. Based on its experience implementing the margin requirements for several years and for the reasons described below, the Commission preliminarily recommends the elimination of the restriction."
The proposal continues, "MMFs are regulated, short-term investment vehicles that are subject to liquidity and diversification requirements under U.S. regulations, such as SEC Rule 2a-7. The MMFs that could qualify as eligible IM collateral under Commission Regulation 23.156 invest in high quality underlying instruments, namely securities issued or unconditionally guaranteed as to the timely payment of principle and interest by the U.S. Department of the Treasury and cash. More generally, the Margin Subcommittee Report stated that the Commission has recognized MMFs as safe, high quality investments, noting that, for example, Commission Regulation 1.25 permits the investment of customer margin by futures commission merchants ('FCM') in MMFs without an asset transfer restriction."
It tells us, "The elimination of the asset transfer restriction in paragraph (C) of Commission Regulation 23.156(a)(1)(ix) would allow for a broader range of money market and similar fund securities to qualify as eligible IM collateral. This is consistent with the Commission’s intent in identifying certain fund securities as eligible collateral when it adopted the CFTC Margin Rule. The Commission stated that it intended to permit MMF securities to be pledged as IM collateral in order to permit flexibility, while also 'maintaining a level of safety.' As noted above, according to the Margin Subcommittee Report, most multi-billion dollar MMFs available to the institutional marketplace use repurchase or similar arrangements as part of their management strategy. Given the widespread use of repurchase and similar arrangements by MMFs, only a few of the MMFs currently available to institutional clients satisfy the asset transfer restriction in paragraph (C). As a result, unless the restriction is eliminated, this form of margin collateral would be of very limited availability to swap counterparties, contrary to the intent of the Commission."
The proposal also says, "The Commission preliminarily believes that expanding the scope of eligible money market and similar fund securities may lead to more efficient collateral management practices. In particular with respect to the use of MMF securities as IM collateral, the Margin Subcommittee Report noted that many custodians offer money market sweep programs, which facilitate buy-side market participants' timely meeting margin calls in cash that is subsequently used to purchase MMF securities, thereby avoiding the settlement delays or additional costs associated with the purchase and posting of non-cash assets. This is particularly important given that under the custodian arrangement rules under Commission Regulation 23.157, IM collateral in cash must be promptly converted into other types of eligible collateral, such as securities of MMF or similar funds, to avoid the possibility that cash collateral may become a deposit liability of the custodian and to prevent rehypothecation by the custodian."
The CFTC writes, "Moreover, the Report stated that the use of MMF securities as collateral may enable market participants to avoid potential negative interest rate charges that may be applied by custodian banks on cash collateral. Finally, according to the Report, the sweep of cash into MMF securities helps market participants mitigate the risk of custodian insolvency as non-cash assets would not be consolidated with the custodian's balance sheet or estate from a supplemental leverage ratio or bankruptcy perspective."
They write, "Allowing a broader selection of money market and similar fund securities to serve as collateral may address the potential concentration of margin collateral in the securities of a few MMFs. The removal of the asset transfer restriction could lead to an increased use of MMF securities as margin collateral. The Commission acknowledges the risk of concentration of collateral in particular assets and reiterates, as stated in the preamble to the CFTC Margin Rule, that CSEs should take concentration into account and prudently manage their margin collateral. For the same reasons, the Commission preliminarily believes that CSEs should consider the overall investment strategy of a money market or similar fund, including the terms of repurchase or similar arrangements the fund may undertake, in determining whether to use the fund's securities to meet margin obligations under the CFTC rules."
The proposal adds, "Commission Regulation 23.156(a) aims to identify assets as eligible collateral that are liquid, and, with haircuts, will hold their value in times of financial stress. Current paragraph (C) of Commission Regulation 23.156(a)(1)(ix) furthers the goal that money market and similar fund securities posted as IM collateral remain liquid and retain their value during times of financial stress. More specifically, paragraph (C) disqualifies the securities of money market and similar funds that transfer their assets through repurchase or similar arrangements to mitigate the potential impact of such transfers on the liquidity or value of fund securities."
Finally, it states, "Given these safeguards and the recognition that the asset transfer restriction is severely limiting the use of money market and similar fund securities as eligible collateral, the Commission preliminary believes that it is appropriate to eliminate the asset transfer restriction. The Commission also notes that the elimination of the restriction would bring the CFTC's eligible collateral framework more in line with the SEC approach, which does not impose asset transfer restrictions on funds whose securities are used as collateral for margining purposes and expressly permits the use of government money market fund securities as collateral, thereby potentially leading to a reduction in costs for those market participants that dually register as SDs and security based swap SDs with the CFTC and the SEC, respectively."
