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The Voice of the Global Alternative Investment Industry 'I~ Y {) 1 

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Via Electronic Mail: secretary@cftc.gov 

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rn~ David A. Stawick 

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U.S. Commodity Futures Trading Commission 

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Re: Proposed Rulemaking (RIN 3038-AC82) to Create a Separate Account Class for 

Customer Positions in Cleared OTC Derivatives 

Dear Mr. Stawick: 

Managed Funds Association ("MFA") 1 appreciates the opportunity to comment on the U.S. 

Commodity Futures Trading Commission's (the "Commission" or "CFTC") proposed rulemaking 

issued on August 13, 2009 (RIN 3038-AC82) (the "Proposal"i to amend Part 190 of its regulations to: 

(1) create a sixth and separate "account class" for cleared over-the-counter ("OTC") derivatives, 

applicable in the case of a bankruptcy of a commodity broker that is a futures commission merchant 

("FCM"); and (2) codify the appropriate allocation of OTC derivatives positions and collateral during 

bankruptcy when positions and collateral of different account classes are pooled together pursuant to a 

Commission order. MFA applauds the Commission's efforts to provide necessary protection to 

customers of FCMs regarding the treatment of cleared OTC derivatives positions and collateral in the 

event of an FCM bankruptcy. MFA members are active participants in the OTC derivatives markets 

and are generally customers of commodity brokers that are FCMs. 

MFA strongly supports both parts of the Proposal. In particular, we believe the 

implementation of each part ofthe Proposal: (1) will significantly mitigate counterparty risks as 

between market participants and systemic risk to U.S. financial markets by providing clear bankruptcy 

protection when an FCM customer clears its OTC derivatives positions; (2) is necessary to ensure 

broad market support of customer clearing initiatives in light of alleged uncertainty; and (3) is 

consistent with current policy objectives and some legislative proposals that include measures to 

protect customer positions and collateral in the context of central clearing. In addition, we also ask the 

Commission to consider additional measures that are not contemplated by the Proposal, which will 

further mitigate counterparty and systemic risks. We elaborate on each of these points in Section II of 

this letter. 

1 MFA is the voice of the global alternative investment industry. Our members include professionals in hedge 

funds, fund of funds and managed futures funds. Established in 1991, MFA is the primary source of information 

for policy makers and the media and the leading advocate for sound business practices and industry growth. 

MFA members represent the vast majority of the largest hedge fund groups in the world that manage a 

substantial portion of the approximately $1.5 trillion invested in absolute return strategies. MFA is headquartered 

in Washington D.C. with an office in New York, NY. 

2 74 FR 40794 (August 13, 2009) (the "Proposal"). 

2025 M Street, NW, Suire 610 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.managedfunds.org 

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Mr. Stawick 

September 14, 2009 

Page 2 of9 

I. Background 

The Proposal seeks to amend Part 190 of the CFfC Regulations in two important respects in 

the case of a bankruptcy of a commodity broker that is an FCM? Immediately below, we describe the 

concept of an account class, followed by a summary of each part of the Proposal. 

1. Account Class Designation Provides Bankruptcy Protection. 

Under Section 20 of the Commodity Exchange Act (the "CEA'~) , the Commission has the 

power to define the amount of a customer's claim (also referred to as "net equity" under the CEA and 

the Bankruptcy Code) against a commodity broker in bankruptcy and to prescribe by regulation the 

procedures for determining such amount. Section 761(17) of the Bankruptcy Code5 also provides the 

Commission with the power to prescribe those procedures. In furtherance ofthese powers, the 

Commission has established: the concept of an account class; procedures outlining the types of 

commodity contracts that fall within a certain account class; and how FCMs and Derivatives Clearing 

Organizations ("DCOs") should manage accounts. 

CFTC Regulation 190.01(a) currently sets forth five separate account classes-(1) domestic 

futures accounts; (2) foreign futures accounts; (3) leverage accounts; (4) commodity option accounts; 

and (5) delivery accounts-to ensure that, in the bankruptcy of a commodity broker that is an FCM, 

customers who hold positions in different types of commodity contracts are afforded certain 

protections based on the underlying characteristics of those contracts. The concept of an account class 

is included in the definition of net equity under section 20 of the CEA and section 7 61 ( 17) of the 

Bankruptcy Code. In the event of an FCM bankruptcy, a bankruptcy trustee calculates and generates 

the total amount that each FCM customer is entitled to recover based on the account class or classes in 

which all money, securities and/or other property are held on behalf of such customer (i.e., an FCM 

customer's net equity). If an FCM customer's positions and collateral are not held in such an 

account-which is current industry practice with respect to OTC derivatives-the FCM customer 

would become an unsecured creditor of a bankrupt FCM. 

Depending on the account class, an FCM or DCO will have to comply with differing levels of 

segregation requirements with respect to a customer's positions and any related collateral. CFfC 

Regulations 1.20 through 1.30 provide the strongest protections to positions (and any related 

collateral) that are held in a domestic futures account. An FCM or DCO must segregate customer 

3 /d. at 40796. 

4 7 u.s.c. 24. 

5 11 U.S.C. 761(17). Section 761(17) of the Bankruptcy Code specifically defines "net equity" as, "subject to 

such rules and regulations as the Commission promulgates under the [CEA], with respect to the aggregate of all 

of a customer's accounts that such customer has in the same capacity- (A) the balance remaining in such 

customer's accounts immediately after- (i) all commodity contracts of such customer have been transferred, 

liquidated, or become identified for delivery; and (ii) all obligations of such customer in such capacity to the 

debtor have been offset; plus (B) the value, as of the date of return under section 766 of [the Bankruptcy Code], 

of any specifically identifiable customer property actually returned to such customer before the date specified in 

subparagraph (A) of this paragraph; plus (C) the value, as of the date of transfer, of- (i) any commodity contract 

to which such customer is entitled that is transferred to another person under section 766 of [the Bankruptcy 

Code]; and (ii) any cash, security, or other property of such customer transferred to such other person under 

section 766 of this title to margin or secure such transferred commodity contract." (Emphasis added.) 

2025 M Street, NW, Suite 6!0 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.managedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 3 of9 

positions and collateral into separate accounts under these regulations, unless the Commission issues 

an order pursuant to Section 4d of the CEA, permitting the FCM or DCO to commingle those 

accounts.6 

2. First Part of the Proposal: Proposed Amendments to Include "Cleared OTC Derivatives" 

as a Separate Account Class. 

The first part of the Proposal seeks to make three amendments to Part 190 of the CFTC 

Regulations in the case where positions and collateral in different account classes are not commingled. 

The first amendment would create a sixth and separate account class for "cleared OTC derivatives" 

positions and collateral under CFTC Regulation 190.01(a). 

The second amendment would define "cleared OTC derivatives" in CFTC Regulation 190.01 

by incorporating the term "cleared-only contracts" from the Commission's "Interpretative Statement 

Regarding Funds Related to Cleared-Only Contracts Determined to Be Included in a Customer's Net 

Equity," dated September 28, 2008 (the "Statement on Cleared OTC Derivatives").7 By incorporating 

this term, the Commission is seeking to limit the term cleared OTC derivatives to only those positions 

and collateral that "are required to have been (i) segregated in accordance with a rule, regulation, or 

order issued by the Commission, or (ii) held in a separate account for 'cleared-only contracts' in 

accordance with the rules or bylaws of a DC0."8 

The third amendment to Part 190 of the CFTC Regulations would make certain conforming 

changes. In particular, this amendment would: (a) incorporate the new cleared OTC derivatives 

account class into the procedures for calculating a customer's net equity in the bankruptcy of an FCM 

under CFTC Regulation 190.07(b)(2)(viii); and (b) add the new account class to certain bankruptcy 

claim forms. 

Prior to the release of the Proposal, some market professionals questioned whether, in the 

absence of a Commission order or rule, OTC derivatives positions and collateral would fall within the 

domestic futures account class or any of the other account classes (i.e., would constitute a "commodity 

contract"), thereby providing those positions and collateral with certain protections in the bankruptcy 

of an FCM.9 The Commission states that the first part of the Proposal would make it clear that those 

positions and collateral (held separate from other positions) are afforded bankruptcy protection. 

6 7 u.s. c. 6d. 

7 See 73 FR 65514, 65515 (November 4, 2008). 

8 See 74 FRat 40796. 

9 See pages 34-5 of the "Report to the Supervisors of the Major OTC Derivatives Dealers on the Proposals of 

Centralized CDS Clearing Solutions for the Segregation and Portability of Customers CDS Positions and Related 

Margin" dated June 30, 2009 (the "Customer Access Report"), which provides there is uncertainty as to the 

proposition that cleared OTC derivatives contracts constitute "commodity contracts", thereby receiving account 

class protections under the CEA and the Bankruptcy Code. The Customer Access Report is publicly available 

at: http://www.newyorkfed.org/newsevents/news/markets/2009/an090713.html. 

2025 M Srreer, NW, Suire 6!0 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2!40 I www.managedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 4 of9 

3. Second Part of the Proposal: Proposed Amendment to Codify Appropriate Allocation of 

Collateral to Certain Account Classes When Positions Are Commingled. 

The second part of the Proposal intends to codify the appropriate allocation of positions and 

related collateral during the bankruptcy of an FCM when those positions and collateral are 

commingled or otherwise pooled together pursuant to a Commission order under Section 4d of the 

CEA. 10 A Section 4d order permits an FCM or DCO to commingle positions and collateral of one 

account class with positions and collateral of the domestic futures account class. 11 If the Commission 

issues a Section 4d order, CFTC Regulation 190.01(a) provides that those commingled positions are 

treated as being held in the domestic futures account class. As a result, FCMs or DCOs who 

commingle commodity options positions with domestic futures positions in one account are required 

to implement the most stringent protections under CFTC Regulation section 1.20 through 1.30 for all 

customer positions and related collateral. 

In the Proposal, the Commission also notes that some have questioned the certainty regarding 

whether cleared OTC derivatives positions that are commingled with domestic futures positions would 

be afforded the same bankruptcy protections of the latter. The Proposal cites to two of its previous 

interpretations in support of this treatment. The Commission issued its first interpretation on October 

21, 2004 regarding the commingling of positions in the foreign futures accounts class with positions in 

the domestic futures account class ("Statement on Commingling Foreign Futures Positions"). 12 In the 

Statement on Commingling Foreign Futures Positions, the Commission stated that "collateral 

supporting foreign futures placed in [an account with] domestic [futures] segregation pursuant to a 

Commission Order should be treated as in a futures account, not a foreign futures account, for 

purposes of Part 190." 13 The Commission subsequently issued the Statement on Cleared OTC 

Derivatives, which extended the conclusion reached in the Statement on Commingling Foreign 

Futures Positions to cover cleared OTC derivatives that are commingled with positions relating to 

commodity contracts of the domestic futures account class. Notwithstanding the release of the 

Statement on Cleared OTC Derivatives, some argue that ambiguity continues to exist as to the legal 

effect of these interpretations on cleared OTC derivative positions. 

Through the release of the Proposal, the Commission now seeks to "codify explicitly, in 

Regulation 190.01(a), a generalized version of the Statement on Commingling Foreign Futures 

Positions and the Statement on Cleared OTC Derivatives."14 The Commission intends for the second 

part of the Proposal to remove doubts as to whether cleared OTC derivatives positions can be afforded 

the highest bankruptcy protections (i.e., the protections under CFTC Regulation 1.20 through 1.30) 

when those positions are commingled with domestic futures account positions pursuant to a Section 4d 

order. 

10 See 74 FRat 40797. 

11 7 u.s.c. 6d. 

12 See 69 FR 69510 (November 30, 2004). 

13 /d. at 69511. The Commission also noted in the Statement on Commingling Foreign Futures Positions that it 

would accord similar treatment to other positions that were commingled with domestic futures accounts. 

14/d. 

2025 M Street, NW, Suire 610 I Washingron, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.managedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 5 of9 

II. Discussion 

As mentioned above, MFA strongly supports both parts of the Proposal. Specifically, we 

believe the implementation of each part ofthe Proposal: (1) will significantly mitigate counterparty 

risks as between market participants and systemic risk to U.S. financial markets; (2) is necessary to 

ensure broad market support of customer clearing initiatives; and (3) is consistent with current policy 

objectives and some legislative proposals. Lastly, in Sub-section 4 below, we raise an important issue, 

which is not addressed in the Proposal, but that we believe the Commission should consider with 

respect to non-cleared OTC derivatives. 

1. The Proposal Would Significantly Mitigate Counterparty Risk and Systemic Risk. 

We believe that both parts of the Proposal would significantly mitigate counterparty risk and 

systemic risk in the context of the OTC derivatives market. As noted above, some market 

professionals have questioned whether cleared OTC derivatives positions and collateral would be 

considered a commodity contract that falls within any of the five account classes under the CEA and 

Bankruptcy Code in the absence of a Commission order or rule. The first part of the proposal would 

enact such a rule pursuant to the Commission's authority under the CEA and Bankruptcy Code. As a 

result, cleared OTC derivatives (which are required to be segregated) would be included within the 

definition of net equity and FCM customers would thereby receive the minimum protections afforded 

to commodity contracts in other account classes. 

The second part of the Proposal would provide even greater protections to those FCM 

customers. Specifically, FCM customers' cleared OTC derivatives positions and collateral would 

benefit from the strongest protections under CFTC Regulations 1.20 through 1.30 following the 

Commission's issuance of a Section 4d order. Thus, a customer's cleared OTC derivatives would be 

treated like domestic futures positions once both positions are commingled pursuant to such an order. 

By issuing both parts of the Proposal pursuant to its authority under the CEA and Bankruptcy 

Code, the Commission would mitigate counterparty and systemic risks that were seen during the most 

recent financial crisis. In a letter to the Commission, the Federal Reserve Bank of New York and the 

U.S. Securities and Exchange Commission dated December 23, 2008, MFA explained how these risks 

arise in the context of OTC derivatives trading between the major OTC derivatives dealers (the "Major 

Dealers") and their non-dealer counterparties, which include MFA's members. 15 

As is described more fully in MFA's letter, when entering into an OTC derivatives contract 

with non-dealers, the Major Dealers require their counterparties to post upfront collateral (also known 

as "initial margin") to cushion against default risk. The Major Dealers do not typically segregate initial 

margin posted by their counterparties from other unsecured assets. When a Major Dealer becomes 

insolvent, initial margin posted by a counterparty is treated in bankruptcy as a general unsecured claim 

of that counterparty. As a result, counterparties to the Major Dealers stand to incur significant losses, 

regardless of the current value of their OTC derivatives contracts. When the creditworthiness of a 

Major Dealer appears to be diminishing, certain counterparties will seek to protect the assets of their 

investors and minimize their losses by purchasing credit default swap ("CDS") protection, shorting 

15 See Letter from Richard H. Baker (President and C.E.O., Managed Funds Association) dated December 23, 

2008 to Timothy F. Geithner (President) the Federal Reserve Bank of New York; The Honorable Christopher 

Cox (Chairman) U.S. Securities and Exchange Commission; and The Honorable Walter Lukken (Acting 

Chairman) U.S. Commodity Futures Trading Commission. A copy of this letter is attached. 

2025 M Street, NW, Suite 610 I Washington, DC 20036 I 202.367.1140 I fax 202.367.2140 I www.managedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 6 of9 

equity, and, if the Major Dealer is their prime broker, transferring assets held at that Major Dealer to 

another prime broker. Each of these factors may contribute to market instability and uncertainty at the 

point when the markets are most volatile. 

Additionally, if a Major Dealer files for bankruptcy, its counterparties must cover their losses 

arising from the loss of initial margin held at the Major Dealer. These counterparties may be forced to 

sell unrelated assets, which may further contribute to market instability. 

A good example of this uncertainty and its affects on the global economy was seen in the 

bankruptcy of Lehman Brothers Holdings, Inc. ("LBHI"). LBHI traded OTC derivatives through one 

of its affiliates. LBHI' s failure triggered the unwinding of a significant percentage of the CDS and 

other OTC derivatives positions held by LBHI' s derivatives affiliate. The majority of the affiliate's 

customer assets were not segregated. Once LBHI was placed into bankruptcy, its customers became 

general unsecured creditors, freezing up several billions of dollars of its customers' investment capital. 

Since LBHI and the Major Dealers were highly interconnected to each other through their exposures to 

one another, LBHI' s failure resulted in market concerns about the viability of other Major Dealers. 

These concerns ultimately caused significant volatility in global capital markets when many market 

participants simultaneously begun selling assets to cover their losses. 

Ultimately, we support both parts of the Proposal because we believe they would help reduce 

counterparty risks associated with cleared OTC derivatives positions and all related collateral (not for 

just initial margin, and regardless of whether those positions and collateral are segregated or 

commingled) in the event of the bankruptcy of an FCM. In addition, by providing protections to 

customers in the event of an FCM failure, the Proposal would help promote broader market stability 

by allowing capital to continue to flow freely regardless of such a failure. 

2. The Proposal Is Necessary to Ensure Broad Market Support of Customer Clearing 

Initiatives. 

MFA also strongly supports both parts of the Proposal because each would provide necessary 

protections to FCM customers, which to date, have been discouraged from centrally clearing their 

OTC derivatives positions as a result of the uncertainty surrounding the protection that would be 

afforded to those positions. MFA members and other FCM customers are supportive of, and extremely 

interested in, centrally clearing their OTC derivatives positions because of the benefits central clearing 

would provide to them in terms of reducing counterparty exposure. To date, however, some market 

professionals have expressed concern regarding whether central clearing through use of an FCM 

would actually reduce counterparty exposure in the absence of a Commission order or rule providing 

bankruptcy protection to FCM customer positions and collateral. In addition, some central 

counterparty offerings, which operate outside of the commodity futures regulatory framework, do not 

provide any bankruptcy protection to customers of clearing members with respect to their positions 

and collateral. 16 Many market observers have asserted that, without certainty regarding such protection 

when centrally clearing under any regulatory framework, counterparty exposure would continue to 

present a problem for customers. 17 

16 See pages 1-31 of the Customer Access Report. 

17 See id. 

2025 M Street, NW, Suite 610 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.managedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 7 of9 

Again, we believe that the two parts of the Proposal would provide certainty to MFA members 

and other FCM customers with respect to the protection afforded to their cleared OTC derivatives 

positions under the CEA and the Bankruptcy Code regardless of whether an FCM segregates those 

positions or commingles them with positions in other accounts classes. While we completely agree 

with the Commission that its prior interpretations were clear on this issue18, we believe that the two 

parts of the Proposal will make certain that a bankruptcy trustee includes such positions and collateral 

in its calculation of net equity, regardless of whether those positions are segregated or commingled. 

We recognize that policy makers and regulators are proposing a regulatory regime under 

which large volumes of OTC derivatives are centrally cleared. 19 In addition, a number of central 

clearing offerings have begun to central clear inter-dealer OTC contracts, with a 2009 year-end goal to 

expand those offerings to customers.20 In MFA's view, the Commission's issuance of the Proposal is 

an important and necessary first step in encouraging all market participants to centrally clear their 

positions, which ultimately will result in the central clearing of a significant number of OTC 

derivatives positions. 

3. The Proposal Is Consistent with Current Policy Objectives and Legislative Proposals. 

MFA believes that the Commission's actions are consistent, in part, with sweeping legislative 

reform proposals that are currently under review by Congress with respect to the OTC derivatives 

market. All of these proposals seek to promote stability in the OTC derivatives market through the 

enhancement of market transparency and strengthening of market infrastructure. Some proposals even 

include measures to provide protections to customer OTC derivatives positions and related collateral. 

For example, on August 11, the Obama Administration released a comprehensive legislative proposal 

to regulate the OTC derivatives market.21 The Administration's proposal includes a measure requiring 

central counterparties to develop risk control mechanisms that protect customer positions and related 

collateral in the event a clearing member default. 

In addition to the introduction of several legislative proposals, Congress has held several 

hearings on OTC derivatives regulatory reform, during which protection of customer positions and 

related collateral were discussed. At one such hearing before the House Financial Services Committee 

on July 22, Commission Chairman Gary Gensler asserted that a comprehensive regulatory framework 

governing OTC derivatives dealers and the OTC derivatives market should include safeguards for 

customer positions and collateral.22 In particular, Chairman Gensler stated that "Congress should also 

18 See 73 FRat 65514; see also 69 FRat 69510. 

19 See the Obama Administration's legislative proposal, which is available at: 

www.financialstability.gov/docs/regulatorvreform/titleVII.pdf. See also House Chairmen Barney Frank and 

Collin Peterson's outline, which is available at: 

www.house.gov/appsnist/presslfinancialsvcs dem/otc principles final 7-30.pdf. 

20 See Letter from market participants to William Dudley, President of the Federal Reserve Bank of New York, 

June 2, 2009. A copy of this letter is available at: www.newyorkfed.org/newsevents/news/markets/2009/ma090602.html. 

21 See the Obama Administration's legislative proposal. 

22 CFTC Chairman Gensler's written statement is available at: 

www.house.gov/apps/list/hearing/financialsvcs dem/gensler - testimony before house financial services 7-

22-09 final.pdf 

2025 M Street, NW, Suite 610 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.rnanagedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 8 of9 

consider explicitly authorizing regulators to require derivatives dealers and counterparties to segregate, 

or set aside, from their own funds, the margin required." 

Lastly, MFA acknowledges and applauds Chairman Gensler's Letter to Congressional leaders 

dated August 17, 2009, in which he comments on the Administration's legislative proposal. 23 In 

Chairman Gensler's letter, he requests, among other things, the imposition of a mandatory set-aside 

requirement with respect to collateral received by OTC derivatives dealers on all OTC derivatives, 

including those transactions that are not centrally cleared. MFA firmly supports Chairman Gensler's 

statements before Congress and in his letter on this specific issue, as well as any measures in 

legislative proposals that provide protections to customer positions and related collateral across all 

OTC derivatives transactions, irrespective of whether those transactions are centrally cleared. 

4. Important Consideration: Protections for Non-Cleared OTC Derivatives. 

In addition to the Commission's issuance of the Proposal, we believe that the Commission 

should consider additional measures to promote broader market stability and to mitigate counterparty 

risk associated with OTC derivatives trading. That is, while MFA believes that protection of customer 

positions and collateral held by an FCM is absolutely crucial to the success of central clearing 

initiatives, we also believe that these protections should be implemented more broadly for all OTC 

derivatives, irrespective of the launch of any central counterparty. In particular, we ask that the 

Commission and other regulators work with Congress to provide bankruptcy protection to customer 

positions and collateral with respect to both cleared and non-cleared OTC derivatives. 

As noted above in the discussion on cleared positions, in his testimony before Congress on 

July 22 and in his letter to Congressional leaders, Chairman Gensler expressed his agreement with 

applying bankruptcy protection to non-cleared positions. In particular, at the hearing, Chairman 

Gensler stated, 

Congress should consider amending the Bankruptcy Code to ensure that, if 

a derivatives dealer or counterparty of a customized OTC transaction that is 

not cleared becomes insolvent, either party can make themselves whole by 

accessing margin, and can continue economic activity without major 

disruption by moving positions to another derivatives dealer. 

We applaud Chairman Gensler's recommendation to Congressional leaders and the proposed statutory 

language that he included in his letter, which would in effect legislate a set aside requirement for all 

customer OTC derivatives positions and collateral.24 

MFA has consistently advocated for the protection of customer collateral in all OTC 

derivatives trading. As mentioned above, MFA submitted a letter on December 23, 2008 to the 

Commission and other regulators, emphasizing the importance of providing adequate bankruptcy 

protection and safeguards to customer OTC derivatives collateral within a central clearing regime and 

in bilaterally negotiated OTC derivatives contracts. 

23 See page 3 of the Letter from CFTC Chairman Gary Gensler dated August 17, 2009 to the Honorable Tom 

Harkin (Chairman, Committee on Agriculture, Nutrition, and Forestry, U.S. Senate) and the Honorable Saxby 

Chambliss (Ranking Member, Committee on Agriculture, Nutrition, and Forestry, U.S. Senate). 

24 See Attachment B to Chairman Gensler's letter. 

2025 M Street, NW, Suite 610 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.managedfunds.org 
Mr. Stawick 

September 14, 2009 

Page 9 of9 

III. Conclusion 

MFA appreciates the opportunity to provide its views on the Proposal. MFA believes that the 

proposed changes to Part 190 of the CFTC Regulations would promote broader market stability and 

mitigate counterparty risk, as well as help ensure the success of OTC derivatives clearing initiatives. 

We would be pleased to meet with CFTC staff to further discuss our comments in greater detail. If the 

staff has comments or questions, please do not hesitate to contact Jennifer Han, Carl Kennedy or me at 

(202) 367-1140. 

CC: The Hon. Gary Gensler, Chairman 

Respectfully submitted, 

\s\ Stuart J. Kaswell 

Stuart J. Kaswell 

Executive Vice President and Managing Director, 

General Counsel 

The Hon. Michael Dunn, Commissioner 

The Hon. Walter Lukken, Commissioner 

The Hon. Jill E. Sommers, Commissioner 

The Hon. Bart Chilton, Commissioner 

Attachment 

2025 M Street, NW, Suite 610 I Washington, DC 20036 I 202.367.1140 I Fax 202.367.2140 I www.managedfunds.org 
MANAGED FUNDS ASSOCIATION 

The Voice of the Global Alternative l.nvestment Industry 

WASHIKGTON. DC I NE\i:'YORK 

President Timothy F. Geithner 

President 

Federal Reserve Bank of New York 

33 Liberty Street, lOF 

New York, NY I 0045 

December 23, 2008 

The Honorable Christopher Cox 

Chairman 

U.S. Securities and Exchange Commission 

100 F Street, N.E. 

Washington, D.C. 20549 

Dear President Geithner, Chairman Cox and Chairman Lukken: 

The Honorable Walter Lukken 

Acting Chairman 

U.S. Commodity Futures Trading 

Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington D.C. 20581 

Recently, Managed Funds Association ("MFA") 1 and its members met with the Federal Reserve Bank of 

New York (the "NYFRB") to discuss and provide comments regarding the state of the credit default swap 

("CDS") market, including our feedback on current proposals to establish a central clearing counterparty 

for the CDS market. As part of our ongoing commitment to proactively work with regulators on topics 

that pose significant market or systemic risk concerns, we wish to direct your attention to the protection 

and safeguarding of customers' initial margin that they deposit with dealer financial institutions in 

connection with the trading of all over-the-counter ("OTC") derivatives. 

Effects of Current Collateral Management Practices 

By way of background, the default of Lehman Brothers, a major OTC derivatives counterparty, and the 

resulting market concerns about the viability of other major dealers, has caused significant volatility in the 

capital markets. These concerns demonstrate that current mechanisms for collateral management, outside 

of the context of broker-dealer accounts covered by Exchange Act Rule I 5c3-3, do not adequately protect 

the pledgors of collateral and can contribute to systemic risk in several important respects: 

• The purpose of initial margin is to provide dealers with a cushion against the potential counterparty 

risk they assume when entering into an OTC derivatives contract with a customer. However, since 

such margin is not typically segregated from the dealers' other unsecured assets, what is supposed to 

be a credit mitigant for the dealer instead subjects the customer to actual credit risk on the posted 

amounts. 

• If a dealer becomes insolvent, initial margin posted by customers that is not so segregated is treated in 

bankruptcy as a general unsecured claim of the customer. As a result, customers who are 

counterparties to that dealer stand to incur significant losses, regardless of the current value of their 

derivatives contracts. 

1 MFA is the voice of the global alternative investment industry. Its members are professionals in hedge funds, 

funds of funds and managed futures funds, as well as industry service providers. Established in 1991, MFA is the 

primary source of information for policy makers and the media and the leading advocate for sound business 

practices and industry growth. MFA members include the vast majority of the largest hedge fund groups in the 

world who manage a substantial portion of the approximately $1.5 trillion invested in absolute return strategies. 

MFA is headquartered in Washington, D.C., with an office in New York. For more information, please visit: 

www. managedfunds.org. 

2025 M Street, NW, Suite 610 I Washington, DC 20036 I 202.367. I 140 I Fox 202.367.2140 I www.managedfunds.org 
Mr. Geithner, Mr. Cox and Mr. Lukken 

December 19, 2008 

Page 2 of 3 

• Investment managers have fiduciary duties to their investors. When a dealer experiences difficulties, 

the risk to initial margin may cause managers to seek to hedge counterparty exposure to such dealer 

(either through the CDS market or by trying to close-out or assign derivatives trades away from such 

dealer). These hedging actions can have a further destabilizing impact on such dealer and the market 

generally, thereby increasing systemic risk. 

• In addition, given that dealers are able to freely use posted collateral, they have come to rely on initial 

margin, a fluctuating source of cash, to fund their business activities. As trades are closed-out or 

assigned, dealers are required to return initial margin to their customers. The return of margin 

constricts dealers' liquidity and, as recent events demonstrate, the inability of the dealers to access 

cash has potentially severe market consequences. 

We highlight that the aforementioned counterparty risks related to customer initial margin have been 

greatly exacerbated over the last few months as dealers as a whole have significantly increased their 

demands for initial margin. These risks are in tum further compounded by the general weakening of the 

financial sector as a whole. 

Enhanced Customer Segregated Accounts 

As you are aware, the segregation of initial margin is a key component of the central clearing party 

initiatives for the CDS market, and we understand that the NYFRB, SEC and CFfC have stipulated this 

condition to be a prerequisite for regulatory approval. We agree that segregation of initial margin is 

crucial to the success of these clearing initiatives, but also believe that the protection of customer initial 

margin should be implemented more broadly for all OTC derivatives, irrespective of the launch of any 

CDS central counterparty because it is critical in order to promote broader market stability and to mitigate 

counterparty risk. Protection of customer initial margin with respect to all bilaterally negotiated OTC 

derivatives could be incorporated into the existing transaction structure through dealer use of a segregated 

account, in the name of, and held for the benefit of, the customer (e.g., at a U.S. depository institution or a 

regulated U.S. broker-dealer), whereby the dealer would not be permitted to rehypothecate the initial 

margin held in such an account. This would promote broader market stability and mitigate counterparty 

risk. 

Given that dealers will be required to provide initial margin segregation as part of the clearing initiatives, 

they should be capable of offering this to customers on a broader basis. However, to date the dealer 

community, as a whole, has been resistant to such efforts by MFA's members and other investment 

managers. 

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2025 :VI Sm•.:r, NW, Suire 610 Wa.,hi n~rnn. DC 20036 I 202.3(>7. I 140 I Fax 202.3(>7. 2140 I www.managedfunds.org 
Mr. Geithner, Mr. Cox and Mr. Lukken 

December 19, 2008 

Page 3 of 3 

We recognize the efforts of regulators to collaborate on mitigating risk and promoting market stability. We 

appreciate the constructive working relationship fostered by each of you as well as the opportunity to share the 

views of our members on this important topic. We welcome the opportunity to discuss this issue further with 

each of your staffs. If we can provide further information on this topic, or be of further assistance, please do not 

hesitate to contact us at (202) 367-1140. 

Yours Sincerely, 

Richard H. Baker 

President and Chief Executive Officer 

cc: The Honorable Ben Bemanke, Chairman, Board of Governors of the Federal Reserve System 

Patrick M. Parkinson, Deputy Director, Division of Research and Statistics, Board of the Federal 

Reserve System 

Ananda Radhakrishnan, Director, Division of Clearing and Intermediary Oversight, Commodity Futures 

Trading Commission 

Theodore Lubke, Senior Vice President, Bank Supervision Group, Federal Reserve Bank of New York 

Erik R. Sirri, Director, Division of Trading and Markets, U.S. Securities and Exchange Commission 

2025 M Srreer, NW, Suire(, I 0 I Washing""'· DC 20036 I 202.367.1140 I bx 202 . .1(>7.2140 I www.managedfnnds.org