CME Clearing Europe Receives Approval for New Full Segregation Client Protection Model
Commentary by Bob Zwirb
CME Clearing Europe ("CME Europe"), CME Group's European clearinghouse, announced that it is the first central counterparty ("CCP") to receive Bank of England approval of the full segregation client protection model with enhanced protection for all bankruptcy scenarios. According to CME Europe, this new client protection model fully segregates collateral with an external custodian at the client level, and is designed to allow the client protection and control of their securities at all times with regard to how client assets would be treated in all bankruptcy scenarios. It is available across all of CME Clearing Europe's OTC financial and commodity derivatives as well as futures products.
The full segregation account, according to CME Europe, expands client asset protection beyond European Market Infrastructure Regulation ("EMIR") requirements. In a separate document, linked below, the CME explains that, under EMIR section 39, a European CCP must offer a choice of both omnibus and individual client segregation, but that CME Europe has developed an additional type of account structure. The CME account, according to CME, "enhances the levels of protection offered by individual segregation," ensuring that "clients are able to port or recoup exactly the collateral that they posted in the case of clearing member or CCP default." This is achieved through CME Europe's working with the client on their custodial arrangements and ensuring that the collateral remains where it belongs: within the custodial venue chosen by the client.
Commentary
One interesting aspect of this new account is whether and, if so, how it will interact with CFTC Rule 30.7 ("Treatment of Foreign Futures or Foreign Options Secured Amount"), which provides a degree of protection for U.S. customers who enter into non-U.S. futures contracts that are cleared at foreign clearinghouses. Under Rule 30.7, FCMs that accept money, securities or property from U.S. customers trading foreign futures or options are required to maintain in a separate account sufficient funds to cover their obligations to such customers. However, the degree of protection provided customer funds under Rule 30.7 is somewhat less than that provided for futures customers trading on U.S. DCMs and for swaps customers that enter into cleared swap transactions.
This disparity not only provides less protection to U.S. customers of foreign futures, but also makes it more difficult for such customers (more so than for customers of domestic futures) to retrieve their property in the event of an FCM insolvency. Indeed, recent insolvencies involving Lehman Brothers' holding company and MF Global's FCM exposed the difficulties that customers could incur in retrieving funds used to secure positions in OTC derivatives cleared by non-U.S. clearing organizations. In such circumstances, U.S. customers discovered that assets held in 30.7 accounts were subject to foreign rather than U.S. law even where related positions originated on U.S. exchanges. In response, the CFTC adopted amendments to Rule 30.7, requiring more stringent investment requirements for 30.7 funds. See Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 FR 68506 (Nov. 14, 2013), and Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012).
Ultimately, such funds are protected only to the extent provided by foreign law, which traditionally has not afforded segregation-like treatment to funds of U.S. customers, though some steps in that direction have been taken recently in Britain as a result of judicial action. See Judgment, In re Lehman Brothers International (Europe) (In Administration) and In re matter of the Insolvency Act 1986, Hilary Term [2012] UKSC 6 (Feb. 29, 2012) ("LBIE Judgment"), available at http://www.supremecourt.gov.uk/decided-cases/docs/UKSC_2010_0194_Judgment.pdf (treating the funds of such customers as "client money" eligible for pro rata distribution following the bankruptcy of their FCM or FCM affiliate even where such funds were not subject to segregation or were improperly segregated). It is not entirely clear from the CME press release here, but the Bank of England-CME action appears to provide further protection and clarity for the funds of U.S. customers of foreign futures and swaps, at least in the UK.