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2011-31689

  • Federal Register, Volume 76 Issue 243 (Monday, December 19, 2011)[Federal Register Volume 76, Number 243 (Monday, December 19, 2011)]

    [Rules and Regulations]

    [Pages 78776-78803]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2011-31689]

    [[Page 78775]]

    Vol. 76

    Monday,

    No. 243

    December 19, 2011

    Part III

    Commodity Futures Trading Commission

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    17 CFR Parts 1 and 30

    Investment of Customer Funds and Funds Held in an Account for Foreign

    Futures and Foreign Options Transactions; Final Rule

    Federal Register / Vol. 76 , No. 243 / Monday, December 19, 2011 /

    Rules and Regulations

    [[Page 78776]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1 and 30

    RIN 3038-AC79

    Investment of Customer Funds and Funds Held in an Account for

    Foreign Futures and Foreign Options Transactions

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

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    SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

    is amending its regulations regarding the investment of customer

    segregated funds subject to Commission Regulation 1.25 (Regulation

    1.25) and funds held in an account subject to Commission Regulation

    30.7 (Regulation 30.7, and funds subject thereto, 30.7 funds). Certain

    amendments reflect the implementation of new statutory provisions

    enacted under Title IX of the Dodd-Frank Wall Street Reform and

    Consumer Protection Act. The amendments address: certain changes to the

    list of permitted investments (including the elimination of in-house

    transactions), a clarification of the liquidity requirement, the

    removal of rating requirements, and an expansion of concentration

    limits including asset-based, issuer-based, and counterparty

    concentration restrictions. They also address revisions to the

    acknowledgment letter requirement for investment in a money market

    mutual fund (MMMF), revisions to the list of exceptions to the next-day

    redemption requirement for MMMFs, the elimination of repurchase and

    reverse repurchase agreements with affiliates, the application of

    customer segregated funds investment limitations to 30.7 funds, the

    removal of ratings requirements for depositories of 30.7 funds, the

    elimination of the option to designate a depository for 30.7 funds, and

    certain technical changes.

    DATES: This rule is effective February 17, 2012. All persons shall be

    in compliance with this rule not later than June 18, 2012.

    FOR FURTHER INFORMATION CONTACT: Ananda K. Radhakrishnan, Director,

    (202) 418-5188, aradhakrishnan@cftc.gov, or Jon DeBord, Special

    Counsel, (202) 418-5478, jdebord@cftc.gov, Division of Clearing and

    Risk, Commodity Futures Trading Commission, Three Lafayette Centre,

    1151 21st Street NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Background

    A. Regulation 1.25

    B. Regulation 30.7

    C. Advance Notice of Proposed Rulemaking

    D. The Dodd-Frank Act

    E. The Notice of Proposed Rulemaking

    II. Discussion of the Final Rules

    A. Permitted Investments--Regulation 1.25

    1. Government Sponsored Enterprise Securities

    2. Commercial Paper and Corporate Notes or Bonds

    3. Foreign Sovereign Debt

    4. In-House Transactions

    B. General Terms and Conditions

    1. Marketability

    2. Ratings

    3. Restrictions on Instrument Features

    4. Concentration Limits

    (a) Asset-Based Concentration Limits

    (b) Issuer-based Concentration Limits

    (c) Counterparty Concentration Limits

    C. Money Market Mutual Funds

    1. Acknowledgment Letters

    2. Next-day Redemption Requirement

    D. Repurchase and Reverse Repurchase Agreements

    E. Regulation 30.7

    1. Harmonization

    2. Ratings

    3. Designation as a Depository for 30.7 Funds

    4. Technical Amendment

    F. Implementation

    III. Cost Benefit Considerations

    IV. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    Text of Rules

    I. Background

    A. Regulation 1.25

    Under Section 4d \1\ of the Commodity Exchange Act (Act),\2\

    customer segregated funds may be invested in obligations of the United

    States and obligations fully guaranteed as to principal and interest by

    the United States (U.S. government securities) and general obligations

    of any State or of any political subdivision thereof (municipal

    securities). Pursuant to authority under Section 4(c) of the Act,\3\

    the Commission substantially expanded the list of permitted investments

    by amending Regulation 1.25 \4\ in December 2000 to permit investments

    in general obligations issued by any enterprise sponsored by the United

    States (government sponsored enterprise or GSE debt securities), bank

    certificates of deposit (CDs), commercial paper, corporate notes,\5\

    general obligations of a sovereign nation, and interests in MMMFs.\6\

    In connection with that expansion, the Commission included several

    provisions intended to control exposure to credit, liquidity, and

    market risks associated with the additional investments, e.g.,

    requirements that the investments satisfy specified rating standards

    and concentration limits, and be readily marketable and subject to

    prompt liquidation.\7\

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    \1\ 7 U.S.C. 6d.

    \2\ 7 U.S.C. 1 et seq. (2006), as amended by the Dodd-Frank Wall

    Street Reform and Consumer Protection Act, Pub. L. 111-203, 124

    Stat. 1376 (2010).

    \3\ 7 U.S.C. 6(c).

    \4\ 17 CFR 1.25. Commission regulations may be accessed through

    the Commission's Web site, http://www.cftc.gov.

    \5\ This category of permitted investment was later amended to

    read ``corporate notes or bonds.'' See 70 FR 28190, 28197 (May 17,

    2005).

    \6\ See 65 FR 77993 (Dec. 13, 2000) (publishing final rules);

    and 65 FR 82270 (Dec. 28, 2000) (making technical corrections and

    accelerating effective date of final rules from February 12, 2001 to

    December 28, 2000).

    \7\ Id.

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    The Commission further modified Regulation 1.25 in 2004 and 2005.

    In February 2004, the Commission adopted amendments regarding

    repurchase agreements using customer-deposited securities and time-to-

    maturity requirements for securities deposited in connection with

    certain collateral management programs of derivatives clearing

    organizations (DCOs).\8\ In May 2005, the Commission adopted amendments

    related to standards for investing in instruments with embedded

    derivatives, requirements for adjustable rate securities, concentration

    limits on reverse repurchase agreements, transactions by futures

    commission merchants (FCMs) that are also registered as securities

    brokers or dealers (in-house transactions), rating standards and

    registration requirements for MMMFs, an auditability standard for

    investment records, and certain technical changes.\9\

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    \8\ 69 FR 6140 (Feb. 10, 2004).

    \9\ 70 FR 28190.

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    The Commission has been, and continues to be, mindful that customer

    segregated funds must be invested in a manner that minimizes their

    exposure to credit, liquidity, and market risks both to preserve their

    availability to customers and DCOs and to enable investments to be

    quickly converted to cash at a predictable value in order to avoid

    systemic risk. Toward these ends, Regulation 1.25 establishes a general

    prudential standard by requiring that all permitted investments be

    ``consistent with the objectives of preserving principal and

    maintaining liquidity.'' \10\

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    \10\ 17 CFR 1.25(b).

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    In 2007, the Commission's Division of Clearing and Intermediary

    Oversight (Division) launched a review of the nature and extent of

    investments of Regulation 1.25 funds and 30.7 funds

    [[Page 78777]]

    (2007 Review) in order to further its understanding of investment

    strategies and practices and to assess whether any changes to the

    Commission's regulations would be appropriate. As part of this review,

    all registered DCOs and FCMs carrying customer accounts provided

    responses to a series of questions. As the Division was conducting

    follow-up interviews with respondents, the market events of September

    2008 occurred and changed the financial landscape such that much of the

    data previously gathered no longer reflected current market conditions.

    However, that data remains useful as an indication of how Regulation

    1.25 was implemented in a more stable financial environment.

    Additionally, recent events in the economy have underscored the

    importance of conducting periodic reassessments and, as necessary,

    revising regulatory policies to strengthen safeguards designed to

    minimize risk, while retaining an appropriate degree of investment

    flexibility and opportunities for capital efficiency for DCOs and FCMs

    investing customer segregated funds.

    B. Regulation 30.7

    Regulation 30.7 \11\ governs an FCM's treatment of customer money,

    securities, and property associated with positions in foreign futures

    and foreign options. Regulation 30.7 was issued pursuant to the

    Commission's plenary authority under Section 4(b) of the Act.\12\

    Because Congress did not expressly apply the limitations of Section 4d

    of the Act to 30.7 funds, the Commission historically has not subjected

    those funds to the investment limitations applicable to customer

    segregated funds.

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    \11\ 17 CFR 30.7.

    \12\ 7 U.S.C. 6(b).

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    The investment guidelines for 30.7 funds are general in nature.\13\

    Although Regulation 1.25 investments offer a safe harbor, the

    Commission does not currently limit investments of 30.7 funds to

    permitted investments under Regulation 1.25. Appropriate depositories

    for 30.7 funds currently include certain financial institutions in the

    United States, financial institutions in a foreign jurisdiction meeting

    certain capital and credit rating requirements, and any institution not

    otherwise meeting the foregoing criteria, but which is designated as a

    depository upon the request of a customer and the approval of the

    Commission.

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    \13\ See Commission Form 1-FR-FCM Instructions at 12-9 (Mar.

    2010) (``In investing funds required to be maintained in separate

    section 30.7 account(s), FCMs are bound by their fiduciary

    obligations to customers and the requirement that the secured amount

    required to be set aside be at all times liquid and sufficient to

    cover all obligations to such customers. Regulation 1.25 investments

    would be appropriate, as would investments in any other readily

    marketable securities.'').

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    C. Advance Notice of Proposed Rulemaking

    In May 2009, the Commission issued an advance notice of proposed

    rulemaking (ANPR) \14\ to solicit public comment prior to proposing

    amendments to Regulations 1.25 and 30.7. The Commission stated that it

    was considering significantly revising the scope and character of

    permitted investments for customer segregated funds and 30.7 funds. In

    this regard, the Commission sought comments, information, research, and

    data regarding regulatory requirements that might better safeguard

    customer segregated funds. It also sought comments, information,

    research, and data regarding the impact of applying the requirements of

    Regulation 1.25 to investments of 30.7 funds.

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    \14\ 74 FR 23962 (May 22, 2009).

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    The Commission received twelve comment letters in response to the

    ANPR, and it considered those comments in formulating its proposal.\15\

    Eleven of the 12 letters supported maintaining the current list of

    permitted investments and/or specifically ensuring that MMMFs remain a

    permitted investment. Five of the letters were dedicated solely to the

    topic of MMMFs, providing detailed discussions of their usefulness to

    FCMs. Several letters addressed issues regarding ratings, liquidity,

    concentration, and portfolio weighted average time to maturity. The

    alignment of Regulation 30.7 with Regulation 1.25 was viewed as non-

    controversial.

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    \15\ The Commission received comment letters from CME Group Inc.

    (CME), Crane Data LLC, The Dreyfus Corporation (Dreyfus), FCStone

    Group Inc. (FCStone), Federated Investors, Inc. (Federated), Futures

    Industry Association (FIA), Investment Company Institute (ICI), MF

    Global Inc. (MF Global), National Futures Association (NFA), Newedge

    USA, LLC (Newedge), and Treasury Strategies, Inc.. Two letters were

    received from Federated: a July 10, 2009 letter and an August 24,

    2009 letter.

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    The FIA's comment letter expressed its view that ``all of the

    permitted investments described in Rule 1.25(a) are compatible with the

    Commission's objectives of preserving principal and maintaining

    liquidity.'' This opinion was echoed by MF Global, Newedge and FC

    Stone. CME asserted that only ``a small subset of the complete list of

    Regulation 1.25 permitted investments are actually used by the

    industry.'' NFA also wrote that investments in instruments other than

    U.S. government securities and MMMFs are ``negligible,'' and

    recommended that the Commission eliminate asset classes not ``utilized

    to any material extent.''

    D. The Dodd-Frank Act

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street

    Reform and Consumer Protection Act (Dodd-Frank Act).\16\ Title IX of

    the Dodd-Frank Act \17\ was enacted in order to increase investor

    protection, promote transparency and improve disclosure.

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    \16\ See Dodd-Frank Wall Street Reform and Consumer Protection

    Act, Pub. L. 111-203, 124 Stat. 1376 (2010). The text of the Dodd-

    Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

    \17\ Pursuant to Section 901 of the Dodd-Frank Act, Title IX may

    be cited as the ``Investor Protection and Securities Reform Act of

    2010.''

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    Section 939A of the Dodd-Frank Act obligates federal agencies to

    review their respective regulations and make appropriate amendments in

    order to decrease reliance on credit ratings. The Dodd-Frank Act

    requires the Commission to conduct this review within one year after

    the date of enactment.\18\ Included in these rule amendments are

    changes to Regulations 1.25 and 30.7 that remove provisions setting

    forth credit rating requirements. Separate rulemakings addressed the

    removal of credit ratings from Commission Regulations 1.49 and 4.24

    \19\ and the removal of Appendix A to Part 40 (which contains a

    reference to credit ratings).\20\

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    \18\ See Section 939A(a) of the Dodd-Frank Act.

    \19\ See 76 FR 44262 (July 25, 2011).

    \20\ See 75 76 FR 44776 (July 27, 2011).

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    E. The Notice of Proposed Rulemaking

    A Notice of Proposed Rulemaking (NPRM) was issued by the Commission

    on October 26, 2010, having been considered in conjunction with the

    Dodd-Frank rulemaking regarding credit ratings. The NPRM was published

    in the Federal Register on November 3, 2010, and the comment period

    closed on December 3, 2010.\21\

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    \21\ See 75 FR 67642 (Nov. 3, 2010); see also 76 FR 25274 (May

    4, 2011) (reopening the comment period for certain NPRMs until June

    3, 2011).

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    The Commission invited comments related to topics covered by

    Regulations 1.25 and 30.7, including the scope of permitted

    investments, liquidity, marketability, ratings, concentration limits,

    portfolio weighted average maturity requirements, and the applicability

    of Regulation 1.25 standards to foreign futures accounts. The

    Commission received 32 comment letters.\22\

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    \22\ Comment letters were received from ADM Investor Services,

    Inc. (ADM), Bank of New York Mellon (BNYM), BlackRock, Inc.

    (BlackRock), Brown Brothers Harriman & Co. (BBH), Business Law

    Society of the University of Mississippi (BLS), CME, Committee on

    the Investment of Employee Benefit Assets (CIEBA), Dreyfus, Farm

    Credit Administration (FCA), Farm Credit Council (Farm Credit

    Council), Farr Financial Inc. (Farr Financial), Federal Farm Credit

    Banks Funding Corporation (FFCB), Federal Housing Finance Authority

    (FHFA), Federated, Futures and Options Association (FOA), FIA and

    International Swaps and Derivatives Association, Inc. (FIA/ISDA),

    International Assets Holding Corporation and FCStone (INTL/FCStone),

    ICI, Joint Audit Committee (JAC), J.P. Morgan Futures Inc. (J.P.

    Morgan), LCH.Clearnet Group (LCH), MF Global and Newedge (MF Global/

    Newedge), MorganStanley & Co. (MorganStanley), NFA, Natural Gas

    Exchange, Inc. (NGX), Office of Finance of the Federal Home Loan

    Banks (FHLB), R.J. O'Brien and Associates (RJO), and UBS Global

    Asset Management (Americas) Inc. (UBS). Federated sent multiple

    letters. Federated's November 30, 2010 letter will be referred to as

    ``Federated I,'' its December 2, 2010 letter will be referred to as

    ``Federated II,'' and Arnold & Porter LLP's post-comment period

    letter on behalf of Federated, dated March 21, 2011, will be

    referred to as ``Federated III.'' Federated also sent a letter dated

    November 8, 2010 and a post-comment period letter dated February 28,

    2011. The letters from BLS and NGX were received during the reopened

    comment period, on May 12, 2011 and May 31, 2011, respectively.

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    [[Page 78778]]

    II. Discussion of the Final Rules

    A. Permitted Investments--Regulation 1.25

    In finalizing amendments to Regulation 1.25, the Commission seeks

    to impose requirements on the investment of customer segregated funds

    with the goal of enhancing the preservation of principal and

    maintenance of liquidity consistent with Section 4d of the Act. The

    Commission has endeavored to tailor its amendments to achieve these

    goals, while retaining an appropriate degree of investment flexibility

    and opportunities for attaining capital efficiency for DCOs and FCMs

    investing customer segregated funds.

    In issuing these final rules, the Commission is narrowing the scope

    of investment choices in order to eliminate the potential use of

    portfolios of instruments that may pose an unacceptable level of risk

    to customer funds. The Commission seeks to increase the safety of

    Regulation 1.25 investments by promoting diversification.

    Below, the Commission details its decisions regarding the proposals

    in the NPRM. The Commission has decided to:

    Retain investments in U.S. agency obligations, including

    implicitly backed GSE debt securities, and impose limitations on

    investments in debt issued by the Federal National Mortgage Association

    (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie

    Mac);

    Remove corporate debt obligations not guaranteed by the

    United States from the list of permitted investments;

    Eliminate foreign sovereign debt as a permitted

    investment; and

    Eliminate in-house and affiliate transactions.

    1. Government Sponsored Enterprise Securities

    In the NPRM, the Commission proposed to amend Regulation

    1.25(a)(1)(iii) to expressly add U.S. government corporation

    obligations \23\ to GSE debt securities \24\ (together, U.S. agency

    obligations) and to add the requirement that the U.S. agency

    obligations must be fully guaranteed as to principal and interest by

    the United States. As proposed, all current GSE debt securities,

    including that of Fannie Mae and Freddie Mac, would have been

    impermissible as Regulation 1.25 investments since no GSE debt

    securities have the explicit guarantee of the U.S. government. The

    Commission received 14 comment letters discussing GSEs. Thirteen of

    those 14 comment letters opposed the proposal.

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    \23\ See 31 U.S.C. 9101 (defining ``government corporation'').

    \24\ GSEs are chartered by Congress but are privately owned and

    operated. Securities issued by GSEs do not have an explicit federal

    guarantee, although they are considered by some to have an

    ``implicit'' guarantee due to their federal affiliation. Obligations

    of U.S. government corporations, such as the Government National

    Mortgage Association (known as GNMA or Ginnie Mae), are explicitly

    backed by the full faith and credit of the United States. Although

    the Commission is not aware of any GSE securities that have an

    explicit federal guarantee, in the NPRM the Commission concluded

    that GSE securities should remain on the list of permitted

    investments in the event this status changes in the future.

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    Generally, the arguments focused on the safety of GSEs, GSEs'

    performance during the financial crisis, and the detrimental,

    unintended consequences of the proposal. In addition, there were

    several letters from organizations related to the Farm Credit System

    GSE (Farm Credit System) and FHLB System GSE (FHLB System) supporting,

    at a minimum, the inclusion of their GSE debt as a permitted Regulation

    1.25 investment.

    In terms of safety, commenters expressed the view that GSE debt

    securities are sufficiently liquid and that the U.S. government would

    not allow a GSE to fail.\25\ FFCB remarked that the Securities and

    Exchange Commission (SEC) has retained GSE debt securities as

    investments appropriate under SEC Rule 2a-7 \26\ (which governs

    MMMFs).\27\ In addition to GSEs being safe, BlackRock noted that ``any

    changes in the viability of such entities should be telegraphed well in

    advance resulting in minimal disruption to the credit markets.'' \28\

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    \25\ MF Global/Newedge letter at 4.

    \26\ 17 CFR 270.2a-7.

    \27\ FFCB letter at 3.

    \28\ BlackRock letter at 6.

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    With respect to Fannie Mae and Freddie Mac, the FHFA's support of

    those GSEs effectively amounts to a federal guarantee, according to two

    commenters.\29\ As long as the federal government holds exposure of

    greater than 50 percent in Fannie Mae and Freddie Mac, RJO wrote that

    it believes that the quality of these issuances is better than those of

    any bank or corporation.\30\

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    \29\ FIA/ISDA letter at 5, J.P. Morgan letter at 1.

    \30\ RJO letter at 5.

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    Commenters averred that the safety of GSEs is further proven by

    their stability during the financial crisis. MF Global/Newedge,

    BlackRock and ADM noted that non-Fannie Mae/Freddie Mac GSEs performed

    well during the financial crisis.\31\

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    \31\ MF Global/Newedge letter at 5, BlackRock letter at 6, ADM

    letter at 3. MF Global cited the Student Loan Marketing Association,

    FFCB Federal Home Loan Banks and Federal Agricultural Mortgage

    Corporation as examples of GSEs that performed well during the

    financial crisis.

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    Limiting investments to only those agency obligations backed by the

    full faith and credit of the U.S. government would be a mistake because

    ``none'' satisfy the requirement, according to the NFA, or ``only

    GNMAs'' satisfy the requirement, according to ADM.\32\ The FHFA wrote

    that specific criteria for eligible investments is preferable to

    speculation on the actions of third parties (such as whether the

    federal government will or will not bail out a GSE).\33\

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    \32\ NFA letter at 2, ADM letter at 3.

    \33\ FHFA letter at 1.

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    Several commenters were concerned that the Commission's proposal

    would have the unintended consequence of harming the broader market for

    GSEs, as investors would question the safety of such investments.\34\

    The Farm Credit Council wrote that ``[u]ntil and unless Congress

    signals its intention to erode the federal government's support of

    GSEs, we respectfully request that the CFTC not amend Regulation 1.25

    with respect to investments in GSEs.'' \35\

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    \34\ FCA at 2, Farm Credit Council letter at 3, RJO letter at 4,

    FFCB letter at 3.

    \35\ Farm Credit Council letter at 1-2.

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    Most commenters recommended that GSE debt securities, including

    those not explicitly guaranteed by the U.S. government, remain

    permitted investments to varying extents. There were a range of

    recommendations regarding the debt of Fannie Mae and Freddie Mac. MF

    Global/Newedge suggested that GSEs with implicit guarantees should have

    a 50 percent asset-based concentration limit along

    [[Page 78779]]

    with a 10 percent issuer-based limit, or, alternatively, that GSEs

    meeting specific outstanding float standards should be allowed. MF

    Global/Newedge stated that, at a minimum, the Commission should allow

    FCMs to invest in GSEs other than Fannie Mae and Freddie Mac.\36\ CME

    wrote that highly liquid GSEs, including those of Fannie Mae and

    Freddie Mac, should remain as permitted investments and should have a

    25 percent asset-based concentration limit.\37\ RJO recommended that

    all GSE securities be permitted, and that, at the very least, the

    Commission should permit investments in Fannie Mae and Freddie Mac

    until December 31, 2012, when the government guarantee expires.\38\

    FIA/ISDA recommended that investments in GSE securities be permitted

    subject to the conditions that (i) with the exception of ``agency

    discount notes,'' the size of the issuance is at least $1 billion, (ii)

    trading in the securities of such agency remains highly liquid, (iii)

    the prices at which the securities may be traded are publicly available

    (through, for example, Bloomberg or Trace), and (iv) investments in

    GSEs are subject to a maximum of 50 percent asset-based and 15 percent

    issuer-based concentration limits.\39\ BlackRock recommended a 30

    percent issuer limitation on GSEs.\40\

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    \36\ MF Global/Newedge letter at 5.

    \37\ CME letter at 3.

    \38\ RJO letter at 5.

    \39\ FIA/ISDA letter at 5.

    \40\ BlackRock at 6.

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    The Farm Credit Council, FHLB, the FCA, the FFCB and RJO all wrote

    letters supporting one or both of the FHLB System \41\ and Farm Credit

    System debt securities.\42\ FHLB stated that the prohibition on GSEs

    not explicitly backed by the full faith and credit of the federal

    government is overly broad. In particular, FHLB noted that FHLB debt

    securities performed well throughout the financial crisis. FHLB stated

    that it maintained funding capabilities even during the most severe

    periods of market stress, due to investors' favorable views of its debt

    securities.\43\ Similarly, the Farm Credit Council wrote that Farm

    Credit debt securities remained safe during the recent period of market

    volatility, and the Farm Credit System was able to supply much-needed

    financial support to farmers, rangers, harvesters of aquatic products,

    agricultural cooperatives, and rural residents and businesses.\44\ Farm

    Credit discount notes, among other Farm Credit debt securities, ``have

    been a staple in risk-averse investor portfolios since the [Farm Credit

    System's] inception in 1916 and have proven their creditworthiness

    across a range of market environments.'' \45\ During the recent crisis,

    the Farm Credit System was able to issue and redeem over $400 billion

    in discount notes annually, while issuing over $100 billion per year in

    longer-maturity debt securities.\46\ RJO concurred regarding both GSEs,

    noting that the FHLB System and Farm Credit System experienced minimal,

    if any, problems during the crisis.\47\

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    \41\ The FHLB System, which is regulated by the FHFA, comprises

    an ``Office of Finance'' and 12 independently-chartered, regional

    cooperative Federal Home Loan Banks created by Congress to provide

    support for housing finance and community development through member

    financial institutions. The 12 Federal Home Loan Banks issue debt

    securities (FHLB debt securities), the proceeds from which are used

    to provide liquidity to the 7,900 FHLB member banks through

    collateralized loans. See FHLB letter at 1-3.

    \42\ The Farm Credit System comprises five banks and 87

    associations which provide credit and financial services to farmers,

    ranchers, and similar agricultural enterprises by issuing debt (Farm

    Credit debt securities) through the FFCB.

    \43\ FHLB letter at 1-3.

    \44\ Farm Credit Council letter at 1. Farm Credit debt

    securities are regulated by the FCA and insured by an independent

    U.S. government-controlled corporation which maintains an insurance

    fund of roughly 2 percent of the outstanding loans. The total

    outstanding loan amount was over $3 billion as of the end of 2009.

    See Farm Credit Council letter at 2.

    \45\ FFCB letter at 1.

    \46\ Id.

    \47\ RJO letter at 4.

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    CIEBA, which represents 100 of the country's largest pension funds,

    was the only commenter that backed the proposal.\48\

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    \48\ CIEBA letter at 3.

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    After reviewing the comments, the Commission has concluded that

    U.S. agency obligations should remain permitted investments. The

    Commission acknowledges the fact, mentioned by several commenters, that

    most GSE debt performed well during the most recent financial crisis.

    The Commission believes it appropriate to include a limitation for

    debt issued by Fannie Mae and Freddie Mac, two GSEs which did not

    perform well during the recent financial crisis. Both entities failed

    and, as a result, have been operating under the conservatorship of the

    FHFA since September of 2008. As conservator of Fannie Mae and Freddie

    Mac, FHFA has assumed all powers formerly held by each entity's

    officers, directors, and shareholders. In addition, FHFA, as

    conservator, is authorized to take such actions as may be necessary to

    restore each entity to a sound and solvent condition and that are

    appropriate to preserve and conserve the assets and property of each

    entity.\49\

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    \49\ See 12 U.S.C. 4617(b)(2)(D). The primary goals of the

    conservatorships are to help restore confidence in the entities,

    enhance their capacity to fulfill their mission, mitigate the

    systemic risk that contributed directly to instability in financial

    markets, and maintain Fannie Mae and Freddie Mac's secondary

    mortgage market role until their future is determined through

    legislation. To these ends, FHFA's conservatorship of Fannie Mae and

    Freddie Mac is directed toward minimizing losses, limiting risk

    exposure, and ensuring that Fannie Mae and Freddie Mac price their

    services to adequately address their costs and risk.

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    In consideration of the above comments, the Commission is amending

    Regulation 1.25(a)(1)(iii) by permitting investments in U.S. agency

    obligations. The Commission is adding new paragraph (a)(3) to include

    the limitation that debt issued by Fannie Mae and Freddie Mac are

    permitted as long as these entities are operating under the

    conservatorship or receivership of FHFA.

    2. Commercial Paper and Corporate Notes or Bonds

    In order to simplify Regulation 1.25 by eliminating rarely-used

    instruments, and in light of the credit, liquidity, and market risks

    posed by corporate debt securities, the Commission proposed amending

    Regulation 1.25(a)(1)(v)-(vi) to limit investments in ``commercial

    paper'' \50\ and ``corporate notes or bonds'' \51\ to commercial paper

    and corporate notes or bonds that are federally guaranteed as to

    principal and interest under the Temporary Liquidity Guarantee Program

    (TLGP) and meet certain other prudential standards.\52\

    ---------------------------------------------------------------------------

    \50\ 17 CFR 1.25(a)(1)(v).

    \51\ 17 CFR 1.25(a)(1)(vi).

    \52\ Commercial paper would remain available as a direct

    investment for MMMFs and corporate notes or bonds would remain

    available as indirect investments for MMMFs by means of a repurchase

    agreement.

    ---------------------------------------------------------------------------

    The NPRM supported this proposal by noting the credit, liquidity

    and market risks associated with corporate notes or bonds and

    referenced that information obtained during the 2007 Review indicated

    that commercial paper and corporate notes or bonds were not widely used

    by FCMs or DCOs.\53\ Second, the NPRM provided background on the TLGP

    and explained that TLGP debt would be permissible if: (1) The size of

    the issuance is greater than $1 billion; (2) the debt security is

    denominated in U.S. dollars; and (3) the debt security is guaranteed

    for its entire term.\54\

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    \53\ The 2007 Review indicated that out of 87 FCM respondents,

    only nine held commercial paper and seven held corporate notes/bonds

    as direct investments during the November 30, 2006--December 1, 2007

    period.

    \54\ Debra Kokal, Joint Audit Committee, CFTC Staff Letter 10-01

    [Current Transfer Binder] Comm. Fut. L. Rep. (CCH) ] 31,514 (Jan.

    15. 2010) (TLGP Letter).

    ---------------------------------------------------------------------------

    Seven comment letters discussed commercial paper and corporate

    notes

    [[Page 78780]]

    or bonds in a substantive manner. Six of the comment letters weighed in

    favor of retaining commercial paper and corporate notes or bonds to

    some degree. Comments included statements as to the effects of the

    proposal, the safety of these instruments, and the lack of reliability

    of the 2007 Commission review of customer funds investments.

    According to three commenters, limiting commercial paper and

    corporate notes or bonds to just those backed by the TLGP is

    essentially eliminating the asset class altogether.\55\ BlackRock, ADM

    and RJO asserted that TLGP debt is not liquid due to the lack of

    available supply and therefore might not be a viable option for

    investment.\56\

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    \55\ BlackRock letter at 6, RJO letter at 6, ADM letter at 3.

    \56\ By contrast, the Commission found that TLGP debt that (1)

    has an issuance size of greater than $1 billion, (2) is denominated

    in U.S. dollars and (3) is guaranteed for its entire term, is

    sufficiently safe and liquid for use as a Regulation 1.25

    investment. See TLGP Letter.

    ---------------------------------------------------------------------------

    There was general support for maintaining corporate notes or bonds

    as Regulation 1.25 permitted investments. FIA/ISDA wrote that as long

    as trading in the relevant security remains highly liquid, such

    securities should continue to be eligible investments under Regulation

    1.25.\57\ RJO noted that commercial paper and corporate notes and bonds

    (i) have many high quality names, (ii) have a mature and liquid

    secondary market, and (iii) provide greater diversification than merely

    ``financial sector'' bank CDs.\58\ Further, RJO averred that high

    quality corporate notes or bonds are no different than those used by

    prime MMMFs.\59\ MF Global/Newedge stated that they were unaware of any

    instances of an FCM unable to meet its obligations under Regulation

    1.25 as a result of investment losses it suffered involving corporate

    notes or commercial paper. They believe that commercial paper and

    corporate notes or bonds should continue to be permitted; however, to

    the extent that there are limitations, they suggest (a) permitting FCMs

    to invest only in corporate notes or commercial paper issued by

    entities with a certain minimum capital level or which meet a certain

    float size, or (b) limiting FCM investments in such instruments to 25

    percent of their portfolio and 5 percent with any one issuer. BlackRock

    supports a 25-50 percent asset-based concentration limit for TLGP debt,

    but also notes that a lack of creditworthy supply may prevent an FCM

    from reaching that limit.\60\

    ---------------------------------------------------------------------------

    \57\ FIA/ISDA letter at 5.

    \58\ RJO letter at 6.

    \59\ RJO letter at 5.

    \60\ BlackRock letter at 6.

    ---------------------------------------------------------------------------

    Commenters rejected the Commission's contention that the lack of

    investment in commercial paper and corporate notes or bonds illustrated

    in its 2007 Review was dispositive. MF Global/Newedge suggested that

    the investment review is outdated and is inadequate to justify removing

    an important source of revenue for FCMs.\61\ RJO noted that commercial

    paper and corporate notes likely appear to be used minimally during the

    relevant period because investments in such instruments were not as

    safe during that time frame.\62\

    ---------------------------------------------------------------------------

    \61\ MF Global/Newedge at 8.

    \62\ RJO letter at 5.

    ---------------------------------------------------------------------------

    The Commission does not find the arguments in favor of retaining

    corporate notes and bonds to be persuasive. While the Commission

    encourages FCMs and DCOs to increase or decrease their holdings of

    certain permitted instruments depending on market conditions, the

    Commission is following the language of the statute and its goal of

    eliminating instruments that may, during tumultuous markets, tie up or

    threaten customer principal. The Commission recognizes that certain

    high-quality paper and notes may be sufficiently safe. As discussed in

    Section I.B.4.(a) of this rulemaking, an FCM or DCO may invest up to 50

    percent of its funds in prime MMMFs, which may invest in high-quality

    paper and notes meeting certain standards. To the extent that

    commenters suggested that the 2007 Report does not accurately reflect

    the volume of investment of customer segregated funds in commercial

    paper and corporate notes or bonds, the Commission believes that the

    2007 Report contains sufficiently accurate information reflective of

    the circumstances at that time.\63\ Further, notwithstanding the

    relative paucity of investment in such instruments, the Commission

    believes that the investment of customer funds in such instruments runs

    counter to the overarching objective of preserving principal and

    maintaining liquidity of customer funds.

    ---------------------------------------------------------------------------

    \63\ While the Commission does not have similar data reflecting

    Regulation 1.25 investments from more recent years, the Commission

    believes that investment in commercial paper and corporate notes or

    bonds remains minimal. This belief is supported by a July 21, 2009

    letter from NFA, in response to the ANPR, which averred that

    segregated funds were primarily invested in government securities

    and MMMFs, while investments in other instruments were

    ``negligible.'' Moreover, the Commission has received no evidence to

    contradict its position.

    ---------------------------------------------------------------------------

    Although the TLGP expires in 2012, the Commission believes it is

    useful to include commercial paper and corporate notes or bonds that

    are fully guaranteed as to principal and interest by the United States

    as permitted investments. This would permit continuing investment in

    TLGP debt securities, even though the Commission has otherwise

    eliminated commercial paper and corporate notes or bonds from the list

    of permitted investments. Therefore, the Commission is adopting the

    proposed amendments to Regulation 1.25(a) and (b) that limit the

    commercial paper and corporate notes or bonds that can qualify as

    permitted investments to only those guaranteed as to principal and

    interest under the TLGP and that meet the criteria set forth in the

    Division's interpretation.\64\ The Commission is amending Regulation

    1.25 by (1) amending paragraphs (a)(1)(v) and (a)(1)(vi) to specify

    that commercial paper and corporate notes or bonds must be federally

    backed and (2) inserting new paragraph (b)(2)(vi) that describes the

    criteria for federally backed commercial paper and corporate notes or

    bonds.\65\

    ---------------------------------------------------------------------------

    \64\ See TLGP Letter; 75 FR 67642, 67645 (Nov. 3, 2010).

    \65\ In the NPRM, the Commission proposed removing paragraph

    (b)(3)(iv) (as amended in this rulemaking, paragraph (b)(2)(iv))

    which permits adjustable rate securities as limited under that

    paragraph. As proposed, Regulation 1.25 would have only permitted

    corporate and U.S. agency obligations that had explicit U.S.

    government guarantees. However, since the Commission is, for the

    most part, retaining the current treatment of U.S. agency

    obligations, as described in more detail in section II.A.1 of this

    rulemaking, the Commission has decided not to adopt the proposed

    removal of paragraph (b)(3)(iv) (now paragraph (b)(2)(iv)).

    ---------------------------------------------------------------------------

    3. Foreign Sovereign Debt

    Currently, an FCM or DCO may invest in the sovereign debt of a

    foreign country to the extent it has balances in segregated accounts

    owed to its customers (or, in the case of a DCO, to its clearing member

    FCMs) denominated in that country's currency.\66\ In the NPRM, the

    Commission proposed to remove foreign sovereign debt as a permitted

    investment in the interests of both simplifying the regulation and

    safeguarding customer funds in light of

    [[Page 78781]]

    recent crises experienced by a number of foreign sovereigns. The

    Commission requested comment on whether foreign sovereign debt should

    remain, to any extent, as a permitted investment and, if so, what

    requirements or limitations might be imposed in order to minimize

    sovereign risk.

    ---------------------------------------------------------------------------

    \66\ The inclusion of foreign sovereign debt as a permitted

    investment can be traced to an August 7, 2000 comment letter from

    the Federal Reserve Bank of Chicago requesting that the Commission

    allow FCMs and DCOs to invest non-dollar customer funds in the

    foreign sovereign debt of the currency so denominated. The

    Commission agreed in its final rule, explaining that an FCM

    investing deposits of foreign currencies would be required to

    convert the foreign currencies to a U.S. dollar denominated asset,

    and that such conversion would ``increase its exposure to foreign

    currency fluctuation risk, unless it incurred the additional expense

    of hedging.'' See 65 FR 78003 (Dec. 13, 2000).

    ---------------------------------------------------------------------------

    Thirteen comment letters discussed foreign sovereign debt. Twelve

    of the 13 suggested retaining foreign sovereign debt to varying

    degrees. One comment letter supported the Commission's proposal. As

    discussed in more detail below, both the importance of hedging against

    foreign currency exposure as well as the unintended consequences of the

    proposal were cited frequently by commenters as reasons to retain

    foreign sovereign debt as a permitted investment.

    Six commenters discussed the need to mitigate the risks associated

    with foreign currency exposure. FIA/ISDA, MF Global/Newedge, J.P.

    Morgan, LCH, NFA and FOA each noted that when a DCO requires margin

    deposited in a foreign currency, an FCM will face a foreign currency

    exposure in order to meet that margin requirement. The FCM is able to

    mitigate this exposure by investing customer funds in foreign sovereign

    debt securities denominated in the relevant currency.\67\

    ---------------------------------------------------------------------------

    \67\ FIA/ISDA letter at 6, MF Global/Newedge letter at 5, J.P.

    Morgan letter at 1, LCH letter at 2, NFA letter at 3, FOA letter at

    4.

    ---------------------------------------------------------------------------

    The benefits of increased diversification and liquidity were

    mentioned by three commenters. FOA and ADM noted that outside

    investment in sovereign debt played a key role, during the recent

    financial crisis, in maintaining liquidity and demand in such

    instruments, which, in turn, had a beneficial impact on pricing and

    spreads.\68\ BlackRock wrote that, notwithstanding the current limited

    investment in foreign sovereign debt, there are opportunities to add

    diversification and liquidity by allowing such investments.\69\ FIA/

    ISDA, FOA and BlackRock suggested that lack of use should not

    disqualify an investment as long as permitting it would still serve to

    preserve principal and maintain liquidity.\70\

    ---------------------------------------------------------------------------

    \68\ FOA letter at 2, ADM letter at 2.

    \69\ BlackRock letter at 6.

    \70\ FIA/ISDA letter at 6, FOA letter at 3, BlackRock letter at

    6.

    ---------------------------------------------------------------------------

    Several commenters predicted harmful unintended consequences if the

    proposal to remove foreign sovereign debt as a permitted investment

    becomes the final rule. CME suggested that the implementation of the

    Dodd-Frank Act will result in an increase in the amount of customer

    funds held by FCMs and an increase in the number of foreign customers

    and foreign-domiciled clearing members.\71\ Removing foreign sovereign

    debt would limit diversification, would undermine the role of non-US

    sovereign debt, and would have the unintended consequence of increasing

    market volatility, according to FOA.\72\ LCH and FOA predicted that

    retaliatory action from foreign jurisdictions also could occur.\73\

    ---------------------------------------------------------------------------

    \71\ CME letter at 3.

    \72\ FOA letter at 3.

    \73\ LCH letter at 2, FOA letter at 2-3.

    ---------------------------------------------------------------------------

    Most commenters supported retaining foreign sovereign debt to some

    degree. CME and FIA/ISDA suggested that foreign sovereign debt be

    retained as a permitted investment, adding that all investments must be

    highly liquid under the terms of Regulation 1.25, so risky foreign

    sovereign debt would not be permitted.\74\ LCH recommended that foreign

    sovereign debt remain permitted as an investment, or, at a minimum,

    that investments be limited to only high quality sovereign issuers.\75\

    LCH also noted that DCOs have conservative investment policies in place

    already.\76\ RJO suggested limiting foreign sovereign debt to only G-7

    issuers, with limits based upon the margin requirement for all client

    positions.\77\ NGX suggested that DCOs domiciled outside of the U.S.,

    in G-7 countries, be permitted to invest in their country's sovereign

    debt, adding that not allowing such investments may be a ``hardship''

    on such DCOs.\78\ ADM suggested that G-7 countries serve as a ``safe

    harbor'' for Regulation 1.25 foreign sovereign debt investments.\79\

    One commenter, CIEBA, backed the Commission's proposal without further

    explanation.\80\

    ---------------------------------------------------------------------------

    \74\ CME letter at 3, FIA/ISDA letter at 6.

    \75\ LCH letter at 2.

    \76\ Id.

    \77\ RJO letter at 6.

    \78\ NGX letter at 3.

    \79\ ADM letter at 2.

    \80\ CIEBA letter at 3.

    ---------------------------------------------------------------------------

    The Commission has considered the comments and has decided to adopt

    the proposed amendment, thereby eliminating foreign sovereign debt from

    the list of permitted investments. As discussed in more detail below,

    the Commission believes that, in many cases, the potential volatility

    of foreign sovereign debt in the current economic environment and the

    varying degrees of financial stability of different issuers make

    foreign sovereign debt inappropriate for hedging foreign currency risk.

    The Commission also is not persuaded that foreign sovereign debt is

    used with sufficient frequency to justify the commenters' claims that

    foreign sovereign debt assists with diversification of customer fund

    investments, and it is not persuaded that the specter of backlash from

    other jurisdictions or increased market volatility requires a different

    outcome.

    First, while it appreciates the risks of foreign currency exposure,

    the Commission does not believe that foreign sovereign debt is, in all

    situations, a sufficiently safe means for hedging such risk. Recent

    global and regional financial crises have illustrated that

    circumstances may quickly change, negatively impacting the safety of

    sovereign debt held by an FCM or DCO. An FCM or DCO holding troubled

    sovereign debt may then be unable to liquidate such instruments in a

    timely manner--and, when it does, it may be only after a significant

    mark-down. Given the choice between an FCM holding devalued currency,

    which can be exchanged for a portion of the customers' margin and

    returned to the customer immediately, and an FCM holding illiquid

    foreign sovereign debt, which might not be able to be exchanged for any

    currency in a timely manner, the Commission believes that the former is

    in the customers' best interests. The Commission notes that FCMs can

    avoid foreign currency risk by not accepting collateral that is not

    accepted at the DCO or foreign board of trade, or by providing in its

    customer agreement that the customer will bear any currency

    exposure.\81\

    ---------------------------------------------------------------------------

    \81\ Additionally, the Commission believes that it is

    appropriate to note that Regulation 1.25 does not dictate the

    collateral that may be accepted by FCMs from customers or by DCOs

    from clearing member FCMs. If FCMs and DCOs so allow, customers and

    clearing member FCMs, respectively, may continue to post foreign

    currency or foreign sovereign debt as collateral.

    ---------------------------------------------------------------------------

    Second, the Commission is not persuaded by commenters' assertions

    that investment in foreign sovereign debt has increased the

    diversification of customer funds in any meaningful way. The Commission

    has noted that investment in foreign sovereign debt was minimal in the

    2007 Review.\82\ The Commission has received no data or evidence from

    any commenter suggesting that investment in foreign sovereign debt has

    materially increased since the 2007 Review.

    ---------------------------------------------------------------------------

    \82\ 75 FR 67642, 67645.

    ---------------------------------------------------------------------------

    Third, the Commission does not believe that eliminating foreign

    sovereign debt as a permitted investment of customer funds will cause

    the market or jurisdictional problems claimed by commenters. As

    discussed above, no commenter has demonstrated that foreign sovereign

    debt is widely used, so its elimination should not

    [[Page 78782]]

    undermine foreign sovereign debt nor cause a disruption in the market.

    The foregoing points notwithstanding, the Commission is aware that

    FCMs and DCOs have varying collateral management needs and investment

    policies. The Commission also recognizes that the safety of sovereign

    debt issuances of one country may vary greatly from those of another,

    and that investment in certain sovereign debt might be consistent with

    the objectives of preserving principal and maintaining liquidity, as

    required by Regulation 1.25.

    Therefore, the Commission is amenable to considering applications

    for exemptions with respect to investment in foreign sovereign debt by

    FCMs or DCOs upon a demonstration that the investment in the sovereign

    debt of one or more countries is appropriate in light of the objectives

    of Regulation 1.25 and that the issuance of an exemption satisfies the

    criteria set forth in Section 4(c) of the Act.\83\ Accordingly, the

    Commission invites FCMs and DCOs that seek to invest customer funds in

    foreign sovereign debt to petition the Commission pursuant to Section

    4(c). The Commission will consider permitting investments (1) to the

    extent that the FCM or DCO has balances in segregated accounts owed to

    its customers (or clearing member FCMs, as the case may be) in that

    country's currency and (2) to the extent that such sovereign debt

    serves to preserve principal and maintain liquidity of customer funds

    as required for all other investments of customer funds under

    Regulation 1.25.

    ---------------------------------------------------------------------------

    \83\ See 7 U.S.C. 6(c).

    ---------------------------------------------------------------------------

    Finally, in response to NGX, the Commission does not agree that

    foreign domiciled FCMs and DCOs should be able to invest in the

    sovereign debt of their domicile nation. A compelling argument has not

    been presented as to why this constitutes a ``hardship'' to DCOs

    domiciled outside of the United States.

    4. In-house Transactions

    The Commission allowed in-house transactions as a permitted

    investment for the first time in 2005.\84\ At that time, the Commission

    stated that in-house transactions ``provide the economic equivalent of

    repos and reverse repos,'' and, like repurchase agreements with third

    parties, preserve the ``integrity of the customer segregated account.''

    \85\ The Commission further wrote that in-house transactions should not

    disrupt FCMs and DCOs from maintaining ``sufficient value in the

    account at all times.'' \86\ In the May 2009 ANPR, the Commission noted

    that the recent events in the economy underscored the importance of

    conducting periodic reassessments and refocused its review of permitted

    investments, including in-house transactions.\87\

    ---------------------------------------------------------------------------

    \84\ 70 FR 28190, 28193.

    \85\ 70 FR 28193. See also 70 FR 5577, 5581 (February 3, 2005).

    \86\ 70 FR 28190, 28193.

    \87\ 74 FR 23963, 23964.

    ---------------------------------------------------------------------------

    In the NPRM, the Commission proposed to eliminate in-house

    transactions permitted under paragraph (a)(3) and subject to the

    requirements of paragraph (e) of Regulation 1.25. The Commission noted

    that ``[r]ecent market events have * * * increased concerns about the

    concentration of credit risk within the FCM/broker-dealer corporate

    entity in connection with in-house transactions.'' \88\ The Commission

    requested comment on the impact of this proposal on the business

    practices of FCMs and DCOs. Specifically, the Commission requested that

    commenters present scenarios in which a repurchase or reverse

    repurchase agreement with a third party could not be satisfactorily

    substituted for an in-house transaction.

    ---------------------------------------------------------------------------

    \88\ 75 FR 67642, 67646.

    ---------------------------------------------------------------------------

    Six commenters discussed in-house transactions. Four requested that

    in-house transactions be retained to some extent, while two supported

    the Commission's proposal to eliminate in-house transactions.

    FIA/ISDA, CME, MF Global/Newedge and MorganStanley recommended that

    the Commission allow FCMs to engage in in-house transactions. FIA/ISDA

    and CME suggested that the current terms of Regulation 1.25(e) should

    be more than sufficient to assure that the customer segregated account

    and the foreign futures and foreign options secured amount are

    protected in the event of an FCM bankruptcy.\89\ MorganStanley wrote

    that FCM efficiency relies heavily on in-house transactions,

    particularly when customer margin is not appropriate for DCO margin. It

    further stated that relying entirely on third party repurchase

    agreements will materially increase operational risk in an area where

    it is negligible today.\90\ According to MorganStanley,

    ---------------------------------------------------------------------------

    \89\ CME letter at 3, FIA/ISDA letter at 12.

    \90\ MorganStanley letter at 2-3.

    Because the in-house transaction can be effected and recorded

    through book entries on the FCM/broker-dealer's general ledger, it

    can be accomplished through automated internal processes that are

    subject to a high level of control. The same is not routinely true

    of third-party repurchase arrangements, which often involve greater

    time lags than do in-house transactions between execution and

    settlement and also typically require more manual processing than

    their in-house counterparts.\91\

    ---------------------------------------------------------------------------

    \91\ Morgan Stanley letter at 2.

    MorganStanley further noted that, as with the FCM of Lehman Brothers

    Holdings Inc. (Lehman Brothers) in 2008, a third party custodial

    arrangement is not without risk.\92\ MF Global/Newedge wrote that

    removing in-house transactions would not reduce FCM risk, ``since FCMs

    would be unable to enter into and execute such transactions with and

    through entities and personnel with whom they have created an

    effective, efficient and liquid settlement framework.'' \93\

    ---------------------------------------------------------------------------

    \92\ MorganStanley letter at 3-4.

    \93\ MF Global/Newedge letter at 7.

    ---------------------------------------------------------------------------

    However, RJO stated that in-house transactions currently do not

    provide ``protection to the capital base of the FCM arm of a dually

    registered entity.'' \94\ Without ``ring fencing the capital associated

    with the separately regulated business lines,'' RJO does not consider

    in-house transactions to be satisfactory substitutes for separately

    capitalized affiliates or third parties.\95\

    ---------------------------------------------------------------------------

    \94\ RJO letter at 3.

    \95\ Id.

    ---------------------------------------------------------------------------

    CME and FIA/ISDA support retaining in-house transactions as they

    currently are permitted under Regulation 1.25. MorganStanley suggested

    retaining in-house transactions subject to a concentration limit of 25

    percent of total assets held in segregation or secured amount; or if

    the Commission is determined to eliminate in-house transactions,

    raising the proposed concentration limit for reverse repurchase

    agreements to 25 percent of total assets held in segregation or secured

    amount.\96\ RJO, for the reasons noted above, and CIEBA, without

    explanation, both support the proposal to remove in-house transactions

    from the list of permitted investments.\97\

    ---------------------------------------------------------------------------

    \96\ MorganStanley letter at 4.

    \97\ RJO letter at 3, CIEBA letter at 3.

    ---------------------------------------------------------------------------

    Many commenters to the NPRM similarly suggest that the benefits of

    repurchase and reverse repurchase agreements can also be realized by

    in-house transactions, without any decrease in safety to customer

    funds. The Commission rejects this position. The Commission believes

    that in-house transactions are fundamentally different than repurchase

    or reverse repurchase agreements with third parties. In the case of a

    reverse repurchase agreement, the transaction is similar to a

    collateralized loan whereby customer cash is exchanged for unencumbered

    collateral, both of which are housed in legally separate entities. The

    agreement is transacted at arms-length (often by

    [[Page 78783]]

    means of a tri-party repo mechanism), on a delivery versus payment

    basis, and is memorialized by a legally binding contract. By contrast,

    in an in-house transaction, cash and securities are under common

    control of the same legal entity, which presents the potential for

    conflicts of interest in the handling of customer funds that may be

    tested in times of crisis. Unlike a repurchase or reverse repurchase

    agreement, there is no mechanism to ensure that an in-house transaction

    is done on a delivery versus payment basis. Furthermore, an in-house

    transaction, by its nature, is transacted within a single entity and

    therefore cannot be legally documented, since an entity cannot contract

    with itself (the most one could do to document such a transaction would

    be to make an entry on a ledger or sub-ledger).

    Other advocates of in-house transactions explained that in-house

    transactions help them better manage their balance sheets. For example,

    if a firm entered into a repurchase or reverse repurchase transaction

    with an unaffiliated third party, the accounting of that transaction

    may cause the consolidated balance sheet of the firm to appear larger

    than if the transaction occurred in-house. In 2005, the Commission

    wrote that in-house transactions could ``assist an FCM both in

    achieving greater capital efficiency and in accomplishing important

    risk management goals, including internal diversification targets.''

    \98\ However, the purpose of Regulation 1.25 is not to assist FCMs and

    DCOs with their balance sheet maintenance. The purpose of Regulation

    1.25 is to permit FCMs and DCOs to invest customer funds in a manner

    that preserves principal and maintains liquidity.

    ---------------------------------------------------------------------------

    \98\ 70 FR 28193; see also 70 FR 5581.

    ---------------------------------------------------------------------------

    The Commission reiterates that customer segregation is the

    foundation of customer protection in the commodity, futures and swaps

    markets. Segregation must be maintained at all times, pursuant to

    Section 4d of the Act and Commission Regulation 1.20,\99\ and customer

    segregated funds must be invested in a manner which preserves principal

    and maintains liquidity in accordance with Regulation 1.25. As such,

    the Commission must be vigilant in narrowing the scope of Regulation

    1.25 if transactions that were once considered sufficiently safe later

    prove to be unacceptably risky. Based on the concerns outlined above,

    the Commission now believes that in-house transactions present an

    unacceptable risk to customer segregated funds under Regulation 1.25.

    The final regulation deletes paragraph (a)(3), as proposed.\100\

    ---------------------------------------------------------------------------

    \99\ 17 CFR 1.20.

    \100\ Conversely, transactions that at one point in time are

    considered to be unacceptably risky may later prove to be

    sufficiently safe. Should any person, in the future, believe that

    circumstances warrant reconsideration of the deletion of paragraph

    (a)(3) regarding in-house transactions, such person may petition the

    Commission for an amendment in accordance with the procedures set

    forth in Regulation 13.2, 17 CFR 13.2. Such a petition may include

    proposed conditions to the listing of in-house transactions as

    permitted investments in order to address the concerns (e.g.,

    concentration of credit risk within the FCM/broker-dealer corporate

    entity, potential for conflicts of interest in handling customer

    funds, etc.) that are the basis for the Commission's determination

    to eliminate in-house transactions as permitted investments at this

    time.

    ---------------------------------------------------------------------------

    For the removal of doubt, the Commission wishes to distinguish in-

    house transactions from in-house sales of permitted investments. An in-

    house transaction is an exchange of cash or permitted instruments, held

    by a dually registered FCM/broker dealer, for customer funds. An in-

    house sale is the legal purchase of a permitted investment, which may

    be owned by a dually registered FCM/broker-dealer, with customer funds.

    Such in-house sales of permitted investments at fair market prices are

    acceptable and are unaffected by the elimination of in-house

    transactions.

    In addition, the Commission wishes to distinguish in-house

    transactions from collateral exchanges for the benefit of the customer.

    As described above, a dually registered FCM/broker-dealer may not

    engage in in-house transactions, which are exchanges made at the

    discretion of the dually registered entity. However, a dually

    registered FCM/broker-dealer receiving customer collateral not

    acceptable at the DCO or foreign board of trade may exchange that

    collateral for acceptable collateral held by its dually registered

    broker-dealer to the extent necessary to meet margin requirements.\101\

    ---------------------------------------------------------------------------

    \101\ FCMs, whether or not dually registered as broker-dealers,

    may also engage in collateral exchanges for the benefit of customers

    with affiliates or third parties.

    ---------------------------------------------------------------------------

    B. General Terms and Conditions

    FCMs and DCOs may invest customer funds only in enumerated

    permitted investments ``consistent with the objectives of preserving

    principal and maintaining liquidity.''\102\ In furtherance of this

    general standard, paragraph (b) of Regulation 1.25 establishes various

    specific requirements designed to minimize credit, market, and

    liquidity risk. Among them are requirements that the investment be

    ``readily marketable'' (a concept borrowed from SEC regulations), that

    it meet specified rating requirements, and that it not exceed specified

    issuer concentration limits. The Commission proposed and has decided to

    amend these standards to facilitate the preservation of principal and

    maintenance of liquidity by establishing clear, prudential standards

    that further investment quality and portfolio diversification and to

    remove references to credit ratings. The Commission notes that an

    investment that meets the technical requirements of Regulation 1.25,

    but does not meet the overarching prudential standard, cannot qualify

    as a permitted investment.

    ---------------------------------------------------------------------------

    \102\ 17 CFR 1.25(b).

    ---------------------------------------------------------------------------

    1. Marketability

    Regulation 1.25(b)(1) states that ``[e]xcept for interests in money

    market mutual funds, investments must be `readily marketable' as

    defined in Sec. 240.15c3-1 of this title.'' \103\ In the NPRM, the

    Commission proposed to remove the ``readily marketable'' requirement

    from paragraph (b)(1) of Regulation 1.25 and substitute in its place a

    ``highly liquid'' standard. The Commission proposed to define ``highly

    liquid'' as having the ability to be converted into cash within one

    business day, without a material discount in value. As an alternative,

    the Commission offered a calculable standard, in which an instrument

    would be considered highly liquid if there was a reasonable basis to

    conclude that, under stable financial conditions, the instrument has

    the ability to be converted into cash within one business day, without

    greater than a one percent haircut off of its book value.

    ---------------------------------------------------------------------------

    \103\ See 17 CFR 240.15c3-1(c)(11)(i) (SEC regulation defining

    ``ready market'').

    ---------------------------------------------------------------------------

    The Commission requested comment on whether the proposed definition

    of ``highly liquid'' accurately reflected the industry's understanding

    of that term, and whether the term ``material'' might be replaced with

    a more precise or, perhaps, even calculable standard. The Commission

    welcomed comment on the ease or difficulty in applying the proposed or

    alternative ``highly liquid'' standards.

    Six commenters mentioned the ``highly liquid'' definition. All six

    supported the proposed, but not the alternative, standard.\104\ Several

    noted that under the alternative standard, even some Treasuries would

    likely fall outside of the scope of permitted investments. No

    commenters provided more precise language than ``material'' or any

    calculable option.

    ---------------------------------------------------------------------------

    \104\ CME letter at 7, JAC letter at 1-2, FIA/ISDA letter at 3,

    Farr Financial letter at 3, RJO letter at 7, BlackRock letter at 6.

    ---------------------------------------------------------------------------

    Certain commenters requested additional clarification. FIA/ISDA

    wrote

    [[Page 78784]]

    that some liquid securities do not trade every day and requested that

    the Commission confirm that, in determining whether a security is

    highly liquid, an FCM may use, as a reference, securities that are

    directly comparable, particularly for those issuers with many classes

    of securities outstanding.\105\ FIA/ISDA also asked the Commission to

    confirm that FCMs may rely on publicly available prices as well as

    third party pricing vendors such as Bloomberg, TradeWeb, TRACE, IDCG

    and MSRB.\106\ Additionally, JAC requested assurance that the highly

    liquid standard will not be substituted for ``ready market'' in other

    places in Commission regulations, in the Form 1-FR-FCM instructions, or

    for offsets to debit/deficits on 30.7 statements.\107\

    ---------------------------------------------------------------------------

    \105\ FIA/ISDA letter at 3.

    \106\ Id.

    \107\ JAC letter at 2.

    ---------------------------------------------------------------------------

    The Commission has considered the comments received and concludes

    that the ``readily marketable'' standard is no longer appropriate and

    should be removed as it creates an overlapping and confusing standard

    when applied in the context of the express objective of ``maintaining

    liquidity.'' While ``liquidity'' and ``ready market'' appear to be

    interchangeable concepts, they have distinctly different origins and

    uses. The objective of ``maintaining liquidity'' is to ensure that

    investments can be promptly liquidated in order to meet a margin call,

    pay variation settlement, or return funds to the customer upon demand.

    Meanwhile, the SEC's ``ready market'' standard is intended for a

    different purpose (which is to set appropriate haircuts in order to

    calculate capital) and is easier to apply to exchange-traded equity

    securities than debt securities. The Commission is therefore adopting

    the proposal and amending the text of Regulation 1.25(b)(1) to delete

    ``readily marketable'' and replace it with ``highly liquid,'' defined

    as having the ability to be converted into cash within one business

    day, without a material discount in value.

    In response to FIA/ISDA's request for clarification, when

    determining whether a security which does not trade every day is

    sufficiently liquid, the Commission believes that an FCM may use any

    data that reasonably provides evidence of liquidity. However, it is the

    Commission's position that theoretical pricing data is not enough, on

    its own, to establish that a security is highly liquid. FCMs seeking

    pricing information should be able to use publicly-available as well as

    third party pricing vendors. Finally, in response to JAC, the

    Commission confirms that the ``highly liquid'' standard is for

    Regulation 1.25 purposes only. This standard will not be substituted

    for ``ready market'' elsewhere in Commission regulations at the present

    time.

    2. Ratings

    Consistent with Section 939A of the Dodd-Frank Act, the Commission

    is amending Regulation 1.25, as proposed, by removing all references to

    ratings requirements.\108\ Only one commenter discussed ratings.

    BlackRock cautioned that complete removal of ratings criteria as a risk

    filter may place undue responsibility on an FCM or DCO to complete a

    thorough risk assessment of an issuer's financial strength.\109\

    ---------------------------------------------------------------------------

    \108\ Section 939A(a) directs each Federal agency to review

    their regulations for references to or requirements of credit

    ratings and assessments of credit-worthiness. Section 939A(b)

    states, in part, that ``each such agency shall modify such

    regulation * * * to remove any reference to or requirement of

    reliance on credit ratings and to substitute in such regulation such

    standard of credit-worthiness as each respective agency shall

    determine as appropriate for such regulations.'' See 75 FR 67254

    (Nov. 2, 2010).

    \109\ BlackRock letter at 2.

    ---------------------------------------------------------------------------

    The Commission notes that the removal of references to ratings does

    not prohibit a DCO or FCM from taking into account credit ratings as

    one of many factors to be considered in making an investment decision.

    Rather, the presence of high ratings is not required and would not

    provide a safe harbor for investments that do not satisfy the

    objectives of preserving principal and maintaining liquidity.

    3. Restrictions on Instrument Features

    In the NPRM, the Commission proposed to amend Regulation

    1.25(b)(3)(v) (as amended, Regulation 1.25(b)(2)(v)) by restricting CDs

    to only those instruments which can be redeemed at the issuing bank

    within one business day, with any penalty for early withdrawal limited

    to accrued interest earned according to its written terms. Five

    commenters discussed restrictions on the instrument features of CDs.

    Four suggested that CDs be retained to varying degrees. One suggested

    that CDs be removed from the list of permitted investments entirely.

    On the subject of safety, MF Global/Newedge asserted that brokered

    CDs are preferable to non-brokered CDs. In support of this conclusion,

    MF Global/Newedge pointed out that brokered CDs receive price quotes,

    are marked-to-market every day and have numerous buyers, while non-

    brokered CDs have only one buyer, ``which creates significant

    counterparty risk for FCMs purchasing such products.''\110\

    ---------------------------------------------------------------------------

    \110\ MF Global/Newedge letter at 7-8.

    ---------------------------------------------------------------------------

    ADM and RJO discussed the liquidity of the market for CDs. ADM

    suggested that brokered CDs are liquid despite an inactive secondary

    market.\111\ RJO averred that non-negotiable CDs were not intended for

    institutional size transactions. RJO also predicted that this proposal

    could severely limit the quantity and quality of banks willing to

    accept the proposed stringent limitation on breakage fees.\112\

    ---------------------------------------------------------------------------

    \111\ ADM letter at 2. According to ADM, the inactivity of the

    secondary market for CDs is due to the fact that most buyers hold

    CDs to maturity. Id.

    \112\ RJO letter at 6. However it should be noted that this

    proposal does not alter Regulation 1.25 with regard to penalties;

    therefore the Commission views this concern as unwarranted.

    ---------------------------------------------------------------------------

    MF Global/Newedge recommended that brokered CDs remain permitted;

    however, if limits are to be imposed, they recommended (a) that issuers

    of brokered CDs meet certain capital criteria or the CDs meet certain

    float size thresholds, or (b) that FCMs be allowed to invest in

    brokered CDs up to 50 percent of their portfolio and/or 10 percent with

    any one issuer.\113\ MF Global/Newedge also suggested that the

    Commission consider allowing brokered CDs with puts. Such an instrument

    may be traded in the secondary market, but also may be put back to the

    issuer.\114\ Rather than restricting negotiable CDs, ADM suggested that

    the Commission restrict the allowable issuers of CDs using guidelines

    that the Commission sees fit.\115\ Farr Financial recommended that

    brokered CDs be allowed as long as they generally meet the criteria of

    ``highly liquid.''\116\ Farr Financial also suggested that the portion

    of the proposed rule limiting penalties for early withdrawal to ``any

    accrued interest earned'' be modified to account for the standard

    practices of CD penalties. For example, Farr Financial stated that CDs

    with a term of one year or less have an early withdrawal penalty of up

    to 90 days of simple interest earned. For CDs with a term of more than

    one year, typically the early withdrawal penalty is up to 180 days of

    simple interest. CIEBA recommended eliminating investments in both

    brokered and non-brokered CDs, without further explanation.\117\

    ---------------------------------------------------------------------------

    \113\ MF Global/Newedge letter at 8.

    \114\ Id.

    \115\ ADM letter at 2.

    \116\ Farr Financial letter at 3.

    \117\ CIEBA letter at 3.

    ---------------------------------------------------------------------------

    The Commission is adopting the proposed amendment to Regulation

    1.25(b)(3)(v) (as amended, Regulation 1.25(b)(2)(v)) by restricting CDs

    to only

    [[Page 78785]]

    those instruments which can be redeemed at the issuing bank within one

    business day, with any penalty for early withdrawal limited to accrued

    interest earned according to its written terms. The preservation of

    customer principal and the maintenance of liquidity are the two

    overriding determining factors in the permissibility of a CD for

    purposes of Regulation 1.25.

    Customer principal can be threatened by market fluctuations and

    early redemption penalties. Unlike a non-brokered CD, the purchaser of

    a brokered CD cannot, in most instances, redeem its interest from the

    issuing bank. Rather, an investor seeking redemption prior to a CD's

    maturity date must liquidate the CD in the secondary market. Depending

    on the brokered CD terms (interest rate and duration) and the current

    economic conditions, the market for a given CD can be illiquid and can

    result in a significant loss of principal. Penalties for early

    redemption may cut into customer principal unless such penalties are

    limited, as they are in paragraph (b)(2)(v) of Regulation 1.25, to

    accrued interest.\118\

    ---------------------------------------------------------------------------

    \118\ 17 CFR 1.25(b)(2)(v).

    ---------------------------------------------------------------------------

    The ability of a CD purchaser to redeem a CD at the issuing bank

    within one day is the second key factor in determining whether a CD is

    acceptable as a Regulation 1.25 investment. As noted above, the

    purchaser of a brokered CD cannot, in most instances, redeem its

    interest from the issuing bank. If the secondary market for a brokered

    CD is illiquid, it can prevent FCMs and DCOs from retrieving customer

    funds for the purpose of making margin calls.

    In response to MF Global/Newedge's request for clarification, the

    Commission notes that a brokered CD with a put option back to the

    issuing bank is an acceptable investment, assuming that the issuing

    bank obligates itself to redeem within one business day and that the

    strike price for the put is not less than the original principal amount

    of the CD.

    4. Concentration Limits

    Regulation 1.25(b)(4) currently sets forth issuer-based

    concentration limits for direct investments, other than MMMFs, and

    securities subject to repurchase or reverse repurchase agreements and

    in-house transactions. In the NPRM, the Commission proposed to adopt

    asset-based concentration limits for direct investments and a

    counterparty concentration limit for reverse repurchase agreements in

    addition to amending its issuer-based concentration limits and

    rescinding concentration limits applied to in-house transactions.

    (a) Asset-Based Concentration Limits

    The Commission's proposed asset-based concentration limits would

    restrict the amount of customer funds an FCM or DCO could hold in any

    one class of investments, expressed as a percentage of total assets

    held in segregation.

    In the NPRM, the Commission proposed the following asset-based

    limits: No concentration limit (100 percent) for U.S. government

    securities; a 50 percent concentration limit for U.S. agency

    obligations fully guaranteed as to principal and interest by the United

    States; a 25 percent concentration limit for TLGP guaranteed commercial

    paper and corporate notes or bonds; a 25 percent concentration limit

    for non-negotiable CDs; a 10 percent concentration limit for municipal

    securities; and a 10 percent concentration limit for interests in

    MMMFs.

    The Commission requested comment on whether asset-based

    concentration limits are an effective means for facilitating investment

    portfolio diversification and whether there are other methods that

    should be considered. The Commission, in particular, sought opinions on

    what alternative asset-based concentration limit might be appropriate

    for MMMFs and, if such asset-based concentration limit is higher than

    10 percent, what corresponding issuer-based concentration limit should

    be adopted. The Commission also solicited comment on whether MMMFs

    should be eliminated as a permitted investment.\119\ In discussing

    whether MMMF investments satisfy the overall objective of preserving

    principal and maintaining liquidity, the Commission specifically

    requested comment on whether changes in the settlement mechanisms for

    the tri-party repo market might impact an MMMF's ability to meet the

    requirements of Regulation 1.25.\120\ The Commission requested comment

    on whether MMMF investments should be limited to Treasury MMMFs, or to

    those MMMFs that have portfolios consisting only of permitted

    investments under Regulation 1.25.\121\

    ---------------------------------------------------------------------------

    \119\ Comment request appears in section II.A of the NPRM. See

    75 FR at 67646.

    \120\ Id.

    \121\ Comment request appears in section II.C of the NPRM. See

    75 FR at 67649.

    ---------------------------------------------------------------------------

    Eighteen comment letters discussed MMMFs. The overwhelming majority

    of comments focused on the proposed limitations on MMMFs, which many in

    the industry believed to be ``arbitrary and unduly severe.'' \122\

    According to Federated, the Dodd-Frank Act ``represents the collective

    effort of Congress and the executive branch to prevent a repetition of

    the activities largely confined to the financial services sector that

    precipitated the domino effect of the failure of a large systemically

    risky company, such as Lehman Brothers, that led to the events at the

    Reserve Primary Fund.'' \123\ Federated further asserted that unless

    the Commission does not believe that Congress' ``efforts were

    successful, the proposed limitations on [MMMFs] are unduly restrictive

    and unwarranted.'' \124\ Commenters discussed a variety of topics

    including the safety of MMMFs, the recent enhancements to SEC Rule 2a-

    7, a comparison of the safety of MMMFs to other permitted investments,

    the appropriate concentration limits for MMMFs, and potential problems

    that would arise as a result of a 10 percent concentration limit, among

    other comments.

    ---------------------------------------------------------------------------

    \122\ ICI letter at 2.

    \123\ Federated I letter at 6. The Commission notes that the

    Reserve Primary Fund (Reserve Primary) was an MMMF that satisfied

    the enumerated requirements of Regulation 1.25 and at one point was

    a $63 billion fund. Reserve Primary's ``breaking the buck,'' in

    September 2008, called attention to the risk to principal and

    potential lack of sufficient liquidity of any MMMF investment.

    \124\ Federate I letter at 6.

    ---------------------------------------------------------------------------

    First, commenters stressed that MMMFs are safe, liquid investments,

    comprising roughly $3-4 trillion in assets \125\ and representing

    approximately 25 percent of the total assets in registered investment

    companies in the United States. Commenters noted that only two funds in

    the 40-year history of MMMFs have failed to return $1 per share to

    investors (and those funds returned more than 99 cents and 96 cents on

    the dollar, respectively).\126\

    ---------------------------------------------------------------------------

    \125\ Federated estimated $2.8 trillion. Federated I letter at

    2. UBS noted a figure of $3.8 trillion as of May 2009. UBS letter at

    6.

    \126\ Federated I letter at 1, CME letter at 4-5, J.P. Morgan

    letter at 1-2, Farr Financial letter at 1, UBS letter at 2.

    ---------------------------------------------------------------------------

    According to many of the comment letters, the recent enhancements

    to SEC Rule 2a-7 have made MMMFs even safer and more prepared to

    withstand heavy redemption requests during a crisis. In this regard,

    heightened credit quality and shortened maturity limits increase

    liquidity, \127\ as does a requirement that 10 percent of assets be in

    cash, Treasuries or securities that

    [[Page 78786]]

    convert into cash within one day. The SEC has increased the

    transparency of MMMFs by requiring that MMMFs provide portfolio

    information, updated monthly, on their Web sites. In addition, MMMFs

    are now required to conduct periodic stress tests, which examine an

    MMMF's ability to maintain a stable net asset value under hypothetical

    market conditions.\128\

    ---------------------------------------------------------------------------

    \127\ ICI letter at 4. ICI noted that the weighted average

    maturity (WAM) for MMMFs has been reduced from 90 to 60 days. As a

    result 60 percent of MMMFs have a WAM of 45 days or less. In

    contrast, more than half of all MMMFs had a WAM of greater than 45

    days prior to the SEC's amendments to its Rule 2a-7.

    \128\ CME letter at 4-5, Federated I letter at 1, FIA/ISDA

    letter at 6-8, MF Global/Newedge letter at 6, J.P. Morgan letter at

    1-2, UBS letter at 2-4, Dreyfus letter at 2, RJO letter at 7-8,

    INTL/FCStone letter at 2, BlackRock letter at 2-4, ADM letter at 1,

    BNYM letter at 2-3, BLS letter at 2.

    ---------------------------------------------------------------------------

    Second, many commenters compared the safety of MMMFs to that of one

    or more other permitted investments. Six commenters averred that MMMFs

    are safer than Treasuries.\129\ One commenter argued that municipal

    bonds are less liquid than MMMFs.\130\ Two commenters argued that MMMFs

    were better investments than TLGP debt.\131\ Five commenters wrote that

    MMMFs compared favorably with CDs.\132\

    ---------------------------------------------------------------------------

    \129\ CME letter at 6, Farr Financial letter at 2, ICI letter at

    7, Dreyfus letter at 4, ADM letter at 3, Federated II letter (Bilson

    essay at 8).

    \130\ Dreyfus letter at 4.

    \131\ UBS letter at 6, Dreyfus letter at 4.

    \132\ Federated I letter at 1, CME letter at 4-5, MF Global/

    Newedge letter at 6, UBS letter at 5, 7, Dreyfus letter at 4.

    ---------------------------------------------------------------------------

    Third, many commenters suggested that a 10 percent MMMF limitation

    would cause some inconsonant and unintended results. CME stated that,

    in theory, Regulation 1.25 as proposed would permit over 50 percent of

    a customer funds portfolio to be invested in TLGP securities, municipal

    securities and non-negotiable CDs. In practice, however, FCMs' use of

    these investment categories is limited.\133\ ICI wrote that an

    incongruity exists where an FCM may invest all of its assets in a self-

    managed portfolio of Treasuries, but may only invest 10 percent of its

    assets in an MMMF consisting of the same securities.\134\ Federated

    expressed views similar to those of ICI, writing that investments in

    government funds should not be subject to any concentration limits.

    Federated also recommended that the Commission require that MMMFs

    maintain certain minimum financial thresholds in order to qualify as a

    Regulation 1.25 investment. Federated suggested, as thresholds, that an

    MMMF should manage assets of at least $10 billion and that the MMMF's

    management company should manage assets of at least $50 billion.\135\

    Dreyfus noted that, under the proposal, an FCM may construct a pool of

    individual securities outside the constraints of SEC Rule 2a-7 which

    would have maturities of longer than those required of MMMFs.

    Therefore, greater interest rate risk might be associated with a self-

    managed portfolio than with the portfolio in an MMMF.\136\ The decrease

    in MMMF investment might lead more funds to be held in cash in banks

    (with only $250,000 FDIC insurance).\137\ According to Farr Financial,

    another possible result of a 10 percent limitation on MMMFs is that

    FCMs and DCOs would hold a large amount of Treasuries, and, in the

    event that an FCM or DCO would need to liquidate such Treasuries, would

    experience potential loss in the secondary market.\138\ BlackRock wrote

    that an overreliance on Treasuries and government securities would

    place portfolios in greater danger due to changes to interest rates.

    For example, a sudden rise in interest rates may negatively impact the

    principal valuation of Treasuries.\139\ If liquidation is required

    during such a circumstance, FCMs may experience a loss in

    principal.\140\

    ---------------------------------------------------------------------------

    \133\ CME letter at 6.

    \134\ ICI letter at 8.

    \135\ Federated III letter at 2-3.

    \136\ Dreyfus letter at 2.

    \137\ As pointed out by Farr Financial, FDIC insurance passes

    through to an FCM's customers. See Farr Financial letter at 2-3.

    \138\ Farr Financial letter at 2.

    \139\ BlackRock letter at 2, 5.

    \140\ Id.

    ---------------------------------------------------------------------------

    Fourth, several commenters highlighted other potential difficulties

    that could result from the proposed 10 percent concentration limit,

    including issues of diversification, self-management and liquidity. The

    NFA warned that by limiting investment in MMMFs and other instruments,

    the Commission risks decreasing diversification rather than increasing

    it.\141\ Along similar lines, ICI stated that the average MMMF is more

    diversified than the portfolio of bank CDs or municipal securities that

    FCMs or DCOs would be permitted to hold under the proposed

    amendments.\142\

    ---------------------------------------------------------------------------

    \141\ NFA letter at 2.

    \142\ ICI letter at 10.

    ---------------------------------------------------------------------------

    Three commenters discussed the problems that arise from self-

    managed accounts. ICI, Dreyfus and BNYM suggest that by limiting MMMFs

    to 10 percent, the Commission would be forcing FCMs and DCOs to manage

    90 percent of their portfolios themselves. Investments in TLGP debt,

    CDs and municipals require asset management skills that FCMs and DCOs

    might not have without hiring an investment adviser. While some FCMs

    and DCOs may be large enough to do this, many are not--and requiring

    FCMs to ``go it alone'' will cause customer funds to be at greater

    risk.\143\ ADM wrote that because intraday settlements from clearing

    organizations are not known until 12 noon CST or later, it would be

    difficult to maintain sufficient liquid assets without the use of

    MMMFs.\144\

    ---------------------------------------------------------------------------

    \143\ ICI letter at 6-8, Dreyfus letter at 4, BNYM letter at 2-

    3.

    \144\ ADM letter at 1.

    ---------------------------------------------------------------------------

    In response to the Commission's request for comment on the proposed

    changes in the tri-party repo market, which have not been fully

    implemented, ICI wrote that the changes would allow sellers in tri-

    party repurchase agreements to repurchase the underlying securities

    later in the afternoon. Previously, such sellers would repurchase

    securities in the morning using funds borrowed from their clearing

    banks. The proposed changes should not, according to ICI, adversely

    affect an MMMF's ability to pay redemptions by the end of each day.

    Because the repurchases would occur while the Fedwire system is open,

    MMMFs can transfer the proceeds to their transfer agents to cover daily

    redemptions.\145\

    ---------------------------------------------------------------------------

    \145\ ICI letter at 12.

    ---------------------------------------------------------------------------

    The NPRM also requested comment on whether, or to what extent,

    MMMFs ought to be limited to Treasury funds. Dreyfus stated that it

    would not support such a limitation, as it believes that Government,

    prime, and municipal MMMFs are subject to sufficient risk-limiting

    constraints that merit their availability to FCMs and DCOs.\146\

    Treasury funds are traditionally smaller in size and less liquid than

    prime MMMFs, according to FIA/ISDA.\147\ RJO wrote that because

    Treasury funds lag interest rate movements for significant periods of

    time, they are likely not viable options for FCMs in upward interest

    rate environments or over long periods of time.\148\ Taking a different

    position, BlackRock suggested that Treasury MMMFs should be exempt from

    any asset-based limitations instituted by the Commission.\149\ In

    addition, BlackRock recommended that the Commission require investment

    decision-makers at FCMs to perform periodic assessments of their MMMF

    providers.\150\

    ---------------------------------------------------------------------------

    \146\ Dreyfus letter at 2.

    \147\ FIA/ISDA letter at 8.

    \148\ RJO letter at 8.

    \149\ BlackRock letter at 4.

    \150\ BlackRock letter at 2, 5.

    ---------------------------------------------------------------------------

    CIEBA would support limiting MMMFs to only those funds which invest

    in securities that would be permitted investments under Regulation

    1.25.\151\ CIEBA did not include further discussion or explanation.

    ---------------------------------------------------------------------------

    \151\ CIEBA letter at 3.

    ---------------------------------------------------------------------------

    [[Page 78787]]

    As noted above, the Commission proposed a 10 percent asset-based

    concentration limit for investments in MMMFs. In response to comments,

    the Commission has decided to revise the rule language that was

    proposed. Specifically, the Commission will impose different

    concentration limits for investments in Treasury-only funds than for

    investments in all other MMMFs. The Commission also will distinguish

    between funds that do not have both $1 billion in assets and a

    management company that has at least $25 billion in MMMF assets under

    management (small MMMFs) and those that do (large MMMFs). Federated, as

    noted above, recommended that asset thresholds for MMMFs be set at $10

    billion and $50 billion, respectively. However, the Commission

    believes, at this time, that such thresholds may needlessly constrain

    the pool of MMMFs available for investment and result in an unsafe

    concentration of customer funds in a limited number of MMMFs. The

    modifications to the proposed rule text discussed below reflect the

    Commission's consideration of the comments received on the proposed

    concentration limit for investments in MMMFs, in light of the

    overarching objective of preserving principal and maintaining liquidity

    of customer funds.

    First, an FCM or DCO may invest all of its customer segregated

    funds in Treasury-only MMMFs, subject to the limitation on investment

    in small MMMFs discussed below. The Commission agrees with commenters

    that since an FCM or DCO may invest all of its funds in Treasuries

    directly, an FCM or DCO therefore should be able to make the same

    investment indirectly via an MMMF.

    Second, for all other MMMFs, the Commission believes that a 50

    percent asset-based concentration limit is appropriate, subject to the

    limitation on investment in small MMMFs discussed below. After

    considering the views presented by market participants, Commission

    staff and other regulators, the Commission has determined that a 50

    percent asset-based concentration limit strikes the right balance

    between providing FCMs and DCOs with sufficient Regulation 1.25

    investment options and, at the same time, encouraging adequate

    portfolio diversification.

    MMMFs' portfolio diversification, administrative ease, and the

    heightened prudential standards recently imposed by the SEC, continue

    to make them an attractive investment option. However, their volatility

    during the 2008 financial crisis, which culminated in one fund

    ``breaking the buck'' and many more funds requiring infusions of

    capital, underscores the fact that investments in MMMFs are not without

    risk. The Commission is persuaded to increase the proposed asset-based

    concentration limit for MMMFs, other than Treasury-only MMMFs, from 10

    percent to 50 percent in part by commenters who noted that MMMFs are

    safe and liquid relative to other permitted investments.\152\

    Commenters were persistent in reminding the Commission that, aside from

    Reserve Primary, no MMMFs had ``broken the buck'' during the 2008

    financial crisis and aftermath. The Commission is also cognizant that

    decreasing the number of investment options might have the unintended

    consequence of over-concentrating customer funds into a small universe

    of viable investments. Further, these concentration limits provide FCMs

    and DCOs with the ability to delegate investment decisions for their

    entire portfolio of customer segregated funds to MMMFs, should the FCMs

    and DCOs not wish to make such decisions on their own.

    ---------------------------------------------------------------------------

    \152\ Although MMMFs allow FCMs and DCOs to indirectly invest in

    instruments which would not be permitted under Regulation 1.25 as

    direct investments, the Commission believes that the credit quality,

    maturity limitations and liquidity required by the SEC make prime

    MMMFs acceptable investments, subject to the concentration limits

    imposed by paragraph (b)(3).

    ---------------------------------------------------------------------------

    To the extent that an FCM or DCO invests customer segregated funds

    in an MMMF, subject to the asset-based concentration limits outlined

    above, the FCM or DCO may only invest up to 10 percent of its

    segregated funds in small MMMFs. The Commission believes that

    distinguishing between small MMMFs and large MMMFs is a necessary

    corollary to increasing the concentration limits proposed in the NPRM,

    since large MMMFs have capital bases better capable of handling a high

    volume of redemption requests in the event of a market event. To the

    extent that an FCM or DCO invests customer segregated funds in small

    MMMFs, the 10 percent asset-based concentration limit in the final rule

    is unchanged from the concentration limit set forth in the NPRM.

    However, having considered the comments received on this issue, the

    Commission has determined it appropriate to elevate the asset-based

    concentration limits from what had been proposed--both for Treasury-

    only MMMFs and for all other MMMFs--to the extent that an FCM or DCO

    invests in large MMMFs.

    Accordingly, the Commission is amending Regulation 1.25 by adding

    new paragraphs (b)(3)(i)(E)-(G), which implement the changes described

    above. The addition of these paragraphs enables the Commission to

    increase the concentration limits originally proposed without

    undermining the protection of customer funds and reduction of systemic

    risk, while addressing the concerns specifically raised in the

    comments.

    The Commission has concluded that all other asset-based

    concentration limits remain as proposed in the NPRM. The 50 percent

    asset-based limitation on U.S. agency obligations \153\ and the 25

    percent asset-based limitation on each of TLGP corporate notes or bonds

    and TLGP commercial paper,\154\ are consistent with commenter

    recommendations. Therefore, the Commission is amending Regulation

    1.25(b)(3)(i), as proposed, to reflect the asset-based concentration

    limits described above.

    ---------------------------------------------------------------------------

    \153\ See Section II.A.1. CME recommended 25 percent, BlackRock

    recommended 30 percent, and FIA/ISDA and MF Global/Newedge both

    recommended 50 percent.

    \154\ See Section II.A.2. MF Global/Newedge recommended 25

    percent and BlackRock recommended 25 percent-50 percent. The

    Commission is aware that MF Global/Newedge's recommendation was for

    all corporate notes or bonds and commercial paper--not merely those

    which are TLGP debt. Regardless, such a recommendation is helpful in

    establishing a percentage that will allow for ample investment in

    instrument categories while still promoting diversification.

    ---------------------------------------------------------------------------

    With respect to the calculation of concentration limits, ADM wrote

    that concentration limits should be calculated by aggregating

    Regulation 1.25 funds and 30.7 funds.\155\ ADM explained, by way of

    example, that if there is a 50 percent concentration limit for

    investment X, along with $5 billion in the segregated account and $1

    billion in the 30.7 account, that the maximum amount that could be

    invested in X would be $3 billion. From this comment, the Commission

    concludes that ADM would like the choice of investing up to 60 percent

    of its segregated account funds in investment X, as long as that

    amount, when combined with the size of the 30.7 account, does not

    exceed 50 percent of the cumulative size of the segregated and 30.7

    account. However, the Commission has determined that concentration

    limits are to be calculated on a fund-by-fund basis. In the example

    above, the maximum amount of segregated funds that could be invested in

    X would be $2.5 billion, and the maximum amount of 30.7 funds that

    could be invested in X would be $0.5 billion. ADM presented no

    compelling argument as to why the aggregation of

    [[Page 78788]]

    funds held in Regulation 1.25 and 30.7 accounts should be permitted.

    ---------------------------------------------------------------------------

    \155\ ADM letter at 2.

    ---------------------------------------------------------------------------

    (b) Issuer-Based Concentration Limits

    The Commission proposed to amend its issuer-based limits for direct

    investments to include a 2 percent limit for an MMMF family of funds,

    expressed as a percentage of total assets held in segregation.

    Currently, there is no concentration limit applied to MMMFs. Under the

    NPRM, the 25 percent issuer-based limitation for GSEs (now proposed to

    be encompassed within the term ``U.S. agency obligations'') and the 5

    percent issuer-based limitation for municipal securities, commercial

    paper, corporate notes or bonds, and CDs would remain in place.

    Commenters expressed doubts over whether issuer-based concentration

    limits, on individual or families of MMMFs, would have a meaningful,

    positive effect on the safety of customer funds. Adverse market

    conditions would probably affect all funds, according to ICI, and

    therefore issuer concentration limits would do little to mitigate these

    risks.\156\

    ---------------------------------------------------------------------------

    \156\ ICI letter at 11.

    ---------------------------------------------------------------------------

    BlackRock, ICI and Dreyfus suggested that limits on family of funds

    may not achieve increased safety of customer funds as each MMMF in a

    family is managed on an individual basis and will not necessarily share

    risks with other MMMFs managed by the same adviser. Dreyfus wrote that

    it sees ``no benefit * * * to requiring FCMs to have to potentially

    invest in a [prime MMMF] with one provider and a [government or

    Treasury MMMF] with another provider, on the basis that such an

    arrangement is safer than if the FCM invested in each of these types of

    funds with a single provider.'' \157\ BlackRock also noted that MMMF

    complexes do not typically aggregate and publish consolidated family

    data on a daily basis.\158\

    ---------------------------------------------------------------------------

    \157\ Dreyfus letter at 5. See also ICI letter at 10.

    \158\ BlackRock letter at 4.

    ---------------------------------------------------------------------------

    Commenters also questioned the effectiveness of issuer-based

    limitations on individual funds. Dreyfus asserted that the operations

    and results of one fund do not impact the operation and results of

    another fund.\159\ ICI propounded that similar types of MMMFs often

    have common holdings. Thus, according to ICI, limiting investments in

    individual funds will have a marginal effect on the diversification of

    underlying credit risks.\160\

    ---------------------------------------------------------------------------

    \159\ Dreyfus letter at 5.

    \160\ ICI letter at 10-11.

    ---------------------------------------------------------------------------

    Taken as a whole, these arguments, that concentration limits will

    not increase the safety of customer funds, are untenable. The

    commenters assert that neither family-of-funds limits nor issuer-based

    limits will increase the diversification and safety of customer funds.

    If believed, this leads to the conclusion that it would be safer and

    more diverse (or at least as safe and diverse) for an FCM, investing

    the maximum amount in MMMFs, to invest all customer cash in one fund

    than it would be for that FCM to invest that customer cash among five

    funds in three families. As such, the Commission is not persuaded by

    the arguments.\161\

    ---------------------------------------------------------------------------

    \161\ In response to Dreyfus and ICI's comment regarding limits

    on family of funds, the Commission believes that a failure of, or a

    run on, an individual fund would likely cause a run on other funds

    in the family due to investors' reputational concerns.

    ---------------------------------------------------------------------------

    The Commission has considered the comments received on this issue,

    and is mindful of the comments and Commission analysis of the asset-

    based concentration limits discussed in the preceding section. Having

    considered the arguments raised, the Commission has decided to revise

    the rule language that was proposed. Specifically, the Commission has

    determined that there will be no family-of-funds or issuer-based

    concentration limit for MMMFs that consist entirely of Treasuries, and

    a 25 percent family of funds issuer-based limitation as well as a 10

    percent individual fund issuer-based limitation for all other MMMFs.

    Investments in Treasury-only funds are not to be combined with

    investments in other MMMFs for purposes of calculating either family-

    of-funds or issuer-based concentration limits. The increase in the

    family of funds issuer-based concentration limit is related to the

    increase in the asset-based concentration limit and addresses the

    recommendations of commenters. The introduction of the 10 percent

    individual fund issuer-based concentration limit serves to add an

    additional layer of diversification and also aligns with

    recommendations of commenters.

    (c) Counterparty Concentration Limits

    In the NPRM, the Commission proposed a counterparty concentration

    limit of 5 percent of total assets held in segregation for securities

    subject to reverse repurchase agreements. Seven commenters discussed

    counterparty concentration limits. All expressed their belief that the

    5 percent concentration limit was too low and that such a limit would

    greatly increase administrative risks and costs. Most commenters

    favored a 25 percent concentration limit, in the event that a

    concentration limit was imposed.

    FIA/ISDA, LCH, MF Global/Newedge, J.P. Morgan and RJO expressed

    similar views that a 5 percent concentration limit might actually

    decrease liquidity and increase operational and systemic risk. LCH and

    MF Global/Newedge wrote that a counterparty concentration limit would

    unnecessarily restrict a very liquid and secure investment that has

    provided flexibility and reasonable returns to FCMs and their

    customers.\162\ According to FIA/ISDA, because clearing members are

    often required to execute and unwind reverse repurchase agreements

    intraday and within a brief period of time, and because DCOs strictly

    define the securities they will accept as collateral, an FCM must

    review the securities received under reverse repurchase transactions to

    ensure that they are both eligible for delivery to the DCO and in

    compliance with applicable concentration limits.\163\ Several

    commenters observed that requiring an FCM to effect reverse repurchase

    transactions with multiple counterparties under tight time frames will

    substantially increase an FCM's operational risk and invite

    errors.\164\ By way of example, INTL/FCStone noted that it currently

    has one counterparty and would potentially need to open 20 reverse

    repurchase accounts were the proposed rule enacted.\165\ Further, two

    commenters wrote that a critical factor to consider is that, in the

    event of a counterparty's default, all amounts are collateralized with

    permitted investments under Regulation 1.25.\166\

    ---------------------------------------------------------------------------

    \162\ LCH letter at 3, MF Global/Newedge letter at 6.

    \163\ FIA/ISDA letter at 9-10.

    \164\ FIA/ISDA letter at 9-10, MF Global/Newedge letter at 7,

    J.P. Morgan letter at 2, LCH letter at 3, RJO letter at 3.

    \165\ INTL/FCStone at 2.

    \166\ LCH letter at 3, MF Global/Newedge letter at 7.

    ---------------------------------------------------------------------------

    INTL/FCStone \167\ and FIA/ISDA \168\ recommended a 25 percent

    counterparty concentration limit. RJO wrote that limits are

    unnecessary--however if a limit were imposed, RJO recommended 25

    percent.\169\ LCH suggested a 10 percent-20 percent limitation.\170\ MF

    Global/Newedge recommended having no counterparty limits; however to

    the extent that there must be, it recommended (a) limiting FCM

    repurchase and reverse repurchase transactions to those external

    counterparties maintaining a certain level of capital (such as $50 or

    $100

    [[Page 78789]]

    million) or (b) setting counterparty concentration limits at 25

    percent.\171\ ADM wrote that it does not believe any concentration

    limit is necessary due to the collateralized nature of the loans.\172\

    However, ADM stated that it would support only allowing certain

    collateral, such as Treasuries and GSEs, in repurchase

    transactions.\173\

    ---------------------------------------------------------------------------

    \167\ INTL/FCStone at 2.

    \168\ FIA/ISDA letter at 10.

    \169\ RJO letter at 3.

    \170\ LCH letter at 3.

    \171\ MF Global/Newedge letter at 7.

    \172\ ADM letter at 2.

    \173\ Id.

    ---------------------------------------------------------------------------

    As noted above, the Commission proposed a 5 percent counterparty

    concentration limit in the NPRM. Having considered the comments

    submitted in response to the proposal, the Commission has determined

    that a 25 percent counterparty concentration limit is appropriate.

    The Commission continues to believe that counterparty concentration

    limits are necessary for safeguarding customer funds. Under current

    rules, an FCM or DCO could have 100 percent of its segregated funds

    subject to one reverse repurchase agreement. The obvious concern in

    such a scenario is the credit risk of the counterparty. This credit

    risk, while concentrated, is significantly mitigated by the fact that

    in exchange for cash, the FCM or DCO is holding Regulation 1.25-

    permitted securities of equivalent or greater value. However, a default

    by the counterparty would put pressure on the FCM or DCO to convert

    such securities into cash immediately and would exacerbate the market

    risk to the FCM or DCO, given that a decrease in the value of the

    security or an increase in interest rates could result in the FCM or

    DCO realizing a loss. Even though the market risk would be mitigated by

    asset-based and issuer-based concentration limits, a situation of this

    type could seriously jeopardize an FCM or DCO's overall ability to

    preserve principal and maintain liquidity with respect to customer

    funds.

    The Commission is persuaded to increase the limit, from the

    proposed level of 5 percent in the NPRM to 25 percent, primarily due to

    comments expressing concern about the administrative costs and burdens

    of a low counterparty concentration limit. Whereas a 5 percent

    limitation would require an FCM reverse-repurchasing all of its

    customer cash to have 20 counterparties, a 25 percent limitation

    decreases the number of counterparties to four. Further, 25 percent is

    in line with commenter recommendations, which ranged from 10 to 25

    percent.\174\

    ---------------------------------------------------------------------------

    \174\ As noted above, certain commenters wished to have no

    counterparty concentration limits, a position with which the

    Commission does not agree.

    ---------------------------------------------------------------------------

    C. Money Market Mutual Funds

    The Commission has decided to make two technical amendments to

    paragraph (c) of Regulation 1.25. First, the Commission is clarifying

    the acknowledgment letter requirement under paragraph (c)(3); and

    second, the Commission is revising and clarifying the exceptions to the

    next-day redemption requirement under paragraph (c)(5)(ii).

    1. Acknowledgment Letters

    In the NPRM, the Commission sought to clarify that the intent of

    Regulation 1.25(c)(3) is to require that an FCM or DCO obtain an

    acknowledgment letter from a party that has substantial control over a

    fund's assets and has the knowledge and authority to facilitate

    redemption and payment or transfer of the customer segregated funds

    invested in shares of the MMMF. The Commission concluded that in many

    circumstances, the fund sponsor, the investment adviser, or fund

    manager would satisfy this requirement. The Commission also proposed to

    remove the current language in Regulation 1.25(c)(3) relating to the

    issuer of the acknowledgment letter when the shares of the fund are

    held by the fund's shareholder servicing agent. This revision was

    designed to eliminate any confusion as to whether the acknowledgment

    letter requirement is applied differently based on the presence or

    absence of a shareholder servicing agent.

    The Commission requested comment on whether the proposed standard

    for entities that may sign an acknowledgment letter is appropriate and

    whether there are other entities that could serve as examples. The

    Commission requested comment on whether removal of the ``shareholder

    servicing agent'' language helps clarify the intent of Regulation

    1.25(c)(3).

    Three commenters discussed this proposal. CME, BBH and FIA/ISDA

    support the proposal, and FIA/ISDA and BBH had additional comments and

    suggested changes as well.\175\

    ---------------------------------------------------------------------------

    \175\ CME letter at 7, FIA/ISDA letter at 13, BBH letter at 2.

    ---------------------------------------------------------------------------

    BBH and FIA/ISDA requested that the Commission confirm that, in

    those circumstances in which an FCM deposits customer funds with a bank

    or other depository and thereafter instructs the bank to invest such

    customer funds in an MMMF, the bank is the appropriate entity from

    which the FCM should obtain the acknowledgment letter.\176\ BBH

    explained that such settlement banks are ``universally recognized, both

    by regulation and standard contractual terms, as an entity that

    exercises legitimate control and authority over assets deposited both

    directly with it or held in an account at a third party depository or

    fund.'' \177\

    ---------------------------------------------------------------------------

    \176\ BBH letter at 2, FIA/ISDA letter at 13.

    \177\ BBH letter at 2.

    ---------------------------------------------------------------------------

    The Commission is amending Regulation 1.25(c)(3) to reflect that an

    FCM or DCO must obtain an acknowledgment letter from a party that has

    substantial control over MMMF shares purchased with customer segregated

    funds and has the knowledge and authority to facilitate redemption and

    payment or transfer of the customer segregated funds invested in shares

    of the MMMF and is removing the current language in Regulation

    1.25(c)(3) relating to the issuer of the acknowledgment letter when the

    shares of the fund are held by the fund's shareholder servicing agent.

    In response to FIA/ISDA and BBH, the Commission agrees that when an FCM

    deposits customer funds in a bank or other depository and thereafter

    instructs the depository to invest such customer funds in an MMMF, the

    acknowledgment letter may come from the depository if it is acting as a

    custodian for the fund shares owned by the FCM or DCO. The Commission

    therefore clarifies in the rule text that a ``depository acting as

    custodian for fund shares'' is an appropriate entity to issue an

    acknowledgment letter.

    2. Next-Day Redemption Requirement

    Regulation 1.25(c) requires that ``[a] fund shall be legally

    obligated to redeem an interest and to make payment in satisfaction

    thereof by the business day following a redemption request.'' \178\

    This ``next-day redemption'' requirement is a significant feature of

    Regulation 1.25 and is meant to ensure adequate liquidity.\179\

    Regulation 1.25(c)(5)(ii) lists four exceptions to the next-day

    redemption requirement, and incorporates by reference the emergency

    conditions listed in Section 22(e) of the Investment Company Act

    (Section 22(e)).\180\ The Commission has, on occasion, fielded

    questions from FCMs regarding Regulation 1.25(c)(5), particularly

    because the exceptions listed in paragraph (c)(5)(ii) overlap with some

    of those appearing in Section 22(e).

    ---------------------------------------------------------------------------

    \178\ 17 CFR 1.25(c)(5)(i).

    \179\ See 70 FR 5585 (noting that ``[t]he Commission believes

    the one-day liquidity requirement for investments in MMMFs is

    necessary to ensure that the funding requirements of FCMs will not

    be impeded by a long liquidity time frame'').

    \180\ 15 U.S.C. 80a-22(e).

    ---------------------------------------------------------------------------

    [[Page 78790]]

    In order to expressly incorporate SEC Rule 22e-3 into the permitted

    exceptions for purposes of clarity, and to otherwise clarify the

    existing exceptions to the next-day redemption requirement, the

    Commission proposed to amend paragraph (c)(5)(ii) of Regulation 1.25 by

    more closely aligning the language of that paragraph with the language

    in Section 22(e) and specifically including a reference to Rule 22e-3.

    The Commission proposed to include, as an appendix to the rule text

    (Regulation 1.25 Appendix), safe harbor language that could be used by

    MMMFs to ensure that their prospectuses comply with Regulation

    1.25(c)(5).

    The Commission requested comment on all aspects of its proposed

    amendments to the provisions regarding MMMFs in paragraph (c) of

    Regulation 1.25. The Commission sought comment specifically on any

    proposed regulatory language that commenters believe requires further

    clarification. In addition, commenters were invited to submit views on

    the usefulness and substance of the proposed safe harbor language

    contained in the proposed Regulation 1.25 Appendix.

    Only one commenter, ICI, mentioned this aspect of the NPRM. ICI

    supported this proposal to clarify exemptions from next-day redemption

    and to include safe harbor language.\181\ Therefore, the Commission

    amends paragraph (c)(5)(ii) of Regulation 1.25 by more closely aligning

    the language of that paragraph with the language in Section 22(e) and

    specifically including a reference to Rule 22e-3. The Commission is

    also adding the Regulation 1.25 Appendix to the rule text, in order to

    provide MMMFs with safe harbor language to ensure that their

    prospectuses comply with Regulation 1.25(c)(5).

    ---------------------------------------------------------------------------

    \181\ ICI letter at 11.

    ---------------------------------------------------------------------------

    D. Repurchase and Reverse Repurchase Agreements

    The Commission proposed specifically eliminating repurchase and

    reverse repurchase transactions with affiliate counterparties.

    Repurchase and reverse repurchase transactions are functionally similar

    to collateralized loans, whereby cash is exchanged for unencumbered

    collateral. In the NPRM, the Commission explained its view that the

    concentration of credit risk increases the likelihood that the default

    of one party could exacerbate financial strains and lead to the default

    of its affiliate. The Commission used the example of Bear Stearns

    Companies, Inc. (Bear Stearns) in 2008 \182\ to illustrate that even

    possession and control of liquid securities may be insufficient to

    alleviate concerns relating to transactions with financially troubled

    affiliated counterparties.

    ---------------------------------------------------------------------------

    \182\ See SEC Press Release No. 2008-46, ``Answers to Frequently

    Asked Investor Questions Regarding the Bear Stearns Companies,

    Inc.'' (Mar. 18, 2008), available at http://www.sec.gov/news/press/2008/2008-46.htm (noting that rumors of liquidity problems at Bear

    Stearns caused their counterparties to become concerned, creating a

    ``crisis of confidence'' which led to the counterparties'

    ``unwilling[ness] to make secured funding available to Bear Stearns

    on customary terms'').

    ---------------------------------------------------------------------------

    The Commission received four comment letters discussing this topic.

    CME and FIA/ISDA both suggested that FCMs have much greater certainty

    and are exposed to substantially less counterparty risk to the extent

    that they enter into transactions with affiliates.\183\ FIA/ISDA stated

    that funds held in affiliate accounts are at no greater risk in the

    event of a default than they would be in the event of a default of a

    non-affiliate. In both cases, the requirements of Regulation 1.25(d)

    are the same. Further, FIA/ISDA wrote that the Bear Stearns example

    used by the Commission in the NPRM relates to Bear Stearns' abilities

    to enter into agreements with third parties, not its affiliates.\184\

    RJO noted that affiliates should be judged as acceptable if the

    affiliate meets or exceeds the capital base or some other methodology

    deemed satisfactory for adding an arms-length counterparty.\185\ MF

    Global/Newedge wrote that removing repurchase agreements with

    affiliates would not reduce FCM risk, ``since FCMs would be unable to

    enter into and execute such transactions with and through entities and

    personnel with whom they have created an effective, efficient and

    liquid settlement framework.'' \186\

    ---------------------------------------------------------------------------

    \183\ CME letter at 3, FIA/ISDA letter at 9-11.

    \184\ FIA/ISDA letter at 10-11.

    \185\ RJO letter at 4.

    \186\ MF Global/Newedge letter at 7.

    ---------------------------------------------------------------------------

    The Commission is not persuaded by these comments. In particular,

    while the Commission acknowledges that affiliates have a legal status

    that may distinguish such transactions from in-house transactions, the

    concentration of credit risk and the potential for conflicts of

    interest during times of crisis remain significant concerns. Indeed,

    the Commission's reference to Bear Stearns in the preamble was intended

    to serve as an illustration of how an elevated concentration of credit

    risk may produce broad, unforeseen consequences.

    Further, as discussed in the NPRM, the interest of consistency of

    the regulation weighs in favor of disallowing repurchase agreements

    between affiliates. The Commission finds it incongruous that an

    investment in the debt instrument of an affiliate (effectively a

    collateralized loan between affiliates) could be prohibited by

    paragraph (b)(6) while a repurchase agreement between affiliates (which

    is the functional equivalent of a short-term collateralized loan

    between affiliates) could be allowed.

    Finally, the Commission believes that firms engage in repurchase

    agreements with affiliates for purposes of balance sheet maintenance.

    Repurchase agreements with affiliates may cause a consolidated balance

    sheet to appear smaller than it would if the same transaction occurred

    with an unaffiliated third party because such transactions, while they

    may appear on sub-ledgers, are typically eliminated on the consolidated

    balance sheet. While FCMs and DCOs may prefer to use such transactions

    to manage their balance sheets, as mentioned in the context of in-house

    transactions in Section II.A.4 of this release, the purpose of

    Regulation 1.25 is not to assist FCMs and DCOs with managing their

    balance sheets. Rather, the purpose of Regulation 1.25 is to permit

    FCMs and DCOs to invest customer funds in a manner that preserves

    principal and maintains liquidity. Because of the concerns expressed

    above, particularly with respect to the potential for conflicts of

    interest, the Commission believes that the interests of protecting

    customer funds are best served by eliminating repurchase agreements

    with affiliates. Therefore, the Commission is amending paragraph (d) as

    proposed.\187\

    ---------------------------------------------------------------------------

    \187\ See supra n. 100 (discussing petition procedures set forth

    in Regulation 13.2, 17 CFR 13.2).

    ---------------------------------------------------------------------------

    E. Regulation 30.7

    1. Harmonization

    In the NPRM, the Commission proposed to harmonize Regulation 30.7

    with the investment limitations of Regulation 1.25 by adding new

    paragraph (g) to Regulation 30.7. As noted above, the Commission had

    not previously restricted investments of 30.7 funds to the permitted

    investments under Regulation 1.25, although Regulation 1.25 limitations

    can be used as a safe harbor for such investments.\188\

    [[Page 78791]]

    The Commission now believes that it is appropriate to align the

    investment standards of Regulation 30.7 with those of Regulation 1.25

    because many of the same prudential concerns arise with respect to both

    segregated customer funds and 30.7 funds. Such a limitation should

    increase the safety of 30.7 funds and provide clarity for the FCMs,

    DCOs, and designated self-regulatory organizations. Two comment

    letters, from JAC and FIA/ISDA discussed this subject and both

    supported the amendment.

    ---------------------------------------------------------------------------

    \188\ See Commission Form 1-FR-FCM Instructions at 12-9 (Mar.

    2010) (``In investing funds required to be maintained in separate

    section 30.7 account(s), FCMs are bound by their fiduciary

    obligations to customers and the requirement that the secured amount

    required to be set aside be at all times liquid and sufficient to

    cover all obligations to such customers. Regulation 1.25 investments

    would be appropriate, as would investments in any other readily

    marketable securities.'').

    ---------------------------------------------------------------------------

    2. Ratings

    In the NPRM, the Commission proposed to remove all rating

    requirements from Regulation 30.7. This amendment is required by

    Section 939A of the Dodd-Frank Act and further reflects the

    Commission's views on the unreliability of ratings as currently

    administered and its interest in aligning Regulation 30.7 with

    Regulation 1.25.\189\ The Commission requested comment on this proposal

    including whether there existed any sound alternatives to credit

    ratings.

    ---------------------------------------------------------------------------

    \189\ See supra Section II.B.2 regarding the Commission's policy

    decision to remove references to credit ratings from Regulation 1.25

    and other regulations.

    ---------------------------------------------------------------------------

    One comment letter, from FIA/ISDA, discussed the topic and

    supported the proposal. No comments provided an alternative to credit

    ratings. As proposed, the Commission is removing paragraph

    (c)(1)(ii)(B) of Regulation 30.7 as it views a nationally recognized

    statistical rating organization (NRSRO) rating as unreliable to gauge

    the safety of a depository institution for 30.7 funds. This change also

    serves to align Regulation 30.7 with Regulation 1.25 on the topic of

    NRSROs.

    3. Designation as a Depository for 30.7 Funds

    As proposed, the Commission will no longer allow a customer to

    request that a bank or trust company located outside the United States

    be designated as a depository for 30.7 funds. Previously, under

    Regulation 30.7(c)(1)(ii)(C), a bank or trust company that did not

    otherwise meet the requirements of paragraph (c)(1)(ii) could still be

    designated as an acceptable depository by request of its customer and

    with the approval of the Commission. However, the Commission never

    allowed a bank or trust company located outside the United States to be

    a depository through these means, and has decided that it is

    appropriate to require that all depositories meet the regulatory

    capital requirement under paragraph (c)(1)(ii)(A).

    FIA/ISDA and ADM both supported this amendment in their comment

    letters. Based on the foregoing, the Commission is amending Regulation

    30.7, as proposed, by deleting paragraph (c)(1)(ii)(C).

    4. Technical Amendments

    JAC recommended reinserting ``foreign board of trade'' in

    Regulation 30.7(c)(1), believing it was inadvertently omitted in

    February of 2003.\190\ The Commission agrees that the February 2003

    Federal Register final rule notice contained a clear administrative

    error, and to address that administrative error, the Commission is

    reinserting ``[t]he clearing organization of any foreign board of

    trade'' in the rule text as new paragraph (c)(1)(v) and renumbering

    subsequent paragraphs accordingly.\191\

    ---------------------------------------------------------------------------

    \190\ JAC letter at 2.

    \191\ Prior to 2003, Regulation 30.7(c) permitted an FCM to

    maintain 30.7 funds in, among other depositories, ``[t]he clearing

    organization of any foreign board of trade.'' ``Foreign Futures and

    Foreign Options Transactions,'' 52 FR 28980, 29000 (Aug. 5, 1987).

    In 2002, the Commission requested comment, in an NPRM, on whether

    the list of depositories enumerated in Regulation 30.7(c) should be

    expanded. ``Denomination of Customer Funds and Location of

    Depositories,'' 67 FR 52641, 52645 (Aug. 13, 2002). The Commission

    determined it appropriate to expand the list; however, in publishing

    the final rule, the Commission inadvertently failed to include

    ``[t]he clearing organization of any foreign board of trade'' on the

    list. See ``Denomination of Customer Funds and Location of

    Depositories,'' 68 FR 5545, 5550 (Feb. 4, 2003) (``Rule 30.7 will be

    amended to provide that the funds of foreign futures or options

    customers may, in addition to those depositories already enumerated

    * * *.'' (emphasis added)). The technical amendment set forth in

    this notice corrects that administrative error.

    ---------------------------------------------------------------------------

    F. Implementation.

    RJO, FIA/ISDA, CME, JAC and NFA suggest a phased implementation

    period of 180 days.\192\ The Commission has determined to allow an

    implementation period of 180 days following the publication of the

    final rules.

    ---------------------------------------------------------------------------

    \192\ CME letter at 7, JAC letter at 3, FIA/ISDA letter at 13,

    NFA letter at 3, RJO letter at 3.

    ---------------------------------------------------------------------------

    III. Cost Benefit Considerations

    Section 15(a) of the Act requires the Commission to consider the

    costs and benefits of its action before promulgating a regulation.\193\

    In particular, costs and benefits must be evaluated in light of five

    broad areas of market and public concern: (1) Protection of market

    participants and the public; (2) efficiency, competitiveness, and

    financial integrity of futures markets; (3) price discovery; (4) sound

    risk management practices; and (5) other public interest

    considerations. The Commission may in its discretion give greater

    weight to any one of the five enumerated areas, depending upon the

    nature of the regulatory action.

    ---------------------------------------------------------------------------

    \193\ 7 U.S.C. 19(a).

    ---------------------------------------------------------------------------

    Section 4d of the Act \194\ limits the investment of customer

    segregated funds to obligations of the United States and obligations

    fully guaranteed as to principal and interest by the United States

    (U.S. government securities), and general obligations of any State or

    of any political subdivision thereof (municipal securities). The

    Commission has exercised its authority to grant exempt relief under

    Section 4(c) of the Act to permit additional investments beyond those

    prescribed in Section 4d. Regulation 1.25 sets out the list of

    permissible investments, which the Commission has expanded

    substantially over the years.\195\ As detailed in the discussion above,

    the final rules narrow the scope of investment choices in order to

    reduce risk and to increase the safety of Regulation 1.25 investments,

    consistent with the statute. Further, certain changes to the rule

    relating to the elimination of credit ratings are mandated by Section

    939A of the Dodd-Frank Act.

    ---------------------------------------------------------------------------

    \194\ 7 U.S.C. 6(d).

    \195\ 7 U.S.C. 6(c).

    ---------------------------------------------------------------------------

    FCMs currently hold over $170 billion in segregated customer funds

    and $40 billion in funds held subject to Regulation 30.7.\196\ The

    funds are held as performance bond for the purpose of meeting margin

    calls and Commission regulations allow these funds to be invested by

    the FCMs and DCOs in enumerated investments subject to various

    restrictions. Through this rulemaking, the Commission has determined

    that certain investments are no longer permitted as they may not

    adequately meet the statute's paramount goal of protecting customer

    funds.

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    \196\ Based on CFTC data as of April 30, 2011. See CFTC Web

    site, Market Reports, Financial Data for FCMs at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

    ---------------------------------------------------------------------------

    The Commission recognizes that restricting the type and form of

    permitted investments could result in certain FCMs and DCOs earning

    less income from their investments of customer funds. The Commission is

    unable to determine the magnitude of such income reduction, if any,

    because information was not provided to allow the Commission to

    estimate any such income reduction. No commenter provided information

    about the composition of the portfolio in which customer segregated

    funds are invested.

    [[Page 78792]]

    As noted above, the list of permitted investments under the rules,

    notwithstanding the restrictions instituted herein, still represent a

    significantly wider selection of investment options than those

    permitted by the Act. Further, in most cases, the amended rules allow

    for investment in many of the same instruments as previously permitted,

    subject to asset-based and issuer-based concentration limits.

    In issuing these final rules, the Commission has considered the

    costs and benefits of each aspect of the rules, as well as alternatives

    to them. In addition, the Commission has evaluated comments received

    regarding costs and benefits in response to its proposal.\197\ Where

    quantification has not been reasonably estimable due to lack of

    necessary underlying information, the Commission has considered the

    costs and benefits of the final rules in qualitative terms.\198\

    Generally, as discussed more specifically below with respect to the CEA

    section 15(a) factors, the Commission believes that the restrictions on

    segregated customer funds and Regulation 30.7 fund investments promote

    important benefits. These include greater security for customer funds

    and enhanced stability for the financial system as a whole.

    ---------------------------------------------------------------------------

    \197\ The commenters cost/benefit concerns fall in two

    categories, summarized below with the Commission's corresponding

    response.

    Potentially reduced investment income may cause

    increases in customer fee. Some public commenters suggested that a

    loss of investment income on customer segregated funds and those

    funds held pursuant to Regulation 30.7 potentially attributable to

    the rules' investment choice limitations, might incentivize FCMs and

    DCOs to raise customer fees to make up for reduced investment

    income. No objective evidence was provided to predict the likelihood

    of this speculated outcome. The Commission believes that the

    corresponding benefit--i.e., substantially reduced risk and greater

    protection of customer segregated funds--justifies this speculative

    cost, particularly given that the purpose of the segregated funds is

    not investment income, but customer fund protection. Moreover, as

    discussed herein, two factors mitigate the magnitude of concern for

    the significance of any such a potential income reduction. First,

    under the final rules, most asset classes are still available to

    managers and are only subject to concentration limits. All other

    types of investments remain permitted, including Treasuries,

    municipals, other U.S. agency obligations, foreign sovereign debt

    and MMMFs. Second, the comment letters do not specify how

    extensively FCMs and DCOs actually directly invest in those assets

    classes the rules will exclude. Rather, comments expressing that

    limitations on direct investments in MMMFs would occasion extra cost

    and additional investment expertise, suggest that FCMs and DCOs have

    eschewed investment in these products, at least to some degree.

    Potentially increased portfolio management costs.

    Multiple commenters focused on the additional expense FCMs and DCOs

    might incur to acquire additional investment staff and expertise

    needed to manage portfolios under the new rules. Particular areas of

    concern related to the investment process in light of the removal of

    credit ratings from that process and portfolio management subject to

    the percentage limitations with regard to asset-type, issuer, and

    counterparty. Removal of credit ratings is not within Commission

    discretion. Moreover, the Commission believes the burden of on-

    boarding and risk managing additional counterparties, as well as the

    tracking of investments across more issuers, are offset by the

    benefit of increased portfolio diversification and more limited

    exposure to large credit and counterparty risk profiles.

    \198\ In the NPRM, the Commission invited the public ``to submit

    any data or other information that may have quantifying or

    qualifying the costs and benefits of the Proposal with their comment

    letters.'' The Commission received no such quantitative data or

    information with respect to these rules.

    ---------------------------------------------------------------------------

    A discussion of the costs and benefits of this rule and the

    relevant comments is set out immediately below. The remainder of this

    Section III considers the costs and benefits of this rule under Section

    15(a) of the CEA, organized by (i) impact on each class of permitted

    investment, (ii) certain other limitations on permitted investments,

    and (iii) Regulation 30.7.

    Municipal Securities

    Municipal securities are permitted investments pursuant to the Act.

    For the reasons discussed above, the final rule restricts the

    percentage of total customer segregated funds that may be held by an

    FCM or DCO in municipal securities to 10 percent. This is in addition

    to the 5 percent limitation of total customer segregated funds that

    previously existed for the investment in the municipal securities of

    any individual issuer.

    The Commission has determined that the overall benefits of the

    concentration limitations for municipal securities and the resultant

    portfolio risk reductions--as compared to those without such

    limitations--are compelling, notwithstanding any related costs.

    (1) Protection of Market Participants and the Public

    The public has a strong interest in the stability of the nation's

    financial system, a goal of the Dodd-Frank Act. The new asset-based

    concentration limitation for municipal securities will protect market

    participants and the public by limiting losses to customer segregated

    funds in the event of a crisis in the municipal bond markets.

    The Commission believes that such restrictions are appropriate and

    will benefit the public and market participants by safeguarding

    customer funds.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that this rule promotes market efficiency,

    competitiveness and financial integrity in an important way. Imposing

    portfolio concentration limits lowers the risk of FCMs and DCOs

    suffering losses and/or being unable to liquidate assets to meet margin

    calls. This type of liquidity loss may operate to undermine market

    integrity and public confidence in the absence of this rule. While

    there may be some potential for ``forced sale'' losses for FCMs and

    DCOs on investments that may now be subject to restrictions, the

    Commission cannot gauge the magnitude and believes that it has taken

    measures appropriate to the circumstances to mitigate any potential

    costs. More specifically, the Commission is not in a position to know,

    with any precision, the portfolio holdings of FCMs and DCOs with

    respect to municipal securities, nor can the Commission predict the

    prevailing market conditions if FCMs and DCOs must sell municipal

    securities. Consequently, the Commission cannot quantify this cost.

    Further, as mentioned above, the Commission does not believe that FCMs

    or DCOs invest heavily in municipal securities, so ``forced sales,'' if

    necessary, should be of little impact. However, to reduce any potential

    impact, slight though it may be, the rules allow for a 180 day phase-in

    period, giving FCMs and DCOs ample time to adjust their portfolios to

    the extent necessary to comply with the regulations. Since municipal

    securities remain eligible investments for FCMs and DCOs and may be

    held either directly or indirectly through MMMFs,\199\ the Commission

    believes that any potential impact on municipal securities markets

    generally also should be mitigated. Accordingly, the Commission

    believes that the significant benefits of having portfolios less

    concentrated in municipal securities justify any cost, as mitigated

    under the rules.

    ---------------------------------------------------------------------------

    \199\ These investments, of course, remain subject to the

    ``highly liquid'' requirement in these rules. To be a permitted

    investment, a municipal security must have the ability to be

    converted into cash within one business day, without a material

    discount in value.

    ---------------------------------------------------------------------------

    (3) Price Discovery

    The Commission has considered the restrictions on municipal

    securities and has determined that the final rules should not have an

    impact on price discovery.

    (4) Sound Risk Management Practices

    As previously noted, the rules enhance risk management practices by

    reducing vulnerability to municipal securities defaults by the

    introduction of additional investment restrictions in the

    [[Page 78793]]

    form of asset-based concentration limits. However, given that the list

    of permitted investments remains relatively unchanged and that there is

    believed to be little investment in municipal securities at this time,

    there should be little or no additional resources required to comply

    with the final rule and the existing risk management strategies and

    systems should be largely unaffected.

    (5) Other Public Interest Considerations

    The greatest potential impact of this rule on public interest

    considerations stem from the increased stability of the financial

    system as a whole. The inclusion of asset-based concentration limits

    for municipal securities contributes to financial stability by

    encouraging sound investment strategies for customer segregated funds.

    For FCMs and DCOs, the expenses associated with managing within these

    limitations and the potential for reduced investment return

    opportunities are costs. As discussed above, municipal securities are

    not a widely used investment, however. Further, as a general matter,

    FCMs and DCOs still have a great deal of flexibility and the Commission

    believes that any added expense associated with a more active

    management of the investment portfolios should be minor relative to the

    benefits fostered.

    U.S. Agency Obligations

    U.S. agency obligations will continue to be permitted investments

    pursuant to the Commission's authority under Section 4(c), subject to

    certain restrictions under the rules. In addition to the existing 25

    percent limitation on the securities of any single U.S. agency being

    held with customer segregated funds, the new rules limit this asset

    class in aggregate to 50 percent of the total customer segregated funds

    held by the FCM or DCO. The rules also condition investment in debt

    issued by Fannie Mae and Freddie Mac only while these entities are

    operating under the conservatorship or receivership of the FHFA.

    (1) Protection of Market Participants and the Public

    In response to concerns regarding the safety of GSE debt

    securities, highlighted by the 2008 failures of both Fannie Mae and

    Freddie Mac, these additional restrictions are designed to protect

    market participants and the public from the excessive risk that

    concentrated investment in these assets might present. The reduction of

    credit risk and the portfolio diversification requirements set forth by

    the amendment will provide greater security for customer funds, and

    ultimately to the FCMs and DCOs that rely on those funds.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that this rule promotes market efficiency,

    competitiveness and financial integrity in an important way. Imposing

    portfolio concentration limits lowers the risk the risk of FCMs and

    DCOs suffering losses and/or being unable to liquidate assets to meet

    margin calls. This type of liquidity loss may operate to undermine

    market integrity and public confidence in the absence of this rule.

    While there may be some potential for ``forced sale'' losses for

    FCMs and DCOs on investments that may now be subject to restrictions,

    the Commission cannot gauge the magnitude and believes that it has

    taken measures appropriate to the circumstances to mitigate any

    potential costs. More specifically, the Commission is not in a position

    to know, with any precision, the portfolio holdings of FCMs and DCOs

    with respect to U.S. agency obligations, nor can the Commission predict

    the prevailing market conditions if FCMs and DCOs must sell U.S. agency

    obligations. Consequently, the Commission cannot quantify this cost.

    However, to reduce any potential cost, the rules contemplate a 180 day

    implementation period, giving FCMs and DCOs ample time to liquidate

    portfolios to the extent necessary to comply with the regulations.

    Since investments in U.S. agency obligations remain available for

    indirect investment through MMMFs, the Commission believes any impact

    on the markets for U.S. agency obligations generally also should be

    mitigated. Accordingly, the Commission believes that the significant

    potential benefits of having portfolios less concentrated in U.S.

    agency obligations justify any cost, as mitigated under the rules.

    (3) Price Discovery

    The Commission has considered the restrictions on U.S. agency

    obligations and has determined that the final rules should not have an

    impact on price discovery.

    (4) Sound Risk Management Procedures

    The greatest costs relative to sound risk management procedures

    have been mentioned previously. The introduction of additional

    investment restrictions for U.S. agency obligations in the form of

    asset-based and issuer-based concentration limits may require FCMs and

    DCOs to enhance their investment management and portfolio monitoring

    resources. However, given that investments in U.S. agency obligations--

    including GSE debt securities--are currently permitted, the risk

    management strategies and systems should largely be in place already.

    The Commission continues to believe that the overall benefits of

    the restrictions and concentration limits on U.S. agency obligations,

    as compared to those based on a regulatory standard without such

    limitations, are compelling, notwithstanding attendant costs of the

    restrictions and concentration limits. By limiting the concentration of

    an FCM's or DCO's investment in U.S. agency obligations, the Commission

    is encouraging a diverse portfolio that is more likely to withstand a

    crisis in the GSE debt securities market or a failure of one or more

    GSEs.

    (5) Other Public Interest Considerations

    The greatest potential effect of this rule on public interest

    considerations stem from the implications of these rules on the overall

    stability of the financial system. The inclusion of asset-based and

    issuer-based limits on U.S. agency obligations contributes to financial

    stability by reducing concentration risk for funds held in customer

    segregated accounts. For FCMs and DCOs, the expenses associated with

    administration and the potential for lost upside investment

    opportunities are costs. However, as discussed above, notwithstanding

    the limitations on U.S. agency obligations, FCMs and DCOs still have a

    great deal of flexibility to invest in such instruments and the added

    expense associated with a more active management of the investment

    portfolios should be minor relative to the benefits fostered.

    Certificates of Deposit

    CDs will continue to be permitted investments pursuant to the

    Commission's authority under Section 4(c), subject to certain

    restrictions under the rules. In addition to the current issuer-based

    limitation of 5 percent, the new rules impose a 25 percent asset-based

    limitation. The rules also condition investment in CDs to those that

    are redeemable at the issuing bank within one day, or are brokered CDs

    that have embedded put options.

    (1) Protection of Market Participants and the Public

    This rulemaking continues to allow CDs as a permitted investment

    for FCMs and DCOs while ensuring that such instruments adequately

    preserve the customers' principal and maintain liquidity. The costs of

    this rulemaking

    [[Page 78794]]

    include the administrative costs of moving from non-permitted CDs to

    permitted CDs (or other permitted investments) and potential lost

    upside investment opportunities from the inability to invest in non-

    permitted CDs. The Commission is unable to determine the reduction in

    income, if any, because it does not know the composition of the

    portfolio in which customer segregated funds are invested. The

    Commission believes that there is a strong benefit in creating a

    framework for CDs in which such instruments must be able to be

    redeemed, within one business day, at the issuing bank, however. The

    Commission believes that any cost brought about by this amendment is

    justified by a more diversified risk structure as a result of

    concentration limits. Further, given the availability of indirect

    investment in CDs generally through MMMFs, any income loss resulting

    from these limitations should be minor.

    Like other asset types, FCMs and DCOs may need additional resources

    and expertise, and incur the related expense, to manage a portfolio

    subject to the percentage limitations of the rules with regard to

    asset-type and issuer. With sizeable allowances for MMMFs, FCMs and

    DCOs will be able to continue to leverage the expertise of fund

    managers and access indirect investment in otherwise restricted asset

    types.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that this rule promotes financial integrity

    in an important way. Imposing portfolio concentration limits lowers the

    risk of FCMs and DCOs suffering losses and/or being unable to liquidate

    assets to meet margin calls. This type of liquidity loss may operate to

    undermine market integrity and public confidence in the absence of this

    rule.

    While there may be some potential for ``forced sale'' losses for

    FCMs and DCOs on CDs now subject to restrictions, the Commission cannot

    gauge the magnitude and believes that it has taken measures appropriate

    to the circumstances to mitigate any potential costs. More

    specifically, the Commission is not in a position to know, with any

    precision, the portfolio holdings of FCMs and DCOs with respect to CDs,

    nor can the Commission predict the prevailing market conditions if FCMs

    and DCOs must sell CDs. Consequently, the Commission cannot quantify

    this cost. However, to reduce any potential cost, the rules contemplate

    a 180 day implementation period, giving FCMs and DCOs ample time to

    liquidate portfolios to the extent necessary to comply with the

    regulations. Since CDs remain eligible investments for FCMs and DCOs

    and may be held either directly or indirectly through MMMFs, the

    Commission believes that any potential impact on CD markets generally

    also should be mitigated. Accordingly, the Commission believes that the

    significant potential benefits of having portfolios less concentrated

    in CDs justify any cost, as mitigated under the rules.

    (3) Price Discovery

    The Commission has reviewed the restrictions on CDs and determined

    that the final rules should not have an impact on price discovery.

    (4) Sound Risk Management Procedures

    The greatest costs relative to sound risk management procedures

    have been mentioned previously. The introduction of additional

    investment restrictions to CDs in the form of asset-based concentration

    limits may require FCMs and DCOs to enhance their investment management

    and portfolio monitoring resources. However, the risk management

    strategies and systems should largely be in place already.

    The Commission believes that the overall benefits of the

    concentration limitations and other restrictions on CDs and the

    resultant reductions in risk to portfolios, as compared to those based

    on a regulatory framework without such limitations, mitigate the costs.

    (5) Other Public Interest Considerations

    The greatest potential impact of this rule on public interest

    considerations stem from the implications of these rules on the

    stability of the financial system as a whole. The inclusion of asset-

    based limitations on CDs, as well as the restriction that all CDs must

    be redeemable at the issuing bank, contributes to financial stability

    by reducing concentration risk for funds held in customer segregated

    accounts. For FCMs and DCOs, the expenses associated with managing to

    these limitations on CDs and the potential for reduced upside

    investment return on CD investments are costs. However, as discussed

    above, notwithstanding these limitations, FCMs and DCOs may still

    invest directly in CDs and may invest indirectly through MMMFs. The

    added expense associated with a more active management of the

    investment portfolios should be minor relative to the benefits

    fostered.

    Commercial Paper and Corporate Debt

    Some commercial paper and corporate notes or bonds will continue to

    be permitted investments pursuant to the Commission's authority under

    Section 4(c), subject to certain restrictions under the rules. In

    addition to the existing 5 percent limitation on the securities of any

    single issuer of such instruments being held with customer segregated

    funds, the new rules limit these asset classes in aggregate to 25

    percent, respectively, of the total customer segregated assets held by

    the FCM or DCO. The rules also restrict investment in commercial paper

    and corporate notes or bonds to those that are federally guaranteed as

    to principal and interest under the TLGP.

    (1) Protection of Market Participants and the Public

    The lack of liquidity that impacted these markets during the recent

    financial crisis, and which necessitated the federal guarantee under

    TLGP, highlights the concerns of permitting FCMs and DCOs unrestricted

    investment of customer funds in these assets. The limits imposed by

    this rule will protect customer funds from being invested in

    concentrated pools of unrated commercial paper and corporate notes or

    bonds. While the requirement that these instruments be guaranteed by

    TLGP may, in effect, severely limit investment in these instruments by

    FCMs and DCOs, the actual costs of this limitation for FCMs and DCOs

    are unclear, given that there is little data evidencing the extent of

    their use as an investment option, and the fact that indirect

    investment is still permitted through the use of MMMFs.

    Like other asset types, FCMs and DCOs may need additional resources

    and expertise, and incur the related expense, to manage a portfolio of

    TLGP corporate notes or bonds and/or commercial paper subject to the

    percentage limitations of the rules and the TLGP restrictions. With

    sizeable allowances for MMMFs, FCMs and DCOs will be able to continue

    to leverage the expertise of fund managers and access indirect

    investment in otherwise restricted asset types.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that this rule promotes financial integrity

    in an important way. Imposing portfolio concentration limits lowers the

    risk of FCMs and DCOs suffering losses and/or being unable to liquidate

    assets to meet margin calls. This type of liquidity loss may operate to

    undermine market integrity and public confidence in the absence of this

    rule.

    While there may be some potential for ``forced sale'' losses for

    FCMs and DCOs

    [[Page 78795]]

    on commercial paper and corporate debt now subject to restrictions, the

    Commission cannot gauge the magnitude and believes that it has taken

    measures appropriate to the circumstances to mitigate any potential

    costs. More specifically, the Commission is not in a position to know,

    with any precision, the portfolio holdings of FCMs and DCOs with

    respect to commercial paper and corporate debt, nor can the Commission

    predict the prevailing market conditions if FCMs and DCOs must sell

    commercial paper and corporate debt. Consequently, the Commission

    cannot quantify this cost. However, to reduce any potential cost, the

    rules contemplate a 180 day implementation period, giving FCMs and DCOs

    ample time to liquidate portfolios to the extent necessary to comply

    with the regulations. Since investments in commercial paper and

    corporate debt remain available for indirect investment through MMMFs,

    the Commission believes any impact on commercial paper and corporate

    debt markets also should be mitigated. Accordingly, the Commission

    believes that the significant potential benefits of having portfolios

    less concentrated in commercial paper and corporate debt justify any

    cost, as mitigated under the rule.

    (3) Price Discovery

    The Commission has reviewed the restrictions on commercial paper

    and corporate notes or bonds and determined that the final rules should

    not have an impact on price discovery.

    (4) Sound Risk Management Procedures

    The greatest costs relative to sound risk management procedures

    have been mentioned previously. The introduction of additional

    investment restrictions in the form of asset-based concentration limits

    and the TLGP restriction may require FCMs and DCOs to enhance their

    investment management and portfolio monitoring resources. However, the

    risk management strategies and systems should largely be in place

    already.

    The Commission believes that the overall benefits of the

    concentration limits and TLGP restrictions on commercial paper and

    corporate notes or bonds, and the resultant reductions in risk to

    portfolios, as compared to those based on a regulatory framework

    without such limitations, are compelling, notwithstanding attendant

    costs of the restrictions and concentration limits. By adding

    restrictions and increasing diversification through concentration

    limits, customer segregated funds should be better protected in the

    event of a crisis in the broader financial market.

    (5) Other Public Interest Considerations

    The greatest potential impact of this rule on public interest

    considerations stem from the implications of these rules for the

    stability of the financial system as a whole. The inclusion of asset-

    based limits on commercial paper and corporate notes or bonds, as well

    as the exclusion of corporate instruments that are not guaranteed by

    the TLGP, will contribute to financial stability by increasing the

    safety of funds in customer segregated accounts. For FCMs and DCOs, the

    expenses associated with managing these limitations and the potential

    for reduced upside investment opportunities are costs. However, as

    discussed above, notwithstanding the limitations on commercial paper

    and corporate notes or bonds, FCMs and DCOs still have a great deal of

    flexibility and the added expense associated with a more active

    management of the investment portfolios should be minor relative to the

    benefits fostered.

    Foreign Sovereign Debt

    Foreign sovereign debt is eliminated as a permitted investment in

    this rulemaking. However, the Commission invites FCMs or DCOs to

    request an exemption pursuant to the Commission's authority under

    Section 4(c), allowing them to invest in foreign sovereign debt: (1) To

    the extent that the FCM or DCO has balances in segregated accounts owed

    to its customers (or clearing member FCMs, as the case may be) in that

    country's currency; and (2) to the extent that investment in such

    foreign sovereign debt would serve to preserve principal and maintain

    liquidity of customer funds, as required by Regulation 1.25. Upon an

    appropriate demonstration, the Commission has noted that it may be

    amenable to granting such an exemption.

    (1) Protection of Market Participants and the Public

    The recent sovereign debt crises highlight the concerns of

    permitting FCMs and DCOs to invest customer funds in foreign sovereign

    debt. The restriction of this investment class will protect customer

    funds from being invested in risky or illiquid foreign sovereign debt.

    While this rule eliminates investment in these instruments by FCMs and

    DCOs, the actual costs of this restriction on FCMs and DCOs are

    unquantifiable, in large part because the extent to which DCOs invest

    in foreign sovereign debt is uncertain.

    Certain commenters argued that investment in foreign sovereign debt

    is necessary to hedge currency risk, and a prohibition on doing so may

    be costly. While the Commission recognizes that the restriction may

    impose costs, such costs are mitigated by the ability of an entity to

    seek an exemption from the Commission. Further, in a scenario where a

    market event has caused a currency devaluation and/or the illiquidity

    of a country's sovereign debt, the Commission believes that customers'

    best interests are served by an FCM holding a devalued currency, which

    (albeit devalued) can be delivered immediately to the customer as

    opposed to an illiquid foreign sovereign debt issuance, which may not

    be able to be exchanged for any currency in a reasonably short

    timeframe.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that this rule promotes financial integrity

    in an important way. Eliminating unpredictable and potentially risky

    instruments lowers the risk of FCMs and DCOs suffering losses and/or

    being unable to liquidate assets to meet margin calls. This type of

    liquidity loss may operate to undermine market integrity and public

    confidence in the absence of this rule.

    While there may be some potential for ``forced sale'' losses for

    FCMs and DCOs on foreign sovereign debt now prohibited, the Commission

    cannot quantify any such losses and believes that through the exemption

    process under Section 4(c), it has mitigated any such potential costs.

    Moreover, the Commission is not in a position to know, with any

    precision, the portfolio holdings of FCMs and DCOs with respect to

    foreign sovereign debt, nor can the Commission predict the prevailing

    market conditions if FCMs and DCOs must sell such instruments.

    Consequently, the Commission cannot quantify this cost. However, to

    mitigate any such potential cost, the rules contemplate a 180-day

    implementation period, giving FCMs and DCOs ample time to liquidate

    portfolios to the extent necessary to comply with the regulations and/

    or allowing FCMs and DCOs the opportunity to request an exemption.

    (3) Price Discovery

    The Commission does not believe that the restrictions on foreign

    sovereign debt will have an impact on price discovery.

    [[Page 78796]]

    (4) Sound Risk Management Procedures

    The restriction on foreign sovereign debt is intended to require an

    FCM or DCO to protect against currency exposure in a way that fosters

    sound risk management, particularly the protection of customer funds.

    (5) Other Public Interest Considerations

    The prohibition on investment in foreign sovereign debt will

    contribute to financial stability by increasing the safety of funds in

    customer segregated accounts. For FCMs and DCOs, any expense associated

    with the elimination of foreign sovereign debt is a cost. However, as

    discussed above, notwithstanding the elimination of this investment

    class, the Commission believes that the benefits to the public and

    market participants of this provision of the rule are significant.

    Money Market Mutual Funds

    MMMF investments will continue to be permitted pursuant to the

    Commission's authority under Section 4(c), albeit with some

    restrictions. First, an FCM or DCO may invest all of its customer

    segregated funds in Treasury-only MMMFs, but for all other MMMFs, as

    discussed below, the Commission believes that a 50 percent asset-based

    concentration is appropriate. In addition, an FCM or DCO may invest up

    to 10 percent of its assets in segregation in funds that do not have

    both $1 billion in assets and a management company that has at least

    $25 billion in MMMF assets under management (small MMMFs), while,

    subject to the caveats described above, an FCM or DCO may invest up to

    50 percent of its assets in segregation in funds that do (large MMMFs).

    In arriving at these concentration limits, in addition to its own

    staff research, the Commission took into consideration information

    presented in meetings with the market participants, comment letters and

    discussions with other regulators. The Commission decided to allow

    investment without asset- or issuer-based limitations for Treasury-only

    MMMFs due to the fact that Regulation 1.25 allows direct investments

    entirely in Treasuries. Indirect investment in Treasuries via a

    Treasury-only MMMF is essentially the risk equivalent of a direct

    investment in Treasuries, while allowing an FCM or DCO the

    administrative ease of delegating the management of its portfolio to a

    MMMF. The Commission decided upon a 50 percent asset-based

    concentration limit for large prime MMMFs, as it remains concerned

    that, in another crisis, a run on a prime MMMF may threaten both the

    liquidity and principal of customer segregated funds. After weighing

    the information described above, the Commission determined that a 50

    percent asset-based limitation struck the right balance between

    providing FCMs and DCOs with sufficient Regulation 1.25 investment

    options and, at the same time, encouraging adequate portfolio

    diversification. The issuer-based limitation reflects the view that the

    Commission seeks to protect FCMs and DCOs from runs on particular funds

    and families of funds. As a necessary corollary for increasing the

    asset-based concentration limits, the Commission decided to implement

    the fund and fund family size requirements in order to ensure that

    MMMFs invested in heavily by FCMs and DCOs were large enough to handle

    a high volume of redemption requests while still allowing for limited

    investment in small MMMFs.

    Finally, the Commission notes that these restrictions are such that

    an FCM could invest all of its customer funds in MMMFs, by, as

    examples, investing entirely in a large Treasury-only MMMF or by

    investing 50 percent of its funds in large prime MMMFs (spread out

    among five individual funds and three fund families) and 50 percent in

    a large Treasury-only MMMF. The Commission believes that this should

    alleviate the concerns of FCMs that expressed, in their comment

    letters, a reluctance to manage their own portfolios and instead wished

    to delegate those responsibilities entirely to fund managers.

    (1) Protection of Market Participants and the Public

    The recent financial crisis exposed the risks attendant to MMMFs--

    in particular, their susceptibility to runs. Though only one fund broke

    the buck, many others were supported by their sponsors and/or

    affiliates during the crisis. In response, the SEC has made a number of

    changes to Rule 2a-7 to address the risks inherent in MMMFs. The

    changes are aimed at reducing the perceived credit and liquidity risks

    of the MMMFs' underlying portfolios. However, as the President's

    Working Group on Financial Markets has noted, systemic risks remain in

    the MMMF market, notwithstanding the SEC's recent reforms.\200\ Absent

    further changes in the way MMMF shares are valued, redeemed and/or

    supported through private or public sector guarantees, future runs on

    MMMFs cannot be ruled out.

    ---------------------------------------------------------------------------

    \200\ President's Working Group on Financial Markets, Money

    Market Fund Reform Options, at 16-18 (2010). The full report may be

    accessed at http://www.treasury.gov/press-center/press-releases/Documents/10.21%20PWG%20Report%20Final.pdf.

    ---------------------------------------------------------------------------

    The minimum $1 billion asset requirement for individual fund and

    $25 billion asset requirement for family of funds of large MMMFs are

    designed to ensure that customer funds are typically invested in

    sufficiently large funds with diversified portfolios of holdings that

    are better positioned to withstand unexpected redemptions requests.

    Limited investment in small MMMFs was retained from the NPRM in order

    to provide flexibility for FCMs and DCOs and to promote

    diversification. The new asset-based concentration limitations for non-

    Treasury MMMFs in aggregate, by family and by individual fund will

    provide additional protection for customer segregated funds in the

    event of both runs on MMMFs generally, and more targeted runs that may

    affect a specific family of funds or an individual fund. The portfolio

    diversification requirements set forth by the amendment will provide

    greater security for customer funds, and ultimately to the FCMs and

    DCOs that rely on those funds.

    Individual FCMs and DCOs may need additional resources and

    expertise, and incur the related expense, to manage a portfolio subject

    to the percentage limitations of the rules with regard to asset-type,

    issuer and size. However, with sizeable allowances for MMMFs, FCMs and

    DCOs will be able to continue to leverage the expertise of fund

    managers. The Commission notes that under this rule, an FCM or DCO is

    able to invest all of their customer segregated funds in one or more

    MMMFs. Therefore, FCMs or DCOs not wishing to manage their portfolios

    may delegate entirely to MMMF managers.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that this rule promotes financial integrity

    in an important way. Imposing portfolio concentration limits lowers the

    risk of FCMs and DCOs suffering losses and/or being unable to liquidate

    assets to meet margin calls. This type of liquidity loss may operate to

    undermine market integrity and public confidence in the absence of this

    rule.

    While there may be some potential for ``forced sale'' losses for

    FCMs and DCOs on MMMFs that are above the concentration limits or not

    meet the asset requirements, the Commission cannot gauge the magnitude

    and believes that it has taken measures appropriate to the

    circumstances to mitigate any potential costs. More specifically, the

    Commission is not in a

    [[Page 78797]]

    position to know, with any precision, the portfolio holdings of FCMs

    and DCOs with respect to MMMFs, nor can the Commission predict the

    prevailing market conditions if FCMs and DCOs must sell MMMFs.

    Consequently, the Commission cannot quantify this cost. However, to

    reduce any potential cost, the rules contemplate a 180 day

    implementation period, giving FCMs and DCOs ample time to liquidate

    portfolios to the extent necessary to comply with the regulations.

    Since investments in MMMFs remain available, the Commission believes

    any impact on MMMF markets generally also should be mitigated.

    Accordingly, the Commission believes that the significant potential

    benefits of having portfolios less concentrated in a small number of

    MMMFs justify any cost, as mitigated under the rules.

    (3) Price Discovery

    The final rules should not have an impact on price discovery.

    (4) Sound Risk Management Procedures

    The greatest costs relative to sound risk management procedures

    have been mentioned previously. The introduction of additional

    investment restrictions on MMMFs in the form of asset-based and issuer-

    based concentration limits may require FCMs and DCOs to enhance their

    investment management and portfolio monitoring resources. However, to

    the extent that FCMs and DCOs had invested in MMMFs previously, the

    risk management strategies and systems should largely be in place

    already.

    (5) Other Public Interest Considerations

    The greatest potential benefit of this rule on public interest

    considerations stem from the implications of these rules on the

    stability of the financial system as a whole. The inclusion of asset-

    based concentration limitations on non-Treasury MMMFs, placing

    limitations on families of funds and on individual funds, and allowing

    only limited investment in funds not meeting certain asset limits

    contributes to financial stability by promoting the diversification of

    investment for funds held in customer segregated accounts. For FCMs and

    DCOs, the expenses associated with managing their MMMF investments and

    the potential for lost upside investment opportunities are costs.

    However, as discussed above, notwithstanding the limitations on the

    permitted investments, FCMs and DCOs may still invest all customer

    segregated funds in a portfolio of MMMFs, and the added expense

    associated with a more active management of the MMMF portfolio should

    be minor.

    Other Investment Limitations

    The final rules also include other limitations and restrictions on

    those investments that are permitted for customer segregated funds by

    FCMs and DCOs, including the elimination of in-house transactions and

    repurchase agreements with affiliates as well as a 25 percent

    counterparty concentration limit on repurchase agreements.

    (1) Protection of Market Participants and the Public

    As stated above, the guiding investment principle for customer

    funds is that investments are liquid and preserve principal. The

    lessons of the recent financial crisis highlighted the contagion that

    can occur in the financial markets from a single failure or default. As

    such, the new rules are designed to broadly spread counterparty risk,

    such that customer funds are protected and may be liquidated quickly,

    notwithstanding select failures in the marketplace. In-house

    transactions and repurchase agreements with affiliates have been

    eliminated due to the conflicts of interest that can arise during

    periods of crisis, the concentration risk associated with engaging in

    such transactions within an FCM-broker dealer entity (in the case of an

    in-house transaction) and within an affiliate structure (in the case of

    a repurchase agreements with affiliates), among other reasons. The 25

    percent counterparty-concentration limit has been introduced to ensure

    that an FCM or DCO does not have all of its customer funds subject to

    the risk profile of a single counterparty.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The Commission believes that these additional limitations promote

    financial integrity in an important way. By broadly spreading

    counterparty risk and enhancing customer fund protections and

    liquidity, the risk of FCMs and DCOs suffering losses and/or being

    unable to liquidate assets to meet margin calls is decreased. This type

    of liquidity loss may operate to undermine market integrity and public

    confidence in the absence of this rule.

    Moreover, to the extent there are potential costs noted below,

    offsetting benefits justify them. Any decrease in efficiency resulting

    from the elimination of in-house transactions and repurchase agreements

    with affiliates need be considered in light of the benefits of the

    increased certainty of arms-length transactions between two legally

    distinct, unaffiliated parties. And, a crucial benefit offsets the

    administrative costs associated with having five counterparties rather

    than one: Reduced counterparty risk.

    (3) Price Discovery

    The final rules should not have an impact on price discovery.

    (4) Sound Risk Management Procedures

    There may be additional expense associated with the on-boarding and

    risk managing additional counterparties, but the scale of this

    additional burden does not appear large and is justified by the

    benefits of improved counterparty concentration limits.

    (5) Other Public Interest Considerations

    The greatest potential impact of this rule on public interest

    considerations stem from the increased stability of the financial

    system as a whole. The inclusion of counterparty concentration limits,

    in particular, contributes to financial stability by reducing risk for

    funds held in customer segregated accounts.

    Regulation 30.7

    The Commission has decided to harmonize Regulation 30.7 with the

    investment limitations of Regulation 1.25. The Commission had not

    previously restricted investments of 30.7 funds to the permitted

    investments under Regulation 1.25. The Commission now believes that it

    is appropriate to align the investment standards given the similar

    prudential concerns that arise with respect to both segregated customer

    funds and 30.7 funds. The Commission has also removed the credit

    ratings requirements for depositories of 30.7 funds and eliminated the

    option of customers to designate, with the permission of the

    Commission, a depository not otherwise meeting the standards to be a

    depository of 30.7 funds.

    (1) Protection of Market Participants and the Public

    The public has a strong interest in the stability of the nation's

    financial system, a goal of the Dodd-Frank Act. Applying Regulation

    1.25 standards to 30.7 funds will better insulate them against the

    negative shocks of future financial crises, thereby enhancing

    protection to market participants and the public. Also, no benefit

    justifies applying a different standard for 30.7 funds than for

    segregated customer funds. FCMs and DCOs traditionally have used

    Regulation 1.25 as a safe harbor for 30.7 funds; accordingly, there is

    no basis to anticipate material additional expense

    [[Page 78798]]

    as a result of extending these requirements to 30.7 funds.

    The removal of credit ratings from Regulation 30.7 was necessitated

    by Section 939A of the Dodd-Frank Act and is in line with the

    Commission's removal of credit ratings under Regulation 1.25. The

    removal of the designation option for depositories stemmed from the

    fact that the Commission had never entertained such a request and from

    the belief that a depository should meet the capital requirements for

    depositories in order to hold 30.7 funds.

    (2) Efficiency, Competitiveness and Financial Integrity of the Markets

    The investments made with 30.7 funds generally have been similar to

    those made under Regulation 1.25. Accordingly, the Commission believes

    that harmonization of Regulation 30.7 with Regulation 1.25 promotes

    financial integrity in the same important ways and relative to less

    significant cost as discussed in the above. Specifically, imposition of

    the restrictions discussed above with respect to Regulation 1.25 asset

    classes lowers the risk of FCMs and DCOs suffering losses and/or being

    unable to liquidate assets to meet margin calls. This type of liquidity

    loss may operate to undermine market integrity and public confidence in

    the absence of this rule.

    The Commission does not expect the removal of credit ratings to

    have a significant impact on choice of depositories for 30.7 funds. The

    Commission expects the elimination of the designation option to have no

    impact, since it has never been used.

    (3) Price Discovery

    The final rules regarding Regulation 30.7 should not have an impact

    on price discovery.

    (4) Sound Risk Management Procedures

    As mentioned above, most FCMs and DCOs have used Regulation 1.25 as

    a safe harbor for 30.7 funds. As such, the incremental costs associated

    with applying the additional investment restrictions in the form of

    asset-based and issuer-based concentration limits should not be

    substantial. The risk management strategies and systems should largely

    be in place already, and will now be applied to 30.7 funds.

    The Commission believes that the overall benefits of applying

    Regulation 1.25 standards to 30.7 funds, as compared to those based on

    a regulatory framework without such limitations, justify the less

    significant costs. By adding restrictions and increasing

    diversification through concentration limits, 30.7 funds should be

    better protected in the event of a crisis in the broader financial

    market. The removal of credit ratings for depositories and the removal

    of the designation option should not have a significant impact on risk

    management practices because depositories must still meet the capital

    requirements in order to qualify under Regulation 30.7 and, as

    mentioned, no depositories have ever qualified through designation. The

    only cost associated with the former would be the administrative cost

    of moving funds from one depository to another, in the event that a

    previously qualifying depository now no longer qualifies.

    (5) Other Public Interest Considerations

    The greatest potential impact of this rule on public interest

    considerations stem from the implications of these rules for the

    stability of the financial system as a whole. The application of

    Regulation 1.25 standards to 30.7 funds will contribute to financial

    stability by reducing concentration risk for 30.7 funds. For FCMs and

    DCOs, the expenses associated with managing these limitations and the

    potential for lost upside investment opportunities are costs. However,

    as discussed above, the added expense associated with a more active

    management of the investment portfolios should be minor.

    IV. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) \201\ requires federal

    agencies, in promulgating rules, to consider the impact of those rules

    on small businesses. The rule amendments contained herein will affect

    FCMs and DCOs. The Commission has previously established certain

    definitions of ``small entities'' to be used by the Commission in

    evaluating the impact of its rules on small entities in accordance with

    the RFA.\202\ The Commission has previously determined that registered

    FCMs \203\ and DCOs \204\ are not small entities for the purpose of the

    RFA. Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman, on behalf

    of the Commission, certifies that the final rules will not have a

    significant economic impact on a substantial number of small entities.

    ---------------------------------------------------------------------------

    \201\ 5 U.S.C. 601 et seq.

    \202\ 47 FR 18618 (Apr. 30, 1982).

    \203\ Id. at 18619.

    \204\ 66 FR 45604, 45609 (Aug. 29, 2001).

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    B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) imposes certain

    requirements on federal agencies (including the Commission) in

    connection with their conducting or sponsoring any collection of

    information as defined by the PRA. The final rules do not require a new

    collection of information on the part of any entities subject to the

    rule amendments. Accordingly, for purposes of the PRA, the Commission

    certifies that these rule amendments, promulgated in final form, do not

    impose any new reporting or recordkeeping requirements.

    Lists of Subjects

    17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Reporting and

    recordkeeping requirements.

    17 CFR Part 30

    Commodity futures, Consumer protection, Currency, Reporting and

    recordkeeping requirements.

    In consideration of the foregoing and pursuant to the authority

    contained in the Commodity Exchange Act, in particular, Sections 4d,

    4(c), and 8a(5) thereof, 7 U.S.C. 6d, 6(c) and 12a(5), respectively,

    the Commission hereby amends Chapter I of Title 17 of the Code of

    Federal Regulations as follows:

    PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    0

    1. The authority citation for part 1 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

    6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

    13a-1, 16, 16a, 19, 21, 23, and 24, as amended by the Dodd-Frank

    Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124

    Stat. 1376 (2010).

    0

    2. Section 1.25 is revised to read as follows:

    Sec. 1.25 Investment of customer funds.

    (a) Permitted investments. (1) Subject to the terms and conditions

    set forth in this section, a futures commission merchant or a

    derivatives clearing organization may invest customer money in the

    following instruments (permitted investments):

    (i) Obligations of the United States and obligations fully

    guaranteed as to principal and interest by the United States (U.S.

    government securities);

    (ii) General obligations of any State or of any political

    subdivision thereof (municipal securities);

    (iii) Obligations of any United States government corporation or

    enterprise sponsored by the United States government (U.S. agency

    obligations);

    (iv) Certificates of deposit issued by a bank (certificates of

    deposit) as defined

    [[Page 78799]]

    in section 3(a)(6) of the Securities Exchange Act of 1934, or a

    domestic branch of a foreign bank that carries deposits insured by the

    Federal Deposit Insurance Corporation;

    (v) Commercial paper fully guaranteed as to principal and interest

    by the United States under the Temporary Liquidity Guarantee Program as

    administered by the Federal Deposit Insurance Corporation (commercial

    paper);

    (vi) Corporate notes or bonds fully guaranteed as to principal and

    interest by the United States under the Temporary Liquidity Guarantee

    Program as administered by the Federal Deposit Insurance Corporation

    (corporate notes or bonds); and

    (vii) Interests in money market mutual funds.

    (2)(i) In addition, a futures commission merchant or derivatives

    clearing organization may buy and sell the permitted investments listed

    in paragraphs (a)(1)(i) through (vii) of this section pursuant to

    agreements for resale or repurchase of the instruments, in accordance

    with the provisions of paragraph (d) of this section.

    (ii) A futures commission merchant or a derivatives clearing

    organization may sell securities deposited by customers as margin

    pursuant to agreements to repurchase subject to the following:

    (A) Securities subject to such repurchase agreements must be

    ``highly liquid'' as defined in paragraph (b)(1) of this section.

    (B) Securities subject to such repurchase agreements must not be

    ``specifically identifiable property'' as defined in Sec. 190.01(kk)

    of this chapter.

    (C) The terms and conditions of such an agreement to repurchase

    must be in accordance with the provisions of paragraph (d) of this

    section.

    (D) Upon the default by a counterparty to a repurchase agreement,

    the futures commission merchant or derivatives clearing organization

    shall act promptly to ensure that the default does not result in any

    direct or indirect cost or expense to the customer.

    (3) Obligations issued by the Federal National Mortgage Association

    or the Federal Home Loan Mortgage Association are permitted while these

    entities operate under the conservatorship or receivership of the

    Federal Housing Finance Authority with capital support from the United

    States.

    (b) General terms and conditions. A futures commission merchant or

    a derivatives clearing organization is required to manage the permitted

    investments consistent with the objectives of preserving principal and

    maintaining liquidity and according to the following specific

    requirements:

    (1) Liquidity. Investments must be ``highly liquid'' such that they

    have the ability to be converted into cash within one business day

    without material discount in value.

    (2) Restrictions on instrument features. (i) With the exception of

    money market mutual funds, no permitted investment may contain an

    embedded derivative of any kind, except as follows:

    (A) The issuer of an instrument otherwise permitted by this section

    may have an option to call, in whole or in part, at par, the principal

    amount of the instrument before its stated maturity date; or

    (B) An instrument that meets the requirements of paragraph

    (b)(2)(iv) of this section may provide for a cap, floor, or collar on

    the interest paid; provided, however, that the terms of such instrument

    obligate the issuer to repay the principal amount of the instrument at

    not less than par value upon maturity.

    (ii) No instrument may contain interest-only payment features.

    (iii) No instrument may provide payments linked to a commodity,

    currency, reference instrument, index, or benchmark except as provided

    in paragraph (b)(2)(iv) of this section, and it may not otherwise

    constitute a derivative instrument.

    (iv)(A) Adjustable rate securities are permitted, subject to the

    following requirements:

    (1) The interest payments on variable rate securities must

    correlate closely and on an unleveraged basis to a benchmark of either

    the Federal Funds target or effective rate, the prime rate, the three-

    month Treasury Bill rate, the one-month or three-month LIBOR rate, or

    the interest rate of any fixed rate instrument that is a permitted

    investment listed in paragraph (a)(1) of this section;

    (2) The interest payment, in any period, on floating rate

    securities must be determined solely by reference, on an unleveraged

    basis, to a benchmark of either the Federal Funds target or effective

    rate, the prime rate, the three-month Treasury Bill rate, the one-month

    or three-month LIBOR rate, or the interest rate of any fixed rate

    instrument that is a permitted investment listed in paragraph (a)(1) of

    this section;

    (3) Benchmark rates must be expressed in the same currency as the

    adjustable rate securities that reference them; and

    (4) No interest payment on an adjustable rate security, in any

    period, can be a negative amount.

    (B) For purposes of this paragraph, the following definitions shall

    apply:

    (1) The term adjustable rate security means, a floating rate

    security, a variable rate security, or both.

    (2) The term floating rate security means a security, the terms of

    which provide for the adjustment of its interest rate whenever a

    specified interest rate changes and that, at any time until the final

    maturity of the instrument or the period remaining until the principal

    amount can be recovered through demand, can reasonably be expected to

    have market value that approximates its amortized cost.

    (3) The term variable rate security means a security, the terms of

    which provide for the adjustment of its interest rate on set dates

    (such as the last day of a month or calendar quarter) and that, upon

    each adjustment until the final maturity of the instrument or the

    period remaining until the principal amount can be recovered through

    demand, can reasonably be expected to have a market value that

    approximates its amortized cost.

    (v) Certificates of deposit must be redeemable at the issuing bank

    within one business day, with any penalty for early withdrawal limited

    to any accrued interest earned according to its written terms.

    (vi) Commercial paper and corporate notes or bonds must meet the

    following criteria:

    (A) The size of the issuance must be greater than $1 billion;

    (B) The instrument must be denominated in U.S. dollars; and

    (C) The instrument must be fully guaranteed as to principal and

    interest by the United States for its entire term.

    (3) Concentration--(i) Asset-based concentration limits for direct

    investments. (A) Investments in U.S. government securities shall not be

    subject to a concentration limit.

    (B) Investments in U.S. agency obligations may not exceed 50

    percent of the total assets held in segregation by the futures

    commission merchant or derivatives clearing organization.

    (C) Investments in each of commercial paper, corporate notes or

    bonds and certificates of deposit may not exceed 25 percent of the

    total assets held in segregation by the futures commission merchant or

    derivatives clearing organization.

    (D) Investments in municipal securities may not exceed 10 percent

    of the total assets held in segregation by the futures commission

    merchant or derivatives clearing organization.

    (E) Subject to paragraph (b)(3)(i)(G) of this section, investments

    in money market mutual funds comprising only

    [[Page 78800]]

    U.S. government securities shall not be subject to a concentration

    limit.

    (F) Subject to paragraph (b)(3)(i)(G) of this section, investments

    in money market mutual funds, other than those described in paragraph

    (b)(3)(i)(E) of this section, may not exceed 50 percent of the total

    assets held in segregation by the futures commission merchant or

    derivatives clearing organization.

    (G) Investments in money market mutual funds comprising less than

    $1 billion in assets and/or which have a management company comprising

    less than $25 billion in assets, may not exceed 10 percent of the total

    assets held in segregation by the futures commission merchant or

    derivatives clearing organization.

    (ii) Issuer-based concentration limits for direct investments. (A)

    Securities of any single issuer of U.S. agency obligations held by a

    futures commission merchant or derivatives clearing organization may

    not exceed 25 percent of total assets held in segregation by the

    futures commission merchant or derivatives clearing organization.

    (B) Securities of any single issuer of municipal securities,

    certificates of deposit, commercial paper, or corporate notes or bonds

    held by a futures commission merchant or derivatives clearing

    organization may not exceed 5 percent of total assets held in

    segregation by the futures commission merchant or derivatives clearing

    organization.

    (C) Interests in any single family of money market mutual funds

    described in paragraph (b)(3)(i)(F) of this section may not exceed 25

    percent of total assets held in segregation by the futures commission

    merchant or derivatives clearing organization.

    (D) Interests in any individual money market mutual fund described

    in paragraph (b)(3)(i)(F) of this section may not exceed 10 percent of

    total assets held in segregation by the futures commission merchant or

    derivatives clearing organization.

    (E) For purposes of determining compliance with the issuer-based

    concentration limits set forth in this section, securities issued by

    entities that are affiliated, as defined in paragraph (b)(5) of this

    section, shall be aggregated and deemed the securities of a single

    issuer. An interest in a permitted money market mutual fund is not

    deemed to be a security issued by its sponsoring entity.

    (iii) Concentration limits for agreements to repurchase--(A)

    Repurchase agreements. For purposes of determining compliance with the

    asset-based and issuer-based concentration limits set forth in this

    section, securities sold by a futures commission merchant or

    derivatives clearing organization subject to agreements to repurchase

    shall be combined with securities held by the futures commission

    merchant or derivatives clearing organization as direct investments.

    (B) Reverse repurchase agreements. For purposes of determining

    compliance with the asset-based and issuer-based concentration limits

    set forth in this section, securities purchased by a futures commission

    merchant or derivatives clearing organization subject to agreements to

    resell shall be combined with securities held by the futures commission

    merchant or derivatives clearing organization as direct investments.

    (iv) Treatment of customer-owned securities. For purposes of

    determining compliance with the asset-based and issuer-based

    concentration limits set forth in this section, securities owned by the

    customers of a futures commission merchant and posted as margin

    collateral are not included in total assets held in segregation by the

    futures commission merchant, and securities posted by a futures

    commission merchant with a derivatives clearing organization are not

    included in total assets held in segregation by the derivatives

    clearing organization.

    (v) Counterparty concentration limits. Securities purchased by a

    futures commission merchant or derivatives clearing organization from a

    single counterparty, subject to an agreement to resell to that

    counterparty, shall not exceed 25 percent of total assets held in

    segregation by the futures commission merchant or derivatives clearing

    organization.

    (4) Time-to-maturity. (i) Except for investments in money market

    mutual funds, the dollar-weighted average of the time-to-maturity of

    the portfolio, as that average is computed pursuant to Sec. 270.2a-7

    of this title, may not exceed 24 months.

    (ii) For purposes of determining the time-to-maturity of the

    portfolio, an instrument that is set forth in paragraphs (a)(1)(i)

    through (vii) of this section may be treated as having a one-day time-

    to-maturity if the following terms and conditions are satisfied:

    (A) The instrument is deposited solely on an overnight basis with a

    derivatives clearing organization pursuant to the terms and conditions

    of a collateral management program that has become effective in

    accordance with Sec. 39.4 of this chapter;

    (B) The instrument is one that the futures commission merchant owns

    or has an unqualified right to pledge, is not subject to any lien, and

    is deposited by the futures commission merchant into a segregated

    account at a derivatives clearing organization;

    (C) The derivatives clearing organization prices the instrument

    each day based on the current mark-to-market value; and

    (D) The derivatives clearing organization reduces the assigned

    value of the instrument each day by a haircut of at least 2 percent.

    (5) Investments in instruments issued by affiliates. (i) A futures

    commission merchant shall not invest customer funds in obligations of

    an entity affiliated with the futures commission merchant, and a

    derivatives clearing organization shall not invest customer funds in

    obligations of an entity affiliated with the derivatives clearing

    organization. An affiliate includes parent companies, including all

    entities through the ultimate holding company, subsidiaries to the

    lowest level, and companies under common ownership of such parent

    company or affiliates.

    (ii) A futures commission merchant or derivatives clearing

    organization may invest customer funds in a fund affiliated with that

    futures commission merchant or derivatives clearing organization.

    (6) Recordkeeping. A futures commission merchant and a derivatives

    clearing organization shall prepare and maintain a record that will

    show for each business day with respect to each type of investment made

    pursuant to this section, the following information:

    (i) The type of instruments in which customer funds have been

    invested;

    (ii) The original cost of the instruments; and

    (iii) The current market value of the instruments.

    (c) Money market mutual funds. The following provisions will apply

    to the investment of customer funds in money market mutual funds (the

    fund).

    (1) The fund must be an investment company that is registered under

    the Investment Company Act of 1940 with the Securities and Exchange

    Commission and that holds itself out to investors as a money market

    fund, in accordance with Sec. 270.2a-7 of this title.

    (2) The fund must be sponsored by a federally-regulated financial

    institution, a bank as defined in section 3(a)(6) of the Securities

    Exchange Act of 1934, an investment adviser registered under the

    Investment Advisers Act of 1940, or a domestic branch of a foreign bank

    insured by the Federal Deposit Insurance Corporation.

    (3) A futures commission merchant or derivatives clearing

    organization shall maintain the confirmation relating to

    [[Page 78801]]

    the purchase in its records in accordance with Sec. 1.31 and note the

    ownership of fund shares (by book-entry or otherwise) in a custody

    account of the futures commission merchant or derivatives clearing

    organization in accordance with Sec. 1.26. The futures commission

    merchant or the derivatives clearing organization shall obtain the

    acknowledgment letter required by Sec. 1.26 from an entity that has

    substantial control over the fund shares purchased with customer

    segregated funds and has the knowledge and authority to facilitate

    redemption and payment or transfer of the customer segregated funds.

    Such entity may include the fund sponsor or depository acting as

    custodian for fund shares.

    (4) The net asset value of the fund must be computed by 9 a.m. of

    the business day following each business day and made available to the

    futures commission merchant or derivatives clearing organization by

    that time.

    (5)(i) General requirement for redemption of interests. A fund

    shall be legally obligated to redeem an interest and to make payment in

    satisfaction thereof by the business day following a redemption

    request, and the futures commission merchant or derivatives clearing

    organization shall retain documentation demonstrating compliance with

    this requirement.

    (ii) Exception. A fund may provide for the postponement of

    redemption and payment due to any of the following circumstances:

    (A) For any period during which there is a non-routine closure of

    the Fedwire or applicable Federal Reserve Banks;

    (B) For any period:

    (1) During which the New York Stock Exchange is closed other than

    customary week-end and holiday closings; or

    (2) During which trading on the New York Stock Exchange is

    restricted;

    (C) For any period during which an emergency exists as a result of

    which:

    (1) Disposal by the company of securities owned by it is not

    reasonably practicable; or

    (2) It is not reasonably practicable for such company fairly to

    determine the value of its net assets;

    (D) For any period as the Securities and Exchange Commission may by

    order permit for the protection of security holders of the company;

    (E) For any period during which the Securities and Exchange

    Commission has, by rule or regulation, deemed that:

    (1) Trading shall be restricted; or

    (2) An emergency exists; or

    (F) For any period during which each of the conditions of Sec.

    270.22e-3(a)(1) through (3) of this title are met.

    (6) The agreement pursuant to which the futures commission merchant

    or derivatives clearing organization has acquired and is holding its

    interest in a fund must contain no provision that would prevent the

    pledging or transferring of shares.

    (7) The Appendix to this section sets forth language that will

    satisfy the requirements of paragraph (c)(5) of this section.

    (d) Repurchase and reverse repurchase agreements. A futures

    commission merchant or derivatives clearing organization may buy and

    sell the permitted investments listed in paragraphs (a)(1)(i) through

    (vii) of this section pursuant to agreements for resale or repurchase

    of the securities (agreements to repurchase or resell), provided the

    agreements to repurchase or resell conform to the following

    requirements:

    (1) The securities are specifically identified by coupon rate, par

    amount, market value, maturity date, and CUSIP or ISIN number.

    (2) Permitted counterparties are limited to a bank as defined in

    section 3(a)(6) of the Securities Exchange Act of 1934, a domestic

    branch of a foreign bank insured by the Federal Deposit Insurance

    Corporation, a securities broker or dealer, or a government securities

    broker or government securities dealer registered with the Securities

    and Exchange Commission or which has filed notice pursuant to section

    15C(a) of the Government Securities Act of 1986.

    (3) A futures commission merchant or derivatives clearing

    organization shall not enter into an agreement to repurchase or resell

    with a counterparty that is an affiliate of the futures commission

    merchant or derivatives clearing organization, respectively. An

    affiliate includes parent companies, including all entities through the

    ultimate holding company, subsidiaries to the lowest level, and

    companies under common ownership of such parent company or affiliates.

    (4) The transaction is executed in compliance with the

    concentration limit requirements applicable to the securities

    transferred to the customer segregated custodial account in connection

    with the agreements to repurchase referred to in paragraphs

    (b)(3)(iii)(A) and (B) of this section.

    (5) The transaction is made pursuant to a written agreement signed

    by the parties to the agreement, which is consistent with the

    conditions set forth in paragraphs (d)(1) through (13) of this section

    and which states that the parties thereto intend the transaction to be

    treated as a purchase and sale of securities.

    (6) The term of the agreement is no more than one business day, or

    reversal of the transaction is possible on demand.

    (7) Securities transferred to the futures commission merchant or

    derivatives clearing organization under the agreement are held in a

    safekeeping account with a bank as referred to in paragraph (d)(2) of

    this section, a derivatives clearing organization, or the Depository

    Trust Company in an account that complies with the requirements of

    Sec. 1.26.

    (8) The futures commission merchant or the derivatives clearing

    organization may not use securities received under the agreement in

    another similar transaction and may not otherwise hypothecate or pledge

    such securities, except securities may be pledged on behalf of

    customers at another futures commission merchant or derivatives

    clearing organization. Substitution of securities is allowed, provided,

    however, that:

    (i) The qualifying securities being substituted and original

    securities are specifically identified by date of substitution, market

    values substituted, coupon rates, par amounts, maturity dates and CUSIP

    or ISIN numbers;

    (ii) Substitution is made on a ``delivery versus delivery'' basis;

    and

    (iii) The market value of the substituted securities is at least

    equal to that of the original securities.

    (9) The transfer of securities to the customer segregated custodial

    account is made on a delivery versus payment basis in immediately

    available funds. The transfer of funds to the customer segregated cash

    account is made on a payment versus delivery basis. The transfer is not

    recognized as accomplished until the funds and/or securities are

    actually received by the custodian of the futures commission merchant's

    or derivatives clearing organization's customer funds or securities

    purchased on behalf of customers. The transfer or credit of securities

    covered by the agreement to the futures commission merchant's or

    derivatives clearing organization's customer segregated custodial

    account is made simultaneously with the disbursement of funds from the

    futures commission merchant's or derivatives clearing organization's

    customer segregated cash account at the custodian bank. On the sale or

    resale of securities, the futures commission merchant's or derivatives

    clearing organization's customer segregated cash account at the

    custodian bank must receive same-day funds credited to such segregated

    [[Page 78802]]

    account simultaneously with the delivery or transfer of securities from

    the customer segregated custodial account.

    (10) A written confirmation to the futures commission merchant or

    derivatives clearing organization specifying the terms of the agreement

    and a safekeeping receipt are issued immediately upon entering into the

    transaction and a confirmation to the futures commission merchant or

    derivatives clearing organization is issued once the transaction is

    reversed.

    (11) The transactions effecting the agreement are recorded in the

    record required to be maintained under Sec. 1.27 of investments of

    customer funds, and the securities subject to such transactions are

    specifically identified in such record as described in paragraph (d)(1)

    of this section and further identified in such record as being subject

    to repurchase and reverse repurchase agreements.

    (12) An actual transfer of securities to the customer segregated

    custodial account by book entry is made consistent with Federal or

    State commercial law, as applicable. At all times, securities received

    subject to an agreement are reflected as ``customer property.''

    (13) The agreement makes clear that, in the event of the bankruptcy

    of the futures commission merchant or derivatives clearing

    organization, any securities purchased with customer funds that are

    subject to an agreement may be immediately transferred. The agreement

    also makes clear that, in the event of a futures commission merchant or

    derivatives clearing organization bankruptcy, the counterparty has no

    right to compel liquidation of securities subject to an agreement or to

    make a priority claim for the difference between current market value

    of the securities and the price agreed upon for resale of the

    securities to the counterparty, if the former exceeds the latter.

    (e) Deposit of firm-owned securities into segregation. A futures

    commission merchant shall not be prohibited from directly depositing

    unencumbered securities of the type specified in this section, which it

    owns for its own account, into a segregated safekeeping account or from

    transferring any such securities from a segregated account to its own

    account, up to the extent of its residual financial interest in

    customers' segregated funds; provided, however, that such investments,

    transfers of securities, and disposition of proceeds from the sale or

    maturity of such securities are recorded in the record of investments

    required to be maintained by Sec. 1.27. All such securities may be

    segregated in safekeeping only with a bank, trust company, derivatives

    clearing organization, or other registered futures commission merchant.

    Furthermore, for purposes of Sec. Sec. 1.25, 1.26, 1.27, 1.28, and

    1.29, investments permitted by Sec. 1.25 that are owned by the futures

    commission merchant and deposited into such a segregated account shall

    be considered customer funds until such investments are withdrawn from

    segregation.

    Appendix to Sec. 1.25--Money Market Mutual Fund Prospectus Provisions

    Acceptable for Compliance With Section 1.25(c)(5)

    Upon receipt of a proper redemption request submitted in a

    timely manner and otherwise in accordance with the redemption

    procedures set forth in this prospectus, the [Name of Fund] will

    redeem the requested shares and make a payment to you in

    satisfaction thereof no later than the business day following the

    redemption request. The [Name of Fund] may postpone and/or suspend

    redemption and payment beyond one business day only as follows:

    a. For any period during which there is a non-routine closure of

    the Fedwire or applicable Federal Reserve Banks;

    b. For any period (1) during which the New York Stock Exchange

    is closed other than customary week-end and holiday closings or (2)

    during which trading on the New York Stock Exchange is restricted;

    c. For any period during which an emergency exists as a result

    of which (1) disposal of securities owned by the [Name of Fund] is

    not reasonably practicable or (2) it is not reasonably practicable

    for the [Name of Fund] to fairly determine the net asset value of

    shares of the [Name of Fund];

    d. For any period during which the Securities and Exchange

    Commission has, by rule or regulation, deemed that (1) trading shall

    be restricted or (2) an emergency exists;

    e. For any period that the Securities and Exchange Commission,

    may by order permit for your protection; or

    f. For any period during which the [Name of Fund,] as part of a

    necessary liquidation of the fund, has properly postponed and/or

    suspended redemption of shares and payment in accordance with

    federal securities laws.

    PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS

    0

    3. The authority citation for part 30 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6c, and 12a, unless otherwise

    noted.

    0

    4. In Sec. 30.7, revise paragraph (c) and add paragraph (g) to read as

    follows:

    Sec. 30.7 Treatment of foreign futures or foreign options secured

    amount.

    * * * * *

    (c)(1) The separate account or accounts referred to in paragraph

    (a) of this section must be maintained under an account name that

    clearly identifies them as such, with any of the following

    depositories:

    (i) A bank or trust company located in the United States;

    (ii) A bank or trust company located outside the United States that

    has in excess of $1 billion of regulatory capital;

    (iii) A futures commission merchant registered as such with the

    Commission;

    (iv) A derivatives clearing organization;

    (v) The clearing organization of any foreign board of trade;

    (vi) A member of any foreign board of trade; or

    (vii) Such member or clearing organization's designated

    depositories.

    (2) Each futures commission merchant must obtain and retain in its

    files for the period provided in Sec. 1.31 of this chapter an

    acknowledgment from such depository that it was informed that such

    money, securities or property are held for or on behalf of foreign

    futures and foreign options customers and are being held in accordance

    with the provisions of these regulations.

    * * * * *

    (g) Each futures commission merchant that invests customer funds

    held in the account or accounts referred to in paragraph (a) of this

    section must invest such funds pursuant to the requirements of Sec.

    1.25 of this chapter.

    Issued in Washington, DC, on December 5, 2011 by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    Appendices to Investment of Customer Funds and Funds Held in an Account

    for Foreign Futures and Foreign Options Transactions--Commission Voting

    Summary and Statements of Commissioners

    Note: The following appendices will not appear in the Code of

    Federal Regulations.

    Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler, Commissioners Sommers,

    Chilton, O'Malia and Wetjen voted in the affirmative; no

    Commissioner voted in the negative.

    Appendix 2--Statement of Chairman Gary Gensler

    I support the final rule to enhance customer protections

    regarding where derivatives clearing organizations (DCOs) and

    futures commission merchants (FCMs) can invest customer funds. I

    believe that this rule is critical for the safeguarding of customer

    money.

    The Commodity Exchange Act in section 4d(a)(2) prescribes that

    customer funds can only be placed in a set list of permitted

    investments. From 2000 to 2005, the

    [[Page 78803]]

    Commission granted exemptions to this list, loosening the rules for

    the investment of customer funds. These exemptions allowed FCMs to

    invest customer funds in AAA-rated sovereign debt, as well as to

    lend customer money to another side of the firm through repurchase

    agreements.

    This rule prevents such in-house lending through repurchase

    agreements. I believe there is an inherent conflict of interest

    between parts of a firm doing these transactions. The rule also

    would limit an FCM's ability to invest customer money in foreign

    sovereign debt.

    In addition, this rule fulfills a Dodd-Frank requirement that

    the CFTC remove all reliance on credit ratings from its regulations.

    [FR Doc. 2011-31689 Filed 12-16-11; 8:45 am]

    BILLING CODE P

    Last Updated: December 19, 2011



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