SEC Allows Bank to Subordinate Swap Positions Cleared Through Affiliate
The SEC Division of Trading and Markets ("Division") permitted a swap dealer to clear securities of an affiliated banking entity without customer segregation, subject to a subordination agreement between them.
In a no-action letter, the Division said that the relief responds to a request by the banking entity ("bank") to use the affiliated swap dealer ("affiliate") to clear single-name and index credit default swaps at a clearing house on a portfolio margined basis. The Division said granting the request was based on the bank and affiliate entering into a non-conforming subordination agreement that requires: (i) the bank irrevocably agreeing that its claims regarding cleared positions and margin are subordinate to the claims of all other security-based swap customers of the affiliate and (ii) treating the bank's positions as proprietary under applicable commodity regulations rather than subjecting them to security-based swap segregation rules.
The Division also required certain safeguards to be met, including: (i) requiring the bank to acknowledge that the assets are proprietary and will be maintained in an account at the clearing house commingled with other proprietary swap transactions, (ii) that the bank's assets held at the affiliate will not constitute "customer property" for bankruptcy purposes and will not give rise to a customer claim in the event of a liquidation of the affiliate, and (iii) requiring the affiliate to obtain an opinion of counsel confirming that the bank is legally authorized to enter into the agreement.
Under the no-action position, the Division said that it would not recommend enforcement action against the affiliated swap dealer under SEA Sections 3E(b) ("Segregation of assets held as collateral in security-based swap transactions"), (d), and (e), and Rule 18a-4 ("Segregation requirements for security-based swap dealers and major security-based swap participants") regarding the treatment of affiliate accounts subject to the subordination agreement.