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Part 22/LSOCPrinciples and ImplementationLCH.Clearnet Limited on behal o SwapClear

Bud Novin & Nathan Ondyak11/9/2012

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Summary

LCH.Clearnet Limiteds (LCH.Clearnet) SwapClear1 service intends to

support LSOC Without Excess, beginning November 13, 2012, ahead o theregulatory compliance deadline o November 14, 2012. SwapClear plans to

oer LSOC With Excess in Q1 2013, although a specic date has not beendecided. This document details the LSOC Without Excess model, as well as

the LSOC With Excess model, that SwapClear is building.

(Please note that this document includes LCH.Clearnets current intentionswith respect to the planned implementation o CFTC regulation Part 22 or the

SwapClear clearing service, but does not necessarily represent the views orimplementation plans or the other clearing services o LCH.Clearnet.)

SwapClears LSOC Without Excess model will not require LSOC reportingor any certication rom FCMs. And the development required o FCMs toadhere to this model will be what is already required or all LSOC models at

any CCP: the ability to perorm the LSOC Compliance Calculation describedin General LSOC Principles below. For LSOC With Excess, the undamental

distinction will be the requirement or FCMs to provide LCH.Clearnet witha daily report that allocates the value o collateral at the DCO to individual

customers. This change, however, will be implemented only in Q1 2013.

1. It is expected that the LSOC models described herein are identical to the models also to be adopted byLCH.Clearnet LLCs SwapClear US service in Q4 2012.

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Contents

Summary 2

Contents 3

Disclaimer 4

Background 5DCO Deault Waterall Under Both Models 5

The Value o Collateral That Is Protected 6

General LSOC Principles 8Initial Margin Must Be Legally Segregated 8

The LSOC Segregation Calculation 8Unallocated Excess 9

Variation Margin Is Not Required to Be Segregated 10Legal Segregation at the DCO Is Based on Post-Haircut Value 11

The FCMs Buer May Be Commingled With Customer Funds 12Post FCM Deault Portability 12

Part 22 Does Not Remove Pro-Rata Loss Sharing 13

LSOC Without Excess 15Establishing a Customers Legally Segregated Value (LSV) 15The Treatment o Excess in LSOC Without Excess 16

FCM Lodged Excess 17

Margining 18Summary o the SwapClear Model 18Intraday Excess Return 21

LSOC With Excess 22

Establishing a Customers Legally Segregated Value 22The Collateral Value Report 22

Delivery and Removal o Excess Collateral 24Margining 25

Summary o the SwapClear Model 26

Appendix 1. Deault Scenario: Gross Omnibus Model vs. LSOC 30

Appendix 2. LSOC Segregation Calculation 33

Appendix 3. Attribution o a Net Variation Margin Loss 35

Appendix 4. Post-FCM Deault Timeline 37

Appendix 5. Allocation o Called Margin 38

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Disclaimer

The contents o this paper do not, and do not seek to, constitute advice o any

nature. In particular, nothing in this document constitutes legal advice. Thecontents o this paper are based on LCH.Clearnet Limiteds interpretation o

various statutes, including the Commodity Exchange Act and CFTC regulationPart 22. This interpretation should not be relied upon and readers should always

take their own legal advice. There is no substitute or analyzing the rules andregulations o LCH.Clearnet Limited. This paper should not be construed as a

commitment by LCH.Clearnet Limited to oer any particular product or service.This paper merely describes LCH.Clearnets intentions at the date hereo, which

are subject to change.

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Background

Segregation o customer assets in the existing U.S. utures model is

governed by CFTC regulation 1.20, or what is commonly known as thegross omnibus account structure. Under gross omnibus, the positions and

collateral o one customer are legally and operationally segregated rom theassets o the FCM, but are legally and operationally commingled with the

assets o other customers o the FCM in the same omnibus client account.

In the event o a deault under gross omnibus, the assets in the FCMs houseaccount may be used by the DCO in order to meet the obligations o the

FCMs client account, but the assets in the client account cannot be usedby the DCO to meet the obligations o the FCMs house positions. However,

the DCO may utilize all assets in the omnibus client account to meet the

obligations o any client o the FCM. As a result, in the event that a clientsloss exceeds its available collateral, other clients may suer losses. Thisdynamic is commonly reerred to as ellow customer risk.

The introduction o a Legally Segregated Operationally Commingled, or

LSOC, model is designed to protect customers rom this risk. The rulescovered in Part 22 o CFTC regulations (LSOC rules) restrict DCOs and

FCMs rom utilizing the assets o one customer to meet the obligationso another. In addition to the protections provided by CFTC regulation

1.20, LSOC requires the DCO to legally segregate the value o collateralassociated with each individual customer, while allowing or a DCO to hold

the collateral o all customers in an operationally commingled account.

CFTC regulation 22.15, Treatment o Cleared Swaps Customer Collateralon an Individual Basis, specically states that:

[E]ach derivatives clearing organization . . . receiving Cleared SwapsCustomer Collateral rom a utures commission merchant shall treatthe value o collateral required with respect to the portolio o rights

and obligations arising out o the Cleared Swaps intermediated or eachCleared Swaps Customer . . . as belonging to such customer, and such

amount shall not be used to margin, guarantee, or secure the ClearedSwaps or other obligations o the utures commission merchant or o any

other Cleared Swaps Customer or Customer.

To understand the new protections granted via LSOC, it is helpul to walkthrough a deault scenario under both the gross omnibus and LSOC

segregation models. For a detailed example, please reer to Appendix 1.

DCO Deault Waterall Under Both Models

The primary dierence between the gross omnibus and LSOC models is

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evidenced by the DCO deault waterall. The gross omnibus deault waterall

utilized to cover the losses o any customer contains the initial margin o allellow customers o the FCM. In practice, this means that i a loss associated

with an individual client is large enough to deplete (1) the individualclients initial margin and (2) the deaulting FCMs initial margin and (3) the

deaulting FCMs deault und contribution, then any additional loss will besatised with the collateral o the other clients o the deaulting FCM. LSOC

is designed to remove this risk. Under LSOC, a clients collateral value at theDCO can be used only to cover losses relating to that clients own portolio.

A visual representation o each waterall can be ound in Exhibit 1 on theollowing page.

The Value o Collateral That Is Protected

CFTC regulation 22.15 grants protection or a customer o the value ocollateral associated with its portolio o swaps. Further, CFTC regulation

22.13, Additions to Cleared Swaps Customer Collateral, extends thisprotection to the value o excess collateral belonging to individual customers

i the DCO accepts excess customer collateral. Excess is allocated via adaily FCM report that stipulates the value o collateral that should be legally

segregated or each customer. CFTC regulation 22.13 states:

A utures commission merchant may transmit to a derivatives clearing

organization any collateral posted by a Cleared Swaps Customer in excesso the amount required by the derivatives clearing organization i: (1) therules o the derivatives clearing organization expressly permit the utures

commission merchant to transmit collateral in excess o the amountrequired by the derivatives clearing organization; and (2) the derivatives

clearing organization provides a mechanism by which the uturescommission merchant is able to, and maintains rules pursuant to which

the utures commission merchant is required to, identiy each BusinessDay, or each Cleared Swaps Customer, the amount o collateral posted in

excess o the amount required by the derivatives clearing organization.

Collateral reporting is not required i the DCO does not accept excesscustomer collateral. In a model where the DCO is not receiving collateral

value reporting rom the FCM, the value o segregated collateral o anindividual customer at the DCO will be dependent on a customers initial

margin requirement in accordance with regulation 22.15. The practicalimplementation o this will be reerred to as LSOC Without Excess and

will be described in detail in the section titled LSOC Without Excess. I anFCM is operating under the model where detailed collateral value reporting

is provided to the DCO, a customers legally segregated collateral value at

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the DCO, or a customers Legally Segregated Value (LSV), can include

both a customers required and excess collateral and will be dependent onthe reporting provided to the DCO by the FCM. As a result o collateral value

reporting, excess customer unds could be delivered to the DCO.Although the practical application o each model is dierent, there are

certain principles and rules that apply to both models. These commonprinciples are described in the ollowing section, General LSOC Principles.

Defaulting Members Initial Margin

Remaining Default Fund

Replenishment of Default Fund

Defaulting Members Default Fund Contribution

Margin Requirement of the Customer

LCH.Clearnets Capital & Reserves to 20mm

Defaulting Members Initial Margin

Legally Segregated Collateral of the Customer at the DCO

Remaining Default Fund

Replenishment of Default Fund

Service Closure

Defaulting Members Default Fund Contribution

LCH.Clearnets Capital & Reserves to 20mm

Default Waterfall for a Defaulting or Non-porting Customer in a Member Default

Gross Omnibus LSOC

Service Closure

Remaining Initial Margin of all Customers of Defaulting FCM

Exhibit 1

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Initial Margin Must Be Legally Segregated

The CFTC regulation Part 22 requires that Cleared Swaps Customer

Collateral be provided with legal segregation. Regulation 22.15,Treatment o Cleared Swaps Customer Collateral on an Individual Basis,

states that:

[E]ach derivatives clearing organization and each Collecting FuturesCommission Merchant receiving Cleared Swaps Customer Collateral rom autures commission merchant shall treat the value o collateral required with

respect to the portolio o rights and obligations arising out o the Cleared Swapsintermediated or each Cleared Swaps Customer . . . as belonging to such

customer, and such amount shall not be used to margin, guarantee or secure

the Cleared Swaps . . . o any other Cleared Swaps Customer.

This means that a DCO is prohibited rom using the Cleared Swaps

Customer Collateral o one customer to collateralize the risk o anothercustomer beore a deault or use the collateral o one customer to cover the

losses o another customer in the event o a deault. We expect interpretiveguidance rom the CFTC to state that Cleared Swaps Customer Collateral

is meant to reer only to assets delivered by a client as initial margin andvariation margin once it is actually paid to an FCMs account, thereore

excluding unsettled variation margin rom legal segregation.

This means that in a deault, the DCO is limited in the amount o collateralthat is available to it or covering losses arising rom the Cleared Swaps

Customer Account, but the only obligation that the DCO is exposed to is thenet variation margin obligation across all customers, as is the case in the

gross omnibus model. However, a DCO may elect to extend legal segregationto unpaid variation margin, in which case the DCO would be exposed to each

individual clients variation margin gains and losses with only that clientsindividual collateral value available to meet its obligations.

The LSOC Segregation Calculation

Under CFTC regulation Part 22, FCMs must ensure that their swapscustomers are always provided legal segregation o their collateral at

both the DCO and FCM. This requirement is apparent in CFTC regulation 22.2(d), Limitations o Use, which states that:

No utures commission merchant shall use, or permit the use o, the

Cleared Swaps Customer Collateral o one Cleared Swaps Customer topurchase, margin, or settle the Cleared Swaps . . . o, any person other

than such Cleared Swaps Customer.

General LSOC Principles

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As the rule does not allow or any period o time when individual treatment

may be orgone, in either model, it is the responsibility o the FCM to ensurethat the inormation that the DCO is relying upon is accurate. In order to

ensure compliance, to the extent that the collateral that a customer hasprovided to the FCM is less than the clients initial margin requirement, an

FCM must und the remaining required margin rom its own capital and notthe excess collateral o any other customer. A simple example is provided in

Appendix # 2.

Unallocated Excess

In order to ensure that customers are receiving the protections required

by LSOC, the FCM must always ensure that the DCO has an accurate andcurrent record o the allocation o customer unds in its possession. I the

DCO is unclear about the manner in which it should be segregating any othe value o customer collateral it holds, a DCO should not use this value

to margin any customer. It is critical that the DCO behaves in this way,otherwise FCMs will not be able to ensure compliance with their obligation

not to permit the use o the collateral o one customer to margin anothercustomer, as required by CFTC regulation 22.2.

I the DCO is not certain o the manner in which particular unds should be

segregated, those unds must be treated as Unallocated Excess. In the

event that a deault occurs while the DCO is holding Unallocated Excess,the DCO does not have the ability to rely on this value to meet any losses,and should instead return the Unallocated Excess to the Trustee. Just as

a DCO is unable to rely on Unallocated Excess in a deault, a DCO may notutilize Unallocated Excess to collateralize any customer. This is in line with

the DCOs obligation under CFTC regulation 22.15, Treatment o ClearedSwaps Customer Collateral on an Individual Basis, not to use the collateral

o one customer to margin, guarantee, or secure any other customer.

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Variation Margin Is Not Required to Be Segregated

CFTC regulation Part 22 indicates that the protection rom ellow customer

risk granted by LSOC applies to Swap Customer Collateral. Swap CustomerCollateral, as expected to be dened in interpretive guidance rom the

CFTC, includes any property in the customer account belonging to swapscustomers. Thereore, only once variation margin is paid to an FCMs

swaps customer collateral account will it receive the protections grantedunder LSOC. The CFTC has said that it will provide a written clarication onvariation margin as it relates to LSOC in advance o the implementation o

the LSOC Without Excess model.

Although Gross Margining has been mandated by the CFTC pursuant to

regulation 39.13(g)(8), this requirement applies only to initial margin.DCOs are still permitted to settle the variation margin gains and losses oan FCMs underlying customers on a net basis, beore and ater a deault.

Because o this, customers receive a similar protection o variation marginthat they have in the gross omnibus model. In the gross omnibus model,

i an FCM deaults on a variation margin call rom the DCO, the DCO isresponsible only or ullling the obligations o the FCM to the DCO (and

rom the DCO to the FCM). This obligation is the net variation margin o all oan FCMs underlying customers. (To understand how the DCO is permitted

to attribute a net variation margin loss across clients, in order to utilizecustomer collateral in the event o an FCM deault, please reer to Appendix

3.)

Thereore, customers with variation margin gains that contribute to a netvariation margin loss across all customers have no recourse to the DCO or

these gains. Instead, these customers maintain a claim over the estate otheir deaulted FCM which includes their variation margin gains rom the

margin run in which the FCM has deaulted up until the time at which acustomer is either transerred to another FCM or liquidated. This equates

to a minimum o two days and a maximum o eight days o mark to market(VM) gains. This is described in greater detail in Appendix 1.

The above description o a net variation margin settlement post deaultdescribes the minimum requirements under CFTC regulations. Regardlesso the minimum requirement, a DCO is able to elect to provide greater

protection o variation margin gains or customers o an FCM post deault.SwapClear intends to oer this additional protection to customers, where

in the event o a deault, SwapClear will transer a customer with 100% othat customers gains rom the margin run in which the FCM deaulted up

until the time at which the customer is transerred. This is limited only bythe deault resources available to the DCO. An example o this protection isound in Appendix 1.

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Please note that SwapClear is not able to pay customers or variation

margin gains that were settled between the FCM and DCO prior to an FCMsdeault, but were not paid to a customer. For these gains, a customer will

have a claim with the Trustee. The DCO has no visibility as to what has beensettled between the FCM and its customers. Once a margin settlement is

completed between the DCO and FCM, the DCO must assume that the FCMhas completed the settlement with its underlying customers. The DCO is

unable to manage risk on any other basis. Although a customer can limitthis risk by requesting the return o any VM gains it is owed on a daily basis,

there would be no way or the DCO to manage the risk o a customer who didnot request VM each day and was owed more than one day o VM gains at the

time o an FCM deault.

Legal Segregation at the DCO Is Based on Post-Haircut Value

As stated previously, the LSOC protection a customer is granted, at the

DCO in LSOC Without Excess, is based on the value o the initial marginrequirement associated with the customers portolio o rights and

obligations, as determined by the DCO. All collateral delivered to the DCOis valued on a post-haircut basis, regardless o whether it is required initial

margin or excess collateral. Thereore, the value that is segregated underLSOC or a customer at the DCO is based on the post-haircut value o a

customers collateral. The DCO does not have the inormation necessary to

grant legal segregation on any other basis.

I the haircuts applied by the DCO prove to be too liberal, and the proceeds

o collateral liquidation are less than the post-haircut value o the DCO, theDCO will ratably reduce the amount available to cover the losses o each

customer. Similarly, in the event that collateral is liquidated or more thanthe post-haircut value given by the DCO, the DCO is permitted to rely on this

additional value. However, the proceeds o the liquidation must be ratablydistributed to all customers and made available to the DCO on this basis or

meeting individual customer losses in a deault.

In either scenario, any improper distribution by the DCO will be correctedthrough the bankruptcy process. It is only where the DCO utilizes more

collateral than it should have or a customer, and where this value cannotbe recouped through the bankruptcy court, because that customer is itsel

bankrupt, that the risk o losses to non-deaulting customers exists as aresult o ellow customer collateral.

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The FCMs Buer May Be Commingled With Customer Funds

CFTC regulation 22.13, Additions to Cleared Swaps Customer Collateral,

allows or a portion o the customer collateral pool to be used to margin anycustomer. The rule states that:

[A]ny collateral deposited by a Futures Commission Merchant . . . which

collateral is identied as such utures commission merchants ownproperty may be used by the derivatives clearing organization . . . tomargin, guarantee, or secure the Cleared Swaps o any or all Cleared

Swaps Customers.

Because it is the responsibility o the FCM to identiy the value o collateral

that is the FCMs own contribution to the customer pool at the DCO, it isalso the responsibility o the FCM to ensure that the amount the DCO isrelying upon as the FCMs own value is always accurate, in accordance with

regulation 22.2.

Although regulations 22.2(e)(3)(ii) and 22.3(c) imply that an FCM may notdeposit its own unds into the Cleared Swaps Customer Account, CFTC sta

has indicated that it will issue the necessary clarication to assure FCMsand DCOs that this is not an intended interpretation or requirement o the

rule. To be clear, and subject to the terms o the CFTCs clarication, DCOswill allow an FCM to deposit its own unds into the Cleared Swaps Customer

account at the DCO, but these unds must be separately identied to theDCO in order or them to be treated as such.

Post FCM Deault Portability

The CFTC regulation Part 190 dictates that it is the responsibility o the DCOto negotiate or the transer o as many customers as possible to potential

transeree FCMs. While the CFTC can approve the transer o customerpositions without the consent o the Trustee or Bankruptcy Court, the DCO

cannot transer customer collateral without the consent o the Trustee.Under the U.S. Bankruptcy Code, only a court-approved distribution can

aect the transer o customer collateral away rom an FCM that has ledor bankruptcy protection.

From the time an FCM deaults, the Trustees role is to determine i a

shortall exists and i so, to estimate the extent o the shortall. The Trusteewill then present to the Bankruptcy Court what it estimates as each

customers claim relative to the total amount o customer assets available,as well as what the Trustee believes should be distributed to customers by

the DCO as part o a bulk port o customers and their collateral. It is logical

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to assume that the Trustee will use the Legally Segregated Value gures o

the DCO to determine what will transer with each customer (or speed andsimplicity). The Bankruptcy Court will then look to approve a bulk collateral

distribution based on two actors. The court will balance the need todistribute as much collateral as possible as quickly as possible, in order to

limit disruption to the market, with protecting against the over-distributiono collateral. Once the Bankruptcy Court approves a bulk distribution, the

DCO is ree to distribute collateral in a single bulk transer.

Customers that are not included in the bulk transer have up to sevencalendar days ollowing the FCM deault to port their positions to a new

FCM. These customers may deliver individual transer requests to the

Trustee o the deaulted FCM as well as to potential transeree FCMs. TheDCO will act on these individual transer requests, but is permitted only totranser those customers positions, as distributions o collateral outside o

a court-ordered bulk distribution are not permissible.

The amount o collateral that transers with a customer will be determinedby the Trustee and Bankruptcy Court. It is likely that the Trustee would use

the Legally Segregated Value o the DCO as the basis o the distributionthat it proposes to the court. For a customer with variation margin losses,

this amount may be reduced, at most, by the amount o collateral thatwas used to meet that individual customers variation margin obligation.

I a DCO, such as LCH.Clearnet, is providing post-deault variation margin

segregation, a customer will also be ported with any variation margin gainsrelated to the individual customers portolio rom the time o deault upuntil the time at which the customer is transerred. For a timeline o the

events that ensue ater an FCM deault, please reer to Appendix 4.

Part 22 Does Not Remove Pro-Rata Loss Sharing

The CFTCs stated intention in issuing the Part 22 rules is to remove the

ability o a DCO to utilize a customers collateral to meet the losses oanother customer (ellow customer risk). However, a DCO utilizing ellow

customer collateral to cover losses is not the only risk that exists in thegross omnibus model. There are other risks in the utures model that can

result in a customer receiving less than its ull value o collateral throughthe bankruptcy process in the event o an FCM deault. These loss cases are

mainly centered on Section 766 o the U.S. Bankruptcy Code. In the section I.Backgroundo the preamble to CFTC regulation Part 22, the CFTC notes that:

[S]ection 766(h) o the Bankruptcy Code (Section 766(h)) subjects

customers to mutualized risk by requiring that customer property bedistributed ratably to customers on the basis and to the extent o such

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customers allowed net equity claims. This requirement, in turn, limits

the Commissions fexibility in designing a model or the protection ocustomer collateral.

Generally, Section 766 states that all customers o a deaulted FCM should

be given equal treatment in the distribution o collateral that remains in theevent o a shortall. All customers o an FCM are at risk o this type o loss

sharing. As long as a client is considered to be a customer o the FCM, andthe clients assets have been delivered to the FCM, DCO, or custodian on

behal o an FCM requirement, directly or via a Tri/Quad-Party relationship,this risk will remain.

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CFTC regulation 22.13 makes it clear that certain requirements must be

met in order or excess customer unds to be provided to the DCO. The keyrequirement is that the FCM provide reporting to the DCO that allocates

collateral value to each customer. This is necessary or the DCO to be able toappropriately segregate the value that is in excess o the DCOs requirement.

Thereore, an FCM and DCO may operate in an LSOC-compliant model thatdoes not allow or excess customer unds to be held at the DCO. In such a

model, a customers collateral value that is legally segregated at the DCO isdependent on a customers initial margin requirement, as determined by the

DCO. Regulation 22.15 states that:

[E]ach [DCO] . . . and each [FCM] . . . shall treat the value o collateral

required with respect to the portolio o rights and obligations arising outo the Cleared Swaps intermediated or each Cleared Swaps Customer,and collected rom the utures commission merchant, as belonging

to such customer, and such amount shall not be used to margin,guarantee, or secure the Cleared Swaps or other obligations o the

utures commission merchant or o any other Cleared Swaps Customer orCustomer.

The value o collateral required arising rom a customers portolio o

rights and obligations, or swap portolio, is a customers initial marginrequirement.

Establishing a Customers Legally Segregated Value (LSV)

Each morning when a DCO is required to meet its Gross MarginingRequirement, i the FCM meets its margin call with the DCO, the DCO

will assume that the collateral meeting the margin requirement o eachcustomer belongs to that customer. In reality, the FCM may be meeting a

margin call with its own capital. O course, the FCM is not permitted, underLSOC, to meet the margin requirement o a customer with the excess

collateral o another customer. So, the collateral meeting a call either doesbelong to the customer generating the call or is a loan to the customer rom

the FCM. In LSOC Without Excess, the DCO has insucient inormation todierentiate between cases where a customer has provided unds and where

an FCM has made a loan to the customer, so all collateral that is used tomeet the start-o-day margin settlement will be treated as belonging to the

customer. Once an FCM meets its margin obligation at the DCO as part othe start-o-day margin cycle, the DCO will adjust the LSV o each customer

to equal a customers initial margin requirement.

This will be the only time that the DCO will ever decrease a customers LSV

LSOC Without Excess

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without the express consent o the FCM. This will occur or those customers

whose initial margin requirements have decreased rom the start o theprior day where its LSV was xed at the previous, and higher, initial margin

requirement. When a customers LSV is decreased, the resulting excess willbe treated as Unallocated Excess and thus is not at risk o being utilized to

margin any other customer.

In the event o a deault, a DCO is permitted to use customer collateral tocover the losses relating to customer positions. However, under LSOC, the

DCO can use an individual customers LSV only to meet the loss arisingrom that customers swap portolio. Once porting can be arranged, the aim

is that a customer be transerred with its LSV (pending Trustee approval).

I a customer had actually deposited more than its LSV with its FCM, thecustomers excess beyond its LSV should not be at the DCO, and thereoreis not at risk o being utilized to meet the losses o another customer. This

excess should likely be at the FCM, not the DCO, and although it wouldnot be available or porting, it would be returned through the bankruptcy

process.

The Treatment o Excess in LSOC Without Excess

As a result o the nature o clearing, unds may become excess without an

explicit excess deposit. This will be evident in cases where a customers

margin requirement decreases or the value o the swaps customercollateral pool increases. In such cases, the DCO is limited in how it isable to treat this excess value. I detailed collateral value reporting were

available, the DCO would know how to treat excess created rom customerrequirement decreases. For example, i it were reported that a customers

collateral value at the DCO were $100 and the customers requirementdecreased rom $100 to $50, the DCO would know that the $50 o excess

that was created belonged to that customer alone. Alternatively, i it werereported to the DCO that a customer initial margin requirement was being

met with $50 o the customers own unds at the DCO and $50 o the FCMsown capital at the DCO, and the requirement decreased to $50, the DCO

would know that the $50 o excess created, as a result o the initial margindecrease, belonged to the FCM and could be used to meet the requirement

o any customer.

In a model where the DCO does not have collateral value reporting rom theFCM, the DCO will be unaware o whether an FCM has met a margin call

on behal o a customer or i the customer has actually preunded, and thecollateral meeting that customers requirement at the DCO belongs to that

individual customer. As a result o the ambiguity that exists in LSOC Without

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Excess, when a customers requirement decreases, creating excess, the

DCO may not presume such excess to be FCM Buer. This excess must betreated as Unallocated Excess in order to ensure compliance with regulation 22.15, Treatment o Cleared Swaps Customer Collateral on an Individual

Basis. Regulation 22.15 states that the collateral o one customer cannotbe used to margin, guarantee, or secure the Cleared Swaps . . . o any other

Cleared Swaps Customer. As long as the discussed ambiguity exists, theDCO cannot use those unallocated unds to meet the requirement o any

customer with certainty that it is not in breach o the individual treatmentrequirement.

This leaves the DCO with limited options or the treatment o Unallocated

Excess, which will exist at the start o each day when LSVs are reset. Whatis clear is that the DCO is not permitted to unilaterally oset the marginrequirement increase o any customer using Unallocated Excess. A DCO

may collateralize initial margin increases only by using FCM Buer or theexcess collateral specically allocated to a customer. I these amounts are

insucient, a DCO must call or additional unds. I a DCO does not call oradditional unds, it is in breach o its Gross Margining Requirement dened

in regulation 39.13(g)(8).

FCM Lodged Excess

In LSOC Without Excess, an FCM is permitted to deposit excess undswith the DCO or the purposes o meeting any customers requirement in

the uture, but these unds may only consist o the FCMs Buer. Thus,these unds are required to be o no greater value than the FCMs capital

contribution to its swaps customer segregation pool in order to constituteResidual Financial Interest as stipulated in CFTC regulation 22.2. CFTCSta has stated that FCMs may also deposit excess customer unds with

the DCO, but in LSOC Without Excess, the DCO must consider this amountto be Unallocated Excess, not reely available to the DCO to meet the uture

requirement o any customer. This Unallocated Excess must be separatelyaccounted or, and given dierent treatment than the value o customer

collateral that is rm buer. SwapClear will allow FCMs to post FCM Buer,but will not allow FCMs to post customer-specic excess that is treated as

unallocated until LSOC With Excess is made available.

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Margining

Initial Margin

Each time the DCO wishes to perorm an initial margin settlement with theFCM, or collateralize the increase in requirements o individual customers,

the DCO should not assume that it can oset this amount against thosecustomers with initial margin decreases. Instead, SwapClear will base its

call on the total amount by which customers requirements have increasedin aggregate. This amount may be reduced by the rms buer depositedat the DCO. This amount can not be oset by the net variation margin

obligation o the customer account and thus must be settled separately.

Variation Margin

The variation margin settlement each day will be handled separately romthe initial margin settlement described above. By separating the two, theDCO will ensure that it is not using the variation margin gains o a specic

client to meet the initial margin obligation o another. Conversely, notseparating the decrease in initial margin requirements rom the variation

margin losses o specic customers would be analogous to the DCO usingUnallocated Excess without the consent o the FCM to meet a variation

margin call. Thereore, SwapClear will separate initial margin and variationmargin settlement in a model where it does not receive customer-specic

excess reporting rom the FCM. Here, the collection o initial margin mustoccur beore the variation margin settlement, as the DCO would never pay

out variation margin until it is certain that an FCM is not in deault.

Summary o the SwapClear Model

Start-o-Day Margin SettlementAt the start o each day, SwapClear will ensure that it has the additionalcollateral necessary to collateralize any customer whose initial margin

requirement has increased above the customers LSV. This aggregateamount will be reduced by the amount o FCM Buer at the DCO. The

remainder will generate an initial margin call. Once this call has been met,the DCO will pay any variation margin owed to the FCM. Once the morning

margin settlement is complete, SwapClear will set the LSV o each customer

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equal to the customers initial margin requirement. For customers whose

LSV was reduced, the resulting excess will be treated as unallocated.SwapClear will then return all Unallocated Excess to the FCM.

Intraday Margin SettlementThroughout the day, SwapClear will not update the Legally Segregated Value

o any customer as initial margin requirements change, notwithstandinga call or additional collateral. Thereore, i a customers initial margin

requirement decreases below the customers LSV, the excess that resultswill be treated as belonging to that customer. Conversely, i a customers

initial margin requirement increases above that customers legallysegregated value, SwapClear will collateralize the resulting requirement via

the FCMs specically identied Buer, then using the tolerance granted tothe FCM. In the event that this is insucient, an initial margin call will begenerated.

In the event that a call is met intraday, SwapClear will increase the LSVs o

the customers who generated the call. The LSVs will be increased or thesecustomers, pro-rata, based on the amount by which these customers were

under-margined. At the time that an intraday call is delivered to the FCM,SwapClear will generate a new LSOC report or the FCM. This report will

provide the FCM with the inormation necessary to ensure the maintenanceo the LSOC Segregation calculation.

FCM BuerIn order to remove the need or a reporting requirement, SwapClear willallow FCMs to operate in a model where all excess delivered outside o

a margin call, specically as excess, will be treated as rm buer (FCMBuer). This will be enorced through the SwapClear Rule Book.

Example o Margin Call Process

Start o Day 1 IM Required

Client 1 $100

Client 2 $100

Collateral at LCH $200

End o Day 1 IM Required VM

Client 1 $95 $2

Client 2 $105 $(3)

IM Call $(5)

VM Call $(1)

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Prior to Open Day 2

Margin Calls Met

Excess Returned $5

Start o Day 2 IM Required

Client 1 $95

Client 2 $105

Collateral at LCH $200

End o Day 2 IM Required VM

Client 1 $75 $1

Client 2 $105 $(4)

VM Call $(3)

Prior to Open Day 3

VM Call Met

Excess Returned $20

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Intraday Excess Return

Although SwapClear will be recalculating initial margin requirements

throughout the day as a customers portolio changes, we will update LSVsonce a day ater the start-o-day margin settlement is completed. Thereore,

those customers whose initial margin requirements go down throughoutthe day will have their Legally Segregated Values lowered to equal their

initial margin only ater the morning settlement is complete. This will createunallocated excess that will be quickly returned.

Throughout the day, i a customers initial margin is less than its LSV, thenwe will treat the excess collateral created as customer-specic. I the FCM

wants to remove this excess prior to the ollowing morning, the FCM may

specically request that we do so.

In order to have this excess returned, the FCM will request that SwapClear

decrease the LSV o all customers whose margin requirements havegone down rom the start o the day. SwapClear will then set the LSV o

each o these customers equal to its current initial margin requirement.The resulting Unallocated Customer Excess may be returned to the FCM

immediately, and prior to the close o business.

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As previously mentioned, CFTC regulation Part 22 states that i a DCO is

going to accept excess customer unds rom an FCM, the FCM must reportto the DCO, at least once per day, the value o collateral belonging to eachindividual customer. The model o LSOC in which an FCM is providing daily

collateral value reporting to the DCO is reerred to as LSOC With Excess.This section will describe the manner in which the DCO will operate and

require FCMs to operate, and how this will impact legal segregation.

Establishing a Customers Legally Segregated Value

The key dierence between LSOC With Excess and LSOC Without Excess

is the determination o a customers Legally Segregated Value (LSV). In

LSOC Without Excess, a customers LSV is the value o collateral requiredarising rom a customers portolio o rights and obligations, or acustomers initial margin requirement. In LSOC With Excess, this is not the

case. Instead, a customers LSV will be based on the reporting provided bythe FCM.

In LSOC With Excess, the FCM is required, at least once per day, to provide

the DCO with a report that stipulates how much o the collateral value at theDCO belongs to each customer. In turn, the DCO will base each customers

LSV on the amount o collateral allocated to the customer via the FCMsmost recent Collateral Value Report (CVR).

The treatment provided to a customers LSV is the same as it is in LSOC

Without Excess. A customers LSV is used only to meet the initial marginrequirements o that customer, and can be used to cover the losses o

that customer only in the event o a deault. Similarly, the amount ocollateral that will port with a customer in LSOC With Excess will likelybe based on a customers LSV, not just the customers initial margin. The

LSV o a customer may at times be less than a customers initial marginrequirement, as it is based on the collateral value reporting provided to the

DCO, independent o DCO initial margin requirements.

The Collateral Value Report

CFTC regulation Part 22 requires that FCMs operating in LSOC With Excessprovide a Collateral Value Report (CVR) to the DCO at least once each day.

The CVR will list a single USD value or each individual customer o the FCM.The DCO will implement this number as the LSV or each customer. As the

protection provided to swaps customers under CFTC law and the BankruptcyCode in the US is based on value, and all collateral at a DCO is carried based

on post-haircut values, so too will the CVR be based on post-haircut value.

LSOC With Excess

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In order to determine i a CVR that an FCM has delivered is compliant, the

DCO will calculate the sum o all customer LSVs as reported by the FCM.This total must be no greater than the post-haircut value o all customercollateral delivered by the FCM, at that time, to the DCO. Essentially, the

DCO determines the post-haircut value that it will give the FCMs customersor the entire amount o collateral that has been provided, and it is up to

the FCM to allocate that value to its clients. I an FCM has allocated morecollateral to clients than it has actually delivered to the DCO, the report will

be rejected. (FCMs are permitted to provide an updated CVR to the DCO atany time, and as many times as they wish, throughout the day, as long as the

report is compliant.)

In addition to being required to report the LSV o each client at least onceper day via the CVR, FCMs are also required to report to the DCO in the CVR,the value o the FCMs buer. This is made clear in the preamble section o

CFTC regulation Part 22, IV., Section by Section Analysis: Regulation Part22, which states that:

The Commission also notes that, to the extent the DCO permits the

FCM to post excess collateral, the DCO must, through its own rules,require that the FCM separately account or the separately identied

buer collateral (which originated rom the FCMs own capital) and thecollateral attributed (at the DCO) to the FCMs Cleared Swaps Customers

(which belongs to those customers).

This buer amount must always be less than or equal to the amount o theFCMs own assets that it has placed into segregation. As stated above, the

DCO has a compliance check that ensures that the sum o customer LSVsis not greater than the post-haircut value o all customer collateral o the

FCM at the DCO. The FCMs buer reported in the CVR is not included in thisspecic compliance check.

Ater checking to see that a CVR passes the rst compliance check, the

DCO will determine the amount o value that has not been allocated toany customer. The DCO will then check to see that the amount o Firm

Buer reported by the FCM in the CVR is less than or equal to that residualamount. As long as the rm buer value reported in the CVR is less than

or equal to that amount, the DCO will use the buer value reported by theFCM. However, unlike a customer LSV, which is never altered by the DCO to

orce the CVR into compliance, the DCO will decrease the rm buer amountreported by an FCM in the event that the reported amount is greater than the

residual value that had not been allocated to any customer. (This is a serviceprovided to the FCM so that reconciliation to the penny is not required when

the FCM provides sucient buer.)

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The nal compliance check or the CVR will be to ensure that the report

would not generate a margin call. The intention o the report is not or theFCM to indicate that it would like to increase or reduce the amount o excess

at the DCO. The sole purpose o the CVR is or the FCM to notiy the DCOo how collateral should be legally segregated at the DCO. Thereore, the

DCO will ensure that or any customers whose LSV, as reported in the CVRby the FCM, is less than the customers initial margin requirement, there

is sucient buer at the DCO to cover this shortall. Any value that is notallocated to a customer or the rm buer is treated as Unallocated Excess.

Delivery and Removal o Excess Collateral

A DCO is never permitted to make assumptions with respect to theallocation o excess customer unds at the DCO. Excess unds must be

allocated either to the FCMs buer or to an individual customer based oninstructions provided to the DCO. Thereore, unds that are delivered to the

DCO, but are yet to be allocated by the FCM, will be treated as UnallocatedExcess. As discussed in LSOC Without Excess, the only thing that a DCO can

do with Unallocated Excess is return it to the FCM. This is not the case inLSOC With Excess. Instead, the FCM has the ability to allocate Unallocated

Excess via the CVR.

When an FCM wants to increase the amount o collateral at the DCO, or one

or more individual clients or its buer, the FCM will begin by delivering theadditional collateral. The DCO will immediately treat the additional collateralvalue as Unallocated Excess. As the FCM is permitted to deliver a new CVR

at any time, once the FCM delivers a report with increased allocations, it willbe implemented immediately by the DCO. There is no limit as to the length

o time that unds may remain Unallocated Excess, but the value will notbe implemented into the DCO margining process until it has been allocated

by the FCM. O course, FCMs may deliver a new CVR immediately aterdelivering the additional collateral.

Similarly, FCMs may withdraw Unallocated Excess at any time. But an FCM

is not able to withdraw excess rom a customers LSV without rst notiyingthe DCO o a reduction in that customers LSV. Essentially, the only excess

that an FCM may ever have returned is Unallocated Excess. In order toremove customer-specic excess rom the DCO, the FCM must rst deliver

a CVR that creates Unallocated Excess, as the only thing that the DCO cando with Unallocated Excess is return it to the FCM (or allocate via CVR).

I an FCM wishes to withdraw more collateral than what is being treatedas Unallocated Excess, it may do so, but only to the extent that there is

unencumbered rm buer, as the DCO will never unilaterally reduce the LSVo any client or allow an FCM to become under-collateralized.

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Margining

Any time at which the DCO wishes to collateralize risk (initial margin

settlement), it will rely on the most recent CVR that it has received romthe FCM. To determine i a margin call is required, the DCO will compare

a customers LSV to the customers initial margin requirement. The DCOwill calculate the total decit o all customers whose LSV is less than the

customers margin requirement. To the extent that customers are under-margined, the DCO will look to collateralize this residual risk via the FCMsbuer. To the extent that the buer is insucient, the DCO will provide the

FCM with a tolerance intraday beore determining that a call is required.

When an initial margin settlement is run, the DCO will call or additional

unds to the extent that customers are under-collateralized. On an intradaybasis, both the FCMs buer and the tolerance provided to the FCM aretreated as collateral, or the purpose o determining i a customer is under-

collateralized. Thereore, an intraday call would be made only to the extentthat the tolerance provided to an FCM is insucient. However, initial margin

calls made as part o the end-o-day settlement will not be decreased by anytolerance, per the DCOs gross margining requirement.

When initial margin is collected as part o a call, it must be immediately

available to the DCO or covering losses, even i a CVR has not beenprovided. Thereore, the amount o margin called by the DCO will need to

benet rom an assumed allocation until a CVR is provided by the FCM. Theassumed allocation is necessary so that the DCO is able to use the called

amount in the event that an FCM were to deault prior to delivering a CVRthat allocates the called amount. The assumed allocation will be tracked

separately rom a customers LSV so that there is no conusion in the DCOsrecords, on behal o DCO or Trustee, in the event that a CVR has not been

received prior to an FCMs deault.

The called amount will be allocated ratably to under-margined customers,and may be corrected immediately by the FCM via delivery o a CVR. Until

the FCM updates the CVR, the DCO will treat the called amount allocated to

each customer as pseudo-customer property. This means that in the evento a deault, the called amount could be used only to cover that customerslosses, but whatever was not required or covering losses would be treated

as Unallocated Excess and returned to the Trustee o the deaulted FCMto be distributed accurately. An example o Allocation o Called Margin

(Pseudo-Customer Property) can be ound in Appendix 5.

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Summary o the SwapClear Model

Start-o-Day Margin Settlement

Each morning, SwapClear will base its End-o-Day Margin Settlement onthe last Collateral Value Report that was received rom the FCM. At the

end o the day, SwapClear will review each customers LSV, as determinedby the last CVR, and compare it to the customers current initial margin

requirement. SwapClear will then calculate the sum o all customers whoseinitial margin is greater than their LSV. To the extent that this sum is less

than the FCM Buer, SwapClear will make an initial margin call. The marginthat is called will be treated as belonging to the clients that generate the

call. A clients LSV will be increased by the DCO only to the extent o themargin called. The amount allocated to the FCMs buer will not change and

no client will ever have its LSV decreased unilaterally by the DCO.

The margin that is collected via a call will need to be allocated by the FCM inthe next CVR received by the DCO. FCMs are required to deliver a CVR to the

DCO at least once a day, and that is when the called margin will be properlyallocated. O course, the FCM is required to always ensure that the behavior

o the DCO is not causing a breach o the FCMs LSOC requirement. FCMswill be encouraged to deliver a CVR by 10 AM EST each day in order to limit

the amount o time that the DCOs assumptions about called margin arerefected. O course, the temporary assumed allocation should never harm

a customer; it is only in the best interest o the FCM to correct it as soon as

possible.

Intraday Margin SettlementThroughout the day, the DCO will monitor to ensure that all customers are

ully collateralized by either their own LSV, rm buer, or the toleranceprovided to the FCM. To the extent that a customer is under-collateralized

with insucient tolerance available, the DCO will make a call, treating thecalled margin in the same manner as it is treated in the morning call. This

assumption will need to be corrected by the FCM in the next delivered CVR.As is the case in LSOC Without Excess, at the time an FCM is notied o an

intraday call, the DCO will provide the FCM with the appropriate reporting

necessary to maintain LSOC segregation calculations.

While FCMs are not required to deliver more than one CVR per day, anytime

the FCM wishes to deliver and receive credit or additional excess or removeexcess rom the DCO, the FCM will be required to deliver a CVR. For these

transactions, the FCM may not be required to deliver a ull CVR restating thevalue or unaected clients, but may do so. O course, the FCM is permitted

at any time to deliver an updated CVR to the DCO. I an updated CVR reducesthe total allocated value, the remainder will be treated as unallocated

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excess. This unallocated excess is the amount that the FCM will be able to

have returned to it at any time.

(The ormat o the le that FCMs will be required to use to communicate thevalue o collateral associated with each client, at least once a day, is detailed

in the document LSOC Part 22 Collateral Value Reporting Compliance.An example o the margin call process in LSOC With Excess can be ound

on the ollowing page.

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Example o Margin Call Process (Day 1Day 2)

Start o Day 1: Collateral Value Report: Received on Day 1 at 10AM EST

Sub Account Value

Client 1 $100

Client 2 $50

Client 3 $250

FCM Buer $100

Total $500

Tolerance $50

End o Day 1

Sub Account Sub Acct. Value IM Requirement Excess

Client 1 $100 $50 $50

Client 2 $50 $100 $(50)

Client 3 $250 $100 $150

Total Decits $(50)

FCM Buer $100Tolerance $50

Start o Day 2

IM Call Required $-

Collateral Value Report Delivered - No Change

End o Day 2

Sub Account Sub Acct. Value IM Excess

Client 1 $100 $150 $(50)

Client 2 $50 $125 $(75)

Client 3 $250 $200 $50

Total Decits $(125)

FCM Buer $100

Tolerance $50

EOD Tolerance Unitilization $25

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Example o Margin Call Process (Day 3)

Start o Day 3

IM Call $(25)

LSOC Report Delivered to FCM showing the allocation o called margin

Sub Account Starting Value Allocation Basis Additional Value New Sub Acct. Value

Client 1 $100 $(50) $10 $110

Client 2 $50 $(75) $15 $65

Client 3 $250 $250

FCM Buer $100 $100

Total $500 $25 $525

New Collateral Value Report Delivered sometime ater

the completion o the Start o Day Settlement

CVR

Sub Account Value

Client 1 $100

Client 2 $50

Client 3 $250

FCM Buer $125

Total $525

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The ollowing example compares an FCM deault in the utures model and

under the CFTC regulation Part 22 LSOC rule.

Assumptions: Thereisnochangeinpositionsonthedaybeforethedefault.

BothclientswerecompletelysettledupwiththeirFCMpriortotheFCMdeault.

TheFCMhasnohousecollateralorGuaranteeFunds. Thereis$200inclientcollateralattheDCOallofwhichiscash.

TheFCMdefaultsonaNetVariationMarginCallof-$150. Client2isalsoindefaultandwillnotbeported.

TheDCOisabletocloseanyclientoutatnoadditionalcost.

FCM Client Account

Client 1 Client 2

Position Long $2B 5Y Short $1B 10Y

Collateral Value $100 $100

VM +$150 -$300

*Please note that the variation margin moves in this example have beenexaggerated or simplicity.

Futures Model Deault

The DCO makes a net variation margin call to the FCM o -$150. The

FCM is unable to pay the DCO and is put into deault. In order to meet theobligations o the deaulting FCM, the DCO utilizes $150 o client collateral.

But $50 o client collateral remains in the Client Account o the deaultedFCM. The DCO immediately liquidates the positions o Client 2 at no cost.

The DCO will then attempt to port Client 1 to a surviving FCM, but there isonly $50 available to do so and Client 1s initial margin requirement is $100.

Client 1 may need to preund $50 to its new FCM in order to transer its

portolio.

Total DCO Loss: $0

Assuming Client 1 is ported with $50, then Client 1s claim made to thedeaulted FCMs estate is:

IMLoss:$50 VMLoss:$150

TotalClaim:$200

Appendix 1. Deault Scenario:Gross Omnibus Model vs. LSOC

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LSOC Model Deault (baseline LSOC without variation

margin segregation)The DCO makes a net variation margin call to the FCM o -$150. TheFCM is unable to pay the DCO and is put into deault. In order to meet the

obligations o the deaulting FCM, the DCO is able to utilize client collateral.But only $100 o client collateral is available to the DCO in order to meet

the net variation margin loss on the client account o -$150. $100 o swapscustomer collateral remains in the client account. The DCO is orced toutilize $50 rom its deault waterall in order to cover the net loss beyond

the available collateral. The DCO will immediately liquidate the portolio oClient 2, and does so at no additional cost. The DCO will now look to port

Client 1 and $100 is available to do so. As all o the necessary initial margin

is available to port Client 1, this should not be dicult and Client 1 shouldnot need to put up any additional unds.

Total DCO Loss: $50


IMLoss:$0

VMLoss:$150 TotalClaim:$150

LSOC Model Deault (with variation margin segregation)

The DCO makes a net variation margin call to the FCM o -$150. The FCMis unable to pay the DCO and is put into deault. To provide post-deault

variation margin segregation to Client 1, SwapClear will ignore the actthat it made a net variation margin call to the deaulted FCM and instead

disaggregate Client 1 and Client 2. Since Client 2 has deaulted, the DCO willrst manage the losses resulting rom Client 2s portolio. In order to meet

the $300 in variation margin losses rom Client 2s portolio, the DCO hasat its disposal $100 o Client 2s collateral. In order to cover the remaining

$200 o residual losses, the DCO may not use any o Client 1s initial marginor VM, and must instead go to its deault und. The DCO now has $100 o

Client 2s collateral and $200 o its own deault resources available to meetthe net call o $150. But $150 remains in the customer account as a result

o Client 2 as well as Client 1s $100. Thereore, the DCO is now able toport Client 1 with not only $100 o Client 1s collateral, but also with $150

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o Client 1s variation margin gains. Client 1 can thus be ported with $250,

covering both its initial margin and VM.

Total DCO Loss: $200


IMLoss:$0

VMLoss:$0 TotalClaim:$0

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Please note that this is an oversimplied example. It is meant only to convey

the general idea o the calculation.

AssumptionsAll Collateral is in the orm o Cash

Start o Day 1

Client Collateral Deposited with FCM

Client 1 $100

Client 2 $200

Total $300

FCM Buer $100

Total FCM Client Account

Total $400

DCO IM Requirements

Client 1 $100

Client 2 $100

Total $200Collateral Deposited With DCO

Total $200

Example 1

At the End o Day 1, the only change is the IM Requirement o Client 2. Client2s new IM Requirement is $250. Since the DCO does not have any excess,

it will call or the ull amount o the increase, $150. Prior to meeting theinitial margin call the ollowing morning, the FCM should perorm the LSOC

Segregation Calculation to ensure that it will be LSOC compliant when itmeets the call the ollowing morning.

Calculation: or each client (Collateral Deposited IM)Client 1: $100 - $100 = $0Client 2: $200 - $250 = -$50

Appendix 2. LSOC Segregation Calculation

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Add up all negative clients.

Total: $-50

Thereore, the FCM Buer must be at least $50.FCM Buer is greater than $50

The FCM is LSOC-compliant

Example 2

At the end o day 1, the only change is the IM Requirement o Client 1. Client1s new IM Requirement is $250. Since the DCO does not have any excess,it will call or the ull amount o the increase, $150. Prior to meeting the

initial margin call the ollowing morning, the FCM should perorm the LSOCSegregation Calculation to ensure that it will be LSOC compliant when it

meets the call the ollowing morning.

Calculation: or each client (Collateral Deposited - IM )Client 1: $100 - $250 = -$150

Client 2: $200 - $100 = $100

Add up all negative clients.Total: -$150

Thereore, the FCM Buer must be at least $150.

The FCM Buer is only $100The FCM must deposit an additional $50 in segregation in order to be LSOCcompliant.

Example 3

End o Day 1 IM Requirements:Client 1: $250

Client 2: $50

Calculation: or each client (Collateral Deposited - IM )

Client 1: $100 - $250 = -$150Client 2: $200 - $50 = +$150Total: -$150

Thereore, the FCM Buer must be at least $150.

The FCM Buer is only $100The FCM must deposit an additional $50 in segregation in order to be LSOC

compliant

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The below examples detail how a DCO determines the amount o swaps

customer collateral that it may use in order to cover the loss resulting rom anFCM deaulting on its net variation margin obligation.

The principle o the attribution methodology is to protect a customers margin

rom the losses o another customer. This means that a customers loss is nogreater than the loss the customer would have suered in a ully segregated

account.

When a deault happens, the DCO must determine how much collateral isavailable to cover a net variation margin call to the FCMs customer account.

In the gross omnibus model, the DCO could use all collateral available to cover

the net variation margin call. Under LSOC, the DCO must perorm a calculationto determine how much margin is available to it to meet the FCMs net variationmargin call, prior to using any customer margin to satisy the obligation o the

FCMs customer account. This calculation is provided and explained below.

For each customer, the DCO can use a maximum amount o collateral equalto the customers individual variation margin loss, limited by the customers

Legally Segregated Value. I this total amount is insucient to cover the netvariation margin call to the FCMs customer account, then the DCO cannot use

any urther customer collateral. Instead, the DCO must go to the next level oits waterall, protecting customers rom ellow customer risk.

Example 1: The FCM deaults on a net variation margin call o $25

VM

Legally Segregated

Value

Collateral Available to

the DCO to cover VM

Customer 1 6 5 N/A

Customer 2 -12 5 5

Customer 3 3 5 N/A

Customer 4 -4 5 4

Customer 5 -3 5 3

Customer 6 2 5 N/A

Customer 7 -7 5 5

Customer 8 -9 5 5

Customer 9 3 5 N/A

Customer 10 -4 5 4

Net -25 50 26

Appendix 3. Attribution o a Net VariationMargin Loss

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Here, there is a net loss o -$25 but $26 o collateral available to the DCO.

Thereore, $1 remains to be distributed ratably to those customers withvariation margin losses that did not exceed the customers LSV.

Example 2: The FCM deaults on a net variation margin call o $30

VM

Legally Segregated

Value

Collateral Available to the

DCO to cover VM

Customer 1 1 5 N/A

Customer 2 -12 5 5

Customer 3 3 5 N/A

Customer 4 -4 5 4

Customer 5 -3 5 3

Customer 6 2 5 N/A

Customer 7 -7 5 5

Customer 8 -9 5 5

Customer 9 3 5 N/A

Customer 10 -4 5 4

Net -30 50 26

Here, there is a net loss o -$30 but $26 o collateral available. Thereore, $0

remains to be distributed to customers and the DCO must rely on its deaultwaterall to cover the remaining $4 o the net variation margin loss.

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DCO

TRUSTEE

Day 3Day 0 Day 7

4 Propose transfer to CFTC

8 Auction hedged customer close-out portfolio

9 Provide final accounting to trustee

10 Distribute remaining collateral

per trustee's instruction

3 Negotiate bulk transfer

of customers

1 Put FCM in default

2 Begin close out of defaulted

and non-porting customers

7 Close out customers that have not ported

6 Take individual transfer requests

5 Initiate bulk transfer

3 Notify CFTC of bulk

transfer intentions

by Day 3

1 File petition in

bankruptcy court

2 Determine if a

shortfall exists7 Distribute collateral via DCOs

6 Determine final collateral distribution

5 Take individual transfer requests

4 Allow bulk distribution of collateral

Court Approves

Bulk Transfer"Determination Date"

Appendix 4. Post-FCM Deault Timeline

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Appendix 5. Allocation o Called Margin

The ollowing example demonstrates how the DCO will temporarily allocate

called margin prior to receiving an updated CVR rom an FCM.

Each time the DCO initiates an initial margin settlement, it will base theneed or a call on the most recently received CVR. In the example below, the

DCO does just that.

1. The example begins by showing the CVR that was most recently deliveredby the FCM to the DCO. Please note that the example is assuming that

the CVR delivered by the FCM was compliant. This means that at the timethe CVR was delivered, the amount o rm buer needed to cover under-

margined customers was less than or equal to 25.

2. At some later time, customers enter into risk-increasing trades. Thebuer is no longer sucient. The example shows the DCO records ocustomer IM requirements and the calculation used to determine the

amount o the call.3. Ater the call is made, the DCO must assume the allocation o the called

margin until a new CVR is received. This shows how the DCO determinesthe assumed allocation.

4. The FCM now sends a new CVR, which allocates the called margin. TheFCM noties the DCO, via the CVR, that all o the margin called was rm

buer.5. The DCO can now send updated reporting to the FCM that refects its own

records.

1. Most Recent CVR

Customers Amount

A 125

B 300

C 50

Firm Buer 25

2. DCO Records at the Time o Initial Margin Settlement

Customers IM LSV Excess

Client

Defcit

Total

Defcits

Firm

Buer

Margin

Call

A 95 125 30

-125 25 -100B 325 300 -25

C 150 50 -100

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3. Temporary Allocation o Called Margin

Customers Client Defcit Margin Call Allocation

A

-100B -25 -20

C -100 -80

4. Updated CVR

Customers Amount

A 125

B 300

C 50

Firm Buer 125

5. Updated DCO Records

Customers IM LSV Excess

Client

Defcit

Total

Defcits

Firm

Buer

Margin

Call

A 95 125 30

-125 125 0B 325 300 -25

C 150 50 -100

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