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4240. Margin Requirements for Credit Default Swaps

(a) Effective Period of Interim Pilot Program
This Rule establishes an interim pilot program ("Interim Pilot Program") with respect to margin requirements for any transactions in credit default swaps held in an account at a member (regardless of the type of account in which the transaction is booked), including transactions that are effected by the member in contracts that are cleared through a clearing agency that provides central counterparty clearing services using a margin methodology the use of which has been approved by FINRA as announced in a Regulatory Notice. The Interim Pilot Program shall automatically expire on July 17, 2015. For purposes of this Rule, the term "credit default swap" ("CDS") shall include any product that is commonly known to the trade as a credit default swap and is a security-based swap as defined pursuant to Section 3(a)(68) of the Exchange Act or the rules and guidance of the SEC and its staff. The term "transaction" shall include any ongoing CDS position.
(b) Central Counterparty Clearing Arrangements
Any member, prior to establishing any clearing arrangement with respect to CDS transactions that makes use of any central counterparty clearing services provided by any clearing agency must notify FINRA in advance in writing, in such manner as may be specified by FINRA in a Regulatory Notice.
(c) Margin Requirements
(1) CDS Cleared Through a Clearing Agency Using a Margin Methodology the Use of Which Has Been Approved By FINRA
Members shall require as a minimum for computing customer or broker-dealer margin, with respect to any customer or broker-dealer transaction in CDS that is cleared through the central counterparty clearing facilities of a clearing agency using a margin methodology the use of which has been approved by FINRA as announced in a Regulatory Notice, the applicable margin pursuant to the rules of such clearing agency regardless of the type of account in which the transaction in CDS is booked. Members shall, based on the risk monitoring procedures and guidelines set forth in paragraph (d) of this Rule, determine whether the applicable clearing agency requirements are adequate with respect to their customer and broker-dealer accounts and the positions in those accounts and, where appropriate, increase such margin in excess of such minimum margin. For this purpose, members are permitted to use the margin requirements set forth in Supplementary Material .01 of this Rule.
The aggregate amount of margin the member collects from customers and broker-dealers for transactions in CDS must equal or exceed the aggregate amount of margin the member is required to post at the clearing agency with respect to those customer and broker-dealer transactions.
Transactions that are cleared through a clearing agency using a margin methodology the use of which has been approved by FINRA as announced in a Regulatory Notice are not subject to the provisions of paragraph (c)(2) of this Rule.
(2) CDS That Are Cleared on Central Counterparty Clearing Facilities That Do Not Use a Margin Methodology the Use of Which Has Been Approved By FINRA or That Settle Over-the-Counter ("OTC")
Unless otherwise permitted by FINRA in writing, members shall require, with respect to any transaction in CDS that makes use of central counterparty clearing facilities that do not use a margin methodology the use of which has been approved by FINRA as announced in a Regulatory Notice or that settle OTC, the applicable minimum margin as set forth in Supplementary Material .01 of this Rule regardless of the type of account in which the transaction in CDS is booked. However, members shall, based on the risk monitoring procedures and guidelines set forth in paragraph (d) of this Rule, determine whether such margin is adequate with respect to their customer and broker-dealer accounts and, where appropriate, increase such requirements.
In addition to requiring the applicable minimum margin as set forth pursuant to this paragraph (c)(2) (initial margin), the member shall collect daily from each customer or broker-dealer counterparty an amount at least equal to the member's current exposure, as defined in SEA Rule 15c3-1e(c)(4) (provided, however, that members not otherwise subject to SEA Rule 15c3-1e are not required to take into account paragraph (c)(4)(v)(G) of such Rule), arising from the daily mark to market of the CDS (variation margin).
(3) CDS That Are Held in an Account Subject To a CDS Portfolio Margining Program
In lieu of the requirements set forth in paragraphs (c)(1) and (c)(2) of this Rule, a member may require, with respect to CDS held in an account subject to an approved portfolio margining program, the amount of margin determined by the member's portfolio margin methodology, provided that, prior to margining CDS on a portfolio margin basis, the member shall notify FINRA in advance in writing of its intent to operate under the portfolio margin program.
(d) Risk Monitoring Procedures and Guidelines
Members shall monitor the risk of any customer or broker-dealer accounts with exposure to CDS and shall maintain a comprehensive written risk analysis methodology for assessing the potential risk to the member's capital over a specified range of possible market movements over a specified time period. For purposes of this Rule, members must employ the risk monitoring procedures and guidelines set forth in paragraphs (d)(1) through (8) of this Rule. The member must review, in accordance with the member's written procedures, at reasonable periodic intervals, the member's credit extension activities for consistency with the risk monitoring procedures and guidelines set forth in this Rule, and must determine whether the data necessary to apply the risk monitoring procedures and guidelines is accessible on a timely basis and information systems are available to adequately capture, monitor, analyze and report relevant data, including:
(1) obtaining and reviewing the required account documentation and financial information necessary for assessing the amount of credit to be extended to customers and broker-dealers;
(2) assessing the determination, review and approval of credit limits to each customer and broker-dealer, and across all customers and broker-dealers, engaging in CDS transactions;
(3) monitoring credit risk exposure to the member from CDS, including the type, scope and frequency of reporting to senior management;
(4) the use of stress testing of accounts containing CDS contracts in order to monitor market risk exposure from individual accounts and in the aggregate;
(5) managing the impact of credit extended related to CDS contracts on the member's overall risk exposure;
(6) determining the need to collect additional margin from a particular customer or broker-dealer, including whether that determination was based upon the creditworthiness of the customer or broker-dealer and/or the risk of the specific contracts;
(7) monitoring the credit exposure resulting from concentrated positions within both individual accounts and across all accounts containing CDS contracts; and
(8) maintaining sufficient margin in each customer and broker-dealer account to protect against the default of the largest individual exposure in the account as measured by computing the largest maximum possible loss (that is, the notional amount of the CDS less the estimated recovery given default).
(e) Concentrations
Unless otherwise permitted by FINRA in writing, where the current and maximum potential exposure, as defined in SEA Rule 15c3-1e(c)(4) (provided, however, that members not otherwise subject to SEA Rule 15c3-1e are not required to take into account paragraph (c)(4)(v)(G) of such Rule), with respect to the largest single name CDS across all accounts exceeds the member's tentative net capital, the member must take a capital charge equal to the aggregate margin requirement for such accounts on the positions in such single name CDS in accordance with the tables set forth in Supplementary Material .01 of this Rule. This capital charge may be reduced by the amount of excess margin held in each such counterparty account holding such exposure, on an account by account basis.

• • • Supplementary Material: --------------

.01 Margin Requirements for CDS. Unless otherwise permitted by FINRA in writing, the following customer and broker-dealer margin requirements shall apply, as appropriate, pursuant to paragraph (c) of this Rule. In addition to requiring the applicable minimum margin (initial margin) as set forth pursuant to this Supplementary Material, the member shall collect daily from each customer or broker-dealer counterparty an amount at least equal to the member's current exposure, as defined in SEA Rule 15c3-1e(c)(4) (provided, however, that members not otherwise subject to SEA Rule 15c3-1e are not required to take into account paragraph (c)(4)(v)(G) of such Rule), arising from the daily mark to market of the CDS (variation margin).

(a) Customer and Broker-Dealer Accounts That Are Short a CDS
The following table shall be used to determine the margin that a member must collect from a customer or broker-dealer that is short a single name debt security CDS contract (sold protection). The margin to be collected based upon the basis point spread over LIBOR of the CDS contract as well as the maturity of that contract as a percentage of the notional amount shall be as follows:

Length of Time to Maturity of CDS Contract Basis Point Spread
100 or below 101-300 301-400 401-500 501-699 700 and above
12 months & shorter 1.00% 2.00% 5.00% 7.50% 10.00% 15.00%
13-24 months 1.50% 3.50% 7.50% 10.00% 12.50% 17.50%
25-36 months 2.00% 5.00% 10.00% 12.50% 15.00% 20.00%
37-48 months 3.00% 6.00% 12.50% 15.00% 17.5% 22.50%
49-60 months 4.00% 7.00% 15.00% 17.50% 20.00% 25.00%
61-72 months 5.50% 8.50% 16.00% 20.00% 22.50% 27.50%
73-84 months 7.00% 10.00% 20.00% 22.50% 27.50% 30.00%
85-120 months 8.50% 15.00% 22.50% 25.00% 30.00% 40.00%
121 months & longer 10.00% 20.00% 25.00% 27.50% 35.00% 50.00%
For those CDS contracts where the underlying obligation is a narrow-based debt index, rather than a single name bond, the margin requirement shall be based upon a margin methodology using the member's internal models the use of which has been approved by FINRA.
(b) Accounts That Are Long a CDS
For customer or broker-dealer accounts that are long the CDS contracts (purchased protection), the margin to be collected shall be 50% of the above amounts.
(c) Accounts That Maintain Both Long and Short CDS
In instances where the customer or broker-dealer maintains both long and short CDS, the member may elect to collect 50% of the above margin requirements on the lesser of the long or short position within the same Bloomberg CDS sector (or, if the long and short positions are equal, the long position), provided those long and short positions are in the same spread and maturity bucket, plus the above margin requirements on the excess long or short position, if any.
If a customer or broker-dealer is long the bond and long a CDS contract on the same underlying obligor, margin needs to be collected only on the long bond position, provided that bond can be delivered against the long CDS contract, as prescribed pursuant to applicable FINRA margin rules.
In instances where the customer or broker-dealer is short the bond and short the CDS on the same underlying obligor, margin need only be collected on the short bond, as prescribed pursuant to applicable FINRA margin rules.
Amended by SR-FINRA-2014-029 eff. June 23, 2014.
Amended by SR-FINRA-2013-030 eff. July 11, 2013.
Amended by SR-FINRA-2013-017 eff. Mar. 8, 2013.
Amended by SR-FINRA-2012-035 eff. July 13, 2012.
Amended by SR-FINRA-2012-015 eff. Mar. 7, 2012.
Amended by SR-FINRA-2012-014 eff. Jan. 17, 2012.
Amended by SR-FINRA-2011-034 eff. July 16, 2011.
Amended by SR-FINRA-2010-063 eff. Nov. 22, 2010.
Amended by SR-FINRA-2009-063 eff. Sep. 21, 2009.
Adopted by SR-FINRA-2009-012 eff. June 3, 2009.

Selected Notices: 09-30, 11-31.

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