REPORT

Futures & Derivatives Law

The Journal on the Law of Investment & Risk Management Products

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

markets, provide an update on portfolio

margining options which are now being offered for cleared OTC derivatives, and conclude with a discussion of the policy rationale for continuing to encourage portfolio
margining.

CONTINUED ON PAGE 3

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CONTINUED FROM PAGE 1

I. Portfolio Margining and

OTC Swap Clearing

In 2009, the Group of Twenty Finance Ministers

and Central Bank Governors (G20) met to discuss
regulatory responses to the global financial crisis of
2008. Among the many significant outcomes of the
2009 G20 summit was a global commitment to the
clearing of OTC derivatives as a means of controlling systemic risk. Following the 2009 G20 summit, new regulations were proposed in the United
States, the European Union and elsewhere across
the globe to implement the clearing of OTC derivatives.1 While these proposals have taken time to develop, in the U.S. mandatory clearing has been fully
implemented for large parts of the OTC derivatives
market.2
Clearing in the context of OTC derivatives results
in the novation of executed trades to a central counterparty (CCP) which then acts as the counterparty
to each trade. CCPs also perform other functions
such as calculating and collecting margin, trade
reporting, and default management in the event a
clearing member firm fails. Under the U.S. model for
OTC derivatives clearing, customers are not direct
clearing member of a CCP. Instead, they engage a
futures commission merchant (FCM) to act as their
clearing member at the CCP. Although the CCP is
the counterparty to the trade, the FCM performs the
critical task of collecting and delivering margin to
the CCP and acting as guarantor for its customers
obligations to the CCP in the event of the customers
default. Once the OTC derivatives trade has been
accepted by the CCP, the original parties to the trade
no longer face each other directly. In this way, OTC
clearing acts as a mitigant against counterparty risk
of the kind that became apparent in the OTC derivatives market when Lehman Brothers failed in
September 2008. In the event of the failure of an individual clearing member, the CCP will manage the
defaulted clearing members portfolio, transferring
positions to solvent clearing members and arranging for the termination of positions which cannot be
transferred. In this way, a CCP is designed to prevent the disruptive effects on a market when a large
firm collapses.3
As the U.S. clearing mandate took shape during
2011-2013, certain practical considerations came
to light for market participants. Unlike the clearing
of other financial products such as securities, clearing OTC derivatives requires a much greater focus
on counterparty risk management. Further, OTC
derivatives clearing requires market participants to
create new documentation to govern their relation-

2014 THOMSON REUTERS

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Volume 34

Issue 8

ships, and new operational processes to facilitate

credit limit checks, trade submission, and margin
transfer. Additionally, because the initial clearing
mandate in the U.S. was limited to certain interest
rate swaps and credit default swap (CDS) indices,
mandatory clearing resulted in the bifurcation of a
customers OTC derivatives portfolio into cleared
and uncleared buckets, each with different margin
requirements. At least in the short term, mandatory
clearing has increased the cost to the end user of
OTC derivatives in the form of upfront costs paid to
its FCM for clearing the trades, and costs incurred
due to an increase in the margin requirement for
trades which are imposed by the CCP and not subject to negotiation.4
In light of these increased costs, portfolio margining can play an important role. Fortunately,
as described below in Part II-D, there is extensive
precedent for portfolio margining and ample regulatory support. Dodd-Frank itself specifically recognized the importance of portfolio margining5, and
a number of CCPs are presently offering differing
levels of portfolio margining or building out new
offerings to help customers achieve better margin
efficiency. While an integral part of this equation
is the relationship between cleared and uncleared
OTC derivatives portfolios (as well as between
cleared OTC derivatives and other cleared futures
products), in the absence of final rules on margin
requirements for uncleared swaps, market efforts
to date have focused on the potential for portfolio
margining amongst cleared products. For example,
ICE allows for portfolio margining between cleared
CDS indices and cleared single name swaps. CME
allows for portfolio margining across cleared interest rate swaps and certain cleared interest rate futures. These types of offerings have shown market
participants the potential opportunities for margin
optimization and efficiency in the world of mandatory clearing. Additionally, as jurisdictions outside
the U.S. begin to implement their clearing mandates,
the experience with portfolio margining programs
implemented in the U.S. may provide useful guidance for other regulators.

II. Portfolio Margining

Arrangements Today
A. What is Portfolio Margining?

Margin provides protection to a party where its

counterpartys positions are closed out at a loss and
the counterparty fails to cover the loss. There are

September 2014 n Volume 34 n Issue 8

a number of approaches to calculating the required

amount of margin, but, generally speaking, there are
two starting points for determining the appropriate
level of margin. Margin can be calculated-1. On a trade by trade or gross basis, where the
amount of required margin is determined independently for each position in a counterpartys
portfolio. Under this approach, the total margin that must be provided by the counterparty
is equal to the sum of the amount of margin
required for each individual position.
2. On a portfolio or net basis where the amount
of required margin is based on the risk posed by
a counterpartys portfolio across all positions.
Under this approach, each individual position
held by the counterparty is not considered in
isolation from all other positions.
There are many ways to describe what is meant
by portfolio margining. The Securities Exchange
Commission (SEC), in its customer margin rules
relating to security futures, describes portfolio margining as follows:
Portfolio margining establishes margin
levels by assessing the market risk of a
portfolio of positions in securities or
commodities. Under a portfolio margining
system, the amount of required margin is
determined by analyzing the risk of each
component position in a customer account
(e.g., a class of options, with the same expiration date) and by recognizing any risk
offsets in an overall portfolio of positions
(e.g., across options and futures on the
same underlying instrument).6
When we refer to portfolio margining, like the
SEC, we are primarily talking about establishing
risk offsets across an aggregate portfolio of positions. Additionally, portfolio margining includes
the concept of netting, where the party receiving the
benefit of risk offsets grants a security interest in its
portfolio to the legal entities who are its counterparties. The combination of these two elements creates
a portfolio margining regime.

B. How Does Portfolio Margining

Work?

Portfolio margining allows a clearinghouse or

dealer (depending on the type of product) to call
for margin commensurate with the net risk of a cus-

Futures & Derivatives Law Report

tomers portfolio. Margin requirements calculated

on the basis of net risk are generally lower than the
amounts that would be required where positions are
considered in isolation of one another. This reflects
the fact that many times, positions in a customers
portfolio offset or hedge against the risk of other
positions in the portfolio. For example, holding a
long futures position on a 10-year treasury is often
a hedge against the fixed rate payments due under a
10-year interest rate swap. As interest rates change,
the value of each position will move in opposite directions. Portfolio margining reflects such offsetting
risks and thus allows customers to use margin more
efficiently, and in totality, for margin to be more efficiently utilized across the market.
Dealers also benefit from portfolio margining because measuring the risk of pairs or groups of positions which are correlated based on reference assets
(e.g., options on the S&P 500 and S&P futures) or
historical data provides a better methodology for
evaluating the risk associated with a customers default than would be the case were the risk associated
with each customers positions analyzed in isolation.
For this reason, many swap dealers currently offer portfolio margining arrangements in uncleared
OTC derivatives to their customers which allow for
margin optimization. Although portfolio margining
arrangements result in a reduction in overall margin
held by a dealer at any time, the dealer can nevertheless maintain sufficient collateralization at all times
in the event of customer default utilizing the most
accurate risk methodologies.
Portfolio margining arrangements typically recognize offsets among products within the same asset class but not across multiple asset classes (e.g.,
rates, credit, commodities, equities, and foreign
exchange). However, within an asset class, different types of cash and synthetic products can and
do qualify. For example, in the interest rates asset
class, bonds, Treasury futures, interest rate swaps,
and repos may all be subject to the same portfolio
margining framework. Some commentators use the
expression cross-product margining to describe
these types of relationships. For purposes of this
article, we use the terms portfolio margining and
cross-product margining interchangeably.

C. Examples of Portfolio Margining

Portfolio margining arrangements exist today in a

number of contexts:
Among cleared derivatives (e.g., single name
CDS and CDS indices)

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Futures & Derivatives Law Report

Among cleared derivatives and other cleared

products (e.g., interest rate swaps and futures)
Additionally, there are other potential applications between uncleared derivatives and cleared derivatives which could develop over time, although
these are not presently available.
As discussed below, portfolio margining has existed for decades. For example, The Options Clearing
Corporation (OCC) has used portfolio margining to
calculate margin levels since 1989. Regulation T of
the Board of Governors of the Federal Reserve System (Reg T), which governs the amount of margin
that must be maintained by customers at a brokerdealer (BD) in connection with open securities positions, was amended in 1998 to allow BDs to use exchange-approved portfolio margining programs to
calculate initial and variation margin.7 Additionally,
in 2006, the New York Stock Exchange (NYSE) and
the Chicago Board of Options Exchange (CBOE)
amended certain exchange rules to allow margin
requirements to be calculated on a portfolio basis,
across a wide variety of products, including security
futures and listed options.

D. Markets Which Currently Utilize

Portfolio Margining

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.

1. Cleared Futures and Options (SPAN)

For the past 26 years, commodity exchanges in

the United States, Europe, and Asia have been calculating margin requirements on a portfolio basis us-

2014 THOMSON REUTERS

September 2014

Volume 34

Issue 8

ing the Standard Portfolio Analysis of Risk (SPAN)

margin system developed by the Chicago Mercantile
Exchange (CME). The introduction of SPAN completely changed the world of futures and options risk
management by allowing margin requirements for
futures and options on futures to be calculated on the
basis of overall portfolio risk.
SPAN calculates the likely loss in a portfolio of
derivatives positions using a set of portfolio parameters, and sets this value as the initial margin payable
by the firm holding the portfolio.10 For example, the
CME determined that there is a high correlation in
the price fluctuations of the S&P 500 and the NASDAQ 100 futures contracts. If a customer holds offsetting positions in the two contracts, that customer
will have less market risk on a net basis than if it
held either position by itself. Consequently, under
SPAN, the customers net margin requirement will
be less than would have been otherwise required
due to the correlated positions that result in a reduction in overall market risk.
SPAN is used today by 50 exchanges and clearinghouses.11 Each exchange or clearinghouse sets its
own risk parameters using SPAN. Therefore, identical futures contracts traded on more than one exchange may have different SPAN-calculated margin
requirements depending on the risk parameters set
by the particular exchange. However, each SPAN
model generally uses options pricing models and
value-at-risk (VaR) models to determine how positions will perform under different scenarios in order
to assess for changes to a portfolios price and volatility. SPAN then allows projected gains and losses
for each position in a portfolio to be netted under
each scenario in order to determine a portfolio-wide
net gain or loss. The scenario representing the greatest potential loss is then used to determine the customers required margin level.

2. OCC Multiple Clearing Venue Model

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 n Volume 34 n Issue 8

joint account via a clearing member trade or give-up

agreement. At the end of each trading day, the applicable clearinghouse transmits closing positions and
settlement activity to OCC, which in turn calculates
a single margin level to support the covered positions
and then produces and distributes position, margin
and settlement reports to clearing members. Following the 1998 Reg T amendments, OCC adopted
SPAN for its portfolio margining model.

3. NYSE Portfolio Margining

NYSE Rule 431, adopted in accordance with

Reg T, establishes margin requirements for NYSE
member firms. Rule 431 establishes initial margin
requirements equal to the greater of the amount required pursuant to Reg T, Rules 400 through 406
of the Securities Exchange Act of 1934 (Exchange
Act) or Rules 41.42 through 41.48 of the Commodity Exchange Act (CEA) or, if higher, the amount
required by NYSE rules. Rule 431 also imposes
maintenance margin requirements when the value
of the positions in a customers account falls below
a specified level. Rule 431 prescribes specific margin
requirements for customers based on the type of securities held in their accounts. Generally, Rule 431
requires that margin be calculated using fixed percentages, on a position-by-position basis. This approach does not fully recognize hedges or other risk
offsets between different positions that may reduce
the overall risk of a portfolio. In addition, the fixed
margin percentages established for each position do
not take into account the fact that the prices of different security positions, such as options, related to
the same underlying instrument do not necessarily
change equally (in percentage terms) in relation to
a change in the price of the underlying instrument.
In 2002, the NYSE sought approval from the
SEC to modify Rule 431 and launch a pilot portfolio margining program. In 2006, the SEC approved
parallel rule amendments by the NYSE and the
Chicago Board of Options Exchange (CBOE) expanding their respective pilot programs permitting
margin requirements to be calculated on a portfolio
basis.12
As amended, Rule 431 permits a BD to calculate
customer margin requirements for eligible products
including equity securities, listed options, unlisted derivatives (that is, any equity-based or equity
index-based unlisted option, forward contract, or
security-based swap that can be valued by a theoretical pricing model approved by the SEC) and securities futures products by grouping those products
in an account that are based on the same index or

Futures & Derivatives Law Report

issuer into a single portfolio so that offsets between

positions within that portfolio can be recognized.13
A theoretical pricing model is used to measure
the potential gains and losses to each position in the
portfolio under multiple pricing scenarios. Subject
to a per contract minimum requirement, the margin required for each portfolio is determined by reference to the greatest theoretical loss incurred by the
portfolio in aggregate after shocking the portfolio
for upward and downward price movements within
a defined range above and below the current market
price (e.g., +/- 10%) of the instrument or, in the case
of a derivative, its underlier.
In the release approving the initial pilot programs,
the SEC noted that the use of the methodology employed by BDs to calculate net capital haircuts for
certain options and related positions for purposes of
SEC Rule 15c3-1 may better align a customers total margin requirement with the actual risk associated with the customers positions taken as a whole,
and may alleviate excessive margin calls, improve
cash flows and liquidity, and reduce volatility.14

E. Portfolio Margining and Cleared

OTC Derivatives
1. ICE Clear Credit Customer Portfolio
Margining

As part of its efforts to more closely regulate OTC

derivatives, Dodd Frank divided regulatory authority between the Commodity Futures Trading Commission (CFTC) and the SEC.15 Under Dodd-Frank,
the SEC oversees security-based swaps which are
defined as swaps based on single security or loan
or narrow-based index (10 or fewer securities). All
other swaps, including CDS indices such as CDX
and iTraxx and interest rate swaps, fall under CFTC
jurisdiction. What this means in practice is that,
market participants are no longer able to commingle and margin their CDS indices and single-name
CDS on a portfolio basis under Dodd-Frank, even if
those trades are cleared at a single CCP. Due to the
distinct requirements with respect to maintenance of
accounts for cleared security-based swap positions
regulated by the SEC and cleared swap positions
regulated by the CFTC. Since this was such a departure from past practice, ICE Clear Credit petitioned
the SEC and the CFTC to permit the commingling
and portfolio margining of both single name and index CDS in a CFTC-regulation 4d(f) account.
In the absence of relief from the SEC and CFTC,
a portfolio margining program could not be estab-

2014 THOMSON REUTERS

Futures & Derivatives Law Report

lished to commingle and portfolio margin cleared

customer portfolios of CDS for a portfolio that
includes both security-based swaps such as single
name credit default swaps and swaps such as CDX
and iTraxx credit indices. Clients would have to
post full margin on a single-name position held in
an SEC account as well as full margin on an index
position held in a CFTC account even if the two positions offset each other from a risk perspective. In
its application to regulators ICE Clear Credit noted
that by combining the positions in one account and
applying ICE Clear Credits portfolio margining
methodology, the CCP provides capital efficiencies
to customers while enhancing its risk management
practices. In addition, by commingling in the CFTC
regulated 4d(f) account, FCM customers would receive the same bankruptcy treatment and customer
collateral protections under the CFTCs Legally Segregated Operationally Commingled (LSOC) regime
for all cleared CDS positions, not just those regulated by the CFTC.
On January 30, 2012 ICE Clear Credit received
approval from the CFTC and the SEC to offer margin offsets between single names and index CDS for
proprietary positions held by clearing members.
However, this benefit was not extended to customers of clearing members, until, after protracted negotiation with the SEC and CFTC during 2012, ICE
Clear Credit received an SEC16 exemptive order,
later confirmed by the CFTC in its own exemptive
order17. While the CFTC release was issued specifically in response to ICE Clear Credit LLC, which
submitted a request to both regulators, the SEC order includes general conditions that, if satisfied by
a clearing member that is both an FCM registered
with the CFTC and a BD registered with the SEC,
permit the clearing member to provide customers
with CDS portfolio margining in a single segregated
account across both index CDS and single-name
CDS. These orders allowed ICE Clear Credit to
provide relief for BD/FCMs that maintain clearing
accounts for customer-related transactions, subject
to the satisfaction of certain conditions by the BD/
FCMs themselves.
The most important condition placed on the relief granted to ICE Clear Credit was a requirement
that each BD/FCM obtain approval for its internal
margin methodology from the SEC prior to offering portfolio margining to customers. The SEC delegated the responsibility of evaluation to FINRA,
which in turn gave the BD/FCMs a set of 20 different hypothetical CDS portfolios and asked that
they provide an aggregate risk margin number for
each portfolio using their internal model. These re-

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Volume 34

Issue 8

sults allowed FINRA to challenge the applicant BD/

FCMs assumptions about their risk management
processes and work with them for a more consistent approach to managing and margining CDS
and thus reducing credit risk.18 On January 31,
2014 eight firms received approval for their internal margin models.19 For the most part, in order to
permit such portfolio margining, the approval models require that BD/FCMs require customers to post
margin equal to 110% of the margin that otherwise
would be required by the CCP but on an amount
of risk measured on a net basis, rather than gross.
Consequently, after receiving these approvals, BD/
FCMs dually registered with the CFTC and SEC
can comply with certain requirements applicable
to maintenance of customer accounts under the
CEA without complying with parallel requirements
under the Exchange Act. Put simply, these various
orders and approvals allow Ice Clear Credit LLC
and its clearing members to offer programs that
provide for commingling and portfolio margining
of cleared customer CDS. While customer clearing
of single name CDS is not currently required by law,
the looming possibility of punitive uncleared margin
requirements and potential SEC clearing mandates
may make this topic more important for customers
in the near future.20

2. CME Portfolio Margining

In May 2012, the CME began offering portfolio

margining of CME listed Eurodollar and Treasury
futures and CME-cleared OTC interest rate swap
products.21 Full regulatory approval to offer portfolio margining to customers was granted in November
2012. Portfolio margining at CME takes account of
correlations between different cleared products when
calculating initial margin requirements, rather than
calculating margin requirements on a product-byproduct basis. A lower net margin number can be
achieved where the risk in the futures and cleared
swap positions is reliably offsetting, such as when futures have been used to hedge a portfolio of interest
rate swaps.
To effect portfolio margining across exchange
traded derivatives and cleared OTC swaps, CME
created the Optimizer, a proprietary software
program that is hosted on the FCMs clearing network. With certain inputs from FCMs, and relying
on proprietary algorithms, the Optimizer selects futures positions that should be moved into the cleared
swap account type to offset the overall initial margin requirement across a single clearing client. The
tool automates the selection of futures to move and

September 2014 n Volume 34 n Issue 8

creates a transfer message that is produced and can

be copied and sent to CME to make the change for
the books and record at the CCP.
In practice, FCMs have a small window of time
to complete the Optimizer processing, clear transfer
trades, and ultimately book the trades into their internal systems. CME files required for the Optimizer
computation are not available until 7:30pm EST.
Therefore, FCMs must create files with the trades
available at this time each night. CME then calculates the portfolio margin value and provides it to
clearing members. However, FCMs must develop
their own operational processes to effect portfolio
margining for their clients, resulting in different account structures and protocols for reporting to customers among FCMs.
In some ways, the CME Optimizer was a useful test case for portfolio margining of cleared
OTC derivatives. It has brought to light operational complexities, such as the difficulty an FCM
faces in transferring positions for a large customer
with multiple accounts into a portfolio margining
account that is separate and distinct from the customers futures account (a 4d account) or cleared
swap account (a 4d(f) account). Additionally, there
are practical limitations on the benefits that can be
achieved since not all trading strategies lend themselves naturally to offsets, meaning that the bottom
line reduction in margin may be less that the best
case estimates provided by CME.22
However, despite these limits and operational
challenges, market participants agree that this type
of portfolio margining creates substantial cost savings for all market participants who are eligible to
participate. With nine clearing members currently
participating, and over 100 accounts using portfolio
margining, CME estimates that this type of interest
rate swap portfolio margining has resulted in $4 billion in initial margin savings across customer and
house accounts.23

III. Policy Rationale for Encouraging

Portfolio Margining

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,

Futures & Derivatives Law Report

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.

A. Reduces costs and promotes

liquidity

As both the historical and recent examples in Part

II demonstrate, portfolio margining has been broadly
accepted under various regulatory regimes and for
different types of financial products.24 Portfolio
margining enables market participants to avoid
posting redundant margin while ensuring that the
FCM has access to sufficient margin in the event of
a customer default. Therefore, a system of portfolio
margining eliminates excess margin requirements
without foregoing necessary protection and avoids
a reduction in market liquidity resulting from
the additional margin that would be required if
cleared products or cleared swap types were treated
separately.

B. Allows capital to be deployed

efficiently

Portfolio margining practices minimize otherwise

unnecessary increased costs of trading. Without the
margin offsets available under portfolio margining,
these increased trading costs are passed on to
swaps end-users and thereby reduce liquidity and
competitiveness in the markets as well as raise the
costs of bona fide hedging in the swaps market.
Furthermore, a system of portfolio margining allows
capital to be invested more effectively (i.e., not tied
up as redundant margin securing swaps positions)
with no compromise of dealer or systemic safety.
More effective investment of capital yields more
profitable returns for the investing public without
increasing the risk associated with entering into
uncleared swaps.

C. Facilitates clearing

Portfolio margining of cleared OTC derivatives

has eased the market transition to mandatory clearing requirements of Dodd-Frank, and should have
the same result in other jurisdictions which are
expected to implement their clearing requirements
shortly. Because of the CFTCs phased approach
to mandatory clearing (and the absence of parallel SEC rules for security-based swaps), not all liquid swaps are required to be cleared, and market
participants still have significant uncleared swaps

2014 THOMSON REUTERS

Futures & Derivatives Law Report

positions. Without the ability to portfolio margin

between cleared and uncleared positions, a market
participant will be forced to post redundant margin
for its cleared positions and its uncleared positions.
The availability of portfolio margining may provide
economic incentives for market participants to clear
their swap positions ahead of regulatory requirements in order to alleviate some of the cost of holding separate cleared and uncleared portfolios.

September 2014

3.

4.

IV. Conclusion

Portfolio margining can achieve cost reduction

for the users of cleared OTC derivatives, futures
and equity products without any loss of systemic
risk protection for BDs, FCMs and CCPs. Additionally, portfolio margining programs incentivize clearing, and avoid the liquidity drain that would result
if participants were required to post excess margin
to satisfy multiple, independent requirements. The
work ahead for CCPs and FCMs is to expand their
portfolio margining offerings wherever possible.
For example, while CCPs for OTC derivatives have
tended to develop as single product clearing facilities, there is a range of portfolio offsets that could
be realized across products in different asset classes
that are now cleared in separate CCPs. Work must
be done to bridge the structural challenges caused
by this separation. Potentially, as liquidity builds in
cleared OTC derivatives, consideration can be given
to tighter integration of clearinghouse default fund
structures for different products that present risk
offsets. While we have learned a great deal from the
Dodd-Frank clearing mandates, the picture will become much more complete once clearing becomes
implemented on a global basis, and regulators both
in the U.S. and abroad adopt final rules for uncleared
margin. In the meantime, market participants will
need to evaluate portfolio margining offerings in
place today as part of their overall collateral optimization efforts and look for new opportunities to
implement portfolio margining as new regulatory
requirements become effective.

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/

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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).

September 2014 n Volume 34 n Issue 8

13.

14.
15.

16.

17.

18.

10

NYSE Rule 431(g) also provides: In addition,

a member organization, provided that it is a
Futures Commission Merchant (FCM) and is
either a clearing member of a futures clearing
organization or has an affiliate that is a clearing member of a futures clearing organization,
is permitted under this section (g) to combine
an eligible participants related instruments as
defined in section (g)(2)(E), with listed index
options, options on exchange traded funds
(ETF), index warrants and underlying instruments and compute a margin requirement for
such combined products on a portfolio margin
basis. See also FINRA Regulation Portfolio
Margin Frequently Asked Questions, available
at: http://www.finra.org/Industry/Regulation/
Guidance/P038849#products.
SEC Release No. 34-54918 (Dec. 12, 2006), 71
Fed. Reg. 75790 (Dec. 18, 2006).
See Further Definition of Swap, SecurityBased Swap, and Security-Based Swap Agreement; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 77 Fed. Reg. 48208
(Aug. 13, 2012), available at: http://www.gpo.
gov/fdsys/pkg/FR-2012-08-13/pdf/2012-18003.
pdf.
Order Granting Conditional Exemptions under
the Securities Exchange Act of 1934 in connection with Portfolio Margining of Swaps and
Security-Based Swaps, December 14, 2012,
available
at:
http://www.sec.gov/rules/exorders/2012/34-68433.pdf.
On January 14, 2013, the CFTC issued an order
permitting ICE Clear Credit and its participants
to hold customer property used to margin,
guarantee, or secure positions in cleared security-based swaps and cleared swaps in a Section
4d(f) account and to provide for portfolio margining of such cleared swaps and cleared security-based swaps. The CFTCs order is available
at: http://www.cftc.gov/ucm/groups/public/@
newsroom/documents/file/icecreditclearorderO11413.pdf.
Joe Rennison, FCM Models for CDS Portfolio
Margin varied widely, Risk Magazine, May 1,
2014

Futures & Derivatives Law Report

19.

20.

21.

22.
23.

24.

Goldman, Sachs & Co., Morgan Stanley & Co.

LLC, UBS Securities LLC, Barclays Capital Inc.,
J.P. Morgan Securities LLC, Credit Suisse Securities (USA) LLC, Citigroup Global Markets Inc.,
and Deutsche Bank Securities, Inc. have each
received Temporary Conditional Approval Letters. See Release No 34-68433, available at:
http://www.sec.gov/rules/exorders/exordersarchive/exorders2012.shtml.
On September 3, 2014 the Federal Reserve,
Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Farm
Credit Administration, and the Federal Housing Finance Agency released re-proposed rules
requiring swap dealers and major swap participants to hold margin for uncleared swaps.
These rules replaced a proposal originally released by these same regulators in 2011 and are
designed to conform to international norms
set forth in a framework outlined by the Basel
Committee on Banking Supervision and the International Organization of Securities Commission (BASEL-IOSCO). The reproposed rules are
available here: http://www.federalreserve.gov/
newsevents/press/bcreg/bcreg20140903c1.pdf.
Introducing Portfolio Margining of Interest
Rate Swaps vs. Futures, CME press release dated May 7, 2012 available at http://www.cmegroup.com/trading/otc/files/cme-irs-portfoliomargining-sell-sheet.pdf.
Tom Osborn, The Slow Growth of Cross-Product
Margining, Risk Magazine, August 28, 2013.
Significant Margin SavingsCleared OTC
IRS http://www.cmegroup.com/trading/interest-rates/cleared-otc/portfolio-margining-ofcleared-otc-irs-swaps-and-futures.html
(last
visited August 27, 2014).
FINRA permits portfolio margining for certain
products pursuant to NASD Rule 2520(g) and
NYSE Rule 431(g). OCC, CME Group and LCH.
Clearnet also permit portfolio margining for
certain products.

2014 THOMSON REUTERS