(The article featured below is a selection from Hedge Funds and Private Equity: Risk Management and Regulatory Update, which is available to subscribers of that publication.)

Hedge Fund Industry Supports CFTC Proposal to Create a New Account Class

In a recent comment letter, the Managed Funds Association expressed support for the CFTC’s proposal to amend its regulations to create certainty regarding allocations of cleared OTC derivatives that are part of a bankruptcy proceeding involving a commodity broker that is also a futures commission merchant.

The CFTC proposed to amend its rules to create a new account class applicable only to specific OTC-derivative positions to govern the manner in which a bankruptcy trustee calculates net equity and claims against the estate for each customer of the commodity broker. The account classes are designed to ensure that, in a bankruptcy proceeding involving a commodity broker that is a futures commission merchant, customers holding positions in different types of commodity contracts are afforded asset-segregation protections based on the underlying characteristics of the types of contracts they hold. Also proposed was the codification of the appropriate allocations of OTC-derivative positions and related collateral in bankruptcy proceedings when such positions and collateral falling into different account classes are pooled together.

The MFA applauded these changes, stating that the new classification and mandatory allocation system will mitigate risk for customers and provide market stability by ensuring the continuing flow of capital. Also, the group explained, central clearing of OTC-derivatives positions reduces counterparty exposure and provides certainty of financial protection for clearing customers.

However, the MFA cautioned, the CFTC should consider additional measures to mitigate risk regarding positions involving OTC derivatives by including bankruptcy protections for both cleared and non-cleared OTC derivatives. According to the group, this broader action would encourage enhanced stability for customers and would benefit the industry as a whole by applying a consistent approach without regard to the possible involvement of a central counterparty.