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Futures & Derivatives September 2014 n Volume 34 n Issue REPORT 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 re- markets, provide an update on portfolio forms arising from the 2008 financial crisis margining options which are now being of- fered for cleared OTC derivatives, and con- The Journal on the Law of Investment & Risk Management Products The Journal resulted in a new market structure for over- the-counter (OTC) derivatives. This new clude with a discussion of the policy ratio- structure, designed to address the twin goals nale for continuing to encourage portfolio of transparency and risk mitigation, has dis- margining. rupted traditional portfolio margining by imposing mandatory clearing requirements for much of the OTC derivatives market. Al- though many portfolio margining arrange- ments, such as those employed in securities CONTINUED ON PAGE 3 and futures markets in the U.S., were spe- cifically permitted by the Dodd-Frank Wall Street Reform and Consumer Protection Act Article REPRINT (Dodd-Frank), they have taken some time to Reprinted from the Futures & Derivatives Law develop in practice. In this article we discuss Report. Copyright © 2014 Thomson Reuters. examples of portfolio margining which have For more information about this publication existed for years in equity and fixed income please visit legalsolutions.thomsonreuters.com Futures & Derivatives Law Futures ARTICLE REPRINT September 2014 n Volume 34 n Issue 8 Futures & Derivatives Law Report © 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 West’s 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: [email protected] Editorial Board STEVEN W. SEEMER W. IAIN CULLEN DENNIS KLEJNA KENNETH M. RAISLER Publisher, West Legal Ed Center Simmons & Simmons New York, NY Sullivan & Cromwell London, England New York, NY RICHARD A. MILLER PETER Y. MALYSHEV Editor-in-Chief, Prudential Financial IAN CUILLERIER Latham & Watkins KENNETH M. ROSENZWEIG Two Gateway Center, 5th Floor, Newark, NJ White & Case LLP Washington, D.C., and New York, NY Katten Muchin Rosenman 07102 New York Chicago, IL Phone: 973-802-5901 Fax: 973-367-5135 ROBERT M. MCLAUGHLIN E-mail: [email protected] WARREN N. DAVIS Fried, Frank, Harris, Shriver & Jacobson LLP THOMAS A. RUSSO Sutherland Asbill & Brennan New York, NY American International Group, Inc. MICHAEL S. SACKHEIM Washington, D.C. New York, NY Managing Editor, Sidley Austin LLP CHARLES R. MILLS 787 Seventh Ave., New York, NY 10019 SUSAN C. ERVIN K&L Gates, LLP HOWARD SCHNEIDER Phone: (212) 839-5503 Davis Polk & Wardwell LLC Washington, D.C. Charles River Associates Washington, D.C. New York, NY Fax: (212) 839-5599 DAVID S. MITCHELL E-mail: [email protected] RONALD H. FILLER Fried, Frank, Harris, Shriver & Jacobson LLP LAUREN TEIGLAND-HUNT PAUL ARCHITZEL New York Law School New York, NY Teigland-Hunt LLP New York, NY Wilmer Cutler Pickering Hale and Dorr DENIS M. FORSTER RITA MOLESWORTH Washington, D.C. New York, NY Willkie Farr & Gallagher PAUL UHLENHOP CONRAD G. BAHLKE New York, NY Lawrence, Kamin, Saunders & Uhlenhop THOMAS LEE HAZEN Chicago, IL Strook & Strook & Lavan LLP University of North Carolina at Chapel Hill PAUL J. PANTANO New York, NY Cadwalader, Wickersham & Taft LLP SHERRI VENOKUR DONALD L. HORWITZ ANDREA M. CORCORAN Washington, D.C. Venokur LLC North American Derivatives Exchange New York, NY Align International, LLC Chicago, IL GLEN A. RAE Washington, D.C. Banc of America Merrill Lynch PHILIP MCBRIDE JOHNSON New York, NY Washington, D.C. Futures & Derivatives Law Report 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 West’s Copyright Services at 610 Opperman Drive, Eagan, MN 55123, fax (651) 687-7551. Please outline the specific material involved, the number of copies you West LegalEdcenter wish to distribute and the purpose or format of the use. 610 Opperman Drive This publication was created to provide you with accurate and authoritative information concerning the subject matter covered. However, this publication was not necessarily Eagan, MN55123 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. © 2014 Thomson Reuters 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 person’s official duties. One Year Subscription n 11 Issues n $752.04 (ISSN#: 1083-8562) 2 © 2014 THOMSON REUTERS Futures & Derivatives Law Report September 2014 n Volume 34 n Issue 8 CONTINUED FROM PAGE 1 I. Portfolio Margining and ships, and new operational processes to facilitate credit limit checks, trade submission, and margin OTC Swap Clearing transfer. Additionally, because the initial clearing In 2009, the Group of Twenty Finance Ministers mandate in the U.S. was limited to certain interest and Central Bank Governors (G20) met to discuss rate swaps and credit default swap (CDS) indices, regulatory responses to the global financial crisis of mandatory clearing resulted in the bifurcation of a 2008. Among the many significant outcomes of the customer’s OTC derivatives portfolio into cleared 2009 G20 summit was a global commitment to the and uncleared buckets, each with different margin clearing of OTC derivatives as a means of control- requirements. At least in the short term, mandatory ling systemic risk. Following the 2009 G20 sum- clearing has increased the cost to the end user of mit, new regulations were proposed in the United OTC derivatives in the form of upfront costs paid to States, the European Union and elsewhere across its FCM for clearing the trades, and costs incurred the globe to implement the clearing of OTC deriva- due to an increase in the margin requirement for tives.1 While these proposals have taken time to de- trades which are imposed by the CCP and not sub- velop, in the U.S. mandatory clearing has been fully ject to negotiation.4 implemented for large parts of the OTC derivatives In light of these increased costs, portfolio mar- market.2 gining can play an important role. Fortunately, Clearing in the context of OTC derivatives results as described below in Part II-D, there is extensive in the novation of executed trades to a central coun- precedent for portfolio margining and ample regu- terparty (CCP) which then acts as the counterparty latory support. Dodd-Frank itself specifically recog- to each trade. CCPs also perform other functions nized the importance of portfolio margining5, and such as calculating and collecting margin, trade a number of CCPs are presently offering differing reporting, and default management in the event a levels of portfolio margining or building out new clearing member firm
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