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2013-26665

  • Federal Register, Volume 78 Issue 220 (Thursday, November 14, 2013)[Federal Register Volume 78, Number 220 (Thursday, November 14, 2013)]

    [Rules and Regulations]

    [Pages 68505-68657]

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

    [FR Doc No: 2013-26665]

    [[Page 68505]]

    Vol. 78

    Thursday,

    No. 220

    November 14, 2013

    Part II

    Commodity Futures Trading Commission

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    17 CFR Parts 1, 3, 22, et al.

    Enhancing Protections Afforded Customers and Customer Funds Held by

    Futures Commission Merchants and Derivatives Clearing Organizations;

    Final Rule

    Federal Register / Vol. 78 , No. 220 / Thursday, November 14, 2013 /

    Rules and Regulations

    [[Page 68506]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1, 3, 22, 30, and 140

    RIN 3038-AD88

    Enhancing Protections Afforded Customers and Customer Funds Held

    by Futures Commission Merchants and Derivatives Clearing Organizations

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Final rule.

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    SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

    ``CFTC'') is adopting new regulations and amending existing regulations

    to require enhanced customer protections, risk management programs,

    internal monitoring and controls, capital and liquidity standards,

    customer disclosures, and auditing and examination programs for futures

    commission merchants (``FCMs'').

    The regulations also address certain related issues concerning

    derivatives clearing organizations (``DCOs'') and chief compliance

    officers (``CCOs''). The final rules will afford greater assurances to

    market participants that: Customer segregated funds, secured amount

    funds, and cleared swaps funds are protected; customers are provided

    with appropriate notice of the risks of futures trading and of the FCMs

    with which they may choose to do business; FCMs are monitoring and

    managing risks in a robust manner; the capital and liquidity of FCMs

    are strengthened to safeguard their continued operations; and the

    auditing and examination programs of the Commission and the self-

    regulatory organizations (``SROs'') are monitoring the activities of

    FCMs in a prudent and thorough manner.

    DATES: Effective date: January 13, 2014.

    Compliance date: The applicable compliance dates are discussed in

    the section of the release titled ``III. Compliance Dates.''

    FOR FURTHER INFORMATION CONTACT: Division of Swap Dealer and

    Intermediary Oversight: Gary Barnett, Director, 202-418-5977,

    gbarnett@cftc.gov; Thomas Smith, Deputy Director, 202-418-5495,

    tsmith@cftc.gov;mailto: Jennifer Bauer, Special Counsel, 202-418-5472,

    jbauer@cftc.gov; Joshua Beale, Attorney-Advisor, 202-418-5446,

    jbeale@cftc.gov, Three Lafayette Centre, 1155 21st Street NW.,

    Washington, DC 20581; Kevin Piccoli, Deputy Director, 646-746-9834,

    kpiccoli@cftc.gov, 140 Broadway, 19th Floor, New York, NY 10005; or

    Mark Bretscher, Special Counsel, 312-596-0529, mbretscher@cftc.gov, 525

    W. Monroe Street, Suite 1100, Chicago, IL. 60661. Division of Clearing

    and Risk: Ananda Radhakrishnan, Director, 202-418-5188,

    aradhakrishnan@cftc.gov; Robert B. Wasserman, Chief Counsel, 202-418-

    5092, rwasserman@cftc.gov; Phyllis P. Dietz, Deputy Director, 202-418-

    5449, pdietz@cftc.gov; M. Laura Astrada, Associate Chief Counsel, 202-

    418-7622, lastrada@cftc.gov, Eileen Donovan, Associate Director, 202-

    418-5096, edonovan@cftc.gov; Kirsten V. K. Robbins, Special Counsel,

    202-418-5313, krobbins@cftc.gov; or Shawn R. Durrani, Attorney-Advisor,

    202-418-5048, sdurrani@cftc.gov, Three Lafayette Centre, 1155 21st

    Street NW., Washington, DC 20581.

    Office of the Chief Economist: Stephen Kane, Research Economist,

    skane@cftc.gov, 202-418-5911, Three Lafayette Centre, 1155 21st Street

    NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    Table of Contents

    I. Background

    A. General Statutory and Current Regulatory Structure

    B. Self-Regulatory Structure

    C. Futures Commission Merchant Insolvencies and Failures of Risk

    Management

    D. Recent Commission Rulemakings and Other Initiatives Relating

    to Customer Protection

    E. The Proposed Amendments

    II. Comments on the Notice of Proposed Rulemaking

    A. Sec. 1.10: Financial Reports of Futures Commission Merchants

    and Introducing Brokers

    1. Amendments of the Segregation and Secured Amount Schedules

    With Respect to the Reporting of Residual Interest

    2. New Cleared Swaps Segregation Schedules

    3. Amendments to Form 1-FR-FCM

    4. FCM Certified Annual Report Deadline

    5. Leverage Ratio Calculation

    6. Procedural Filing Requirements

    B. Sec. 1.11: Risk Management Program for Futures Commission

    Merchants

    1. Applicability

    2. Definitions

    3. Approval of Policies and Procedures and Submission to the

    Commission

    4. Organizational Requirements of the Risk Management Program

    a. Separation of Risk Management Unit From Business Unit

    5. Components of the Risk Management Program

    6. Annual Review, Distribution of Policies and Procedures and

    Recordkeeping

    7. CCO or CEO Certification

    C. Sec. 1.12: Maintenance of Minimum Financial Requirements by

    Futures Commission Merchants and Introducing Brokers

    1. Timing of Notices

    2. Undercapitalized FCMs and IBs

    3. Insufficient Segregation of Funds of Cleared Swaps Customers

    4. Investment of Customer Funds in Contravention of Regulation

    1.25

    5. Notice of Residual Interest Falling Below Targeted Level or

    Undermargined Amounts

    6. Events Causing Material Adverse Financial Impact or Material

    Change in Operations

    7. Notice of Correspondence From Other Regulatory Authorities

    8. Filing Process and Content

    9. Public Disclosure of Early Warning Notices

    D. Sec. 1.15: Risk Assessment Reporting Requirement for Futures

    Commission Merchants

    E. Sec. 1.16: Qualifications and Reports of Accountants

    1. Mandatory PCAOB Registration Requirement

    2. PCAOB Inspection Requirement

    3. Remediation of PCAOB Inspection Findings by the Public

    Accountant

    4. Auditing Standards

    5. Review of Public Accountant's Qualifications by the FCM's

    Governing Body

    6. Electronic Filing of Certified Annual Reports

    F. Sec. 1.17: Minimum Financial Requirements for Futures

    Commission Merchants and Introducing Brokers

    1. FCM Cessation of Business and Transfer of Customer Accounts

    if Unable To Demonstrate Adequate Liquidity

    2. Reducing Time Period for FCMs To Incur a Capital Charge for

    Undermargined Accounts to One Day after Margin Calls Are Issued

    3. Permit an FCM that is not a BD To Develop Policies and

    Procedures To Determine Creditworthiness

    4. Revisions to Definitions in Regulation 1.17(b)

    G. Sec. 1.20: Futures Customer Funds To Be Segregated and

    Separately Accounted for

    1. Identification of Customer Funds and Due Diligence

    2. Permitted Depositories

    3. Limitation on the Holding of Futures Customer Funds Outside

    of the United States

    4. Acknowledgment Letters

    a. Background

    b. Technical Changes to the Template Letters

    c. Federal Reserve Banks as Depositories

    d. Foreign Depositories

    e. Release of Funds Upon Commission Instruction

    f. Read-Only Access and Information Requests

    g. Requirement To File New Acknowledgment Letters

    h. Standard of Liability

    i. Liens

    j. Examination of Accounts

    5. Prohibition Against Commingling Customer Funds

    6. Limitations on the Use of Customer Funds

    7. Segregation Requirements for DCOs

    [[Page 68507]]

    8. Immediate Availability of Bank and Trust Company Deposits

    9. Segregated Funds Computation Requirement

    10. Segregation Regimes

    H. Sec. 1.22: Use of Futures Customer Funds

    I. Sec. 1.23: Interest of Futures Commission Merchant in

    Segregated Futures Customer Funds; Additions and Withdrawals

    J. Sec. 1.25: Investment of Customer Funds

    1. General Comments Regarding the Investment of Customer Funds

    2. Reverse Repurchase Agreement Counterparty Concentration

    Limits

    K. Sec. 1.26: Deposit of Instruments Purchased With Futures

    Customer Funds

    L. Sec. 1.29: Increment or Interest Resulting From Investment

    of Customer Funds

    1. FCM's Responsibility for Losses Incurred on the Investment of

    Customer Funds

    2. FCM's Obligation in Event of Bank Default

    M. Sec. 1.30: Loans by Futures Commission Merchants: Treatment

    of Proceeds

    N. Sec. 1.32: (Sec. 22.2(g) for Cleared Swaps Customers and

    Sec. 30.7(l) for Foreign Futures and Foreign Options Customers):

    Segregated Account: Daily Computation and Record

    O. Sec. 1.52: Self-Regulatory Organization Adoption and

    Surveillance of Minimum Financial Requirements

    1. Swap Execution Facilities Excluded From the Scope of

    Regulation 1.52

    2. Revisions to the Current SRO Supervisory Program

    3. Auditing Standards Utilized in the SRO Supervisory Program

    4. ``Examinations Expert'' Reports

    P. Sec. 1.55: Public disclosures by Futures Commission

    Merchants

    1. Amendments to the Risk Disclosure Statement

    a. Firm Specific Disclosure Document

    i. General Requirements

    ii. Specific Disclosure Information Required (by rule paragraph)

    2. Public Availability of FCM Financial Information

    Q. Part 22--Cleared Swaps

    R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7:

    Treatment of Foreign Futures or Foreign Options Secured Amount

    1. Elimination of the ``Alternative Method'' for Calculating the

    Secured Amount

    2. Funds Held in Non-U.S. Depositories

    3. Commingling of Positions in Foreign Futures and Foreign

    Options Accounts

    4. Further Harmonization With Treatment of Customer Segregated

    Funds

    5. Harmonization With Other Commission Proposals

    S. Sec. 3.3: Chief Compliance Officer Annual Report

    III. Compliance Dates

    A. Financial Reports of FCMs: Sec. 1.10

    B. Risk Management Program for FCMs: Sec. 1.11

    C. Qualifications and Reports of Accountants: Sec. 1.16

    D. Minimum Financial Requirements for FCMs

    E. Written Acknowledgment Letters: Sec. Sec. 1.20, 1.26, and

    30.7

    F. Undermargined Amounts: Sec. Sec. 1.22(c), 30.7(a)

    G. SRO Minimum Financial Surveillance: Sec. 1.52

    H. Public Disclosures by FCMs: Sec. 1.55

    IV. Cost Benefit Considerations

    V. Related Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act

    Appendix 1--Table of Comment Letters

    Appendix 2--CFTC Form 1-FR-FCM

    I. Background

    A. General Statutory and Current Regulatory Structure

    The protection of customers--and the safeguarding of money,

    securities or other property deposited by customers with an FCM--is a

    fundamental component of the Commission's disclosure and financial

    responsibility framework. Section 4d(a)(2) \1\ of the Commodity

    Exchange Act (``the Act'' or ``the CEA'') \2\ requires each FCM to

    segregate from its own assets all money, securities, and other property

    deposited by futures customers to margin, secure, or guarantee futures

    contracts and options on futures contracts traded on designated

    contract markets.\3\ Section 4d(a)(2) further requires an FCM to treat

    and deal with futures customer funds as belonging to the futures

    customer, and prohibits an FCM from using the funds deposited by a

    futures customer to margin or extend credit to any person other than

    the futures customer that deposited the funds.

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    \1\ 7 U.S.C. 6d(a)(2).

    \2\ 7 U.S.C. 1 et seq.

    \3\ The term ``futures customer'' is defined in Sec. 1.3(iiii)

    of the Commission's regulations to include any person who uses an

    FCM as an agent in connection with trading in any contract for the

    purchase or sale of a commodity for future delivery or an option on

    such contract (excluding any proprietary accounts under Sec.

    1.3(y)). The Commission adopted the definition of the term ``futures

    customer'' on October 16, 2012 as part of the final rulemaking that

    amended existing Commission regulations to incorporate swaps. The

    Federal Register release adopting the final rules can be accessed at

    http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101612.pdf. Commission regulations can be found at 17

    CFR Ch. 1.

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    Section 4d(f) of the Act, which was added by section 724(a) of the

    Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank

    Act''),\4\ requires each FCM to segregate from its own assets all

    money, securities, and other property deposited by Cleared Swaps

    Customers to margin Cleared Swaps.\5\ Section 4d(f) also provides that

    an FCM shall treat and deal with all money, securities, and property of

    any swaps customer received to margin, guarantee, or secure a swap

    cleared by or through a DCO (including money, securities, or property

    accruing to the swaps customer as the result of such a swap) as

    belonging to the swaps customer. Section 4d(f) further provides that an

    FCM shall separately account for and not commingle with its own funds

    any money, securities, and property of a swaps customer, and shall not

    use such swaps customer's funds to margin, secure, or guarantee any

    trades or contracts of any swaps customer or person other than the

    person for whom the same are held.

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    \4\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376

    (2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm.

    \5\ The term ``Cleared Swap'' is defined in section 1a(7) of the

    Act as any swap that is, directly or indirectly, submitted to and

    cleared by a DCO registered with the Commission. The term ``Cleared

    Swaps Customer'' is defined in Sec. 22.1 as any person entering

    into a Cleared Swap, but excludes: (1) Any owner or holder of a

    Cleared Swaps Proprietary Account with respect to the Cleared Swaps

    in such account; and (2) A clearing member of a DCO with respect to

    Cleared Swaps cleared on that DCO.

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    The Commission adopted Sec. Sec. 1.20 through 1.30, and Sec.

    1.32, to implement section 4d(a)(2) of the Act, and adopted part 22 to

    implement section 4d(f) of the Act. The purpose of these regulations is

    to safeguard funds deposited by futures customers and Cleared Swaps

    Customers, respectively.

    Regulation 1.20 requires each FCM and DCO to separately account for

    and to segregate from its own proprietary funds all money, securities,

    or other property deposited by futures customers for trading on

    designated contract markets. In addition, all futures customer funds

    must be separately accounted for, and may not be commingled with the

    money, securities or property of an FCM or of any other person, or be

    used to secure or guarantee the trades, contracts or commodity options,

    or to secure or extend the credit, of any person other than the one for

    whom the same are held. Regulation 1.20 also provides that an FCM or

    DCO may deposit futures customer funds only with a bank or trust

    company, and for FCMs only, a DCO or another FCM. The funds must be

    deposited under an account name that clearly identifies the funds as

    belonging to the futures customers of the FCM or DCO and further shows

    that the funds are segregated as required by section 4d(a)(2) of the

    Act and Commission regulations. FCMs and DCOs also are required to

    obtain a written acknowledgment from a depository stating that the

    depository was informed that the funds deposited are customer funds

    being held in accordance with the Act.

    FCMs and DCOs also are restricted in their use of futures customer

    funds. Regulation 1.22 prohibits an FCM from using, or permitting the

    use of, the

    [[Page 68508]]

    futures customer funds of one futures customer to purchase, margin, or

    settle the trades, contracts, or commodity options of, or to secure or

    extend the credit of, any person other than such futures customer. In

    addition, Sec. 1.22 provides that futures customer funds may not be

    used to carry trades or positions of the same futures customer other

    than in commodities or commodity options traded through the facilities

    of a contract market. Under Sec. 1.20, an FCM or DCO may, however, for

    convenience, commingle and hold funds deposited as margin by multiple

    futures customers in the same account or accounts with one of the

    recognized depositories. An FCM or DCO also may invest futures customer

    funds in certain permitted investments under Sec. 1.25.

    Part 22 of the Commission's regulations, which governs Cleared

    Swaps, implements section 4d(f) of the Act and parallels many of the

    provisions in part 1 that address the manner in which, and the

    responsibilities imposed upon, an FCM may hold funds for futures

    customers trading on designated contract markets.\6\ For example, Sec.

    22.2 requires an FCM to treat and to deal with funds deposited by

    Cleared Swaps Customers as belonging to such Cleared Swaps Customers

    and to hold such funds separately from the FCM's own funds. Regulation

    22.4 provides that an FCM may deposit Cleared Swaps Customer Collateral

    with a bank, trust company, DCO, or another registered FCM.\7\

    Regulation 22.6 requires that the account holding the Cleared Swaps

    Customers Collateral must clearly identify the account as an account

    for Cleared Swaps Customers of the FCM engaging in Cleared Swaps and

    that the funds maintained in the account are subject to the segregation

    provisions of section 4d(f) of the Act and Commission regulations.

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    \6\ The Commission approved the part 22 regulations on January

    11, 2012, with an effective date of April 9, 2012. Compliance with

    the part 22 regulations was required by November 8, 2012. See

    Protection of Cleared Swaps Customer Contracts and Collateral;

    Conforming Amendments to the Commodity Broker Bankruptcy Provisions,

    77 FR 6336 (Feb. 7, 2012).

    \7\ The term ``Cleared Swaps Customer Collateral'' is defined in

    Sec. 22.2 to mean all money, securities, or other property

    (including accruals) received by an FCM or DCO from, for, or on

    behalf of a Cleared Swaps Customer to margin, guarantee, or secure a

    Cleared Swap.

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    Regulation 22.2(d) also prohibits an FCM from using the Cleared

    Swaps Customer Collateral of one Cleared Swaps Customer to purchase,

    margin, or settle the Cleared Swaps or any other trade or contract, or

    to secure or extend credit, of any person other than such Cleared Swaps

    Customer. Further, Sec. 22.2(c) permits an FCM to commingle the

    Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers

    into one or more accounts, and Sec. 22.2(e)(1) permits an FCM to

    invest Cleared Swaps Customer Collateral in accordance with Sec. 1.25.

    In addition to holding funds for futures customers transacting on

    designated contract markets and for Cleared Swaps Customers engaging in

    Cleared Swaps, FCMs also hold funds for persons trading futures

    contracts listed on foreign boards of trade. Section 4(b) of the Act

    provides that the Commission may adopt rules and regulations

    proscribing fraud and requiring minimum financial standards, the

    disclosure of risk, the filing of reports, the keeping of books and

    records, the safeguarding of the funds deposited by persons for trading

    on foreign markets, and registration with the Commission by any person

    located in the United States (``U.S.'') who engages in the offer or

    sale of any contract of sale of a commodity for future delivery that is

    made subject to the rules of a board of trade located outside of the

    U.S. Pursuant to the statutory authority of section 4(b), the

    Commission adopted part 30 of its regulations to address foreign

    futures and foreign option transactions.

    The segregation provisions for funds deposited by foreign futures

    or foreign options customers to margin foreign futures or foreign

    options transactions under part 30, however, are significantly

    different from the requirements set forth in Sec. 1.20 for futures

    customers trading on designated contract markets and part 22 for

    Cleared Swaps Customers engaging in Cleared Swaps.\8\ Regulation 30.7

    provides that an FCM may deposit the funds belonging to foreign futures

    or foreign options customers in an account or accounts maintained at a

    bank or trust company located in the U.S.; a bank or trust company

    located outside of the U.S. that has in excess of $1 billion of

    regulatory capital; an FCM registered with the Commission; a DCO; a

    member of a foreign board of trade; a foreign clearing organization; or

    a depository selected by the member of a foreign board of trade or

    foreign clearing organization. The account with the depository must be

    titled to clearly specify that the account holds funds belonging to the

    foreign futures or foreign options customers of the FCM that are

    trading on foreign futures markets. An FCM also is permitted to invest

    the funds deposited by foreign futures or foreign option customers in

    accordance with Sec. 1.25.

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    \8\ The term ``foreign futures or foreign options customer'' is

    defined in Sec. 30.1 to mean any person located in the U.S., its

    territories or possessions who trades in foreign futures or foreign

    options, with the exception of accounts that are proprietary

    accounts under Sec. 1.3. The term ``foreign futures or foreign

    option'' is defined in Sec. 30.1 to generally mean any futures and/

    or options transactions executed on a foreign board of trade.

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    However, unlike Sec. 1.20 and part 22, which require an FCM to

    hold a sufficient amount of funds in segregation to meet the total

    account equities of all of the FCM's futures customers and Cleared

    Swaps Customers ``at all times'' (i.e., the ``Net Liquidating Equity

    Method''), Sec. 30.7 requires an FCM to maintain in separate accounts

    an amount of funds only sufficient to cover the margin required on open

    foreign futures contracts, plus or minus any unrealized gains or losses

    on such open positions, plus any funds representing premiums payable or

    received on foreign options (including any additional funds necessary

    to secure such options, plus or minus any unrealized gains or losses on

    such options) (i.e., the ``Alternative Method''). Thus, under the part

    30 Alternative Method an FCM is not required to maintain a sufficient

    amount of funds in such separate accounts to pay the full account

    balances of all of its foreign futures or foreign options customers at

    all times.

    In addition to the segregation requirements of sections 4d(a)(2)

    and 4d(f) of the Act, and the secured amount requirements in part 30 of

    the Commission's regulations, FCMs also are subject to minimum net

    capital and financial reporting requirements that are intended to

    ensure that such firms meet their financial obligations in a regulated

    marketplace, including their financial obligations to customers and

    DCOs. Each FCM is required to maintain a minimum level of ``adjusted

    net capital,'' which is generally defined under Sec. 1.17 as the

    firm's net equity as computed under generally accepted accounting

    principles, less all of the firm's liabilities (except for certain

    qualifying subordinated debt) and further excluding all assets that are

    not liquid or readily marketable. Regulation 1.17(c)(5) further

    requires an FCM to impose capital charges (i.e., deductions) on certain

    of its liquid assets to protect against possible market risks in such

    assets.

    FCMs also are subject to financial recordkeeping and reporting

    requirements. FCMs that carry customer accounts are required under

    Sec. 1.32 to prepare a schedule each business day demonstrating their

    compliance with the segregation and secured amount requirements.

    Regulation 1.32 requires the calculation to be performed by noon

    [[Page 68509]]

    each business day, reflecting the account balances and open positions

    as of the close of business on the previous business day.

    Each FCM also is required by Sec. 1.10 to file with the Commission

    and with its designated self-regulatory organization (``DSRO'') monthly

    unaudited financial statements and an annual audited financial

    report.\9\ Regulation 1.12 requires an FCM to file a notice with the

    Commission and with the firm's DSRO whenever, among other things, the

    firm: (1) Fails to maintain compliance with the Commission's capital

    requirements; (2) fails to hold sufficient funds in segregated or

    secured amount accounts to meet its regulatory requirements; (3) fails

    to maintain current books and records; or (4) experiences a significant

    reduction in capital from the previous month-end. The purpose of the

    regulatory notices is to alert the Commission and the firm's DSRO as

    early as possible to potential financial issues at the firm that may

    adversely impact the ability of the FCM to comply with its obligations

    to safeguard customer funds, or to meet its financial obligations to

    other FCMs or DCOs.

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    \9\ The term ``self-regulatory organization'' is defined by

    Sec. 1.3 to mean a contract market, a swap execution facility, or a

    registered futures association. A DSRO is the SRO that is appointed

    to be primarily responsible for conducting ongoing financial

    surveillance of an FCM that is a member of two or more SROs under a

    joint audit agreement submitted to and approved by the Commission

    under Sec. 1.52.

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    The statutory mandate to segregate customer funds--to treat them as

    belonging to the customer and not use the funds inappropriately--takes

    on greater meaning in light of the devastating events experienced over

    the last two years. Those events, which are discussed in greater detail

    below, demonstrate that the risks of misfeasance and malfeasance, and

    the risks of an FCM failing to maintain sufficient excess funds in

    segregation: (i) Put customer funds at risk; and (ii) are exacerbated

    by stresses on the business of the FCM. Many of those risks can be

    mitigated significantly by better risk management systems and controls,

    along with an increase in risk-oriented oversight and examination of

    the FCMs.

    Determining what is a ``sufficient'' amount of excess funds in

    segregation for any particular FCM requires a full understanding of the

    business of that FCM, including a proper analysis of the factors that

    affect the actual amount of segregated funds held by the FCM relative

    to the minimum amount of segregated funds it is required to hold.

    Further, appropriate care must be taken to avoid withdrawing such

    excess funds at times of great stress to cover needs unrelated to the

    purposes for which excess segregated and secured funds are maintained.

    In times of stress, excess funds may look like an easy liquidity source

    to help cover other risks of the business; yet withdrawing such excess

    funds makes the funds unavailable when they may be most needed. The

    recent market events illustrate both the need to: (i) Require that care

    be taken about monitoring excess segregated and secured funds, and the

    conditions under and the extent to which such funds may be withdrawn;

    and (ii) place appropriate risk management controls around the other

    risks of the business to help relieve (A) the likelihood of an exigent

    event or, (B) if such an event occurs, the likelihood of a failure to

    prepare for such an event, which in either case could create pressures

    that result in an inappropriate withdrawal of customer funds.

    Although the Commission's existing regulations provide an essential

    foundation to fostering a well-functioning marketplace, wherein

    customers are protected and institutional risks are minimized, recent

    events have demonstrated that additional measures are necessary to

    effectuate the fundamental purposes of the statutory provisions

    discussed above. Further, concurrently with the enhanced

    responsibilities for FCMs that were proposed by the Commission, the

    oversight and examination systems must be enhanced to mitigate risks

    and effectuate the statutory purposes.

    B. Self-Regulatory Structure

    The Commission's oversight structure provides that SROs are the

    frontline regulators of FCMs, introducing brokers (``IBs''), commodity

    pool operators, and commodity trading advisors. In 2000, Congress

    affirmed the Commission's reliance on SROs by amending section 3 of the

    Act to state: ``It is the purpose of this Act to serve the public

    interests through a system of effective self-regulation of trading

    facilities, clearing systems, market participants and market

    professionals under the oversight of the Commission.''

    As part of its oversight responsibility, an SRO is required to

    conduct periodic examinations of member FCMs' compliance with

    Commission and SRO financial and related reporting requirements,

    including the FCMs' holding of customer funds in segregated and secured

    accounts. The Commission oversees the SROs by examining them for the

    performance of their duties. The Commission recently has moved to

    conducting continuous reviews of the SROs' FCM examination program that

    includes a process whereby the Commission selects a small sample of the

    SRO's FCM work papers to review. In addition, the Commission also

    conducts limited-scope reviews of FCMs in ``for cause'' situations that

    are sometimes referred to as ``audits,'' but they are not full-scale

    audits as accountants commonly use that term.

    In addition, because there are multiple SROs who share the same

    member FCMs, to avoid subjecting FCMs to duplicative examinations from

    SROs, the Commission has a permissive system that allows the SROs to

    agree how to allocate FCMs amongst them. An SRO who is allocated

    certain FCMs for such examination is referred to as the DSRO of those

    FCMs.

    Under Commission regulations, FCMs must have their annual financial

    statements audited by an independent certified public accountant

    following generally accepted auditing standards as adopted in the U.S.

    (``U.S. GAAS''). As part of this certified annual report, the

    independent accountant also must conduct appropriate reviews and tests

    to identify any material inadequacies in systems and controls that

    could violate the Commission's capital, segregation or secured amount

    requirements. Any such inadequacies are required to be reported to the

    FCM's DSRO and to the Commission.

    C. Futures Commission Merchant Insolvencies and Failures of Risk

    Management

    The recent insolvencies of two FCMs demonstrate the need for

    revisions to the Commission's customer protection regime. On October

    31, 2011, MF Global, Inc. (``MFGI''), which was dually-registered as an

    FCM with the Commission and as a securities broker-dealer (``BD'') with

    the U.S. Securities and Exchange Commission (``SEC''), was placed into

    a liquidation proceeding under the Securities Investor Protection Act

    by the Securities Investor Protection Corporation (``SIPC'').

    The trustee appointed to oversee the liquidation of MFGI reported a

    potential $900 million shortfall of funds necessary to repay the

    account balances due to customers trading futures on designated

    contract markets, and an approximately $700 million shortfall in funds

    immediately available to repay the account balances of customers

    trading on foreign futures markets.\10\ The shortfall in customer

    segregated accounts was attributed by the MFGI Trustee to significant

    transfers of funds

    [[Page 68510]]

    out of the customer accounts that were used by MFGI for various

    purposes other than to meet obligations to or on behalf of customers.

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

    \10\ See Report of the Trustee's Investigation and

    Recommendations, In re MF Global Inc., No. 11-2790 (MG) SIPA (Bankr.

    S.D.N.Y. June 4, 2012).

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

    In addition, the Commission filed a civil injunctive complaint in

    federal district court on July 10, 2012, against Peregrine Financial

    Group, Inc. (``PFGI''), a registered FCM and its Chief Executive

    Officer (``CEO'') and sole owner, Russell R. Wasendorf, Sr., alleging

    that PFGI and Wasendorf, Sr. committed fraud by misappropriating

    customer funds, violated customer fund segregation laws, and made false

    statements regarding the amount of funds in customer segregated

    accounts in financial statements filed with the Commission. The

    complaint states that in July 2012 during an NFA examination PFGI

    falsely represented that it held in excess of $220 million of customer

    funds when in fact it held approximately $5.1 million.\11\

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

    \11\ Complaint, U.S. Commodity Futures Trading Commission v.

    Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr., No.

    12-cv-5383 (N.D. Ill. July 10, 2012). A copy of the Commission's

    complaint has been posted to the Commission's Web site.

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

    Recent incidents also have demonstrated the value of establishing

    robust risk management systems within FCMs and enhanced early warning

    systems to detect and address financial and regulatory issues. In

    particular, problems that arise through an FCM's non-futures-related

    business can have a direct and significant impact on the FCM's

    financial condition, raising questions as to whether the FCM will be

    able to protect customer funds \12\ and maintain the minimum financial

    requirements mandated by the Act and Commission regulations.\13\

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

    \12\ The Commission notes that the definition of ``customer

    funds'' in Sec. 1.3(gg) includes funds held for customers trading

    on designated contract markets and customers engaging in cleared

    swap transactions. However, as used in this notice, unless otherwise

    specified, the term ``customer funds'' also includes funds held for

    customers trading on foreign markets pursuant to part 30 of the

    Commission's regulations.

    \13\ See, e.g., Edward Krudy, Jed Horowitz and John McCrank,

    ``Knight's Future in Balance After Trading Disaster,'' Reuters (Aug.

    3, 2012), available at http://in.reuters.com/article/2012/08/03/knightcapital-loss-idINL2E8J27QE20120803 (noting that a software

    issue caused the firm to incur a $440 million trading loss, which

    represented much of the firm's capital).

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

    These recent incidents highlighted weaknesses in the customer

    protection regime prescribed in the Commission's regulations and

    through the self-regulatory system. In particular, questions have

    arisen on the requirements surrounding the holding and investment of

    customer funds, including the ability of FCMs to withdraw funds from

    futures customer segregated accounts and part 30 secured accounts.

    Additionally, the incidents have underscored the need for additional

    safeguards--such as robust risk management systems, strengthened early-

    warning systems surrounding margin and capital requirements, and

    enhanced public disclosures--to promote the protection of customer

    funds and to minimize the systemic risk posed by certain actions of

    market participants. Further questions have arisen on the system of

    audits and examinations of FCMs, and whether the system functions

    adequately to monitor FCMs' activities, verify segregated funds and

    secured amount balances, and detect fraud.

    D. Recent Commission Rulemakings and Other Initiatives Relating to

    Customer Protection

    Since late 2011, the Commission has promulgated rules directly

    impacting the protection of customer funds. The Commission also has

    studied the current regulatory framework surrounding customer

    protection, particularly in light of the recent incidents outlined

    above, in order to identify potential enhancements to the systems and

    Commission regulations protecting customer funds. The Commission's

    efforts have been informed, in part, by efforts undertaken by industry

    participants. The proposed rule amendments were informed by the efforts

    detailed below.

    In December 2011, the Commission adopted final rule amendments

    revising the types of investments that an FCM or DCO can make with

    customer funds under Sec. 1.25, for the purpose of affording greater

    protection for such funds.\14\ Among other changes to Sec. Sec. 1.25

    and 30.7, the final rule amendments removed from the list of permitted

    investments: (1) Corporate debt obligations not guaranteed by the U.S.

    Government; (2) foreign sovereign debt; and (3) in-house and affiliate

    transactions.

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

    \14\ See Investment of Customer Funds and Funds Held in an

    Account for Foreign Futures and Foreign Options Transactions, 76 FR

    78776 (Dec. 19, 2011).

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

    In adopting the amendments to Sec. 1.25, the Commission was

    mindful that customer segregated funds must be invested by FCMs and

    DCOs 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. The amendments are

    consistent with the general prudential standard contained in Sec.

    1.25, which provides that all permitted investments must be

    ``consistent with the objectives of preserving principal and

    maintaining liquidity.''

    The Commission also approved final regulations that require DCOs to

    collect initial customer margin from FCMs on a gross basis.\15\ Under

    the final regulations, FCMs are no longer permitted to offset one

    customer's margin requirement against another customer's margin

    requirements and deposit only the net margin collateral with the DCO.

    As a result of the rule change, a greater portion of customer initial

    margin is posted by FCMs to the DCOs.

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

    \15\ See Commission Regulation 39.12(g)(8)(i) and Derivatives

    Clearing Organization General Provisions and Core Principles, 76 FR

    69334 (Nov. 8, 2011).

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

    The Commission also approved regulations that impose requirements

    on FCMs and DCOs regarding the treatment of Cleared Swaps and Cleared

    Swaps Customer Collateral.\16\ Under the traditional futures model,

    DCOs hold an FCM's futures customers' funds on an omnibus basis in a

    futures customer account. In the event of a double default, which is a

    situation where a futures customer defaults on its obligation to its

    clearing FCM and the loss is so great that the clearing FCM defaults on

    its obligation to the DCO, the DCO is permitted to use the funds held

    in the futures customers' omnibus account to cover the loss of the

    defaulting futures customer before applying its own capital or the

    guaranty fund contributions of non-defaulting FCM members.

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

    \16\ See 77 FR 6336 (Feb. 7, 2012).

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

    The Commission approved an alternative model for Cleared Swaps.

    Under the ``LSOC'' (legal segregation with operational comingling)

    model, DCOs may hold Cleared Swaps Customer Collateral on an omnibus

    basis in a Cleared Swaps Customer Account.\17\ However, unlike with the

    futures model, following a double default the DCO would only be

    permitted to access the collateral of the defaulting Cleared Swaps

    Customers; it would not be permitted to use the collateral of non-

    defaulting Cleared Swaps Customers to cover a defaulting Cleared Swaps

    Customer's losses.

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

    \17\ The term ``Cleared Swaps Customer Account'' is defined in

    Sec. 22.1 and generally refers to an account that an FCM or a DCO

    maintains at a permitted depository for the Cleared Swaps (and

    related collateral) of Cleared Swaps Customers.

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

    Pursuant to section 724(c) of the Dodd-Frank Act, the final rule on

    segregation for uncleared swaps, approved by the Commission on October

    30, 2013, implements the

    [[Page 68511]]

    requirements of section 4s(l) of the CEA that Swap Dealers (``SDs'')

    and Major Swap Participants (``MSPs'') notify their counterparties that

    such counterparties have a right to require that any initial margin

    which they post to guarantee uncleared swaps be segregated at an

    independent custodian. Where the counterparty elects segregation for

    its initial margin, the account must be held at a custodian that is

    independent of both the counterparty and the SD or MSP.

    The Commission also included customer protection enhancements in a

    final rulemaking for designated contract markets issued in June 2012.

    These enhancements codify into regulations staff guidance on minimum

    requirements for SROs regarding their financial surveillance of

    FCMs.\18\ The regulations require a DCM to have arrangements and

    resources for effective rule enforcement and trade and financial

    surveillance programs, including the authority to collect information

    and examine books and records of members and market participants. The

    regulations also establish minimum financial standards for both member

    FCMs and IBs and non-intermediated market participants. The Commission

    expressly noted in the preamble of the Federal Register release that

    ``a DCM's duty to set financial standards for its FCM members involves

    setting capital requirements, conducting surveillance of the potential

    future exposure of each FCM as compared to its capital, and taking

    appropriate action in light of the results of such surveillance.'' \19\

    Further, the rules mandate that DCMs adopt rules for the protection of

    customer funds, including the segregation of customer and proprietary

    funds, the custody of customer funds, the investment standards for

    customer funds, intermediary default procedures and related

    recordkeeping.

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

    \18\ See Core Principles and Other Requirements for Designated

    Contract Markets, 77 FR 36612 (June 19, 2012).

    \19\ Id. at 36646.

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

    In addition to the rulemaking efforts outlined above, the

    Commission sought additional information through a series of

    roundtables and other meetings. On February 29 and March 1, 2012, the

    Commission solicited comments and held public roundtables to solicit

    input on customer protection issues from a broad cross-section of the

    futures industry, including market participants, FCMs, DCOs, SROs,

    securities regulators, foreign clearing organizations, and

    academics.\20\ The roundtable focused on issues relating to the

    advisability and practicality of modifying the segregation models for

    customer funds; alternative models for the custody of customer

    collateral; enhancing FCM controls over the disbursement of customer

    funds; increasing transparency surrounding an FCM's holding and

    investment of customer funds; and lessons learned from recent commodity

    brokerage bankruptcy proceedings.

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

    \20\ Further information on the public roundtable, including

    video recordings and transcripts of the discussions, have been

    posted to the Commission's Web site. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29,

    2012); http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).

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

    The Commission also hosted a public meeting of the Technology

    Advisory Committee (``TAC'') on July 26, 2012.\21\ Panelists and TAC

    members discussed potential technological solutions directed at

    enhancing the protection of customer funds by identifying and exploring

    technological issues and possible solutions relating to the ability of

    the Commission, SROs and customers to verify the location and status of

    funds held in customer segregated accounts.

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

    \21\ Additional information, including documents submitted by

    meeting participants, has been posted to the Commission's Web site.

    See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612.

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

    Commission staff hosted an additional roundtable on August 9, 2012,

    to discuss SRO requirements for examinations of FCMs and Commission

    oversight of SRO examination programs. The roundtable also focused on

    the role of the independent public accountant in the FCM examination

    process, and proposals addressing various alternatives to the current

    system for segregating customer funds.

    The Commission also considered industry initiatives to enhance

    customer protections. On February 29, 2012, the Futures Industry

    Association (``FIA'') initiated steps to educate customers on the

    extent of the protections provided under the current regulatory

    structure. FIA issued a list of Frequently Asked Questions (``FAQ'')

    prepared by members of the FIA Law and Compliance Division addressing

    the basics of segregation, collateral management and investments,

    capital requirements and other issues for FCMs and joint FCM/BDs, and

    clearinghouse guaranty funds.\22\ The FAQ is intended to provide

    existing and potential customers with a better understanding of the

    risks of engaging in futures trading and a clear explanation of the

    extent of the protections provided to customers and their funds under

    the Act and Commission regulations.

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

    \22\ The FIA's release addressing FAQs on the protection of

    customer funds is accessible on the FIA's Web site at http://www.futuresindustry.org/downloads/PCF-FAQs.PDF.

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

    FIA also issued a series of initial recommendations for the

    protection of customer funds.\23\ The recommendations were prepared by

    the Financial Management Committee, whose members include

    representatives of FIA member firms, DCOs and depository institutions.

    The initial recommendations address enhanced disclosure on the

    protection of customer funds, reporting on segregated funds balances by

    FCMs, FCM internal controls surrounding the holding and disbursement of

    customer funds, and revisions to part 30 regulations to make the

    protections comparable to those provided for customers trading on

    designated contract markets.

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

    \23\ The FIA's initial recommendations are accessible on the

    FIA's Web site at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

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

    On July 13, 2012, the Commission approved new FCM financial

    requirements proposed by the National Futures Association

    (``NFA'').\24\ The NFA Financial Requirements Section 16 and its

    related Interpretive Notice entitled ``NFA Financial Requirements

    Section 16: FCM Financial Practices and Excess Segregated Funds/Secured

    Amount Disbursements'' (collectively referred to as ``the Segregated

    Funds Provisions'') were developed in consultation with Commission

    staff.

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

    \24\ For more information relating to the new FCM financial

    requirements, see http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

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

    NFA's Segregated Funds Provisions require each FCM to: (1) Maintain

    written policies and procedures governing the deposit of the FCM's

    proprietary funds (i.e., excess or residual funds) in customer

    segregated accounts and part 30 secured accounts; (2) maintain a

    targeted amount of excess funds in segregate accounts and part 30

    secured accounts; (3) file on a daily basis the FCM's segregation and

    part 30 secured amount computations with NFA; (4) obtain the approval

    of senior management prior to a withdrawal that is not for the benefit

    of customers whenever the withdrawal equals 25 percent or more of the

    excess segregated or part 30 secured amount funds; (5) file a notice

    with NFA of any withdrawal that is not for the benefit of customers

    whenever the withdrawal equals 25 percent or more of the excess

    segregated or part 30 secured amount funds; (6) file detailed

    information regarding the depositories holding customer funds and the

    investments made with customer funds as of the 15th day (or

    [[Page 68512]]

    the next business day if the 15th is not a business day) and the last

    business day of each month; and (7) file additional monthly net capital

    and leverage information with NFA.

    Significantly, NFA's Segregated Funds Provisions also require FCMs

    to compute their part 30 secured amount requirement and compute their

    targeted excess part 30 secured funds using the same Net Liquidating

    Equity Method that is required by the Act and Commission regulations

    for computing the segregation requirements for customers trading on

    U.S. contract markets under section 4d of the Act. FCMs are not

    permitted under the NFA rules to use the Alternative Method to compute

    the part 30 secured amount requirement. The failure of an FCM to

    maintain its targeted amount of excess part 30 funds computed using the

    Net Liquidating Equity Method may result in NFA initiating a Membership

    Responsibility Action against the firm.

    In addition, in setting the target amount of excess funds, the

    FCM's management must perform a due diligence inquiry and consider

    various factors relating, as applicable, to the nature of the FCM's

    business, including the type and general creditworthiness of the FCM's

    customers, the trading activity of the customers, the types and

    volatility of the markets and products traded by the FCM's customers,

    and the FCM's own liquidity and capital needs. The FCM's Board of

    Directors (or similar governing body), CEO or Chief Financial Officer

    (``CFO'') must approve in writing the FCM's targeted residual amount,

    any changes thereto, and any material changes in the FCM's written

    policies and procedures.

    The NFA and CME Group Inc. (``CME'') also adopted rules requiring

    FCMs to instruct each depository holding futures customer funds to

    report such balances on a daily basis to the NFA or CME,

    respectively.\25\ Initially, the NFA and CME retained the services of a

    third-party vendor which received account balance information directly

    from certain banks, custodians of securities, and money market funds,

    and passed such information on to the NFA and CME. The CME, however,

    took over the role of the third-party vendor effective October 29, 2013

    and receives account information directly from all depositories holding

    futures customer funds. The CME also provides NFA with daily account

    balance information for the FCMs that NFA is the DSRO. The same process

    applies to the FCM's customer secured account(s) held for customers

    trading on foreign futures exchanges, and for the FCM's Cleared Swaps

    Customers engaging in Cleared Swaps.

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

    \25\ See NFA Financial Requirements Rules, Section 4. Financial

    Requirements and Treatment of Customer Property, and CME Rule 971,

    Segregation, Secured, and Cleared Swaps Customer Account

    Requirements.

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

    In addition, NFA and CME expanded their oversight of FCMs under the

    amended rules, by developing programs that compare the daily balances

    reported by the depositories with the balances reported by the FCMs in

    their daily segregation reports. An immediate alert is generated for

    any material discrepancies.

    E. The Proposed Amendments

    The incidents outlined above, coupled with the information

    generated through the recent efforts undertaken by the Commission and

    industry participants, demonstrate the need for new rules and

    amendments to existing rules. In particular, an examination of FCM

    business operations--including the non-futures business of FCMs--and

    the currently regulatory framework, evince a need for enhanced customer

    protections, risk management programs, disclosure requirements, and

    auditing and examination programs. To address these needs, the

    Commission issued a Notice of Proposed Rulemaking (``NPRM'') on

    November 14, 2012 (``the Proposal'') containing a series of amendments

    to enhance customer protections.\26\

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

    \26\ 77 FR 67866 (Nov. 14, 2012).

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

    The Proposal addressed six main issues. First, recognizing problems

    surrounding the treatment of customer segregated funds and foreign

    futures or foreign options secured amounts, the Commission proposed to

    amend several components of parts 1, 22, and 30 of the Commission's

    regulations to provide greater certainty to market participants that

    the customer funds entrusted to FCMs will be protected. Second, to

    address shortcomings in the risk management of FCMs, the Commission

    proposed a new Sec. 1.11 that establishes robust risk management

    programs. Third, the Commission determined that the current regulatory

    framework should be re-oriented to implement a more risk-based,

    forward-looking perspective, affording the Commission and SROs with

    read-only access to accounts holding customer funds and additional

    information on depositories and the customer assets held in such

    depositories. Fourth, given the difficulties that can arise in an FCM's

    business, and the direct and significant impact on the FCM's regulatory

    capital that can result from such difficulties, the Commission proposed

    to amend Sec. 1.17(a)(4) to ensure that an FCM's capital and liquidity

    are sufficient to safeguard the continuation of operations at the FCM.

    Fifth, to effect the change in orientation needed in FCM examinations

    programs, as well as to assure quality control over program contents,

    administration and oversight, the Commission proposed to amend Sec.

    1.52, which, among other things, addresses the formation of Joint Audit

    Committees and the implementation of Joint Audit Programs. And sixth,

    recognizing the need to increase the information provided to customers

    concerning the risks of futures trading and the FCMs with which they

    may choose to conduct business, the Commission proposed amendments to

    Sec. 1.55 that enhance the disclosures provided by FCMs.

    II. Comments on the Notice of Proposed Rulemaking

    The Proposal, aimed at: (1) Amending and enhancing its current

    customer protection regime; (2) imposing risk management requirements

    on FCMs; (3) requiring additional ``early warning'' notices from FCMs

    regarding material changes in their operations or financial condition;

    (4) imposing additional liquidity requirements for FCMs; (5) revising

    the examination process of FCMs by both the SROs and public

    accountants; and (6) requiring additional disclosures to customers

    concerning the risks of futures trading and the FCMs that hold customer

    funds. The Commission extended the initial 60-day comment period for

    approximately 30 additional days at the request of various commenters

    and in order to provide interested parties with an additional

    opportunity to comment on the proposal.\27\ The comment period closed

    on February 15, 2013.

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

    \27\ 78 FR 4093 (Jan. 18, 2013).

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

    During the comment period the Commission held two public

    roundtables to solicit input on issues related to the proposal from a

    cross-section of the futures industry, including market participants,

    FCMs, DCOs, SROs, securities regulators, foreign clearing

    organizations, and academics. The Commission received more than 120

    written submissions on the proposing release from a range of

    commenters.\28\ Commission staff also met with representatives from at

    least eight of the commenters and other

    [[Page 68513]]

    members of the public. Commenters represented a broad spectrum of

    industry participants, trade organizations, law firms, accounting firms

    and self-regulatory organizations. The majority of commenters supported

    the overall principles proposed by the Commission although many raised

    concerns or offered suggestions regarding certain proposal specifics.

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

    \28\ The written submissions from the public are available in

    the comment file on www.cftc.gov. They include, but are not limited

    to, those listed in the table in Appendix 1 to this release. In

    citing to the comments received during the discussion of the

    comments in this Section, the Commission used the abbreviations set

    forth in the table in Appendix 1.

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

    The Commission also held a meeting of the Agricultural Advisory

    Committee on July 25, 2013, and included in the agenda a discussion of

    the Proposal. The transcript of the Agricultural Advisory Committee

    meeting is included in the comment file to the Proposal, and the

    Commission has considered those comments in finalizing the regulations.

    The Commission has carefully considered the comments received and

    is adopting the Proposal herein subject to various amendments that

    address certain concerns raised or suggestions made by commenters. Each

    section of the final rules, including any relevant revisions to the

    corresponding section of the Proposal, is discussed in greater detail

    in the following sections.

    A. Sec. 1.10: Financial Reports of Futures Commission Merchants and

    Introducing Brokers

    Regulation 1.10 requires each FCM to file with the Commission and

    with the firm's DSRO an unaudited financial report each month. The

    financial report must be prepared using Form 1-FR-FCM. An FCM that is

    dually-registered as a BD, however, may file a Financial and

    Operational Combined Uniform Single Report under the Securities

    Exchange Act of 1934 (``FOCUS Report'') in lieu of the Form 1-FR-FCM.

    Each FCM also is required to file with the Commission and with its DSRO

    an annual financial report certified by an independent public

    accountant.

    The unaudited monthly and certified annual financial reports are

    required to contain basic financial statements, including a statement

    of financial condition, a statement of income (loss), and a statement

    of changes in ownership equity. The financial reports also are required

    to include additional schedules designed to address specific regulatory

    objectives to demonstrate that the FCM is in compliance with minimum

    capital and customer funds segregation requirements. These additional

    schedules include a statement of changes in liabilities subordinated to

    claims of general creditors, a statement of the computation of the

    minimum capital requirements (``Capital Computation Schedule''), a

    statement of segregation requirements and funds in segregation for

    customers trading on U.S. commodity exchanges (``Segregation

    Schedule''), and a statement of secured amounts and funds held in

    separate accounts for foreign futures and foreign options customers

    (``Secured Amount Schedule''). In addition, the certified annual report

    must contain a reconciliation of material differences between the

    Capital Computation Schedule, the Segregation Schedule, and the Secured

    Amount Schedule contained in the certified annual report and the

    unaudited monthly report for the FCM's year-end month.

    1. Amendments to the Segregation and Secured Amount Schedules With

    Respect to the Reporting of Residual Interest

    The Segregation Schedule and the Secured Amount Schedule generally

    indicate, respectively, (1) The total amount of funds held by the FCM

    in segregated or secured accounts; (2) the total amount of funds that

    the FCM must hold in segregated or secured accounts to meet its

    regulatory obligations to futures customers and foreign futures or

    foreign options customers; and (3) whether the firm holds excess

    segregated or secured funds in the segregated or secured accounts as of

    the reporting date. FCMs also deposit proprietary funds into customer

    segregated and secured accounts to protect against becoming

    undersegregated or undersecured by failing to hold a sufficient amount

    of funds in such accounts to meet the regulatory requirements. This

    cushion of proprietary funds is referred to as the FCM's ``residual

    interest'' in the customer segregated and secured accounts.

    The Commission proposed to amend Sec. 1.10 to require each FCM to

    also disclose in the Segregation Schedule and in the Secured Amount

    Schedule its targeted amount of ``residual interest'' that the FCM

    seeks to maintain in customer segregated accounts and secured accounts

    as computed under Sec. 1.11.\29\ As more fully discussed in section

    II.B. below, new Sec. 1.11(e)(3)(i)(D) requires the senior management

    of each FCM that carries customer funds to perform appropriate due

    diligence in setting the amount of the residual interest. Such due

    diligence must consider the nature of the FCM's business including the

    type and general creditworthiness of its customer base, the types of

    markets and products traded by the firm's customers, the proprietary

    trading activities of the FCM, the volatility and liquidity of the

    markets and products traded by the customers and by the FCM, the FCM's

    own liquidity and capital needs, historical trends in customer

    segregation and secured account funds balances, and historical trends

    in customer debits and margin deficits (i.e., undermargined

    amounts).\30\ The FCM also is required to maintain policies and

    procedures establishing the targeted amount of residual interest that

    the FCM seeks to maintain as its residual interest in the segregated

    and secured accounts. The FCM's due diligence and policies and

    procedures must be designed to reasonably ensure that the FCM maintains

    the targeted residual interest amount and remains in compliance with

    its segregation requirements at all times.\31\

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

    \29\ The Commission also proposed to revise the title of the

    ``Secured Amount Schedule'' by adding the term ``30.7 Customer'' to

    specify that the secured amount will include both U.S.-domiciled and

    foreign-domiciled customers consistent with the proposed amendments

    to part 30 of the Commission Regulations discussed in Section II.R.

    below. No comments were received regarding the revisions to the

    title of the ``Secured Amount Schedule,'' and the Commission is

    adopting the revisions as proposed.

    \30\ The NPRM explained that a margin deficit occurs when the

    value of the customer funds for a customer's account is less than

    the total amount of collateral required by DCOs for that account's

    contracts. As explained further in the discussion in sections

    II.G.9., II.Q., and II.R., the term ``undermargined amount,'' as

    defined in Sec. Sec. 1.22(c)(1), 22.2(f)(6)(i), and

    30.7(f)(1)(ii)(A), is used in place of the term ``margin deficit''

    in the final rule.

    \31\ The NFA adopted a similar amendment to its rules, mandating

    that FCMs maintain written policies and procedures identifying a

    target amount that the FCM will seek to maintain as its residual

    interest in customer segregated and secured accounts. See NFA Notice

    I-12-14 (July 18, 2012), available at http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

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

    The disclosure of the targeted amount of the FCM's residual

    interest in segregated or secured accounts will allow the Commission

    and the FCM's DSRO to determine whether the FCM actually maintains

    funds in segregated and secured accounts in amounts sufficient to cover

    the respective targeted residual interest amounts. If a firm does not

    maintain sufficient funds to cover the targeted residual interest

    amounts, the Commission and/or DSRO will take appropriate steps to

    assess whether the FCM is experiencing financial issues that may

    indicate potential threats to the overall safety of customer funds. The

    disclosure of the amounts of the FCM's targeted residual interest also

    will enhance the Commission's and DSROs' surveillance of FCMs by

    providing information that will allow for the assessment of the size of

    the targeted residual interest relative to both the total funds held in

    segregation or secured accounts and to

    [[Page 68514]]

    the size of the targeted residual interest maintained by other

    comparable FCMs. This information will assist the Commission and DSROs

    in the overall risk assessment of the FCMs, including the assessment of

    the potential risk that a firm may become undersegregated or

    undersecured. This additional information will further enhance the

    Commission's and DSROs' overall ability to protect customer funds.

    The Commission also proposed to amend the Segregation Schedule and

    the Secured Amount Schedule to require each FCM filing such schedules

    to disclose the sum of the outstanding margin deficits (i.e.,

    undermargined amounts) as of the reporting date. The purpose of this

    disclosure was to demonstrate that the FCM's residual interest in the

    segregated and secured account exceeded the respective customer margin

    deficits (i.e., undermargined amounts) as proposed in Sec. Sec. 1.22

    and 1.23.

    The Commission has considered the proposal and has determined not

    to amend the Segregation Schedule and Secured Amount Schedule to

    require the disclosure of the undermargined amounts. As further

    discussed in sections II.G.9. and II.R. below, the Commission is

    revising the proposed amendments to Sec. 1.22 that would have required

    an FCM to maintain at all times a residual interest in segregated or

    secured accounts in excess of its undermargined amounts. The final

    regulations being adopted in Sec. 1.22, Sec. 22.2, and Sec. 30.7

    will require computations as of different points in time than that of

    the computations reflected on the Segregation Schedule and the Secured

    Amount Schedule, which are prepared as of the close of business each

    day. The reporting of the undermargined amount information on the

    Segregation and Secured Amount Schedules would not be accurate as the

    firm's customers may not be undermargined, or may be less

    undermargined, at the time the undermargined amount calculations are

    required to be performed due, for example, to customers meeting margin

    calls.\32\

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    \32\ The Commission notes, however, that it will receive notice

    under Sec. 1.12 from an FCM if the firm maintains residual interest

    in the segregated or secured amount accounts that is less than the

    sum of the firm's undermargined amount at the point in time the FCM

    is required to maintain such undermargined amounts under Sec. 1.22,

    Sec. 22.2, and Sec. 30.7. The notice provision will alert the

    Commission and the FCM's DSRO to the fact that the undermargined

    amounts exceed the firm's residual interest in the accounts, and the

    Commission and DSRO can monitor the firm's actions to restore its

    residual interest to a level that is above the undermargined

    amounts, or take other actions as appropriate. See section II.C.

    below.

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

    The Commission has considered the comments and is adopting the

    amendments to Sec. 1.10 as proposed, with the above revisions to the

    Segregation Schedule and the Secured Amount Schedule.

    2. New Cleared Swaps Segregation Schedules

    The Commission proposed to amend Sec. 1.10(d) and to revise the

    Form 1-FR-FCM to adopt a new ``Statement of Cleared Swap Customer

    Segregation Requirements and Funds in Cleared Swap Customer Accounts

    Under Section 4d(f) of the Act'' (``Cleared Swaps Segregation

    Schedule'').\33\ The Commission proposed the Cleared Swaps Segregation

    Schedule to further implement section 724(a) of the Dodd-Frank Act.

    Section 724(a) of the Dodd-Frank Act amended section 4d of the Act by

    adding a new paragraph (f) to require an FCM to separately account for

    and segregate from its own assets Cleared Swaps Customers Collateral

    deposited by Cleared Swaps Customers. Section 4d(f) of the Act also

    requires FCMs to treat and deal with all the Cleared Swaps Customer

    Collateral deposited by a Cleared Swaps Customer as belonging to such

    customer, and prohibits an FCM from, with certain exceptions, using the

    Cleared Swaps Customer Collateral to margin, secure or guarantee the

    Cleared Swaps of any person other than the Cleared Swaps Customer who

    deposited the Cleared Swaps Customer Collateral. FCMs currently prepare

    a schedule comparable to the Cleared Swaps Segregation Schedule for

    Cleared Swaps under applicable contract market or NFA rules, and the

    Commission's proposal would codify existing practices.

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

    \33\ The Commission previously proposed a Cleared Swaps

    Segregation Schedule as part of its proposed regulations to adopt

    capital requirements for swap dealers and major swap participants.

    See Capital Requirements of Swap Dealers and Major Swap

    Participants, 76 FR 27802 (May 12, 2011). The Commission re-proposed

    the schedule as part of the Proposal in light of the Commission's

    decision to revise the schedule by requiring FCMs to separately

    disclose their targeted residual interest in Cleared Swaps Customer

    Accounts and the sum of margin deficits (i.e., undermargined

    amounts) for such accounts. The Commission also has adopted new

    regulations requiring FCMs to hold in segregated accounts funds

    received from customers engaging in Cleared Swaps to margin, secure

    or guarantee their Cleared Swaps in accordance with section 4d(f) of

    the Act. See 77 FR 6336 (Feb. 7, 2012).

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

    The Commission received one comment on the proposed Cleared Swaps

    Segregation Schedule. The Students at the SUNY Buffalo Law School

    supported the development of the Cleared Swaps Segregation

    Schedule.\34\ The Commission has considered the comment and has

    determined to adopt the Cleared Swaps Segregation Schedule as

    proposed.\35\

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    \34\ SUNY Buffalo Comment Letter at 7 (Mar. 19, 2013).

    \35\ The Commission will revise the Cleared Swaps Segregation

    Schedule consistent with the revisions to the Segregation Schedule

    and Secured Amount Schedule discussed in section II.A.1. to remove

    the requirement for the firm to disclose the amount of the margin

    deficits as of the close of business on the previous business day.

    In addition, Sec. 1.10(h) provides that a dually-registered FCM/BD

    may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that

    all information that is required to be included in the Form 1-FR-FCM

    is included in the FOCUS Report. Currently, dual-registrant FCM/BDs

    include a Segregation Schedule and a Secured Amount Schedule in the

    FOCUS Report filings as supplemental schedules. Dual-registrant FCM/

    BDs that have Cleared Swaps Customers will also have to include a

    Cleared Swaps Segregation Schedule to their Focus Report filings.

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

    In addition, Sec. 1.10 currently provides that the Commission will

    treat the monthly Form 1-FR-FCM reports, and monthly FOCUS Reports

    filed in lieu of the Forms 1-FR-FCM, as exempt from mandatory public

    disclosure for purposes of the Freedom of Information Act and the

    Government in the Sunshine Act.\36\ Regulation 1.10(g)(2) provides,

    however, that the following information in Forms 1-FR-FCM, and the same

    or equivalent information in FOCUS Reports filed in lieu of Forms 1-FR-

    FCM, are publicly available: The amount of the FCM's adjusted net

    capital; the amount of the FCM's minimum net capital requirement under

    Sec. 1.17; and the amount of its adjusted net capital in excess of its

    minimum net capital requirement. In addition, Sec. 1.10(g)(2) further

    provides that the FCM's Statement of Financial Condition in the

    certified annual financial report and the Segregation Schedule and

    Secured Amount Schedule are public documents.

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

    \36\ 5 U.S.C. 552.

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

    The Commission proposed to amend Sec. 1.10(g)(2)(ii) to add the

    Cleared Swaps Segregation Schedule to the list of documents that are

    publicly available. The only comment that the Commission received

    regarding making the Cleared Swaps Segregation Schedule public was

    received from students at the SUNY Buffalo Law School. The students at

    the SUNY Buffalo Law School supported the development and

    implementation of the Cleared Swaps Segregation Schedule as a

    regulatory tool for the Commission to receive additional information

    and to provide greater protection to customer funds.\37\ The students,

    however, also stated that the public disclosure of the Cleared Swaps

    Segregation Schedule and other financial information could

    [[Page 68515]]

    cause public panic in certain situations.\38\ They cited MFGI and Bear

    Stearns as examples of how public panic can rapidly accelerate a

    company's collapse by exacerbating the effects of financial injuries

    that might otherwise be manageable.\39\

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

    \37\ SUNY Buffalo Comment Letter at 8 (Mar. 19, 2013).

    \38\ Id. at 8-9.

    \39\ Id.

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

    The Commission notes that the monthly Segregation Schedules and

    Secured Amount Schedules have been available to the public for many

    years and provide important information that allows customers to

    monitor the financial condition of FCMs. As noted in the Proposal, the

    Commission believes that making the Cleared Swaps Segregation Schedule

    publicly available will benefit customers and potential customers by

    providing greater transparency on the status of the Cleared Swaps

    Customer Collateral held by FCMs. This disclosure allows customers and

    other members of the public to review an FCM's compliance with its

    regulatory obligations to safeguard customer funds. The disclosure of

    the Cleared Swaps Segregation Schedule also will provide a certain

    amount of detail as to how the FCM holds Cleared Swaps Customer

    Collateral, which customers and potential customers will be able to

    assess as part of their risk management process.

    The disclosure of the status of an FCM's compliance with its

    obligation to segregate customer funds, coupled with the additional

    firm risk disclosures that the Commission proposed in Sec. 1.55 (and

    is adopting in relevant part herein as discussed in detail in section

    II.P. below), will provide customers with greater transparency

    regarding the risks of entrusting their funds and engaging in

    transactions with particular FCMs. The Commission believes that these

    benefits to customers outweigh any potential adverse market impact

    which, in any event, has not been shown to be an issue based on the

    Commission's experience in making FCMs' Segregation Schedules and

    Secured Amount Schedules publicly available. The Commission has,

    therefore, determined to adopt the amendments to Sec. 1.10(g)(2) as

    proposed.

    3. Amendments to Form 1-FR-FCM

    The Commission proposed to amend several statements in the Form 1-

    FR-FCM. The Commission proposed to amend the Statement of Financial

    Condition by adding a new line item 1.D. Line 1 currently separately

    details: (1) The amount of funds that the FCM holds in segregated

    accounts for customers trading on designated contract markets (Line

    1.A.); (2) the amount of funds held in segregation for dealer options

    (Line 1.B.); and (3) the amount of funds held in secured accounts for

    foreign futures and foreign option customers (Line 1.C.).

    Proposed line item 1.D. would set forth the amount of funds held by

    the FCM in segregated accounts for Cleared Swaps Customers. This

    amendment is necessary due to the adoption of the part 22 regulations,

    which requires the segregation of Cleared Swaps Customer Collateral and

    the proposed adoption of the Cleared Swaps Segregation Schedule as part

    of the Form 1-FR-FCM.\40\

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

    \40\ See 77 FR 6336 (Feb. 7, 2012).

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

    The Commission also proposed to amend the Statement of Financial

    Condition by adding a new line item 22.F., which would require the

    separate disclosure of the FCM's liability to Cleared Swaps Customers.

    The proposed amendments to disclosure the total amount of funds held by

    the FCM for Cleared Swaps Customers, and the FCM's total obligation to

    Cleared Swaps Customers, is consistent with the reporting required on

    the Form 1-FR-FCM for customers trading on designated contract markets.

    The Commission also proposed to revise line item 27.J. of the

    Statement of Financial Condition to require an FCM to disclose

    separately its obligation to retail forex customers. Currently, an

    FCM's obligation to retail forex customers is included with other

    miscellaneous liabilities and reported under current line item 27.J.

    ``Other.'' The separate reporting of an FCM's retail forex obligation

    will provide greater transparency on the Statement of Financial

    Condition regarding the firm's obligations to its retail counterparties

    in off-exchange foreign currency transactions, and is appropriate given

    the Commission's direct jurisdiction over such activities when

    conducted by an FCM under section 2(c) of the Act.\41\

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

    \41\ 7 U.S.C. 2(c).

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

    NFA filed the only comment addressing the proposed amendments to

    the Statement of Financial Condition. NFA noted its full support of the

    proposed amendments to line item 27.J of the Statement of Financial

    Condition contained in Form 1-FR-FCM, and further requested that the

    Commission consider amending the asset section of the Statement of

    Financial Condition of Form 1-FR-FCM to require an FCM or Retail

    Foreign Exchange Dealer (``RFED'') to report the total funds on deposit

    to cover its obligations to retail forex customers as required by

    Commission Regulation 5.8.\42\ NFA stated that this revision would

    result in more accurate reporting and is consistent with the reporting

    for customer segregated funds.\43\

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

    \42\ NFA Comment Letter at 9 (Feb. 15, 2013).

    \43\ Id.

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

    The Commission has considered the comment and has determined to

    adopt the amendments as proposed. The Commission also is revising the

    Statement of Financial Condition in the Form 1-FR-FCM in response to

    the NFA's comment to include a new line item to require FCMs and RFEDs

    to separately disclose the assets held in qualifying accounts in excess

    of the firms' obligations to retail forex customers as required by

    Commission Regulation 5.8.

    Regulation 5.8 requires each FCM and RFED offering or engaging in

    retail forex transactions to hold, at all times, assets of the type

    permissible in Sec. 1.25 in an amount that exceeds the FCM's or RFED's

    total obligation to its retail forex customers at qualifying

    institutions set forth in the Regulation. The requirement of Regulation

    5.8 is to ensure the RFED or FCM holds liquid assets in relation to the

    amount of liability to retail forex customers.\44\ However, such retail

    forex customer funds are not held in ``segregated accounts'' in manner

    comparable to section 4d of the Act, which are provided with explicit

    protections in the event of the bankruptcy of the FCM. The Commission

    is revising the Statement of Financial Condition of the Form 1-FR-FCM

    to require each FCM or RFED to report on line 19.B. the aggregate

    amount of funds held in qualifying accounts to meet its total

    obligation to retail forex customers as required by Sec. 5.8. Such

    disclosure will provide greater transparency as to the firm's

    compliance with Commission regulations.

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

    \44\ See 75 FR 3282, 3290 (Jan. 20, 2010).

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

    4. FCM Certified Annual Report Deadline

    The Commission proposed to amend Sec. 1.10(b)(1)(ii) to require an

    FCM to submit its certified annual report to the Commission and to the

    firm's DSRO within 60 days of its year-end date. Currently, an FCM is

    required to submit the annual certified financial statements within 90

    days of its year-end date, except for FCMs that also are registered

    with the SEC as BDs, which are require to submit the certified annual

    report within 60 days of the year-end date under both Commission and

    SEC regulations. Therefore, the proposal would impact only FCMs that

    are not

    [[Page 68516]]

    dually-registered as BDs and would align the filing deadlines for both

    FCMs and dual registrant FCMs/BDs.

    The Commission received one comment on the proposal. NFA supported

    the proposal noting that the amendment will provide both the Commission

    and DSROs with more timely information for monitoring the financial

    condition of an FCM.\45\ The Commission considered the comment received

    and is adopting the amendments to Sec. 1.10(b)(1)(ii) as proposed. The

    Commission also is cognizant of the fact that public accountants are

    currently engaged in the audit of FCMs for the year ending December 31,

    2013 and possible for other year-end dates in 2014. Accordingly, in

    order to ensure that the amendments do not impede examinations that are

    currently in process, the Commission is establishing a compliance date

    for FCM annual audits for years ending June 1, 2014 or later. This

    compliance date also will align the revised reporting deadline with the

    auditing amendments to the auditing standards that public accountants

    use in the audit of FCMs and discussed in section II.E. below.

    Compliance dates are discussed further in section III below.

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

    \45\ NFA Comment Letter at 9 (Feb. 15, 2013).

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

    5. Leverage Ratio Calculation

    The Commission proposed to add a new requirement in Sec.

    1.10(b)(5) to require each FCM to file with the Commission on a monthly

    basis its balance sheet leverage ratio. Proposed Sec. 1.10(b)(5)

    defined the term ``leverage'' as an FCM's total balance sheet assets,

    less any instruments guaranteed by the U.S. Government and held as an

    asset or to collateralize an asset (e.g., a reverse repurchase

    agreement) divided by the FCM's total capital (i.e., the sum of the

    FCM's stockholders' equity and subordinated debt). FCMs currently file

    the same leverage information with NFA on a monthly basis using the

    same definition of the term ``leverage.'' The leverage ratio would

    provide information regarding the amount of assets supported by the

    FCM's capital base, and would allow the Commission to enhance its

    oversight of FCMs that are highly leveraged relative to their peers or

    based upon the Commission's understanding of the firm's business model.

    The Commission received three comments with respect to this

    proposal. Commenters were concerned that the leverage metrics proposed

    might not provide meaningful information and/or that the Commission's

    leverage definition was not consistent with those of other regulatory

    authorities. NFA noted that while the leverage definition proposed by

    the Commission is the same definition as that set forth in NFA

    Financial Requirement Section 16, it may not be the most appropriate

    measure.\46\ NFA noted that it has been studying an alternative

    calculation method and encouraged the Commission to defer codifying a

    single definition until it has the opportunity to examine NFA's

    calculation results.\47\ NFA also suggested the Commission consider

    adopting a requirement that FCMs report a leverage ratio as defined by

    a registered futures association rather than including a specific

    definition in the Commission's regulations.\48\

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

    \46\ NFA Comment Letter at 7-8 (Feb. 15, 2013).

    \47\ Id. at 7.

    \48\ Id. at 8.

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

    FIA indicated that it supported the proposed amendment, but stated

    that it is essential that the definition of the term ``leverage'' be

    consistent among regulatory authorities with supervision over FCMs and

    encouraged the Commission to coordinate with the SEC and the relevant

    SROs to ensure consistent treatment across the industry.\49\

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

    \49\ FIA Comment Letter at 12 (Feb. 15, 2013).

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

    RJ O'Brien objected to the proposal on the grounds that the

    definition of ``leverage'' in the proposal ``penalizes'' FCMs that are

    not dually-registered as BDs.\50\ RJ O'Brien stated that an FCM-only

    entity's balance sheet is primarily composed of funds deposited by

    customers for trading commodity interests, and that the leverage ratio

    computed under the proposed regulation does not properly reflect the

    risk of the firm's business.\51\ RJ O'Brien recommended that the

    Commission work with NFA to develop a more meaningful metric and

    further recommended that the Commission not permit or require public

    disclosure of FCM leverage ratios under the current methodology because

    RJ O'Brien believes it could provide the public with misleading

    information.\52\

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

    \50\ RJ O'Brien Comment Letter at 8-9 (Feb. 15, 2013)

    \51\ Id.

    \52\ Id.

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

    The Commission has considered the comments and has determined to

    adopt a final regulation requiring FCMs to submit to the Commission

    monthly balance sheet leverage information. As noted above, such

    information will enhance the Commission's ability to conduct financial

    surveillance of FCMs. The final regulation, however, will define the

    term ``leverage'' by referencing to the rules of a registered futures

    association as suggested by NFA. This revision to the final regulation

    will align the Commission's definition of leverage with the current NFA

    definition of leverage.\53\

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

    \53\ NFA is currently the only registered futures association.

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

    As stated above, in proposing the requirement for FCMs to report

    their monthly leverage ratios, the Commission intended for FCMs to file

    the same leverage information that they currently file with the NFA. In

    this regard, the Commission proposed a definition of leverage that is

    identical to the current NFA definition contained in its Financial

    Requirement Section 16. Such an approach will enhance the consistency

    in how the Commission and the SROs impose leverage reporting

    requirements on FCMs and in how leverage is monitored by the

    regulators. Furthermore, in response to RJ O'Brien's comment, the

    Commission intends to work with NFA and other regulators going forward

    on any revisions to the definition of ``leverage'' to maintain as

    consistent a definition as practicable.

    6. Procedural Filing Requirements

    The Commission proposed to amend Sec. 1.10(c)(2)(i) to require

    FCMs to electronically file with the Commission their monthly unaudited

    Forms 1-FR-FCM or FOCUS Reports and their certified annual financial

    reports. FCMs currently file their monthly unaudited financial

    statements with the Commission electronically using the WinJammer

    Online Filing System (``WinJammer'') and the proposed amendments merely

    codify current practices.\54\

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

    \54\ WinJammer is a web-based application developed and

    maintained jointly by the Chicago Mercantile Exchange and the NFA.

    The WinJammer system is provided at no cost to FCMs. FCMs currently

    use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports, and other

    financial information and regulatory notices to the Commission and

    to the SROs.

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

    FCM annual financial reports are filed in paper form with the

    Commission. Under the Commission's proposal, an FCM would use the

    WinJammer system to electronically file its certified financial report

    as a ``PDF'' document.

    No comments were received on the proposed amendments to Sec.

    1.10(c)(2)(i). The Commission is adopting the amendments as proposed.

    The Commission also is adopting a proposed technical amendment to

    Sec. 1.10(c)(1) on which no comments were received. Regulation

    1.10(c)(1) provides that any report or information required to be

    provided to the Commission by an IB or FCM will be considered filed

    [[Page 68517]]

    when received by the Commission Regional office with jurisdiction over

    the state in which the FCM has its principal place of business. The

    amendments to Sec. 1.10(c)(1) sets forth the jurisdiction of each of

    the Commission's three Regional offices under Sec. 140.02, and is

    intended to ensure that FCM's financial reports are filed expeditiously

    with the correct Commission Regional office.

    B. Sec. 1.11: Risk Management Program for Futures Commission Merchants

    The Commission proposed new Sec. 1.11 to require each FCM that

    carries customer accounts to establish a ``Risk Management Program,''

    as defined in Sec. 1.11(c), designed to monitor and manage the risks

    associated with the FCM's activities as an FCM. Under the Commission's

    proposal, the Risk Management Program must: (1) consist of written

    policies and procedures that have been approved by the ``governing

    body'' (defined below) of the FCM and furnished to the Commission; and

    (2) establish a risk management unit that is independent from an FCM's

    ``business unit'' (defined below) to administer the Risk Management

    Program.

    NFA, FIA, ICI, CFA, Chris Barnard, and Paul/Weiss generally

    supported proposed Sec. 1.11.\55\ Advantage stated ``that most aspects

    of proposed Sec. 1.11 are appropriate and unlikely to be burdensome as

    FCMs typically have most (if not all) of these requirements in place.''

    \56\ Several other commenters raised issues with specific components of

    the proposed regulation, which are discussed in the sections below. The

    Commission has considered the comments received and is adopting Sec.

    1.11 as proposed, with the following observations and clarifications.

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

    \55\ NFA Comment Letter at 10 (Feb. 15, 2013); FIA Comment

    Letter at 52 (Feb. 15, 2013); ICI Comment Letter at 7 (Jan. 14,

    2013); CFA Comment Letter at 4 (Feb. 13, 2013); Chris Barnard

    Comment Letter at 2 (Dec. 18, 2012); Paul/Weiss Comment Letter at 2

    (Feb. 15, 2013).

    \56\ Advantage Comment Letter at 2 (Feb. 15, 2013).

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

    1. Applicability

    Proposed paragraph (a) of Sec. 1.11 provides that the regulation

    would only apply to FCMs that accept money, securities, or property (or

    extend credit in lieu thereof) to margin, guarantee, or secure any

    trades or contracts that result from soliciting or accepting orders for

    the purchase or sale of any commodity interest. FCMs that do not accept

    or hold customer funds to margin, guarantee or secure commodity

    interests are generally not operating as FCMs, and are not subject to

    Sec. 1.11. To clarify, the Commission notes that it would expect

    registered FCMs that do not accept customer funds to establish a Risk

    Management Program that complies with Sec. 1.11 and file such program

    with the Commission and with the FCMs' DSROs prior to changing their

    business model to begin accepting customer funds.

    The Commission also requested comment on whether different risk

    management requirements for FCMs should be based upon some measurable

    criteria, such as size of the firm, and whether different elements of

    Sec. 1.11 should apply to smaller FCMs versus larger FCMs. Advantage

    stated that a one-size fits all approach is less than optimal, and that

    the Commission could establish minimum risk management standards for

    specific business lines/customer type, and then require that FCMs

    engaging in those lines of business/clearing that type of customer have

    those programs in place.\57\

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

    \57\ Advantage Comment Letter at 2 (Feb. 15, 2013).

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

    The Commission has considered the comment and has determined that

    Sec. 1.11 provides sufficient flexibility for FCMs to establish a risk

    management program that is appropriate to its business operations. To

    develop specific requirements for different business activities would

    not be appropriate in that each FCM may operate in a different manner.

    The Commission believes that each FCM can develop its own program to

    meet its business activities using the general framework established by

    Sec. 1.11.

    The Commission received no additional comments on proposed Sec.

    1.11(a) and is adopting the provision as proposed.

    2. Definitions

    The Commission proposed definitions of the terms ``customer,''

    ``business unit,'' ``governing body,'' ``segregated funds,'' and

    ``senior management'' in paragraph (b) of Sec. 1.11. These definitions

    are designed to ensure that there is accountability at the highest

    levels for the FCM's key internal controls and processes regarding the

    FCM's responsibility to meet its obligations as a futures market

    participant, including acting as an intermediary for customer

    transactions, and its obligation to safeguard customer funds.

    The term ``business unit'' was proposed to include generally any

    department, division, group or personnel of an FCM or any affiliate

    involved in soliciting orders and handling customer money, including

    segregation functions, and personnel exercising direct supervisory

    authority over the performance of such activities. The definition was

    intended to delineate clearly the separation of the risk management

    unit required by the regulation from the other personnel of an FCM from

    whom the risk management must be independent.

    The term ``customer'' was proposed broadly to include futures

    customers (as defined in Sec. 1.3) trading futures contracts, or

    options on futures contracts listed on designated contract markets,

    30.7 customers (as proposed to be defined in Sec. 30.1) trading

    futures contracts or options on futures contracts listed on foreign

    contract markets, and Cleared Swaps Customers (as defined in Sec.

    22.1) engaging in Cleared Swaps.

    The term ``governing body'' was proposed to be defined as the sole

    proprietor, if the FCM is a sole proprietorship; a general partner, if

    the FCM is a partnership; the board of directors, if the FCM is a

    corporation; and the chief executive officer, chief financial officer,

    the manager, the managing member, or those members vested with the

    management authority if the FCM is a limited liability company or

    limited liability partnership. The term ``senior management'' was

    proposed to mean any officer or officers specifically granted the

    authority and responsibility to fulfill the requirements of senior

    management under proposed Sec. 1.11 by the governing body.

    The term ``segregated funds'' was proposed to mean money,

    securities, or other property held by an FCM in separate accounts

    pursuant to Sec. 1.20 for futures customers, pursuant to Sec. 22.2

    for Cleared Swaps Customers, and pursuant to Sec. 30.7 for 30.7

    customers. The proposed definition of ``segregated funds'' makes clear

    that the requirements of Sec. 1.11 apply to all customer funds that

    may be held by an FCM. The Act and Commission regulations currently

    require FCMs to hold each type of segregated funds in separate accounts

    and to segregate such segregated funds from the FCM's own funds and to

    segregate each class of segregated funds from each other type, except

    if otherwise permitted by Commission rule, regulation or order.\58\

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

    \58\ See 7 U.S.C. 6d(a)(2) and 7 U.S.C. 6d(f).

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

    The Commission did not receive any comments regarding the proposed

    definitions in Sec. 1.11(b) and is adopting the amendments as

    proposed.

    3. Approval of Policies and Procedures and Submission to the Commission

    The Commission proposed Sec. 1.11(c) to require each FCM to

    establish, maintain, and enforce a system of risk management policies

    and procedures

    [[Page 68518]]

    designed to monitor and manage the risks associated with the activities

    of the FCM as an FCM.\59\ The policies and procedures are collectively

    referred to as the FCM's Risk Management Program.

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

    \59\ Because Sec. 1.11 applies to all FCMs that accept money,

    securities, or property (or extend credit in lieu thereof) from

    customers, it necessarily applies to any risks generated by the FCMs

    customers' trading activities. See, e.g., In re FCStone LLC, CFTC

    Docket 13-24, (May 29, 2013), where a customer's trading activities

    and the FCM's inadequate risk management practices caused the firm

    to lose over $127,000,000.

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

    Under proposed Sec. 1.11, the FCM's governing body is required to

    approve in writing the FCM's Risk Management Program and any material

    changes to the Risk Management Program. The FCM also is required to

    provide a copy of the Risk Management Program to the Commission and to

    the FCM's DSRO upon application for registration or upon request by the

    Commission or by the FCM's DSRO. The filing of the Risk Management

    Program is intended to allow the Commission and the FCM's DSRO to

    monitor the status of risk management practices among FCMs.

    Several commenters expressed general support for the requirement

    that an FCM implement a risk management program.\60\ The Commission

    received no other comments on proposed Sec. 1.11(c) and is adopting

    the amendments as proposed.

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

    \60\ See Franklin Comment Letter at 2 (Feb. 15, 2013); AIMA

    Comment Letter at 1 and 4 (Feb. 15, 2013); TIAA-CREF Comment Letter

    at 3 (Feb. 15, 2013).

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

    4. Organizational Requirements of the Risk Management Program

    a. Separation of Risk Management Unit from Business Unit

    The Commission proposed Sec. 1.11(d), requiring an FCM to

    establish a risk management unit that is independent from the FCM's

    business unit to administer the Risk Management Program. As part of the

    Risk Management Program, each FCM must establish and maintain a risk

    management unit with sufficient authority, qualified personnel, and

    financial, operational, and other resources to carry out the Risk

    Management Program. The risk management unit is required to report

    directly to senior management.

    Several commenters opposed the separation of the risk management

    unit from the business unit. RCG stated that requiring FCMs to separate

    the risk management function from the ``business unit'' is unnecessary,

    counterproductive, and will likely result in increased risk to the FCM

    and its customers.\61\ RCG argued that the proposed requirement removes

    a valuable, mature talent pool from participating in risk management,

    and the proposal is counterproductive in that it has the potential of

    blocking the flow of historical and financial information about a

    customer from the business side of the FCM to the risk management side

    of the FCM, information that is crucial to evaluating risk.\62\

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

    \61\ RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip

    Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

    \62\ RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip

    Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

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

    Phillip Futures Inc. stated that the proposed separation of the

    business unit from the risk management unit will lead to a decrease in

    the timeliness of decision making as decisions will have to be filtered

    through new supervisory employees that the proposal will ultimately

    create, which will hinder each FCM's ability to assess risk.\63\

    Phillip Futures Inc. stated that so long as internal controls, senior

    leadership, and training programs of a firm are created with the proper

    checks and balances which ensure proper supervision of activities

    conducted by the business unit and the risk management unit, the

    respective units need not be independent from each other.\64\ Phillip

    Futures Inc. also asserted that the separation of duties required by

    the regulation would require it to hire multiple employees who would

    have limited job responsibilities.\65\

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

    \63\ Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

    \64\ Id.

    \65\ Id.

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

    CHS Hedging stated that it would not be realistic or cost effective

    for smaller FCMs to establish an entirely separate risk management

    unit, and argued that if supervisory risk management personnel report

    to senior management separately from the business side to avoid a

    conflict of interest, a standalone unit should not be required.\66\

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

    \66\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

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

    RJ O'Brien also argued that requiring FCMs to create a separate

    risk management unit is not operationally or financially practical for

    all FCMs, particularly small to midsized FCMs, and needlessly increases

    the costs of compliance for most firms without producing significant

    benefits.\67\ RJ O'Brien stated that supervisors at many small to mid-

    sized FCMs have the knowledge and expertise that can be essential to

    maintaining a strong risk management program at their firm, however,

    such supervisors also may have a role in the business unit

    activities.\68\ They proposed that the Commission revise the proposed

    regulation such that supervisors of business unit personnel are

    permitted to be part of the risk management unit provided that such

    supervisors are not compensated in connection with soliciting or

    accepting orders for the purchase or sale of any commodity

    interest.\69\

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

    \67\ RJ O'Brien Comment Letter at 9 (Feb. 15, 2013).

    \68\ Id.

    \69\ Id.

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

    The Commission notes that, as stated above, only employees involved

    in soliciting orders and handling customer money (including the

    segregation functions), and employees directly supervising such

    activities would fall within the definition of ``business unit'' under

    Sec. 1.11(b)(1). Therefore, the Commission does not agree with the

    assertion that a large pool of employees will be barred from

    participating in the risk management unit. Further, the Commission

    observes that the independence of the risk management unit required by

    proposed Sec. 1.11 does not require FCMs to establish information

    partitions between the risk management unit and members of the business

    unit, and disagrees with commenters that such independence requirement

    would block the flow of historical and financial information about a

    customer from the business side of the FCM to the risk management side

    of the FCM. In any event, the Commission believes that the freedom from

    conflicts of interests that the independence of the risk management

    unit provides is critically important to the protection of customer

    funds in the custody of the FCM.

    The FIA commented that in adopting the rules governing risk

    management programs for SDs and MSPs, the Commission clarified the

    interpretation of certain provisions, and asked that the Commission

    confirm that such clarifications apply equally to the provisions of

    Sec. 1.11.\70\ In general, the FIA requested the Commission to

    confirm, subject to certain exceptions or requirements, that the

    requirements of Sec. 1.11:

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

    \70\ See 77 FR 20128 (April 3, 2012).

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

    (1) Do not prescribe rigid organization structures;

    (2) do not require an FCM's risk management unit to be a formal

    division in the FCM's organizational structure, provided that the FCM

    will be able to identify all personnel responsible for required risk

    management activities

    [[Page 68519]]

    even if such personnel fulfill other functions; and

    (3) Allow FCMs to establish dual reporting lines for risk

    management personnel performing functions in addition to their risk

    management duties, provided that Sec. 1.11 would not permit a member

    of the risk management unit to report to any officer in the business

    unit for any non-risk management activity.\71\

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

    \71\ FIA Comment Letter at 54-55 (Feb. 15, 2013).

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

    The FIA further commented that the ``policies and procedures''

    approach provides an adequate amount of flexibility that will allow the

    FCMs to rely upon any existing compliance or risk management

    capabilities to meet the requirements of the rule.\72\

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

    \72\ Id. at 52.

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

    The Commission generally agrees with the FIA in that, while the

    requirements of Sec. 1.11 represent prudent risk management practices,

    they do not prescribe rigid organizational structures. The Commission

    also believes that the ``policies and procedures'' approach provides an

    adequate amount of flexibility that will allow FCMs to rely upon any

    existing compliance or risk management capabilities to meet the

    requirements of the final rule. The Commission further believes that

    nothing in Sec. 1.11 would prevent FCMs from relying upon existing

    compliance and risk management programs to a significant degree.

    As the Commission confirmed in its final rulemaking discussing

    Sec. 23.600(b) regarding the risk management program for SDs and MSPs,

    the Commission also confirms that Sec. 1.11(d) does not require a

    registrant's risk management unit to be a formal division in the

    registrant's organizational structure, provided that the FCM will be

    able to identify all personnel responsible for required risk management

    activities as its ``risk management unit'' even if such personnel

    fulfill other functions in addition to their risk management

    activities; and permits FCMs to establish dual reporting lines for risk

    management personnel performing functions in addition to their risk

    management duties, but this rule would not permit a member of the risk

    management unit to report to any officer in the business unit for any

    non-risk management activity.\73\ Such dual reporting invites conflicts

    of interest and would violate Sec. 1.11's risk management unit

    independence requirement.

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

    \73\ 77 FR 20128 (April 3, 2012).

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

    The Commission notes that the formal independence of the risk

    management unit from the business unit does not relieve an FCM from the

    duty to resolve other conflicts of interest that may have an adverse

    effect on the effectiveness of the FCM's risk management program. An

    FCM's CCO is required under Sec. 3.3(d)(2) to resolve any conflicts of

    interest that may arise, in consultation with the FCM's board of

    directors or its senior officer. Thus, the Commission would expect an

    FCM to recognize and eliminate or appropriately mitigate any conflict

    of interest between the FCM's business interests and its duty to

    establish and maintain an effective risk management program.

    Having considered the comments regarding Sec. 1.11(d), the

    Commission is adopting the provision as proposed.

    5. Components of the Risk Management Program

    The Commission's proposed Sec. 1.11(e) provides for a non-

    exclusive list of the elements that must be a part of the Risk

    Management Program of an FCM. Those elements include: (1) Identifying

    risks (including risks posed by affiliates, all lines of business of

    the FCM, and all other trading activity of the FCM) and setting of risk

    tolerance limits; (2) providing periodic risk exposure reports to

    senior management and the governing body; (3) operational risk

    controls; (4) capital controls; and (5) establishing a risk management

    program that takes into account risks associated with the safekeeping

    and segregation of customer funds.

    Proposed Sec. 1.11(e)(1)(ii) requires the Risk Management Program

    to take into account risks posed by affiliates, all lines of business

    of the FCM, and all other trading activity engaged in by the FCM. The

    FIA asked the Commission to confirm its position that, to the extent

    that many FCMs are part of a larger holding company structure that may

    include affiliates that are engaged in a wide array of business

    activities, the Commission understands that, in some instances, the top

    level company in the holding company structure, which has the benefit

    of an organization-wide view, is in the best position to evaluate the

    risks that an affiliate of an FCM may pose to the FCM.\74\ Therefore,

    to the extent an FCM is part of a holding company within an integrated

    risk management program, the FCM may address affiliate risks and comply

    with Sec. 1.11 through its participation in a consolidated entity risk

    management program provided that such program does in fact assess the

    risks posed to the FCM by its affiliated entities.\75\

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

    \74\ FIA Comment Letter at 55 (Feb. 15, 2013).

    \75\ Id.

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

    The Commission recognizes that some FCMs will be part of a larger

    holding company structure that may include affiliates that are engaged

    in a wide array of business activities. The Commission understands with

    respect to these entities, that in some instances, the top level

    company in the holding company structure is in the best position to

    evaluate the risks that an affiliate of an FCM may pose to the

    enterprise, as it has the benefit of an organization-wide view and

    because an affiliate's business may be wholly unrelated to an FCM's

    activities. Therefore, to the extent an FCM is part of a holding

    company with an integrated risk management program, the Commission

    would allow an FCM to address affiliate risks and comply with Sec.

    1.11(e)(1)(ii) through its participation in a consolidated entity risk

    management program.

    In regard to customer funds, the Commission notes that FCMs are

    required by the Act and Commission regulations to segregate and

    safeguard funds deposited by customers for trading commodity interests.

    Recent events have emphasized that it is essential that FCMs maintain

    adequate systems of internal controls, involving the participation and

    review of the firm's senior management, in order to properly safeguard

    customer funds. Accordingly, Sec. 1.11(e)(3)(i) requires that the risk

    management policies and procedures of an FCM related to the risks

    associated with safekeeping and segregation of customer funds must

    include: (1) The evaluation and monitoring of depositories; \76\ (2)

    account opening procedures that ensure the FCM obtains the

    acknowledgment required under Sec. 1.20 from the depository and that

    the account is properly titled as belonging to the customers of the

    FCM; \77\ (3) establishing

    [[Page 68520]]

    and maintaining an adequate targeted amount of excess funds in customer

    accounts reasonably designed to ensure the FCM is at all times in

    compliance with the segregation requirements for customer funds under

    the Act and Commission regulations, as discussed further below; (4)

    controls ensuring that the withdrawal of cash, securities, or other

    property from accounts holding customer funds not for the benefit of

    customers are in compliance with the Act and Commission regulations;

    \78\ (5) procedures for assessing the appropriateness of investing

    customer funds in accordance with Sec. 1.25; \79\ (6) the valuation,

    marketability, and liquidity of customer funds and permitted

    investments made with customer funds; (7) the appropriate separation of

    duties of personnel responsible for compliance with the Act and

    Commission regulations relating to the protection and financial

    reporting of customer funds; \80\ (8) procedures for the timely

    recording of transactions in the firm's books and records; and (9)

    annual training of personnel responsible for compliance with the Act

    and Commission regulations relating to the protection and financial

    reporting of customer funds.

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

    \76\ The evaluation process must include documented criteria

    that any depository will be assessed against in order to qualify to

    hold funds belonging to customers. The criteria must address a

    depository's capitalization, creditworthiness, operational

    reliability, and access to liquidity. The criteria must also address

    risks associated with concentration of customer funds in any

    depository or group of depositories, the availability of deposit

    insurance, and the regulation and supervision of depositories. The

    evaluation criteria is intended to ensure that the FCM adopts an

    evaluation process which reviews potential depositories against

    substantive criteria relevant to the safe custody of customer funds

    and that the FCM's process for evaluating and selecting depositories

    can be reviewed by regulators and auditors. The FCM also must

    maintain a documented process addressing the ongoing monitoring of

    selected depositories, including a thorough due diligence review of

    each depository at least annually.

    \77\ As required by Sec. 1.20, such account opening

    documentation is necessary to ensure that the depositories are aware

    of their obligations regarding the accounts and the statutory and

    regulatory protections afforded the funds held in the accounts due

    to their status as segregated funds.

    \78\ The controls must include the conditions for pre-approval

    and the notice to the Commission for such withdrawals required by

    Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.

    \79\ The FCM's assessment must take into consideration the

    market, credit, counterparty, operational, and liquidity risks

    associated with the investments.

    \80\ The policies and procedures must provide for the separation

    of duties among personnel that are responsible for customer trading

    activities, and approving and overseeing cash receipts and

    disbursements (including investment and treasury operations). The

    policies and procedures must further require that any movement of

    funds to affiliated companies or parties be approved and documented.

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

    Regarding the requirement that FCMs establish and maintain an

    adequate targeted amount of excess funds in customer accounts, the

    Commission notes that FCMs currently deposit proprietary funds into

    both customer segregated accounts and part 30 secured accounts as a

    buffer to minimize the possibility of the firm being in violation of

    its segregated and secured fund obligations at any time. Under the

    final rule, the senior management of the FCM must perform appropriate

    due diligence in setting the amount of this buffer and must consider

    the nature of the FCM's business including the type and general

    creditworthiness of its customer base, the types of markets and

    products traded by the firm's customers, the proprietary trading

    activities of the FCM, the volatility and liquidity of the markets and

    products traded by the customers and the FCM, the FCM's own liquidity

    and capital needs, and historical trends in customer segregation and

    secured account funds balances, customer debits, and margin deficits

    (i.e., undermargined amounts). The FCM also must reassess the adequacy

    of the targeted residual interest quarterly.

    The Commission believes that each FCM must set the amount of excess

    segregated and secured funds required utilizing a quantitative and

    qualitative analysis that reasonably ensures compliance at all times

    with segregated and secured fund obligations. Such analysis must take

    into account the various factors that could affect segregated and

    secured balances, and must be sufficiently described in writing to

    allow the DSRO of the FCM and the Commission to duplicate the

    calculations and test the assumptions. The analysis must provide a

    reasonable level of assurance that the excess is at an appropriate

    level for the FCM.\81\ A failure to adopt or maintain appropriate risk

    management policies and procedures or to implement, monitor and enforce

    controls required by Sec. 1.11 may result in a referral to the

    Commission's Division of Enforcement for appropriate action.

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

    \81\ Separate from requiring the establishment of a target for

    residual interest, the Commission is further requiring, as discussed

    in more detail under sections II.G.9., II.H., and II.I. for

    Sec. Sec. 1.20, 1.22, and 1.23, respectively, that residual

    interest exceed the sum of outstanding undermargined amounts to

    provide a mechanism for ensuring compliance with the prohibition of

    the funds of one customer being used to margin or guarantee the

    positions of another customer under the Act and existing

    regulations.

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

    Proposed Sec. 1.11(e)(3)(i)(G) requires the appropriate separation

    of duties among individuals responsible for compliance with the Act and

    Commission regulations relating to the protection and financial

    reporting of segregated funds, including the separation of duties among

    personnel that are responsible for advising customers on trading

    activities, approving or overseeing cash receipts and disbursements

    (including investment operations), and recording and reporting

    financial transactions. Phillip Futures Inc. stated that such a

    separation of duties would require it to hire multiple employees that

    would have limited job responsibilities, and suggested that as long as

    internal controls are adequate and supervisory personnel are properly

    registered with the Commission and NFA, the separation of duties is not

    necessary.\82\

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

    \82\ Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

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

    Regulation 1.11(e)(3)(i)(I) requires that the written policies and

    procedures include procedures for the reporting of suspected breaches

    of the policies and procedures to the CCO, without fear of retaliation,

    and the consequences of failing to comply with the segregation

    requirements of the Act and regulations. Chris Barnard recommended that

    the procedures for reporting breaches should allow and stress the

    complete anonymity of the reporting party (whistleblower).\83\ The

    Commission takes note of Mr. Barnard's comments related to

    whistleblowers as sound practices. The Commission notes, however, that

    such additional requirements were not proposed and, in any event, are

    outside the scope of this rulemaking.\84\

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

    \83\ Chris Barnard Comment Letter at 2 (Dec. 18, 2012).

    \84\ The Commission further notes that it maintains a

    whistleblower program that provides for the anonymous reporting of

    violations of the Act and Commission regulations. See part 165 of

    the Commission's regulations.

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

    Also, to ensure the effectiveness of a Risk Management Program,

    Sec. 1.11(e)(4) requires that the Risk Management Program include a

    supervisory system that is reasonably designed to ensure that the risk

    management policies and procedures are diligently followed.

    The Commission has considered the comments received on the proposal

    and, for the reasons stated above, is adopting Sec. 1.11(e) as

    proposed.

    6. Annual Review, Distribution of Policies and Procedures and

    Recordkeeping

    The Commission's proposal also includes: (1) Sec. 1.11(f) which

    requires an annual review and testing of the adequacy of each FCM's

    Risk Management Program by internal audit staff or a qualified

    external, third party service; (2) Sec. 1.11(g) which requires the

    timely distribution of written risk management policies and procedures

    to relevant supervisory personnel; and (3) Sec. 1.11(h) which

    discusses recordkeeping and availability of records. The Commission

    received no comments on paragraphs (f), (g), and (h) of Sec. 1.11 and

    is adopting the paragraphs as proposed.

    7. CCO or CEO Certification

    Regulation 3.3 requires the CCO or CEO of an FCM to provide an

    annual report to the Commission that must review each applicable

    requirement under the Act and Commission regulations, and with respect

    to each

    [[Page 68521]]

    applicable requirement, identify the policies and procedures that are

    reasonably designed to ensure compliance with the requirement, and

    provide an assessment of the effectiveness of the policies and

    procedures.\85\ The annual report also must include a certification by

    the CCO or CEO that, to the best of his or her knowledge and reasonable

    belief, and under penalty of law, the information contained in the

    annual report is accurate and complete.

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

    \85\ Such report is mandated by Sec. 3.3 of the Commission's

    regulations; See Swap Dealer and Major Swap Participant

    Recordkeeping, Reporting, and Duties Rules; Futures Commission

    Merchant and Introducing Broker Conflicts of Interest Rules; and

    Chief Compliance Officer Rules for Swap Dealers, Major Swap

    Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,

    2012 (promulgating final rules concerning the CCOs of FCMs, swap

    dealers, and major swap participants); see also Sec. 4d(d) of the

    Act, 7 U.S.C. 6d(d).

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

    The Commission requested comment on whether the standard for the

    CCO's or CEO's certification in the annual report (i.e., based on the

    CCO's or CEO's knowledge and reasonable belief) required under Sec.

    3.3 is adequate for a certification of the FCM's compliance with

    policies and procedures for the safeguarding of customer funds.

    Specifically, the Commission requested comment on whether Sec. 1.11

    should contain a separate CCO or CEO certification requirement that

    would impose a higher duty of strict liability or some other higher

    obligation on a CCO or CEO.

    The Commission received three comments in this regard. NFA and FIA

    believed that the ``knowledge and reasonable belief'' standard in Sec.

    3.3 remains appropriate for a CCO's/CEO's certification regarding an

    FCM's customer funds safeguards.\86\ That is, the CCO or CEO should not

    be liable for matters that are beyond the CCO's/CEO's knowledge and

    reasonable belief. Further, NFA stated that the Commission should

    reconsider whether the CCO's/CEO's annual report should contain a

    separate certification (with the ``knowledge and reasonable belief

    language'') executed by the FCM's CEO or CFO regarding the adequacy of

    the FCM's customer funds safeguards.\87\ Newedge opposed the imposition

    of a strict liability standard on a CCO/CEO for the annual

    certifications because the CCO/CEO is relying on internal

    representations from other FCM employees that are far more expert

    regarding these matters.\88\ Newedge stated that such a standard would

    make it difficult to recruit qualified persons to serve as a CCO/

    CEO.\89\

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

    \86\ FIA Comment Letter at 11 (Feb. 15, 2013); NFA Comment

    Letter at 10 (Feb. 15, 2013).

    \87\ NFA Comment Letter at 10 (Feb. 15, 2013).

    \88\ Newedge Comment Letter at 3 (Feb. 15, 2013).

    \89\ Id.

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

    In response to these comments, the Commission is not requiring a

    separate CCO/CEO certification requirement imposing a higher duty of

    strict liability or other standard for the segregation of customer

    funds. The Commission also is not imposing a separate certification by

    the FCM's CEO or CFO at this time. Commission staff will monitor the

    role of the CCO/CEO as the regulation is implemented and propose to the

    Commission any amendments to the CCO's/CEO's standard for certifying

    compliance as deemed appropriate based upon staff's experiences.

    C. Sec. 1.12: Maintenance of Minimum Financial Requirements by Futures

    Commission Merchants and Introducing Brokers

    The regulatory notices required under Sec. 1.12 are intended to

    provide the Commission and SROs with prompt notice of potential adverse

    conditions at FCMs that may indicate a possible threat to the financial

    condition of the firm or to the safety of customer funds held by the

    FCM. Regulation 1.12 currently obligates FCMs to provide notice to the

    Commission and to the respective DSROs if certain specified reportable

    events occur. Reportable events include: Failing to maintain the

    minimum level of required regulatory capital (Sec. 1.12 (a)); failing

    to maintain current books and records (Sec. 1.12(c)); and failing to

    comply with the requirements to properly segregate customer funds

    (Sec. 1.12(h)). As discussed further below, the Commission proposed to

    amend Sec. 1.12 to include several additional reportable events and to

    revise the process for submitting reportable events to the Commission

    and DSROs.

    1. Timing of Notices

    The proposed new reportable events, discussed individually below,

    will require immediate notice to the Commission and the firm's DSRO

    upon the occurrence of the relevant event. FIA commented that while it

    is not opposed to a requirement for FCMs to provide prompt notice of a

    reportable event, it questioned the need for ``immediate'' notice as

    proposed by the Commission.\90\ FIA recommended that if the Commission

    determined to adopt the proposed early warning notices that it allow 24

    hours if the event is financial in nature and 48 hours for business-

    related events in order to afford FCMs time to determine the cause of

    the event and take an appropriate corrective action.\91\

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

    \90\ FIA Comment Letter at 37-38 (Feb. 15, 2013).

    \91\ Id.

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

    The purpose of the ``early warning'' notice system established

    under Sec. 1.12 is to provide the Commission and an FCM's DSRO with

    adequate and prompt notice of a reportable event in order to allow

    Commission staff to assess the situation and to consult with the

    registrant and the SROs to determine if further action is necessary in

    order to protect customer funds or to determine if the FCM can continue

    to meet its obligations to the marketplace and clearing process. The

    filing of a notice is often the first step where the Commission staff

    is alerted to a potential issue at a firm. The Commission also

    initiates a dialogue with the firm and the firm's DSRO, as necessary,

    upon receipt of a Sec. 1.12 notice.

    Given the critical role that notices play in the Commission's and

    DSRO's surveillance of FCMs, the Commission believes that immediate

    notice is necessary when a reportable event is financial in nature

    (e.g., the FCM is not in compliance with the Commission's capital or

    segregation requirements). In such situations, the firm should file

    immediate notice with the Commission. If a firm needs additional time

    to assess the cause of the reportable event, or if additional time is

    needed to document what steps the FCM will take to remedy the situation

    causing the reportable event, it may file an amendment to its initial

    notice with the Commission. In addition, in a situation where the

    registrant is reporting that it is undercapitalized or undersegregated,

    the Commission and DSRO will have initiated an ongoing dialogue whereby

    the Commission and the DSRO will be in frequent communication with the

    registrant and will receive updated information as the registrant

    becomes aware of the facts.

    Reportable events that are not related to an FCM's ability to meet

    its financial obligations or not directly related to the protection of

    customer funds may not be subject to the same sense of immediacy and

    the Commission is revising its proposed regulations accordingly. The

    revisions to the proposed amendments are discussed in the appropriate

    sections below with the comments received on the proposed new notice

    provisions.

    2. Undercapitalized FCMs and IBs

    Regulation 1.12(a) requires an FCM or IB that fails to maintain the

    minimum level of adjusted net capital required by Sec. 1.17 to provide

    immediate notice to

    [[Page 68522]]

    the Commission and to the entity's DSRO. The notice must include

    additional information to adequately reflect the FCM's or IB's current

    capital condition as of any date that the entity is undercapitalized.

    The Commission proposed to amend Sec. 1.12(a) to clarify that if

    the FCM or IB cannot compute or document its actual capital at the time

    it knows that it is undercapitalized, it must still provide the written

    notice required by Sec. 1.12(a) immediately and may not delay filing

    the notice until it has adequate information to compute its actual

    level of adjusted net capital.

    NFA commented in support of the Commission's proposal noting that

    in situations where an FCM is in potential distress, it may be even

    more important for the Commission and the firm's DSRO to become

    immediately aware of the situation so that the Commission and DSRO

    staff can assist in determining the firm's current, accurate financial

    condition.\92\ The Commission agrees that it is imperative that an FCM

    or IB provide immediate notice if the firm is undercapitalized and,

    accordingly is adopting the amendment as proposed.

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

    \92\ NFA Comment Letter at 10 (Feb. 15, 2013).

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

    3. Insufficient Segregation of Funds of Cleared Swaps Customers

    Regulation 1.12(h) currently requires an FCM that fails to hold

    sufficient funds in segregated accounts to meet its obligations to

    futures customers, or that fails to hold sufficient funds in separate

    accounts for foreign futures or foreign options customers, to provide

    immediate notice to the Commission and to the FCM's DSRO. The

    Commission proposed to amend paragraph (h) to include an explicit

    requirement that an FCM provide immediate notice to the Commission and

    to its DSRO if the FCM fails to hold sufficient funds in segregated

    accounts for Cleared Swaps Customers to meet its obligation to such

    customers.\93\ The amendment will ensure immediate notification of a

    failure to hold sufficient funds in segregation for Cleared Swaps

    Customers so that the Commission and the firm's DSRO can promptly

    assess the financial condition of an FCM and determine if there are

    threats to the safety of the Cleared Swaps Customers Collateral held by

    the FCM. The amendment also harmonizes the notice requirements whenever

    an FCM fails to hold in proper segregated or secured accounts

    sufficient funds to meet its total obligations to futures customers,

    30.7 customers, and Cleared Swaps Customers.

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

    \93\ Commencing November 13, 2012, the compliance date for

    certain Commission part 22 regulations, FCMs are required under

    Sec. 22.2 to hold a sufficient amount of funds in Cleared Swaps

    Customer Accounts to meet the Net Liquidating Equity of each Cleared

    Swaps Customer. 77 FR 6336 (Feb. 7, 2012).

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

    The Commission did not receive any comments on proposed Sec.

    1.12(h). The Commission is adopting the amendments to paragraph (h) as

    proposed.

    4. Investment of Customer Funds in Contravention of Regulation 1.25

    The Commission also proposed to amend Sec. 1.12 by adding new

    paragraph (i) to require an FCM to provide immediate notice whenever it

    discovers or is informed that it has invested funds held for customers

    in investments that are not permitted investments under Sec. 1.25, or

    if the FCM holds permitted investments in a manner that is not in

    compliance with the provisions of Sec. 1.25, such as the investment

    concentration limitations contained in Sec. 1.25(b)(3). The proposal

    applies to funds held for futures customers, 30.7 customers, and

    Cleared Swaps Customers.

    The Commission received no comments on the proposed amendments to

    Sec. 1.12(i). The Commission is adopting paragraph (i) as proposed.

    5. Notice of Residual Interest Falling Below Targeted Level or

    Undermargined Amounts

    The Commission proposed to amend Sec. 1.12 to provide a new

    paragraph (j) to require an FCM to provide immediate notice to the

    Commission and to the firm's DSRO if the FCM does not hold an amount of

    funds in segregated accounts for futures customers or for Cleared Swaps

    Customers, or if the FCM does not hold sufficient funds in secured

    accounts for 30.7 customers, sufficient to meet the firm's targeted

    residual interest in one or more of these accounts as computed under

    proposed Sec. 1.11, which is being adopted herein, or if its residual

    interest in one or more of these accounts is less than the sum of

    outstanding margin deficits (i.e., undermargined amounts) for such

    accounts. Regulation 1.11, as adopted herein, also requires each FCM

    that carries customer funds to calculate an appropriate amount of

    excess funds (i.e., proprietary funds) to hold in segregated or secured

    accounts to mitigate the possibility of the FCM being undersegregated

    or undersecured due to a withdrawal of proprietary funds from a

    segregated or secured account.

    FIA questioned the necessity of the proposed provision noting that

    under the proposed amendments to Sec. 1.32 each FCM holding customer

    funds is required to file a report with the Commission on a daily basis

    that will disclose if the FCM's residual interest has fallen below the

    FCM's targeted amount or if the residual amount is less than the sum of

    the customers' margin deficits.\94\ FIA also noted that under current

    regulations an FCM's residual interest will frequently fall below its

    targeted amount and that if the Commission adopts its proposed

    amendments to Sec. Sec. 1.20, 22.2 and 30.7 to require an FCM to use

    proprietary funds to cover margin deficits, withdrawals in excess of 25

    percent of the firm's residual interest will likely be a daily event

    requiring daily notices to be filed with the Commission and with the

    FCM's DSRO.\95\

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

    \94\ FIA Comment Letter at 38 (Feb. 15, 2013). The Commission is

    proposing to require each FCM to file with the Commission and with

    the firm's DSRO a daily: (1) Segregation Schedule (Sec. 1.32); (2)

    Secured Amount Schedule (Sec. 30.7); and, (3) Cleared Swaps

    Segregation Schedule (Sec. 22.2)). The Commission proposed to

    include information disclosing the FCM's targeted residual interest

    and whether the amount of the actual residual interest exceeds the

    targeted residual interest and the total amount of the FCM's margin

    deficiencies in the Segregation Schedule, Secured Amount Schedule,

    and the Cleared Swaps Segregation Schedule.

    \95\ Id.

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

    One of the primary objectives of the proposed amendments to Sec.

    1.12 is to ensure that the Commission and DSROs receive notice of

    potential financial or operational issues at an FCM, or of rule

    violations by an FCM, in as timely a manner as possible such that the

    Commission and the FCM's DSRO will be in a position to assess the

    issues and the potential impact on the FCM's ability to meet its

    regulatory obligations and its ability to safeguard customer funds.

    While the proposed amendments to Sec. 1.32 do require each FCM holding

    customer funds to file on a daily basis a Segregation Schedule, Secured

    Amount Schedule, and Cleared Swaps Segregation Schedule (as

    appropriate) that includes information concerning the amount of the

    firm's actual and targeted residual interests, the notice required by

    Sec. 1.12(j) requires the firm to include a discussion of the cause of

    the event, and what steps the firm will take to increase the residual

    interest. The notice will assist the Commission and the DSROs in

    determining what, if any, additional steps may be necessary in order to

    mitigate potential market disruptions if the FCM cannot meet its

    regulatory obligations, and will enhance the overall safety of customer

    funds. In addition, the Commission believes that the filing of a notice

    by an FCM will focus greater attention by management at the firm on the

    fact that the firm's

    [[Page 68523]]

    actual residual interest is below its targeted residual interest, which

    should result in further reflection by management on the adequacy of

    the target amount and/or any changes in operations that may be

    appropriate, including increasing the firm's residual interest or using

    other sources of liquidity.

    The Commission also notes that an FCM's obligation under Sec.

    1.12(j) to file a notice when the firm's residual interest is less than

    the sum of the undermargined amounts in its customer accounts is

    determined at the point in time that the firm is required to maintain

    as residual interest the undermargined amounts under Sec. 1.22, Sec.

    22.2, and Sec. 30.7. In addition, the Commission further notes that

    the obligation to file a notice under Sec. 1.12(j) when the firm's

    residual interest is less than the sum of the undermargined amounts in

    its customer accounts commences as of the respective compliance dates

    for Sec. 1.22, Sec. 22.2, and Sec. 30.7 established by the

    Commission and discussed further in section III below.

    The Commission has considered the comments and has determined to

    adopt new paragraph 1.12(j) as proposed and as clarified above.

    6. Events Causing Material Adverse Financial Impact or Material Change

    in Operations

    The Commission proposed new paragraphs (k) and (l) to Sec. 1.12.

    Proposed paragraphs (k) and (l) will require an FCM to provide notice

    to the Commission and to the firm's DSRO in the event of a material

    adverse impact in the financial condition of the firm or a material

    change in the firm's operations. Proposed paragraph (k) will require an

    FCM to provide immediate notice if the FCM, its parent, or a material

    affiliate, experiences a material adverse impact to its

    creditworthiness or its ability to fund its obligations. Indications of

    a material adverse impact of an FCM's creditworthiness may include a

    bank or other financing entity withdrawing credit facilities, a credit

    rating downgrade, or the FCM being placed on ``credit watch'' by a

    credit rating agency.

    Proposed paragraph (l) will require an FCM to provide immediate

    notice of material changes in the operations of the firm, including: A

    change in senior management; the establishment or termination of a

    material line of business; a material change in the FCM's clearing

    arrangements; or a material change in the FCM's credit arrangements.

    Paragraph (l) is intended to provide the Commission with notice of

    material events, such as the departure of the FCM's CCO, CFO, or CEO.

    Two comments were received on the proposal. FIA stated that the

    proposed amendments do not provide an FCM sufficient guidance on the

    circumstances that would require notice and requested that the

    Commission define more precisely the events that would require

    notice.\96\ RJ O'Brien similarly stated its concern that the term

    ``creditworthiness'' as used in proposed Regulation 1.12(k) is

    ambiguous and subjective and requires a clearer definition to afford

    FCMs the ability to reasonably ascertain their reporting duties and

    obligations.\97\

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

    \96\ Id.

    \97\ RJ O'Brien Comment Letter at 10 (Feb. 15, 2013).

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

    FIA also recommended that the Commission coordinate with the SEC

    and the banking regulators to establish a uniform standard identifying

    ``material adverse'' changes or impacts.\98\ Finally, FIA noted that it

    does not believe that a change in senior management at an FCM should

    require an early warning notice of any kind because such notice is

    already provided to NFA in the ordinary course.\99\

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

    \98\ FIA Comment Letter at 38 (Feb. 15, 2013).

    \99\ Id.

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

    The Commission has considered the comments and has determined to

    adopt the amendments to Sec. 1.12(k) and (l) as proposed, with the

    revision that the notices required by Sec. 1.12(l) must be filed

    promptly, but not later than 24 hours after the event, instead of

    immediately. By adopting this revision, the Commission acknowledges

    that immediate notice is not necessary in all situations.

    An FCM should report Sec. 1.12(l) notices in a punctual or prompt

    manner, but may do so without the expediency required by an immediate

    notice provision that is required, for example, when a firm is

    undercapitalized or undersegregated, which may indicate that immediate

    Commission or DSRO action is required to assess the financial condition

    of the FCM or the safety of customer funds. This revision provides the

    appropriate balance between the receipt of timely notices and the

    ability of the FCM to document an explanation of the events that

    trigger the notice.

    As noted above, the Commission proposed additional notice

    provisions under Sec. 1.12 in order to ensure that the Commission and

    DSROs receive timely information regarding certain events that should

    be assessed by the Commission and the DSROs as part of the overall

    oversight and risk assessment of FCMs. Regulation 1.12(k) will require

    an FCM to provide notice if the FCM or its parent or material affiliate

    experiences a material adverse impact to its creditworthiness or its

    ability to fund its obligations. Regulation 1.12(l) will require an FCM

    to provide notice if there is a material change in the firm's

    operations, senior management, clearing arrangements, or a material

    line of business.\100\ The purpose of paragraphs (k) and (l) is to

    provide the Commission and the relevant DSRO with an opportunity to

    initiate a dialogue with the firm regarding any potential adverse

    impact that such a material change may have on the ability of the FCM

    to meet its obligations as a market intermediary and on the protection

    of the customer funds held by the FCM.

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

    \100\ Regulation 1.12(k) and (l) both require an FCM to report a

    material change in the firm's creditworthiness or its ability to

    fund its obligations. Accordingly, the Commission is removing the

    reference to the FCM's credit arrangements in Sec. 1.12(l).

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

    The Commission is cognizant of the commenters' desire for more

    precise guidance on when notices must be filed under Sec. 1.12(k) and

    (l). However, FCMs represent a broad range of entities, with diverse

    business models. In this regard, some FCMs are small operations with a

    minimum level of capital, and others are highly capitalized entities

    with more sophisticated operations. Some FCMs focus on retail and/or

    agricultural clients, and others focus exclusively on institutional

    clients. Some FCMs are standalone entities that do not engage in

    proprietary or securities trading, and others are dually-registered

    with the SEC as BDs and engage in a significant amount of securities

    transactions for both their proprietary and customer accounts.

    With FCMs covering such a broad and diverse spectrum of business

    organizations and models, the Commission does not believe that it would

    be appropriate to define by regulation the scenarios that are material

    to an FCM and would automatically require the filing of a regulatory

    notice. Instead, the regulation has been developed to allow each FCM to

    assess whether any particular or unique event is material to the

    specific firm. In making this determination, each FCM should assess the

    potential impact that an event may have on the FCM. This would include

    whether new lines of business would result in a significant increase in

    the firm's capital requirement or otherwise result in a significant

    additional financial or operational risk to the FCM's existing

    business, or whether the change in credit terms will significantly

    impact

    [[Page 68524]]

    the liquidity resources available to the FCM.

    The Commission also considered the comment that FCMs should not be

    required to report to the Commission changes in senior management as

    such information is reported to NFA. The Commission does not agree with

    this comment. As previously noted, the Sec. 1.12 notice provisions are

    intended to provide the Commission and DSROs with prompt notice of

    material events at FCMs that will allow the Commission and DSROs to

    monitor the impact of such material events on FCMs and to factor such

    events into the risk assessment of the firm as part of their respective

    surveillance programs. The resignation or appointment of a new chief

    executive officer or chief risk officer at an FCM is a material change

    at an FCM and is information that should be reported to enhance the

    Commission's and DSRO's understanding of the firm's operations and the

    assessment of risk at the FCM.

    7. Notice of Correspondence From Other Regulatory Authorities

    The Commission proposed to add a new paragraph (m) to Sec. 1.12 to

    require an FCM that receives a notice, examination report, or any other

    correspondence from a DSRO, the SEC, or a securities self-regulatory

    organization to immediately file a copy of such notice, examination

    report, or correspondence with the Commission. The Commission stated in

    proposing Sec. 1.12(m) that the receipt of such notices, examination

    reports, or correspondence is necessary for the Commission to conduct

    appropriate oversight of FCMs.

    The Commission received several comments that expressed a general

    concern that the language of the proposal is overbroad.\101\ FIA noted

    that FCMs receive regular, and often routine, correspondence from their

    DSROs and that the amount of correspondence is multiplied for FCMs that

    are also registered as BDs and receive similar correspondence from

    their securities SROs and the SEC.\102\ NFA agreed with the Commission

    that notices of material regulatory actions would provide the

    Commission and the DSROs with important information to carry out their

    oversight responsibilities, but also encouraged the Commission to

    reconsider the breadth of the proposal.\103\ NFA noted that with

    respect to futures examinations reports, it already files such reports

    with the Commission's Division of Swap Dealer and Intermediary

    Oversight.\104\ NFA also requested that the Commission clarify that

    FCMs would not have to file notices of public regulatory actions taken

    by futures SROs against an FCM because NFA already provides the

    complaint associated with these actions to the Commission and makes the

    action available on NFA's BASIC system.\105\ TD Ameritrade recommended

    that the Commission limit notification to items that pertain to

    financial responsibility rules.\106\

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

    \101\ FIA Comment Letter at 39 (Feb. 15, 2013); TD Ameritrade

    Comment Letter at 3 (Feb. 15, 2013); RCG Comment Letter at 7 (Feb.

    12, 2013); CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

    \102\ FIA Comment Letter at 39 (Feb. 15, 2013).

    \103\ NFA Comment Letter at 10 (Feb. 15, 2013).

    \104\ Id. at 11.

    \105\ Id.

    \106\ TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).

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

    The Commission notes that it was not its intention to require an

    FCM to file with the Commission routine or non-material correspondence

    from regulators or SROs. Regulation 1.12 in general is intended to

    provide the Commission with information regarding an FCM's interaction

    with its other regulators regarding the regulators' examinations and

    other material communications with FCMs. The Commission would use such

    information to enhance its understanding of the firm and its compliance

    with regulatory requirements to assess the operations of the firm and

    learn of events that may present a potential adverse impact on the

    firm, including its ability to properly operate in a regulated

    environment or otherwise safeguard customer funds.

    The Commission is revising final Sec. 1.12(m) to require an FCM to

    file notice with the Commission: (1) if the FCM is informed by the SEC

    or a SRO that it is the subject of a formal investigation; (2) if the

    FCM is provided with an examination report issued by the SEC or a SRO,

    and the FCM is required to file a copy of such examination report with

    the Commission; and (3) if the FCM receives notice of any

    correspondence from the SEC or a securities SRO that raises issues with

    the adequacy of the FCM's capital position, liquidity to meet its

    obligations or otherwise operate its business, or internal controls.

    The Commission believes that the revised regulation will provide the

    Commission with information necessary for the effective oversight of

    FCMs and will minimize the notices that dual-registrant FCMs/BDs will

    have to file with the Commission.

    8. Filing Process and Content

    The Commission proposed to amend the process that an FCM uses to

    file the notices required by Sec. 1.12. Currently, Sec. 1.12 requires

    an FCM to provide the Commission and DSROs with telephonic and

    facsimile notice in some situations, and to provide written notice by

    mail in other situations. An FCM also is permitted, but not required,

    to file notices and written reports with the Commission and with its

    DSRO using an electronic filing system in accordance with instructions

    issued by, or approved by, the Commission.

    The Commission proposed to amend Sec. 1.12(n) to require that all

    notices and reports filed by an FCM with the Commission or with the

    FCM's DSRO must be in writing and submitted using an electronic filing

    system.\107\ Each FCM currently uses WinJammer to file regulatory

    notices with the Commission and with the firm's DSRO. The proposed

    regulation further provides that if the FCM cannot file a notice due to

    the electronic system being inoperable, or for any other reason, it

    must contact the Commission's Regional office with jurisdiction over

    the firm and make arrangements for the filing of the regulatory notices

    with the Commission via electronic mail at a specially designated email

    address established by the Commission; fcmnotices@cftc.gov. The

    Commission also proposed to amend Sec. 1.12(n) to require that each

    notice filed by an FCM, IB, or SRO under Sec. 1.12 include a

    discussion of what caused the reportable event, and what steps have

    been, or are being taken, to address the reportable event. Additional

    amendments to Sec. 1.12(b), (d), (e), (f) and (g) were proposed that

    were necessary and technical in nature, and primarily revise internal

    cross-references to the filing requirements in Sec. 1.12(n).

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

    \107\ The Commission's proposed amendment to require the

    electronic filing of reports applies to both registered FCMs and

    applicants for registration as FCMs. Applicants for FCM registration

    currently file regulatory notices with NFA using WinJammer.

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

    The Commission received one comment on the proposed amendments to

    Regulation 1.12(n), specifically with respect to the requirement that

    notices under the regulation include a discussion of what caused the

    reportable event and what steps have been or will be taken to address

    the event.\108\ CHS Hedging stated its concern that requiring such a

    discussion in the notice is at odds with the requirement that notices

    be filed immediately.\109\

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

    \108\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

    \109\ Id.

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

    The Commission has determined to adopt the amendments to Sec.

    1.12(n) and the technical and related amendments

    [[Page 68525]]

    in Sec. 1.12(b), (d), (e), (f) and (g) as proposed. In the

    Commission's experience, in many cases an FCM has sufficient

    information to provide a notice of reportable event and the remedial

    steps that can be taken to mitigate future issues upon learning of the

    reportable event or very shortly thereafter. The Commission does not

    believe that the requirement to provide such information is at odds

    with the need to provide the information immediately. In the event that

    an FCM does not possess complete information on what caused the event,

    or the steps that have been taken or are being taken to address the

    event, it may revise its notice at a later date when it has more

    complete or accurate information. It is essential, however, that the

    Commission receives timely notice of early warning events, and

    compliance with the relevant notice time period should be an FCM's

    first priority. Accordingly, as noted in the Proposal, even if such

    information is not immediately readily available, the reporting entity

    may not delay the reporting of a reportable event.

    9. Public Disclosure of Early Warning Notices

    The Commission requested comment as to whether reportable events

    should be made public by the Commission, SROs, or FCMs and what the

    benefits and/or negative impact from public disclosure of such events

    would be. The Commission received several comments regarding the public

    disclosure of reportable events. Several commenters, including FHLB,

    the ICI, ACLI, BlackRock, and SIFMA believed that the Commission should

    mandate public disclosure of such information.\110\ Two commenters, FIA

    and NFA, believed that such events should not be made public.\111\ NFA

    did not believe any of the filings should be public, but emphasized

    that those events that are not subject to a formal public action

    particularly should not be subject to public disclosure.\112\ FIA was

    concerned that without context, public disclosure of the notices would

    be subject to misinterpretation and could create an adverse market

    event.\113\

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

    \110\ FHLB Comment Letter at 10 (Feb. 15, 2013); ICI Comment

    Letter at 7-8 (Jan. 14, 2013); ACLI Comment Letter at 4 (Feb. 15,

    2013); BlackRock Letter at 3 (Feb. 15, 2013); and SIFMA Comment

    Letter at 2 (Feb. 21, 2013).

    \111\ NFA Comment Letter at 11 (Feb. 15, 2013); FIA Comment

    Letter at 38 (Feb. 15, 2013).

    \112\ NFA Comment Letter at 11 (Feb. 15, 2013).

    \113\ FIA Comment Letter at 38 (Feb. 15, 2013).

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

    The Commission has considered the comments and has determined that

    regulatory notices filed under Sec. 1.12 should not be made publicly

    available. The notices required under Sec. 1.12 provide a mechanism

    whereby Commission and SRO staff are alerted to potential issues at an

    FCM. In order to fully assess the potential impact of a reportable

    event, Commission and SRO staff generally must contact the firm to

    obtain additional information, including up to date information on how

    the firm is addressing the matter that caused the reportable event to

    develop. If reportable events were disclosed to the public, they may

    not provide complete or current information. For example, an FCM may be

    required to file immediate notice that it was undersegregated at a

    point in time, but the notice may not contain information that the FCM

    has taken corrective action and is no longer in violation of the

    segregation requirements. The Commission also recognizes that many of

    the Sec. 1.12 notices are required to be filed as a result of one-off

    processing errors or timing differences that trigger a reportable event

    but are immediately rectified by the FCM and do not indicate a failure

    of the FCM's control system nor the firm's ability to effectively

    operate as an FCM.

    In addition, under Sec. 1.12 FCMs that are dually registered BDs

    with the SEC are required to file with the Commission copies of certain

    regulatory notices that they are required to file with the SEC. The

    SEC, however, does not make such notices public. The Commission

    believes it is important to ensure consistency such that information

    that a firm must file with the SEC and that is otherwise not publicly

    disclosed is not made public by the Commission as a result of the firm

    also being required to file a notice with the Commission under Sec.

    1.12.

    D. Sec. 1.15: Risk Assessment Reporting Requirement for Futures

    Commission Merchants

    Regulation 1.15 currently requires each FCM subject to the risk

    assessment reporting requirements to file certain financial reports

    with the Commission within 120 days of the firm's year end. The risk

    assessment filings include FCM organizational charts; financial,

    operational, and risk management policies, procedures, and systems

    maintained by the FCM; and, fiscal year-end consolidated and

    consolidating financial information for the FCM and its highest level

    material affiliate.

    The Commission proposed to amend Sec. 1.15 to require the

    financial information to be filed in electronic format. The Commission

    received no comments on the proposed amendments to Sec. 1.15. The

    Commission is adopting the amendments as proposed. The Commission also

    has revised the final regulation to provide that the risk assessment

    filings should be filed via transmission using a form of user

    authentication assigned in accordance with procedures established by or

    approved by the Commission, and otherwise in accordance with

    instructions issued by or approved by the Commission. The Commission

    will provide direction regarding how FCMs should file the risk

    assessment reports in a secure manner with the Commission prior to the

    effective date of the regulation.

    E. Sec. 1.16: Qualifications and Reports of Accountants

    Regulation 1.16 addresses the minimum requirements a public

    accountant must meet in order to be recognized by the Commission as

    qualified to conduct an examination for the purpose of expressing an

    opinion on the financial statements of an FCM. Regulation 1.16(b)

    currently provides that the Commission will recognize a person as

    qualified if such person is duly registered and in good standing as a

    public accountant under the laws of the place of the accountant's

    principal office or principal residence.

    The Commission proposed several amendments to enhance the

    qualifications that a public accountant must meet in order to conduct

    an examination of an FCM. Specifically, the Commission proposed to

    require that the public accountant must: (1) Be registered with the

    Public Company Accounting Oversight Board (``PCAOB''); (2) have

    undergone an examination by the PCAOB; and, (3) have remediated to the

    satisfaction of the PCAOB any deficiencies identified during the

    examination within three years of the PCAOB issuing its report.

    The Commission also sought to enhance the quality of the public

    accountant's examination of an FCM by proposing to require that the

    examination be conducted in accordance with U.S. GAAS after full

    consideration of the auditing standards issued by the PCAOB. The

    Commission further sought to ensure that the FCM's governing body took

    an active role in the assessment and appointment of the public

    accountant by imposing an obligation on the governing body to evaluate,

    among other things, the accountant's experience auditing FCMs; the

    adequacy of the accountant's knowledge of the Act and Commission

    regulations; the depth of the accountant's staff; and, the independence

    of the accountant.

    Additionally, the Commission proposed technical amendments to

    [[Page 68526]]

    Sec. 1.16. The Commission proposed to amend Sec. 1.16(f)(1)(i)(C) to

    require each FCM to submit its certified annual report to the

    Commission in an electronic format. The Commission also proposed to

    amend Sec. 1.16(c)(2) to remove the requirement that the accountant

    manually sign the accountant's report, which would facilitate the

    electronic filing of the FCM's certified annual report with the

    Commission.

    The proposed amendments to Sec. 1.16, including a discussion of

    the comments received, are discussed below.

    1. Mandatory PCAOB Registration Requirement

    Regulation 1.16(b)(1) would continue to require a public accountant

    to be registered and in good standing under the laws of the place of

    the accountant's principal office or principal residence in order to be

    qualified to conduct examinations of FCMs. The Commission proposed to

    enhance the qualifications of public accountants by further requiring

    the public accountant to be registered with the PCAOB.

    The PCAOB is a nonprofit corporation established by Congress under

    the Sarbanes-Oxley Act of 2002 (``SOX'') to oversee the audits of

    public companies and BDs of securities registered with the SEC in order

    to protect investors and the public interest by promoting informative,

    accurate, and independent audit reports.\114\ The SEC has oversight

    authority over the PCAOB, including the approval of the PCAOB's rules,

    auditing and other standards, and budget.\115\

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

    \114\ Public Law 107-204, 116 Stat. 745 (July 30, 2002). See

    also section 101 of SOX.

    \115\ Sections 107 and 109 of SOX.

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

    The Commission received several comments on the proposed amendments

    to Regulation 1.16, which are discussed below. The commenters, however,

    did not oppose the proposed PCAOB registration requirement. In

    addition, the Commission does not anticipate that the PCAOB

    registration requirement will present a significant issue to FCMs or

    public accountants. In this regard, only one public accountant that

    currently conducts examinations of FCMs is not registered with the

    PCAOB. PCAOB-registered public accountants conducted the examinations

    of 103 of the 104 registered FCMs based upon a review of the most

    current annual reports submitted by FCMs to the Commission.

    Accordingly, after considering the comments, the Commission is adopting

    the PCAOB registration requirement as proposed.

    2. PCAOB Inspection Requirement

    The Commission proposed to amend Sec. 1.16(b)(1) to require that a

    public accountant must have undergone a PCAOB examination in order to

    be qualified to conduct examinations of FCMs. Section 104 of SOX

    requires the PCAOB to conduct an annual inspection of each registered

    public accountant that regularly provides audit reports for more than

    100 public issuers each year.\116\ Section 104 further requires public

    accountants that provide audit reports for 100 or fewer issuers to be

    inspected by the PCAOB no less frequently than once every three

    years.\117\

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

    \116\ Section 104(b)(1)(A) of SOX.

    \117\ Section 104(b)(1)(B) of SOX.

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

    In addition, the Dodd-Frank Act amended SOX and vested the PCAOB

    with new oversight authority over the audits of BDs registered with the

    SEC.\118\ The PCAOB was provided with the authority, subject to SEC

    approval, to determine the scope and frequency of the inspection of

    public accountants of BDs. The SEC also approved a PCAOB temporary rule

    implementing an inspection program for BDs.\119\

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

    \118\ Section 982 of the Dodd-Frank Act.

    \119\ See Public Company Oversight Board; Order Approving

    Proposed Temporary Rule for an Interim Program of Inspection Related

    to Audits of Brokers and Dealers, 76 FR 52996 (Aug. 24, 2011).

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

    Several commenters raised issues with, or objected to, the

    proposal. Ernst & Young requested clarification that the term

    ``examination'' in proposed Sec. 1.16(b)(1) referred to the

    ``inspections'' that are required under section 104 of SOX.\120\ The

    Commission confirms that the term ``examination'' in proposed Sec.

    1.16 was intended to refer to the ``inspections'' required under

    section 104 of the SOX, and has revised the regulation accordingly.

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

    \120\ Section 104 of SOX requires the PCAOB to conduct a

    continuing program of inspections to assess the degree of compliance

    of each registered public accounting firm and associated persons of

    that firm with the provisions of the SOX, the rules of the PCAOB,

    the rules of the SEC, or professional standards, in connection with

    its performance of audits, issuance of audit reports, and related

    matters involving public issuers.

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

    Several commenters stated that the proposed inspection requirement

    would disqualify public accountants that were registered with the

    PCAOB, but had not yet undergone an inspection.\121\ These commenters

    stated that the proposal would disqualify accounting firms that

    recently registered with the PCAOB, but due to the triennial

    inspections schedule may not be subject to a PCAOB inspection for

    almost three years.\122\ Commenters also noted that certain PCAOB

    registered accounting firms may audit non-issuer BDs and may be subject

    to inspection under the PCAOB's temporary or permanent inspection

    program, but may not have been selected yet for inspection by the

    PCAOB.\123\ The AICPA stated that, while any public accounting firm can

    register with the PCAOB, by law only accountants that audit public

    issuers or audit certain non-issuer BDs may be inspected by the

    PCAOB.\124\ KPMG also stated that the requirement that accounting firms

    auditing an FCM must have undergone an inspection makes the rules

    governing the audits of FCMs more restrictive than the SEC rules

    governing the audits of BDs.\125\ KPMG suggests that the Commission

    align the standards required of auditors of FCMs and BDs.\126\

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

    \121\ Center for Audit Quality Comment Letter at 2 (Jan. 14,

    2013); Deloitte Comment Letter at 2 (Jan. 14, 2013); Ernst & Young

    Comment Letter at 2 (Jan. 14, 2013).

    \122\ Id.

    \123\ Center for Audit Quality Comment Letter at 2 (Jan. 14,

    2013); Deloitte Comment Letter at 2 (Jan 14, 2013).

    \124\ AICPA Comment Letter at 2 (Feb. 11, 2013).

    \125\ KPMG Comment Letter at 2 (Jan. 11, 2013).

    \126\ Id.

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

    The AICPA also stated that the Commission should permit a practice

    monitoring program (such as the AICPA peer review program) that

    evaluates and opines on an accounting firm's system of quality control

    relevant to the firm's non-issuer accounting and auditing practice as

    an alternative to the PCAOB inspection requirement.\127\ The AICPA also

    stated that a robust process, such as the AICPA's peer review program,

    whereby a team of certified public accountants conducts a comprehensive

    evaluation of a public accountant's system of quality control and whose

    work is subject to the oversight and approval by a separate group of

    certified public accountants should be required rather than having one

    certified public accountant review another.\128\

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

    \127\ AICPA Comment Letter at 3 (Feb 11, 2013).

    \128\ Id.

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

    The NFA also supported a temporary alternative to the PCAOB

    inspection requirement in order to ensure that public accountants that

    are unable to obtain a PCAOB inspection within the time period required

    by the Commission will not automatically be prohibited from conducting

    FCM examinations.\129\ NFA recommended that the Commission specifically

    designate the AICPA's peer review program as the only peer review

    program that will be acceptable to alleviate any uncertainty as to

    whether a certified public

    [[Page 68527]]

    accountant is ``qualified'' to conduct the peer review.\130\

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

    \129\ NFA Comment Letter at 11 (Feb. 15, 2013).

    \130\ Id.

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

    As noted in the proposal, FCMs are sophisticated financial market

    participants that are entrusted with more than $182 billion of

    customers' funds.\131\ FCMs intermediate futures customers activities

    and guarantee customers' financial performance to DCOs, other FCMs, and

    foreign brokers. In addition, FCMs are anticipated to hold significant

    amounts of Cleared Swaps Customer Collateral deposited to margin,

    secure or guarantee Cleared Swaps as more provisions of the Dodd-Frank

    Act are implemented. FCMs also may conduct proprietary futures and

    securities transactions, and handle business for securities customers

    in addition to futures customers. The sophistication of the futures

    markets and the Commission's regulations, coupled with the critical

    role played by FCMs in the futures market (and in the case of many of

    the largest FCMs, the securities markets) necessitates the engagement

    of competent and experienced accountants to conduct the examinations of

    FCMs.

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

    \131\ The customer funds information is based upon the 1-FR-FCM

    reports and FOCUS Reports filed by FCMs for the month ending April

    30, 2013.

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

    The Commission believes that registration with the PCAOB and being

    subject to the PCAOB inspection program will help to ensure that

    accounting firms engaged to conduct audits of FCMs remain competent and

    qualified. The PCAOB inspection program involves the review of the

    accounting firm's compliance with PCAOB issued audit, quality control,

    independence and ethics standards.

    In addition, the purpose of the PCAOB registration and inspection

    requirement in the final rule is not to ensure that the accounting

    firm's audits of FCMs are subject to inspection by the PCAOB. The

    Commission acknowledges that the PCAOB's primary jurisdiction and

    inspections are directed toward the audits of public issuers and BDs.

    However, the Commission's objective is to reasonably ensure the quality

    and competence of the public accountants engaged in the audits of FCMs.

    The Commission believes that such quality and competence may be

    assessed by the PCAOB inspecting the accounting firms' audit process

    for issuers and BDs, and is not dependent solely upon the inspection of

    the accounting firms' audits of FCMs.

    The Commission further believes that its proposed PCAOB inspection

    requirement is consistent with the SEC's audit requirements for BDs.

    Any auditor of an SEC-registered BD must register with the PCAOB and

    will be subject to the PCAOB inspection program.

    Moreover, the Commission believes that the imposition of a PCAOB

    inspection requirement provides several benefits over a peer review

    program. The PCAOB is an entity that was created by Congress and

    charged with improving audit quality, reducing the risks of audit

    failures in the U.S. public securities markets and promoting public

    trust. As previously noted, the PCAOB is subject to oversight by the

    SEC, which approves the PCAOB's rules, auditing and other standards,

    and budget. A peer review program, while providing many benefits in the

    oversight of the accounting profession, is overseen by the accounting

    industry and is not subject to oversight by a federal regulator, which

    the Commission believes is a key advantage of the PCAOB in the

    furtherance of the protection of customer funds.

    The Commission also does not anticipate a significant impact on

    existing FCMs from the imposition of the PCAOB inspection requirement

    on public accountants. As noted above, 103 of the 104 FCMs currently

    are subject to examination by public accountants that are registered

    with the PCAOB. In addition, only six of the PCAOB-registered public

    accountants that conduct examinations of fourteen FCMs have not been

    subject to a PCAOB inspection at this time. However, all six of these

    firms have indicated in their PCAOB filings that they conduct audits of

    BDs and, therefore, will be subject at a future date to the PCAOB

    inspection program for the inspection of accountants that conduct

    audits of BDs.

    The Commission, based upon the analysis above and further

    consideration of the comments, has determined to adopt the regulation

    as proposed. The Commission recognizes, however, that the audits of

    many FCMs with a year-end date of December 31, 2013 or later have

    already been initiated. Accordingly, the Commission has determined that

    the PCAOB registration requirement will apply for audit reports issued

    for the year ending June 1, 2014 or later so as not to unnecessarily

    interrupt the examinations that currently are in progress. The

    Commission also is adopting a December 31, 2015 compliance date for a

    PCAOB inspection. The deferred compliance date will provide public

    accountants with additional time to register with, and to be inspected

    by, the PCAOB. The compliance dates are discussed further in section

    III below.

    3. Remediation of PCAOB Inspection Findings by the Public Accountant

    The Commission proposed in Sec. 1.16(b)(1) that any deficiencies

    noted during a PCAOB inspection must be successfully remediated to the

    satisfaction of the PCAOB within three years.

    KPMG, the Center for Audit Quality, Deloitte, the AICPA, and PWC

    generally argued that it is not clear how the requirement that any

    deficiencies noted during the PCAOB exam must have been remediated to

    the satisfaction of the PCAOB would work or what it means.\132\ The

    commenters also noted that the Commission's proposed requirement that

    the public accountant remediate any deficiencies noted in a PCAOB

    inspection report is more stringent than the SEC's requirements for

    auditors of BDs and public issuers. KPMG also asked who would make a

    determination of remediation as there is no procedure for the PCAOB to

    communicate such determinations to the public accountant or the

    public.\133\ PWC also stated that reliance on the PCAOB inspection

    results was misplaced and that the PCAOB inspection comments are issued

    in the context of a constructive dialogue to encourage Certified Public

    Account (``CPA'') firms to improve their practices and procedures.\134\

    PWC further noted that disciplinary sanctions such as revocation of the

    firm's right to audit a public company or BD can only be made in the

    context of an adjudicative process in which the firm is afforded

    procedural rights.\135\ Lastly, PWC asserted that the Commission's

    proposal would disqualify a firm without providing any of the

    procedural rights or safeguards established by SOX.\136\

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

    \132\ KPMG Comment Letter at 2-3 (Jan. 11, 2013); Center for

    Audit Quality Comment Letter at 2-3 (Jan. 14, 2013); Deloitte

    Comment Letter at 2-3 (Jan. 14, 2013); AICPA Comment Letter at 2

    (Feb. 11, 2013); PWC Comment Letter at 2 (Jan. 15, 2013).

    \133\ KPMG Comment Letter at 2 (Jan. 11, 2013).

    \134\ See PWC Comment Letter at 2 (Jan. 15, 2013).

    \135\ Id.

    \136\ Id.

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

    The Commission has considered the comments and recognizes that the

    PCAOB inspection process does not involve a formal process for

    communicating that a public accountant has adequately remediated

    deficiencies identified during the PCAOB's last inspection. In

    addition, the Commission understands that the PCAOB may not always

    issue a report at the conclusion of an inspection, or that the report

    may contain both public and non-public sections.

    In light of these comments, the Commission has determined to revise

    [[Page 68528]]

    the final regulation by removing the requirement that a public

    accountant must remediate any deficiencies identified during a PCAOB

    inspection to the satisfaction of the PCAOB within three years of the

    inspection. The Commission is further revising Sec. 1.16(b)(1) to

    provide that a public accountant that, as a result of the PCAOB

    disciplinary process, is subject to a sanction that would permanently

    or temporarily bar the public accountant from engaging in the

    examination of a public issuer or BD may not conduct the examination of

    an FCM. The Commission notes that the PCAOB has the authority to

    initiate a disciplinary action against a firm and its associated

    persons for failing to adequately address inspection findings or for

    other transgressions.

    The Commission also is revising Sec. 1.16(b)(4) to require the

    governing body of the FCM to review and consider the PCAOB's inspection

    reports of the public accountant as part of the governing body's

    assessment of the qualifications of the public accountant to perform an

    audit of the FCM. The governing body is in a position to request

    information from the public accountant regarding the PCAOB inspections

    and general oversight of the public accountant and should use such

    information in assessing the competency of the accountant to conduct an

    examination of the FCM. An FCM's governing body should be concerned if

    the PCAOB inspection reports indicate that the public accountant has

    significant deficiencies and should take such information into

    consideration in assessing the qualifications of the public accountant.

    4. Auditing Standards

    The Commission proposed to amend Sec. 1.16(c)(2) to require that

    the public accountant's report of its examination of an FCM must state

    whether the examination was done in accordance with generally accepted

    auditing standards promulgated by the Auditing Standards Board of the

    AICPA (i.e., U.S. GAAS), after giving full consideration to the

    auditing standards issued by the PCAOB. Commenters raised issues with

    the proposal noting that there is no existing reporting framework that

    requires the application of one set of auditing standards and the

    consideration of another set of auditing standards.\137\ Deloitte noted

    that public accountants may be specifically engaged to conduct an audit

    of an entity under both PCAOB auditing standards and U.S. GAAS, but

    that there is no reporting framework for an audit under one set of

    auditing standards, after giving ``full consideration'' to a separate

    set of auditing standards.\138\

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

    \137\ Ernst & Young Comment Letter at 3 (Jan. 14, 2013);

    Deloitte Comment Letter at 1 (Jan. 14, 2013); PWC Comment Letter at

    3 (Jan. 15, 2013); AICPA Comment Letter at 2 (Feb. 11, 2013); and

    KPMG Comment Letter at 3 (Jan. 11, 2013).

    \138\ Deloitte Comment Letter at 1 (Jan. 14, 2013).

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

    The Commission has reviewed the comments and has determined to

    revise the final regulation to provide that the accountant's report

    must state whether the examination of the FCM was conducted in

    accordance with the auditing standards issued by the PCAOB. The

    Commission acknowledges the fact that there is no reporting framework

    for public accountants to report on one set of auditing standards after

    giving full consideration to another set of auditing standards. Also,

    the Commission recognizes that the SEC has recently adopted final

    regulations to its Rule 17a-5 to require public accountants to use

    PCAOB standards in the examination of the financial statements of

    BDs.\139\ Therefore, the Commission's amendments to Sec. 1.16(c)(2) to

    require public accountants to use PCAOB standards in conducting the

    examination of the financial statements of an FCM is consistent with

    the SEC's revisions to its Rule 17a-5. The Commission also is setting a

    compliance date for public accountants to use PCAOB auditing standards

    for all FCM examinations with a year-end date of June 1, 2014 or later.

    The extended compliance date allows FCMs currently subject to an

    examination by a public accountant to complete the examination cycle

    without having the public accountant adjust the examination for the new

    PCAOB standards requirement. The June 1, 2014 compliance date also is

    consistent with the SEC's compliance date for revisions to Rule 17a-5

    and, therefore, will allow FCMs that are dually-registered as FCMs/BDs

    to be subject to uniform CFTC and SEC requirements.\140\ Compliance

    dates are discussed further in section III below.

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

    \139\ Broker Dealer Reports, 78 FR 51910 (Aug. 21, 2013).

    \140\ Id.

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

    5. Review of Public Accountant's Qualifications by the FCM's Governing

    Body

    The Commission proposed to amend Sec. 1.16(b) by adding new

    paragraph (4) which would require the FCM's governing body to ensure

    that a public accountant engaged to conduct an examination of the FCM

    is duly qualified to perform the audit. The proposed new paragraph

    further provided that the evaluation should include, among other

    things, the public accountant's experience in auditing FCMs, the public

    accountant's knowledge of the Act and Commission regulations, the depth

    of the public accountant's staff, and the public accountant's size and

    geographical location. The proposed requirements are intended to ensure

    that the FCM's governing body takes an active role in the assessment

    and appointment of the public accountant.

    PWC requested clarification of the Commission's expectations for

    the criteria that would be expected to be used by the FCM's governing

    body for determining qualification. PWC stated that such clarification

    may be helpful so that a consistent framework for determining the

    qualifications is used across the industry and FCM governing

    bodies.\141\

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

    \141\ PWC Comment Letter at 3 (Jan. 15, 2013).

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

    The Commission has considered the comments and has determined to

    adopt the amendments as proposed. FCMs represent a diverse group of

    entities and business models. Some FCMs focus primarily on

    institutional clients and engage in securities transactions as their

    primary business. Other FCMs focus on retail customers and engage in no

    proprietary or securities transactions.

    With such a wide range of business models, the Commission believes

    that it is not practical to provide a uniform set of criteria that each

    governing body of each FCM should use to assess the qualifications of a

    public accountant. In fact, such a standard list would go against the

    Commission's objective of ensuring that the governing body is actively

    reviewing the qualifications of the public accountant relative to the

    FCM's particular business model. The requirement is not intended to

    exclude regional or smaller public accountants from being qualified to

    conduct examinations, provided that the governing body is satisfied

    that the public accountant has the appropriate skill, knowledge, and

    other resources to effectively conduct an examination, and is otherwise

    in compliance with the qualification requirements in Sec. 1.16.

    The Commission also is revising final Sec. 1.16(b)(4) in response

    to the comments received on proposed Sec. 1.16(b)(1) that would have

    required that a public accountant remediate any findings issued by the

    PCAOB in its inspection report within 3 years of the issuance of the

    inspection report. As stated above, commenters noted that there is no

    formal mechanism to assess whether a public accountant has remediated

    any inspection findings to the satisfaction of

    [[Page 68529]]

    the PCAOB. Accordingly, the Commission is revising Sec. 1.16(b)(4) to

    provide that the governing body of the FCM should review the inspection

    report of the public accountant and discuss inspection findings as

    appropriate with the public accountant. Such reviews and discussions

    will provide additional information to the governing body that will

    allow it to better assess the qualifications of the public accountant

    to conduct an audit of the FCM.

    6. Electronic Filing of Certified Annual Reports

    The Commission proposed to amend Sec. 1.16(f)(1)(i)(C) to require

    each FCM to submit its certified annual report to the Commission in an

    electronic format. The Commission also proposed to amend Sec.

    1.16(c)(2) to remove the requirement that the accountant manually sign

    the account's report, which will facilitate the electronic filing of

    the FCM's certified annual report with the Commission. The Commission

    received no comments on the above amendments and is adopting the

    amendments as proposed.

    F. Sec. 1.17: Minimum Financial Requirements for Futures Commission

    Merchants and Introducing Brokers

    1. FCM Cessation of Business and Transfer of Customer Accounts if

    Unable To Demonstrate Adequate Liquidity

    Section 4f(b) of the Act provides that no person may be registered

    as an FCM unless it meets the minimum financial requirements that the

    Commission has established as necessary to ensure that the FCM meets

    its obligations as a registrant at all times, which would include its

    obligations to customers and to market participants, including DCOs.

    The Commission's minimum capital requirements for FCMs are set forth in

    Sec. 1.17 which, among other things, currently provides that an FCM

    must cease operating as an FCM and transfer its customers' positions to

    another FCM if the FCM is not in compliance or is not able to

    demonstrate its compliance with the minimum capital requirements.

    The proposed amendments to Sec. 1.17 authorize the Commission to

    request certification in writing from an FCM that it has sufficient

    liquidity to continue operating as a going concern. If an FCM is not

    able to immediately provide the written certification, or is not able

    to demonstrate adequate access to liquidity with verifiable evidence,

    the FCM must transfer all customer accounts and immediately cease doing

    business as an FCM.

    The FIA stated that it agreed with the regulatory purpose

    underlying this proposed amendment, but stated that the Commission

    should not adopt the rule before it clearly articulates the objective

    standards by which it will determine that an FCM has ``sufficient

    liquidity.'' \142\ Similarly, FCStone requested clarity with respect to

    the exigent circumstances that would give the Commission authority to

    require an FCM to cease operating.\143\

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

    \142\ FIA Comment Letter at 8 (Feb. 15, 2013).

    \143\ FCStone Comment Letter at 4 (Feb. 15, 2013).

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

    The Commission understands the concerns of commenters regarding the

    process by which the Commission, or the Director of the Division of

    Swap Dealer and Intermediary Oversight acting pursuant to delegated

    authority under Sec. 140.91(6), could require immediate cessation of

    business as an FCM and the transfer of customer accounts; however, that

    same authority currently exists should a firm fail to meet its minimum

    capital requirement. The Commission believes the ability to certify,

    and if requested, demonstrate with verifiable evidence, access to

    sufficient liquidity to operate as a going concern to meet immediate

    financial obligations is a minimum financial requirement necessary to

    ensure an FCM will continue to meet its obligations as a registrant as

    set forth under section 4f(b) of the Act. Further, the Commission notes

    that the ``going concern'' standard is well defined in accounting

    literature and practice, and generally means an ability to continue

    operating in the near term.

    The proposed liquidity provision is intended to cover circumstances

    that require immediate attention and would provide the Commission with

    a means of addressing exigent circumstances by requiring an FCM to

    produce a written analysis showing the sources and uses of funds over a

    short period of time not to exceed one week. The purpose of the

    provision is to address situations where an FCM may currently be in

    compliance with minimum financial requirements, but lacks liquidity to

    meet pending, non-discretionary obligations such that the firm's

    ability to continue operating in the near term is in serious jeopardy.

    In such a situation, it is expected that the Commission and the FCM's

    DSRO and applicable DCOs would be in frequent communication with the

    firm to review the FCM's options and plans to continue operating as a

    going concern and to assess what actions were necessary to ensure the

    firm continues to meet its obligations as a market intermediary and to

    protect customer funds. If an FCM's management cannot in good faith

    certify that the FCM has sufficient liquidity to permit it to operate

    throughout the following week, then the FCM has failed to meet its

    minimum financial requirements necessary to ensure that the firm will

    continue to meet its obligations as a registrant and the Commission

    would have to determine how to minimize the impact of a potential FCM

    insolvency or default.

    The Commission has considered the comments and has determined to

    adopt the amendments as proposed.

    2. Reducing Time Period for FCMs To Incur a Capital Charge for

    Undermargined Accounts to One Day After Margin Calls Are Issued

    Regulation 1.17 requires an FCM to incur a charge to capital for

    customer and noncustomer accounts that are undermargined beyond a

    specified period of time.\144\ Regulation 1.17(c)(5)(viii) currently

    requires an FCM to reduce its capital (i.e., take a capital charge) if

    a customer account is undermargined for three business days after the

    margin call is issued.\145\ Regulation 1.17(c)(5)(ix) requires an FCM

    to take a capital charge for noncustomer and omnibus accounts that are

    undermargined for two business days after the margin call is issued.

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

    \144\ Noncustomers are defined in Sec. 1.17(b)(4) as accounts

    carried by the FCM that are not customer accounts or proprietary

    accounts. Noncustomer accounts are generally accounts carried by an

    FCM for affiliates and certain employees of the FCM.

    \145\ For purposes of these Commission regulations, a margin

    call is presumed to be issued by the FCM the day after an account

    becomes undermargined.

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

    The Commission proposed to amend Sec. 1.17(c)(5)(viii) and (ix) to

    require an FCM to take capital charges for undermargined customer,

    noncustomer, and omnibus accounts that are undermargined for more than

    one business day after a margin call is issued. Thus, for example,

    under the proposal, if an account carried by an FCM became

    undermargined on Monday, the operation of the regulation assumes that

    the FCM would issue a margin call on Tuesday, and the FCM would have to

    incur a capital charge at the close of business on Wednesday if the

    margin call was still outstanding.

    Vanguard commented that it supported the Commission's proposal,

    stating that the accelerated timetable makes sense given modern trading

    and asset transfer timing.\146\ Vanguard further stated that each

    customer must stand up for its trades and promptly post margin, and it

    further stated that it believes the overall market may be weakened to

    the extent an FCM is

    [[Page 68530]]

    extending significant amounts of credit over an extended period to

    cover a customer's margin deficit.\147\

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

    \146\ Vanguard Comment Letter at 7 (Feb. 22, 2013).

    \147\ Id.

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

    MFA objected to the proposal noting that, while in the ordinary

    course of business, few margin calls remain outstanding for more than

    two business days, the proposal does recognize the practical reasons

    why a margin call may be outstanding more than 2 business days after

    the call issued.\148\ MFA cited disputes between an FCM and its

    customer as to the appropriate level of margin, and good faith errors

    that may cause a delay beyond 2 days for a margin call to be met.\149\

    MFA also stated that an increase in costs resulting from the regulation

    will ultimately be passed on the customers.

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

    \148\ MFA Comment Letter at 7 (Feb. 15, 2013).

    \149\ Id.

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

    The NCBA stated that the proposal may require market participants

    to use wire transfers in lieu of checks, which will increase the costs

    and impose a significant financial burden to the cattle industry.\150\

    The NCBA also stated that the proposal will cause customers to prefund

    their accounts for anticipated margin requirements, which will reduce

    customers' capital and impede their other business operations.\151\ The

    NCBA further noted that the proposal is not related to the MFGI and

    PFGI failures, which were not caused by customers failing to meet

    margin calls.\152\

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

    \150\ NCBA Comment Letter at 2 (Feb. 15, 2013).

    \151\ Id.

    \152\ Id. See also JSA Comment Letter at 2 (Feb. 15, 2013) and

    ICA Comment Letter at 1-2 (Feb. 15, 2013).

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

    JSA stated that an effective increase in a capital charge for

    undermargined customer accounts could cause an increase in requirements

    for customers to prefund their accounts, which would be punitive in a

    highly competitive environment that already places midsized FCMs and

    FCMs that are not affiliated with a banking institution at a

    disadvantage to larger, more highly capitalized firms, or FCMs that are

    affiliated with banking institutions.\153\ JSA also stated that if

    smaller FCMs are forced out of the market, larger FCMs or FCMs

    affiliated with banks may not be willing to service customers that are

    farmers, ranchers, retail, or introduced brokerage accounts, for which

    they have historically shown little interest.\154\

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

    \153\ JSA Comment Letter at 2 (Feb. 15, 2013). See also Frontier

    Futures Comment Letter at 2-3 (Feb. 14, 2013).

    \154\ Id.

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

    FIA stated that while institutional and many commercial market

    participants generally meet margin calls by means of wire transfers,

    the proposal, creates operational problems because it does not consider

    delays arising from accounts located in other time zones that cannot

    settle same day, or ACH settlements, or the requirement to settle or

    convert certain non-U.S. dollar currencies.\155\ FIA also stated that a

    substantial number of customers that do not have the resources of large

    institutional customers (in particular members of the agricultural

    community) depend on financing from banks to fund margin requirements,

    which may require more than one day to obtain.\156\

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

    \155\ FIA Comment Letter at 26 (Feb. 15, 2013).

    \156\ Id.

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

    RJ O'Brien stated that it recognized that the collection of margin

    is a critical component of an FCM's risk management program, however,

    it objected to the proposed amendment.\157\ RJ O'Brien stated that as

    the largest independent FCM serving a client base that includes a great

    number of farmers and ranchers, it is well aware that many customers

    that use the markets to hedge commercial risk still meet margin calls

    by check or ACH because of the impracticality and costliness of wire

    transfers in their circumstances.\158\ RJ O'Brien stated that in many

    cases, the costs of a wire transfer would exceed the transaction costs

    paid by the client to its FCMs, and additionally, that some customers

    in the farming and ranching community finance their margin calls, which

    can require additional time to arrange for delivery of margin call

    funds due to routine banking procedures.\159\

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

    \157\ RJ O'Brien Comment Letter at 3-4 (Feb. 15, 2013).

    \158\ Id. See also RCG Comment Letter at 5 (Feb. 12, 2013). RCG

    also recommended that the Commission implement a pilot program that

    requires FCMs to provide the Commission with daily undermargined

    reports. The Commission does not believe that a pilot program is

    necessary for gathering additional information.

    \159\ Id.

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

    RJ O'Brien also stated that if the proposal is adopted, FCMs that

    service non-institutional clients will struggle to remain competitive

    and the proposal may result in fewer clearing FCMs and greater systemic

    risk to the marketplace.\160\ RJ O'Brien further stated that many of

    the larger FCM/BDs likely have little interest in servicing smaller

    rancher and farmer clients, as was evidenced in the wake of MFGI's

    failure, and that a loss of such smaller FCMs will result in fewer

    options available to these ranchers, farmers and other commercial

    market participants that wish to hedge their commercial risks.\161\

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

    \160\ Id.

    \161\ Id.

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

    TD Ameritrade stated that it did not support the proposed

    amendments to Sec. 1.17(c)(5)(viii) and (ix) as it would impose

    financial hardships on customers that the Proposal was intended to

    protect.\162\ TD Ameritrade stated that a large number of retail

    customers do not currently use wire transfers to meet a margin

    requirement in one business day.\163\ TD Ameritrade also noted that

    non-U.S. customer accounts are faced with time zone differences and

    inherent delays in meeting margin calls.\164\

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

    \162\ TD Ameritrade Comment Letter at 3-4 (Feb. 15, 2013).

    \163\ Id.

    \164\ Id.

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

    Other commenters expressed the general concern that the proposal

    will harm the customers it is meant to protect by requiring more

    capital to be kept in customer accounts, possibly forcing users to hold

    funds at FCMs well in excess of their margin requirements, or resulting

    in certain segments of the market to forego the futures markets to

    hedge their commercial operations.\165\ Those commenters argued that

    such pre-funding could add significant financial burdens to trading as

    customers find themselves having to provide excess funds to their

    brokers which could increase their risk with regard to the magnitude of

    funds potentially at risk in the event of future FCM insolvencies.\166\

    The commenters general expressed significant concerns that reducing

    margin calls to one day will harm many customers as: (1) Many small

    businesses, farmers, cattle producers and feedlot operators routinely

    pay by check and forcing them to use wire transfers increases their

    cost of doing business; (2) clients who make margin calls by ACH

    payments instead of wire transfers because ACH is cheaper, would no

    longer be able to do so because there is a one-day lag in availability

    of funds; and (3) foreign customers would not be able to make margin

    calls due to time zone differences, the time required to convert

    certain non-USD currencies, and for

    [[Page 68531]]

    whom banking holidays fall on different days.\167\

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

    \165\ NPPC Comment Letter at 2 (Feb. 14, 2013); RCG Comment

    Letter at 4-5 (Feb. 12, 2013); NGFA Comment Letter at 3 (Feb. 15,

    2013); NEFI/PMAA Comment Letter at 3 (Jan. 14, 2013); AIM Comment

    Letter at 15 (Jan. 24, 2013); Amarillo Comment Letter at 1 (Feb. 14,

    2013); NCFC Comment Letter at 1 (Feb. 15,2013); NFA Comment Letter

    at 12-13 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15,

    2013); Advantage Comment Letter at 1-2 (Feb. 15, 2013); AFBF Comment

    Letter at 2 (Feb. 15, 2013); CCC Comment Letter at 2 (Feb. 15,

    2013); Steve Jones Comment Letter at 1 (Feb. 14, 2013); ICA Comment

    letter at 1-2 (Feb. 15, 2013);TCFA Comment Letter at 1-2 (Feb. 15,

    2013); CME Comment Letter at 5 (Feb. 15, 2013). AIM resubmitted the

    comment letters of Premier Metal Services, NEFI/PMAA, and the ISRI

    and indicated its support for the recommendations therein (Jan. 14,

    2013).

    \166\ Id.

    \167\ Id.

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

    The CCC stated that the proposed amendment to the capital rule

    places an undue burden on the FCMs, which will likely result in FCMs

    demanding that customers prefund trades to prevent market calls and

    potential capital charges.\168\ The CCC also stated that the proposal

    could result in forced liquidations of customer positions to ensure

    that the FCM does not incur a capital charge.\169\

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

    \168\ CCC Comment Letter at 2-3 (Feb. 15, 2013).

    \169\ Id.

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

    FIA and RJ O'Brien provided alternatives to the Commission's

    proposal. Both FIA and RJ O'Brien offered that an FCM be required to

    take a capital charge for any customer margin deficit exceeding

    $500,000 that is outstanding for more than one business day.\170\ FIA

    further suggested that if the customer's margin deficit is $500,000 or

    less, the FCM should take a capital charge if the margin call is

    outstanding two business days or more after the margin call is

    issued.\171\ RJ O'Brien's comment letter does not address the timing of

    the capital charge for accounts with a margin deficit of $500,000 or

    less.

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

    \170\ FIA Comment Letter at 27 (Feb. 27, 2013); RJ O'Brien

    Comment Letter at 4 (Feb. 15, 2013).

    \171\ FIA Comment Letter at 27 (Feb. 15, 2013).

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

    NFA, FIA, MFA and AIMA stated that if the Commission adopts the

    amendments regarding residual interest as proposed, then the Commission

    should consider whether a capital charge for undermargined accounts

    remains necessary at all because the FCM will have already accounted

    for an undermargined account by maintaining a residual interest

    sufficient at all times to exceed the sum of all margin deficits; hence

    the capital charges related to an undermargined account appear to

    impose an additional financial burden without any necessary financial

    protection.\172\

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

    \172\ NFA Comment Letter at 13 (Feb. 15, 2013); FIA Comment

    Letter at 26 (Feb. 15, 2013); MFA Comment Letter at 6-7 (Feb. 15,

    2013); and AIMA Comment Letter at 3 (Feb. 15, 2013).

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

    RJ O'Brien also stated that the Commission should provide at least

    a one-year period of time for any changes to the timeframe for taking a

    capital charge for undermargined accounts to be effective.\173\ RJ

    O'Brien stated that FCMs will need to educate and develop systems to

    assist their clients in meeting margin calls in an expedited

    timeframe.\174\ Lastly, RJ O'Brien stated that the Commission should

    require futures exchanges to increase their margin requirements to 135%

    of maintenance margin to reduce the number and frequency of margin

    calls.\175\

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

    \173\ RJ O'Brien Comment Letter at 4 (Feb. 15, 2013).

    \174\ Id.

    \175\ Id.

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

    With respect to the reduction of the timeframe in Sec.

    1.17(c)(5)(viii) for an FCM to incur a capital charge for undermargined

    customer accounts, the Commission has considered the comments and has

    determined to adopt the amendments as proposed. The timely collection

    of margin is a critical component of an FCM's risk management program

    and is intended to ensure that an FCM holds sufficient funds deposited

    by customers to meet their potential obligations to a DCO. As guarantor

    of the financial performance of the customer accounts that it carries,

    the FCM is financially responsible if the owner of an account cannot

    meet its margin obligations to the FCM and ultimately to a DCO.

    The timeframe for meeting margin calls currently provided in Sec.

    1.17(c)(5)(viii) was established in the 1970s when the use of checks

    and the mail system were more prevalent for depositing margin with an

    FCM. However, in today's markets, with the increasing use of

    technology, 24-hour-a-day trading, and the use of wire transfers to

    meet margin obligations, the Commission believes that the timeframe for

    taking a capital charge should be reduced both to give an incentive to

    FCMs to exercise prudent risk management and to strengthen the

    financial protections of FCMs, and to enhance the safety of the

    clearing systems and other customers by requiring FCMs to reserve

    capital for undermargined customer accounts that fail to meet a margin

    call on a timely basis.

    Several commenters have stated that the proposal would harm

    customers by increasing costs to customers or by exposing more of the

    customers' funds to the FCM.\176\ The Commission notes that the final

    regulation provides for at least two full days from the point in time

    that a customer's account is undermargined to the time the FCM is

    required to incur a capital charge for the undermargined account. Under

    the regulation, if a customer's account becomes undermargined at some

    point before close of business on Monday, the FCM will have until the

    close of business on Wednesday before it is required to take a capital

    charge. Customers are responsible for monitoring the activity in their

    account and should have information that would allow them to determine

    that their trading account is undermargined prior to the close of

    business on Monday.

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

    \176\ See, e.g., NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA

    Comment Letter at 3-4 (Feb. 15, 2013).

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

    The alternative proposed by FIA and RJ O'Brien is premised on their

    belief that the regulation would not provide an adequate amount of time

    for a customer to meet a margin call before the FCM would have to take

    a capital charge for an undermargined account. As noted above, the

    Commission believes that the regulation, which provides at least two

    full business days for a customer to fund its undermargined account,

    does provide an adequate period of time for margin calls to be met. In

    situations involving customers located in foreign jurisdictions and the

    associated issues of time zone differences and differences in banking

    holidays, the Commission believes that the FCM should include such

    factors in its risk management program and operating procedures with

    such customers in an effort to ensure compliance with the regulations.

    The Commission believes that the time period provided in Sec.

    1.17(c)(5)(viii) is adequate in most situations for a customer to

    receive and fund a margin call. The intent of margin is to ensure that

    a customer maintains a sufficient amount of funds in its account to

    cover 99 percent of the observed market moves of its portfolio of

    positions over a specified period of time. Customers that maintain

    fully margined accounts are exposed to greater risk to the safety of

    their funds if other customer accounts carried by the FCM are

    undermargined. In order to provide greater protection to the customers

    that are fully margined or maintain excess margin on deposit, and to

    provide greater assurance that the FCM can continue to meet its

    financial obligations to DCOs, the Commission believes that the FCM

    should maintain a sufficient amount of capital to cover the potential

    shortfall in undermargined customers' accounts.

    The Commission also has considered the comments on the proposed

    amendments to Sec. 1.17(c)(5)(ix), which reduce the timeframe for an

    FCM to incur a capital charge on an undermargined noncustomer or

    omnibus account from two days after the call was issued to one day

    after the call was issued. The Commission notes that the majority of

    the comments addressed the undermargined charge on customer accounts,

    but considered the comments generally in reviewing the proposed

    amendments to Sec. 1.17(c)(5)(ix).

    The Commission has considered the proposal and is adopting the

    amendments to Sec. 1.17(c)(5)(ix) as

    [[Page 68532]]

    proposed. As noted above, Sec. 1.17(c)(5)(ix) applies to noncustomers

    and omnibus accounts carried by an FCM. Many of the concerns raised by

    the comments regarding the ability to fund a margin call under Sec.

    1.17(c)(5)(viii) do not apply to accounts held by an affiliate or an

    omnibus accounts. Such accounts should pay margin calls promptly and by

    wire transfer to reduce the potential exposure to the FCM resulting

    from undermargined accounts.

    The Commission also believes that the amendments to Sec.

    1.17(c)(5)(viii) and (ix) are appropriate even if the Commission amends

    its regulations to require an FCM to maintain residual interest in

    segregated accounts in excess of the undermargined amount of customer

    accounts. The purpose of the capital rule is to ensure that an FCM

    maintains sufficient liquid assets to meet its obligations as a going

    concern. Proprietary funds held in segregated accounts that exceed the

    total obligation to customers are included in an FCM's capital

    computation. However, in situations where the FCM's residual interest

    in segregated accounts is covering an undermargined customer account, a

    capital charge is appropriate because the FCM's residual interest is

    necessary to cover potential market losses on the undermargined

    accounts.

    3. Permit an FCM That Is Not a BD To Develop Policies and Procedures To

    Determine Creditworthiness

    The Commissions proposed to amend Sec. 1.17(c)(v) to permit an FCM

    that is not a BD to develop a framework to establish, maintain and

    enforce written policies and procedures for determining

    creditworthiness of commercial paper, convertible debt, and

    nonconvertible debt instruments that are readily marketable. In

    recommending the proposal, the Commission noted that the SEC proposed

    to permit a BD to establish written policies and procedures to assess

    the credit risk of commercial paper, convertible debt, and

    nonconvertible debt instruments that are readily marketable.\177\

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

    \177\ The SEC has proposed rule amendments to implement the

    Dodd-Frank Act requirement to remove references to credit ratings in

    its regulations and substitute a standard for creditworthiness

    deemed appropriate. See 76 FR 26550 (May 6, 2011).

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

    Under both the Commission's proposal and the SEC's proposal, an FCM

    or BD would assess the security's credit risk using the following

    factors, to the extent appropriate:

    Credit spreads (i.e., whether it is possible to

    demonstrate that a position in commercial paper, nonconvertible debt,

    and preferred stock is subject to a minimal amount of credit risk based

    on the spread between the security's yield and the yield of Treasury or

    other securities, or based on credit default swap spreads that

    reference the security);

    Securities-related research (i.e., whether providers of

    securities-related research believe the issuer of the security will be

    able to meet its financial commitments, generally, or specifically,

    with respect to securities held by the FCM or BD);

    Internal or external credit risk assessments (i.e.,

    whether credit assessments developed internally by the FCM or BD or

    externally by a credit rating agency, irrespective of its status as an

    NRSRO, express a view as to the credit risk associated with a

    particular security);

    Default statistics (i.e., whether providers of credit

    information relating to securities express a view that specific

    securities have a probability of default consistent with other

    securities with a minimal amount of credit risk);

    Inclusion on an index (i.e., whether a security, or issuer

    of the security, is included as a component of a recognized index of

    instruments that are subject to a minimal amount of credit risk);

    Priorities and enhancements (i.e., the extent to which a

    security is covered by credit enhancements, such as

    overcollateralization and reserve accounts, or has priority under

    applicable bankruptcy or creditors' rights provisions);

    Price, yield and/or volume (i.e., whether the price and

    yield of a security or a credit default swap that references the

    security are consistent with other securities that the FCM or BD has

    determined are subject to a minimal amount of credit risk and whether

    the price resulted from active trading); and

    Asset class-specific factors (e.g., in the case of

    structured finance products, the quality of the underlying assets).

    An FCM that maintains written policies and procedures and

    determines that the credit risk of a security is minimal is permitted

    under the proposal to apply the lesser haircut requirement currently

    specified in the SEC capital rule for commercial paper (i.e., between

    zero and \1/2\ of 1 percent), nonconvertible debt (i.e., between 2

    percent and 9 percent), and preferred stock (i.e., 10 percent).

    The CFA does not believe it is appropriate for FCMs to use internal

    models to determine minimum required capital.\178\ The CFA believes

    that capital models should be established by the relevant regulatory

    agencies for use by FCMs or BDs.\179\ It has serious concerns that

    internal models used for calculating minimum capital requirements are

    prone to failure in a crisis.\180\ The CFA states that the regulatory

    agency should provide an objective and clear minimum risk-based capital

    baseline.\181\

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

    \178\ CFA Comment Letter at 4-5 (Feb. 13, 2013).

    \179\ Id.

    \180\ Id.

    \181\ Id.

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

    As noted above, the SEC has proposed amendments to its net capital

    rule to allow BDs to take a lower net capital charge on certain

    securities based on the BDs' own determinations that certain securities

    have minimal credit risk, pursuant to the BDs having protocols for

    assessing the credit risk and maintaining appropriate documentations.

    If the SEC approves the proposal, the SEC capital charges would apply

    to an FCM that is dually-registered as an FCM/BD. In the absence of the

    Commission adopting a similar provision, certificates of deposit,

    bankers acceptances, commercial paper and nonconvertible debt

    securities held by standalone FCMs that have very low credit and market

    risk securities would be subject to the minimum default securities

    haircut of 15 percent.

    The Commission proposed that standalone FCMs be permitted the same

    flexibility as FCM/BDs with respect to taking a lower capital charges

    for certain securities that may be determined to have minimal credit

    risk. The Commission also notes that based upon a review of Forms 1-FR-

    FCM filed with the Commission, standalone FCMs generally have limited

    investments in the types of securities that would be subject to the

    internal models, and such haircuts are not material to most standalone

    FCM's adjusted net capital.

    The Commission has considered the proposal and is adopting the

    amendments as proposed.

    4. Revisions to Definitions in Regulation 1.17(b)

    The Commission proposed technical amendments to certain definitions

    in Sec. 1.17(b)(2) and (7) to reflect proposed changes the term ``30.7

    customer'' and to remove surplus language due to other revisions to the

    regulations. No comments were received on these proposed changes and

    the Commission is adopting the proposal as final.

    Regulation 1.17(a) requires each FCM, in computing its minimum

    capital requirement, to include 8 percent of the risk margin required

    on futures and over the counter derivative instruments that the FCM

    carries in customer and non-

    [[Page 68533]]

    customer accounts. Regulation 1.17(b)(9) defines the term ``over the

    counter derivative instruments'' as those instruments set forth in 12

    U.S.C. 4421. Section 740 of the Dodd-Frank Act, however, repealed 12

    U.S.C. 4421.

    The Commission, however, has not revised its capital requirements

    and continues to require FCMs to include over the counter derivative

    instruments that it carries in customer and non-customer accounts in

    their minimum capital computations. The Commission interprets Sec.

    1.17(b)(9) to require an FCM to include the types of derivative

    transactions or instruments that were previously set forth in 12 U.S.C.

    4421 in its computation of its minimum capital requirement. The

    Commission also has directed staff to develop a rulemaking to amend

    Regulation 1.17(b)(9) to account for the repeal of 12 U.S.C. 4421.

    G. Sec. 1.20: Futures Customer Funds To Be Segregated and Separately

    Accounted for

    Regulation 1.20 imposes obligations on FCMs, DCOs, and other

    depositories regarding the holding, and accounting for, customer funds.

    The Commission proposed to reorganize the structure of Sec. 1.20 by

    providing additional subparagraphs to the existing specific

    requirements, and by applying headings to the regulation to assist in

    the reading and understanding of the regulation. The Commission also

    proposed new provisions discussed below to enhance the protection of

    customer funds.

    1. Identification of Customer Funds and Due Diligence

    The Commission proposed to amend Sec. 1.20(a) to more clearly

    define the requirements regarding how FCMs must hold customer funds.

    Proposed paragraph (a) of Sec. 1.20 requires an FCM to separately

    account for all futures customer funds and to segregate futures

    customer funds from its own funds. The proposed amendments further

    provide that an FCM shall deposit customer funds with a depository

    under an account name that clearly identifies the funds as futures

    customer funds and shows that the funds are segregated as required by

    the Act and Commission regulations. Proposed paragraph (a) also

    provides that an FCM must perform due diligence of each depository

    holding customer segregated funds (including depositories affiliated

    with the FCM), as required by new Sec. 1.11, and to update its due

    diligence on at least an annual basis.

    Proposed paragraph (a) also provides that an FCM must maintain at

    all times in the separate account or accounts funds in an amount at

    least sufficient in the aggregate to cover its total obligations to all

    futures customers. Proposed paragraph (a) further provides that an FCM

    computes its ``total obligations'' to futures customers as the

    aggregate amount of funds necessary to cover the Net Liquidating

    Equities of all futures customers as set forth in paragraph Sec.

    1.20(i).

    The Commission stated in the Proposal that it is not sufficient for

    an FCM to be in compliance with its segregation requirement at the end

    of a business day, but fail to hold sufficient funds in segregation to

    meet the Net Liquidating Equities of each of its customers on an intra-

    day basis. This provision explicitly clarifies the Commission's long-

    standing interpretation of existing statutory and regulatory

    requirements on how FCMs must hold customer funds. Section 4d(a)(2) of

    the Act requires an FCM to treat and deal with all money, securities,

    and property received by the FCM to margin, guarantee, or secure the

    trades or contracts of any customer of the FCM, or accruing to such

    customer as the result of such trades or contracts, as belonging to

    such customer. Section 4d(a)(2) further provides that funds belonging

    to a customer must be separately accounted for by the FCM and may not

    be commingled with the funds of the FCM or be used to margin or

    guarantee the trades or contracts, or extend the credit, of any

    customer or person other than the customer for whom the FCM holds the

    funds. The separate treatment of customer funds is further set forth in

    Sec. 1.22 which provides that no FCM shall use, or permit the use of,

    the funds of one customer to purchase, margin, or settle the trades,

    contracts, or commodity options of, or to secure or extend the credit

    of, any person other than such customer. Therefore, the current

    statutory and regulatory regime requires an FCM to maintain at all

    times a sufficient amount of funds in segregation to cover the full

    amount of the firm's obligations to its customers (i.e., the aggregate

    Net Liquidating Equity of each customer) to prevent the FCM from using

    the funds of one customer to margin or guarantee the commodity

    interests of other customers, or to extend credit to other customers.

    In its letter, the FIA stated that ``[t]he Commission has stated,

    and [FIA] agrees, that FCMs are required to comply with the segregation

    provisions of the Act at all times.'' \182\ FIA further cited to a

    Commission 1998 rulemaking where the Commission stated the segregation

    rules require compliance at all times.\183\ If an FCM is not in

    compliance with its obligation to maintain a sufficient amount of funds

    in segregation to meet the Net Liquidating Equities of all of its

    customer on an intra-day basis, the FCM would be using the funds of one

    customer to margin positions of another customer, or to cover the

    losses of another customer in violation of section 4d of the Act and

    Commission regulations.

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

    \182\ FIA Comment Letter at 2 (Jun 20, 2013). In addition, FIA

    expressed its agreement with the existing requirement for an FCM to

    maintain sufficient funds in segregation at all times to cover its

    total obligation to its customers.

    \183\ Id. (citing 63 FR 2188, 2190 (Jan. 14, 1998)).

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

    The Commission did not receive any comments on revised paragraph

    (a) and is adopting the amendments as proposed.

    2. Permitted Depositories

    Proposed paragraph (b) of Sec. 1.20 lists the permitted

    depositories for futures customer funds as any bank, trust company,

    DCO, or another FCM, subject to compliance with the FCM's risk

    management policies and procedures required in new Sec. 1.11. The

    Commission did not propose changes to the list of permitted

    depositories for FCMs. The Commission did not receive any comments on

    paragraph (b) and is adopting the amendments as proposed.

    3. Limitation on the Holding of Futures Customer Funds Outside of the

    United States

    Proposed paragraph (c) of Sec. 1.20 provides that an FCM may hold

    futures customer funds in depositories outside of the U.S. only in

    accordance with the current provisions of Sec. 1.49. The Commission

    received no comments on paragraph (c) and is adopting the amendments as

    proposed.

    4. Acknowledgment Letters

    a. Background

    Proposed paragraph (d) of Sec. 1.20 would require an FCM to obtain

    a written acknowledgment from each bank, trust company, DCO, or FCM

    with which the FCM opens an account to hold futures customer funds,

    with the exception of a DCO that has Commission-approved rules

    providing for the segregation of such funds. Similarly, proposed Sec.

    1.20(g)(4) would require a DCO to obtain a written acknowledgment from

    each depository prior to or contemporaneously with the opening of a

    futures customer funds account. Paragraphs (d) and (g) further

    enumerate requirements for acknowledgment letters, expanding upon the

    requirements set forth in current Sec. 1.20. Proposed Sec. 1.26,

    which would require an FCM or DCO that

    [[Page 68534]]

    invests customer funds in instruments described in Sec. 1.25 to obtain

    an acknowledgment letter from the depository holding such

    instruments,\184\ and proposed Sec. 30.7(c)(2), which would require an

    FCM to obtain an acknowledgment letter from each depository with which

    it opens an account to hold funds on behalf of its foreign futures and

    foreign options customers, are consistent with proposed Sec. 1.20(a)

    and (g)(4). The Commission proposed to repeal and replace Sec.

    30.7(c)(2), but retain the requirement to obtain an acknowledgment

    letter in proposed Sec. 30.7(d).

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

    \184\ Section 22.5 applies the written acknowledgment

    requirements of Sec. Sec. 1.20 and 1.26 to FCMs and DCOs in

    connection with depositing Cleared Swaps Customer Collateral in an

    account at a permitted depository.

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

    The Commission has proposed amendments to the acknowledgment letter

    requirements in Sec. Sec. 1.20, 1.26, and 30.7 in three separate

    notices of proposed rulemaking, the first being published on February

    20, 2009 (the ``Original Proposal'').\185\ The Original Proposal set

    out specific representations that would have been required to be

    included in all acknowledgment letters in order to reaffirm and to

    clarify the obligations that depositories incur when accepting customer

    funds.

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

    \185\ 74 FR 7838 (Feb. 20, 2009).

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

    In light of the comments on the Original Proposal, in 2010 the

    Commission re-proposed the amendments with several changes made in

    response to comments (the ``First Revised Proposal'').\186\ As part of

    the First Revised Proposal, the Commission proposed the required use of

    standard template acknowledgment letters, which were included as

    Appendix A to each of Sec. Sec. 1.20 and 1.26, and Appendix E to part

    30 of the Commission's regulations (referred to herein as the

    ``Template Letters'').

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

    \186\ 75 FR 47738 (Aug. 9, 2010).

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

    The Commission received nine comment letters on the First Revised

    Proposal. In general, the commenters were supportive of the First

    Revised Proposal and, in particular, were very supportive of requiring

    the use of Template Letters. It was noted by certain commenters that

    use of a standard letter would simplify the process of obtaining an

    acknowledgment letter. In addition, commenters were in agreement that

    uniformity of acknowledgment letters would provide consistency and

    greater legal certainty across the commodities and banking industries.

    The Commission proposed further refinements to the acknowledgment

    letter requirements in 2012 to address several issues that had arisen

    in the context of the MFGI and PFGI failures and their adverse impact

    on customers of those FCMs (``Second Revised Proposal'').\187\ In the

    Second Revised Proposal, the Commission also addressed comments it had

    received in response to the First Revised Proposal and incorporated

    related changes to the Template Letters.

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

    \187\ 77 FR 67866 (Nov. 14, 2012).

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

    The Commission received 15 comment letters related to the Template

    Letters in response to the Second Revised Proposal.\188\ Again, the

    commenters were generally supportive of the Commission's proposal and,

    in particular, were supportive of the mandatory use of Template

    Letters. The Depository Bank Group commented that the Template Letters

    will help ``facilitate a more efficient process for the establishment

    and maintenance of customer segregated accounts'' and clarify the

    rights and responsibilities of depositories.\189\ Eurex noted that it

    appreciated the ``potential convenience'' and increased certainty and

    transparency afforded by the Template Letters.\190\ CME supported the

    Commission's efforts to ``strengthen and standardize'' the Template

    Letters.\191\

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

    \188\ Letters were submitted by Schwartz & Ballen, FIA,

    LCH.Clearnet, MGEX, the Federal Reserve Banks, NYPC, CME, the

    Depository Bank Group, Eurex, RJ O'Brien, RCG, NFA, FCStone, ICI,

    and Katten-FIA.

    \189\ Depository Bank Group Comment Letter at 2 (Feb. 15, 2013).

    \190\ Eurex Comment Letter at 1 (Aug. 1, 2013).

    \191\ CME Comment Letter at 7 (Feb. 15, 2013).

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

    While many of the comments were supportive of the Template Letters,

    FCStone expressed the view that ``prescriptive rules'' could drive

    participants out of the futures industry.\192\ MGEX commented that the

    required use of a Template Letter appeared to be a ``dramatic shift''

    from the current requirements and questioned whether depositories would

    be willing to sign the Template Letter due to the ``access and timing

    information requirements.'' \193\ RCG stated that early indications

    were that many depositories ``with extensive experience servicing

    FCMs'' are unwilling to sign the Template Letter and expressed concern

    that if such depositories refuse to sign, customer funds will become

    concentrated with depositories ``less experienced in carrying FCM

    accounts.'' \194\

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

    \192\ FCStone Comment Letter at 5 (Feb. 15, 2013).

    \193\ MGEX Comment Letter at 3 (Feb. 18, 2013).

    \194\ RCG Comment Letter at 7 (Feb. 12, 2013).

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

    Regulation 1.20 in its current form already requires FCMs and DCOs

    to obtain acknowledgment letters, and the Commission believes that use

    of a standardized Template Letter will reduce negotiation costs, create

    efficiencies for Commission registrants as well as non-registrant

    depositories, provide greater legal certainty as to the rights and

    obligations of parties under the Act and CFTC regulations, and

    facilitate consistent treatment of customer funds across FCMs, DCOs,

    and depositories. In addition, the use of a standardized letter is the

    approach that has been proposed by the Financial Conduct Authority

    (``FCA'') in the United Kingdom (``U.K.'').\195\

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

    \195\ See Financial Conduct Authority, ``Review of the client

    assets regime for investment business,'' Consultation Paper CP13/5

    (July 2013).

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

    The Commission has taken into consideration the comments and

    recommendations provided by FCMs, DCOs, and depositories, and it

    believes the final rules and Template Letters largely address the

    concerns they have expressed. The Commission's response to comments on

    the major issues raised by commenters is discussed by subject matter,

    below.

    b. Technical Changes to the Template Letters

    Proposed paragraphs (d)(2) and (g)(4)(ii) of Sec. 1.20 would

    require FCMs and DCOs, respectively, to use the Template Letter set

    forth in Appendix A to Sec. 1.20 when opening a customer segregated

    account with a depository. In response to the comments, and in

    recognition of the different functions FCMs and DCOs perform in

    relation to customer funds, the Commission has determined to finalize

    different versions of the Template Letters for FCMs and DCOs. The

    Template Letter specific to FCMs is being adopted as Appendix A to

    Sec. 1.20, and the Template Letter for DCOs is being adopted as

    Appendix B to Sec. 1.20. Paragraph (g)(4)(ii) has been revised to

    require DCOs to use the Template Letter in Appendix B.

    Another change concerns the full account name as it appears in the

    Template Letter. Proposed Sec. 1.20(a) and (g)(1) provides in part

    that customer funds shall be deposited ``under an account name that

    clearly identifies them as futures customer funds and shows that such

    funds are segregated as required by sections 4d(a) and 4d(b) of the Act

    and [part 1 of the Commission's regulations].'' Schwartz & Ballen noted

    that operational constraints limit the number of characters available

    for account names, and requested additional flexibility with regard to

    account titles ``so long as the accounts are clearly identified as

    custodial

    [[Page 68535]]

    accounts held for the benefit of the FCM's customers.'' \196\

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

    \196\ Schwartz & Ballen Comment Letter at 8 (Feb. 15, 2013).

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

    The Commission has modified the Template Letters to accommodate a

    depository's account titling conventions. The Commission will permit a

    depository to abbreviate the account name when the full name as set

    forth in the Template Letter is too long for a depository's operational

    system to include all characters, provided that (i) the Template Letter

    includes both the full and abbreviated account name(s) and (ii) the

    abbreviated account name clearly identifies the account as a

    Commission-regulated segregated/secured account that holds customer

    funds (e.g., ``segregated'' may be shortened to ``seg;'' ``customer''

    may be shortened to ``cust;'' ``account'' to ``acct;'' etc.).

    FIA recommended several modifications to the Template Letters,

    including the addition of a clause to address banking practices used to

    provide third-party access to account information. As a result, the

    Commission has added the following language to the FCM Template Letter

    (and similar language to the other Template Letters): ``The parties

    agree that all actions on your part to respond to the above information

    and access requests will be made in accordance with, and subject to,

    such usual and customary authorization verification and authentication

    policies and procedures as may be employed by you to verify the

    authority of, and authenticate the identity of, the individual making

    any such information or access request, in order to provide for the

    secure transmission and delivery of the requested information or access

    to the appropriate recipient(s).''

    In addition, the proposed Template Letters, as well as proposed

    Sec. Sec. 1.20(d)(4) and (g)(4)(iv) and 30.7(d)(4), would require the

    depository to agree to provide a copy of the executed acknowledgment

    letter to the Commission at a specific email address. The email address

    has been deleted from the Template Letters, and the depository is now

    required to provide a copy to the Commission via electronic means in a

    format and manner determined by the Commission. The rule text has been

    revised accordingly (and Sec. 1.20(g)(4)(iv) has been renumbered as

    Sec. 1.20(g)(4)(iii)).

    Finally, the Commission has made minor technical revisions to the

    Template Letters in the form of grammatical and stylistic changes to

    clarify meaning and provide consistency among the letters.

    c. Federal Reserve Banks as Depositories

    Pursuant to Sec. 806(a) of the Dodd-Frank Act, the Board of

    Governors of the Federal Reserve System (the ``Board'') may authorize a

    Federal Reserve Bank to establish and maintain an account for

    systemically important DCOs (``SIDCOs'') that have been designated by

    the Financial Stability Oversight Council (``FSOC'') as systemically

    important financial market utilities (``Designated FMUs'').\197\ In

    their comment letter, the Federal Reserve Banks stated: ``Absent

    clarification, the [Federal] Reserve Banks must assume that we would be

    treated as depository institutions under the proposed rules if we were

    to hold Designated FMU customer funds.'' The Federal Reserve Banks

    commented that they do not believe that they can accept all of the

    terms of the Template Letters given the ``unique nature of the

    [Federal] Reserve Banks and of Designated FMUs.'' \198\

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

    \197\ Section 806(a) of the Dodd-Frank Act; see also Federal

    Reserve Banks Comment Letter at 1 (Feb. 22, 2013).

    \198\ Federal Reserve Banks Comment Letter at 2 (Feb. 22, 2013).

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

    The Federal Reserve Banks raised specific concerns with two terms

    of the Template Letters: (1) The provision authorizing the Commission

    to order the immediate release of customer funds; and (2) the provision

    that allows a depository to presume legality for any withdrawal of

    customer funds, provided the depository has no knowledge of, or could

    not reasonably know of, any violation of the law. The Federal Reserve

    Banks suggested that under ``exceptional circumstances, such as a

    prospective insolvency of the SIDCO that threatens customer funds,'' a

    Commission-authorized withdrawal would need to be considered in the

    context of a larger coordinated effort, which would include FSOC.\199\

    The Federal Reserve Banks further asserted that, due to their dual

    roles as both supervisory bodies and providers of financial services,

    coupled with the Board prohibition on sharing supervisory information

    with personnel performing financial services, the standard of liability

    leaves them in the ``untenable position of not being able to rely on

    the presumption of legality.'' \200\

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

    \199\ Id. at 1.

    \200\ Id. at 2.

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

    The Commission is adopting, as proposed, Sec. 1.20(g)(2), which

    confirms that the Federal Reserve Banks are depositories for purposes

    of section 4d of the Act and Commission regulations thereunder.

    Accordingly, a Federal Reserve Bank would be required to execute a

    written acknowledgment when it accepts customer funds from a SIDCO or

    other DCO for which it holds customer funds. However, the Commission

    recognizes the unique role of the Federal Reserve Bank and is therefore

    modifying proposed Sec. 1.20(g)(4)(ii) to provide an exception for

    Federal Reserve Banks from the requirement that depositories accepting

    customer funds from DCOs execute the Template Letter in Appendix B to

    Sec. 1.20. Rather, a Federal Reserve Bank will be required only to

    execute a written acknowledgment that: (1) It was informed that the

    customer funds deposited therein are those of customers who trade

    commodities, options, swaps, and other products and are being held in

    accordance with the provisions of section 4d of the Act and Commission

    regulations thereunder; and (2) it agrees to reply promptly and

    directly to any request from the director of the Division of Clearing

    and Risk or the director of the Division of Swap Dealer and

    Intermediary Oversight, or any successor divisions, or such directors'

    designees, for confirmation of account balances or provision of any

    other information regarding or related to an account.

    The Commission is modifying proposed Sec. 1.20(g)(2) from ``A

    [DCO] may deposit futures customer funds with a bank or trust company,

    which shall include a Federal Reserve Bank with respect to deposits of

    a systemically important [DCO]'' to ``A [DCO] may deposit futures

    customer funds with a bank or trust company, which may include a

    Federal Reserve Bank with respect to deposits of a [DCO] that is

    designated by the Financial Stability Oversight Council to be

    systemically important.'' Changing the phrase ``which shall include a

    Federal Reserve Bank'' to ``which may include a Federal Reserve Bank,''

    avoids possible ambiguity as to whether the DCO is required to deposit

    futures customer funds with a Federal Reserve Bank. By revising the

    description of the DCO, the Commission has effectively captured any

    DCO, such as one that is also registered with the SEC as a clearing

    agency and has been designated to be systemically important in that

    capacity, which could hold customer funds at a Federal Reserve

    Bank.\201\

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

    \201\ For example, The Options Clearing Corporation is a

    registered DCO that has been designated as ``systemically

    important'' but is not a SIDCO as defined in Sec. 39.2 of the

    Commission's regulations. A Federal Reserve Bank would be required

    to segregate customer funds and provide an acknowledgment letter

    under Sec. 1.20 with respect to any customer account subject to

    section 4d of the Act and opened by The Options Clearing Corporation

    in its capacity as a DCO.

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

    [[Page 68536]]

    d. Foreign Depositories

    In its comment letter, Eurex questioned whether foreign

    depositories could fully comply with the proposed regulations and

    execute the Template Letters, noting the probability of ``strong

    resistance'' by foreign depositories to providing the Commission with

    read-only electronic access to account information.\202\ Eurex pointed

    to the ``detailed nature of the representations'' in the Template

    Letters and further expressed its belief that foreign depositories

    would not be permitted to legally execute the Template Letters.\203\

    Eurex recommended that the Commission consider alternative methods for

    achieving the goal of the Template Letters, such as authorizing

    Commission staff to ``accept alternate language'' from foreign

    depositories.\204\ FIA commented that it had not discussed the Template

    Letters with foreign depositories and thus did not know whether the

    Template Letters would ``cause concern'' under a foreign jurisdiction's

    laws.\205\

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

    \202\ Eurex Comment Letter at 1 (Aug. 1, 2013).

    \203\ Id. at 2.

    \204\ Id.

    \205\ FIA Comment Letter at 40 (Feb. 15, 2013).

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

    The Commission appreciates these perspectives related to foreign

    depositories, but notes that the comments are of a general nature and

    do not provide any specific examples to support the commenters'

    assertions. The Commission did not receive a comment letter from any

    foreign depository holding customer funds.

    As noted above, the FCA recently proposed the use of template

    acknowledgment letters for purposes of satisfying FCA acknowledgment

    letter requirements. The proposed letters are similar in many respects

    to the Template Letters the Commission is adopting herein, and FCA

    regulations would require both U.K. and non-U.K. depositories to

    execute the template acknowledgment letters.

    The Commission recognizes that there may be valid reasons why some

    foreign depositories would require modifications to the Template

    Letters. In such circumstances, the Commission would consider

    alternative approaches, including no-action relief, on a case-by-case

    basis.

    e. Release of Funds Upon Commission Instruction

    As proposed, the Template Letters would require a depository to

    release funds immediately upon instruction from the director of the

    Division of Clearing and Risk, the director of the Division of Swap

    Dealer and Intermediary Oversight, or any successor divisions, or such

    directors' designees. The purpose of this provision was to enable the

    Commission to expeditiously carry out measures to protect customer

    funds in exceptional circumstances, such as the imminent bankruptcy of

    an FCM. Commenters expressed concerns about this requirement, citing

    liability that might arise from a depository acting or failing to act

    ``immediately,'' \206\ and the need for the depository to implement

    proper security and authorization procedures in connection with acting

    upon instructions from the Commission rather than the account

    holder.\207\

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

    \206\ Depository Bank Group Comment Letter at 10.

    \207\ Id. at 11; Schwartz & Ballen Comment Letter at 2 (Feb. 15,

    2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013).

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

    With respect to DCOs in particular, NYPC pointed out that a DCO

    normally holds customer funds in a segregated account without further

    subdivision by customer or clearing member and, as a result, a DCO

    would effectuate a transfer of customer funds from a defaulting

    clearing member to a non-defaulting clearing member by book entry on

    the DCO's books and records.\208\ NYPC noted that no transfer of funds

    may be required if the DCO holds the funds at the same depository.

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

    \208\ NYPC Comment Letter at 2 (Feb. 15, 2013).

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

    The Depository Bank Group commented that the term ``immediately''

    may subject a depository to potential claims by FCMs, DCOs or the

    Commission in the event of a delay in the transfer of customer funds,

    even if such delay is the result of reasonable actions or events beyond

    the control of the depository.\209\ As previously noted, the Federal

    Reserve Banks commented that during such ``exceptional circumstances''

    in which instructions to transfer funds from a SIDCO's account would

    likely be made, the FSOC would be involved.\210\ The Depository Bank

    Group, FIA, and Schwartz & Ballen all commented that the proposal is

    ``inconsistent'' with a depository's security policies and

    procedures.\211\ CME requested that the Commission clarify the

    exceptional circumstances that would give rise to the Commission's

    request for an immediate release of customer funds and the impact such

    an instruction could have on the timely payment of obligations to a

    DCO.\212\

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

    \209\ Depository Bank Group Comment Letter at 10 (Feb. 15,

    2013).

    \210\ Federal Reserve Banks Comment Letter at 1 (Feb. 22, 2013).

    \211\ Id. at 11; Katten-FIA Comment Letter at 2 (Aug. 2, 2013);

    and Schwartz & Ballen Comment Letter at 5 (Feb. 15, 2013).

    \212\ CME Comment Letter at 7 (Feb. 15, 2013).

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

    After considering the concerns raised by the commenters, the

    Commission has determined not to require depositories to agree to

    release or transfer customer funds upon its instruction. The Commission

    notes that in exceptional circumstances such as the imminent bankruptcy

    of an FCM, Commission staff would be in regular communication with the

    FCM, its DSRO, DCOs, and depositories in an effort to protect customer

    funds.

    f. Read-Only Access and Information Requests

    Proposed paragraphs (d)(3) and (g)(4)(iii) of Sec. 1.20, proposed

    Sec. 30.7(d)(3), and the proposed Template Letters, including the

    Template Letters for Sec. 1.26 investments in money market mutual

    funds, would require depositories to provide the Commission with 24-

    hour, read-only electronic access to accounts holding customer funds.

    The Commission received eight comment letters on this requirement.

    As a preliminary matter, FIA noted that significant time for

    development would be necessary to implement such a requirement.\213\

    Schwartz & Ballen observed that the read-only access approach conflicts

    with bank procedures used to provide account information to third

    parties, which typically involve allowing the customer to grant access

    to a third party, rather than the bank doing so.\214\ The Depository

    Bank Group and FIA also pointed out that Commission staff would be

    required to comply with the depository's security policies and

    procedures.\215\ The Depository Bank Group recommended that the

    Template Letters expressly authorize the depository to provide access

    to the Commission and suggested language that could be incorporated

    into the Template Letters.\216\ RJ O'Brien agreed with the Depository

    Bank Group's position on read-only access.\217\

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

    \213\ FIA Comment Letter at 40 (Feb. 15, 2013).

    \214\ Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013).

    \215\ Depository Bank Group Comment Letter at 13 (Feb. 15,

    2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013).

    \216\ Depository Bank Group Comment Letter at 13 (Feb. 15,

    2013).

    \217\ RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).

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

    FCStone noted that time differences and geographic locations may

    make it difficult for foreign commodity brokers to satisfy the 24-hour-

    a-day requirement and respond promptly to requests made

    [[Page 68537]]

    by the Commission.\218\ The Depository Bank Group commented that often

    a bank denies access during routine maintenance to technology systems,

    and asked that the Commission remove the ``24-hour'' requirement.\219\

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

    \218\ FCStone Comment Letter at 5 (Feb. 15, 2013).

    \219\ Depository Bank Group Comment Letter at 13 (Feb. 15,

    2013).

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

    NYPC commented that, because DCOs hold customer funds on behalf of

    all their clearing members in omnibus accounts that are not further

    subdivided by each customer, the account information to which the

    Commission would have access at a DCO's depository ``would not provide

    the level of detail that would permit reconciliation between either the

    DCO's FCM clearing members or those clearing members' underlying

    customers.'' \220\ In addition, Schwartz & Ballen contended that the

    requirement would not achieve the Commission's goal of quickly

    identifying discrepancies between FCM-reported balances and balances at

    a depository because the depository typically posts all credits and

    debits after the close of business.\221\

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

    \220\ NYPC Comment Letter at 2 (Feb. 15, 2013).

    \221\ Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013).

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

    LCH.Clearnet recommended that the Commission consider ``alternative

    approaches'' for routine access to account balance information at

    depositories holding customer funds. For central banks, LCH.Clearnet

    suggested that the Commission should accept confirmation of balance

    information directly from the central bank in a form acceptable to the

    central bank, but it did not explain why central banks should be

    treated differently than other depositories. For other depositories,

    LCH.Clearnet believes the Commission should consider ``following the

    lead of the [NFA].'' \222\

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

    \222\ LCH.Clearnet Comment Letter at 3 (Jan. 25, 2013).

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

    NFA pointed out that its board of directors had adopted a financial

    requirements rule in August 2012.\223\ NFA explained that instead of

    adopting a read-only access provision of its own in this rule, it

    instead chose to use, in conjunction with CME, an automated daily

    segregation confirmation system to monitor customer segregated and

    secured amount accounts and their balances.\224\ NFA requested that the

    Commission rescind its proposed read-only access requirement.\225\

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

    \223\ NFA Comment Letter at 6 (Feb. 15, 2013).

    \224\ Id.

    \225\ Id. at 7.

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

    With the goal of achieving the highest degree of customer

    protection, the Commission has determined to adopt, with certain

    modifications, the requirement that a depository agree to provide the

    Commission with read-only access to accounts maintained by an FCM.

    Regulations 1.20(d)(3) and 30.7(d)(3) require the depository to agree

    to provide the Commission with ``the technological connectivity, which

    may include provision of hardware, software, and related technology and

    protocol support, to facilitate direct, read-only electronic access to

    transaction and account balance information.'' In the Template Letters,

    the parties further acknowledge and agree that the connectivity has

    either been provided (in the case of a new letter that covers existing

    accounts) or will be provided promptly following the opening of the

    account(s) (with respect to new accounts). However, the Commission is

    not requiring read-only electronic access for an FCM's DSRO, as

    proposed. The Commission was advised by the DSROs that they intend to

    rely on the NFA and CME automated daily segregation confirmation

    system.

    The Commission does not anticipate that its staff would access FCM

    accounts on a regular basis to monitor account activity; rather, staff

    would make use of the read-only access only when necessary to obtain

    account balances and other information that staff could not obtain via

    the NFA and CME automated daily segregation confirmation system, or

    otherwise directly from the depositories, as discussed below. In this

    regard, the CME and NFA will provide the Commission on a daily basis

    with the account balances reported to them by each depository holding

    customer funds, under the CME and NFA's daily confirmation process. In

    addition, as discussed in section N below, each FCM that completes a

    daily Segregation Schedule, Secured Amount Schedule, and/or Cleared

    Swaps Segregation Schedule will be required to file such schedules with

    the Commission on a daily basis. The Commission anticipates that the

    combination of receipt of daily account balances reported by

    depositories and the Commission's ability to confirm account balances

    and transactions directly with depositories will diminish the need to

    rely upon direct electronic access to account information at

    depositories.

    With respect to depositories holding customer funds in accounts

    maintained by a DCO, the Commission has decided not to adopt the

    electronic access requirement. Given that DCOs hold omnibus customer

    accounts that are not subdivided by clearing member or individual

    customer, read-only access to a DCO's customer account would not

    provide the kind of information that would identify inaccuracies in FCM

    reporting. Accordingly, proposed Sec. 1.20(g)(4)(iii), which would

    require a DCO to deposit futures customer funds only with a depository

    that provides read-only access to the Commission, is not being adopted,

    and the remaining subparagraphs of Sec. 1.20(g)(4) are renumbered

    accordingly.

    The Commission also is adopting Sec. Sec. 1.20(d)(6),

    1.20(g)(4)(iv), and 30.7(d)(6), which require an FCM or DCO to deposit

    customer funds only with a depository that agrees to reply promptly and

    directly to any request from the director of the Division of Swap

    Dealer and Intermediary Oversight, the director of the Division of

    Clearing and Risk, or any successor divisions, or such directors'

    designees,\226\ (or, in the case of an FCM, an appropriate officer,

    agent or employee of the FCM's DSRO), for confirmation of account

    balances or provision of any other information regarding or related to

    an account, without further notice to or consent from the FCM or

    DCO.\227\ For DCOs, the Commission believes that this ability, in

    addition to the daily reporting of various accounts by customer origin

    pursuant to Sec. 39.19(c)(1), will enable it to verify DCO account

    balances with a depository as necessary.

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

    \226\ Proposed Sec. Sec. 1.20(d)(5) and (g)(4)(v) and

    30.7(d)(5) would require the depository to reply promptly and

    directly to ``the Commission's'' requests, and the authority to make

    such requests was delegated to the director of the Division of Swap

    Dealer and Intermediary Oversight and the director of the Division

    of Clearing and Risk under proposed Sec. 140.91(a)(7) and (11). The

    proposed Template Letters would require the depository to agree ``to

    respond promptly and directly to requests for confirmation of

    account balances and other account information from an appropriate

    officer, agent, or employee of the CFTC'' and ``immediately upon

    instruction by the director of the Division of Swap Dealer and

    Intermediary Oversight of the CFTC or the director of the Division

    of Clearing and Risk of the CFTC, or any successor divisions, or

    such directors' designees . . . provide any and all information

    regarding or related to the Funds or the Accounts as shall be

    specified in such instruction and as directed in such instruction.''

    The Commission is revising the rule text and the Template Letters so

    that all such requests will come from the director of the Division

    of Swap Dealer and Intermediary Oversight or the director of the

    Division of Clearing and Risk, or any successor divisions, or such

    directors' designees.

    \227\ To assist a depository in verifying authority and

    authenticating identity in connection with a request for information

    or electronic access, the Commission intends to post on its Web site

    an up-to-date list of names (including title and contact

    information) of the directors of the Division of Swap Dealer and

    Intermediary Oversight and the Division of Clearing and Risk, or any

    successor divisions, and the directors' designees, if any, for the

    relevant purpose.

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

    [[Page 68538]]

    g. Requirement To File New Acknowledgment Letters

    Proposed paragraphs (d)(7) and (g)(4)(vii) of Sec. 1.20 and

    proposed Sec. 30.7(d)(7) would require FCMs and DCOs to file amended

    acknowledgment letters with the Commission upon a change to a

    depository's name or other information specified in the regulation. The

    Commission received three comments on this requirement. Schwartz &

    Ballen recommended that the Commission remove this requirement from the

    Template Letters and instead include ``binding effect'' language to

    ensure that the counterparties remain subject to the terms of the

    acknowledgment letter even if a party's name has changed.\228\

    LCH.Clearnet recommended a six-month timeframe after the publication of

    these rules by which DCOs and FCMs must obtain acknowledgment

    letters.\229\ NYPC commented that the proposed requirements impose ``an

    onerous periodic validation process with depositories'' and, given

    this, it suggested that depositories provide written notice to a DCO of

    a name or address change no later than 30 days after any such change in

    order to permit a DCO to execute a new Template Letter.\230\

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

    \228\ Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013).

    \229\ LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013).

    \230\ NYPC Comment Letter at 4 (Feb. 15, 2013).

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

    The Commission believes that acknowledgment letters should be as

    current and up-to-date as possible in order to maintain the clear legal

    status of the customer account, which will better protect customers in

    the event of an FCM failure. Accordingly, the Commission is adopting

    (renumbered) Sec. Sec. 1.20(d)(8) and (g)(4)(vi) and 30.7(d)(8) as

    proposed, except that instead of providing for an ``amended'' letter,

    the regulation requires that a ``new'' letter be executed. The purpose

    of this technical change is to avoid problems in locating the accounts

    covered by a single letter that has been amended multiple times to

    reflect various changes. The Commission expects that a depository would

    notify account holders of a name change as a matter of practice and

    does not believe that it is too burdensome to expect a DCO or FCM to be

    aware of such changes. Any new acknowledgment letter reflecting a

    change enumerated in the regulation must be executed within 120 days of

    such changes, and then filed with the Commission within three business

    days of executing the new letter.

    The Commission also is adopting (renumbered) Sec. Sec. 1.20(d)(7)

    and (g)(4)(v) and 30.7(d)(7), which require an FCM or DCO to submit a

    copy of the acknowledgment letter to the Commission within three

    business days of the opening of an account or obtaining a new

    acknowledgment letter for an existing account; and Sec. Sec.

    1.20(d)(4) and (g)(4)(iii) and 30.7(d)(4), which require an FCM or DCO

    to deposit customer funds only with a depository that agrees to provide

    a copy of the acknowledgment letter to the Commission (and, in the case

    of an FCM, the FCM's DSRO) within the same time frame.\231\ The

    Commission is, however, giving FCMs, DCOs, and depositories 180 days

    from the effective date of the final rules to replace existing

    acknowledgment letters with new ones that conform to the Template

    Letters.

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

    \231\ The acknowledgment letter must be executed upon the

    opening of the account, regardless of when customer funds are

    deposited in the account.

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

    As an additional matter, the Commission advises that it expects an

    FCM or DCO to follow customary authorization verification and signature

    authentication policies and procedures to ensure that an acknowledgment

    letter is executed by an individual authorized to bind the depository

    to the terms of the letter, and that the signature that appears on the

    letter is authentic. For example, an FCM or DCO may request from the

    depository a list of authorized signatories, a duly executed power of

    attorney, or other such documentation.

    h. Standard of Liability

    The proposed Template Letters would provide that a depository ``may

    conclusively presume that any withdrawal from the Account(s) and the

    balances maintained therein are in conformity with the Act and CFTC

    regulations without any further inquiry, provided that [the depository

    has] no notice of or actual knowledge of, or could not reasonably know

    of, a violation of the Act or other provision of law by [the FCM or

    DCO]; and [the depository] shall not in any manner not expressly agreed

    to [in the letter] be responsible for ensuring compliance by [the FCM

    or DCO] with the provisions of the Act and CFTC regulations.''

    The Depository Bank Group commented that this ``standard of

    liability'' provision would impose a burden beyond that currently

    expected of depository institutions.\232\ In this regard, the

    Depository Bank Group asserted that the phrase ``violation of the Act

    or other provision of law'' encompasses much more than section 4d of

    the Act and would effectively require that the depository monitor and

    ensure the FCM's or DCO's compliance with all other laws, even those

    unrelated to the deposit of customer funds.\233\ The Depository Bank

    Group further contended that the proposed standard, ``could not

    reasonably know of a violation'' would likely be read to require

    depositories to ``perform some undefined level of diligence'' which

    would be highly problematic.\234\ The Depository Bank Group also stated

    that this requirement would likely delay transfers or withdrawals, and

    result in depositories passing on related costs to FCMs and DCOs and,

    in turn, to their clients, although the Depository Bank Group did not

    quantify the costs.\235\ FIA similarly expressed concern that the

    requirement could cause delays and increased costs, again, without

    providing specific details and quantifying costs.\236\

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

    \232\ Depository Bank Group Comment Letter at 3 (Feb. 15, 2013).

    See also RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).

    \233\ Depository Bank Group Comment Letter at 5 (Feb. 15, 2013).

    See also Katten-FIA Comment Letter at 2 (Aug. 2, 2013); Schwartz &

    Ballen Comment Letter at 6 (Feb. 15, 2013); and CME Comment Letter

    at 7 (Feb. 15, 2013).

    \234\ Depository Bank Group Comment Letter at 3 (Feb. 15, 2013).

    \235\ Id. at 5.

    \236\ FIA Comment Letter at 40 (Feb. 15, 2013).

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

    Schwartz & Ballen asserted that banks have no ability to determine

    what uses an FCM is making of funds it withdraws from the account.\237\

    As noted above, the Federal Reserve Banks, which may act as

    depositories for Designated FMUs, commented that the ``actual

    knowledge'' standard, which typically imputes knowledge to a legal

    person as a whole, is not feasible for them because of the Board policy

    to not share supervisory information with Federal Reserve Bank

    personnel performing financial services.

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

    \237\ Schwartz & Ballen Comment Letter at 6 (Feb. 15, 2013).

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

    In response to concerns expressed by commenters, the Commission

    clarifies that it does not intend to use the Template Letters as means

    to expand the scope of a depository's liability to FCM or DCO account

    holders, or to alter the responsibility that an FCM or DCO bears for

    its own compliance with the customer funds segregation requirements

    under the Act and Commission regulations. The use of standardized

    acknowledgment letters is intended to promote a uniform understanding

    among FCMs, DCOs, and depositories as to their obligations under the

    Act and Commission regulations with respect to the proper treatment of

    customer funds. In light of the public comments, the Commission is

    revising the language in the Template

    [[Page 68539]]

    Letters to more precisely articulate the intended scope of the

    depository's responsibility.

    The provision, as adopted, reads as follows: ``You [the depository]

    may conclusively presume that any withdrawal from the Account(s) and

    the balances maintained therein are in conformity with the Act and CFTC

    regulations without any further inquiry, provided that, in the ordinary

    course of your business as a depository, you have no notice of or

    actual knowledge of a potential violation by us of any provision of the

    Act or CFTC regulations that relates to the segregation of customer

    funds; and you shall not in any manner not expressly agreed to [in the

    letter] be responsible to us [the FCM or DCO] for ensuring compliance

    by us with the provisions of the Act and CFTC regulations; however, the

    aforementioned presumption does not affect any obligation you may

    otherwise have under the Act or CFTC regulations.'' Changes from the

    proposed language are discussed below.

    The Depository Bank Group recommended inserting the phrase ``in the

    ordinary course of your business as a depository,'' and the Commission

    has accepted this recommendation to clarify the context in which the

    presumption of the FCM's or DCO's compliance is effective. As proposed,

    the presumption would be effective so long as the depository has ``no

    notice of or actual knowledge of, or could not reasonably know of, a

    violation.'' Given the concerns expressed by commenters as to the

    implications of the ``reasonably know'' standard, the Commission has

    determined to eliminate that clause in the final Template Letters.

    In considering the various circumstances in which the conclusive

    presumptions would no longer be effective, the Commission has

    determined that the proposed reference to notice or actual knowledge of

    a ``violation,'' does not adequately capture all of the relevant

    circumstances. This is because the depository might receive information

    that calls into question the conduct of the FCM or DCO account holder,

    but it might not be apparent whether or not the activity rises to the

    level of being an actual violation of the law. Indeed, some actions

    will not be deemed to be ``violations'' until a judicial decision is

    rendered. As a result, the Commission has revised the language to refer

    to a ``potential violation'' so as not to inadvertently exclude

    circumstances which would warrant further inquiry by a depository.

    The Commission agrees that the broad reference to ``the Act and

    CFTC regulations'' should be narrowed with respect to the description

    of the potential violation. Therefore, the Commission is adopting the

    Depository Bank Group's suggestions that the reference to the violation

    specify that it is limited to ``any provision of the Act or the CFTC

    regulations that relates to the segregation of customer funds.'' The

    Commission has made a similar change in the 30.7 Template Letters,

    referring to ``any provision of the Act or Part 30 of the CFTC

    regulations that relates to the holding of customer funds.'' This more

    precisely identifies the legal requirements that are the subject of the

    parties' obligations and the acknowledgment letter as a whole.

    As an additional matter, the Commission has added to the standard

    of liability provision the following proviso: ``however, the

    aforementioned presumption does not affect any obligation you may

    otherwise have under the Act or CFTC regulations.'' This statement

    affirms the depository's understanding that its statutory and

    regulatory obligations with respect to the customer funds on deposit

    are not limited by the presumption upon which it relies in its dealings

    with FCM or DCO account holders.

    The Commission notes that a depository's obligation to comply with

    the segregation requirements under section 4d of the Act is explicitly

    imposed upon depositories by section 4d(b) of the Act,\238\ and legal

    precedent has established a standard of liability to which the

    Commission holds depositories and which is not dependent upon

    affirmation in the Template Letters. The Commission reaffirms its long-

    held position that the depository will be held liable for the improper

    transfers of customer funds by an FCM or DCO if it knew or should have

    known that the transfer was improper.\239\

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

    \238\ Section 4d(b) of the Act explicitly provides that it is

    unlawful for any clearing agency of a contract market and any

    depository that has received customer funds to hold, dispose of, or

    use any such funds as belonging to the depositing FCM or any person

    other than the customers of such FCM. See also section 4d(f)(6) of

    the Act (applying the same requirement to Cleared Swaps Customer

    Collateral).

    \239\ See, e.g., CFTC Interpretative Ltr. No. 79-1, [1977-1980

    Transfer Binder] Comm. Fut. L. Rep. (CCH) ]20,835 (May 29, 1979) at

    page 2. As long ago as 1979, the Commission found that ``if a bank,

    with prior notice, permits or acquiesces in the withdraw [sic] or

    use of customers' funds by a futures commission merchant for an

    unlawful purpose, the bank would violate or be aiding and abetting a

    violation of the Act.''

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

    The Commission recognizes that a depository's treatment of customer

    funds may be limited in particular circumstances on the basis of what

    it knows or reasonably should know of a violation of the Act that would

    preclude it from obtaining rights to such funds superior to those of

    one or more customers of the defaulting FCM.\240\ Such a violation

    could occur, for example, in circumstances in which the depository

    received particular margin funds with actual knowledge, or in

    circumstances in which it is reasonable to conclude that the depository

    should have known, that the depositing FCM or DCO has breached its duty

    under section 4d. The depository's participation in such use of

    customer funds could subject it to liability for violating section 4d

    or aiding and abetting a violation of the Act under section 13(a) of

    the Act (7 U.S.C. 13c).\241\

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

    \240\ See CFTC Interpretative Ltr. No. 86-9, [1986-1987 Transfer

    Binder] Comm. Fut. L. Rep. (CCH) ]23,015 (April 21, 1986) (limiting

    a bank's treatment of customer margin funds ``in particular

    circumstances by reason of what it knows or reasonably should know

    of a violation of the Act or other provision of law that would

    preclude it from obtaining rights to such funds superior to those of

    one or more customers of the defaulting FCM.'').

    \241\ Id. See also CFTC Interpretative Statement. No. 85-3

    [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ]22,703 (Aug.

    12, 1985). A DCO's rights with respect to the use of customer margin

    funds may be limited in particular circumstances by reason of the

    clearing organization's knowledge of or participation in a violation

    of the Act or other provision of law that precludes it from

    obtaining rights to such funds superior to those of one or more

    customers of the defaulting clearing member. The letter provides

    that a DCO could be subject to aiding and abetting liability under

    section 13(a) of the Act if the DCO knowingly participates in a

    violation of the Act.

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

    The Commission emphasizes that while the depository has no

    affirmative obligation to police or monitor an FCM or DCO account

    holder's compliance with the Act or Commission regulations, the

    depository cannot ignore signs of wrongdoing. Should a depository know

    or suspect that funds held in a customer account have been improperly

    withdrawn or otherwise improperly used in violation of section 4d of

    the Act or the Commission's regulations related to segregation of

    customer funds, the Commission expects the depository to immediately

    report its concern to the Division of Swap Dealer and Intermediary

    Oversight, the Division of Clearing and Risk, the Division of

    Enforcement, or the Commission's Whistleblower Office.\242\

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

    \242\ See CFTC Interpretative Ltr. No. 79-1 (stating ``if a bank

    subsequently becomes aware of an unauthorized withdrawal or use of

    customers' funds by an FCM, we would expect the bank to notify the

    Commission immediately'').

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

    i. Liens

    The proposed Template Letters would include the following language:

    ``Furthermore, [the depository]

    [[Page 68540]]

    acknowledge[s] and agree[s] that such Funds may not be used by [the

    depository] or by [the FCM or DCO] to secure or guarantee any

    obligations that [the FCM or DCO] might owe to [the depository], nor

    may they be used by [the FCM or DCO] to secure credit from [the

    depository]. [The depository] further acknowledge[s] and agree[s] that

    the Funds in the Account(s) shall not be subject to any right of offset

    or lien for or on account of any indebtedness, obligations or

    liabilities [the FCM or DCO] may now or in the future have owing to

    [the depository]. This prohibition does not affect [the depository's]

    right to recover funds advanced in the form of cash transfers [the

    depository] make[s] in lieu of liquidating non-cash assets held in the

    Account(s) for purposes of variation settlement or posting initial

    (original) margin.'' This language is consistent with section 4d(b) of

    the Act, which states: ``It shall be unlawful for any person, including

    but not limited to . . . any depository, that has received any money,

    securities, or property for deposit in a separate account as provided

    in [section 4d(a)(2) of the Act], to hold, dispose of, or use any such

    money, securities, or property as belonging to the depositing [FCM] or

    any person other than the customers of such [FCM].''

    Schwartz & Ballen asserted that because many FCMs hold only cash

    assets in the accounts, the language in the letter should be expanded

    to permit banks to recover funds they advance that result in overdrafts

    in the accounts.\243\ Schwartz & Ballen further stated that the failure

    to permit banks to recover such advances whether or not there are non-

    cash assets in the account will likely lead to banks incurring

    losses.\244\ FCStone elaborated on this issue, explaining that a

    customer receives a margin call through an account statement, which is

    transmitted overnight, and the customer wires funds the following

    day.\245\ The DCO, however, automatically drafts the funds from the

    FCM's account at 9:00 a.m. on the basis of a depository's intraday

    daylight overdraft.\246\ Without granting a depository a lien on

    customer funds, FCStone stated that an FCM would be required to

    ``front'' all funds for customers until the customer has wired funds to

    the FCM.\247\ FCStone contended that a change of this sort could

    ``threaten the continued operations of small to mid-sized FCMs not

    affiliated with banks'' and cause a substantial liquidity strain.\248\

    The Depository Bank Group additionally warned that a depository may not

    be willing to provide intraday advances to the customer segregated

    account without the right to take a lien on the account or the right to

    set off between multiple customer segregated accounts and would,

    therefore, not be in a position to provide liquidity.\249\ As a result,

    an FCM or DCO would likely need to maintain a buffer of its own funds

    in the segregated customer accounts to fully pre-fund transactions

    related to such accounts.\250\ The Depository Bank Group contended that

    the impact on small- to mid-sized FCMs would be that of a lesser

    ability to enter into ``everyday transactions'' for the customer

    segregated account, which could result in exclusion from the

    industry.\251\ The Depository Bank Group cited as support a comment

    letter that staff of the Federal Reserve Bank of Chicago submitted in

    2010.\252\

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

    \243\ Schwartz & Ballen Comment Letter at 6-7 (Feb. 15, 2013).

    \244\ Id.

    \245\ FCStone Comment Letter at 4.

    \246\ Id.

    \247\ Id. at 5.

    \248\ Id.

    \249\ Depository Bank Group Comment Letter at 7 (Feb. 15, 2013).

    \250\ Id.

    \251\ Id.

    \252\ Comment letter from David A. Marshall, Federal Reserve

    Bank of Chicago, dated September 8, 2010.

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

    The Commission recognizes that a depository may not want to provide

    unsecured overdraft coverage. However, a depository taking a lien on a

    customer account to facilitate intraday payments presents a serious

    problem if an FCM's customer does not satisfy a margin call and the

    FCM, in turn, cannot cover the call and becomes insolvent before the

    depository can be repaid.

    The Commission interprets the requirements of section 4d of the Act

    to prohibit a lien on customer funds to satisfy an intraday extension

    of credit to an FCM to meet margin requirements at a DCO. As an

    alternative to taking a lien on the customer account, the depository

    could take a lien on a proprietary account held by the FCM at the

    depository, or the FCM could add its own funds to the segregated

    account or collect more margin from its customers in order to provide a

    more substantial financial cushion. It is not the Commission's

    intention to disadvantage mid-size and smaller FCMs in applying this

    standard across all FCMs, regardless of size.

    The Commission notes that no commenter has proffered information or

    data that would indicate intraday advances are a commonplace, routine

    occurrence. Indeed, it may be cause for concern if a large number of

    FCMs cannot meet intraday margin calls for customer accounts on a

    regular basis.

    Without expressing a view of the Commission's position concerning

    section 4d of the Act, FIA recommended expanding the circumstances in

    which a depository could impose a lien with respect to customer

    funds.\253\ FIA recommended revising the language to read: ``You

    further acknowledge and agree that the Funds in the Account(s) shall

    not be subject to any right of offset or lien for or on account of any

    indebtedness, obligations or liabilities we may now or in the future

    have owing to you except to recover from the Account(s) (or from any

    other CFTC Regulation 1.20 Customer Segregated Account(s) we have with

    you), Funds you may advance from time to time to facilitate

    transactions by or on behalf of, or on account of, or otherwise for the

    benefit of, the Account(s) or our customers whose Funds are held in the

    Account(s).'' \254\ The Commission confirms that a depository can

    possess a lien across multiple accounts of the same FCM as long as the

    accounts are of the same account class (i.e., 4d(a) cash and custodial

    accounts). However, the Commission believes FIA's suggested

    modification is overbroad and has the potential to be interpreted to

    permit a depository's imposition of a lien in a greater number of

    circumstances than section 4d of the Act allows.

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

    \253\ Katten-FIA Comment Letter at 2 (Aug. 2, 2013).

    \254\ Id.

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

    NYPC urged the Commission to clarify that DCOs have the right to

    transform non-cash customer funds into cash to satisfy liquidity needs

    related to the customer account of a defaulting FCM clearing member not

    only through the sale of such assets, but also through the use of

    liquidity arrangements, such as lines of credit and repurchase

    agreements.\255\ NYPC recommended that the Commission modify the last

    sentence in the ``lien'' paragraph as follows: ``The prohibitions

    contained in this paragraph do not affect your right to recover funds

    advanced by you in the form of cash transfers, lines of credit,

    repurchase agreements or other similar liquidity arrangements in lieu

    of the liquidation of non-cash assets held in the Account(s) for

    purposes of variation settlement or posting initial (original) margin

    with respect to the Account(s).'' The Commission recognizes that

    liquidity arrangements are an important aspect of a DCO's default

    management plan and agrees that the use of lines of

    [[Page 68541]]

    credit or repurchase agreements are acceptable alternatives to the

    liquidation of non-cash assets held in a customer account. As a result,

    the Commission has determined to modify the sentence in a manner

    similar to that recommended by NYPC.

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

    \255\ NYPC Comment Letter at 3 (Feb. 15, 2013).

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

    In response to the other comments, the Commission notes that it has

    always interpreted and applied section 4d of the Act in a manner

    consistent with the language in the proposed Template Letters. With

    respect to a depository's right of setoff against a customer account,

    the Commission has long recognized only one very limited circumstance.

    CFTC Interpretative Letter No. 86-9 allows, with certain

    limitations,\256\ a bank's right of setoff against a customer cash

    account that does not have sufficient available balances to meet a

    margin call, where there exists an affiliated custodial account that

    contains securities purchased with funds from the customer cash

    account.\257\ In this case, there is no extension of credit because the

    accounts, when aggregated, have enough assets to support the cash

    advance.

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

    \256\ See CFTC Interpretative Ltr. No. 86-9, [1986-1987 Transfer

    Binder] Comm. Fut. L. Rep. (CCH) ]23,015 (April 21, 1986) (limiting

    a bank's treatment of customer margin funds ``in particular

    circumstances by reason of what it knows or reasonably should know

    of a violation of the Act or other provision of law that would

    preclude it from obtaining rights to such funds superior to those of

    one or more customers of the defaulting FCM.'').

    \257\ Id.

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

    The Depository Bank Group raised a question about similar

    circumstances in which a depository might set off amounts owed to a

    customer segregated account holding U.S. dollars, with amounts held in

    foreign currency in another customer segregated account.\258\ To the

    extent that a depository advances cash in lieu of exchanging foreign

    currency held in a related 4d account, the same rationale that serves

    as the basis for CFTC Interpretative Letter No. 86-9 would apply, i.e.,

    the advancement of funds does not represent an extension of credit

    secured by customer funds. The Commission confirms that a depository

    holding customer funds in one segregated account may set off amounts

    withdrawn from another account in cases where the depository advances

    funds in lieu of converting cash in one currency to cash in a different

    currency.

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

    \258\ Id. at 8.

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

    The Template Letters provide for a depository's right of setoff

    against the customer account consistent with Interpretative Letter No.

    86-9. The Commission believes that expanding the scope of a

    depository's right of setoff to support extensions of credit to an FCM

    would violate the requirements of section 4d of the Act and notes that

    none of the commenters provided a legal analysis that would refute this

    position.

    The Commission recognizes, however, that there may be situations

    similar to those specifically enumerated in the proposed Template

    Letters for which an advancement of cash and the related imposition of

    a lien in lieu of liquidating non-cash assets or converting cash in one

    currency to cash in a different currency may be permissible. To

    accommodate this, the Commission is revising the language to remove the

    concluding clause, ``for the purposes of variation settlement or

    posting initial (original) margin.'' This change preserves the intended

    meaning and purpose of the provision without unintentionally limiting

    its application in other similar circumstances.

    Accordingly, the Commission is adopting the proposed ``lien''

    language of the Template Letters, modified to include a reference to

    the depository's right to recover funds related to certain liquidity

    arrangements and to eliminate specific examples of circumstances in

    which imposition of a lien would be permissible. FCMs, DCOs, and

    depositories are reminded that any permissible advancement of cash and

    related imposition of a lien on a customer account must be properly

    documented and recorded in compliance with all applicable recordkeeping

    requirements.

    j. Examination of Accounts

    As proposed, the Template Letters for both FCMs and DCOs would

    require a depository to agree that accounts holding customer segregated

    funds could be ``examined at any reasonable time'' by the Commission

    or, as applicable, an FCM's DSRO, and they further provide that the

    acknowledgment letter ``constitutes the authorization and direction of

    the undersigned to permit any such examination or audit to take

    place.'' Schwartz & Ballen commented that the provision should also

    provide for the Commission or DSRO to give the depository advance

    notice before being permitted to examine FCM accounts.\259\ The

    Commission is not including this recommended precondition because an

    examination of this type is likely to be conducted only in response to

    exigent circumstances and the ``reasonable time'' provision is

    sufficient evidence of the Commission's intent to proceed in a

    commercially reasonable manner under the particular circumstances.

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

    \259\ Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013).

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

    The Commission is retaining the examination provision in the FCM

    Template Letters but is not including it in the DCO Template Letters.

    Consistent with the Commission's determination regarding electronic

    access to DCO account information, the Commission believes that

    authorization to examine a DCO's customer segregated account at a

    depository is not necessary because of the Commission's ability to

    obtain account information directly from the depository upon request,

    and directly from the DCO through daily reporting under Sec.

    39.19(c)(1).

    As a technical matter, the Commission is eliminating use of the

    term ``audit'' to clarify that the examination will be targeted and is

    not intended to be an audit, as that term is used in the field of

    accounting.

    5. Prohibition against Commingling Customer Funds

    The Commission proposed to amend Sec. 1.20(e) to explicitly

    address the commingling of customer funds. Proposed Sec. 1.20(e)(1)

    provides that an FCM may, for convenience, commingle the funds that it

    receives from, or on behalf of, multiple futures customers in a single

    account or multiple accounts with one or more of the permitted

    depositories set forth in Sec. 1.20(b).

    Proposed Sec. 1.20(e)(2) prohibits an FCM from commingling futures

    customers funds with any proprietary funds of the FCM, or with any

    proprietary account of the FCM. Proposed Sec. 1.20(e)(2), however,

    provides that the prohibition on the commingling of futures customer

    funds and the FCM's proprietary funds does not prohibit an FCM from

    depositing proprietary funds into segregated accounts in accordance

    with proposed Sec. 1.23 as a buffer to prevent the firm from becoming

    undersegregated due to normal business activities, such as daily margin

    payments by the FCM to a DCO.

    Proposed Sec. 1.20(e)(3) further prohibits an FCM from commingling

    futures customer funds with funds deposited by 30.7 customers for

    trading foreign futures or foreign option positions in accordance with

    part 30 of the Commission's regulations, or with Cleared Swaps Customer

    Collateral deposited by Cleared Swaps Customers for Cleared Swaps under

    part 22 of the Commission's regulations. Proposed Sec. 1.20(e)(3)

    permits, however, the commingling of futures customer funds with 30.7

    customer funds and/or Cleared Swaps Customer funds if expressly

    permitted by a Commission

    [[Page 68542]]

    regulation or order, or by a DCO rule approved in accordance with Sec.

    39.15(b)(2) of the regulations.\260\

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

    \260\ Regulation 22.2(c)(2) regarding cleared swaps customer

    accounts already prohibits commingling.

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

    Similarly, a proposed amendment to Sec. 30.7 would prohibit an FCM

    from commingling funds required to be deposited in a foreign futures

    and foreign options secured amount account with funds required to be

    deposited in a customer segregated account or cleared swaps customer

    account.\261\

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

    \261\ Proposed Sec. 30.7(e)(3).

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

    The Commission received one comment on the proposed amendments to

    Sec. 1.20(e). FIA stated that it fully supported the proposed

    amendments, which implement the segregation provisions of section 4d(a)

    and 4d(f) of the Act.\262\

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

    \262\ FIA Comment Letter at 36 (Feb. 15, 2013).

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

    FIA further requested that the Commission confirm that the proposed

    amendments would not prohibit a customer that engages in futures

    transactions on a designated contract market, foreign futures or

    options transactions on foreign boards of trade, and Cleared Swaps

    through a single FCM, from meeting its margin obligations for the three

    different segregation accounts by making a single payment to the

    FCM.\263\ FIA states that such practice is common in the industry

    today, reduces the FCM's credit risk, is operationally more efficient

    for both the FCM and its customers, and indirectly reduces customer

    settlement risk.\264\

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

    \263\ Id.

    \264\ Id.

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

    The Commission confirms, subject to the following conditions, that

    a receipt of funds from a customer that wishes to meet its multiple

    margin obligations by making a single deposit payment to the FCM is not

    prohibited by Sec. 1.20. The FCM, however, must initially receive the

    customer's funds into the customer's section 4d(a)(2) segregation

    account. The funds may not be directly deposited into the customer's

    Sec. 30.7 secured account or Cleared Swaps Segregation Account, as

    such accounts may present different risks than the section 4d(a)(2)

    account, and the Commission would like to standardize operationally the

    practice of how customer funds are received by FCMs by authorizing one

    approach that would be applicable to all customers to minimize the

    possibility of transactional errors.

    In addition, the FCM must simultaneously record the book entry

    credit to the customer's Sec. 30.7 secured account and the customer's

    Cleared Swaps Account (as applicable) as directed by the customer upon

    the receipt and recording of the cash into the customer's 4d(a)(2)

    segregation account. Also, the FCM must ensure at the time the book

    entry credit is made to the customer's account, that the credit does

    not result in the FCM having obligations to 30.7 customers or Cleared

    Swaps Customers that are in excess of the total assets held in such

    accounts for such customers. Failure of the FCM to hold a sufficient

    amount of excess funds in the 30.7 customer accounts and Cleared Swaps

    Customer Accounts at any time to meet its obligations to such customers

    would be a violation of the Act and the Commission's regulations.

    Furthermore, if the FCM permits customers to use one wire transfer

    to fund more than one account class, the FCM's policy and procedures

    for assessing the appropriate amount of targeted residual interest

    required under Sec. 1.11 must take this practice into consideration

    and should include appropriate adjustments and estimates to reflect

    this practice. Finally, the Commission hereby clarifies that all prior

    guidance concerning the receipt of customer deposits at branch

    locations or otherwise deposited into the FCM's proprietary accounts,

    regardless of excess funds held in segregation, is repealed and

    withdrawn and such practice is not permitted under Sec. 1.20 as

    adopted.\265\

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

    \265\ Previous guidance permitted a branch office of an FCM to

    deposit customer funds into an unsegregated bank account if the main

    office of the FCM on the same day deposited the same amount of its

    funds into a segregated bank account, and kept records fully

    explaining the transactions. See Commodity Exchange Authority

    Administrative Determination No. 203 (December 1, 1966). See also

    CFTC Interpretative Letter No. 90-7 (Secured Amount Account for

    Foreign Futures and Options, May 1, 1990). This practice is now

    prohibited.

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

    The Commission adopts the amendment as proposed.

    6. Limitations on the Use of Customer Funds

    Proposed Sec. 1.20(f) requires FCMs to treat and deal with the

    funds of a futures customer as belonging to such futures customer. In

    addition, the Commission proposed to prohibit an FCM from using, or

    permitting the use of, the funds of futures customer for any person

    other than for futures customers, subject to certain limited

    exceptions. Proposed Sec. 1.20(f) also states that an FCM may obligate

    futures customers' funds to a DCO or another FCM solely to purchase,

    margin, or guarantee futures and options positions of futures

    customers, and that no person, including any DCO or any depository,

    that has received futures customer funds for deposit in a segregated

    account, may hold, dispose of, or use any such funds as belonging to

    any person other than the futures customers of the FCM that deposited

    such funds.

    The Commission did not receive any comments regarding proposed

    Sec. 1.20(f). However, as discussed above, the FIA stated that it

    agrees that FCMs are required to comply with the segregation provisions

    of the Act at all times, and expressed general support for the

    Commissions efforts to implement the Act's segregation provision.\266\

    The Commission notes that the language in proposed Sec. 1.20(f)

    largely mirrors the language set forth in current Sec. 1.20, which

    language was, and continues to be, intended to further implement the

    segregation provisions of the Act.\267\ Thus, the Commission is

    adopting the provision as proposed.

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

    \266\ FIA Comment Letter at 2 (June 20, 2013). See also section

    II.G.1. above for a further discussion of an FCM's obligation to be

    in compliance with its segregation obligation at all times.

    \267\ Accordingly, relevant prior Commission orders and guidance

    will continue to apply to Sec. 1.20(f). For example, in In re

    JPMorgan Chase Bank CFTC 12-17 (April 4, 2012), the Commission

    simultaneously initiated and settled an action against a depository

    for violating Sec. 1.20(a) and (c) because it unlawfully used

    customer funds as belonging to someone other than the customers of

    an FCM. Specifically, the Commission found that a depository's

    intra-day extension of credit to an FCM (Lehman Brothers) based upon

    customer funds the FCM had deposited with a bank (JPMorgan Chase)

    violated Sec. 1.20(a) and (c). Regulation 1.20(f) would continue to

    prohibit such use of customer funds, as well as any other type of

    disposal, holding or use the Commission has previously identified as

    unlawful.

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

    7. Segregation Requirements for DCOs

    Proposed Sec. 1.20(g) provides segregation requirements applicable

    to DCOs, as opposed to FCMs. Proposed paragraph (g)(2) lists the

    permitted depositories for futures funds received by a DCO as any bank

    or trust company, and clarifies that the term ``bank'' includes a

    Federal Reserve Bank. The necessity for this proposed amendment is

    highlighted by section 806(a) of the Dodd-Frank Act, which provides

    that a Federal Reserve Bank may establish and maintain a deposit

    account for a ``financial market utility'' (in the present case, a DCO)

    that has been designated as systemically important by the Financial

    Stability Oversight Council. Proposed paragraph (g)(3) requires DCOs to

    comply with the provisions of Sec. 1.49 with respect to holding

    segregated funds outside the U.S. Regulation 1.20(g)(5) prohibits a DCO

    from commingling futures customer funds with the DCO's proprietary

    funds or with any proprietary account of any of its clearing members,

    and prohibits the DCO from commingling funds held for futures customers

    with funds deposited by clearing members on behalf of their

    [[Page 68543]]

    Cleared Swaps Customers. DCOs would be permitted to commingle the funds

    of multiple futures customers in a single account or accounts for

    operational convenience. The Commission adopts the amendment as

    proposed.

    8. Immediate Availability of Bank and Trust Company Deposits

    The Commission proposed a paragraph (h) to Sec. 1.20 to require

    that all futures customer funds deposited with a bank or trust company

    must be deposited in accounts that do not impose any restrictions on

    the ability of the FCM or DCO to withdraw such funds upon demand. An

    FCM or DCO may not deposit customer funds in any account with a bank or

    trust company that does not, by the terms of the account or operation

    of banking law, provide for the immediate availability of such deposits

    upon the demand of the FCM or DCO.

    Paragraph (h) codifies a long-standing interpretation of the

    Commission's Division of Swap Dealer and Intermediary Oversight and

    predecessor divisions derived from an Administration Determination by

    the Commission's predecessor, the Commodity Exchange Authority of the

    U.S. Department of Agriculture.\268\ The requirement, as proposed, is a

    practical necessity to the effective functioning of FCMs and futures

    markets. In this regard, customer funds deposited with a bank must be

    maintained in accounts that allow for the immediate availability of the

    funds in order for the FCM to be assured of meeting its obligation to

    make any necessary transfers of customer funds to a DCO or to return

    funds to customers upon their request. The Commission is adopting

    paragraph (h) as proposed.\269\

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

    \268\ See Administrative Determination No. 29 of the Commodity

    Exchange Authority dated Sept. 28, 1937 stating, ``the deposits, by

    a futures commission merchant, of customers' funds * * * under

    conditions whereby such funds would not be subject to withdrawal

    upon demand would be repugnant to the spirit and purposes of the

    Commodity Exchange Act. All funds deposited in a bank should in all

    cases be subject to withdrawal on demand.''

    \269\ CIEBA noted it is comment letter that industry groups are

    involved in various initiatives to provide customers with the option

    for full physical segregation of margin collateral, and requested

    confirmation that Sec. 1.20(h) would not prohibit the use of a full

    segregation model if developed. See CIEBA Comment Letter at 4 (Feb.

    20, 2013). The Commission encourages industry groups to continue to

    assess alternatives to the current segregation structure in an

    effort to provide greater protection of customer funds and to ensure

    the effective operation of the clearing and settlement functions.

    Regulation 1.20(h) is intended to prohibit situations where an FCM

    or DCO deposits customer funds into an account that by law or

    operation limits or potentially limits the FCM's or DCO's ability to

    withdraw the funds from the account for the use intended (i.e., as

    performance bond). The Commission would consider any future

    amendments to Sec. 1.20(h) based upon the developments of

    alternative segregation modes.

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

    9. Segregated Funds Computation Requirement

    The Commission proposed to add a new paragraph (i), which mirrored

    the requirements recently adopted in part 22 for Cleared Swaps

    Customers. Proposed paragraph (i) was designed to implement, with

    increased detail, the Net Liquidating Equity Method of calculating

    segregation requirements. A customer may have positive Net Liquidating

    Equity (i.e., a credit balance) in his or her account, requiring

    segregation of his or her funds, but may have insufficient Net

    Liquidating Equity to cover the margin required for that customer's

    open positions.

    Accordingly, the Commission proposed to require an FCM to record in

    the accounts of its futures customers the amount of margin required for

    each customers' open positions, and to calculate margin deficits (i.e.,

    undermargined amounts) for each of its customers. Moreover, the

    Commission proposed to require that an FCM maintain residual interest

    in segregated accounts in an amount that exceeds the sum of all futures

    customers' margin deficits (``the Proposed Residual Interest

    Requirement'').\270\

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

    \270\ See discussion in note 30 above. Therefore, under the

    Proposed Residual Interest Requirement an FCM would have to maintain

    at all times in segregated account a sufficient amount of funds to

    cover the Net Liquidating Equities of each customer and a sufficient

    amount of residual interest to cover the undermargined amounts of

    each customer.

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

    In addition, the Commission proposed an amendment to Sec.

    1.22.\271\ Regulation 1.22 is a longstanding regulation\272\ and

    currently provides that an FCM may not use the cash, securities or

    other property deposited by one futures customer to purchase, margin or

    settle the trades, contracts, or other positions of another futures

    customer, or to extend credit to any other person.\273\ This

    ``requirement is designed not only to prevent disparate treatment of

    customers by an FCM, but also to insure that there will be sufficient

    money in segregation to pay all customer claims if the FCM becomes

    insolvent.'' \274\ Regulation 1.22 further provides that an FCM may not

    use the funds deposited by a futures customer to carry trades or

    positions, unless the trades or positions are traded through a

    DCM.\275\

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

    \271\ 77 FR 67886.

    \272\ See, e.g., 13 FR, 7820, 7837 (Dec. 18, 1948).

    \273\ 17 CFR 1.22.

    \274\ 46 FR 11668, 11669 (Feb. 10, 1981).

    \275\ 17 CFR 1.22.

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

    The Commission proposed an amendment to Sec. 1.22 to clarify that

    it is not permissible for an FCM to be undersegregated at any point in

    time during the day. As stated in the Proposal, section 4d(a)(2)

    expressly requires an FCM to segregate futures customers' funds from

    its own funds, and prohibits an FCM from using the funds of one

    customer to margin or extend credit to any other futures customer or

    person.\276\ Moreover, to review compliance with these proposed

    requirements, the Commission proposed that the sum of all margin

    deficits (i.e., undermargined amounts) be reported on the Segregation

    Schedule (as discussed previously in section II.A. with respect to

    amendments to Sec. 1.10) and on the daily segregation

    calculation.\277\

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

    \276\ 77 FR 67886.

    \277\ Id.

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

    The Commission requested comment on all aspects of the Proposed

    Residual Interest Requirement, including the costs and benefits of this

    proposed regulation.\278\

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

    \278\ See 77 FR 67882, 67916. The Commission also specifically

    requested comments on the following: Whether the Proposed Residual

    Interest Requirement would serve to increase the protections to

    customer funds in the event of an FCM bankruptcy? To what extent

    would the Proposed Residual Interest Requirement increase costs to

    FCMs and/or futures customers? To what extent would the Proposed

    Residual Interest Requirement benefit futures customers and/or FCMs?

    To what extent would the Proposed Residual Interest Requirement

    increase or mitigated market risk? To what extent would the Proposed

    Residual Interest Requirement lead to FCMs requiring customers to

    provide margin for their trades before placing them? To what extent

    is the Proposed Residual Interest Requirement likely to lead to a

    re-allocation of costs from customers with excess margin to

    undermargined customers? For purposes of margin deficit

    calculations, whether the Commission should address issues

    surrounding the timing of when an FCM must have sufficient funds in

    the futures customer account to cover all margin deficits? If so,

    how should the Commission address such issues? See 77 FR at 67882.

    With regards to the costs and benefits, the Commission asked the

    following questions: Whether FCMs typically maintain residual

    interest in their customer segregated account that is greater than

    the sum of their customer margin deficits, and data from which the

    Commission may quantify the average difference between the amount of

    residual interest an FCM maintains in customer segregated accounts

    and the sum of customer margin deficit. How much additional residual

    interest would FCMs need to hold in their customer segregated

    accounts in order to comply with the Proposed Residual Interest

    Requirement? What is the opportunity cost to FCMs associated with

    increasing the amount of capital FCMs place in residual interest,

    and data that would allow the Commission to replicate and verify the

    calculated estimates provided. Information regarding the additional

    amount of capital that FCMs would likely maintain in their customer

    segregated accounts, if any, to comply with the Proposed Residual

    Interest Requirement. What is the average cost of capital for an

    FCM? See 77 FR at 67916.

    The Commission also specifically requested that commenters

    provide data and calculations that would allow the Commission to

    replicate and verify the cost of capital that commenters estimate.

    See id.

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

    [[Page 68544]]

    The Commission has received and has considered a wide variety of

    public comments regarding the Proposed Residual Interest Requirement,

    including comments from panelists made during public roundtables and

    written submissions from commenters.

    Several commenters supported the Commission's Proposed Residual

    Interest Requirement. CIEBA stated that it strongly supported the

    Proposed Residual Interest Requirement, arguing that the proposed

    regulations are consistent with Congressional intent and the

    Commission's historical interpretations of the Act and sound economic

    and systemic risk policy. Highlighting section 4d(a)(2) of the Act and

    its directive that FCMs ``keep collateral and funds of each individual

    customer distinct from that of customers and the FCM,'' CIEBA argued

    that ``permitting FCMs to use customer funds to cover margin deficits

    of a different customer and thereby subsidize the FCM's obligations

    would'' contravene well established statutory policy.\279\ In addition,

    CIEBA noted that the Dodd-Frank Act was adopted to increase regulatory

    protections for customers.\280\ CIEBA also noted several benefits

    resulting from the Proposed Residual Interest Requirement, including

    the reduction of systemic risk, competitive benefits for those FCMs

    that do not use customer excess to meet the obligations of other

    clients, and the enhancement of customer protection in the event of an

    FCM bankruptcy.\281\ ICI also stated that it supported the Proposed

    Residual Interest Requirement on the basis that it would provide

    additional protections to customer funds.\282\ SIFMA asserted that it

    strongly supported the Proposed Residual Interest Requirement because

    it preserves the sanctity of each customer's margin account by

    maintaining segregation between customer margin accounts through the

    incorporation of appropriate safeguards to protect customer funds.\283\

    SIFMA stated that the proposal, ``in effect, shifts the costs and

    burdens of a margin shortfall from customers with excess margin to

    customers with deficits, where it properly belongs.'' \284\ Paul/Weiss

    supported the Proposed Residual Interest Requirement ``[i]n

    principle.'' \285\ Vanguard stated that it was ``particularly

    supportive'' of the Proposed Residual Interest Requirement.\286\ Noting

    that while an FCM would either have to have its customers pre-fund

    margin requirements for pending trades or ``lend'' such customers

    margin ahead of a margin transfer, Vanguard argued that the ``proposed

    changes correctly shift the risk to customers in deficit and away from

    any excess margin transferred by other customers.'' \287\ Vanguard also

    argued that, in its opinion, comments at the public roundtable that

    ``suggested same-day margin transfers were overly complicated to

    achieve and the accelerated capital charge would therefore impose

    significant added costs to an FCM and, by extension, to its

    customers,'' seem overstated particularly because same-day margin

    transfer is ``the norm in the OTC swap market.'' \288\ In fact,

    Vanguard stated that ``same-day margin transfer is required in

    Vanguard's futures and options agreements, consistent with the long-

    standing market practice.'' \289\ Vanguard encouraged the Commission to

    avoid weakening customer protection, ``at least a weakening beyond the

    need to maintain segregation on no less than a once-a-day basis, with

    the possibility for clearing house initiated intra-day calls (and

    corresponding segregation maintenance) as needed in periods of market

    stress.'' \290\ CFA also supported the Proposed Residual Interest

    Requirement, asserting its belief ``that no futures customer should be

    under-segregated at any time during the day for any reason.'' \291\

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

    \279\ CIEBA Comment Letter at 2 (Feb. 20, 2013).

    \280\ Id.

    \281\ Id. at 3. On this point, CIEBA further noted that allowing

    an FCM to use customer excess to support other customer's positions

    could lead to improper or complex recordkeeping, which can, in turn,

    jeopardize the ability of a trustee to facilitate the return of

    customer funds and the porting of positions to a solvent FCM.

    \282\ ICI Comment Letter at 3 (Jan. 14, 2013). See also Franklin

    Comment Letter at 2 (Feb. 15, 2013) (writing in support of the

    positions taken in the ICI Comment Letter).

    \283\ SIFMA Comment Letter at 2 (Feb. 21, 2013).

    \284\ Id.

    \285\ Paul/Weiss Comment Letter at 3 (Feb. 15, 2013).

    \286\ Vanguard Comment Letter at 7 (Feb. 22, 2013).

    \287\ Id.

    \288\ Id.

    \289\ Id.

    \290\ Id. at 7-8.

    \291\ CFA Comment Letter at 5-6 (Feb. 13, 2013).

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

    A number of commenters opposed the Proposed Residual Interest

    Requirement on the basis that the requirement appeared wholly unrelated

    to the MFGI and PFGI bankruptcies,\292\ with other commenters observing

    that the Proposed Residual Interest Requirement is unnecessary to

    achieve the regulatory goals, including assuring compliance with

    section 4d of the Act, in light of other Commission regulations.\293\

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

    \292\ See, e.g., CHS Hedging Comment Letter at 1 (Feb. 15,

    2013); NFA Comment Letter at 12 (Feb. 15, 2013); JSA Comment Letter

    at 2 (Feb. 15, 2013); Paragon Comment Letter at 1 (Feb. 15, 2013);

    NIBA Comment Letter at 2 (Feb. 15, 2013); ICA Comment Letter at 1

    (Feb. 15, 2013).

    \293\ See, e.g., FIA Comment Letter at 18-21 (Feb. 15, 2013).

    See also FIA Comment Letter at 2-5 (June 20, 2013).

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

    In addition, several commenters commented on the lack of

    feasibility of the proposal, interpreting the ``at all times'' language

    to require FCMs to continuously calculate the sum of their customers'

    margin deficits, and to continuously act on those calculations. For

    example, RCG stated that it would be virtually impossible for FCMs to

    satisfy the Proposed Residual Interest Requirement because an accurate

    assessment of aggregate customer margin deficiencies would be difficult

    given that (1) ``the underlying markets operate on a 24-hour basis and

    customer fund transfers occur repeatedly throughout each business

    day,'' and (2) ``omnibus account offsets are not provided to clearing

    FCMs until the end of the trading day or, in some instances, the next

    business day.'' \294\ MGEX also argued that ``at all times''

    requirement in the Proposed Residual Interest Requirement may be

    impracticable as it is a constantly moving target,\295\ and TD

    Ameritrade argued that because the firm calculates margin calls after

    it receives its nightly downloads, ``it would be difficult, if not

    impossible, to assess customer margin deficiencies at any moment in

    time, because the markets have not closed and the margin requirements

    are not always known.'' \296\ In addition, CME stated that there does

    not appear to be a system that currently exists or that could be

    constructed in the near future that will permit FCMs to accurately

    calculate customer margin deficiencies, at all times.\297\ CMC asserted

    that the ``at all times'' portion of the Proposed Residual Interest

    Requirement would ``create liquidity issues and increase costs for FCMs

    and end users,'' possibly ``limit the number and type of transactions

    FCMs clear, the number of customers they service and the amount of

    financing they provide,'' and ``require executing FCMs to collect

    collateral for give-ups so that customer positions are fully margined

    in the event a trade is rejected by a clearing

    [[Page 68545]]

    FCM,'' \298\ which ``may force many end users to decrease or

    discontinue hedging and risk management practices.'' \299\ Advantage

    opposed the Proposed Residual Interest Requirement asserting that it

    was ``extremely prejudicial to small and midsize firms and their

    customers.'' \300\ Advantage also stated that the Proposed Residual

    Interest Requirement would result in FCMs more quickly liquidating

    customer positions during extreme market moves, which would make

    markets more volatile.\301\ Advantage also maintained that calculations

    of margin for omnibus accounts cannot be determined prior to the

    receipt of offsets, which may not be obtained until late in the day,

    thereby adversely impacting an FCM's ability to assess customer margin

    deficiencies.\302\

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

    \294\ RCG Comment Letter at 3 (Feb. 12, 2013).

    \295\ See MGEX Comment Letter at 2 (Feb. 18, 2013). See also

    NPPC Comment Letter at 2 (Feb. 15, 2013) (stating that the ``at all

    times'' portion of the Proposed Residual Interest Requirement is

    ``burdensome'', and that changing margin procedures ``to anticipate

    future market movements, pre-fund margin calls, [or] make margin

    call deposits throughout the day based on current market movements

    is impractical.'').

    \296\ TD Ameritrade Comment Letter at 4-5 (Feb. 15, 2013).

    \297\ See CME Comment Letter at 5 (Feb. 15, 2013).

    \298\ CMC Comment Letter at 2 (Feb. 15, 2013).

    \299\ Id.

    \300\ Advantage Comment Letter at 8 (Feb. 15, 2013).

    \301\ See id. at 7-8.

    \302\ See id. at 7.

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

    FIA and LCH.Clearnet opposed the Proposed Residual Interest

    Requirement, and focused particularly on the ``at all times'' portion

    of the requirement.\303\ FIA stated that the Proposed Residual Interest

    Requirement may force a number of small to mid-sized FCMs out of the

    market, which will decrease access to the futures markets and increase

    costs for IBs, hedgers, and small traders.\304\ In addition, FIA argued

    that the Proposed Residual Interest Requirement would significantly

    impair the price discovery and risk management purposes of the

    market.\305\ Moreover, FIA stated that the Proposed Residual Interest

    Requirement ``would impose a tremendous operational and financial

    burden on the industry, requiring the development and implementation of

    entirely new systems to assure compliance'' with the ``at all times''

    portion of the requirement.\306\ FIA also averred that the ``provisions

    of section 4d of the Act prohibiting an FCM from using the fund of one

    customer `to margin or guarantee the trades or contracts, or to secure

    or extend the credit, of any customer or person other than the one for

    whom the same are held,' has been the lynchpin of customer funds

    protection since the Commodity Exchange Act was enacted in 1936.''

    \307\ In addition, FIA stated that they were not aware that the

    Commission has interpreted the statute to require the real time

    calculation of margin deficits.\308\

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

    \303\ See FIA Comment Letter at 4-5, 12-26 (Feb. 15, 2013);

    LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013).

    \304\ See FIA Comment Letter at 17 (Feb. 15, 2013).

    \305\ See id. at 4, 17.

    \306\ Id. at 4. See also id. at 13.

    \307\ FIA Comment Letter at 2 (June 20, 2013).

    \308\ Id.

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

    Several commenters requested that the Commission refrain from

    adopting the Proposed Residual Interest Requirement until it conducted

    further analysis with the industry regarding the costs and benefits of

    such proposal,\309\ with others stating that the Proposed Residual

    Interest Requirement would mark a significant departure from current

    market practice and could have a material adverse impact on the

    liquidity and smooth functioning of the futures and swaps markets.\310\

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

    \309\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC

    Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at

    2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF

    Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9

    (Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA

    Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.

    15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment

    Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.

    18, 2013).

    \310\ See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA

    Comment Letter at 2 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb.

    15, 2013); AFMP Group Comment Letter at 1-2 (Sept. 18, 2013); Rice

    Dairy LLC Comment Letter at 1 (Feb. 13, 2013).

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

    In addition, the Commission received several specific comments on

    the potential costs and benefits of the Proposed Residual Interest

    Requirement. The Congressional Committees requested that the Commission

    consider the benefits in light of ``both the costs to America's farmers

    and ranchers and the potential impact on consolidation in the FCM

    industry,'' and in particular the ``consequences of changing the manner

    or frequency in which `residual interest'--the capital an FCM must hold

    to cover customer positions--is calculated.'' \311\

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

    \311\ Congressional Committees Comment Letter at 1 (Sept. 25,

    2013).

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

    FIA noted that FCMs would look to avoid the need to use their own

    resources by seeking to make sure that their customers would not be

    undermargined, and that this process would involve the FCM collecting

    greater amounts of collateral from each customer.\312\ FIA averred that

    collecting greater amounts of collateral from customers would be

    contrary to the desire of the market to reduce the amount of funds

    maintained with FCMs following the failures of MFGI and PFGI.\313\

    Moreover, FIA estimated that compliance with the Proposed Residual

    Interest Requirement would require FCMs or their customers to

    contribute significantly in excess of $100 billion into customer funds

    accounts beyond the sum required to meet initial margin requirements,

    and that the annual financing costs for these increases will range from

    $810 million to $8.125 billion.\314\

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

    \312\ FIA Comment Letter at 17 (Feb. 15, 2013).

    \313\ Id. at 17. See also AFMP Group Comment Letter at 1 (Sept.

    18, 2013) (arguing that ``[m]uch more customer money--maybe twice as

    much--will be at risk in the event of another FCM insolvency.'').

    \314\ FIA Comment Letter at 16 (Feb. 15, 2013).

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

    MFA asserted that applying the Proposed Residual Interest

    Requirement continuously to FCMs ``could significantly increase the

    operational burdens and costs on FCMs and their customers,'' and that

    ``any pre-funding obligation is an unacceptable imposition on

    customers'' because ``[i]t would create margin inefficiencies by

    causing customers to reserve assets to pre-fund their obligations . . .

    , and thus, reduce the amount of assets that customers have to use for

    investment or other purposes.'' \315\ FHLB cautioned that ``[w]hile it

    cannot be disputed that a residual interest buffer should lower the

    risk that an FCM will fall out of compliance with its segregation

    requirements, there will likely be a real economic cost associated with

    maintaining whatever residual interest buffers is established by an

    FCM'' and that ``the prospects of funding an additional residual

    interest buffer may discourage FCMs from appropriately demanding

    collateral from customers in excess of DCO requirements.'' \316\ FHLB

    further noted that the ``funds maintained by an FCM as residual

    interest can reasonably be expected to earn less than the FCM's

    unrestricted funds,'' thus, the proposal ``represents a real cost to

    FCMs'' that will be passed on to customers.\317\ Jefferies stated that

    the Proposed Residual Interest Requirement will result in more assets

    being held at FCMs' custodial facilities at a time when ``the

    Commission has been enacting changes that have been shifting capital

    away from FCMs towards DCO facilities. . . .'' \318\ Newedge also

    stated that the Proposed Residual Interest Requirement ``will result in

    many FCMs requiring customers to pre-fund and over-margin their

    positions, which will increase

    [[Page 68546]]

    their exposure to FCMs'' and ``have a significant impact on customers'

    own liquidity.'' \319\

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

    \315\ MFA Comment Letter at 8 (Feb. 15, 2013).

    \316\ FHLB Comment Letter at 3-4 (Feb. 15, 2013).

    \317\ Id. at 4 n.5.

    \318\ Jefferies Comment Letter at 7 (Feb. 15, 2013). See also

    CCC Comment Letter at 2 (Feb. 15, 2013) (arguing that ``the

    practical effect'' of the Proposed Residual Interest Requirement

    ``is that FCMs would require commodity customers to contribute

    significantly more property to their FCM in order to meet new margin

    requirements far in excess of exchange margin requirements,'' and

    expressing concern over any requirement that would require customers

    ``to contribute even more capital to a system [CCC] believe[s] is

    flawed.'')

    \319\ Newedge Comment Letter at 2 (Feb. 15, 2013).

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

    Steve Jones expressed the view that ``[w]ith more funds on deposit,

    a corrupt FCM CEO (or other staff with access to the funds) will simply

    be more tempted to `misappropriate' the funds.\320\ In addition,

    Jefferies stated that requiring an FCM to maintain this level of

    residual interest ``at all times'' ``would impose tremendous financial

    and operational difficulties'' on FCMs, which would result in

    tremendous increases to necessary liquidity, and ``negatively impact

    competitiveness within the industry. . . .'' \321\ Jefferies further

    stated that the Proposed Residual Interest Requirement would impose

    heavy costs, and that, under the proposal, Jefferies would be required

    to increase its residual interest by $15 million (non-peak) or $30

    million (peak), respectively.\322\ Jefferies also stated that the

    industry would be required to increase its residual interest by $49

    billion (non-peak) or $83 billion (peak) at a cost of approximately $2

    billion (non-peak) or $5 billion (peak), respectively.\323\

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

    \320\ Steve Jones Comment Letter at 1 (Feb. 15, 2013).

    \321\ Jefferies Comment Letter at 7 (Feb. 15, 2013).

    \322\ Id. at 8.

    \323\ Id.

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

    ISDA asserted that the Proposed Residual Interest Requirement will

    make customers ``self-guaranteeing'' and diminish reliance on the FCM,

    and that, while this would diminish overall risk of FCM default, it

    comes at a very significant cost to market participants, market volumes

    and liquidity.\324\ ISDA estimated the funding needed to comply with

    ``at all times'' portion of the Proposed Residual Interest Requirement

    to be $73.2 billion, with a long term impact of $335 billion.\325\ CHS

    Hedging argued that the Proposed Residual Interest Requirement ``would

    substantially increase the amount of capital an FCM would need on hand

    at all times.'' \326\ Further, CHS Hedging stated that ``[i]n the

    current economic environment, the difference between the cost of

    capital and the return an FCM could reasonably expect through

    investment of funds in a compliant and prudent manner would result in a

    material effect on the business of all FCMs.'' \327\ CHS Hedging also

    stated that FCMs ``could require that customers pre-fund their accounts

    in anticipation of adverse market movement,'' which ``would likely

    result in hardship with regard to working capital and may encourage

    customers to seek alternative methods to hedge their risk. . . .''

    \328\ CHS Hedging is also of the view that ``pre-funding accounts

    concentrates additional funds at FCMs, which seems to contradict the

    spirit of the'' customer protection rules.\329\

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

    \324\ ISDA Comment Letter at 3 (Feb. 15, 2013). See also ISDA

    Comment Letter at 2-3 (May 8, 2013).

    \325\ ISDA Comment Letter at 4-5 (Feb. 15, 2013).

    \326\ CHS Hedging Comment Letter at 2 (Feb. 15, 2013).

    \327\ Id.

    \328\ Id.

    \329\ Id.

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

    Other commenters argued that the Proposed Residual Interest

    Requirement would be more burdensome on smaller FCMs and customers.

    Some commenters stated that forcing FCMs to ask customers to pre-fund

    positions will cause many futures industry participants, including

    agricultural producers and other customers to suffer a financial burden

    by tying up capital that is better used in other areas, such as the

    operation of the feedlot, stocker operation or cow/calf operation,\330\

    with two commenters asserting that increased costs associated with the

    use of wire transfers, rather than checks, would have a similar

    impact.\331\ Moreover, NCFC stated that in addition to increased costs

    for hedgers, the Proposed Residual Interest Requirement ``would be more

    burdensome to firms like farmer cooperative-owned FCMs'' because they

    ``are largely homogenous, with virtually all of their commercial

    customers going deficit at the same time.'' \332\ NCFC also asserted

    that ``[t]o require all deficits to be covered immediately would be

    overly stringent on these FCMs given the low-risk profile of their

    customers as hedgers,'' \333\ while NIBA noted that the Proposed

    Residual Interest Requirement ``will actually limit or deny market

    access to many customers'' (such as farmers, ranchers and other

    agricultural organizations) ``who use the markets to hedge their

    financial and commercial risks'' because the proposal ``could raise the

    cost of hedging product to prohibitive levels.'' \334\ NIBA also stated

    that if small to mid-sized FCMs are forced out of business, market

    access ``will become limited and more expensive for IBs and their

    smaller hedge and speculative clients.'' \335\ JSA argued that the

    Proposed Residual Interest Requirement would be ``punitive in a highly

    competitive environment that already places the midsize operator at a

    disadvantage to his better capitalized multinational competitors.''

    \336\ JSA also asserted that the resulting consolidation would cause

    ``the loss of competitive forces, [the] loss of significant numbers of

    jobs, and the loss of transparency and liquidity required for a highly

    functioning hedging environment.'' \337\ Moreover, JSA stated that the

    cost of the Proposed Residual Interest Requirement would result in a

    higher cost of hedging, which would be become prohibitive and prompt

    agricultural users to walk away from the futures market.\338\ CME

    averred that mid-sized and smaller FCMs will not have the capital

    required by the Proposed Residual Interest Requirement and that

    customers will be required to pre-fund potential margin

    obligations.\339\ CME asserted that, given this increase in cost, some

    customers may transfer their accounts to the larger, better-capitalized

    FCMs to reduce the cost of trading,\340\ but that agricultural

    customers ``likely will not be able to transfer to the larger FCMs

    because they do not fit their customer profile,'' thereby making these

    customers bear more of the cost burden.\341\ CME also stated that the

    Proposed Residual Interest Requirement will lead to consolidation among

    FCMs, which will ``actually increase[] systemic risk by concentrating

    risk among fewer market participants.'' \342\ Frontier Futures argued

    that the Proposed Residual Interest Requirement does not give an FCM

    time to collect margin from customers if the market moves against a

    customer's position.\343\ Because many small customers, including most

    farmers, do not watch markets constantly, it would be difficult for

    them to meet margin calls on a

    [[Page 68547]]

    moment's notice, thereby causing FCMs to require significantly higher

    margins or to liquidate customer positions where margin calls cannot be

    immediately met.\344\ Frontier Futures also asserted that the proposal

    ``may force a number of small to mid-sized FCMs out of the market,''

    making it more expensive, if not impossible, for IBs and small members

    to clear their business, removing ``significant capital from the

    futures industry,'' and ``reducing stability to the markets as a

    whole.'' \345\ RJ O'Brien stated that the Proposed Residual Interest

    Requirement is impractical because many farmers and agricultural

    clients still use checks and ACH to meet margin calls.\346\

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

    \330\ TCFA Comment Letter at 2 (Feb. 15, 2013); NCBA Comment

    Letter at 2 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15,

    2013); Randy Fritsche Comment Letter at 1 (Feb. 15, 2013); Global

    Commodity Comment Letter at 1 (Feb. 13, 2013); AFMP Group Comment

    Letter at 1-2 (Sept. 18, 2013).

    \331\ TCFA Comment Letter at 1 (Feb. 15, 2013); NCBA Comment

    Letter at 1 (Feb. 15, 2013).

    \332\ NCFC Comment Letter at 2 (Feb. 15, 2013).

    \333\ Id.

    \334\ NIBA Comment Letter at 1 (Feb. 15, 2013).

    \335\ Id. at 1-2. NIBA also asserted that ``[t]ransferring

    accounts between brokerage houses would become very difficult to

    accomplish'' because open positions would ``need to be margined at

    the receiving house as well as the transferring one,'' thereby

    restraining Brokers ``to remain with one FCM, or completely close

    customers' positions in order to start up again with a different

    FCM.'' Id. at 2.

    \336\ JSA Comment Letter at 1 (Feb. 15, 2013).

    \337\ Id. at 1-2.

    \338\ Id. at 2.

    \339\ CME Comment Letter at 5-6 (Feb. 15, 2013).

    \340\ Id. at 6.

    \341\ Id.

    \342\ Id. (emphasis in original). CME also maintained that

    ``those customers who qualify as [ECPs] can move to the uncleared

    and less regulated swaps space and decline to use centralized

    clearing.'' Id. at 6-7.

    \343\ Frontier Futures Comment Letter at 3 (Feb. 15, 2013).

    \344\ Id.

    \345\ Id.

    \346\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013). See also

    ICA Comment Letter at 1-2 (Feb. 15, 2013).

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

    Several commenters presented alternative proposals for the

    Commission's consideration. For example, two commenters argued that the

    Commission should consider less costly alternatives to the current

    residual interest proposal, such as allowing the FCM ``to count

    guaranty fund deposits with [DCOs] as part of their residual

    interest,'' \347\ with others stating that the residual interest amount

    that an FCM must carry should only apply to a limited number of its

    largest customers.\348\

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

    \347\ Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ

    O'Brien Comment Letter at 5 (Feb. 15, 2013). Cf. Frontier Futures

    Comment Letter at 3 (Feb. 15, 2013) (suggesting further that firm

    firewalls be put in place between customer funds and an FCM's

    proprietary funds in the form of approval by an independent agency

    for an FCM to transfer customer funds and that FCMs ``do their

    proprietary trading through another FCM thereby engaging the risk

    management of a third party.'')

    \348\ See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013).

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

    Moreover, and as discussed more fully below, other commenters urged

    the Commission to conform the final version of proposed Rules

    1.20(i)(4), 22.2(f)(6), and 30.7(a) to the current method of

    calculating residual interest buffer for Cleared Swaps by dropping the

    words ``at all times.'' \349\ For example, ISDA and FIA further urged

    consideration of an alternative under which the residual interest

    calculations would be made once a day and that, by the end of a

    business day, an FCM would be required to maintain a residual interest

    in its customer funds accounts at least equal to its customers'

    aggregate margin deficits for the prior trade date.\350\ ISDA stated

    this alternative ``would rationally reduce'' FCMs cost of

    compliance\351\ and that ``[f]or an FCM with robust credit risk

    management systems, covering end-of-day customer deficits should not be

    a significant cost.'' \352\ ISDA also noted that at the end of the day

    ``typically, all customer calls have been met, and all customer gains

    have been paid out; all achieved without the FCM having recourse to its

    own funding resources.'' \353\ FIA asserted that it would ``achieve the

    Commission's regulatory goals without imposing the damaging financial

    and operational burdens on FCMs, and the resulting financial burdens on

    customers.'' \354\ LCH.Clearnet argued that customer collateral can be

    protected by performing the ``LSOC Compliance Calculation'' once per

    day, prior to settlement at a DCO, because ``prior to meeting a call

    for an increased requirement, a customer may be under collateralized,

    but is not collateralized by another customer.'' \355\ ISDA and FIA

    evaluated the costs associated with requiring FCMs to perform the

    residual interest calculation once each day at the close of business on

    the first business day following the trade date.\356\ ISDA estimated

    that ``removing the predictive element of FCM funding requirements'' of

    the ``at all times'' method in favor of the alternative approach would

    permit markets to ``reap the efficiencies of end-of-day accounting,''

    \357\ thereby significantly reducing the overall cost of compliance

    with the regulation. ISDA estimated that for futures, the costs

    associated with the would be the cost of covering the out-standing

    margin deficits of between 2 and 5% of its futures customers, and thus

    would impose only ``incremental funding requirements'' on FCMs.\358\

    ISDA estimated that the costs of the alternate proposal would be even

    smaller for cleared swaps, due to the ``more professional'' nature of

    the market.\359\ FIA estimated the financing costs to FCMs of complying

    with FIA's proposed alternative and concluded that the costs associated

    with the Proposed Residual Interest Requirement would be approximately

    ten times the costs associated with the FIA proposal.\360\ FIA also

    concluded that their proposal would not ``impos[e] damaging financial

    and operational burdens on FCMs . . . and the resulting financial

    burdens on customers.''\361\

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

    \349\ See, e.g., LCH.Clearnet Comment Letter at 5 (Feb. 15,

    2013); ISDA Comment Letter at 6 (Feb. 15, 2013); RJ O'Brien Comment

    Letter at 5 (Feb. 15, 2013).

    \350\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment

    Letter at 23-25 (Feb. 15, 2013).

    \351\ ISDA Comment Letter at 6 (Feb. 15, 2013).

    \352\ ISDA Comment Letter at 2 (May 8, 2013).

    \353\ Id. ISDA further recommended that because many FCM

    customers use custodians across the world, ``many customers cannot

    assure payment of their morning FCM call before the end of the New

    York day,'' and therefore recommended that Commission study the

    feasibility of reducing the time in which customers have to meet

    margin calls, if that is ``imperative.'' Id. at 3.

    \354\ FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA

    Comment Letter at 4 (May 8, 2013).

    \355\ LCH.Clearnet Comment Letter at 5 (Feb. 15, 2013).

    \356\ ISDA Comment Letter at 1-2 (May 8, 2013); FIA Comment

    Letter at 8-10 (June 20, 2013).

    \357\ Id. at 3.

    \358\ ISDA Comment Letter at 3-4 (May 8, 2013).

    \359\ Id. at 4.

    \360\ See FIA Comment Letter at 8-10 (June 20, 2013). While the

    rates used by FIA in this exercise may be conservative, and thus the

    Commission does not purport to opine on the precise estimates

    reached, the exercise is nevertheless illustrative and useful for

    the purpose of comparing the costs of the Residual Interest

    Proposal, the alternate proposal, and the final rule.

    \361\ Id. at 9.

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

    RJ O'Brien also recommended that the Commission drop the ``at all

    times'' requirement and that the residual interest calculation be done

    once each day at the close of business on the first business day

    following the trade date.\362\ RJ O'Brien asserted that ``this

    alternative will reduce the substantial financial burdens'' on

    customers ``while further enhancing the protection of customer funds.''

    \363\

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

    \362\ RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).

    \363\ Id.

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

    MFA stated that the Commission should modify the proposed FCM

    residual interest requirement in Sec. 1.20(i)(4) so that it is a

    ``point of time'' obligation that requires FCMs to ensure they maintain

    sufficient residual interest ``as of the close of business EST on the

    business day after the FCM issues a customer's margin call.'' \364\ MFA

    argued that this alternative would ``reduce the stress on the market''

    and ``eliminate[] the need for customer pre-funding or intraday margin

    calls, while also ensuring that * * * FCMs will hold sufficient funds

    to protect against customer shortfalls.'' \365\

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

    \364\ MFA Comment Letter at 8-9 (Feb. 15, 2013).

    \365\ Id.

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

    Paul/Weiss stated that the Commission should clarify that the

    residual interest amount an FCM is required to maintain must be

    determined ``at the time of any end-of-day, intra-day or special call

    payment by an FCM to derivatives clearing organization (or other

    clearing house or clearing intermediary). . . .''\366\ Paul/Weiss

    argued that these payments are ``the relevant points in time at which

    [[Page 68548]]

    the FCM is obligated to transfer'' customer margin.\367\

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

    \366\ Paul/Weiss Comment Letter at 4 (Feb. 15, 2013).

    \367\ Id.

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

    As a threshold matter, and as noted above, the Commission

    reiterates that the Act expressly prohibits an FCM from using the

    collateral of one customer to margin, secure, or guarantee the trades

    or contracts of other customers.\368\ Congress specifically added this

    prohibition in response to concerns that certain customers were

    carrying the risks and obligations of other favored customers.\369\ By

    this token, any customer that is undermargined is being favored over

    the customers with excess margin, in contravention of section 4d(a)(2)

    when other customers' funds are being used to cover the undermargined

    amounts.\370\

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

    \368\ The Commission further notes that current Commission

    regulations also include such prohibitions. Namely, Sec. 1.22

    states that ``No futures commission merchant shall use, or permit

    the use of, the futures customer funds of one futures customer to

    purchase, margin, or settle the trades, contracts, or commodity

    options of, or to secure or extend the credit of, any person other

    than such futures customer,'' and Sec. 22.2(d)(1) states that ``No

    futures commission merchant shall use, or permit the use of, the

    Cleared Swaps Customer Collateral of one Cleared Swaps Customer to

    purchase, margin, or settle the Cleared Swaps or any other trade or

    contract of, or to secure or extend the credit of, any person other

    than such Cleared Swaps Customer.''

    \369\ See 80 Cong. Rec. 6159, 6162 (1936) (statement of Sen.

    James. P. Pope) (``It further appears that certain favored dealers

    have not been required actually to put up the money for margins, and

    have been extended credit in that respect. This gives these favored

    dealers an advantage. In some instances, large commission firms have

    become bankrupt and the funds placed with them by a large number of

    dealers were lost.''); ``Regulation of Grain Exchanges: Before the

    H. Comm. on Agriculture,'' 73 Cong. 31 (1934) (statement of Dr. J.

    W. T. Duvel, Chief Grain Futures Admin. Dept. of Agriculture) (``On

    the commodities exchanges certain classes of speculators and others

    are able to secure credit but in many cases the credit so extended

    represents margin money taken from one class of customers and used

    to extend credit on [sic] margin the trades of others. Our aim is to

    protect the customers' margin money and thereby protect the market

    as a whole.'').

    \370\ As some commenters report, institutional customers in

    particular are typically undermargined. This could mean that

    institutional customers are being favored over individual customers.

    See, e.g., FIA Comment Letter at 15 (Feb. 15, 2013).

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

    Moreover, there is an inescapable mathematical fact: When an FCM

    meets the DCO's margin requirements, the property used to meet those

    requirements can only come from one of three sources: the responsible

    customer, the FCM, or other customers. If the property does not come

    from the customer whose positions generated the margin requirement or

    loss, or the FCM itself (that is, the FCM's residual interest), then it

    must, of necessity, come from other customers.\371\ In reviewing the

    Commission's customer protection rules in light of MFGI and PFGI, staff

    identified market practices that were in tension with the plain

    language of the Act, and, as such, the Commission attempted to clarify

    acceptable practices with respect to these existing statutory

    requirements with the Proposed Residual Interest Requirement.

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

    \371\ As recognized by the Commission previously, the obligation

    to ensure that one customer's property is not used to margin or

    settle the trades or contracts of another customer rests with the

    FCM. See 46 FR 11668, 11669. (stating that ``section [4d(a)(2)] of

    the Act and Sec. Sec. 1.20 and 1.22 of the Commission's regulations

    require an FCM to add its own money into segregation in an amount

    equal to the sum of all customer deficits.''). See also CFTC Letter

    00-106 (Nov. 22, 2000) (stating that ``each FCM must segregate

    sufficient funds to cover any amounts it owes to its customers in

    connection with commodity interest transactions. The funds of

    multiple customers may be commingled in a single account for the

    benefit of the customers as a group. If, however, the balance of any

    one of those customers falls into a deficit, the FCM is obligated to

    restore the amount of such deficit out of its own funds or property

    in order to avoid the use of the funds or property or any other

    customer to meet the obligations of the customer in deficit. The

    Commission requires FCM's [sic] to maintain minimum levels of

    capital to help assure that, among other things, they are able to

    meet such obligations.'').

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

    As noted above, several commenters strongly supported the Proposed

    Residual Interest Requirement, noting it is consistent with

    Congressional intent and the Commission's historical interpretations of

    the Act. In general, these commenters argued that the proposal

    correctly shifts the risk of loss to customers with margin deficiencies

    and away from customers with excess margin. Some of these commenters

    questioned market cost estimates and statements regarding the technical

    challenges associated with same-day margin transfers, and urged the

    Commission to avoid unnecessarily weakening customer protection.

    On the other hand, many commenters expressed concern regarding the

    costs associated with the Proposed Residual Interest Requirement. In

    particular, commenters stated that requiring the FCM to be in

    compliance with residual interest requirements ``at all times'' would

    disparately impact agricultural producers, small and mid-size FCMs, and

    hedgers; decrease market liquidity; cause market consolidation; and

    increase systemic risk. Moreover, the Commission notes that many of the

    estimates of the amount of additional capital required as a result of

    the Proposed Residual Interest Requirement seem to result from a

    particular interpretation of the meaning of the ``at all times''

    portion of the proposal, and seemed to range from $49 billion (non-

    peak) and $83 billion (peak),\372\ to $73.2 billion,\373\ to upwards of

    $100 billion.\374\ Further, commenters asserted that the ``at all

    times'' portion of the Proposed Residual Interest Requirement would be

    operationally unachievable, and argued that the Proposed Residual

    Interest Requirement would curtail competition, concentrate capital in

    FCMs at a time when the market would like to reduce the amount of

    customer collateral held at the FCM, and reduce the number of viable

    FCMs, thereby negatively impacting overall market risk and market

    access for smaller customers and agricultural hedgers. Commenters also

    argued that the Proposed Residual Interest Requirement is unnecessary

    because in their view, customer funds are not at risk when fellow

    customer accounts are undermargined.\375\

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

    \372\ See Jefferies Comment Letter at 8-9 (Feb. 15, 2013).

    Jefferies states that the proposal would require them to increase

    residual interest by $15 million (non-peak) to $30 million (peak).

    \373\ See ISDA Comment Letter at 4-5 (Feb. 15, 2013). ISDA

    argued that the long term impact of the ``at all times'' portion of

    the proposal could be as high as $335 billion.

    \374\ See FIA Comment Letter at 15-17 (Feb. 15, 2013). FIA also

    estimated that the annual financing costs associated with the $100

    billion cost could range from $810 million to $8.125 billion.

    \375\ See Transcript, U.S. Commodity Futures Trading Commission

    Agricultural Advisory Committee Meeting held on July 25, 2013,

    available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/aac_transcript072513.pdf.

    _____________________________________-

    Many of the commenters interpreted the proposal to require FCMs to

    continuously calculate and monitor the margin deficits of their

    customers. In the final rulemaking, the Commission is, in general,

    following the concept advanced by Paul/Weiss and LCH.Clearnet--that is,

    what is required is that the FCM not ``use'' one customer's property to

    margin another customer's positions. For an interim phase-in period,

    the Commission is adopting the alternative proposal recommended by

    several commenters, including FIA. Thus, for the reasons set forth

    below, by the Residual Interest Deadline, which is defined in Sec.

    1.22(c)(5), an FCM would be required to maintain a residual interest in

    its customer funds accounts at least equal to its customers' aggregate

    margin deficits for the prior trade date.\376\ The commenters asserted,

    and the Commission agrees that this alternative would significantly and

    materially reduce the financial burdens that would otherwise be imposed

    on

    [[Page 68549]]

    customers and FCMs alike under the Commission's Proposed Residual

    Interest Requirement \377\ because, among other things, this alternate

    approach would not cause an extreme drain on market liquidity, market

    consolidation, increase in systemic risk, and detrimental effect on

    agricultural producers, small and mid-size FCMs, and hedgers.\378\

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

    \376\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013);

    CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5-6

    (Feb. 15, 2013); FIA Comment Letter at 4-5 (Feb. 15, 2013);

    LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MGEX Comment

    Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15,

    2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O'Brien Comment

    Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4-5

    (Feb. 15, 2013).

    \377\ The Commission notes that representatives from FIA, ISDA,

    and ADM Investor Services have all indicated in meetings with

    Commission staff that such an alternative would better protect

    customers, benefit FCMs risk management practices, and materially

    reduce many costs associated with the Commission's original

    proposal.

    \378\ See ISDA Comment Letter at 3 (May 8, 2013) (noting that a

    substantial majority of customer margin calls are met by 5:00 p.m.

    on the day the calls are issued and therefore the this approach

    would not impose the costs and cause the problems associated with

    the Proposed Residual Interest Requirement); FIA Comment Letter at 9

    (June 20, 2013) (estimating that the alternative approach would be

    10 times less costly for FCMs to finance). See also MFA Comment

    Letter at 8-9 (Feb. 15, 2013); RJ O'Brien Comment Letter at 5 (Feb.

    15, 2013).

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

    After careful consideration of the comments and the applicable

    statutory provisions, the Commission has decided to adopt the Proposed

    Residual Interest Requirement with modifications.

    Section 4d(a)(2) of the Act expressly states that the money,

    securities, and property received by an FCM from a customer to margin,

    guarantee, or secure the trades or contracts of that customer shall be

    separately accounted for and shall not be commingled with the funds of

    such commission merchant or be used to margin or guarantee the trades

    or contracts, or to secure or extend the credit, of any customer or

    person other than the one for whom the same are held.\379\ Moreover,

    the Commission notes that when section 22 of the rules and regulations

    of the Secretary of Agriculture under the Act (the predecessor of Sec.

    1.22) was adopted in 1937,\380\ the year after adoption of the Act, it

    expressly stated that ``No futures commission merchant shall use, or

    permit the use of, the money, securities, or property of one customer

    to margin or settle the trades or contracts, or to secure or extend the

    credit, of any person other than such customer. The net equity of one

    customer shall not be used to carry the trades or contracts or to

    offset the net deficit of any other customer or person or to carry the

    trades or offset the net deficit of the same customer in goods or

    property not included in the term `commodity' as defined herein.''

    \381\ This language addresses, by its terms, more than net deficits,

    and appears to have remained substantively unchanged for the next four

    decades.

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

    \379\ See also section 4d(f)(2) of the Commodity Exchange Act,

    as well as Sec. 1.22 of this section and Sec. 22.2(d)(1) of this

    chapter.

    \380\ 2 FR 1223, 1225 (July 16, 1937).

    \381\ Id. at 1225 (emphasis supplied).

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

    In 1981, in its Regulation of Domestic Exchange-Traded Commodity

    Options, the Commission revised Sec. 1.22 to combine segregation

    requirements for options with existing segregation requirements for

    futures.\382\ In doing so, the Commission generalized the regulatory

    language and deleted specific references to ``net equity.'' However,

    neither the adopting release nor the proposing release for the

    ``Regulation of Domestic Exchange-Traded Commodity Options'' rulemaking

    indicated an intent to alter or modify the existing segregation

    requirements for futures.\383\

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

    \382\ See 46 FR 54500 (Nov. 3, 1981).

    \383\ See id. at 54508 (Final Release) (stating that because the

    Commission did not receive any comments on its proposed regulations

    relating to segregation of customer funds, it was adopting the

    amendments essentially as proposed). In addition, in stating that

    ``the Commission is now proposing that the option segregation

    requirements be combined with the existing segregation requirements

    for futures,'' the proposing release noted that certain definitions

    ``have also been added or modified to permit defined terms to be

    used in the sections, as amended, and thereby simplify the

    regulations.'' See 46 FR 33293-01, 33298 (June 29, 1981).

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

    The current version of Sec. 1.22 states that ``[n]o futures

    commission merchant shall use, or permit the use of, the futures

    customer funds of one futures customer to purchase, margin, or settle

    the trades, contracts, or commodity options of, or to secure or extend

    the credit of, any person other than such futures customer.''

    The Commission's Proposed Residual Interest Requirement was

    intended to ensure compliance with section 4d(a)(2) and Sec. 1.22 by

    shifting the risk of loss in the event of a double default back to the

    customer whose positions incurred the loss and away from those

    customers with excess margin at the FCM. Contrary to the assertion of

    certain commenters, whenever an FCM uses the funds of customers with

    excess margin to collateralize the positions of undermargined

    customers, the customers with excess funds are subject to heightened

    risk, and diminished availability of those excess funds for transfer in

    the event the FCM is in financial distress.

    Nonetheless, commenters asserted that there is ambiguity regarding

    (1) the point at which an FCM has ``used'' or ``permitted the use'' of

    the futures customer funds of one futures customer to purchase, margin,

    or settle the trades, contracts, or commodity options of, or to secure

    or extend the credit of, another futures customer, and (2) what an FCM

    is required to do to comply with this requirement. Accordingly, the

    Commission is adopting proposed Sec. Sec. 1.20(i) and 1.22 with

    certain modifications.

    First, the Commission is revising proposed Sec. 1.20(i) by

    removing the Proposed Residual Interest Requirement from paragraph

    (i)(4). In addition, the Commission is revising the language in Sec.

    1.22 to add an amended residual interest requirement and additional

    technical corrections to Sec. 1.20(i) as described further below.

    Moreover, the Commission is reorganizing proposed Sec. 1.22 as

    follows: (1) The sentence that reads ``No futures commission merchant

    shall use, or permit the use of, the futures customer funds of one

    futures customer to purchase, margin, or settle the trades, contracts,

    or commodity options of, or to secure or extend the credit of, any

    person other than such futures customer.'' will be in paragraph (a);

    (2) the remaining language in proposed paragraph (a) will be deleted;

    (3) the sentence that reads ``Futures customer funds shall not be used

    to carry trades or positions of the same futures customer other than in

    contracts for the purchase of sale of any commodity for future delivery

    or for options thereon traded through the facilities of a designated

    contract market.'' will remain in paragraph (b); and (4) as discussed

    below, a new paragraph (c) will be added to address the revised

    residual interest requirements.

    As highlighted above, several commenters questioned the ability of

    FCMs to measure compliance on a continuous and real-time basis,\384\

    and argued that the potential cost associated with a continuous

    residual interest requirement would have an adverse impact on the

    market.\385\ The Commission is persuaded that continuous calculation

    and monitoring requirements are not technologically feasible at this

    time. The Commission is also persuaded that it would not be practical

    to make such calculations in the futures markets based on intra-day

    [[Page 68550]]

    changes.\386\ However, as discussed in more detail below, the

    Commission is persuaded that the calculations required by the residual

    interest requirement are feasible using a point in time approach.

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

    \384\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013);

    CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5-6

    (Feb. 15, 2013); FIA Comment Letter at 4-5 (Feb. 15, 2013);

    LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MGEX Comment

    Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15,

    2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O'Brien Comment

    Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4-5

    (Feb. 15, 2013).

    \385\ See, e.g., CMC Comment Letter at 2 (Feb. 15, 2013); CME

    Comment Letter at 5 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb.

    18, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RJ O'Brien

    Comment Letter at 4 (Feb. 15, 2013).

    \386\ See, e.g., Advantage Comment Letter at 7 (Feb. 15, 2013);

    CME Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4,

    15, 21-22 (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013);

    NPPC Comment Letter at 2 (Feb. 15, 2013); RCG Comment Letter at 3

    (Feb. 12, 2013); TD Ameritrade at 4-5 (Feb. 15, 2013). Cf. ISDA

    Comment Letter at 1-2 (Aug. 27, 2013).

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

    As noted above, the Commission is moving the Proposed Residual

    Interest Requirement from proposed Sec. 1.20(i) to new paragraph (c)

    in Sec. 1.22. Moreover, and as suggested by commenters,\387\ the

    Commission agrees that a point in time approach to the determination of

    the adequate size of the residual interest amount would ``ensure that

    an FCM has appropriately sized the residual interest buffer to cover

    the aggregated gross margin deficiencies in respect of customer

    transactions in the relevant origin.'' \388\ Further, the Commission

    agrees that this approach is consistent with the Act and Commission

    regulations, and would help ensure that the collateral of one customer

    is never used to margin the positions of another customer.\389\

    Moreover, the Commission notes that a point in time approach is

    consistent with the current practice with respect to residual interest

    buffer calculations for Cleared Swaps and with the approach set forth

    in JAC Update 12-03.\390\

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

    \387\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment

    Letter at 23-25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5

    (Feb. 15, 2013); Paul/Weiss Comment Letter at 4-5 (Feb. 15, 2013);

    RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).

    \388\ Paul/Weiss Comment Letter at 4 (Feb. 15, 2013).

    \389\ See generally id.; FIA Comment Letter at 23 (Feb. 15,

    2013); ISDA Comment Letter at 4 (May 8, 2013).

    \390\ Joint Audit Committee Regulatory Update 12-03,

    Part 22 of CFTC Regulations--Treatment of Cleared Swaps Customer

    Collateral--Legally Segregated Operationally Commingled (``LSOC'')

    Compliance Calculation (Oct. 18, 2012).

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

    Accordingly, the Commission is revising the Proposed Residual

    Interest Requirement as follows. Regulation 1.22 (c)(1) defines the

    undermargined amount for a futures customer's account as the amount, if

    any (i.e., the amount must be greater than or equal to zero), by which

    (i) the total amount of collateral required for that futures customer's

    positions \391\ in that account, at the time or times referred to in

    Sec. 1.22(c)(2), exceeds (ii) the value of the net liquidating equity

    for that account, as calculated in Sec. 1.20(i)(2). An FCM is required

    to perform the calculation set forth in Sec. 1.22(c)(1) on a customer

    by customer basis. Regulation 1.22(c)(2) requires an FCM to perform a

    residual interest buffer calculation, at the close of each business

    day, based on the information available to the FCM at that time,\392\

    by calculating (i) the undermargined amounts, based on the clearing

    initial margin that will be required to be maintained by that FCM for

    its futures customers, at each DCO of which the FCM is a member, at the

    point of the daily settlement (as described in Sec. 39.14) that will

    complete during the following business day for each such DCO less (ii)

    any debit balances referred to in Sec. 1.20(i)(4) included in such

    undermargined amounts.\393\

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

    \391\ For purposes of this calculation, the FCM should include

    as ``positions'' any trade or contract that (i) would be required to

    be segregated pursuant to 4d(f) of the Act or (ii) would be subject

    to Sec. 30.7 of this chapter, but which is, in either case,

    pursuant to a Commission rule, regulation, or order (or a

    derivatives clearing organization rule approved in accordance with

    Sec. 39.15(b)(2) of this chapter), commingled with a contract for

    the purchase or sale of a commodity for future delivery and any

    options on such contracts in an account segregated pursuant to

    section 4d(a) of the Act and should exclude as ``positions'' any

    trade or contract that, pursuant to a Commission rule, regulation,

    or order, is segregated pursuant to section 4d(f) of the Act. This

    requirement is intended to be analogous to the definition of Cleared

    Swap in Sec. 22.1 of this chapter.

    \392\ An FCM is not expected to account for changes in

    circumstances that occur after the close of business and prior to

    the next business day's settlement, outside of normal end-of-day

    reconciliation processes. In other words, an FCM may use the

    information (such as position and value information) available to it

    at the close of each business day for this calculation.

    \393\ This subtraction is intended to address the potential

    double-counting of deficit balances that was pointed out in a number

    of comments. See, e.g., Vanguard Comment Letter at 8 (Feb. 22,

    2013).

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

    An FCM is required to perform the calculation in Sec. 1.22(c)(2)

    once per day, based on the information at the close of business on that

    day, so that it can determine the amount of customer funds which will

    be needed to avoid using the funds of one customer to margin,

    guarantee, or secure the positions of another customer. Consistent with

    this revised residual interest requirement, Sec. 1.20(i)(4) is being

    amended to state that the amount of funds an FCM is holding in

    segregation may not be reduced by any debit balances that the futures

    customers of the FCM have in their accounts. In addition, Sec.

    1.20(i)(2)(ii) is being removed because this requirement is now set

    forth in Sec. 1.22(c). Consistent with Federal Register requirements,

    Sec. 1.20(i)(2) is being renumbered and, for clarity, the first

    sentence will be revised to read as follows ``The futures commission

    merchant must reflect in the account that it maintains for each futures

    customer the net liquidating equity for each such customer, calculated

    as follows: the market value of any futures customer funds that it

    receives from such customer, as adjusted by: . . . .'' \394\ Further,

    under Sec. 1.22(c)(3), an FCM is required, prior to the Residual

    Interest Deadline, as defined in Sec. 1.22(c)(5), to have residual

    interest in the segregated account in an amount that is at least equal

    to the computation set forth in Sec. 1.22(c)(2).\395\ However, the

    amount of residual interest that an FCM must maintain may be reduced to

    account for payments received from or on behalf of (net of

    disbursements made to or on behalf of) undermargined futures customers

    between the close of the previous business day and the Residual

    Interest Deadline.

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

    \394\ As noted in the preamble to the proposal, the purpose of

    the amendments to 1.20(i) is to ``provid[e] more detail implementing

    the Net Liquidating Method of calculating segregation

    requirements.'' 77 FR at 67882.

    \395\ Following the completion of the phase-in period, when the

    Residual Interest Deadline moves to the time of settlement, an FCM

    may be subject to multiple Residual Interest Deadlines, in which

    case the FCM must maintain residual interest prior to the Residual

    Interest Deadline in an amount that is at least equal to the portion

    of the computation set forth in Sec. 1.22(c)(2) attributable to the

    clearing initial margin required by the DCO making such settlement.

    Thus, where an FCM is a member of more than one DCO and the DCOs

    conduct their daily settlement cycles at different times, an FCM

    would be required, at the time of the daily settlement for each DCO,

    to maintain the proportionate share of residual interest in the

    futures customer account.

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

    Regulation 1.22(c)(4) provides that for purposes of Sec.

    1.22(c)(2), an FCM should include, as ``clearing initial margin,''

    customer initial margin that the FCM will be required to maintain, for

    that FCM's futures customers, at another FCM, and, for purposes of

    Sec. 1.22(c)(3), must do so prior to the Residual Interest Deadline.

    In other words, Sec. 1.22(c)(4) is intended to make clear that the

    requirements with respect to futures customer funds used by an FCM that

    clears through another FCM are parallel to the requirements applied

    with respect to futures customer funds used when an FCM clears through

    a DCO.

    Regulation 1.22(c)(5) defines the Residual Interest Deadline.

    Paragraph (c)(5)(i) sets forth that except during the phase-in period

    defined in paragraph (c)(5)(ii), the Residual Interest Deadline shall

    be the time of the settlement referenced in paragraph (c)(2)(i), or, as

    appropriate, (c)(4). However, in response to the comments that urge

    that achieving compliance with these requirements may take time, and in

    order to mitigate some of the cost concerns raised by commenters,

    paragraph (c)(5)(ii) provides that the Residual Interest Deadline

    during the phase-in period shall be 6:00 p.m.

    [[Page 68551]]

    Eastern Time on the date of the settlement referenced in paragraph

    (c)(2)(i) or, as appropriate, (c)(4). The phased compliance schedule

    for Sec. 1.22(c) is set forth in Sec. 1.22(c)(5)(iii). However, the

    Residual Interest Deadline of 6:00 p.m. Eastern Time in Sec.

    1.22(c)(5)(ii) shall begin one year following the publication of this

    rule in the Federal Register.\396\

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

    \396\ For further discussion regarding the phase-in schedule for

    the requirements in Sec. 1.22(c), see section III.F.

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

    Additionally, in further response to the commenters' request for

    additional study,\397\ in paragraph (c)(5)(iii)(A), the Commission is

    directing staff to complete and publish for public comment a report

    (``the Report''), no later than 30 months following the date of

    publication of this release, addressing, to the extent information is

    practically available, the practicability (for both FCMs and customers)

    of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on

    the date of the settlement referenced in Sec. 1.22(c)(2)(i) to the

    time of that settlement (or to some other time of day), including

    whether and on what schedule it would be feasible to do so. The Report

    is also expected to address cost and benefit considerations of such

    potential alternatives. Moreover, staff shall, using the Commission's

    Web site, solicit public comment and shall conduct a public roundtable

    regarding specific issues to be covered by the Report. Paragraph

    (c)(5)(iii)(B) sets forth that within nine months after the publication

    of the Report, the Commission may (but shall not be required to) do

    either of the following: (1) terminate the phase-in period, in which

    case the phase-in shall end as of a date established by order published

    in the Federal Register, which date shall be no less than one year

    after the date such order is published, or (2) determine that it is

    necessary or appropriate in the public interest to propose through

    rulemaking a different Residual Interest Deadline, in which event, the

    Commission shall establish, by order published in the Federal Register,

    a phase-in schedule. Finally, paragraph (c)(5)(iii)(C) provides that if

    the phase-in schedule has not been amended pursuant to Sec.

    1.22(c)(5)(iii)(B), then the phase-in period shall end on December 31,

    2018.

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

    \397\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC

    Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at

    2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF

    Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9

    (Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA

    Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.

    15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment

    Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.

    18, 2013).

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

    With respect to the suggestion that a portion (i.e., that portion

    attributable to customer business) of the funds contributed to an

    exchange's guaranty fund by an FCM should be considered in that FCM's

    residual interest calculations,\398\ the Commission notes that

    contributions to a guarantee fund are not segregated for the benefit of

    customers. Rather, they are, by design, available to meet the defaults

    of other clearing members, and thus cannot be counted as customer

    segregated funds. As such, the Commission declines to adopt this

    suggestion.

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

    \398\ See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013); RJ

    O'Brien Comment Letter at 5 (Feb. 15, 2013).

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

    The Commission also received several requests for clarifications.

    CIEBA stated that ``while futures market participants may be familiar

    with terms such as `residual interest' and the technical features of

    the proposed rule, other market participants may not appreciate the

    full scope of the rule and the additional protections provided without

    further explanation.'' \399\ CIEBA requested that the Commission

    clarify ``how this requirement is intended to work with examples of its

    application so as to more broadly communicate the Commission's intent

    to bolster the depth of customer protections to minimize customer risk

    and promote confidence in the markets.'' \400\ The Commission

    recognizes CIEBA's concern and, as discussed above, has provided

    clarification in this release regarding the mechanism by which FCMs

    measure compliance with the statutory requirement of 4d(a)(2). However,

    the Commission also recognizes that FCMs engage in a broad range of

    acceptable business practices and should be given flexibility in how

    best to tailor their businesses to comply with such requirement.

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

    \399\ CIEBA Comment Letter at 3 (Feb. 15, 2013).

    \400\ Id.

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

    AIMA requested clarification that Sec. Sec. 1.17(c)(5) and

    1.20(i)(4) are not duplicative and therefore does not require FCMs to

    ``double count'' residual interest.\401\ The Commission reiterates that

    Sec. 1.17(c)(5) and the residual interest requirement now set forth in

    1.22(c)(2) are two separate requirements. As discussed above, Sec.

    1.17 sets forth the Commission's minimum capital requirements for FCMs

    and requires, among other things, an FCM to incur a charge to capital

    for customer and noncustomer accounts that are undermargined beyond a

    specified period of time.\402\ The residual interest requirements, on

    the other hand, are intended to help make sure that the collateral of

    one customer is never used to margin the positions of another customer.

    These requirements are, therefore, not duplicative, and the Final Rule

    does not actually require an FCM to double count the residual interest

    amount.\403\

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

    \401\ See AIMA Comment Letter at 3 (Feb. 15, 2013).

    \402\ See section II.F. above.

    \403\ See section II.F. above regarding the requirement set

    forth Sec. 1.17(c)(5).

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

    Paul/Weiss requested that the Commission confirm that the

    requirements of jurisdiction and denomination in Sec. 1.49 do not

    apply to an FCM's cash management procedures for meeting its residual

    interest obligation.\404\ Paul/Weiss noted that JAC Update 12-03,\405\

    provides that the denomination and jurisdiction requirements set forth

    in Sec. 1.49 do not apply to the extent that an FCM deposits

    additional funds in order to cover margin deficiencies in the Cleared

    Swaps Customer Account prior to a \406\ DCO's settlement.\407\ The

    Commission agrees that, for purposes of meeting any undermargined

    amount in a customer account with a deposit of additional funds prior

    to payment to any DCO, the requirements of Commission Sec. 1.49 with

    respect to denomination or jurisdiction should not apply, and

    accordingly, they will not.

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

    \404\ Paul/Weiss Comment Letter at 6 (Feb. 15, 2013).

    \405\ This update provides that, for purposes of meeting any

    margin deficiency in the cleared swaps customer account with a

    deposit of additional funds prior to payment to any DCO, the

    requirements of Commission Sec. 1.49 with respect to denomination

    or jurisdiction will not apply.

    \406\ Paul/Weiss Comment Letter at 5-6 (Feb. 15, 2013).

    \407\ Paul/Weiss Comment Letter at 5-6 (Feb. 15, 2013).

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

    FCStone asked the Commission to set price limits at levels equal to

    or below the margin requirement in all commodities to mitigate the

    potential for under margined customer positions.\408\ NPPC requested

    that the Commission give ``customers the opportunity to `opt out' of

    allowing segregated funds to be used outside of the customer

    accounts,'' so that ``customers can proactively protect their funds

    from being used for potentially fraudulent purposes'' and when

    ``coupled with higher fees to help balance the trade off, customers

    could determine the level of risk to which they are comfortable

    subjecting their funds.'' \409\ The Commission notes that

    [[Page 68552]]

    these comments are outside the scope of this rulemaking.

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

    \408\ FCStone Comment Letter at 6 (Feb. 15, 2013).

    \409\ NPPC Comment Letter at 2 (Feb. 15, 2013).

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

    FCStone objected to proposed Sec. 1.20(i), believing that the

    Commission was mandating changing a customer's account balance to

    record margin deficits, which they believe would impact the tax

    treatment of customers' accounts.\410\ The Commission clarifies that

    the proposed amendments were not intended to require any additional

    charges to individual customer accounts, but to ensure that the FCM

    separately tracked the sum of such amounts to ensure it was holding

    residual interest in its segregated accounts greater than the gross

    total of such undermargined amounts.

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

    \410\ FCStone Comment Letter at 4 (Feb. 15, 2013).

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

    10. Segregation Regimes

    Several commenters proposed that language contained in customer

    account agreements used by certain FCMs should be restricted by the

    Commission. These commenters referred to clauses permitting customer

    collateral to be pledged, liquidated or transferred by the FCM and

    asked that the account agreements be viewed as contracts of adhesion

    due to the necessity to agree to such clauses in order to open a

    commodity futures trading account.\411\ These commenters, among other

    issues, requested that the Commission limit the ability of FCMs to

    require such contractual language.

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

    \411\ See Premier Metal Services Comment Letter at 2-3 (Jan. 1,

    2013) and ISRI Comment Letter at 4-5 (Dec. 4, 2012), which letters

    were cited and supported by several other commenters. See also Pilot

    Flying J Comment Letter at 2 (Feb. 14, 2013), which stated that FCMs

    should not be permitted to use customer funds for outside

    investments, capitalization or collateralization.

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

    The Commission notes that any such contractual language does not

    limit the applicability of the Act and Commission regulations with

    respect to the treatment of customer property by FCMs. The customer

    protection regime applies to all segregated customer funds regardless

    of any broader contractual terms.

    The specific ability of an FCM to pledge, liquidate or transfer

    customer collateral is constrained by the Act and Commission

    regulations regardless of any reference in a customer agreement to such

    applicable law, or a lack of reference thereto. Section 4d is the

    relevant provision of the Act that addresses how FCMs must hold

    customer funds. Section 4d(a)(2) of the Act provides that each FCM must

    treat and deal with all money, securities, and property received by the

    FCM to margin, guarantee, or secure the trades or contracts of any

    customer of the FCM, or accruing to such customer as the result of such

    trades or contracts, as belonging to the customer. Section 4d(a)(2)

    further provides that customer funds must be separately accounted for

    and may not be commingled with the funds of the FCM, or be used to

    margin or guarantee the trades or contracts, or to secure or extend

    credit, of any customer or person other than the customer that

    deposited the funds.

    Commission regulations also set requirements on how customer funds

    may be held. Regulation 1.20(a) provides that all customer funds must

    be separately accounted for by the FCM and segregated as belonging to

    commodity or option customers. The funds, when deposited with a bank,

    trust company, clearing organization, or another FCM must be deposited

    under an account name that clearly identifies the funds as belonging to

    customers and shows that the funds are segregated from the FCM's own

    funds as required by Section 4d(a)(2) of the Act. Regulation 1.20(c)

    provides that each FCM must treat and deal with the customer funds of a

    customer as belonging to the customer. The FCM must separately

    accounted for customer funds and may not commingle the funds with the

    FCM's own funds, or use the funds to margin, guarantee, or secure

    futures positions of any person, or extend credit to any person, other

    than the customer that owns the funds.

    Regulation 1.25 sets forth requirements on how FCMs may invest

    customer funds. Pursuant to Sec. 1.25, an FCM is permitted to use

    customer funds to purchase permitted investments. The investments,

    however, are required to be separately accounted for by the FCM under

    Sec. 1.26, and segregated from the FCM's own assets in accounts that

    designate the funds as belonging to customers of the FCM and held in

    segregation as required by the Act and Commission regulations.

    FCMs also may sell customer deposited securities under agreements

    to repurchase the securities pursuant to Sec. 1.25(a)(2)(ii).

    Regulation 1.25(d)(9) provides that the cash transferred to the

    segregation account for customer-owned securities sold under a

    repurchase agreement must be on a payment versus delivery basis, and

    the customer segregated funds account must receive same-day funds

    credited to the segregated account simultaneously with the delivery or

    transfer of the securities from the customer segregated accounts. A

    customer, however, may condition its deposits of securities with an FCM

    by requiring that that FCM not engage in reverse repurchase

    transactions with the customer's collateral.

    Accordingly, FCMs do not have an unfettered ability to pledge,

    rehypothecate, or otherwise use customer funds (including customer

    deposited securities) for their own benefit or purposes. However, FCMs

    also have the ability, as limited by all such applicable law and

    regulation for the benefit of customers, to liquidate customer

    securities if the customer that deposited the securities fails to meet

    a margin call. FCMs also may pledge customer deposited securities to

    DCOs as margin for the customer accounts carried by the FCM. The

    customer collateral pledged to a DCO, however, also must be held in

    customer segregated accounts.

    Even if transformed as permissible under the Act and regulations

    and contemplated by customer agreements, such collateral maintains its

    character as segregated customer property and remains subject to the

    customer protection regime. Commission staff has further confirmed that

    there is variability in the FCM community regarding the specific

    language included in customer account agreements and that not all

    agreements include broad authorities to the FCM for the use of customer

    collateral. However, as noted above, the contractual terms and

    conditions could not result in an FCM holding or using customer funds

    in a manner that was not in conformity with the Act and Commission

    regulations.

    Several commenters also requested that the Commission provide

    alternatives to the current segregation regime, including individual

    segregation, the ability to use third-party custodial accounts, or the

    ability to opt-out of segregation.\412\ While these issues are beyond

    the scope of the Proposal, the Commission notes that in adopting the

    final regulations for the protection of Cleared Swaps Customer

    Collateral in February 2012, it stated that the issue of alternative

    segregation regimes raise important risk management and cost

    externality issues, particularly in ensuring that deposited collateral

    is immediately available to the FCM or DCO in the event of the default

    of the customer or FCM.\413\ The Commission directed staff to continue

    to analyze different proposals with the goal of developing a proposal

    to provide additional or enhanced customer protection.\414\ In this

    regard, staff is continuing to review and meet with

    [[Page 68553]]

    industry representatives regarding alternative segregation regimes.

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

    \412\ See, e.g., ISRI Comment Letter at 6 (Dec. 4, 2013); AIM

    Comment Letter at 2-7 (Jan. 24, 2013); MFA Comment Letter at 9 (Feb.

    15, 2013); State Street Comment Letter at 2 (Jan. 16, 2013).

    \413\ 77 FR 6336, 6343 (Feb. 7, 2012).

    \414\ Id.

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

    In addition, the Commission noted that customer funds held in

    third-party custodial accounts constitute customer property within the

    meaning of the Bankruptcy Code. As such, positions and collateral held

    in third-party accounts are subject to the U.S. Bankruptcy Code and

    applicable provisions of the Act, which provide for the pro rata share

    of available customer property. The Commission also received several

    comments requesting specific and defined protections for funds provided

    to an FCM by retail counterparties engaged in off-exchange foreign

    currency transactions.\415\ The Proposal, however, focused on customer

    protection issues in the futures market, and the issue of the

    protection of funds held by an FCM for retail foreign currency

    counterparties is beyond the scope of the Proposal.

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

    \415\ See forex form letter group: Michael Krall; David Kennedy;

    Robert Smith; Michael Carmichael; Andrew Jackson; Donald Blais;

    Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink; Sam

    Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po Huang;

    Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe; Tracy

    Burns; Treasure Island Coins; Clare Colreavy, Brandon Shoemaker.

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

    H. Sec. 1.22: Use of Futures Customer Funds

    RCG commented that the proposed amendments to Sec. Sec. 1.22,

    1.23, 30.7(f) and 30.7(g) are inconsistent as to when an FCM should use

    its own funds to cover margin deficits with Sec. 1.30, which provides

    that an FCM cannot make an unsecured loan to a customer.\416\ The

    Commission does not believe that the regulations are inconsistent.

    Regulation Sec. 1.30 provides that an FCM may not make a loan to a

    customer, unless such loan is done a fully secured basis. Regulations

    1.22 and 30.7(f) provide that an FCM cannot use the funds of one

    customer to secure or extend credit to another customer. Regulations

    1.23 and 30.7(g) impose conditions upon when an FCM may withdraw

    proprietary funds from segregated accounts.

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

    \416\ RCG Comment Letter at 7 (Feb. 12, 2013).

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

    As discussed in greater detail in section II.G.9. above, the

    Commission has considered the comments and has revised and reorganized

    Sec. 1.22.

    I. Sec. 1.23: Interest of Futures Commission Merchant in Segregated

    Futures Customer Funds; Additions and Withdrawals

    The Commission proposed amending Sec. 1.23 to require additional

    safeguards with respect to an FCM withdrawing futures customer funds

    from segregated accounts that are part of the FCM's residual interest

    in such accounts.

    Proposed Sec. 1.23(a) provides that an FCM may deposit

    unencumbered proprietary funds, including securities from its own

    inventory that qualify as permitted investments under Sec. 1.25, into

    segregated futures customer accounts in order to provide a buffer or

    cushion of funds to protect against the firm failing to maintain

    sufficient funds in such accounts to meet its total obligations to

    futures customers.

    Under proposed Sec. 1.23(a), an FCM has access to its own funds

    deposited into futures customer accounts to the extent of the FCM's

    residual interest in such funds, subject to the restriction on

    withdrawal of residual interest required to cover undermargined

    amounts. However, proposed Sec. 1.23(b) prohibits an FCM from

    withdrawing its residual interest or excess funds from futures customer

    accounts (any withdrawal not made to or for the benefit of futures

    customers would be considered a withdrawal of the FCM's residual

    interest) on any given business day unless the FCM had completed the

    daily calculation of funds in segregation pursuant to Sec. 1.32 as of

    the close of the previous business day, and the calculation showed that

    the FCM maintained excess segregated funds in the futures customer

    accounts as of the close of business on the previous business day.

    Proposed Sec. 1.23(b) further requires that the FCM adjust the excess

    segregated funds reported on the daily segregation calculation to

    reflect other factors, such as overnight and current day market

    activity and the extent of current customer undermargined or debit

    balances, to develop a reasonable basis to estimate the amount of

    excess funds that remain on deposit since the close of business on the

    previous day prior to initiating a withdrawal.

    The Commission proposed additional required layers of authorization

    and documentation if the withdrawal exceeds, individually or in the

    aggregate with other such withdrawals, 25 percent or more of the FCM's

    residual interest computed as of the close of business on the prior

    business day. Proposed Sec. 1.23(c) prohibits an FCM from withdrawing

    more than 25 percent of its residual interest in futures customer

    accounts unless the FCM's CEO, CFO, or other senior official that is

    listed as a principal on the firm's Form 7-R registration statement and

    is knowledgeable about the FCM's financial requirements (``Financial

    Principal'') pre-approves the withdrawal in writing.

    Regulation 1.23(c) requires the FCM to immediately file a written

    notice with the Commission and with the firm's DSRO of any withdrawal

    that exceeds 25 percent of its residual interest. The written notice

    must be signed by the CEO, CFO, or Financial Principal that pre-

    approved the withdrawal, specifying the amount of the withdrawal, its

    purpose, its recipient(s), and contain an estimate of the residual

    interest after the withdrawal. The written notice also must contain a

    representation from the person that pre-approved the withdrawal that to

    such person's knowledge and reasonable belief, the FCM remains in

    compliance with its segregation obligations. Regulation 1.23 further

    requires that the official, in making this representation, specifically

    consider any other factors that may cause a material change in the

    FCM's residual interest since the close of business on the previous

    business day, including known unsecured futures customer debits or

    deficits, current day market activity, and any other withdrawals. The

    written notice would be required to be filed with the Commission and

    with the FCM's DSRO electronically.

    Proposed Sec. 1.23(d) requires an FCM to deposit proprietary funds

    sufficient to restore the residual interest targeted amount when a

    withdrawal of funds from segregated futures customer accounts, not for

    the benefit of the firm's customers, causes the firm to fall below its

    targeted residual interest in such accounts. The FCM must deposit the

    proprietary funds into such segregated accounts prior to the close of

    the next business day. Alternatively, the FCM may revise its targeted

    residual interest amount, if appropriate, in accordance with its

    written policies and procedures for establishing, documenting, and

    maintaining its target residual interest, in accordance with the

    requirements of proposed Sec. 1.11. Proposed Sec. 1.23 also stated

    that should an FCM's residual interest, however, be exceeded by the sum

    of the FCM's futures customers' margin deficits (i.e., undermargined

    amounts), an amount necessary to restore residual interest to that sum

    must be deposited immediately. Identical requirements with respect to

    procedures required for withdrawals of residual interest in Cleared

    Swaps Customer Collateral Accounts and 30.7 secured accounts were

    proposed in Sec. Sec. 22.17(c) and 30.7(g), respectively.

    NFA commented recommending that the Commission revise the language

    in Sec. 1.23 to keep it consistent with the language in NFA Financial

    Requirements Section 16 (prohibiting withdrawals that are made ``not

    for the benefit of commodity and option customers and foreign futures

    and

    [[Page 68554]]

    foreign options customers'').\417\ NFA commented that without a

    definition of ``proprietary use'' a withdrawal that may not be for an

    FCM's own proprietary use may still be a withdrawal that is not for the

    benefit of customers and, therefore, would trigger NFA's approval and

    notice requirements pursuant to NFA Financial Requirements Section 16,

    but not the Commission's approval and notice requirements pursuant to

    Sec. 1.23.\418\ NFA also commented that the Commission should remove

    proposed Sec. 1.23(d)'s reference to ``business days'' in order to

    ensure that FCMs understand that the requirements related to

    withdrawals of 25 percent or more apply at all times.\419\

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

    \417\ NFA Comment Letter at 14 (Feb. 15, 2013).

    \418\ Id.

    \419\ Id.

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

    The Commission has considered NFA's comment and is revising Sec.

    1.23 to remove the term ``proprietary use'' and is replacing it with

    the concept of withdrawals that are not made to or for the benefit of

    customers. The Commission also is revising Sec. 1.23 to remove the

    reference to ``business days.'' The revisions will more closely align

    the Commission's and NFA's regulations governing an FCM's withdrawal of

    proprietary funds from a segregated account by making the language and

    conditions more consistent. This consistency of the Commission and NFA

    requirements is appropriate as it will allow FCMs to operate under one

    set of conditions, while also retaining the overall policy goals of the

    Commission to limit an FCM's ability to withdraw funds from segregated

    accounts until the FCM can be reasonably assured that the funds are

    excess, proprietary funds.\420\

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

    \420\ The Commission also is making comparable revisions to

    Sec. Sec. 22.17(c) and 30.7(g) in light of NFA's comments.

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

    NFA further requested the Commission to clarify that pre-approval

    of a series of transactions that in the aggregate exceeded the 25

    percent threshold would not require after the fact approvals of the

    first transactions of the series, but only approvals of the

    transactions resulting in the 25 percent threshold being exceeded.\421\

    The Commission confirms that an FCM would need to obtain the necessary

    approvals only for the transaction that caused the withdrawals to

    exceed the 25 percent threshold.

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

    \421\ Id.

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

    Jefferies commented that it generally supported proposed amendments

    to Sec. 1.23, but stated that requiring FCMs to report when they draw

    down more than 25 percent of their residual interest will discourage an

    FCM from voluntarily adding to its residual interest.\422\ Jefferies

    commented that FCMs should be permitted to withdraw any residual

    interest amount in excess of their target level and to withdraw up to

    25 percent of the target level before providing notice, or if the last

    calculated residual interest was below the target level, the

    calculation should be 25 percent of the lower amount.\423\ LCH.Clearnet

    and the FIA also recommended revising Sec. Sec. 1.23(d) and 22.17(c)

    to apply only to withdrawal of FCM funds in excess of 25 percent of the

    FCM's targeted residual interest, rather than on 25 percent of the

    total residual interest in the customer segregated account,

    specifically to ensure that FCMs have no disincentive to maintain

    significant excess funds above the targeted residual interest

    segregation at DCOs for swaps clearing.\424\

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

    \422\ Jefferies Comment Letter at 4-6 (Feb. 15, 2013).

    \423\ Id.

    \424\ LCH.Clearnet Comment Letter at 7 (Jan. 25, 2013); FIA

    Comment Letter at 6 (Feb. 15, 2013).

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

    The Commission does not believe that substituting the targeted

    residual amount for the actual residual interest amount would

    appropriately focus management attention on significant withdrawals

    relative to the actual, not just target, excess, as well as clearly

    establish a chain of responsibility for such withdrawals, as is the

    intended purpose of the proposed regulation. The Commission clarifies

    that pre-approval would be required, with respect to a series of

    transactions, for the transactions which would result in the threshold

    being exceeded and not earlier transactions in the series. Accordingly,

    the Commission is adopting Sec. 1.23 and the conforming provisions in

    Sec. Sec. 22.17 and 30.7(g), with changes as recommended by NFA

    substituting language ``not for the benefit of customers'' (with

    description of customer as applicable to each such provision) for

    ``proprietary use'' and eliminating the reference to business

    days.\425\

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

    \425\ See NFA Comment Letter at 14 (Feb. 15, 2013).

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

    In addition, and in light of the changes discussed herein with

    respect to the residual interest requirements set forth in Sec. Sec.

    1.22, 22.2, and 30.7, the Commission is amending Sec. 1.23 and the

    conforming provisions in Sec. Sec. 22.17 and 30.7(g) to make clear

    that if an FCM's residual interest is less than the amounts required to

    be maintained in Sec. 1.22, 22.2(f)(6), or 30.7(f), as applicable, at

    any particular point in time, the FCM must immediately restore the

    residual interest to exceed the sum of such amounts.

    J. Sec. 1.25: Investment of Customer Funds

    1. General Comments Regarding the Investment of Customer Funds

    Regulation 1.25 sets forth the financial investments that an FCM or

    DCO may make with customer funds. The Commission received 32 comment

    letters regarding the investment and handling of customer funds by FCMs

    and DCOs.\426\ In general, all of the commenters supported the position

    that FCMs and DCOs only be allowed to make safe/non-speculative

    investments of customer funds and not be allowed to add risk that

    customers are unaware of or do not sanction. More specifically, 29 of

    the commenters proposed that the Commission amend its regulations to

    provide commodity customers with the ability to ``opt out'' of granting

    FCMs permission to invest their funds (including hypothecation and

    rehypothecation).\427\ Additionally,

    [[Page 68555]]

    seven of the 29 commenters requested that the Commission also mandate

    that an FCM cannot prevent a customer who so ``opts out'' from

    continuing to trade through that FCM merely because the customer

    elected to ``opt out.'' \428\

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

    \426\ Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche

    Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14,

    2013), Strelitz/California Metal X Comment (Jan. 15, 2013), Premier

    Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment

    Letter at 5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24,

    2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba

    Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter

    (Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David

    Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter

    (Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012),

    Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment

    Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17,

    2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders

    Comment Letter (Dec. 17, 2012), Jeff Schlink Comment (Dec. 18,

    2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman

    Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec.

    22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po Huang

    Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter (Jan. 8,

    2013), Vael Asset Management Comment Letter (Jan. 10, 2013), Kos

    Capital Comment Letter (Jan. 11, 2013), James Lowe Comment Letter

    (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013),

    Treasure Island Coins Comment Letter (Jan. 14, 2013), and Clare

    Colreavy Comment Letter (Jan. 9, 2013).

    \427\ NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal

    Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at

    5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke

    Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter

    (Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15,

    2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy

    Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec.

    17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew

    Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter

    (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012),

    Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders

    Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec.

    18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew

    Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter

    (Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po

    Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter

    (Jan. 8, 2013), Vael Asset Management Comment Letter (Jan. 10,

    2013), Kos Capital Comment Letter (Jan. 11, 2013), James Lowe

    Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14,

    2013), Treasure Island Coins Comment Letter (Jan. 14, 2013), and

    Clare Colreavy Comment Letter (Jan. 9, 2013).

    \428\ NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal

    Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at

    6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke

    Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter

    (Dec. 13, 2012); and Solomon Metals Corp Comment Letter (Jan, 15,

    2013).

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

    The Commission did not propose to amend the list of permitted

    investments set forth in Sec. 1.25, and believes that the current

    investments and regulatory requirements establish an appropriate

    balance between providing investment opportunities for FCMs with the

    overall objective of protecting customer funds. As further discussed in

    section II.L. below, the Commission also is amending Sec. 1.29 to

    explicitly provide that an FCM is responsible for any losses resulting

    from the investment of customer funds under Sec. 1.25.

    The Commission further notes that the current regulatory structure

    does not provide for a system whereby customers can elect to ``opt-

    out'' of segregation or Sec. 1.25. In the event of the insolvency of

    an FCM, where there also was a shortfall in customer funds, customers

    would be entitled to a pro-rata distribution of customer property under

    section 766 of the U.S. bankruptcy code.\429\ Therefore, even if a

    customer was permitted by the FCM to ``opt-out'' of segregation, the

    funds held by the FCM would be pooled with other customer funds and

    distributed on a pro-rata basis to all customers participating in that

    account class.

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

    \429\ 11 U.S.C. 766.

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

    2. Reverse Repurchase Agreement Counterparty Concentration Limits

    Regulation 1.25 provides that FCMs and DCOs may use customer funds

    to purchase securities from a counterparty under an agreement for the

    resale of the securities back to the counterparty (``reverse repurchase

    agreements''). Regulation 1.25 places conditions on reverse repurchase

    agreements, including, limiting counterparties to certain banks and

    government securities brokers or dealers, and prohibiting an FCM or DCO

    from entering into such agreements with an affiliate. Regulation

    1.25(b)(3)(v) also imposes a counterparty concentration limit on

    reverse repurchase agreements that prohibits an FCM or DCO from

    purchasing securities from a single counterparty that exceeds 25

    percent of the total assets held in segregation by the FCM or DCO.

    The Commission proposed to amend Sec. 1.25(b)(3)(v) to require an

    FCM or DCO to aggregate the value of the securities purchased under

    reverse repurchase agreements if the counterparties are under common

    control or ownership. The aggregate value of the securities purchased

    under a reverse repurchase agreement from the counterparties under

    common ownership or control could not exceed 25 percent of the total

    assets held in segregation by the FCM or DCO. The Commission proposed

    the amendment as it believed that the expansion of the counterparty

    concentration limitation to counterparties under common ownership or

    control is consistent with the original intent of the regulation, and

    to minimize potential losses or disruptions due to the default of a

    counterparty.

    The Commission received comments from LCH.Clearnet and CFA in

    support of the proposed amendments.\430\ No other comments were

    received. The Commission is adopting the amendments as proposed.

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

    \430\ LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013); CFA

    Comment Letter at 6 (Feb. 13, 2013).

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

    K. Sec. 1.26: Deposit of Instruments Purchased With Futures Customer

    Funds

    Regulation 1.26 requires each FCM or DCO that invests customer

    funds in instruments listed under Sec. 1.25 to separately account for

    such instruments and to segregate the instruments from its own funds.

    An FCM or DCO also must deposit the instruments under an account name

    which clearly shows that they belong to futures customers and that the

    instruments are segregated as required by the Act and Commission

    regulations. The FCM or DCO also must obtain and retain in its files a

    written acknowledgment from the depository holding the instruments

    stating that the depository was informed that the instruments belong to

    futures customers and that the instruments are being held in accordance

    with the provisions of the Act and Commission regulations.

    The Commission proposed amending Sec. 1.26 to specify how direct

    investments by FCMs and DCOs in money market mutual funds (``MMMFs'')

    that qualify as permitted investments under Sec. 1.25 must be held,

    and to adopt a Template Letter to be used with respect to direct

    investments in qualifying MMMFs. Like the proposed Template Letters for

    Sec. Sec. 1.20 and 30.7, the proposed Template Letter for Sec. 1.26

    contained provisions providing for read-only access and release of

    shares upon instruction from the director of the Division of Clearing

    and Risk, the director of the Division of Swap Dealer and Intermediary

    Oversight, or any successor divisions, or such directors' designees.

    With respect to the Template Letter for MMMFs, ICI noted that costs

    to create electronic access to FCM accounts at an MMMF would be ``borne

    by all investors and not just by FCMs,'' which likely only constitute a

    small percentage of an MMMF's investors.\431\ As an alternative, ICI

    proposed that the Template Letter be amended to require the MMMF to

    provide FCM account data promptly (i.e., within 48 hours) upon

    request.\432\ ICI also commented that the Commission should confirm:

    (1) The ``examination or audit'' of the accounts authorized by the

    acknowledgment letter is limited to verification of account balances

    and that further inspection of an MMMF itself would be referred to the

    SEC as primary regulator; and (2) the proposal would require only those

    MMMFs in which FCMs directly invest customer funds (as opposed to those

    held through intermediated positions like omnibus accounts or

    intermediary-controlled accounts) to agree to provide FCM account

    information.\433\

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

    \431\ ICI Comment Letter at 4-5 (Jan. 14, 2013).

    \432\ Id. at 5.

    \433\ Id. at 4-6 (Jan.14, 2013).

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

    The Commission originally proposed one Template Letter, Appendix A

    to Sec. 1.26, to be used by both FCMs and DCOs when investing customer

    funds in an MMMF. However, as noted above in the discussion of the

    Sec. 1.20 Template Letters, the Commission has determined to eliminate

    the read-only access requirement for DCOs. Therefore, the Commission is

    adopting different Template Letters for FCMs and DCOs in Sec. 1.26.

    The Template Letter specific to FCMs is now set forth in Appendix A to

    Sec. 1.26, and the Template Letter for DCOs is set forth in Appendix B

    to Sec. 1.26. The Commission has made other modifications to the Sec.

    1.26 Template Letters consistent with the modifications to the Sec.

    1.20 Template Letters.

    The Commission also confirms that examination of accounts

    authorized by the acknowledgment letter would not involve regulation or

    examination of the MMMF itself, over which the Commission does not have

    supervisory or regulatory authority. The examination would be limited

    to

    [[Page 68556]]

    verification of the account shares of the FCM or DCO, and the Template

    Letters required under Sec. 1.26 are solely applicable to directly-

    held investments in MMMFs. For the purpose of clarification, an FCM or

    DCO that holds shares of an MMMF in a custodial account at a depository

    (not directly with the MMMF or its affiliate) is required to execute

    the Template Letter set forth in Appendix A or B of Regulation 1.20, as

    applicable. In addition, a MMMF would be required to provide the

    Commission with read-only access to accounts holding customer funds

    only if the FCM directly deposits customer funds with the MMMF.

    Proposed paragraph (b) of Sec. 1.26 has been modified to include a

    reference to Appendix B to Sec. 1.20. Otherwise, the Commission is

    adopting Sec. 1.26 as proposed.

    L. Sec. 1.29: Increment or Interest Resulting From Investment of

    Customer Funds

    1. FCM's Responsibility for Losses Incurred on the Investment of

    Customer Funds

    Regulation 1.29 currently provides that an FCM or DCO is not

    required to pass the earnings from the investment of futures customer

    funds to the futures customers. An FCM or DCO may retain any interest

    or other earnings from the investment of futures customer funds.

    The Commission proposed to amend Sec. 1.29 to explicitly provide

    that an FCM or DCO is responsible for any losses incurred on the

    investment of customer funds. Investment losses cannot be passed on to

    futures customers. As the Commission noted in the Proposal, an FCM may

    not charge or otherwise allocate investment losses to the accounts of

    the FCM's customers. To allocate losses on the investment of customer

    funds would result in the use of customer funds in a manner that is not

    consistent with section 4d(a)(2) and Sec. 1.20, which provides that

    customer funds can only be used for the benefit of futures customers

    and limits withdrawals from futures customer accounts, other than for

    the purpose of engaging in trading, to certain commissions, brokerage,

    interest, taxes, storage or other fees or charges lawfully accruing in

    connection with futures trading.\434\ Section 4d(b) of the Act also

    provides that it is unlawful for a DCO to use customer funds as

    belonging to any person other than the customers of the FCM that

    deposited the funds with the DCO. Accordingly, such investment losses

    are the responsibility of the FCM or DCO, as applicable. Similar

    regulations were proposed for Cleared Swaps Customer Collateral under

    part 22 (Sec. 22.2(e)(1)), and for 30.7 customer funds under part 30

    (Sec. 30.7(i)).

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

    \434\ 77 FR 67866, 67888.

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

    FIA and CFA supported the proposed amendments to Sec. 1.29.\435\

    No other comments were received. The Commission adopts the amendments

    to Sec. Sec. 1.29, 22.2(e)(1), and 30.7(i) as proposed.

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

    \435\ FIA Comment Letter at 30-31 (Feb. 15, 2013); CFA Comment

    Letter at 6 (Feb. 13, 2013).

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

    2. FCM's Obligation in Event of Bank Default

    The Commission requested comment on the extent of an FCM's

    responsibility to cover losses in the event of a default of by a bank

    holding customer funds. The CFA commented that FCM's should be

    responsible as such an obligation will require that FCMs conduct

    adequate due diligence on the banks in which they place customers'

    funds, a factor that should limit the effect of a related future bank

    failure.\436\

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

    \436\ CFA Comment Letter at 6 (Feb. 13, 2013).

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

    The FIA noted that the Commodity Exchange Authority issued an

    Administrative Determination in 1971 setting out the appropriate

    standard of liability for an FCM in the event of a bank default.\437\

    The FIA also stated that the deposit of customer funds in a bank or

    trust company is not an investment of customer funds under Sec. 1.25,

    but is a requirement by the Act and Commission regulations.\438\ The

    FIA stated that FCMs should not be strictly liable for a bank's

    failure, and that to hold FCMs to such a standard would presume that

    FCMs have the ability to know more about a bank than the regulatory

    authorities responsible for overseeing the banks.\439\

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

    \437\ FIA Comment Letter at 32-33 (Feb. 15, 2013). The

    Administrative Determination applies to both FCM and DCO deposits at

    banks, and provides as follows:

    To: Associate Administrator

    Division Directors

    Regional Directors

    If a futures commission merchant or a clearing association

    deposits regulated commodity customers' funds in a bank and the bank

    is later closed and unable to repay the funds, the liability of the

    futures commission merchant or clearing association would depend

    upon the manner in which the account was handled. It would not be

    liable if it had used due care in selecting the bank, had not

    otherwise breached its fiduciary responsibilities toward the

    customers, and had fully complied with the requirements of the

    Commodity Exchange Act and the regulations thereunder relating to

    the handling of customers' funds. If two banks were available in a

    particular city only one of which was a member of FDIC and the

    futures commission merchant or clearing association without a

    compelling reason elected to use the nonmember bank, we would

    contend that it had not used due care in its selection.

    Administrative Determination No. 230 issued by Alex Caldwell,

    Administrator, Commodity Exchange Authority (Nov. 23, 1971).

    \438\ FIA Comment Letter at 32-33 (Feb. 13, 2013).

    \439\ Id.

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

    The FIA further stated that the Commission's new Sec. 1.11 will

    require each FCM to establish and enforce written policies and

    procedures reasonably designed to assure compliance with the

    segregation requirements. The policies and procedures also must include

    a process for the evaluation of depositories, and a program to monitor

    a depository on an ongoing basis, including a thorough due diligence

    review of each depository at least annually. FIA notes that the

    policies and procedures will be subject to Commission and DSRO review,

    and that either the Commission or DSRO can direct the FCM to make any

    changes to address identified weaknesses in the policies or procedures,

    or in their enforcement.\440\

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

    \440\ Id.

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

    Advantage stated that the deposit of customer funds into a bank is

    not an investment of the funds, and FCMs should be able to assume that

    banks are properly vetted by the relevant banking and futures

    regulatory authorities.\441\

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

    \441\ Advantage Comment Letter at 3 (Feb. 15, 2013).

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

    The Commission has considered the issue and believes the issue of

    depository risk raises important legal and policy issues that were not

    addressed in the Administrative Determination. There are considerable

    reasons to question whether the Administrative Determination is

    consistent with the CEA and the Commission's regulations thereunder.

    Customers entrust their funds to FCMs, who are required by the Act and

    Commission regulations to treat the funds as belonging to the

    customers, to segregate the funds from the FCM's own funds, and to hold

    such funds in specially designated accounts that clearly state that the

    funds belong to commodity customers of the FCM and are being held as

    required by the Act and Commission regulations. Customers do not select

    the depositories to hold these funds; FCMs do. FCMs are responsible for

    conducting the initial due diligence and ongoing monitoring of

    depositories holding customer funds. Moreover, as a practical matter,

    FCMs are in a better position than customers to perform these

    functions, as well as in a better position than the customers

    individually to make claim in the insolvency proceeding for the

    depository.\442\

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

    \442\ By a parity of reasoning, this would also apply to

    relationships between DCOs and FCMs. Indeed, it would be difficult

    to see how a DCO would be liable for such losses, but an FCM would

    not.

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

    [[Page 68557]]

    Importantly, the AD fails to address the question of precisely

    which customers are exposed to depository losses, and how much should

    be allocated to each such customer. This question is particularly

    important in the context of omnibus customer accounts permitted in the

    futures industry. Would losses be allocated to persons who are

    customers at the point the depository becomes insolvent, to persons who

    were customers at any point the FCM maintained funds at the depository,

    or to persons who were customers at the point the losses were

    crystalized? Would losses be allocated to all customers, or could

    certain favored customers avoid such exposure by negotiation? If the

    depository lost only securities, would customers who deposited only

    cash share in the loss? If the depository lost only cash, would

    customers who deposited only securities share in the loss? Would

    customers whose margin was all used to cover requirements at the DCO

    share in losses of funds at a depository other than a DCO? Moreover,

    would customers to whom losses were allocated share in dividends

    recovered from the estate of the defaulting depository? How would such

    customers have the practical opportunity to demonstrate their claims in

    such a proceeding? How and when would such recoveries be distributed to

    such customers? These practical questions, none of which was answered

    in the Administrative Determination, call its wisdom into

    question.\443\

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

    \443\ This discussion does not apply to funds that have been

    deposited with a third-party depository selected by a customer.

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

    Accordingly, the Commission has directed staff to inquire into

    these issues, and to develop an appropriate proposed rulemaking.

    M. Sec. 1.30: Loans by Futures Commission Merchants: Treatment of

    Proceeds

    Regulation 1.30 provides that an FCM may lend its own funds to

    customers on securities and property pledged by such customers, and may

    repledge or sell such securities and property pursuant to specific

    written agreement with such customers. This provision generally allows

    customers to deposit non-cash collateral as initial and variation

    margin. Absent the provision, an FCM may be required to liquidate the

    non-cash collateral if the customer was subject to a margin call that

    could not be met with other assets in the customer's account.

    Regulation 1.30 further provides that the proceeds of loans used to

    margin the trades of customers shall be treated and dealt with by an

    FCM as belonging to such customers, in accordance with and subject to

    the provisions of the Act and regulations.

    The Commission proposed to amend Sec. 1.30 by adding that an FCM

    may not lend funds to a customer for margin purposes on an unsecured

    basis, or secured by the customer's trading account. The Commission

    stated in the Proposal that it did not believe that FCMs extended

    unsecured credit as a common practice, as the FCM would be required to

    take a 100 percent charge to capital for the value of the unsecured

    loan under Sec. 1.17. The Commission also noted that a trading account

    did not qualify as collateral for the loan under Sec. 1.17 and the FCM

    would have to take a charge to capital for the full value of the

    unsecured loan. The Commission further noted that the proposed

    amendment to Sec. 1.30 was consistent with CME Rule 930.G, which

    provides that a clearing member may not make loans to account holders

    to satisfy their performance bond requirements unless such loans are

    secured by readily marketable collateral that is otherwise unencumbered

    and which can be readily converted into cash.\444\

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

    \444\ See CME rulebook at www.cmegroup.com/rulebook/CME/I/9/9.pdf.

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

    RCG commented that it believes that the proposal prohibiting an FCM

    from making unsecured loans to customers contradicts proposed Sec.

    1.22 as it applies to funding customers' margin deficits.\445\ The

    Commission notes that the requirement in Sec. 1.22 for an FCM to cover

    an undermargined account with its own funds is intended to ensure that

    the FCM complies with section 4d of the Act by not using the funds of

    one futures customer to margin or guarantee the commodity interests of

    another customer. The FCM is obligated under section 4d to maintain

    sufficient funds in segregation to cover undermargined accounts. The

    FCM, however, is not loaning funds to a particular customer as

    performance bond is contemplated by Sec. 1.30. When the FCM deposits

    proprietary funds into segregated accounts under Sec. 1.22, the FCM is

    not loaning any particular customer funds, and the customers with an

    undermargined account are not credited with an increase in their cash

    balance.

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

    \445\ RCG Comment Letter at 4 (Feb. 12, 2013).

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

    Newedge also requested confirmation the proposed prohibition in

    Sec. 1.30 preventing an FCM from loaning unsecured funds to a customer

    to finance such customer's trading would not prohibit an FCM, when

    computing a customer's margin requirement, from giving credit for the

    customer's long option value. The Commission confirms that an FCM may

    continue to consider a customer's long option value when computing such

    customer's overall account value and margin requirements.\446\

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

    \446\ Newedge Comment Letter at 5 (Feb. 15, 2013).

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

    The Commission is adopting the amendments to Sec. 1.30 as

    proposed.

    N. Sec. 1.32: (Sec. 22.2(g) for Cleared Swaps Customers and Sec.

    30.7(l) for Foreign Futures and Foreign Options Customers): Segregated

    Account: Daily Computation and Record

    The Commission proposed to amend Sec. 1.32 to require additional

    safeguards with respect to futures customer funds on deposit in

    segregated accounts, and to require FCMs to provide twice each month a

    detailed listing to the Commission of depositories holding customer

    funds.\447\

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

    \447\ The Commission also proposed amendments to Sec. 22.2(g)

    and Sec. 30.7(l) to impose requirements for Cleared Swaps and

    foreign futures and foreign options transactions, respectively, that

    correspond to the proposed amendments for Sec. 1.32. The comments

    for Sec. Sec. 1.32, 22.2(g), and 30.7(l) are addressed in this

    section.

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

    Regulation 1.32 requires an FCM to prepare a daily record as of the

    close of business each day detailing the amount of funds the firm holds

    in segregated accounts for futures customers trading on designated

    contract markets, the amount of the firm's total obligation to such

    customers computed under the Net Liquidating Equity Method, and the

    amount of the FCM's residual interest in the futures customer

    segregated accounts. In performing the calculation, an FCM is permitted

    to offset any futures customer's debit balance by the market value

    (less haircuts) of any readily marketable securities deposited by the

    particular customer with the debit balance as margin for the account.

    The amount of the securities haircuts are as set forth in SEC Rule

    15c3-1(c)(vi).

    FCMs are required to perform the segregation calculation prior to

    noon on the next business day, and to retain a record of the

    calculation in accordance with Sec. 1.31. Both the CME and NFA require

    their respective member FCMs to file the segregation calculations with

    the CME and NFA, as appropriate, each business day. FCMs, however, are

    only required to file a segregation calculation with the Commission at

    month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-

    registrant FCM/BDs). Regulation 1.12, as discussed in section II.C.

    above, requires the FCM to provide immediate notice to the Commission

    and to the firm's DSRO if the FCM is undersegregated at any time.

    [[Page 68558]]

    The Commission proposed to amend Sec. 1.32 to require each FCM to

    file its segregation calculation with the Commission and with its DSRO

    each business day. The Commission also proposed to amend Sec. 1.32 to

    require FCMs to use the Segregation Schedule contained in the Form 1-

    FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document its

    daily segregation calculation.\448\

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

    \448\ Each FCM currently already submits a daily Segregation

    Schedule to its DSRO pursuant to rules of the CME and NFA.

    Therefore, the Commission's amendments are codifying current

    regulatory practices for each FCM.

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

    As previously noted, the CME and NFA require their respective

    member FCMs to file their segregation calculations with them on a daily

    basis. The CME and NFA also require the FCMs to document their

    segregation calculation using the Segregation Schedule contained in the

    Form 1-FR-FCM. Therefore, the additional requirement of filing a

    Segregation Schedule with the Commission is not a material change to

    the regulation and is consistent with current practices.\449\

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

    \449\ In fact, since FCMs file the Segregation Schedules with

    the CME and NFA via WinJammer, the Commission already has access to

    the filings, and the amendment will not require an FCM to change any

    of its operating procedures.

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

    The Commission stated in the Proposal that the filing of daily

    Segregation Schedules by FCMs will enhance its ability to monitor and

    protect customer funds as the Commission will be able to determine

    almost immediately upon receipt of the Segregation Schedule whether a

    firm is undersegregated and immediately take steps to determine if the

    firm is experiencing financial difficulty or if customer funds are at

    risk.\450\

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

    \450\ Each Form 1-FR-FCM and FOCUS Report is received by the

    Commission via WinJammer. The financial forms are automatically

    electronically reviewed within several minutes of being received by

    the Commission and if a firm is undersegregated an alert is

    immediately issued to Commission staff members via an email notice.

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

    The Commission also proposed to require an FCM to file its

    Segregation Schedule with the Commission and with the FCM's DSRO

    electronically using a form of user authentication assigned in

    accordance with procedures established or approved by the Commission.

    The Commission currently receives the Segregation Schedule

    electronically via the WinJammer filing system and the proposal would

    continue to require FCMs to submit the forms using WinJammer.

    The Commission also proposed to amend Sec. 1.32(b) to provide that

    in determining the haircuts for commercial paper, convertible debt

    instruments, and nonconvertible debt instruments deposited by customers

    as margin, the FCM may develop written policies and procedures to

    assess the credit risk of the securities as proposed by the SEC and

    discussed more fully in section II.F. above. If the FCM's assessment of

    the credit risk is that it is minimal, the FCM may apply haircut

    percentages that are lower than the 15 percent default percentage under

    SEC Rule 15c3-1(c)(2)(vi).

    The Commission also proposed to amend Sec. 1.32 by requiring each

    FCM to file detailed information regarding depositories and the

    substance of the investment of customer funds under Sec. 1.25.

    Proposed paragraphs (f) and (j) of Sec. 1.32 require each FCM to

    submit to the Commission and to the firm's DSRO a listing of every

    bank, trust company, DCO, other FCM, or other depository or custodian

    holding customer funds. The listing must specify separately for each

    depository the total amount of cash and Sec. 1.25 permitted

    investments held by the depository for the benefit of the FCM's

    customers. Specifically, each FCM must list the total amount of cash,

    U.S. government securities, U.S. agency obligations, municipal

    securities, certificates of deposit, money market mutual funds,

    commercial paper, and corporate notes held by each depository, computed

    at current market values. The listing also must specify: (1) If any of

    the depositories are affiliated with the FCM; (2) if any of the

    securities are held pursuant to an agreement to resell the securities

    to a counterparty (reverse repurchase agreement) and if so, how much;

    and (3) the depositories holding customer-owned securities and the

    total amount of customer-owned securities held by each of the

    depositories.

    Each FCM is required to submit the listing of the detailed

    investments to the Commission and to the firm's DSRO twice each month.

    The filings must be made as of the 15th day of each month (or the next

    business day, if the 15th day of the month is not a business day) and

    the last business day of the month. The filings are due to the

    Commission and to the firm's DSRO by 11:59 p.m. on the next business

    day.

    Proposed paragraph (k) of Sec. 1.32 requires each FCM to retain

    the Segregation Statement prepared each business day and the detailed

    investment information, together with all supporting documentation, in

    accordance with Sec. 1.31.

    FIA generally supported the proposal.\451\ FIA noted that proposed

    Sec. 1.32(a) requires an FCM to compute its daily segregation

    requirement on a currency-by-currency basis, and requested that the

    Commission confirm that a single Segregation Schedule can be completed

    for each account class (i.e., futures customers funds, Cleared Swaps

    Customers funds, and Sec. 30.7 customer funds) on a U.S. dollar-

    equivalent basis. FIA further stated that the detail regarding the

    investment of customer funds provided by NFA on its Web site is the

    appropriate level of detail that should be made public because

    additional detail would disclose proprietary financial and business

    information.\452\

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

    \451\ FIA Comment Letter at 30 (Feb. 15, 2013).

    \452\ Id. at 31.

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

    Jefferies supported the proposal, and recommended that the listing

    of detailed investments should include all investments, including cash

    and other investments, regardless of where the investments are held,

    and should provide greater transparency for the FCMs' customers.\453\

    MFA supported the proposed amendments to Sec. 1.32 to require FCMs to

    provide the Commission and their DSROs with: (1) Daily reporting of the

    segregation and part 30 secured amount computations; and (2) semi-

    monthly reporting of the location of customer funds and how such funds

    are invested under Sec. 1.25.\454\

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

    \453\ Jefferies Comment Letter at 4 (Feb. 15, 2013).

    \454\ MFA Comment Letter at 3 (Feb. 15, 2013).

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

    The Commission has considered the comments and is adopting the

    amendments to Sec. Sec. 1.32, 22.2(g), and 30.7(l) as proposed. In

    response to Jefferies comment, the Commission notes that the proposed

    and final regulation require an FCM to report all investments,

    including cash and other investments, regardless of where the

    investments are held.

    In response to FIA's comment, the Commission does not believe that

    a full disclosure of the investment of customer funds would disclose

    proprietary information of the FCM. The Commission would require the

    disclose of investment information in a manner consistent with the

    current NFA disclosures, which includes, for each FCM, the percentage

    of the invested customer funds that are held by banks, or invested in

    U.S. government securities, bank certificates of deposit, money market

    funds, municipal securities, and U.S. government sponsored enterprise

    securities. The Commission, however, further believes that FCMs also

    should disclose the amount of customer funds that are held by clearing

    organizations and brokers. The Commission also believes that FCMs

    should disclose the amount of customer-owned securities that are on

    deposit as margin collateral, and information regarding repurchase

    [[Page 68559]]

    transactions involving customer funds or securities. The additional

    disclosures will provide customers and the market with additional

    information that may be relevant to their assessment of the risks of

    placing their funds with a particular FCM. The Commission further notes

    that it plans to work with the SROs to determine the most efficient and

    effective method to disclose this information to the public.

    The Commission also confirms that an FCM satisfies the requirement

    of Sec. 1.32 if it prepares and submits to the Commission, and to its

    DSRO, a consolidated Segregation Schedule for each account class on a

    U.S. dollar-equivalent basis. The FCM, however, must prepare

    segregation records on a daily basis on a currency-by-currency basis to

    ensure compliance with Sec. 1.49, which governs how FCMs may hold

    funds in foreign depositories. The FCM is not required under Sec. 1.32

    to file the currency-by-currency segregation records with the

    Commission or with its DSRO.

    O. Sec. 1.52: Self-regulatory Organization Adoption and Surveillance

    of Minimum Financial Requirements

    SROs are required by the Act and Commission regulations to monitor

    their member FCMs for compliance with the Commission's and SROs'

    minimum financial and related reporting requirements. Specifically, DCM

    Core Principle 11 provides, in relevant part, that a board of trade

    shall establish and enforce rules providing for the financial integrity

    of any member FCM and the protection of customer funds.\455\ In

    addition, section 17 of the Act requires NFA to establish minimum

    capital, segregation, and other financial requirements applicable to

    its member FCMs, and to audit and enforce compliance with such

    requirements.\456\

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

    \455\ 7 U.S.C. 7(d)(11).

    \456\ 7 U.S.C. 21(p).

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

    The Commission also has established in Sec. 1.52 minimum elements

    that each SRO financial surveillance program must contain to satisfy

    the statutory objectives of Core Principle 11 and section 17 of the

    Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt

    and to submit for Commission approval rules prescribing minimum

    financial and related reporting requirements for member FCMs. The rules

    of the SRO also must be the same as, or more stringent than, the

    Commission's requirements for financial statement reporting under Sec.

    1.10 and minimum net capital under Sec. 1.17.

    In addition, the Commission adopted final amendments to Sec. 1.52

    on May 10, 2012, to codify previously issued CFTC staff guidance

    regarding the minimum elements of an SRO financial surveillance

    program.\457\ In order to effectively and efficiently allocate SRO

    resources over FCMs that are members of more than one SRO, Sec.

    1.52(c) currently permits two or more SROs to enter into an agreement

    to establish a joint audit plan for the purpose of assigning to one of

    the SROs (the DSRO) of the joint audit plan the function examining

    member FCMs for compliance with minimum capital and related financial

    reporting obligations. The audit plan must be submitted to the

    Commission for approval. Currently all active SROs are members of a

    joint audit plan that was approved by the Commission on March 18,

    2009.\458\

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

    \457\ 77 FR 36611 (June 19, 2012).

    \458\ The original signatories of the joint audit plan approved

    on March 18, 2009 are as follows: Board of Trade of the City of

    Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,

    LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile

    Exchange Inc.; Commodity Exchange, Inc.; ELX Futures, L.P.;

    HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,

    L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;

    National Futures Association; New York Mercantile Exchange, Inc.;

    NYSE Liffe US, L.L.C.; and One Chicago, L.L.C.

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

    The Commission proposed additional amendments to Sec. 1.52 to

    enhance and strengthen the minimum requirements that SROs must abide by

    in conducting financial surveillance. As the Commission explained in

    the Proposal, these amendments are intended to minimize the chances

    that FCMs engage in unlawful activities that result, or could result,

    in the loss of customer funds or the inability of the firms to meet

    their financial obligations to market participants. Proposed Sec.

    1.52(a) added a definitions section identifying the terms

    ``examinations expert,'' ``material weakness,'' and ``generally

    accepted auditing standards.''

    The term ``examinations expert'' was defined as a ``nationally

    recognized accounting and auditing firm with substantial expertise in

    audits of futures commission merchants, risk assessment and internal

    control reviews, and is an accounting and auditing firm that is

    acceptable to the Commission.'' The Commission received several

    comments regarding the opinion that the examinations expert is required

    to provide on its review of the SRO programs, which is addressed in

    section II.O.4 below. The Commission did not, however, receive comments

    regarding the defined term ``examinations expert'' and is adopting the

    definition as proposed.

    The term ``material weakness'' was defined as ``as a deficiency, or

    a combination of deficiencies, in internal control over financial

    reporting such that there is a reasonable possibility that a material

    misstating of the entity's financial statements and regulatory

    computations will not be prevented or detected on a timely basis by the

    entity's internal controls.'' The Commission has determined not to

    adopt the definition of material weakness to eliminate the concern that

    the SROs examinations are intended to replicate the financial statement

    audits performed by public accountants under Sec. 1.16.

    Proposed Sec. 1.52(b) requires each SRO to adopt rules prescribing

    minimum financial and related reporting requirements, and requires its

    member FCMs to establish a risk management program that is at least as

    stringent as the risk management program required of FCMs under Sec.

    1.11. Proposed amendments to Sec. 1.52 (c) requires each SRO to

    establish a supervisory program to oversee their member FCMs'

    compliance with SRO and Commission minimum capital and related

    reporting requirements, the obligation to properly segregated customer

    funds, risk management requirements, financial reporting requirements,

    and sales practices and other compliance requirements. The supervisory

    program must address: (1) Levels and independence of SRO examination

    staff; (2) ongoing surveillance of member FCMs; (3) procedures for

    identifying high-risk firms; (4) on-site examinations of member firms;

    and (5) the documentation of all aspects of the supervisory program.

    The supervisory program also must be based on an understanding of the

    internal control environment to determine the nature, timing, and

    extent of controls testing and substantive testing to be performed and

    must address all areas of risk to which the FCM can reasonably be

    foreseen to be subject. Proposed Sec. 1.52(c) also requires that all

    aspects of the SRO's supervisory program must, at a minimum, conform to

    generally accepted auditing standards after consideration to the

    auditing standards issued by the PCAOB.

    Proposed Sec. 1.52(c) also requires each SRO to engage an

    ``examinations expert'' at least once every two years to evaluate the

    quality of the supervisory oversight program and the SRO's application

    of the supervisory program. The SRO must obtain a written report from

    the examinations expert with an opinion on whether the supervisory

    program is reasonably likely to identify a material weakness in

    internal controls over financial and/or regulatory reporting, and in

    any of the other areas

    [[Page 68560]]

    that are subject to the supervisory program.

    Proposed Sec. 1.52(d) provides that two or more SROs may enter

    into an agreement to delegate the responsibility of monitoring and

    examining an FCM that is a member of more than one SRO to a DSRO. The

    DSRO would monitor the FCM for compliance with the Commission's and

    SROs' minimum financial and related reporting requirements, and risk

    management requirements, including policies and procedures relating to

    the receipt, holding, investing and disbursement of customer funds.

    The Commission received several comments on the proposed amendments

    to Sec. 1.52 and, with the exception of the issues discussed below,

    has determined to adopt the amendments as proposed.\459\

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

    \459\ MGEX stated that the Commission's Proposal generally

    supports the current DSRO program by requiring FCMs to file various

    reports and notices with the Commission and with the firms' DSROs.

    MGEX further stated that the Commission should not create a

    regulatory monopoly and should recognize that an SRO may not wish to

    join the JAC. The Commission believes that each SRO has a right to

    elect to perform the financial surveillance required under Sec.

    1.52 directly or to participate in a joint audit agreement with

    other SROs. In addition, Sec. 38.604 requires each SRO to have

    rules in place that require member FCMs to submit financial

    information to the SRO.

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

    1. Swap Execution Facilities Excluded From the Scope of Regulation 1.52

    The Commission is revising the final Sec. 1.52 by adding a new

    defined term, ``self-regulatory organization,'' to paragraph (a). The

    term ``self-regulatory organization'' is defined in paragraph (a) to

    mean, for purpose of Sec. 1.52 only, a contract market, as defined in

    Sec. 1.3(h), or a registered futures association. The term ``self-

    regulatory organization'' is further defined in paragraph (a) to

    explicitly exclude a swap execution facility (``SEF''), as defined in

    Sec. 1.3(rrrr).

    The revision to definition of self-regulatory organization in Sec.

    1.52 is necessary due to the recent amendments to the definition of

    ``self-regulatory organization'' set forth in Sec. 1.3(ee), which

    defines the term as a contract market, as defined in Sec. 1.3(h), a

    SEF, as defined in Sec. 1.3(rrrr), or a registered futures association

    under section 17 of the Act.\460\ Therefore, since Sec. 1.52 applies

    to each SRO, without including a definition for the term ``self-

    regulatory organization'' under Sec. 1.52(a) that excludes SEFs, the

    full provisions of Sec. 1.52 would apply to SEFs.

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

    \460\ 77 FR 66288 (Nov. 2, 2012). Regulation 1.3 is the general

    definitions provision of the Commission's regulations.

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

    In adopting new regulations implement core principles and other

    requirements for SEFs, the Commission did not require SEFs to adopt

    minimum capital and related financial reporting requirements for its

    member firms.\461\ The Commission further stated that a SEF's

    obligation to monitor its member for financial soundness extended only

    to a requirement to ensure that the members continue to qualify as

    eligible contract participants as defined in section 1a(18) of the

    Act.\462\ Therefore, the Commission previously has determined that the

    extensive oversight program required of SROs that are contract markets

    or registered futures associations by Sec. 1.52 is not applicable to

    SEFs.

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

    \461\ 78 FR 33476 (June 4, 2013).

    \462\ Id.

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

    2. Revisions to the Current SRO Supervisory Program

    The Commission received several comments concerning the proposed

    amendments to Sec. 1.52, many of which varied in support and context.

    The NFA stated that it fully supports the requirement that the

    supervisory program include both controls testing and substantive

    testing, and that the examinations process be driven by the risk

    profile of the FCM.\463\ NFA noted that it has been modifying its

    procedures to enhance its examination of FCM internal controls as well

    as substantive testing, and also has updated its risk system to create

    risk profiles of each of its FCMs.\464\ NFA also agreed that SROs

    should identify those FCMs that pose a high degree of potential risk so

    that the SRO can increase its monitoring of those firms and that the

    examinations should focus on the higher risk areas at each FCM.\465\

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

    \463\ NFA Comment Letter at 3 (Feb. 15, 2013). See also Paul/

    Weiss Comment Letter at 2 (Feb. 15 2013), BlackRock Letter at 3

    (Feb. 15. 2013), and MFA Comment Letter at 4 (Feb. 15, 2013)

    expressing general support for the proposed enhancements to the SRO

    examinations program.

    \464\ Id.

    \465\ Id.

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

    The CME and JAC generally did not support the proposed amendments

    to Sec. 1.52, stating that the current limited role of regulatory

    exams is appropriate as its purpose is not intended to give the same

    level of assurances to the FCM, the FCM's investors, or third parties

    as that which external auditors provide in conducting financial

    statement audits of FCMs.\466\ The CME also stated that regulatory

    reviews are not designed to protect investors in FCMs, nor should they

    be.\467\ In addition, the CME believes that SROs and DSROs play

    regulatory roles, and it is no more appropriate to have them report to

    an audit committee of an FCM than it would be to have the Commission

    itself report to that audit committee.\468\

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

    \466\ CME Comment Letter at 8-9 (Feb. 15, 2013); JAC Comment

    Letter at 2-4 (Feb. 14, 2013); JAC Comment Letter 2-4 (July 25,

    2013).

    \467\ CME Comment Letter at 11 (Feb. 15, 2013).

    \468\ Id.

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

    The JAC stated that the SRO examinations are compliance reviews

    focused on the particular and distinctive regulatory requirements and

    associated risks of the futures industry, including whether FCMs are in

    compliance with customer regulations and net capital requirements to

    protect customers and the functioning of the futures industry.\469\ The

    JAC further stated that incorporating the full risk management

    requirements of Sec. 1.11 into the SRO's examinations of FCMs, and the

    requirement that the SRO audit program address all areas of risk to

    which FCMs can reasonably be foreseen to be subject, are overly broad

    requirements that are impractical, and virtually impossible to

    meet.\470\

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

    \469\ JAC Comment Letter at 2 (July 25, 2013).

    \470\ Id. See also JAC Comment Letter at 5 (Feb. 14, 2013).

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

    The JAC further stated that proposed Sec. 1.52 imposes potential

    duplicative oversight of FCM risk management policies and procedures by

    SROs and DCOs. The JAC noted that Sec. 39.13(h)(5) requires a DCO to

    review the risk management policies, procedures, and practices of each

    of its clearing members.\471\ The JAC requested clarification on the

    oversight responsibilities of SROs and DCOs to address potential

    duplicative requirements.\472\ Lastly, the JAC stated that expanding

    the SRO oversight program to include operational and technical risks

    will require additional expertise, time and resources to perform such

    reviews and will result in increased costs.\473\

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

    \471\ Id.

    \472\ Id.

    \473\ Id. The JAC noted that the examination of the controls and

    risk management policies and procedures over an FCM's technology

    systems would require particular expertise that is different from

    the knowledge and expertise or regulatory staff, and that SROs will

    have to hire specialized examiners to conduct such reviews.

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

    The Commission believes that the CME, NFA, JAC, SROs and DSROs play

    a critical role in examining FCMs and other registrants under the self-

    regulatory structure of the futures industry. Recent events, however,

    demonstrate that the SROs' current focus on CFTC and SRO regulatory

    requirements, including segregation and net capital computations, are

    not in and of themselves adequate to assess risk and protect customers

    of the FCM. For instance, a failure in an FCM's non-futures operations

    may pose risks to

    [[Page 68561]]

    futures customers and the operation of an FCM. In addition, technology

    failures at an FCM also may pose risks to the operation of an FCM and

    the overall protection of customer funds. Accordingly, to properly

    monitor and assess risks to the FCM, the SRO must be aware of non-

    futures related activities of the FCM.

    Recent events also demonstrate that the examinations of FCMs must

    be risk based and that the testing must be based on an understanding of

    the registrant's internal control environment to determine the nature,

    timing and extent of the necessary tests. In order to help ensure an

    appropriate risk based exam is performed, an examiner must take into

    account the risk profile of the firm and build the examination program

    accordingly. For example, if a firm has weak controls over cash, the

    risk of inaccurate accounting for cash movements is greater and

    therefore more detailed substantive testing of cash transactions and

    balances is necessary to provide the examiner with sufficient assurance

    that reported balances are accurate. To the contrary, if controls are

    good over cash then less substantive testing is needed.

    The Commission acknowledges that revised Sec. 1.52 imposes new

    obligations on SROs by requiring their supervisory programs to include

    an assessment of whether member FCMs comply with the risk management

    requirements of Sec. 1.11. However, Sec. 1.52 also requires that the

    SRO's examination of FCMs be performed on a risk-based approach. The

    scope of the examinations should be based upon the SRO's assessment of

    risk at the FCM and full, detailed testing is not mandated by Sec.

    1.52 in each area. Lastly, the Commission recognizes that DCOs impose

    certain risk management requirements on clearing FCMs and are required

    to review the operation of such risk management requirements. While

    Sec. 39.13(h)(5) is directed at risk that an FCM may pose to a DCO

    and, therefore, is more narrowly focused than the risk management

    requirements in Sec. 1.11, SROs may coordinate with a DCO to ensure

    that duplicative work is not being performed by the separate

    organizations.\474\

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

    \474\ Under the current JAC structure, the CME is the only

    entity that is both an SRO that performs periodic examinations of

    FCMs and a DCO that has responsibilities under Sec. 39.13(h)(5) to

    perform risk management on clearing FCMs.

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

    3. Auditing Standards Utilized in the SRO Supervisory Program

    Proposed Sec. 1.52(c)(2)(ii) and (d)(2)(ii)(F) require all aspects

    of an SRO's or DSRO's, supervisory program to conform, at a minimum, to

    U.S. GAAS after giving full consideration to the auditing standards

    issued by the PCAOB. NFA, CME, and JAC questioned what is meant by the

    term ``after giving full consideration of auditing standards prescribed

    by the PCAOB.'' \475\ NFA, CME, and JAC did not agree with basing the

    SRO Supervisory Program framework on either U.S. GAAS or PCAOB

    standards, largely because the DSRO does not issue a report that

    expresses an opinion with respect to the FCM's financial statements or

    issue an Accountant's Report on Material Inadequacies.\476\

    Additionally, CME noted that invoking U.S. GAAS and PCAOB standards

    opens up a complex and detailed regulatory structure, which includes a

    framework allowing auditor's to rely on interpretive publications,

    professional journals and auditing publications from state CPA

    societies, none of which were designed to address the regulatory

    function played by an SRO or DSRO.\477\ However, NFA acknowledged that

    certain U.S. GAAS and PCAOB accounting standards and practices should

    be followed by DSROs in performing their regulatory examinations (e.g.,

    those standards focusing on recordkeeping, training and experience, the

    scope of the examination and testing, the confirmation process, and

    other related examination practices).\478\

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

    \475\ NFA Comment Letter at 3 (Feb. 15, 2013); CME Comment

    Letter at 9-10 (Feb. 15, 2013); JAC Comment Letter at 2-3 (Feb 14,

    2013).

    \476\ Id.

    \477\ CME Comment Letter at 9-10 (Feb. 15, 2013).

    \478\ NFA Comment Letter at 3-4 (Feb. 15, 2013).

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

    The Commission notes that the objective of the Proposal was to

    ensure that the SRO examinations are conducted consistent with the

    professional standards that CPAs and others are subject to in

    conducting their examinations. The Commission recognizes that certain

    U.S. GAAS principles and PCAOB principles would not be applicable to

    the SRO examinations (such as principles addressing reporting, which

    provide that the CPA must state whether the financial statements are

    prepared in accordance with Generally Accepted Accounting Principles).

    However, other U.S. GAAS and PCAOB standards would be relevant to SRO

    examinations. Such principles include standards addressing the

    competency and proficiency of the examinations staff and the obtaining

    and documenting of adequate audit evidence to support the examiner's

    conclusions.

    The Commission has considered these comments and has revised the

    proposed language to state that at a minimum, an examination should

    conform to PCAOB auditing standards to the extent such standards

    address non-financial statement audits. While it is acknowledged that

    PCAOB audit standards are directed at financial statement audits, the

    concept of many of the standards are just as applicable to an

    examination performed by an SRO or DSRO, and as such should be adopted

    in that light. The relevant PCAOB standards would include, but are not

    limited to, the training and proficiency of the auditor, due

    professional care in the performance of the work, consideration of

    fraud in an audit, audit risk, consideration of materiality in planning

    and performing an audit, audit planning, identifying and assessing

    risks of material misstatement, the auditor's responses to the risk of

    material misstatement, audit documentation, evaluating the audit

    results, communications with audit committees, and due professional

    care in the performance of work. In developing the supervisory program,

    consideration should also be given to other related guidance such as

    the standards adopted by the Institute of Internal Auditors (Standards

    & Guidance--International Professional Practices Framework) and the

    Policy Statement and Supplemental Policy Statement on the Internal

    Audit Function and its Outsourcing issued by the Board of Governors of

    the Federal Reserve System, and generally accepted auditing standards

    issued by the American Institute of Certified Public Accountants.\479\

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

    \479\ The Commission is revising final Sec. 1.52 to remove from

    paragraph (a) a definition for the term ``U.S. Generally accepted

    auditing standards'' as that term is no longer contained in the

    final regulation.

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

    4. ``Examinations Expert'' Reports

    Proposed Sec. 1.52(c)(2)(iv) and (d)(2)(ii)(I) require each SRO

    and DSRO, respectively, to engage an examinations expert to evaluate

    the SROs or DSROs programs and to express an opinion as to whether the

    program is reasonably likely to identify a material deficiency in

    internal controls over financial and/or regulatory reporting and in any

    of the other areas that are subject to SRO or DSRO review under the

    programs. The JAC, CME, Center for Audit Quality, Ernst & Young, and

    PWC did not support the ``examinations expert'' requirement.\480\

    Several of these commenters expressed concern that the term

    ``examinations expert'' as defined

    [[Page 68562]]

    by Sec. 1.52 imposes a criterion that most CPA firms may not possess

    or would not be willing to issue such a report.\481\ Moreover, NFA,

    JAC, and MGEX stated that requiring an ``examinations expert'' is

    unnecessary and duplicative of already existing Commission

    responsibilities, noting that the JAC provides the examination programs

    to the Commission annually, and that the Commission can perform a

    review of the examination programs.\482\

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

    \480\ JAC Comment Letter at 3-4 (Feb. 14, 2013); Center for

    Audit Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young

    Comment Letter at 3-4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan.

    15, 2013).

    \481\ CME Comment Letter at 13 (Feb. 15, 2013); Center for Audit

    Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young Comment

    Letter at 3-4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan. 15,

    2013).

    \482\ NFA Comment Letter at 4-5 (Feb. 15, 2013); JAC Comment

    Letter at 4 (Feb. 14, 2013) MGEX Comment Letter at 3-4 (Feb. 18,

    2013).

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

    NFA and JAC suggested, as cost effective and more practical

    solution, inviting individuals meeting the ``examinations expert''

    designation to participate in the already existing JAC audit committee

    meetings.\483\ CME suggested that if the proposed structure is adopted,

    the time frame for review be extended from 18 months to 3\1/2\ years,

    matching that required by the AICPA in its Peer Review program.\484\

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

    \483\ NFA Comment Letter at 4-5 (Feb. 15, 2013); JAC Comment

    Letter at 4 (Feb. 14, 2013).

    \484\ CME Comment Letter at 13 (Feb. 15, 2013).

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

    The Commission has taken these comments into consideration and has

    revised the final regulation by providing that the report of the

    examinations expert should conform to the consulting services standards

    of the AICPA. The Commission recognizes that generally accepted

    auditing standards do not provide a reporting framework by which a

    certified public accountant can issue an audit opinion consistent with

    the requirements contained in Sec. 1.52. Accordingly, the Commission

    has revised the final regulation by removing the requirement that the

    examinations expert provide an audit opinion.

    The Commission also does not believe that it is in a position to

    perform the type of review of the SRO examination reports required by

    Sec. 1.52 given its limited resources. Furthermore, the examinations

    expert is an independent party with expert knowledge of risk assessment

    and internal controls reviews and will be able to provide more thorough

    and detailed review of the joint audit program than Commission staff

    can currently devote to such a review. In addition, the Commission

    staff has communicated to the JAC that it would be very supportive of

    having the accounting and auditing experts join the JAC meetings to

    discuss current industry issues.

    The Commission has also considered the impact of performing such a

    review every two years and has modified the proposal to require such a

    report on a three year basis. This reflects the fact that the DSROs

    will be updating their programs as needed and therefore the program

    should not be stagnant during the intervening years. Finally, it was

    pointed out that given the nature of the report and to facilitate an

    open and frank dialogue amongst the examinations expert, the DSROs, and

    the Commission, such report should be considered confidential. The

    Commission is revising the regulation to provide that the report is

    confidential, which is consistent with how the PCAOB conducts its

    reviews of CPA firms.

    P. Sec. 1.55: Public Disclosures by Futures Commission Merchants

    Regulation 1.55(a) currently requires an FCM, or an IB in the case

    of an introduced account, to provide a customer with a separate written

    risk disclosure statement prior to opening the customer's account

    (``Risk Disclosure Statement''). Regulation 1.55(a) also provides that

    the Risk Disclosure Statement may contain only the language set forth

    in Sec. 1.55(c) (with an exception for non-substantive additions such

    as captions), except that the Commission may authorize the use of Risk

    Disclosure Statements approved by foreign regulatory agencies or self-

    regulatory organizations if the Commission determines that such Risk

    Disclosure Statements are reasonably calculated to provide the

    disclosures required by the Commission under Sec. 1.55.\485\

    Regulation 1.55(a) further requires the FCM or IB to receive a signed

    and dated statement from the customer acknowledging his or her receipt

    and understanding of the Risk Disclosure Statement.\486\

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

    \485\ The Commission has previously approved an alternative

    ``generic'' risk disclosure statement for use in the United Kingdom,

    Ireland and the U.S.

    \486\ FCMs and IBs are permitted to open commodity futures

    accounts for ``institutional customers'' pursuant to Sec. 1.55(f)

    without furnishing such institutional customers with a Risk

    Disclosure Statement or obtaining the written acknowledgment

    required by Sec. 1.55. The term ``institutional customer'' is

    defined by Sec. 1.3(g) and section 1a of the Act as an eligible

    contract participant. The Commission did not propose to amend Sec.

    1.55(f) to require FCMs or IBs to furnish institutional customers

    with Risk Disclosure Statements.

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

    The Commission reviewed the adequacy of the current prescribed Risk

    Disclosure Statement in light of its experience with customer

    protection issues during the recent failures of two FCMs, MFGI and

    PFGI. In this regard, in responding to questions and issues raised

    primarily by non-institutional market participants, including market

    participants from the agricultural community and retail market

    participants, the Commission recognized that such market participants

    would benefit from several additional disclosures regarding the

    potential general risks of engaging in futures trading through an FCM,

    and the potential specific risks resulting from the bankruptcy of an

    FCM. In addition to proposing new general risk disclosures, the

    Commission proposed to also require each FCM to provide customers and

    potential customers with information about the FCM, including its

    business, operations, risk profile, and affiliates. The firm specific

    disclosures are intended to provide customers with access to material

    information regarding an FCM to allow the customers to independently

    assess the risk of entrusting funds to the firm or to use the firm for

    the execution of orders.

    1. Amendments to the Risk Disclosure Statement

    The mandatory Risk Disclosure Statement currently addresses the

    risks of engaging in commodity futures trading. The risks that must be

    disclosed include: (1) The risks that a customer may experiences losses

    that exceed the amount of funds that he or she contributed to trading

    and that the customer may be responsible for losses beyond the amount

    of funds deposited for trading; (2) the risks that under certain market

    conditions, a customer may find it difficult or impossible to liquidate

    a position, such as when a market has reached a daily price move limit;

    (3) the risks that placing certain contingent orders (such as a stop

    limit order) may not necessarily limit the customer's losses; (4) the

    risks associated with the high degree of leverage that may be

    obtainable from the futures markets; and (5) the risks of trading on

    non-U.S. markets, which may not provide the same level of protections

    provided under Commission regulations.

    As noted above, the Commission proposed several additional

    disclosures based upon its experience in working with customers,

    particularly retail and other non-institutional market participants,

    during the recent failures of MFGI and PFGI. Specifically, the

    Commission proposed to amend the Risk Disclosure Statement to provide

    market participants with more information regarding the risks

    associated with an FCM holding customer funds. In this regard, certain

    market participants believed that the fact that their funds were

    segregated from the FCM's proprietary funds protected them from loss in

    the event of

    [[Page 68563]]

    an FCM bankruptcy. Other customers believed that a DCO guaranteed

    customer losses, and other customers believed that funds deposited for

    futures trading were protected by the Securities Investor Protection

    Corporation in the event of an FCM/BD bankruptcy.

    To provide greater clarity as to the how customer funds are held

    and the potential risks associated with FCMs holding customer funds,

    the Commission proposed to revise the Risk Disclosure Statement by

    amending Sec. 1.55(b) to include new paragraphs (2) through (7) as

    follows:

    (2) The funds you deposit with an FCM for trading futures positions

    are not protected by insurance in the event of the bankruptcy or

    insolvency of the futures commission merchant, or in the event your

    funds are misappropriated due to fraud;

    (3) The funds you deposit with an FCM for trading futures positions

    are not protected by the Securities Investor Protection Corporation

    even if the futures commission merchant is registered with the SEC as a

    BD;

    (4) The funds you deposit with an FCM are not guaranteed or insured

    by a DCO in the event of the bankruptcy or insolvency of the FCM, or if

    the FCM is otherwise unable to refund your funds;

    (5) The funds you deposit with an FCM are not held by the FCM in a

    separate account for your individual benefit. FCMs commingle the funds

    received from customers in one or more accounts and you may be exposed

    to losses incurred by other customers if the FCM does not have

    sufficient capital to cover such other customers' trading losses;

    (6) The funds you deposit with an FCM may be invested by the FCM in

    certain types of financial instruments that have been approved by the

    Commission for the purpose of such investments. Permitted investments

    are listed in Commission Regulation 1.25 and include: U.S. government

    securities; municipal securities; money market mutual funds; and

    certain corporate notes and bonds. The FCM may retain the interest and

    other earnings realized from its investment of customer funds. You

    should be familiar with the types of financial instruments that an FCM

    may invest customer funds in; and

    (7) FCMs are permitted to deposit customer funds with affiliated

    entities, such as affiliated banks, securities brokers or dealers, or

    foreign brokers. You should inquire as to whether your FCM deposits

    funds with affiliates and assess whether such deposits by the FCM with

    its affiliates increases the risks to your funds.

    The Commission received several comments on the proposed amendment

    to the Risk Disclosure Statement. NFA stated that it fully supported

    the Commission's goal of ensuring that customers receive a full

    description of the risk associated with futures trading, and agreed

    with the Commission that it is important to update the Risk Disclosure

    Statement to provide information on the extent to which customer funds

    are protected when deposited with an FCM as margin or to guarantee

    performance for trading commodity interest.\487\

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

    \487\ NFA Comment Letter at 15 (Feb. 15, 2013).

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

    The FIA generally supported the proposed amendments to the general

    Risk Disclosure Statement set forth in Sec. 1.55(b) and outlined

    above.\488\ The FIA stated that many of the Commission's proposed

    amendments are consistent with FIA's recommendations to enhance

    disclosures set forth in its paper, ``Initial Recommendations for the

    Protection of Customer Funds,'' which was published on February 28,

    2012 (``Initial Recommendations'') in response to MFGI.\489\ FIA also

    stated that its document, ``Protection of Customer Funds--Frequently

    Asked Questions,'' is being used by FCMs to provide customers with

    increased disclosures on the scope of how the laws and regulations

    protect customers in the futures market.\490\

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

    \488\ FIA Comment Letter at 41 (Feb. 15, 2013).

    \489\ FIA Comment Letter at 2 (Feb. 15, 2013). The FIA formed a

    special committee to develop and recommend specific measures that

    could be implemented by both the industry best practices and

    regulatory change to address the issues arising from the bankruptcy

    of MFGI.

    \490\ Id. FIA's ``Protection of Customer Funds--Frequently Asked

    Questions'' provides information covering five broad areas: (1)

    segregation of customer funds; (2) collateral management and

    investments; (3) basic information on FCMs, such as the purpose of

    capital requirements and margin processing: (4) issues for joint

    FCM/BDs; and (5) the role of the DCO guarantee fund.

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

    With respect to the Commission's proposed amendments to Sec.

    1.55(b), FIA recommended that the Commission delete the phrase ``due to

    fraud'' in Sec. 1.55 (b)(2) because customer funds may be

    misappropriated for any reason.\491\ Additionally, FIA suggested the

    disclosure in Sec. 1.55(b)(4) be revised to take account of the CME

    Group Family Farmer and Rancher Protection Fund established in the wake

    of MFGI as this fund will provide up to $25,000 to qualifying

    individual farmers and ranchers and $100,000 to co-ops that hedge their

    risk in CME futures markets.\492\

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

    \491\ Id. at 41.

    \492\ Id. at 41-42.

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

    The Commission has considered FIA's comments and had determined to

    revise the proposal. The Commission recognizes that customer funds may

    be misappropriated as a result of wrongful conduct that does not rise

    to the level of fraud. Accordingly, the Commission is revising Sec.

    1.55(b)(4) by removing the phrase ``due to fraud'' so that the

    disclosure provides that customers' funds are not covered by insurance

    in the event of the insolvency of the FCM or in the event the funds are

    misappropriated.

    The Commission also is revising final Sec. 1.55(b)(4) in response

    to FIA's comment to provide an overall statement that customer funds

    generally are not insured by DCOs. The Commission is further revising

    final Sec. 1.55(b)(4) to include in the disclosure the fact that a DCO

    may offer an insurance program, and that a customer should inquire of

    the FCM the extent of any DCO insurance programs and whether the

    customer would qualify for coverage and understand the limitations and

    benefits of the coverage. The Commission believes that this approach is

    more flexible to address future developments in this area than a direct

    reference to specific DCO insurance programs that currently are

    available.

    NEFI/PMAA questioned whether or not existing and proposed

    disclosures are sufficient, and further stated that disclosure of

    customer protections are equally important as the disclosure of

    potential risks to ensure customer confidence.\493\ Pilot Flying J

    stated FCMs must be required to disclose information to their customers

    on how their accounts and positions will be managed, as well as

    associated risks and what kinds of financial protections are afforded

    to customers by the firm, exchange, and the Commission.

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

    \493\ NEFI/PMAA Comment Letter at 2 (Jan. 14, 2013).

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

    The Commission agrees with NEFI/PMAA and Pilot Flying J that a

    customer's understanding of the protections is as important as

    understanding the risks. The Risk Disclosure Statement is the minimum

    information that an FCM should provide to prospective customers, and is

    intended to provide a high level summary of the general risk of trading

    commodity interests. FCMs should provide additional information as

    necessary to ensure that customers have adequate information. The

    Commission believes that FIA's Initial Recommendation and FAQ, which

    includes the types of information that NEFI/PMAA and Pilot Flying J are

    requesting, should be made available to all potential customers. FIA

    should revise the documents, as appropriate, in

    [[Page 68564]]

    response to changing market events or other factors.

    The Commission also requested comment on whether and how the new or

    revised Risk Disclosure Statement should be provided to existing

    customers at the effective date of the regulation. Particularly, the

    Commission requested comment on whether FCMs should be required to

    obtain new signature acknowledgments from existing customers.

    FIA stated that it was not opposed to a requirement that FCMs

    provide the revised Risk Disclosure Statement to existing customers

    that are otherwise required to receive the disclosure document.\494\

    FIA stated, however, that FCMs should not be required to obtain a

    written acknowledgment from existing customers. FIA further stated that

    it should be sufficient if the FCM makes each customer aware of the

    revised Risk Disclosure Statement by any appropriate means, consistent

    with the means by which the FCM normally communicates important

    information to customers, including but not limited to, a separate

    mailing.\495\ The CFA stated that it is very important for FCMs and

    their DSROs to ascertain whether existing and potential customers have

    acknowledged receipt of the Risk Disclosure Statement, and FCMs should

    keep records of acknowledgments that the Risk Disclosure Statements

    were received.\496\ NGFA noted that providing updated risk disclosure,

    with signed acknowledgment of such to the FCM, is a sound concept.\497\

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

    \494\ FIA Comment Letter at 42-43 (Feb. 15, 2013).

    \495\ Id.

    \496\ CFA Comment Letter at 8 (Feb. 13, 2013).

    \497\ NGFA Comment Letter at 5 (Feb. 15, 2013).

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

    Regulation 1.55(a) will continue to require FCMs to obtain and

    retain signed acknowledgments from new customers that they received and

    understand the Risk Disclosure Statement. With respect to existing FCM

    customers on the effective date of the regulation, the Commission

    believes that it is adequate for an FCM to provide each of the

    customers with a revised Risk Disclosure Statement via its normal means

    of communicating with customers, including the use of a separate

    mailing, or providing a link on the firm's Web site to the revised Risk

    Disclosure Statement, provided that the FCM provides a paper copy of

    the Risk Disclosure Statement upon the request of a customer. The

    communication of the revised Risk Disclosure Statement to customers

    must be highlighted by the FCM in such a manner to reasonably ensure

    that the customers are adequately apprised of the revised Risk

    Disclosure Statement.

    FIA also noted that the Commission previously approved, pursuant to

    Sec. 1.55(c), an alternative risk disclosure statement for use in the

    U.S., the United Kingdom, and Ireland.\498\ The alternative risk

    disclosure statement is set forth in Appendix A to Sec. 1.55. FIA

    requested that the Commission confirm whether FCMs may continue to use

    the alternative risk disclosure statement and further encouraged the

    Commission to coordinate with other derivatives regulatory authorities

    to revise the alternative risk disclosure statement to meet its

    regulatory objectives.\499\

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

    \498\ FIA Comment Letter at 43 (Feb. 15, 2013).

    \499\ Id.

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

    Regulation 1.55(c) provides that the Commission may approve for use

    in lieu of the standard Risk Disclosure Statement required by Sec.

    1.55(b) a risk disclosure statement approved by one or more foreign

    regulatory agencies or self-regulatory organizations if the Commission

    determines that such risk disclosure statement is reasonably calculated

    to provide the disclosure required by the standard Risk Disclosure

    Statement. As noted above, the Commission proposed amendments to the

    Risk Disclosure Statement due to its recent experiences with the MFGI

    and PFGI insolvencies where certain customers, particularly less

    sophisticated customers, did not fully comprehend the nature of the

    protections of customer funds. Based upon this recent experience, the

    Commission does not believe that the disclosures in the alternative

    risk disclosure statement contained in Appendix A provide sufficient

    detailed disclosures to customers regarding the risk of trading futures

    transactions. Accordingly, the Commission is revising Sec. 1.55(c) to

    provide that an FCM may continue to use the alternative risk disclosure

    statement provided that the FCM also provides each customer required to

    receive a disclosure document with the revised Risk Disclosure

    Statement and receives such customer's written acknowledgment that it

    has received and understands the Risk Disclosure Statement. This will

    allow FCMs to continue to have a common risk disclosure statement with

    the United Kingdom and Ireland, and also ensure that customers receive

    additional risk disclosures to enhance their understanding of engaging

    in futures trading.

    a. Firm Specific Disclosure Document

    i. General Requirements

    The Commission proposed new paragraphs (i) and (k) to Sec. 1.55 to

    provide that an FCM may not enter into a customer account agreement or

    accept funds from a customer unless the FCM discloses to the customer

    all information about the FCM, including its business, operations, risk

    profile, and affiliates, that would be material to the customer's

    decision to entrust such funds to such FCM and otherwise necessary for

    full and fair disclosure to customers (``Firm Specific Disclosure

    Document'').

    The Firm Specific Disclosure Document is intended to enable

    customers to make informed judgments regarding the appropriateness of

    selecting an FCM by providing information for the meaningful

    comparisons of business models and risks across FCMs. Such information

    will greatly enhance the due diligence that a customer can conduct both

    prior to opening an account and on an ongoing basis, as the proposal

    will require the FCM to update the Firm Specific Disclosure Document at

    least once every 12 months and as and when necessary to keep it

    accurate and complete. The Commission believes that the proposed firm

    specific Firm Specific Disclosure Document, coupled with the existing

    Risk Disclosure Statement, will provide customers with a more complete

    perspective regarding the risks of participating in the futures markets

    and of opening an account with a particular firm.

    Proposed Sec. 1.55(j) requires an FCM to make the Firm Specific

    Disclosure Document available to customers and to the general public by

    posting the Firm Specific Disclosure Document on the FCM's Web site. An

    FCM may, however, use an alternative electronic means to provide the

    Firm Specific Disclosure document to its customers provided that the

    electronic version is presented in a format that is readily

    communicated to the customers. Paper copies of the Firm Specific

    Disclosure Document also must be available upon the request of a

    customer. The Commission also proposed that each FCM disclose certain

    financial information on its Web site to provide the public with

    additional information on the firm and the customer funds that it

    holds. The additional financial disclosures are set forth in Sec.

    1.55(o) and are discussed below.

    SIFMA stated that the public disclosure requirements will help

    empower its members to choose safe and trustworthy FCMs, and that the

    [[Page 68565]]

    disclosures will hold FCMs accountable to their customers, allowing the

    customers to conduct due diligence efficiently, actively monitor FCMs'

    financial condition and regulatory compliance, and make informed

    decisions when selecting and doing business with FCMs.\500\ Vanguard

    expressed the view that the best protection for customers is their own

    due diligence, and that the proposed additional enhancements add

    significant, and much needed, protections and transparency.\501\ The

    FHLB supported the proposal with respect to the publication of the Firm

    Specific Disclosure Document and strongly endorsed the requirement that

    the FCM update the document as circumstances warrant.\502\

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

    \500\ SIFMA Comment Letter at 2 (Feb. 21, 2013).

    \501\ Vanguard Comment Letter at 4 (Feb. 2, 2013). See also,

    Prudential Comment Letter at 2 (Jun. 9, 2013) and Security Benefit

    Comment Letter at 2 (Jan. 11, 2013 supporting the additional

    disclosures proposed under Sec. 1.55(i).

    \502\ FHLB Comment Letter at 10 (Feb. 15, 2013).

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

    FIA stated that it supports enhancing disclosures to customers

    regarding the FCM through which the customer may elect to trade.\503\

    FIA requested that the Commission confirm that an FCM that is part of a

    publicly-traded company, whether U.S. or non-U.S., or is otherwise

    required to prepare and to make public an annual report including

    information comparable to that required by the Firm Specific Disclosure

    Document under the proposed regulation, may comply with the regulation

    by making such annual report, and any amendments thereto, available on

    its Web site.\504\ FIA noted that the Management Discussion and

    Analysis (``MD&A'') required under SEC rules (17 C.F.R. 229.303)

    requires publicly traded companies to discuss essentially the same

    topics required to be discussed under the Commission's proposal. FIA

    stated that the topics include business environment; critical

    accounting policies; use of estimates; results of operations; balance

    sheet and funding sources; off-balance sheet arrangements and

    contractual obligations; overview and structure of risk management;

    liquidity risk management; market risk management; credit risk

    management; operational risk management; recent accounting

    developments; and certain risk factors that may affect the company's

    business.\505\ FIA estimated that approximately 90 percent of customer

    funds are held by FCMs that are also SEC registered or part of a bank

    holding company or publicly-traded company and believes this position

    is necessary to avoid customer confusion in certain circumstances and

    to assure that FCMs are not subject to duplicative and, perhaps

    conflicting, disclosure requirements.\506\

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

    \503\ FIA Comment Letter at 41 (Feb. 15, 2013).

    \504\ FIA Comment Letter at 43-44 (Feb. 15, 2013).

    \505\ Id.

    \506\ Id.

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

    FIA further requested that the Commission confirm the level of

    detail required to be provided by privately-held FCM companies should

    be consistent with that provided in the annual reports of publicly-

    traded companies.\507\ Additionally, FIA stated that privately-held

    companies would need a period of time to develop the required

    disclosures and requested that the Commission make the compliance date

    of the regulation no sooner than six months after the effective date of

    the regulation.\508\

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

    \507\ Id. at 44.

    \508\ Id.

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

    The Commission has considered the comments and is adopting Sec.

    1.55(i) and (j) as proposed. In response to FIA's comments, the

    Commission confirms that beyond the requirements stated in Sec. 1.55,

    the Commission is not mandating the form in which the required

    information is conveyed, provided it is responsive to the information

    requirements of Sec. 1.55 and provides such information in a clear,

    concise, and understandable matter. Accordingly an FCM that is part of

    a publicly traded company, or is otherwise required to prepare and make

    public an annual report including information comparable to the

    information required by proposed Sec. 1.55(k), may satisfy the

    disclosure requirements in Sec. 1.55 by making an annual report, and

    any amendments thereto, available on its Web site; provided that such

    annual report provides the information required by Sec. 1.55 in a

    manner that is clear, concise and understandable. The Commission is

    similarly confirming that a privately-held company may satisfy the

    requirements in Sec. 1.55 by making an annual report, and any

    amendments thereto, available on its Web site; provided that such

    annual report provides the information required by Sec. 1.55 in a

    manner that is clear, concise and understandable.

    In assessing whether the annual report contains the necessary

    information required by Sec. 1.55 in a clear, concise and

    understandable manner, the FCM must ensure that the disclosures

    specifically address the risks at the FCM and are not so general in

    nature that they reflect that the FCM's business may not be material to

    the public or private company for which the annual report is prepared.

    An FCM is not in compliance with Sec. 1.55 if the annual report

    information does not disclose the information required by Sec. 1.55 as

    it relates to the FCM. The objective of the disclosures is to provide

    prospective and existing customers of the FCM with material information

    that could have an impact on their decision to engage in a relationship

    with the FCM. If the annual report does not include information

    regarding the FCM, or such information is not clear concise and

    understandable, the FCM would have to enhance the disclosure by

    providing supplemental material or otherwise making the required

    disclosures available to customers and the public in a manner that is

    clear, concise and understandable. In addition, in order to provide

    customers with clear, concise and understandable disclosures, an FCM

    may be required to extract information from various sections of its

    annual report and provide such information in an easy to read format.

    If customers are required to search through detailed annual reports to

    locate the required Sec. 1.55 disclosures, the FCM is not providing

    the information in a clear, concise and understandable manner.

    ii. Specific Disclosure Information Required (by Rule Paragraph)

    Proposed Sec. 1.55(k)(1) requires an FCM to disclose contact

    information for the firm including the address of its principal place

    of business and its phone number. No comments were received on the

    proposed Sec. 1.55(k)(1) and the Commission is adopting the amendments

    as proposed.

    Proposed Sec. 1.55(k)(2) requires an FCM to disclose the name and

    business addresses of the FCM's senior management, including business

    titles and background, areas of responsibility and nature of duties of

    each person. The FIA recommended the disclosure be limited to those

    individuals identified as principals on the NFA BASIC system.\509\

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

    \509\ FIA Comment Letter at 51 (Feb. 15, 2013).

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

    The term ``principal'' is defined in Sec. 3.1 to mean, with

    respect to an FCM: (1) The proprietor and chief compliance officer if

    the FCM is organized as a sole proprietorship; (2) any general partner

    and chief compliance officer if the FCM is organized as a partnership;

    (3) any director, the president, chief executive officer, chief

    operating officer, chief financial officer, chief compliance officer,

    and any person in charge of a principal business unit, division or

    function subject to regulation by the Commission if the FCM is

    organized as

    [[Page 68566]]

    a corporation; (4) any director, the president, chief executive

    officer, chief operating officer, chief financial officer, chief

    compliance officer, the manager, managing member or those members

    vested with the management authority for the entity, and any person in

    charge of a principal business unit, division or function subject to

    regulation by the Commission if the FCM is organized as a limited

    liability company or limited liability partnership; and (5) in

    addition, any person at the FCM occupying a similar status or

    performing similar functions as described above, having the power,

    directly or indirectly, through agreement or otherwise, to exercise a

    controlling influence over the entity's activities that are subject to

    regulation by the Commission.

    The Commission agrees with FIA's comment and is revising the final

    regulation to require an FCM to disclose persons that are defined as

    ``principals'' of the FCM under Sec. 3.1.

    Proposed Sec. 1.55(k)(3) requires an FCM to disclose the

    significant types of activities and product lines that the FCM engages

    in and the approximate percentage of assets and capital that are

    contributed to each type of business activity or product line. FIA

    recommended that an FCM be required to update the description in its

    annual report, only if it adds a new business activity or product line

    that requires higher minimum capital under applicable capital rules

    because the approximate percentage of the FCM's assets and capital used

    in each type of activity can change frequently.\510\

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

    \510\ Id. at 45.

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

    The Commission believes that FIA is defining the requirements of

    Sec. 1.55(k)(3) too narrowly. The regulation is intended to provide

    the public with information concerning the major businesses activities

    that an FCM engages in to provide information regarding the benefits

    and risks of using such firm to conduct transactions in commodity

    interests. Minimum capital requirements are generally driven by

    regulated business, such a being registered as a BD. While such

    information is material to potential customers and is required to be

    disclosed under Sec. 1.55(k)(3), the regulation also requires the

    disclosure of non-regulated business that a firm may engage in.

    The Commission also recognizes that an FCM's assets and capital

    contributed to different business activities can change frequently, but

    such information may be material for the public in determining to

    entrust funds with the firm and to perform effective due diligence in

    monitoring the firm. Each FCM will need to assess the materiality of

    changes and use its judgment to determine whether the Firm Specific

    Disclosure Document should be revised. In addition, the Commission

    notes that Sec. 1.55(i) requires that the Firm Specific Disclosure

    Document must be revised as and when necessary, but at least annually,

    to keep the information accurate and complete. The Commission has

    considered the comments and is adopting the amendments as proposed.

    Proposed Sec. 1.55(k)(4) requires an FCM to disclose its business

    on behalf of customers, including types of accounts, markets traded,

    international business, and clearinghouses and carrying brokers used,

    and its policies and procedures concerning the choice of bank

    depositories, custodians, and other counterparties. FIA requested the

    Commission confirm that: (1) The disclosure required under this

    paragraph is limited to the activities of the FCM in its capacity as

    such; (2) the term ``accounts'' means ``customers''; and (3) the term

    ``counterparties'' is limited to counterparties for Sec. 1.25

    investments.\511\

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

    \511\ Id. at 47-48.

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

    Regulation 1.55(k)(4) is intended to provide customers and the

    public with information regarding the FCM operating its FCM's business.

    Accordingly, the Commission confirms that the disclosures required

    under Sec. 1.55(k)(4) are limited to the activities of the FCM acting

    in its capacity as an FCM. The term ``types of accounts'' in Sec.

    1.55(k)(4) should be ``types of customers,'' and requires the FCM to

    disclose the nature of its customer base in the futures markets (i.e.,

    institutional, retail, agricultural, hedgers,) to provide the public

    with information regarding the firm's experiences with different types

    of markets and market participants. The Commission also confirms that

    the term ``counterparties'' is limited to Sec. 1.25 counterparties.

    The Commission is revising final Sec. 1.55(k)(4) accordingly.

    Proposed Sec. 1.55(k)(5) requires an FCM to discuss the material

    risks, accompanied by an explanation of how such risks may be material

    to its customers, of entrusting funds to the FCM, including, without

    limitation, the nature of investments made by the FCM (including credit

    quality, weighted average maturity, and weighted average coupon); the

    FCM's creditworthiness, leverage, capital, liquidity, principal

    liabilities, balance sheet leverage and other lines of business; risks

    to the FCM created by its affiliates and their activities, including

    investment of customer funds in an affiliated entity; and any

    significant liabilities, contingent or otherwise, and material

    commitments.

    FIA commented that the word ``risks'' in Sec. 1.55(k)(5) should be

    replaced with the word ``information,'' and that the Commission remove

    the phrase ``accompanied by an explanation of how such risks may be

    material to its customers.'' \512\ FIA believed it sufficient that an

    FCM present the required information to the customer and that it is the

    customer's responsibility to analyze this information and determine the

    extent to which it is important or relevant to the customer's decision

    to open or maintain an account with the FCM.\513\ FIA further stated

    that if the Commission believes FCMs should provide guidance to

    customers regarding the potential importance of specific information,

    FIA believes this guidance should be provided by means of a generic

    statement.\514\ In addition, FIA asked the Commission to confirm that

    the term ``investments'' is limited to investments of customer funds,

    and does not include all investments made by the FCM as an entity.\515\

    Additionally, FIA requested that the Commission delete the term

    ``creditworthiness,'' stating that such reference is incongruous with

    instructions under section 939A of the Dodd-Frank Act.\516\ Moreover,

    FIA opined that the only lines of business that an FCM should be

    required to disclose are those that would require higher minimum

    capital under applicable capital rules, and that this information

    should only be required to be updated annually.\517\ Additional

    clarification was requested by FIA regarding the phrase ``investment of

    customer funds with an affiliated entity,'' and whether that phrase

    refers to the ``deposit of customer funds in an affiliated bank.''

    \518\ Further clarification was requested regarding the types of

    liabilities and commitments requiring disclosure under this section and

    whether this information should updated no more often than

    semiannually, consistent with comparable disclosures applicable to

    [[Page 68567]]

    BDs.\519\ Finally, FIA, while not opposed to providing leverage

    information, believed that disclosure should not be required until it

    is certain the calculation provides the most appropriate measure of

    risk.\520\

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

    \512\ FIA Comment Letter at 45 (Feb. 15, 2013).

    \513\ Id.

    \514\ Id.

    \515\ Id.

    \516\ Section 939A required that the Commission, ``remove any

    reference to or requirement of reliance on credit ratings and to

    substitute in such regulations such standard of creditworthiness as

    each respective agency shall determine as appropriate for such

    regulations.'' FIA Comment Letter at 46 (Feb. 15, 2013).

    \517\ FIA Comment Letter at 46 (Feb. 15, 2013).

    \518\ Id. at 51.

    \519\ Id. at 46.

    \520\ Id. at 34.

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

    The Commission believes that it is appropriate that Sec.

    1.55(k)(5) requires an FCM to identify material risks and to explain

    how such risks may be material to customers. The Commission further

    believes, based upon its experiences during MFGI, that customers

    (particularly retail and less sophisticated customers) would benefit

    from an FCM providing its assessment of the risks of the firm,

    accompanied by an explanation of such risks.

    The Commission notes, in response to FIA's comments, that Sec.

    1.55(k)(5) requires an FCM to provide information regarding its general

    investments and is not limited to the investment of customer funds. The

    disclosures contemplated by Sec. 1.55(k)(5) go to the full operation

    of the FCM and not just its regulated or futures activities. In

    addition, limiting the disclosures only to investments that result in

    an increase in minimum capital requirements may result in the non-

    disclosure of significant operations that may impact a customer's

    decision to do business with an FCM.

    The Commission also notes that the requirement in Sec. 1.55(k)(5)

    for FCMs to disclose leverage information would be met by an FCM

    providing the leverage information that each FCM is required to

    calculate under Sec. 1.10 and in accordance with the regulations of

    the NFA. An FCM should define the leverage calculation in the

    Disclosure Document and may provide any other information necessary to

    make the information meaningful for the public, but if materially

    different from the then prevailing NFA methodology, should provide an

    explanation of the differences therefrom.

    Proposed Sec. 1.55(k)(6) requires an FCM to disclose the name of

    its DSRO and the DSRO's Web site, and the location of where the FCM's

    annual financial statements are available. The Commission received no

    comments on proposed Sec. 1.55(k)(6) and is adopting the regulation as

    proposed.

    Proposed Sec. 1.55(k)(7) requires an FCM to disclose any material

    administrative, civil, enforcement, or criminal action then pending,

    and any enforcement actions taken in the last three years. FIA

    requested that the Commission confirm that a ``pending'' action is an

    action that has been filed but not concluded, and recommended the

    Commission confirm that the disclosure required under this paragraph

    would be limited to matters required to be disclosed in accordance with

    Sec. 4.24(l)(2).\521\

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

    \521\ Regulation 4.24(l)(2) requires a CPO to disclose in a

    disclosure document for a commodity pool certain material

    administrative, civil, or criminal actions against an FCM that the

    CPO engages to trade futures.

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

    The Commission agrees with FIA that the regulation should require

    an FCM to disclose administrative, civil, enforcement, and criminal

    actions that have been filed but not concluded. The proposal was not

    intended to cover open or closed investigations that have not resulted

    in the filing of a complaint. The Commission is revising Sec.

    1.55(k)(7) as appropriate to reflect this concept.

    The Commission, however, does not agree with FIA's comment that

    disclosures under proposed Sec. 1.55(k)(7) should be limited to

    administrative, civil, enforcement, or criminal matters that would be

    required to be disclosed under Sec. 4.24(l)(2). Regulation 4.24(l)(2)

    provides that an action will be deemed material if: (1) The action

    would be required to be disclosed in the footnotes to a commodity

    pool's financial statements under generally accepted accounting

    principles as adopted in the U.S.; (2) the action was brought by the

    Commission, provided that if the matter was concluded and did not

    result in a civil monetary penalty in excess of $50,000, it does not

    need to be disclosed; and (3) the action was brought by any other

    federal or state regulatory agency, a non-U.S. regulatory agency, or an

    SRO and involved allegations of fraud or other willful misconduct. The

    Commission believes that the regulation's requirement to disclose

    material actions is appropriate in the context of disclosures so that a

    customer can perform adequate due diligence to assess the risk of

    engaging an FCM to conduct futures business and in entrusting funds to

    the FCM. In this regard, the Commission believes that FCMs should

    disclose Commission disciplinary actions that are pending or have been

    concluded against the FCM without regard to the amount of the civil

    monetary penalty that may have been imposed. In addition, the

    Commission believes that there may be circumstances in addition to

    fraud or other willful misconduct that should be disclosed to customers

    to allow customers to better appreciate the potential risks of entering

    into a business relationship with an FCM.

    Proposed Sec. 1.55(k)(8) requires the Firm Specific Disclosure

    Document to contain a basic overview of customer fund segregation,

    collateral management and investments, FCMs, and dual registrant FCM/

    BDs. The disclosures included under Sec. 1.55(k)(8) should not only

    include information regarding the segregation of funds for trading on

    designated contract markets, but should also include information

    regarding the risk to customers of engaging in foreign futures and

    foreign options trading. In conjunction with Sec. 1.55(k)(4), which

    requires an FCM to provide a profile of its customer business,

    including its international business and clearinghouses and carrying

    brokers used, an FCM in order to comply with Sec. 1.55(k)(8) should

    disclose the risks of engaging in trading on foreign markets. The

    disclosures required by Sec. 1.55(k)(8) should include information

    that in the event of the insolvency of the FCM, or the insolvency of a

    foreign broker or foreign depository that is holding customer funds,

    customer funds held in foreign jurisdictions may be subject to a

    different bankruptcy regime and legal system than if the funds were

    held in the U.S. In addition, an FCM should disclose that a customer

    also is subject to fellow customer risk in foreign jurisdictions and

    that, for purposes of bankruptcy protection, a customer that trades

    only in one country or in one market is also exposed to fellow customer

    risk from losses that may be incurred in other countries and other

    markets. The Commission did not receive comment on Sec. 1.55(k)(8) and

    is adopting the amendments as proposed.

    Proposed Sec. 1.55(k)(9) requires the FCM to include in the Firm

    Specific Disclosure Document information on how a customer may obtain

    information regarding filing a complaint with the Commission or the

    firm's DSRO. The Commission did not receive comment on Sec. 1.55(k)(9)

    and is adopting the amendments as proposed.

    Proposed Sec. 1.55(k)(10) requires the Firm Specific Disclosure

    Document to include the following financial information for the most

    recent month end: (1) The FCM's total equity, regulatory capital, and

    net worth, all computed in accordance with U.S. Generally Accepted

    Accounting Principles and the Commission's capital rule, Sec. 1.17;

    (2) the dollar value of the FCM's proprietary margin requirements as a

    percentage of the aggregated margin requirements for futures customers,

    Cleared Swaps Customers, and 30.7 customers; (3) the number of futures

    customers, Cleared Swaps Customers, and 30.7 customers that comprise 50

    percent of the funds held for such customers, respectively; (4) the

    aggregate notional value, by asset class, of all non-hedged, principal

    over-the-counter transactions into which the

    [[Page 68568]]

    FCM has entered; (5) the amount, generic source and purpose of any

    unsecured lines of credit or similar short term funding the FCM has

    obtained but not yet drawn upon; (6) the aggregated amount of financing

    the FCM provides for customer transactions involving illiquid financial

    products for which it is difficult to obtain timely and accurate

    prices; and (7) the percentages of futures customers, Cleared Swaps

    Customers, and 30.7 customers receivable balances that the FCM had to

    write-off as uncollectable during the past 12 months, as compared to

    the current balance held for such customers.

    CMC generally supported proposed Sec. 1.55(k)(10), as it would

    enhance transparency to the public.\522\ NFA provided a general comment

    supporting the Commission's objective of providing customers with

    meaningful information, but expressed concern that much of the

    information proposed to be disclosed under Sec. 1.55(k)(10) may not be

    understandable to smaller and less sophisticated customers.\523\ NFA

    specifically questioned whether such customers would comprehend: (1)

    The dollar value of the FCM's proprietary margin requirements as a

    percentage of the aggregate margin requirements for futures customers,

    Cleared Swaps Customers, and 30.7 customers; (2) the number of futures

    customers, Cleared Swaps Customers, and 30.7 customers that comprise 50

    percent of the funds held for such customers, respectively; (3) the

    aggregate notional value, by asset class, of all non-hedged, principal

    over-the-counter transactions into which the FCM has entered; (4) the

    amount, generic source and purpose of any unsecured lines of credit or

    similar short term funding the FCM has obtained but not yet drawn upon;

    (5) the aggregate amount of financing the FCM provides for customer

    transactions involving illiquid financial products for which it is

    difficult to obtain timely and accurate prices; and (6) the percentages

    of futures customers, Cleared Swaps Customers, and 30.7 customers

    receivable balances that the FCM had to write-off as uncollectable

    during the past 12 months, as compared to the current balance held for

    such customers.\524\ NFA noted that as one of its responses to MFGI,

    its Board of Directors formed a special committee on the protection of

    customer funds (``Special Committee'') that was comprised of NFA's

    public directors.\525\ NFA stated that the Special Committee spent a

    significant amount of time reviewing information that FCMs should make

    available to customers, while focusing on the needs of smaller, less

    sophisticated customers, and concluded that much of the information in

    Sec. 1.55(k)(10) is complicated and not meaningful for less

    sophisticated customers.\526\ NFA also noted that more sophisticated

    institutional customers could request and would likely receive this

    information directly from an FCM.\527\

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

    \522\ CMC Comment Letter at 2 (Feb. 15, 2013).

    \523\ NFA Comment Letter at 15-16 (Feb. 15, 2013).

    \524\ Id.

    \525\ Id. at 1.

    \526\ Id. at 16.

    \527\ Id.

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

    The Commission understands that not all customers would have the

    same use for the detailed information required by Sec. 1.55(k)(10). In

    developing the proposal, the Commission sought to balance the

    information needs of all types of customers and their respective levels

    of sophistication. While certain customers may not use the full amount

    of information in assessing risks, the Commission anticipates that

    other customers will incorporate all or most of the information into

    their risk management process and will benefit from the disclosures in

    performing their due diligence. The Commission also believes that the

    information should be available to all customers without the need for

    customers to specifically request the Sec. 1.55(k)(10) disclosures

    from the FCM.

    FIA agrees that customers should be advised whether an FCM engages

    in proprietary futures trading but does not believe that FCMs should be

    required to disclose the dollar value of their proprietary margin

    requirements as a percentage of customer margin requirements as

    proposed in Sec. 1.55(k)(10(ii) as such percentages will change

    frequently.\528\ FIA also questions the implication that customers may

    be at greater risk if an FCM carries proprietary futures positions

    noting, for instances, that the FCM's funds to margin its proprietary

    positions would be available to cover a potential customer

    default.\529\ RJ Obrien, however, noted that it is important that

    customers be aware of the nature and extent of a firm's proprietary

    trading.\530\

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

    \528\ FIA Comment Letter at 48 (Feb. 15, 2013).

    \529\ Id.

    \530\ RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).

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

    The Commission believes that information regarding an FCM's

    proprietary trading is necessary for customers to appropriately assess

    the risks of entrusting their funds to an FCM. The risk profile of an

    FCM is certainly different if it acts primarily as an agent in handling

    customer funds, or if it acts as agent for customers and also engages

    in proprietary trading. The Commission further believes that customers

    would benefit from some measure of the FCM's proprietary trading rather

    than a simple statement that the firm does or does not engage in

    proprietary trading. The dollar value of the FCM's margin requirements

    for its proprietary trading listed as a percentage of its customer

    margin requirements provides a means of measuring how active and

    extensive a firm's proprietary trading may be relative to its customer

    business, which will factor into the public's risk profile of the firm.

    FIA requested confirmation that the requirement in Sec.

    1.55(k)(10)(iii) for an FCM to disclose the number of futures

    customers, cleared swap customers, and 30.7 customers that comprise 50

    percent of the FCM's total funds held for such customers, respectively,

    should be based upon the smallest number of customers that comprise the

    50 percent threshold.\531\ The Commission confirms that FIA's

    assumption is correct and is revising the final regulation accordingly.

    A purpose of the disclosure is to provide information on the extent to

    which a firm may have customers with large positions relative to the

    FCM's general customer base.

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

    \531\ FIA Comment Letter at 46-47 (Feb. 15, 2013).

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

    FIA stated that the requirement in Sec. 1.55(k)(10)(iv) for an FCM

    to disclose the aggregate notional value, by asset class, of its non-

    hedged, principal over-the-counter transactions would require the FCM

    to disclose proprietary information. In addition, FIA stated that

    providing such information is not practical as firms generally do not

    manage their books this way and the categorization of a swap

    transaction as being hedged or not hedged would change each day.

    The objective of Sec. 1.55(k)(10)(iv) is for an FCM to disclose

    the extent of the risk it is exposed to from over-the-counter

    transactions that are not hedged or for which the FCM does not hold

    margin from the counterparty sufficient to cover the exposure. While

    the Commission recognizes that such information may change frequently,

    Sec. 1.55 only requires an FCM to update the information on an annual

    basis, or more frequently if the changes are material. The information

    also is in the aggregate, which should minimize the risk of disclosing

    detailed proprietary information. After considering the comments, the

    Commission is adopting the regulation as proposed.

    FIA stated that the Commission should distinguish between committed

    [[Page 68569]]

    and uncommitted lines of credit in the requirement in Sec.

    1.55(k)(10)(v), which requires an FCM to disclose the amount, generic

    source and purpose of any unsecured lines of credit it has obtained but

    not yet drawn upon.\532\ The Commission agrees that it would be more

    appropriate to disclose committed lines of credit and to exclude lines

    of credit that could be withdrawn by the potential lender. The

    Commission is revising the final regulation to reflect this change. In

    addition, the Commission is clarifying that the provision in Sec.

    1.55(k)(10)(v) that requires the disclosure of the amount, source and

    purpose of any unsecured lines of credit or similar short-term funding

    would include secured and unsecured short-term funding.

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

    \532\ Id.

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

    Regulation 1.55(k)(10)(vi) requires an FCM to disclose the

    aggregated amount of financing the FCM provides for customer

    transactions involving illiquid financial products for which it is

    difficult to obtain timely and accurate prices. FIA requested that the

    Commission define the type of financing covered by the regulation, and

    also requested that the Commission define the term ``illiquid financial

    products'' and confirm whether the information should include secured

    as well as unsecured financing.\533\

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

    \533\ Id.

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

    The Commission notes that the purpose of the disclosure is to

    provide the public with information regarding the possible extent of

    exposures an FCM may have if customers failed to meet their financial

    obligations to the FCM. The Commission is adopting the requirement as

    proposed. FCMs are required to provide the necessary information in the

    Disclosure Document, and may explain the factors it uses to determine

    if a financial product is liquid or illiquid and the extent to which

    transactions are secured or unsecured.

    Regulation 1.55(k)(10)(vii) requires an FCM to disclose the

    percentage of futures customer, Cleared Swaps Customer, and 30.7

    customer receivable balances that the FCM had to write-off as

    uncollectable during the past 12 months, as compared to the current

    balances of funds held for such customers.

    Newedge and RJ O'Brien commented that providing this information

    would provide customers with valuable insight into the strength of an

    FCM's credit policies, which benefits all customers.\534\ FIA, however,

    commented that it did not recognize the relevance of the requested

    information, which may be misleading without the proper context (such

    as whether the losses were caused by one or two large customers or an

    aggregate of small customers).\535\ FIA further stated that if the

    Commission were to adopt the rule, normal business write-offs should be

    excluded, and the Commission should establish a de minimis threshold

    were reporting would not be required.

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

    \534\ Newedge Comment Letter at 4 (Feb. 15, 2013); RJ O'Brien

    Comment Letter at 11 (Feb. 15, 2013).

    \535\ FIA Comment Letter at 50 (Feb. 15, 2013).

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

    The Commission has considered the comments and is adopting the

    regulation as proposed. The Commission believes that the disclosure of

    the amount of write-offs an FCM had to incur as a result of customers

    failing to pay receivable balances will provide information regarding

    the credit policies of the FCM. The Commission does not believe that

    there should be any de minimis level or threshold amount before the

    disclosure of the information becomes a requirement. In response to

    FIA's comments that the information may be misleading if not provided

    in context, the Commission notes that FCMs may include explanatory text

    in the Disclosure Document provided such information is not misleading.

    Finally, proposed Sec. 1.55(k)(11) requires a summary of the FCM's

    current risk practices, controls and procedures. FIA asked for

    confirmation that the discussion of the FCM's current risk practices,

    controls and procedures may be general in nature, noting that the

    Commission has recognized that an FCM's risk practices, controls and

    procedures may include proprietary information.\536\ The Commission

    confirms that the discussion of the current risk practices, controls

    and procedures may be general in nature so that it does not disclose

    confidential proprietary information.

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

    \536\ FIA Comment Letter at 50 (Feb. 15, 2013).

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

    2. Public Availability of FCM Financial Information

    Proposed Sec. 1.55(o) requires each FCM to make the following

    information available to the public on its Web site: (1) The daily

    Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps

    Segregation Schedule for the most current 12-month period; (2) a

    summary schedule of the FCM's adjusted net capital, net capital, and

    excess net capital, all computed in accordance with Sec. 1.17 and

    reflecting balances as of the month-end for the 12 most recent months;

    and, (3) the Statement of Financial Condition, the Segregation

    Schedule, Secured Amount Schedule, and Cleared Swaps Segregation

    Schedule and all related footnotes contained in the FCM's most recent

    certified annual financial report. Regulation 1.55(o) also requires

    each FCM to include a statement on its Web site that additional

    financial information on the firm and other FCMs may be obtained from

    the NFA and the Commission, and to include hyperlinks to the NFA and

    Commission Web sites.

    MFA, SIFMA, Prudential, Security Benefit, CoBank, and the FHLBs

    supported the requirement for FCMs to post their daily Segregation

    Schedule, Secured Amount Schedule, and Cleared Swaps Segregation

    Schedule on their Web site each day, stating that the disclosure of

    such information would place customers in a better position to assess

    an FCM's stability, and if customers identify concerns and deem

    appropriate, to transfer their positions and funds to a different

    FCM.\537\ MFA, SIFMA, Prudential, Security Benefit, CoBank, and the

    FHLBs also stated that the Commission should require FCMs to disclose

    additional information, including the FCM's monthly Segregation

    Schedule, Secured Amount Schedule, and Cleared Swaps Segregation

    Schedule, and monthly summary balance sheet and income statement

    information, for the most recent 12-month period.\538\ MFA noted that

    each FCM's monthly Segregation Schedule, Secured Amount Schedule, and

    Cleared Swaps Segregation Schedule are publicly available under Sec.

    1.10, and suggested that each FCM should be required to disclose the

    schedules to the public without the public having to request such

    statements from the firms as is currently required under Sec.

    1.10.\539\

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

    \537\ MFA Comment Letter at 4 (Feb. 15, 2013); SIFMA Comment

    Letter at 2 (Feb. 21, 2013); Prudential Comment Letter at 2 (Jun. 9,

    2013); Security Benefit Comment Letter at 2 (Jan. 11, 2013); CoBank

    Comment Letter at 2 (Jan. 14, 2013); FHLB Comment Letter at 7 (Feb.

    15, 2013).

    \538\ Id. See also The Commercial Energy Working Group Comment

    Letter at 2-3 (Feb. 12, 2013).

    \539\ MFA Comment Letter at 4-6 (Feb. 15, 2013); SIFMA Comment

    Letter at 2 (Feb. 21, 2013).

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

    The ACLI encouraged the Commission to make public as much

    information as possible regarding FCMs' financial condition, treatment

    of customer funds, and regulatory compliance.\540\ The ACLI also noted

    that access to these categories of information should be

    straightforward and simple.\541\ TIAA-CREF supported the proposed

    enhanced financial disclosures and encouraged the Commission to require

    the prompt public disclosure of relevant FCM

    [[Page 68570]]

    information.\542\ TIAA-CREF stated that such disclosures would be a

    positive step towards ensuring a level playing field between each FCM

    and its customers and among FCMs themselves, and supported the

    Commission's efforts to require FCMs to disclose information regarding

    the FCM's segregation of customer property (e.g., the Cleared Swaps

    Segregation Schedule), financial health and creditworthiness and would

    also support efforts by the Commission to cause such disclosures to be

    posted on the relevant FCM's Web site, in lieu of requiring customers

    to make a request to the Commission to receive such information (which

    may be administratively burdensome).\543\

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

    \540\ ACLI Comment Letter at 2-3 (Feb. 15, 2013).

    \541\ Id.

    \542\ ACLI Comment Letter at 2-3 (Feb. 15, 2013).

    \543\ TIAA-CREF Comment Letter at 2-3 (Feb. 15, 2013).

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

    FXCM noted that currently the Commission's monthly ``net capital''

    reports is the only publicly available way to determine how much money

    an FCM or RFED has set aside for net capital, but this provides very

    little insight into how the firm is doing financially.\544\ FXCM stated

    that FCMs and RFEDs should be required to publish quarterly

    consolidated balance sheets and income statements, including holding

    company financials, for the trading public so they will know the level

    of risk involved in dealing with a firm.\545\

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

    \544\ FXCM Comment Letter at 2-3 (Dec. 14, 2013).

    \545\ Id. See also forex form letter group: Michael Krall; David

    Kennedy; Robert Smith; Michael Carmichael; Andrew Jackson; Donald

    Blais; Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink;

    Sam Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po

    Huang; Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe;

    Tracy Burns; Treasure Island Coins; Clare Colreavy, Brandon

    Shoemaker.

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

    FIA stated that the daily segregation, secured amount, and cleared

    swaps customer account calculations should not be made publicly

    available. FIA noted that NFA currently makes this information

    available on its Web site as of the 15th and last business day of each

    month and believes disclosure twice each month should be sufficient. If

    the Commission concludes more frequent disclosure is necessary, FIA

    recommended that disclosure should be required no more often than

    weekly, i.e., as of the close of business each Friday (or the last

    business day of the week if Friday is a holiday).

    Phillip Futures Inc. proposed that the Commission limit the

    financial data made public to that which is most appropriate for the

    average customer to make an educated decision regarding his choice of

    broker.\546\ It further stated that rather than making the financial

    information public, it should only be provided to customers at their

    request.\547\

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

    \546\ Phillip Futures Inc. Comment Letter at 3 (Feb. 14, 2013).

    \547\ Id.

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

    RCG stated that if the Commission makes the Segregation Schedule,

    Secured Amount Schedule, and Cleared Swaps Segregation Schedule public,

    the public will only see a targeted residual interest amount, without

    realizing and comprehending the many factors that have impacted a

    particular firm's determination of its target.\548\

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

    \548\ RCG Comment Letter at 6 (Feb. 12, 2013).

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

    TD Ameritrade expressed its concern regarding the public disclosure

    of the firm's targeted residual interest computation.\549\ TD

    Ameritrade stated that the public would not be privy to any of the

    internal discussions and analysis that goes into the development and

    setting of the firm's targeted residual interest, and that any changes

    to its target could cause market upheaval, volatility, and unintended

    consequences.\550\

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

    \549\ TD Ameritrade Comment Letter at 4 (Feb. 15, 2013).

    \550\ Id.

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

    The Commission has considered the comments and is adopting the

    regulations as proposed, with the revision to Sec. 1.55(o) to require

    each FCM to disclose on its Web site its monthly Segregation Schedule,

    Secured Amount Schedule, and Cleared Swaps Segregation Schedule for the

    12 most recent month-end dates.

    The Commission currently discloses FCM financial data on its Web

    site. Specifically, Sec. 1.10(g) provides that the Form 1-FR-FCM (or

    FOCUS Report) is exempt from mandatory public disclosure under the

    Freedom of Information Act and the Government in the Sunshine Act,

    except for the following information: (1) The amount of the FCM's

    adjusted net capital under Sec. 1.17 as of the reporting date, the

    amount of adjusted net capital maintained by the firm on the reporting

    date, and the amount of excess net capital on the reporting date; (2)

    the Segregation Schedule and Secured Amount Schedule as of the

    reporting date; and (3) the Statement of Financial Condition in the

    certified annual report and related footnote disclosures. The

    Commission summarizes the FCM's segregation, secured amount and capital

    information each month and makes such information available to the

    public on its Web site.

    The Commission believes that customers should have access to

    sufficient financial information for each FCM to allow such customers

    to adequately assess and monitor the financial condition of firms. The

    disclosure of the daily segregation and secured amount computations

    will provide customers with additional information to assess the

    adequacy of an FCM's targeted residual interest given the firm's

    business operations and amount of customer funds held in segregated or

    secured accounts. The Commission also believes that the expanded

    disclosures required under Sec. 1.55 offer each FCM with the ability

    to provide an explanation describing the rationale and business

    justification for its computation of the target residual interest to

    better inform the public. The reporting of segregated and secured

    account balances on a daily basis also will provide customers with

    information regarding any trends developing with particular reported

    balances that the customers may wish to consider as part of their risk

    assessment of the FCMs.

    The Commission further believes that customers should have access

    to an FCM's financial information by reviewing such information

    directly on the FCM's Web site as part of the Firm Specific

    Disclosures. By reviewing the Firm Specific Disclosures and having

    access to financial data of the FCM, customers will be able to better

    assess the risks of engaging a particular FCM. The Commission also

    believes that customers would benefit from being informed that

    additional financial information on each FCM is available from the NFA

    and Commission, and by requiring the FCMs to maintain a hyperlink to

    the Commission's and NFA's Web sites. NFA and Commission data provide

    historical information that allows customers to assess financial trends

    on a customer-by-customer basis, and provides sufficient financial

    information such that customers can compare financial data across FCMs

    as part of their risk management program. The NFA also discloses

    additional information regarding how FCMs are holding customer funds

    and investing customer funds under Sec. 1.25, which is material

    information for customers in assessing risk at particular FCMs.

    Regulation 1.10(g) currently requires a customer to request from

    the FCM monthly Segregation Schedules and Secured Amount Schedules, as

    well as the Statement of Financial Condition contained in the FCM's

    certified annual report. In response to several of the comments, the

    Commission is revising Sec. 1.55(o) to require each FCM to post such

    financial information on its Web site. The Commission agrees with the

    commenters that FCMs should disclose this information, which is

    currently

    [[Page 68571]]

    publicly available under Sec. 1.10(g), without requiring each customer

    or member of the public having to specifically request such information

    from the FCM.

    The Commission is not expanding the required disclosures to include

    summary income statement information or balance sheet information as

    requested by several commenters. As noted above, Sec. 1.10(g)

    currently provides that the Form 1-FR-FCM and FOCUS Reports are not

    subject to mandatory public disclosure under the Freedom of Information

    Act or the Government in the Sunshine Act, and the Commission did not

    propose to amend Sec. 1.10(g) in the Proposal. In addition, the

    comments addressing quarterly financial statements and consolidated

    financial statements for FCMs and RFEDs are beyond the scope of the

    Proposal as the Commission did not propose to amend the regulations to

    require an FCM or RFED to prepare or file with the Commission quarterly

    financial statements on either an individual or consolidated basis.

    Accordingly, the Commission is not revising final Sec. 1.55(o) to

    require such disclosures.

    Q. Part 22--Cleared Swaps

    As discussed above, the Commission adopted final regulations in

    part 22 that implement certain provisions of the Dodd Frank Act and

    impose requirements on FCMs and DCOs regarding the treatment of Cleared

    Swaps Customer contracts (and related collateral).\551\ Although

    substantive differences in the segregation regimes between futures and

    cleared swaps exist at the clearing level under the final part 22

    regulations, requirements with respect to collateral which is not

    posted to clearinghouses and maintained by FCMs for Cleared Swaps

    Customers replicate or incorporate by reference many of the same

    regulatory requirements applicable to the segregation of futures

    customer funds under section 4d(a)(2) of the Act and Commission

    regulations (for example, holding funds separate and apart from

    proprietary funds, limitations on the FCM's use of customer funds,

    titling of depository accounts, Acknowledgment Letter from depository

    requirements, and limitations on investment of swap customers' funds,

    are currently contained in both part 1 and part 22 regulations).

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

    \551\ See discussion in section I.A. above.

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

    The determination that appropriate enhancements are necessary with

    respect to the regulatory requirements discussed above for segregated

    futures customer funds under section 4d(a)(2) of the Act is equally

    applicable to Cleared Swaps Customer Collateral. In this regard, the

    risk management program that each FCM that holds customer funds is

    required to implement under Sec. 1.11 encompasses the firm's business

    with futures customers, Cleared Swaps Customers, and 30.7 customers.

    In addition, the Commission proposed amendments to Sec. 22.2(d)(1)

    and (f)(6) that require an FCM to maintain at all times sufficient

    residual interest in Cleared Swaps Customer Accounts to exceed the sum

    of the margin deficits (i.e., undermargined amounts) of all of its

    Cleared Swaps Customers. The proposed amendments to Sec. 22.2(e)(1)

    that explicitly provide that an FCM shall bear sole responsibility for

    any losses resulting from the investment of Cleared Swaps Customer

    Funds in Sec. 1.25 compliant instruments is consistent with the

    amendments adopted for Sec. 1.29(b) that require an FCM to bear sole

    responsibility for any losses resulting from the investment of futures

    customers funds in Sec. 1.25 compliant instruments. The proposed

    amendments to Sec. 22.2(f)(4) provide that an FCM must be in

    compliance at all times with its segregation requirements for Cleared

    Swaps Customers is consistent with amendments adopted in Sec. 1.20(a)

    that require an FCM to be in compliance at all times with its

    segregation requirements for futures customers. The proposed amendments

    in Sec. 22.2(f)(5)(iii)(B) permit an FCM to develop its own program to

    assess credit risk for purposes of computing haircuts on securities

    securing a Cleared Swaps Customer's deficit account is consistent with

    the amendments adopted in 1.32 for computing haircuts on securities

    securing a futures customer's deficit account. The proposed amendments

    to Sec. 22.2(g)(2), (3), and (5) require an FCM to prepare and submit

    to the Commission and the FCM's DSRO a daily Cleared Swap Segregation

    Schedule and twice monthly listing of the holding of Cleared Swaps

    Customer funds is consistent with the amendments adopted to Sec. 1.32

    that require an FCM to prepare and submit to the Commission and the

    FCM's DSRO a daily Segregation Schedule and twice monthly listing of

    the holding of futures customer funds.

    Comments on the substantive provisions being adopted by the

    Commission under part 22 have been considered and addressed in large

    part in the discussion of the related substantive provisions in part 1

    with respect to futures customer segregated funds. The Commission has

    considered those comments and, with the exception of the proposed

    amendments to Sec. 22.2(a) and (f)(6), is adopting the amendments to

    part 22 as proposed.

    In addition, several commenters, including MFA, CIEBA and Franklin

    urged the Commission to adopt a full physical segregation option

    specific for Cleared Swaps Customer Collateral.\552\ This comment is

    outside of the scope of the proposal. The Commission, however, has

    previously clarified the ability of FCMs to employ third party

    custodial accounts for Cleared Swaps Customer Collateral, while

    reiterating that as customer property, in the event of an FCM

    insolvency, any funds held in such a third party custodial account

    would be subject to pro-rata distribution along with all other customer

    property.\553\ Commission staff is also continuing to explore

    alternative collateral custody arrangements as directed by the

    Commission.\554\

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

    \552\ MFA Comment Letter at 9 (Feb. 15, 2013); CIEBA Comment

    Letter at 3-4 (Feb. 20, 2013); Franklin Comment Letter at 2 (Feb.

    15, 2013).

    \553\ 77 FR 6336, 6343.

    \554\ Id. at 6343-6344.

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

    As discussed in more detail above, several commenters objected to

    proposed residual interest requirements under Sec. Sec. 1.20(i) and

    22.2(f).\555\ Of those commenters, a number focused on the proposed

    residual interest requirements for Cleared Swaps and highlighted the

    inconsistency of the ``at all times'' requirement with the Commission's

    analysis in the part 22 final rules.\556\ LCH.Clearnet, ISDA, Paul/

    Weiss, and other commenters specifically stated that the inclusion of

    the language ``at all times'' is inconsistent with the LSOC requirement

    to calculate such deficits at the time of a margin call by a DCO to its

    clearing FCMs, and with the requirement to have sufficient residual

    interest to cover such deficit by the time the clearing FCMs are

    required to meet such payment obligations.\557\ These commenters argued

    that when the Commission adopted the part 22 final rules, it considered

    this point in time

    [[Page 68572]]

    approach to be consistent with the Act and sufficient to ensure that

    the collateral of one Cleared Swaps Customer is never used to margin

    the positions of another customer.\558\

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

    \555\ See section II.G.9. above.

    \556\ See LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013);

    FIA Comment Letter at 22-23 (Feb. 15, 2013).

    \557\ See, e.g., LCH.Clearnet Comment Letter at 4-5 (Jan. 25,

    2013); Paul/Weiss Comment Letter at 3-5 (Feb. 15, 2013); ISDA

    Comment Letter at 2-3 (Feb. 15, 2013). ISDA further argued that

    variation margin payments are not ``used'' until the point of

    settlement. See ISDA Comment Letter at 1-2 (Aug. 27, 2013) (citing

    CFTC Letter No. 12-31, ``Staff Interpretation Regarding Part 22,''

    (November 1, 2012) (``Part 22 Staff Interpretation'') and arguing

    that the use restriction set forth in 4d(f)(2)(B) of the CEA ``is

    driven by the meaning of `property . . . received' '' and that

    ```received' in this context cannot be intended to include variation

    margin fluctuations pre-settlement because it is only upon

    settlement that an item of property will have been received by the

    FCM.'').

    \558\ See LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013);

    FIA Comment Letter at 22-23 (Feb. 15, 2013); ISDA Comment Letter at

    2-3 (Feb. 15, 2013).

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

    In response to these comments, the Commission notes that the

    proposed amendments to Sec. 22.2(a) and (f)(6) were meant to capture

    the current practice with respect to residual interest buffer

    calculations for Cleared Swaps using language that was consistent with

    the Proposed Residual Interest Requirement for futures. In other words,

    the Commission did not intend to alter the current residual interest

    requirements, as set forth in the part 22 final rules.\559\ Indeed, the

    Commission notes that Staff guidance from November 1, 2012, states that

    ``FCMs are prohibited from `us[ing] or permit[ing] the use of, the

    Cleared Swaps Customer Collateral of one Cleared Swaps Customer to

    purchase, margin, or settle the Cleared Swaps or any other trade or

    contract of, or to secure or extend the credit of, any person other

    than such Cleared Swaps Customer.' Where a Cleared Swaps Customer is

    undermargined, then the FCM must ensure that, to the extent of such

    shortfall, its own money, securities, or other property--and not that

    of other Cleared Swaps Customers--is used to cover a margin call

    (whether initial or variation) attributable to that Cleared Swaps

    Customer's portfolio of rights and obligations.'' \560\

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

    \559\ See also Part 22 Staff Interpretation.

    \560\ See id. at 2 (answer to Question 2.1).

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

    Because of the confusion expressed by commenters regarding the

    residual interest requirements for Cleared Swaps, the Commission is

    revising Sec. 22.2(a) and (f). The Commission is revising proposed

    Sec. 22.2(a) by deleting the last sentence. The Commission is revising

    Sec. 22.2(f)(6) by replacing the language from the proposal with new

    language which sets forth the residual interest requirements for

    Cleared Swaps in a manner that is consistent with current market

    practice and that parallels the language used in Sec. 1.22. To be

    clear, and as requested by several commenters, the Commission confirms

    that the language in Sec. 22.2(f)(6) is not intended to, and thus

    should not be read to, change current practice with respect to an FCM's

    residual interest requirements for Cleared Swaps as set forth in

    Commission regulations and JAC Update 12-03, and consistent with Staff

    Interpretation 12-31. Thus, ``where a Cleared Swaps Customer is

    undermargined,\561\ the FCM must ensure that, to the extent of such

    shortfall, its own money, securities, or other property--and not that

    of other Cleared Swaps Customers--is used to cover a margin call

    (whether initial or variation) attributable to that Cleared Swaps

    Customer's portfolio of rights and obligations.'' \562\ Consistent with

    this revised residual interest requirement, Sec. 22.2(f)(4) is being

    amended to state that the amount of funds an FCM is holding in

    segregation may not be reduced by any debit balances that the futures

    customers of the futures commission merchants have in their accounts.

    Finally, Sec. 22.2(f)(2) is being revised, consistent with 1.20(i)(2)

    and current market practice, to clarify that the calculation set forth

    therein is the Net Liquidating Equity Method.

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

    \561\ In this context, a Cleared Swaps Customer is undermargined

    to the extent that (a) the minimum margin requirement, attributable

    to that Cleared Swaps Customer's portfolio of rights and

    obligations, at the DCO (for an FCM that is clearing such Cleared

    Swaps Customer's positions directly) or at the Collecting FCM (for a

    Depositing FCM) exceeds (b) the customer's net liquidating value,

    including securities posted at margin value.

    \562\ See Part 22 Staff Interpretation at 2.

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

    R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of

    Foreign Futures or Foreign Options Secured Amount

    Part 30 of the Commission's regulations was adopted in 1987 and

    governs the offer and sale in the U.S. of futures contracts and options

    traded on or subject to the rules of a foreign board of trade.\563\ The

    Commission proposed to amend several regulations in part 30 to provide

    a more coordinated approach to the regulations governing the offer and

    sales of futures contracts traded on foreign boards of trade and the

    comparable regulations governing the offer and sale of futures

    contracts traded on designated contract markets. Aligning the

    regulations, including regulations governing how an FCM holds funds for

    customers trading on non-U.S. markets with the requirements for

    customers trading on U.S. markets, will greatly enhance the protection

    of customer funds, and avoid competitive imbalances between trading on

    domestic and foreign contract markets that might result in regulatory

    arbitrage. The Commission's Proposal, along with the comments received,

    is discussed in the sections below.

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

    \563\ 52 FR 28980 (Aug. 5, 1987).

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

    1. Elimination of the ``Alternative Method'' for Calculating the

    Secured Amount

    Regulation 30.7(a) requires an FCM to set aside in separate

    accounts for the benefit of its ``foreign futures or foreign options

    customers'' an amount of funds defined as the ``foreign futures or

    foreign options secured amount.'' The term ``foreign futures or foreign

    options customer'' is defined in Sec. 30.1 as any person located in

    the U.S., its territories, or possessions who trades in foreign futures

    or foreign options. The term ``foreign futures or foreign options

    secured amount'' is defined in Sec. 1.3(rr) as the amount of funds

    necessary to margin the foreign futures or foreign options positions

    held by the FCM for its foreign futures or foreign options customers,

    plus or minus any gains or losses on such open positions. The

    calculation of the foreign futures or foreign options secured amount as

    defined in Sec. 1.3(rr) is referred to as the ``Alternative Method.''

    Requirements concerning the collateral of foreign futures or

    foreign options customers are substantially less robust for funds

    deposited with an FCM under the Alternative Method than requirements

    concerning the collateral of futures customers deposited with an FCM

    under section 4d(a)(2) of the Act or Cleared Swaps Customer Funds

    deposited under section 4d(f) of the Act. Section 4d(a)(2) of the Act

    and Sec. Sec. 1.20 and 1.22 require an FCM to hold in accounts

    segregated for the benefit of futures customers a sufficient amount of

    funds to satisfy the full account equities of all of the FCM's futures

    customers trading on designated contract markets.\564\ Section 4d(f)

    and Sec. 22.2 require an FCM to segregate for the benefit of Cleared

    Swaps Customers a sufficient amount of funds to satisfy the full

    account equities of all of the FCM's Cleared Swaps Customers. The

    calculations required under sections 4d(a)(2) and 4d(f) of the Act are

    referred to as the ``Net Liquidating Equity Method.''

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

    \564\ The Commission is also adopting as final amendments to

    Sec. 1.20(a) that clarify and provide explicitly that an FCM is

    required to hold funds in segregated accounts in an amount at all

    times in excess of its total obligations to all futures customers.

    See section II.G.9. above for a discussion of the amendments to

    Sec. 1.20.

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

    The Alternative Method contrasts with the Net Liquidating Equity

    Method in that the Alternative Method obligates an FCM to set aside in

    separate accounts for the benefit of its customers an amount of funds

    sufficient to cover only the margin required on open foreign futures

    and foreign option positions, plus or minus any unrealized gains or

    losses on such positions. Any funds deposited by foreign futures or

    foreign options customers in excess of the amount required to be set

    aside in separate accounts may be held by the

    [[Page 68573]]

    FCM in operating cash accounts and may be used by the FCM as if it were

    its own capital. Since an FCM is not required under the Alternative

    Method to set aside in separate accounts an amount of funds sufficient

    to repay the full account balances of each of its foreign futures or

    foreign options customers, the FCM may not be in a financial position

    to return 100 percent of the account equities (or transfer such account

    equities to another FCM) of each foreign futures or foreign options

    customer in the event of the insolvency of the FCM.

    In addition Sec. 30.7 further differs from the regulations

    governing how FCMs hold funds for futures customers and Cleared Swap

    Customers in that Sec. 30.7 requires an FCM to set aside in a separate

    account funds only for ``foreign futures or foreign options

    customers.'' As previously stated, the term ``foreign futures or

    foreign options customer'' is defined in Sec. 30.1 as any person

    located in the U.S., its territories, or possessions who trades in

    foreign futures or foreign options. Thus, an FCM is not required to set

    aside in separate accounts funds for foreign-domiciled customers

    trading on foreign futures markets. Regulation 30.7 permits an FCM to

    set aside funds for foreign futures customers located outside of the

    U.S., but an FCM is not obligated under the regulations to do so.

    Requiring FCMs to include foreign-domiciled customers' funds in

    segregated accounts benefits all customers placing funds on deposit for

    use in trading foreign futures and foreign options. Neither Subchapter

    IV of Chapter 7 of the Bankruptcy Code nor the Commission's part 190

    regulations discriminate between foreign-domiciled and domestic-

    domiciled customers. Thus, any deficiency arising from the reduced

    requirements will impact both foreign and domestic customers pro rata.

    The Commission proposed various amendments to the part 30

    regulations to eliminate the Alternative Method and to require FCMs to

    use the Net Liquidating Equity Method to compute the amount of funds

    they must set aside in separate accounts for the benefit of foreign

    futures or foreign options customers. The Commission also proposed to

    extend the protections of part 30 to foreign-domiciled customers

    trading on foreign markets through an FCM. The intent of the proposed

    amendments is to provide 30.7 customers with equivalent protections

    available to futures customers and Cleared Swaps Customers by requiring

    each FCM to hold in secured accounts sufficient funds to cover the full

    Net Liquidating Equity of each customer trading on foreign futures

    markets.

    To implement these revisions, the Commission proposed to define the

    term ``30.7 customer'' in Sec. 30.1 to mean any person, whether

    domiciled within or outside of the U.S., that engages in foreign

    futures or foreign options transactions through the FCM. The Commission

    also proposed to amend Sec. 1.3(rr) to match structurally the

    definition of the term ``customer funds'' in Sec. 1.3(gg) \565\ and to

    define the term ``foreign futures or foreign options secured amount''

    to mean ``all money, securities and property received by an FCM for, or

    on behalf of, ``30.7 customers'' to margin, guarantee, or secure

    foreign futures and foreign options transactions, and all funds

    accruing to ``30.7 customers'' as a result of such foreign futures and

    foreign options transactions.'' The effect of the proposed amendments

    is to adopt the Net Liquidating Equity Method for foreign futures and

    foreign options by requiring an FCM to set aside in separate accounts a

    sufficient amount of funds to cover the full account balances (i.e.,

    the Net Liquidating Equities) of both the U.S. and foreign-domiciled

    customers.

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

    \565\ The Commission recently adopted final regulations that

    revised the definitions in Sec. 1.3. In this rulemaking, Sec.

    1.3(gg) was renumbered as 1.3(jjj) and re-designated ``futures

    customer funds.'' The substance of the definition, however, was not

    revised and the final rulemaking has no impact on the analysis in

    this rulemaking. See 77 FR 66288 (Nov. 2, 2012).

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

    The Commission also proposed to amend Sec. 30.7(a) to allow an FCM

    to use an internal credit risk model to compute the appropriate market

    deductions, or haircuts, on readily marketable securities deposited by

    customers that have account deficits. The proposal is consistent with

    the proposed amendments for computing haircuts on securities under

    Sec. 1.32(b) in section II.N. above. The result of these amendments as

    discussed should be consistency between the methodologies applied in

    the 4d segregation calculation and the Sec. 30.7 calculation.

    Consistent with proposed changes in Sec. 1.20(i) and part 22, the

    Commission also proposed to add language to Sec. 30.7(a) to provide

    that an FCM must hold residual interest in accounts set aside for the

    benefit of 30.7 customers equal to the sum of all margin deficits

    (i.e., undermargined amounts) for such accounts, to provide an

    equivalent clear mechanism for ensuring that the funds of one 30.7

    customer are not margining or guaranteeing the positions of another

    30.7 customer

    With the exception of the residual interest proposal, the

    Commission did not receive any comments on the various proposed

    amendments discussed above, including its proposal to eliminate the

    ``Alternative Method'' and to require FCMs to use the ``Net Liquidating

    Equity Method'' to compute the amount of funds they must set aside in

    separate accounts for the benefit of its foreign futures or foreign

    options customers. Accordingly, the amendments referred to above, with

    the exception of the residual interest proposal as discussed further

    below, are being adopted by the Commission.\566\

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

    \566\ See section II.R.4. below for a discussion of the residual

    interest proposal. CFA stated that it generally supported the

    proposed amendments to Sec. 30.7 and treating customers from all

    parts of the globe in a similar manner. CFA Comment Letter at 9

    (Feb. 13, 2013).

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

    2. Funds Held in Non-U.S. Depositories

    The Commission proposed to amend Sec. 30.7(c) to limit the amount

    of 30.7 customers' funds that an FCM could hold in non-U.S.

    jurisdictions. Under the proposal, an FCM must hold 30.7 customer funds

    in the U.S., except to the extent that the funds held outside of the

    U.S. are necessary to margin, guarantee, or secure (including any

    prefunding obligations) the foreign futures or foreign options

    positions of an FCM's 30.7 customers. The proposal further allowed an

    FCM to deposit additional 30.7 customer funds outside of the U.S. up to

    a maximum of 10 percent of the total amount of funds required to be

    held by non-U.S. brokers or foreign clearing organizations for 30.7

    customers as a cushion to meet anticipated margin requirements. The

    proposal also provided that the FCM must hold 30.7 customer funds under

    the laws and regulations of the foreign jurisdiction that provide the

    greatest degree of protection to such funds; and that the FCM may not

    by contract or otherwise waive any of the protections afforded customer

    funds under the laws of the foreign jurisdiction.

    Several comments were received on the proposal. Pilot Flying J

    supported the requirement that 30.7 customer funds, if held outside of

    the U.S., must be held under the laws of the foreign jurisdiction that

    provides the funds with the greatest degree of protection.\567\

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

    \567\ Pilot Flying J Comment Letter at 2 (Feb. 14, 2013).

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

    FIA and Jefferies each recommended that an FCM be permitted to

    maintain an excess of up to 50 percent of the amount an FCM is required

    to deposit with a foreign broker to maintain customer foreign futures

    and foreign options positions, a position that they

    [[Page 68574]]

    stated is consistent with Sec. 1.17 that requires an FCM to incur a

    capital charge for unsecured receivables due from a foreign broker

    greater than 150 percent of the amount required to maintain positions

    in accounts with the foreign broker.\568\ FIA recommended that, at a

    minimum, a cushion of 20 percent should be provided.\569\ FIA stated

    that the proposal is more restrictive than the provisions of Sec.

    1.49, which set out the terms and conditions pursuant to which an FCM

    may hold futures customers' segregated funds and Cleared Swaps

    Collateral outside of the U.S. and suggested that the proposal be

    revised to permit an FCM to hold funds comprising the foreign futures

    and foreign options secured amount in depositories outside of the U.S.

    to the same extent that an FCM may hold futures customer segregated

    funds and Cleared Swaps Collateral outside of the U.S.\570\ They

    further recommended that the ``10% limitation'' apply only to funds

    deposited with a foreign broker or foreign clearing organization.\571\

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

    \568\ FIA Comment Letter at 37 (Feb. 15, 2013); Jefferies Bache

    Comment Letter at 6 (Feb. 15, 2013).

    \569\ FIA Comment Letter at 37 (Feb. 15, 2013).

    \570\ Id. See also RJ O'Brien Comment Letter at 11 (Feb.15,

    2013).

    \571\ FIA Comment Letter at 37 (Feb. 15, 2013).

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

    RCG requested the Commission to clarify application of Sec.

    30.7(c) as it relates to banks located outside the U.S. that FCMs use

    for settlement purposes, and how the limitation applies to variation

    amounts.\572\

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

    \572\ RCG Comment Letter at 7 (Feb. 12, 2013).

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

    Jefferies stated that the proposed rule disadvantages customers who

    may no longer deposit ``customer owned'' securities and would instead

    have to prefund their obligations with cash.\573\

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

    \573\ Jefferies Bache Comment Letter at 6 (Feb. 15, 2013).

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

    Advantage stated that FCMs typically must maintain a relationship

    with a foreign bank in order to meet cutoff times for payment of fees

    and clearing on foreign exchanges and that if an FCM can't maintain

    funds at a foreign institution, it may inhibit its ability to trade

    foreign futures.\574\ The effect, they asserted, could be that U.S.

    FCMs will be required to use non-U.S. brokers that are not regulated by

    the Commission for their foreign futures business.\575\ They further

    requested that the Commission clarify how the prohibition on keeping

    non-margin foreign futures funds in an institution outside the U.S.

    would apply to Sec. 30.7(b), which appears to allow such funds to be

    held at a bank or trust company outside the U.S.\576\

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

    \574\ Advantage Letter at 8 (Feb. 15, 2013).

    \575\ Id. at 9.

    \576\ Id.

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

    In response to commenter concerns, the Commission is adopting the

    amendments generally as proposed, but the final rule will permit an FCM

    to post with depositories outside of the U.S. sufficient funds to cover

    the full margin obligations imposed by foreign brokers or foreign

    clearing organizations on the FCM's 30.7 customers' positions, plus an

    additional amount equal to 20 percent of the required margin on such

    positions.

    The Commission is increasing the amount of 30.7 customer funds that

    an FCM may hold in a foreign jurisdiction in response to the comments.

    The Commission is adopting this regulation to provide greater

    protection to both U.S. and foreign-domiciled customers in the event of

    the insolvency of the FCM. Recent experience has demonstrated that

    funds held outside of the U.S, at depositories subject to foreign

    insolvency regimes, present challenges and potential delays in the

    ability of the Trustee to return customer property to the customers of

    the FCM. In increasing the amount of funds an FCM may hold outside of

    the U.S. from 10 percent of the required margin to 20 percent of the

    required margin, the Commission is striving to strike a proper balance

    that would not interfere with the ability of 30.7 customers to trade on

    foreign markets (and the ability of FCMs to facilitate such

    transactions by allowing them to meet their 30.7 customers' margin and

    other financial obligations to foreign brokers and clearing

    organizations), with the Commission's desire to provide 30.7 customers

    with an appropriate level of protection in the event of the insolvency

    of an FCM. The Commission believes that, to the maximum extent

    commercially practicable, funds deposited by 30.7 customers that are

    not required to margin positions with foreign brokers or foreign

    clearing organizations should be held within in the U.S. to provide

    greater assurance that such funds would be subject to the bankruptcy

    provision of U.S. law and the Commission's regulations under the

    jurisdiction of U.S. courts.

    The Commission further notes that the 20 percent limitation is

    based upon the amount of margin required on open positions. In response

    to RCG's request for clarification, FCMs may transfer funds to foreign

    depositories to cover variation margin calls and exclude such funds

    from the calculation of the 20 percent ``cushion.'' In addition, the

    Commission notes that FCMs may deposit 30.7 customer funds with any of

    the foreign depositories listed under Sec. 30.7(b), provided that the

    FCMs do not exceed the 20 percent limit on the amount of funds that are

    permitted to be held in foreign jurisdictions. The Commission believes

    that the ability to post variation margin in foreign jurisdictions and

    an additional 20 percent cushion should allow FCMs to conduct foreign

    futures activities on behalf of their customers, while also providing

    additional protections to the current regulatory regime.

    3. Commingling of Positions in Foreign Futures and Foreign Options

    Accounts

    Commission staff previously issued an Advisory stating that while

    it was desirable for FCMs to hold only a customer's foreign futures

    transactions (and the funds supporting such transactions) in such

    customer's foreign futures account, this limitation was not mandatory

    and that the FCM could also hold such customer's unregulated

    transactions (and the funds supporting such transactions) in the

    foreign futures accounts.\577\ Thus, pursuant to this Advisory, FCMs

    were permitted to commingle the funds supporting a customer's foreign

    futures and options transactions with such customer's unregulated

    transactions, including over-the-counter transactions. The Advisory was

    issued before the passage of Dodd-Frank, section 724(a) of which

    established in section 4d(f) of the CEA a segregation regime for the

    funds of cleared swaps customers, and the Commission's promulgation of

    part 22, implementing that statute.

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

    \577\ CFTC Advisory No. 87-4 (Nov. 18, 1987).

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

    In response to an FIA recommendation at a public roundtable held in

    advance of the Commission's publication of the proposal, the Commission

    proposed to amend Sec. 30.7 by adopting new paragraph (e) to prohibit

    an FCM from commingling funds from unregulated transactions with funds

    for foreign futures and options transactions in part 30 secured

    accounts, except as authorized by Commission order. The prohibition on

    holding unregulated transactions or other non-foreign futures or

    foreign option transactions in part 30 set aside accounts is consistent

    with the treatment applicable under section 4d(a)(2) of the Act for

    segregated accounts and section 4d(f) of the Act for Cleared Swaps

    Customers' accounts.

    The Commission noted in the proposal that when part 30 was being

    adopted, commenters cited back office operational difficulties with

    establishing multiple ``customer'' account classes or origins.\578\

    Given the technological changes during the intervening decades, and the

    new statutory and regulatory

    [[Page 68575]]

    framework, these concerns should no longer dictate the advisability of

    commingling the funds of regulated foreign futures and foreign options

    transactions with unregulated transactions.

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

    \578\ See 52 FR 28980, 28985-28986.

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

    New Sec. 30.7(e) extends the prohibition against commingling of

    customer funds currently found in section 4d(a)(2) futures customer

    accounts and section 4d(f) Cleared Swaps Customer Accounts to 30.7

    customer accounts, except as otherwise permitted by Commission

    regulation or order.

    CIEBA stated that it supported the prohibition on the commingling

    of funds deposited by futures customers, Cleared Swaps Customers, and

    30.7 customers.\579\ Nodal requested that the Commission make explicit

    in the adopting release that 30.7 accounts may continue to hold

    customer funds to margin contracts traded on a market that is pending

    designation as a contact market at the time the rules become effective,

    until such market is registered as a DCM or upon the withdrawal or

    denial of the DCM application.\580\ LCH.Clearnet noted that while it

    does not have a position on whether the Commission should prohibit

    commingling of 30.7 customer funds with the funds of futures customers

    and Cleared Swaps Customers, if adopted, it urged the Commission to

    preserve the ability to allow such commingling pursuant to a Commission

    rule or order.\581\

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

    \579\ CIEBA Comment Letter at 4 (Feb. 20, 2013).

    \580\ Nodal Comment Letter at 1-2 (Jan. 21, 2013).

    \581\ LCH.Clearnet Comment Letter at 6-7 (Jan. 25, 2013).

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

    The Commission is adopting new Sec. 30.7(e) as proposed. As it

    noted in the proposal, should there be a need to permit commingling of

    funds, the Commission will continue to have the ability to permit such

    commingling under the formalities of processes associated with a

    Commission order or rule pursuant to section 4d of the CEA. Absent such

    a rule or order, however, protection for such customer property would

    not be available under the Commission's part 190 regulations or the

    Bankruptcy Code, and thus such commingling would not be permitted. In

    addition, the Commission does not agree with Nodal's request that FCMs

    may continue to hold margin funds in 30.7 accounts for positions that

    are executed on markets that are pending approval as designed contract

    markets. As noted above, a purpose of Sec. 30.7(e) is to enhance the

    protection of 30.7 customers by prohibiting the commingling of 30.7

    customer funds with funds held by an FCM for unregulated transactions.

    Commingling of unregulated transactions with regulated transactions

    could also impede the resolution of 30.7 customer claims in the event

    of the insolvency of the FCM carrying the funds.

    4. Further Harmonization With Treatment of Customer Segregated Funds

    The Commission proposed to adopt new paragraphs (f) and (k) in

    Sec. 30.7, to extend regulatory provisions from Sec. Sec. 1.20, 1.21,

    1.22 and 1.24, that previously were applicable only to 4d segregated

    funds, to funds set aside as the foreign futures or foreign options

    secured amount under Sec. 30.7. These proposed requirements would make

    clear that: (1) FCMs would not be permitted to use funds set aside as

    the foreign futures or foreign options secured amount other than for

    the benefit of 30.7 customers; (2) FCMs must hold sufficient residual

    interest in 30.7 accounts to make sure that 30.7 customer funds of one

    30.7 customer are not used to margin, secure or guarantee the

    obligations of other customers; (3) funds set aside as the foreign

    futures or foreign options secured amount should not be invested in any

    obligations of clearing organizations or boards of trade; and (4) no

    funds placed at foreign brokers should be included as funds set aside

    as the foreign futures or foreign options secured amount unless those

    funds are on deposit to margin the foreign futures or foreign options

    positions of 30.7 customers. In addition to extending the existing

    Commission regulations noted above to Sec. 30.7, the Commission also

    proposed a new requirement prohibiting an FCM from imposing any liens

    or allowing any liens to be imposed on funds set aside as the foreign

    futures or foreign options secured amount. This requirement parallels

    that currently applicable to cleared swap customers with respect to the

    segregation of Cleared Swaps Collateral.\582\

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

    \582\ See Sec. 22.2(d)(2).

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

    As discussed above, the Commission received several comments

    regarding the residual interest requirements set forth in the

    Proposal.\583\ While most of the commenters focused on the impact of

    the Proposed Residual Interest Requirement to the futures market, some

    of the more general comments would also apply to the foreign futures or

    foreign options market. Given the statutory prohibition in sections

    4d(a) and 4d(f) of the Act against using one customer's funds to

    margin, secure or guarantee the obligations of another customer, FCMs

    that participate in the swaps and futures market may not ``use'' one

    customer's property to margin another customer's positions.

    Nonetheless, the Commission clarified that an FCM does not ``use'' a

    customer's funds until the time of settlement.\584\

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

    \583\ See sections II.G.9. and II.Q. above for discussion of the

    Proposed Residual Interest Requirement.

    \584\ See section II.G.9. above.

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

    The Commission recognizes that the statutory prohibitions set forth

    in sections 4d(a) and 4d(f) of the Act apply to the futures and swaps

    markets. Conversely, as discussed above, the proposed changes to Sec.

    30.7 were intended to provide a more coordinated approach to the

    regulations governing foreign futures and foreign options, with

    standards that are consistent with those for the futures and swaps

    markets. These regulations, including regulations governing how an FCM

    holds funds for customers trading on non-U.S. markets, would greatly

    enhance the protection of customer funds and avoid regulatory

    arbitrage. Such consistency would, to the extent practicable and

    appropriate, contribute to the goal of having customer protection

    across futures, swaps and foreign futures markets be substantively

    similar.

    The Commission did not receive any comments opposing the concept of

    having consistent residual interest requirements across markets. The

    Commission did, however, receive comments regarding the additional

    complexities associated with trading foreign futures and foreign

    options.\585\ As such, the Commission is adopting residual interest

    requirements in part 30 that are substantively similar to the amended

    requirement in part 1, but with a modification as to the time by which

    an FCM must maintain such residual interests that will give FCMs the

    flexibility necessary to account for differences in the regulatory

    requirements and market practices applicable to foreign brokers and

    clearing organizations in other jurisdictions. Thus, the Commission is

    revising Sec. 30.7(f) as follows.

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

    \585\ See Roundtable Tr. at 266-267 (Feb. 5, 2013).

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

    Regulation 30.7(f)(1)(i) sets forth the general requirement that an

    FCM may not use, or permit the use of, the funds of one 30.7 customer

    to purchase, margin or settle the trades, contracts, or commodity

    options of, or to secure or extend credit to, any person other than

    such 30.7 customer. Regulation 30.7(f)(1)(ii)(A) states that the

    undermargined amount for a 30.7 customer's account is the amount, if

    any (i.e., the must be amount equal to or

    [[Page 68576]]

    greater than zero), by which the total amount of collateral required

    for that 30.7 customer's positions in that account at a specified time

    exceeds the value of the 30.7 customer funds in that account, as

    calculated in new Sec. 30.7(f)(2)(ii). Regulation 30.7(f)(1)(ii)(B)

    requires FCMs to perform a residual interest buffer calculation, at the

    close of each business day, based on the information available to the

    FCM at that time, by calculating (1) the undermargined amounts, based

    on the clearing initial margin that will be required to be maintained

    by that FCM for its 30.7 customers, at each clearing organization of

    which the FCM is a member, at any settlement that will occur before

    6:00 p.m. Eastern Time on the following business day for each such

    clearing organization less (2) any debit balances referred to in Sec.

    30.7(f)(2)(B)(iv) that is included in such undermargined amounts.

    In addition, and for the reasons set forth above, pursuant to Sec.

    30.7(f)(1)(ii)(C)(1) FCMs must maintain residual interest prior to 6:00

    p.m. Eastern Time on the date referenced in Sec. 30.7(f)(1)(ii)(B) in

    segregated funds that is equal to or exceeds the computation set forth

    in (ii)(B). Moreover, Sec. 30.7(f)(1)(ii)(C)(2) provides that an FCM

    may reduce the amount of residual interest required in Sec.

    30.7(f)(1)(ii)(C)(1) to account for payments received from or on behalf

    of undermargined 30.7 customers (less the sum of any disbursements made

    to or on behalf of such customers) between the close of business the

    previous business day and 6:00 p.m. Eastern Time on the following

    business day. Regulation 30.7(f)(1)(ii)(D) provides that for purposes

    of Sec. 30.7(f)(1)(ii)(B), an FCM should include, as clearing initial

    margin, customer initial margin that the FCM will be required to

    maintain, for that FCM's 30.7 customers, at a foreign broker, and, for

    purposes of Sec. 30.7(f)(1)(ii)(C), must do so by 6:00 p.m. Eastern

    Time. In other words, Sec. 30.7(f)(1)(ii)(D) is intended to make clear

    that the requirements with respect to 30.7 customer funds that are used

    by an FCM that clears through a foreign broker are parallel to the

    requirements applied to 30.7 customer funds that are used when an FCM

    clears directly on a clearing organization.

    Finally, to provide greater clarity, the Commission is adding a new

    subparagraph (2) to paragraph (f), which sets out the requirements as

    to the FCM's calculation of the Net Liquidating Equities of their 30.7

    customers. Because of the addition of new subparagraph (2), the

    Commission is renumbering proposed Sec. 30.7(f)(2) and (f)(3) to Sec.

    30.7(f)(3) and (f)(4), and since the Commission did not receive any

    comments on the substantive provisions of these paragraphs, it is

    adopting them as proposed.

    The Commission did not receive any comments on the substantive

    provisions of proposed Sec. 30.7(k) and is adopting this new

    paragraphs as proposed.

    MFA, however, requested confirmation that the Commission's prior

    guidance with respect to a customer's authority to grant liens or

    security interests on its own Cleared Swaps Customer Account under part

    22 would also be applicable to customers on their foreign futures or

    foreign options secured amount under Sec. 30.7.\586\ The Commission

    agrees with this position and hereby confirms the applicability of its

    prior guidance.\587\

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

    \586\ MFA Comment Letter at 10 (Feb. 15, 2013).

    \587\ Specifically, In the Final LSOC Release the Commission

    clarified:

    an FCM may not, under any circumstances, grant a lien to any

    person (other than to a DCO) on its Cleared Swaps Customer Account,

    or on the FCM's residual interest in its Cleared Swaps Customer

    Account. On the other hand, a Cleared Swaps Customer may grant a

    lien on the Cleared Swaps Customer's individual cleared swaps

    account (an `FCM customer account') that is held and maintained at

    the Cleared Swaps Customer's FCM.

    77 FR at 6352.

    In addition, Commission Staff issued an interpretive letter that

    stated:

    Regulation 22.2(d) does not prohibit a Cleared Swaps Customer

    from granting security interests in, rights of setoff against, or

    other rights in its own Cleared Swaps Customer Collateral,

    regardless of whether those assets are held in the Cleared Swaps

    Customer's FCM customer account. Furthermore, nothing in the rule is

    intended to inhibit this right of the Cleared Swaps Customer.

    CFTC Letter No. 12-28 at 2 (Oct. 17, 2012).

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

    5. Harmonization With Other Commission Proposals

    The Commission also proposed various other amendments to its part

    30 regulations to harmonize the rules with those applicable to U.S.

    customers under other Commission regulations.

    As discussed in section II.I. above, the Commission is adopting in

    this release new limitations on withdrawals of segregated funds in

    Sec. 1.23. The amendments provide for an FCM's residual interest in

    segregated funds, and permit withdrawals from segregated funds for the

    proprietary use of the FCM to the extent of such residual interest,

    subject to the requirement that the withdrawal must not occur prior to

    the completion of the daily segregation computation for the prior day,

    and should the withdrawal (individually or aggregated with other

    withdrawals) exceed 25 percent of the prior day residual interest, the

    withdrawal must be subject to specific approvals by senior management

    and appropriately documented, and further subject to a complete

    prohibition on withdrawals of residual interest to the extent necessary

    to maintain proper residual interest to cover undermargined amounts.

    The Commission proposed and is adopting paragraph (g) of Sec. 30.7 to

    apply the same restrictions on withdrawals of an FCM's residual

    interest in funds set aside as the foreign futures or foreign options

    secured amount.

    Current Sec. 30.7(g) was recently adopted by the Commission to

    provide that the investment of Sec. 30.7 funds be subject to the

    investment limitations contained in Sec. 1.25.\588\ As proposed, the

    Commission is moving this permitted investment requirement to a new

    paragraph Sec. 30.7(h), and further is adopting a new paragraph Sec.

    30.7(i) to make clear that FCMs are solely responsible for any losses

    resulting from the permitted investment of funds set aside as the

    foreign futures or foreign options secured amount. New paragraph Sec.

    30.7(i) is intended to apply the same standard as is being adopted in

    the amendment to Sec. 1.29 for segregated funds discussed above.

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

    \588\ 76 FR 78776, 78802 (December 19, 2011).

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

    The Commission also proposed and is adopting an amended paragraph

    (j) to Sec. 30.7 to clarify the circumstances under which an FCM may

    make secured loans to 30.7 customers and to adopt the same restriction

    on unsecured lending to 30.7 customers as has been adopted with respect

    to futures customers and 4d segregated funds in the amendment to Sec.

    1.30 discussed above.

    Finally, the Commission proposed and is adopting an amended

    paragraph (l) to Sec. 30.7 to require the daily computation of the

    foreign futures or foreign options secured amount and the filing of

    such daily computation with the Commission and DSROs, as well as to

    require the FCM to provide investment detail of the foreign futures or

    foreign options secured amount as of the middle and end of the month.

    The amendments to paragraph (l) of Sec. 30.7 are intended to be

    consistent with the requirements for the daily segregation calculation

    for segregated customer funds and the provision of the segregation

    investment detail which are adopted in Sec. 1.32.

    No comments were received on the above proposals and the Commission

    is adopting the amendments as proposed.

    S. Sec. 3.3: Chief Compliance Officer Annual Report

    Regulation 3.3 requires each FCM (as well as swap dealers and major

    swap participants) to designate an individual to serve as its CCO. The

    CCO is required

    [[Page 68577]]

    to be vested with the responsibility and authority to develop, in

    consultation with the FCM's board of directors or senior officer,

    appropriate policies and procedures to fulfill the duties set forth in

    the Act and Commission regulations relating to the FCM's activities as

    an FCM. Regulation 3.3(e) also requires the FCM's CCO to prepare an

    annual compliance report that includes a description of any non-

    compliance events that occurred during the last reporting period along

    with the action taken to address such events. The annual compliance

    report currently is required to be filed electronically with the

    Commission simultaneously with the FCM's certified annual financial

    report, and in no event later than 90 days after the firm's fiscal year

    end.

    The Commission proposed a conforming amendment to Sec. 3.3(f)(2)

    to reflect the amendments to Sec. 1.10(b)(1)(ii), discussed in section

    II.A. above, that require an FCM to file its annual certified financial

    statements with the Commission within 60 days of the firm's fiscal year

    end. In this regard, the Commission proposed to require that each FCM

    file the CCO annual report with the Commission simultaneously with the

    filing of the firm's certified annual report, and in no event later

    than 60 days after the FCM's fiscal year end.

    The NFA commented that it supported the proposal.\589\ No other

    comments were received. The Commission has determined to amend Sec.

    3.3 as proposed.

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

    \589\ NFA Comment Letter at 9 (Feb. 15, 2013).

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

    III. Compliance Dates

    The final regulations will be effective January 13, 2014. The

    compliance date for the regulations will be the effective date, subject

    to the following exceptions:

    A. Financial Reports of FCMs: Sec. 1.10

    An FCM that is not dually-registered as a BD currently is required

    to submit its certified annual report to the Commission within 90 days

    of the firm's year end date. The Commission has amended Sec.

    1.10(b)(1)(ii) to require such certified annual report to be submitted

    within 60 days of the firm's year end date.

    The Commission recognizes that many FCMs have contracted with

    public accountants to perform the current year's audit examination, and

    that those audits are currently in process. In order to allow the

    current year audits to be completed, the Commission is setting a

    compliance date for Sec. 1.10(b)(1)(ii) for FCMs with years ending

    after June 1, 2014. This date will also coincide with several other

    compliance dates affecting public accountants discussed under Sec.

    1.16 below.

    B. Risk Management Program for FCMs: Sec. 1.11

    Section 1.11 requires each FCM that carries customer funds to

    establish a risk management program. RJ O'Brien requested that the

    Commission provide at least one year for FCMs to comply with the new

    risk management regulations in the event the proposed Risk Management

    Program is adopted. RJ O'Brien stated that the new requirements would

    likely necessitate a period of time for firms to reorganize, develop

    the policies and procedures, implement the policies and procedures,

    acquire adequate personnel, and conduct extensive training of new and

    existing employees. Advantage stated ``that most aspects of proposed

    Sec. 1.11 are appropriate and unlikely to be burdensome as FCMs

    typically have most (if not all) of these requirements in place.''

    \590\

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

    \590\ Advantage Comment Letter at 2 (Feb. 15, 2013).

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

    The Commission recognizes that some FCMs may need a sufficient

    period of time to develop and implement a risk management program that

    complies with Sec. 1.11, but believes that many firms already maintain

    programs that comply with many of the requirements in Sec. 1.11.

    Accordingly, FCMs must file their initial Risk Management Program

    within 180 days of the effective date of the regulation. The filings

    must be made via electronic transmission to the Commission using the

    WinJammer electronic filing system.

    C. Qualifications and Reports of Accountants: Sec. 1.16

    The Commission is amending Sec. 1.16 to require a public

    accountant to meet certain qualification standards in order to be

    qualified to conduct audits of FCMs. The Commission is amending Sec.

    1.16(b) to require that the public accountant: (1) Must be registered

    with the PCAOB; (2) must have undergone a PCAOB inspection; and (3) may

    not be subject to a temporary or permanent bar to engage in the audit

    of public issuers or BDs as a result of a PCAOB disciplinary action.

    The Commission is further amending Sec. 1.16(c) to require that the

    public accountant's audit report must state whether the audit was

    conducted in accordance with PCAOB auditing standards.

    The Commission is establishing a compliance date of June 1, 2014

    for the amendment to Sec. 1.16(b)(1) that requires a public accountant

    to be registered with the PCAOB in order to conduct an audit of an FCM.

    The Commission also is establishing a compliance date of June 1, 2014

    for the amendment to Sec. 1.16(c) that requires a public accountant to

    conduct an audit of an FCM in accordance with the standards issued by

    the PCAOB. A compliance date of June 1, 2014 will allow current year

    audits to be completed without interruption, and provides sufficient

    time for public accountants that audit FCMs to register with the PCAOB

    if such public accountants are not already registered. In addition, a

    June 1, 2014 compliance date will align the Commission's requirements

    for the use of PCAOB standards in the audit of an FCM with the SEC

    audit standards for public accountants auditing BDs.\591\ Without such

    alignment, public accounts of a dually-registered FCM/BD would have to

    issue two different audit reports; one audit report to the SEC for an

    examination conducted under PCAOB audit standards, and a second audit

    report for the Commission for an examination conducted under U.S. GAAS.

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

    \591\ The SEC recently amended its regulations to require public

    accountants to conduct audits of BDs pursuant to the audit standards

    issued by the PCAOB. This requirement is effective for audits of BDs

    with a year-end of June 1, 2014 or later. See 78 FR 51910 (Aug. 21,

    2013).

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

    The Commission also is establishing a compliance date of December

    31, 2015 for the requirement in Sec. 1.16 that a public accountant

    must have undergone an inspection by the PCAOB in order to qualify to

    conduct an audit of an FCM. The extension of the compliance date to

    December 31, 2015 will provide additional time for the PCAOB to conduct

    inspections of public accountants that registered with, but have not

    been inspected by, the PCAOB.

    Lastly, the compliance date for the amendment to Sec. 1.16(b)(1)

    the provides that a public accountant may not be subject to a temporary

    or permanent bar to engaging in the audit of public issuers or BDs as a

    result of a PCAOB disciplinary action is the effective date of the

    amendment. The Commission believes that if a public accountant is

    registered with the PCAOB and is subject to a PCAOB disciplinary action

    that temporarily or permanently bars the public accountant from

    auditing public issuers, the public accountant is not qualified to

    conduct audits of FCMs.

    D. Minimum Financial Requirements for FCMs

    The Commission is amending the capital rule to require an FCM to

    incur a capital charge for undermargined

    [[Page 68578]]

    customer, noncustomer, and omnibus accounts that are undermargined more

    than one business day after a margin call is issued by the FCM. For

    example, if an account is undermargined on Monday and the FCM issues a

    margin call on Tuesday, the FCM would have to take a reduction to

    capital equal to the amount of the margin call that was not met by

    close of business Wednesday.

    The Commission is establishing a compliance date for the revised

    timeframe for the capital charges required by Sec. 1.17(c)(5)(viii)

    and (ix) of one year following publication of this rule in the Federal

    Register. The compliance date provides FCMs with a period of time that

    the Commission believes is sufficient to adjust its systems for issuing

    and collecting margin from customers and provides customers with an

    opportunity to adjust their operations, as necessary, to meet its

    margin obligations on a reduced timeframe for the current regulation.

    E. Written Acknowledgment Letters: Sec. Sec. 1.20, 1.26, and 30.7

    The Commission is amending Sec. Sec. 1.20(d) and (g), 1.26(b), and

    30.7(d) to require FCMs and DCOs, as applicable, to obtain standard

    form acknowledgment letters from each depository that the FCMs or DCOs

    use to hold customer funds.\592\ The Commission is further requiring

    FCMs and DCOs to use Template Letters set forth in appendices to the

    regulations.

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

    \592\ The regulations, however, provide that an FCM is not

    required to obtain an acknowledgment letter from a DCO if the DCO

    maintains rules that have been submitted to the Commission and that

    provide for the segregation of customer funds in accordance with all

    relevant provisions of the Act and Commission regulations or orders.

    See Sec. Sec. 1.20(d)(1) and 30.7(d)(1).

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

    The Commission is establishing a compliance date of 180 days after

    the effective date of the regulations in order to provide FCMs and DCOs

    with sufficient time to obtain from depositories new acknowledgment

    letters that conform to the Template Letters.

    F. Undermargined Amounts: Sec. Sec. 1.22(c), 30.7(f)

    The Commission received several comments on the appropriate timing

    for the effectiveness of the Proposed Residual Interest Requirement. At

    the public roundtable held on February 5, 2013, several panelists

    argued that the Proposed Residual Interest Requirement would require

    substantial time to implement in order to change the behavior of all

    futures markets participants.\593\ In addition, FIA asserted that

    implementation would require multiple years and ``radical'' changes to

    processing procedures for futures market participants,\594\ and RCG

    requested that the Commission provide ``with a period of time not less

    than one year from the promulgation of the relevant final rules for

    FCMs to implement them.'' \595\

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

    \593\ See Roundtable Tr. at 252-255, 257, 266-267 (Feb. 5,

    2013).

    \594\ See FIA Comment Letter at 21 (Feb. 15, 2013).

    \595\ See RCG Comment Letter at 8 (Feb. 12, 2013).

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

    As discussed above, the residual interest requirements set forth in

    part 22 are the requirements that are currently in place today. As

    such, FCMs are expected to continue meeting their regulatory

    requirements. With respect to the residual interest requirements set

    forth in Sec. Sec. 1.22(c) and 30.7(f), the Commission recognizes that

    these requirements represent a significant change in current market

    practice. Given the costs associated with compliance with these

    requirements, as well as comments received from the interested parties

    requesting sufficient time to achieving compliance with these

    requirements, the Commission has determined that a phased compliance

    schedule for Sec. 1.22(c) is necessary and appropriate. The phased

    compliance schedule for Sec. 1.22(c) is set forth in Sec.

    1.22(c)(5)(iii). However, the Residual Interest Deadline of 6:00 p.m.

    Eastern Time in Sec. 1.22(c)(5)(ii) shall begin one year following the

    publication of this rule in the Federal Register.\596\ With regards to

    the residual interest requirements set forth in Sec. 30.7(f), the

    Commission is establishing a compliance date of one year following the

    publication of this rule in the Federal Register.

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

    \596\ For further discussion regarding the phase-in schedule for

    the requirements in Sec. 1.22(c), see section II.G.9.

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

    G. SRO Minimum Financial Surveillance: Sec. 1.52

    The Commission amended Sec. 1.52 to require each SRO to establish

    a supervisory program to oversee their member FCMs' compliance with SRO

    and Commission minimum capital and related reporting requirements, the

    obligation to properly segregated customer funds, risk management

    requirements, financial reporting requirements, and sales practices and

    other compliance requirements. The Commission also amended Sec.

    1.52(c) to require each SRO to engage an ``examinations expert'' at

    least once every three years to evaluate the quality of the supervisory

    oversight program and the SRO's application of the supervisory program.

    The SRO must obtain a written report from the examinations expert with

    an opinion on whether the supervisory program is reasonably likely to

    identify a material weakness in internal controls over financial and/or

    regulatory reporting, and in any of the other areas that are subject to

    the supervisory program.

    The Commission established a compliance date in amended Sec.

    1.52(e) that requires each SRO to submit a supervisory program to the

    Commission for review, together with the examinations expert's report

    on the supervisory program, within 180 days of the effective date of

    the amendments to Sec. 1.52, or such other time as may be approved by

    the Commission. The Commission further revised Sec. 140.91(10) to

    delegate the authority to extend the time period for the submission of

    the initial supervisory program to the Director of the Division of Swap

    Dealer and Intermediary Oversight and the Director Division of Clearing

    and Risk, with the concurrence of the General Counsel or, in his or her

    absence, a Deputy General Counsel.\597\

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

    \597\ The Commission also amended Sec. 1.52(d)(2)(ii)(H) to

    provide that a Joint Audit Committee must submit an initial Joint

    Audit Program to the Commission, along with an examinations expert's

    report on the Joint Audit Program, within 180 days of the effective

    date of the regulation. The Director of the Division of Swap Dealer

    and Intermediary Oversight and the Director of the Division of

    Clearing and Risk also are authorized under Sec. 1.52(d)(2)(ii)(H)

    an Sec. 140.91(10), with the concurrence of the General Counsel or,

    in his or her absence, a Deputy General Counsel, to extend the

    initial filing deadline if warranted.

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

    Commission staff will consult with the SROs to assess their

    progress in preparing an initial supervisory program, including the

    examinations expert's review, and may adjust compliance dates as

    appropriate.

    H. Public Disclosures by FCMs: Sec. 1.55

    The Commission has amended Sec. 1.55(b) by revising the Risk

    Disclosure Statement to include several additional disclosures intended

    to provide customers and potential customers with enhanced information

    to further their understanding of the risks of engaging in the futures

    markets. The Commission recognizes that FCMs will be required to revise

    the Risk Disclosure Statement to implement the revisions, and is

    establishing a compliance date for the amendments to 1.52(b) of 90 days

    after the effective date of the amendments. The Commission believes

    that this provides sufficient time for FCMs to revise the Risk

    Disclosure Statement and to modify their systems, if necessary, in the

    case of firms that

    [[Page 68579]]

    provide electronic account opening documents.

    The Commission also amended Sec. 1.55(i)-(k) to require each FCM

    to disclose to customers all information that would be material to the

    customers' decision to entrust funds to, or otherwise do business with,

    the FMC, including its business, operations, risk profile, and

    affiliates. The Commission is establishing a compliance date of 180

    days after the effective date of the regulation to provide adequate

    time for FCMs to develop the required disclosures and make them

    available to the public.

    The Commission also amended Sec. 1.55(o) to require each FCM to

    disclose on its Web site certain current and historical information

    regarding its holding of customer funds, and its certified annual

    report. The Commission is establishing a compliance date of 180 days

    after the effective date of the regulation to provide FCMs with

    sufficient time to modify electronic systems, and make any additional

    operational changes, necessary for the firms to comply with the

    requirements.

    IV. Cost Benefit Considerations

    Statutory Mandate To Consider the Costs and Benefits of the

    Commission's Action: Commodity Exchange Act Section 15(a)

    Section 15(a) of the Act requires the Commission to consider the

    costs and benefits of its actions before promulgating a regulation

    under the Act or issuing certain orders. Section 15(a) further

    specifies that the costs and benefits shall be evaluated in light of

    the following five broad areas of market and public concern: (1)

    Protection of market participants and the public; (2) efficiency,

    competitiveness and the financial integrity of futures markets; (3)

    price discovery; (4) sound risk management practices; and (5) other

    public interest considerations. The Commission considers the costs and

    benefits resulting from its discretionary determinations with respect

    to the section 15(a) considerations.

    In the NPRM, the Commission established, based on the subject

    matter of the proposals, that it did not consider any of the proposals

    contained therein to have any significant impact on price discovery.

    The Commission received no responses from commenters with respect to

    its analysis regarding price discovery. For the remaining areas, the

    Commission addressed, section by section, the qualitative substantial

    benefits perceived to be obtained from the regulatory proposals

    contained in the NPRM. Where reasonably possible, the Commission has

    estimated costs quantitatively associated with such proposals section

    by section. The Commission asked specifically and generally for

    comments with respect to its analysis of benefits and such cost

    estimates, and requested information from commenters where the

    Commission qualitatively considered but could not reasonably

    quantitatively estimate costs.

    The underlying purpose of the regulations adopted herein as stated

    in the NPRM was to bolster the protection of customers and customer

    funds, in response to the misuse or mishandling of customer funds at

    specific FCMs like MFGI or PFGI. Further, the purpose of certain

    proposals was to provide regulators the means by which to detect and

    deter the misuse or mishandling of customer funds by FCMs, including

    bolstering standards for the examination and oversight of FCMs by SROs

    and public accountants. In addition to the significant benefits to the

    protection of market participants and the public, the Commission

    determined that a strong package of reforms, including enhanced

    information and disclosures available to customers, adopted in light of

    the recent FCM failures resulting in and from misuse of customer funds,

    would be extremely beneficial to restore trust in the financial

    integrity of futures markets. The Commission also included certain

    proposals intended to both increase the protection of customer funds

    and strengthen FCM risk management, specific to customer funds

    processes and procedures.

    As stated in the NPRM, a loss of trust in the financial integrity

    of futures markets could deter market participants from the benefits of

    using regulated, transparent markets and clearing. The overarching

    purpose of the reforms contained in this rulemaking is to produce the

    benefits that accrue by virtue of avoiding similar defaults in the

    future. This prevents the costs certain to follow, including lost

    customer funds, decreased market liquidity that follows from a crisis

    in confidence, and the potential for the failure of one FCM to cause

    losses in other clearing members.\598\

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

    \598\ The failure of one clearing member could lead to losses

    for other clearing members if the losses due to the first member's

    failure are large enough to exhaust the guarantee fund and require

    additional capital infusion from other clearing members.

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

    In this rulemaking, the Commission adopted new rules and amended

    existing rules to improve the protection of customer funds. The content

    of the Commission's adopted new rules and amended rules can be

    categorized in seven parts: (1) requiring FCMs to implement extensive

    risk management programs including written policies and procedures

    related to various aspects of their handling of customer funds; (2)

    increasing reporting requirements for FCMs related to segregated

    customer funds, including daily reports to the Commission and DSRO; (3)

    requiring FCMs to establish target amounts of residual interest to be

    maintained in segregated accounts as well as creating restrictions and

    increased oversight for FCM withdrawals out of such residual interest

    in customer segregated accounts, specifically including clear sign off

    and accountability from senior management for such withdrawals; (4)

    strengthening requirements for the acknowledgment letters that FCMs and

    DCOs must obtain from their depositories; (5) eliminating the

    Alternative Method for calculating 30.7 customer funds segregation

    requirements and requiring FCMs to include foreign investors' funds in

    segregated accounts; (6) strengthening the regulatory requirements

    applicable to SRO and DSRO oversight of FCMs, including regulating

    oversight provided under the function of a Joint Audit Committee that

    would establish standards for, and oversee the execution of, FCM

    audits; and (7) requiring FCMs to provide additional disclosures to

    investors.

    Overview of the Costs and Benefits of the Proposed Rules and Amendments

    in Light of the 15(a) Considerations--Protection of Market Participants

    and the Public

    The Commission designed the adopted reforms to improve the

    protection of customer funds. The Commission expects each of the seven

    categories identified above to significantly increase the levels of

    protection for customer funds. Requiring FCMs to implement risk

    management programs that include documented policies and procedures

    regarding various aspects of handling customer funds helps to protect

    customer funds by promoting robust internal risk controls and reducing

    the likelihood of errors or fraud that could jeopardize customer funds.

    In addition, by requiring each FCM to document certain policies and

    procedures, the rules enable the Commission, DSROs, and other auditors

    to evaluate each FCM's compliance with their own policies and

    procedures. Moreover, the requirement that FCMs establish a program for

    quarterly audits by independent or external people that is designed to

    identify any breach of the policies and procedures helps to ensure

    [[Page 68580]]

    regular, independent validation that the procedures are followed

    diligently. Audits of this sort provide more thorough review of

    internal procedures than the Commission or DSROs are able to perform

    regularly with existing resources, which provides helpful scrutiny of

    each FCM's procedures on a regular basis. This, together with the

    requirement that FCMs establish a program of governing supervision that

    is designed to ensure the policies required in Sec. 1.11 are followed,

    will tend to promote compliance with the FCM's own policies and

    procedures. And by promoting such compliance, the requirements reduce

    the risk of operational errors, lax risk management, and fraud, and

    thus the risk of consequent loss of customer funds.

    Increasing reporting requirements for FCMs related to segregated

    customer funds helps the Commission and DSRO identify FCMs that should

    be monitored more closely in order to safeguard customer funds.

    Moreover, by making some additional reported information public, the

    rules facilitate additional market discipline that further promotes

    protection of customer funds.

    Creating restrictions and increased oversight for FCM withdrawals

    out of its residual interest in customer segregated accounts, and

    requiring review by senior management for large withdrawals protects

    customers by helping to ensure that such withdrawals do not cause

    segregated account balances to drop below required amounts, which are,

    in turn, designed to prevent losses of customer funds. Moreover,

    requiring personal accountability by senior management for withdrawals

    that affect the balance of such accounts promotes more effective

    oversight of customer segregated accounts.

    The acknowledgments and commitments depositories are required to

    make through Sec. Sec. 1.20, 1.26, and 30.7 provide additional

    protection for customer funds by, among other things, requiring

    depositories that accept customer funds to acknowledge that customer

    funds cannot be used to secure the FCM's obligations to the depository.

    Such an acknowledgment provides additional protection of customer funds

    and fosters prompt transfer in the event of an FCM's default.

    In addition, depositories must agree in the acknowledgment letter

    to give the Commission and DSROs read-only electronic access to an

    FCM's segregated accounts, which benefits customers by enabling the

    Commission and DSROs to review the accounts for discrepancies between

    the FCM's reports and the balances on deposit at various depositories.

    These enhancements to oversight provide an additional mechanism by

    which customers would be protected against a shortfall in customer

    funds due to operational errors or fraud.

    Requiring FCMs to include foreign-domiciled customers' funds in

    segregated accounts benefits all customers placing funds on deposit for

    use in trading foreign futures and foreign options. Because neither the

    Bankruptcy Code nor the Commission's part 190 regulations distinguish

    between foreign-domiciled and U.S. domiciled customers at the point

    customer funds are distributed, any shortfall in available funds would

    be shared among all such customers. As discussed below, the Commission

    understands that most, if not all, FCMs currently compute secured

    amount requirements for both U.S.-domiciled and foreign-domiciled

    customers. However, incorporating foreign-domiciled customers within

    the calculations required for 30.7 customers ensures that both groups

    are fully protected. Similarly, eliminating the Alternative Method

    provides additional protection to customer funds by ensuring that FCMs

    are not allowed to reduce their segregation requirements for 30.7

    accounts during a time of financial strain. As discussed below, this

    change provides protection to both U.S-domiciled and foreign-domiciled

    customers with funds in 30.7 accounts.

    The provisions in Sec. 1.52 include additional requirements for

    both the supervisory program for SROs as well as for the formation of a

    Joint Audit Committee to oversee the implementation and operation of a

    Joint Audit Program that directs audits of FCMs by DSROs. By requiring

    both the SRO supervisory programs and the Joint Audit Program to comply

    with U.S. generally accepted audit standards, to develop written

    policies and procedures, to require controls testing as well as

    substantive testing, and to have an examinations expert review the

    programs at least once every two years, the amendments help to ensure

    that audits of FCMs by SROs or DSROs are thorough, effective, and

    continue to incorporate emerging best practices for such audits. As a

    consequence, the amendments help to ensure that audits are as effective

    as possible at identifying potential fraud, strengthening internal

    controls, and verifying the integrity of FCMs' financial reports, each

    of which tend to provide protection for FCMs' customers,

    counterparties, and investors.

    In addition Sec. 1.55 requires disclosure of firm-specific risks

    to customers. This additional information should be helpful to

    customers when selecting an FCM to deposit their funds. In doing so,

    the rules promote market discipline that incents FCMs to manage their

    risks carefully and assists customers in understanding how their funds

    are held and what risks may be relevant to the safety of their funds.

    Last, FCMs maintaining residual interest in customer accounts is an

    important aspect of protection for customer funds. While an FCM's

    residual interest is not exhausted, it may be used to meet the FCM's

    obligations to each customer without using another customer's funds to

    do so. All else being equal, the larger the residual interest, the less

    likely that market participants will lose customer funds posted as

    collateral, with associated detriment to members of the public with

    interests in such market participants.

    Efficiency, Competitiveness and Financial Integrity of Futures Markets

    The proposed amendments should increase the efficiency and

    financial integrity of the futures markets by ensuring that FCMs have

    strong risk management controls that are subject to multiple and

    enhanced external checks, by enhancing reporting requirements,

    facilitating increased oversight by the Commission and DSROs, by

    allowing FCMs flexibility in the development of newly required policies

    and procedures wherever the Commission has determined that such

    flexibility is appropriate, and by requiring FCMs to implement training

    regarding the handling of customer funds. In addition, the rules

    include some requirements that many industry participants have

    requested as necessary for the adequate protection of customers and

    also highlighted as best practices already adopted within the industry.

    Requiring such standards to be adopted by all FCMs promotes the

    competitiveness of futures markets by preventing an FCM from skimping

    on customer protection safeguards. There are also provisions in the

    proposal that permit FCMs that are not BDs to implement certain

    securities net capital haircuts that apply to jointly registered FCM/

    BDs by the SEC. This enhances competition between FCMs that are not

    dually registered and jointly registered FCM/BDs with respect to such

    requirements.

    Smaller FCMs may have more difficulty than large FCMs in absorbing

    the additional costs created by the requirements of the rules

    (particularly Sec. 1.22). It is possible that some smaller FCMs may

    elect to stop operating as FCMs as a result of these costs. The

    Commission does not anticipate,

    [[Page 68581]]

    however, that the rules will have a material effect on FCM pricing due

    to reduced competition (although the increased costs may affect

    pricing).

    More specifically, the amendments to Sec. Sec. 1.10, 1.11, 1.12,

    1.32, 22.2, and 30.7 increase reporting requirements for FCMs related

    to segregated customer funds, including daily, bi-monthly, and

    additional event-triggered reports to the Commission and DSROs. The

    expanded range and frequency of information that the Commission and

    DSRO receive under the proposed regulations enhances their ability to

    monitor each FCM's segregated accounts, which promotes the integrity of

    futures markets by helping to ensure proper handling of customer funds

    at FCMs.

    In addition, the changes facilitate increased oversight by the

    Commission and DSROs by including additional notification requirements,

    obligating FCMs to alert the Commission when certain events occur that

    could indicate an FCM's financial strength is deteriorating or that

    important operational errors have occurred. Such notifications should

    enable the Commission and DSROs to increase monitoring of such FCMs to

    ensure that customer funds are handled properly in such circumstances.

    The rules also require FCMs to obtain an acknowledgment letter from

    depositories that should give the Commission and DSROs electronic

    access to view customer accounts at each depository when requested by

    the Commission. That should enable both the Commission and DSROs to

    verify the presence of customer funds which would provide a safeguard

    against fraud and would promote the integrity of markets for futures,

    cleared options, and cleared swaps.

    The rules also require FCMs to establish policies and procedures

    regarding several aspects of how they handle customer funds. The rules

    should give FCMs the flexibility, where appropriate, to develop

    policies and procedures tailored to the unique composition of their

    customer base, size, and other operational disincentives. This flexible

    approach protects FCMs from additional regulatory compliance costs that

    could otherwise result from rules requiring every FCM to operate in

    exactly the same way without sacrificing the additional accountability

    that results from written policies and procedures that the Commission

    or DSRO can review and use as the basis for FCM audits.

    The requirement that FCMs provide annual training to all finance,

    treasury, operations, regulatory, compliance, settlement and other

    relevant employees regarding the segregation requirements for

    segregated funds, for notices under Sec. 1.12, procedures for

    reporting non-compliance, and the consequences of failing to comply

    with requirements for segregated funds, should enhance the integrity of

    the futures markets by promoting a culture of compliance by the FCM's

    personnel. The training should help to ensure that FCM employees

    understand the relevant policies and procedures, that they are

    empowered and incented to abide by them, and that they know how to

    report non-compliance to appropriate authorities.

    The rules allow FCMs that are not dual registrants (i.e., are not

    both FCMs and BDs) to follow the same procedures as dual registrants

    when determining what regulatory capital haircut applies to certain

    types of securities in which the FCM invests its own capital or

    customer funds. This change is needed as the SEC has proposed a change

    for BDs which would permit joint registrants to possibly apply a lower

    regulatory haircut for certain securities, but which would not be

    applicable to FCMs that are not dual registrants without this rule.

    Therefore, the rule should help to ensure that FCMs that are not dual

    registrants are not competitively disadvantaged and are able to

    continue applying the same regulatory capital haircuts for such

    securities as joint registrants.

    Last, residual interest is an important aspect of protection for

    customer funds because it enables the FCM to ensure that it can meet

    its obligations to each customer without using another customer's funds

    to do so. All else being equal, the larger the residual interest, the

    more secure are customer funds. This contributes to confidence in U.S.

    futures markets and their financial integrity. Adequate residual

    interest improves the competition between FCMs, inasmuch as FCMs are

    competing less by transferring risks from customers with deficit funds

    to customers with surplus funds.

    Sound Risk Management

    The amendments should promote sound risk management by facilitating

    market discipline, enhancing internal controls, enabling the Commission

    and DSROs to monitor FCMs for compliance with those controls, by

    reducing the risk that an FCM's financial strain could interfere with

    customers' ability to manage their positions, by requiring FCMs to

    notify the Commission in additional circumstances that could indicate

    emerging financial strain, and by requiring senior management to be

    involved in the process of setting targets for residual interest.

    The reporting requirements should enhance market discipline by

    providing additional information to investors regarding the location of

    their funds, and the size of residual interest buffer that an FCM

    targets and maintains in its segregated accounts. This additional

    information should be valuable to customers selecting an FCM and

    monitoring the location of their funds deposited with the FCM which

    should promote market discipline. For example, if an FCM were to

    establish a low target for residual interest, or maintain a very low

    residual interest, then market participants are likely to recognize

    this as a practice that could increase risk to the funds they have on

    deposit at the FCM. Consequently, customers would likely either apply

    pressure to the FCM to raise their target, or take their business to a

    different FCM that maintains a larger residual interest in customer

    fund accounts. This market discipline should incent FCMs to maintain a

    level of residual interest that is adequate to ensure that a shortfall

    does not develop in the customer segregated accounts.

    The rules should also enhance FCM internal controls by requiring

    them to establish a risk management program that includes policies and

    procedures related to various aspects of how segregated customer funds

    are handled. For example, FCMs are required to establish procedures for

    continual monitoring of depositories where segregated customer funds

    are held, and should have to establish a process for evaluating the

    marketability, liquidity, and accuracy of pricing for Sec. 1.25

    compliant investments.

    In addition, documented policies and procedures should benefit the

    FCM customers and the public by providing the Commission and DSROs

    greater ability to monitor and enforce procedures that FCMs perform to

    ensure that the protection of customer funds is achieved, with the

    effect that the Commission should have a greater ability to address and

    protect against operational errors and fraud that put customer funds at

    risk of loss.

    Further, through the amendments to Sec. 1.17(a)(4), FCMs will need

    to manage their access to liquidity so as to be able to certify to the

    Commission, at its request, that they have sufficient access to

    liquidity to continue operating as a going concern. This rule should

    provide the Commission with the flexibility to deal with emerging

    liquidity drains at FCM s which may endanger customers, potentially

    prior to instances of regulatory capital non-compliance,

    [[Page 68582]]

    allowing customer positions and funds to be transferred intact and

    quickly to another FCM. This change should promote sound risk

    management practices by helping to ensure that customers maintain

    control of their positions without interruption.

    The proposed additions to notification requirements established in

    Sec. 1.12 should enhance the Commission's ability to identify

    situations that could lead to financial strain for the FCM, which makes

    it possible for the Commission to monitor further developments with

    that FCM more carefully and to begin planning earlier for the

    possibility that the FCM's customer positions may need to be

    transferred to other FCMs, in the event that the FCM currently holding

    those positions defaults. Advance notice helps to ensure customers'

    positions are protected by enabling the Commission to work closely with

    DCOs and DSROs to identify other FCMs that have requisite capital to

    meet regulatory requirements if they were to take on additional

    customer positions, thus facilitating smooth transition of those

    positions in the event that it is necessary.

    Last, FCMs maintaining residual interest in customer accounts is an

    important aspect of protection for customer funds. While an FCM's

    residual interest is not exhausted, it may be used to meet the FCM's

    obligations to each customer without using another customer's funds to

    do so. All else being equal, the larger the residual interest, the more

    secure are customer funds. Moreover, these requirements will create

    incentives for FCMs to monitor their customers' undermargined amounts,

    thereby enhancing the FCM's risk management. By requiring that senior

    management set the target for residual interest, and that they conduct

    adequate due diligence in order to inform that decision, the rule

    promotes both informed decision making about this important form of

    protection, and accountability among senior management for this

    decision, both of which are consistent with sound risk management

    practices.

    Other Public Interest Considerations

    As discussed above, the recent failures of MFGI and PFGI, FCMs to

    which customers have entrusted their funds, sparked a crisis of

    confidence regarding the security of those funds. This crisis in

    confidence could deter market participants from using regulated,

    transparent markets and clearing which would create additional costs

    for market participants and losses in efficiency and safety that could

    create additional burdens for the public. The Commission hopes that

    this rule will not only address the current crisis of confidence, but

    that it will produce benefits for the public by virtue of avoiding

    similar defaults in the future.

    These amendments are not, however, without costs. First, the most

    significant costs created by the amendments are those that result from

    the increased amount of capital that FCMs are required to hold in

    segregated accounts as part of establishing a target for their residual

    interest and requiring residual interest for undermargined amounts.

    Second, additional costs may be created by the amendments that incent

    FCMs to hold additional capital, and prevent them from holding excess

    segregated funds overseas. Third, operational costs are likely to arise

    from amendments that result in the formation of a risk management unit

    and adoption of new policies and procedures.

    Multiple rule changes are expect to incent or require FCMs to

    increase the amount of residual interest that they maintain in

    segregated accounts including: (1) Requiring FCMs to establish a target

    for residual interest that reflects proper due diligence on the part of

    senior management; (2) disclosing the FCMs' targeted residual interest

    publicly; (3) requiring them to report to the Commission and their

    DSROs any time their residual interest drops below that target, and (4)

    requiring FCMs to hold residual interest large enough to cover their

    customers' undermargined amounts. In addition by restricting FCMs'

    ability to withdraw residual interest from segregated accounts and

    obligating FCMs to report to the Commission and their respective DSRO

    each time the residual interest drops below the target, the regulations

    should incent FCMs to hold additional capital, which is also likely to

    be a significant cost.

    When FCMs hold excess customer funds overseas, such funds will

    likely be held at depositories that are themselves subject to foreign

    insolvency regimes. These regimes may provide less effective

    protections for customer funds than those applicable under U.S. law. By

    prohibiting FCMs from holding some excess customer funds overseas, and

    thereby reducing investment opportunities for customer funds, the

    regulations may reduce the returns that FCMs can obtain on invested

    customer funds.

    And last, the requirements related to operational procedures are

    likely to create significant costs, particularly related to creating

    and documenting policies and procedures, as well as complying with

    ongoing training, due diligence, and audit requirements. However, in

    several cases the implementation costs of the changes should be minor.

    For example, some proposed requirements should obligate FCMs to provide

    the Commission and DSROs more regular access to information that FCMs

    and their depositories are already required to maintain, or in some

    cases are already reporting to their DSROs. The Commission also

    anticipates that some of the changes proposed codify best practices for

    risk management that many FCMs and DCOs may already follow. In such

    cases, the costs of compliance would be mitigated by the compliance

    programs or best practices that the firm already has in place.

    Moreover, in other cases the changes codify practices that are already

    required by SROs, and therefore would impose no additional costs.

    The initial and ongoing costs of the rules for FCMs should vary

    significantly depending on the size of each FCM, the policies and

    procedures that they already have in place, and the frequency with

    which they experience certain events that would create additional costs

    under the rules. In the NPRM, the Commission estimated that the initial

    operational cost \599\ of implementing the rules would be between

    $193,000 and $1,850,000 per FCM.\600\ And the initial cost to the SROs

    and DSROs would be between $41,100 and $63,500 per SRO or DSRO. The

    Commission estimated

    [[Page 68583]]

    that the ongoing operational cost to FCMs would be between $287,000 and

    $2,300,000 per FCM per year.\601\ As described below in Sec. 1.52, the

    Commission did not have adequate information to determine the ongoing

    cost of the proposed requirements for SROs and DSROs.

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

    \599\ The Commission was not able to quantify the costs that

    would result from increased residual interest held in customer

    segregated accounts, from increased capital held by the FCM, or from

    lost investment opportunities due to restrictions on the amount of

    funds that may be held overseas. The Commission did not have

    sufficient data to estimate the amount of additional residual

    interest FCMs are likely to need as a consequence of proposed, the

    amount of additional capital they may hold for operational purposes,

    the cost of capital for FCMs, or the opportunity costs FCMs may

    experience because of restrictions on the amount of customer funds

    they can hold overseas, each of which would be necessary in order to

    estimate such costs.

    \600\ The lower bound assumes an FCM requires the minimum

    estimated number of personnel hours to be compliant with these new

    rules and that, when possible, they already have policies,

    procedures, and systems in place that would satisfy the proposed

    requirements. The upper bound assumes an FCM requires the maximum

    amount of personnel hours and do not have pre-existing policies,

    procedures, and systems in place that would satisfy the proposed

    requirements. The greatest amount of variation within in the range

    would depend on the number of new depositories an FCM must establish

    relationships with due to current depositories that would not be

    willing to sign the required acknowledgment letter. The lower bound

    assumes that an FCM does not need to establish any new relationships

    with depositories. The Commission estimates that the largest FCMs

    may have as many as 30 depositories, and as a conservative estimate,

    the Commission assumes for the upper bound that an FCM would have to

    establish new relationships with 15 depositories.

    \601\ As above, the lower bound assumes that an FCM requires the

    minimum estimated number of personnel hours to be compliant and that

    for event-triggered costs, the FCM bears the minimum number of

    possible events. The upper bound assumes an FCM requires the maximum

    number of personnel hours to be compliant. It also assumes an FCM

    has to notify the Commission pursuant to the proposed amendments in

    Sec. 1.12 five times per year, and that an FCM withdraws funds from

    residual interest for proprietary use 50 times per year. The

    estimate does not include additional costs that would result if FCMs

    increase the amount of residual interest or capital that they hold

    in response to the proposed rules, or certain operational costs that

    the Commission does not have sufficient information to estimate.

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

    On a minor note, the rules also harmonize the definition of

    leverage ratio reporting with the definition established by a

    registered futures association.

    In the sections that follow, the Commission provides its analysis

    of cost benefit considerations including comments received, section by

    section, in light of the relevant 15(a) public interest, cost-benefit

    considerations.

    Consideration of Costs and Benefits Section by Section

    Section 1.3(rr)--Definition of ``Foreign Futures or Foreign Options

    Secured Amount''

    The Commission adopted an amendment to Sec. 1.3(rr) replacing the

    term ``foreign futures or foreign options customers'' with the term

    ``30.7 customers.'' The former only included U.S.-domiciled customers,

    whereas the term ``30.7 customers'' includes both U.S.-domiciled and

    foreign-domiciled customers who place funds in the care of an FCM for

    trading on foreign boards of trade. This change expanded the range of

    funds that the FCM must include as part of the foreign futures or

    foreign options secured amount.

    In addition, the definition of ``foreign futures or foreign options

    secured amount'' was amended so that it is equal to the amount of funds

    an FCM needs in order to satisfy the full account balances of each of

    its 30.7 customers at all times. This definitional change is necessary

    to implement the conversion in Sec. 30.7 from the ``Alternative

    Method'' to the ``Net Liquidating Equity Method'' of calculating the

    foreign futures or foreign options secured amount.

    Costs and Benefits

    These definitional changes determine how much funds are considered

    part of the ``foreign futures or foreign options secured amount.''

    However, the costs and benefits of these changes are attributable to

    the substantive requirements related to the definitions and, therefore,

    are analyzed with respect to changes adopted to Sec. 30.7 and

    discussed below.

    Section 1.10--Financial Reports of Futures Commission Merchants and

    Introducing Brokers

    The Commission adopted amendments to Sec. 1.10 revising the Form

    1-FR-FCM by establishing a new schedule called the ``Cleared Swap

    Segregation Schedule'' that is included in the FCM's monthly report,

    together with the Segregation Schedule and Secured Amount Schedule. The

    amendments also provide that the Cleared Swap Segregation Schedule is a

    public document.\602\ The Commission also amended the Segregation

    Schedule and the Secured Amount Schedule to include reporting of the

    FCM's target for residual interest in the accounts relevant to that

    Schedule, as well as a calculation of any surplus or deficit in

    residual interest with respect to that target. The Commission also

    required each FCM to report to the Commission monthly leverage

    information.

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

    \602\ The Segregation Schedule and Secured Amount Schedule are

    already public documents.

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

    Costs and Benefits

    In the NPRM, the Commission considered the amendments to Sec. 1.10

    to have significant benefits to the protection of market participants,

    namely, customers. The Commission anticipated that continuing the

    public availability of the Segregation Schedule and the Secured Amount

    Schedule, with the addition of the Cleared Swaps Segregation Schedule,

    would be beneficial to customers in assessing the financial condition

    of the FCMs with whom they choose to transact. The Commission posited

    that FCMs would have competing incentives to set higher or lower

    targeted residual amounts, but that public disclosure would enhance the

    quality of the assessment of a reasonable targeted amount of residual

    interest. The Commission stated that providing publicly the additional

    information would permit customers to weigh this consideration, along

    with considerations of price, in selecting an FCM, benefiting the

    protection of market participants. The Commission also stated that

    requiring FCMs to report their leverage to the Commission on a monthly

    basis would assist the Commission in monitoring each FCM's overall risk

    profile, which would help the Commission to identify FCMs that should

    be monitored more closely for further developments that could weaken

    their financial position, enhancing the protection of market

    participants.

    The Commission could not quantitatively estimate the cost of FCMs

    having an incentive by public disclosure to hold higher targeted

    residual amounts in customer segregated accounts. The Commission did

    consider that qualitatively it expected that costs would be incurred as

    a result, as a return available to FCMs on restricted investments

    permissible under Sec. 1.25 would likely be lower than returns on

    capital not restricted by being held as target residual amounts subject

    to the investment requirements of Sec. 1.25, and public disclosure

    would, other factors being equal, give an incentive to FCMs to hold a

    larger target residual amount.

    The Commission estimated quantitatively costs associated with

    system modifications to produce additional reports for leverage. The

    Commission did not receive comments regarding its quantitative

    estimates of those costs or its qualitative analysis that costs would

    be associated with the amendments to Sec. 1.10, particularly the

    public disclosure of the Cleared Swaps Segregation Schedule and the

    changes to the Segregation Schedule and Secured Amount Schedule to

    include the targeted residual amount. Specifically, the Commission

    received no comments regarding the assumption that the target residual

    amount would in fact be higher once publicly disclosed, or as to what

    forms or costs associated with any additional capital that may be

    required following disclosure of the target residual amount, if any at

    all. Nor did the Commission receive comments discussing the

    quantitative spread difference between Sec. 1.25 investments compared

    to investments that are not subject to Sec. 1.25. Without comment as

    to these cost drivers, the Commission is unable to accurately estimate

    these costs.

    The Commission received a comment from NFA to consider an

    alternative to the regulatory language proposed for leverage ratio

    reporting to refer to the formulation of leverage established by a

    registered futures association.\603\ The Commission, believing that

    this alternative would have no detrimental impact on the benefits

    anticipated from obtaining reporting of leverage, modified the language

    in the final regulation to conform to the alternative

    [[Page 68584]]

    suggested by NFA. The alternative language in the final regulation will

    permit the leverage reporting requirement to stay harmonized with NFA's

    leverage reporting requirement as NFA has indicated it intends to

    update and refine the formulation, which will continue to provide the

    Commission with information necessary to monitor FCMs for the

    protection of market participants.\604\

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

    \603\ NFA Comment Letter at 8 (Feb. 15, 2013).

    \604\ Id.

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

    The Commission received numerous comments regarding the benefits of

    the public disclosure of the Segregation Schedule, Secured Amount

    Schedule, and Cleared Swaps Segregation Schedule, and the amounts of

    the FCM's targeted residual interest.\605\ Many commenters reiterated

    the utility of, and value to, customers of the public availability of

    the schedules and financial condition information of FCMs.\606\

    However, several FCMs commented, and FIA expressed concern, that the

    information would not be useful to customers and would be difficult for

    customers to understand without understanding all the factors involved

    in setting a target residual amount.\607\ These commenters were

    concerned that customers may, to their detriment, overweigh the

    consideration of the targeted residual amount.\608\ These comments are

    discussed in detail at section II.P. above.

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

    \605\ See, e.g., SIFMA Comment Letter at 2 (Feb. 21, 2013); SUNY

    Buffalo Comment Letter at 8 (Mar. 19, 2013); Vanguard Comment Letter

    at 5-6 (Feb. 22, 2013).

    \606\ Id.

    \607\ See, e.g., FIA Comment Letter at 52 (Feb. 15, 2013); RJ

    O'Brien Comment Letter at 6 (Feb. 15, 2013).

    \608\ Id.

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

    The Commission understands the concerns of both sets of commenters

    but believes that the protection of market participants is enhanced in

    this circumstance by the greater availability of public information,

    particularly concerning customer funds, to customers and potential

    customers. Notwithstanding the concerns of FIA and several FCMs

    particularly questioning the benefits of the public availability of the

    targeted residual amount, the Commission believes that public

    disclosure--and consequent market discipline--is an important

    counterweight to other FCM incentives with respect to establishing the

    target. The Commission herein has adopted numerous measures increasing

    disclosures to customers, believing, on balance, that additional

    disclosures regarding customer funds in particular to have significant

    benefits to the protection of market participants. Greater availability

    of information may also provide additional confidence in the financial

    integrity of futures markets.

    Finally, the Commission, in its consideration of costs and benefits

    for the amendments to Sec. 1.10, asked questions for particular

    comments on the costs and benefits of making public daily segregation

    and secured amount calculations, or other more frequent calculations,

    and solicited comments on alternatives. Similar to the comments on the

    public availability of the Segregation Schedule, Secured Amount

    Schedule, and the Cleared Swaps Segregation Schedule, some commenters

    supported and other commenters opposed the public availability of daily

    margin segregation calculations.

    The Commercial Energy Working Group noted, generally, that the

    Commission's proposals for the publication of information would be a

    cost-effective mechanism to make FCMs more accountable to their

    customers.\609\ The Commercial Energy Working Group posited that

    additional costs of publication of daily segregation calculations

    should be nominal.\610\ There were no other specific comments on the

    costs of making publicly available daily or more frequent information.

    The Commission proposed requiring daily segregation disclosures in the

    amendments adopted to Sec. 1.55, and the benefits of such disclosures

    will be further discussed in that section, although the only comment

    received as to the costs of such publication of information was as

    discussed herein.

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

    \609\ Commercial Energy Working Group Comment Letter at 2 (Feb.

    12, 2013).

    \610\ Id. at 3

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

    The NFA commented that the Commission should consider the

    alternative of directing customers to its BASIC system where certain

    financial information on FCMs would be available in one place, as

    opposed to requiring FCMs to publish financial information, including

    the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps

    Segregation Schedule on their respective Web sites.\611\ NFA commented

    that the Commission should carefully distinguish between categories of

    information, as those meaningful to all customers which should be

    readily available, meaningful to regulators but which may be sensitive

    and subject to misinterpretation if made public, and meaningful to more

    sophisticated customers that FCMs should be required to provide upon

    request.\612\ The Commission believes enhanced benefits to the

    protection of market participants and the financial integrity of

    futures markets, and market discipline, are best achieved by the public

    availability of the Segregation Schedules, Secured Amount Schedules,

    and Cleared Swaps Segregation Schedules in their entirety on a monthly

    basis, but also agrees with NFA's concern regarding the sensitivity of

    information that may be readily available to regulators but not

    publicly disclosed. The Commission does not agree that there may be a

    benefit to distinguishing between categories of customers with respect

    to public availability of information. The Commission agrees there

    could be enhanced utility to customers by having schedules provided by

    the NFA through its BASIC portal as an alternative, however, also notes

    that NFA could implement this under the rule as adopted so long as the

    schedules are required to be made publicly available and are not exempt

    from public disclosure.

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

    \611\ NFA Comment Letter at 15 (Feb. 15, 2013).

    \612\ Id. at 16.

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

    Section 1.11 Risk Management Program for Futures Commission Merchants

    The Commission adopted new Sec. 1.11 requiring an FCM that carries

    accounts for customers to establish a risk management unit that is

    independent from the business unit handling customers or customer funds

    and reports directly to senior management. In addition, each FCM must

    establish and document a risk management program, approved by the

    governing body of the FCM, that, at a minimum: (a) Identifies risks and

    establishes risk tolerance limits related to various risks that are

    approved by senior management; (b) includes policies and procedures for

    detecting breaches of risk tolerance limits, and for reporting them to

    senior management; (c) provides risk exposure reports quarterly and

    whenever a material change in the risk exposure of the FCM is

    identified; (d) includes annual review and testing of the risk

    management program; and (e) meets specific requirements related to

    segregation risk, operational risk, and capital risk.

    Regarding segregation risk, each FCM must establish written

    policies and procedures that require, at a minimum: (1) Documented

    criteria for selecting depositories that would hold segregated funds;

    (2) a program to monitor depositories on an ongoing basis; (3) an

    account opening process that ensures the depository acknowledges that

    funds in the account are customers' funds before any deposits are made

    to the account, and that also ensures accounts

    [[Page 68585]]

    are titled appropriately; (4) a process for determining a residual

    interest target for the FCM that involves due diligence from senior

    management; (5) a process for the withdrawal of an FCM's residual

    interest when such a withdrawal is not made for the benefit of the

    FCM's customers; (6) a process for determining the appropriateness of

    investing funds in Sec. 1.25 compliant investments; (7) procedures to

    assure that securities and other non-cash collateral held as segregated

    funds are properly valued and readily marketable and highly liquid; (8)

    procedures that help to ensure appropriate separation of duties between

    those who account for funds and are responsible for statutory and

    regulatory compliance versus those who act in other capacities with the

    company (e.g., those who are responsible for treasury functions); (9) a

    process for the timely recording of all transactions; and (10) a

    program for annual training of FCM employees regarding the requirements

    for handling customer funds.

    The new Sec. 1.11 requires automated financial risk management

    controls that address operational risk, and written procedures

    reasonably designed to ensure that an FCM has sufficient capital to be

    in compliance with the Act and regulations and to meet its liquidity

    needs for the foreseeable future.

    Costs and Benefits

    In the NPRM, the Commission provided a detailed discussion of the

    significant benefits of the new risk management requirements for FCMs

    to the protection of market participants and customer funds, sound risk

    management, and directly as well as by extension, the financial

    integrity of futures markets. Specifically, the Commission stated that

    it considered the specific requirements of Sec. 1.11 to reduce the

    negative impact of conflicts of interest on decision making relating to

    customer funds, to result in stronger controls which could quickly

    focus management attention on emerging risks and minimize the risk of a

    breakdown in control at times of financial stress, and to promote more

    formal responsibility and require specific accountability up the chain

    of FCM management and governance for risk controls both generally and

    specific to customer funds processes and procedures. Documentation

    requirements for policies and procedures were considered beneficial to

    promote Commission and SRO oversight of the tools chosen by FCMs in

    putting the stronger controls in place, although the Commission also

    determined that permitting flexibility with respect to the manner of

    the policies and procedures would be beneficial to the efficiency of

    FCMs in putting the new stronger and more rigorous requirements into

    practice. The Commission considers the requirements adopted under Sec.

    1.11 to be extremely important in eradicating the potential for poor

    internal controls environments at FCMs, which could be susceptible to

    fraud or operational error, which in turn could result in losses to

    customer funds without clear and documented management accountability.

    Documentation of the criteria for decision making and management

    determinations with respect to choice of depositories, and other

    management determinations impacting customer funds such as residual

    interest and investment choices, as well as requiring periodic review

    and testing of the risk management program, allows for an iterative

    process with a clear purpose, the protection of customers and customer

    funds, transparent to both Commission and SRO examination. Providing

    clear factors which must be considered by FCMs in their adopted

    practices, such as selection of depositories, was also considered by

    the Commission to provide greater clarity to customers with respect to

    determinations of significant consequence for customers, with a result

    being likely enhanced market discipline coming from customers

    evaluating FCMs. In many specific areas, the Commission considered the

    requirements being adopted to greatly benefit risk management, the

    protection of market participants and the financial integrity of

    futures markets as the requirements would necessarily require FCMs to

    improve internal management communication, internal controls,

    management accountability, separation of duties, and training of

    personnel in many respects. The Commission considered that FCMs were

    already responsible under the Act and existing regulations for the

    protection of customer funds. The adoption of Sec. 1.11 requires now

    that FCMs develop written policies and procedures and put programs and

    controls into practice, to ensure going forward that they have in place

    consistent and reviewable processes to achieve the required outcomes

    for protecting customers and customer funds. The Commission, in

    adopting the rules, was however, cognizant that there would be

    significant costs involved in compliance with Sec. 1.11, to the extent

    that for some FCMs these processes and procedures were not already in

    place or have no equivalent foundation. However, the Commission

    considered an additional benefit to the requirements to be that there

    would no longer be a competitive cost advantage to FCMs to not put in

    place such important measures. Many FCMs are anticipated by the

    Commission to already have in place strong internal controls and

    practices similar to what is now specifically being required to be put

    in place under Sec. 1.11, and those FCMs will not have to bear a

    competitive disadvantage any longer for doing so with respect to

    bearing the costs of such practices in order to adequately protect

    customers. The Commission, cognizant of the significance of its

    estimates of costs with respect to the requirements, adopted the

    regulations in a manner that provides FCMs with flexibility in the

    manner of adopting practices that fulfill the requirements. The

    Commission did not receive specific comments on its quantitative

    estimates of the initial and recurring costs of adopting Sec. 1.11.

    The Commission did receive comments from several FCMs objecting to

    the requirements of Sec. 1.11 to require the independence of risk

    management from the business unit (defined to identify parties

    responsible for customer business or dealing with customer funds or

    supervising such lines of responsibility). RCG and Phillip Futures

    cited the loss of a talent pool available to participate in risk

    management as a negative consequence of the requirement.\613\ Phillip

    Futures also recommended that the Commission consider as an alternative

    that internal controls, senior leadership and training programs could

    suffice in lieu of required separations between risk management and the

    business unit.\614\ Phillip Futures contended that natural conflicts of

    interest will always exist and can be mitigated by supervisory levels,

    policies and procedures.\615\

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

    \613\ RCG Comment Letter at 5 (Feb. 12, 2013); Phillip Futures

    Comment Letter at 2 (Feb. 14, 2013).

    \614\ Phillip Futures Comment Letter at 2 (Feb. 14, 2013).

    \615\ Id.

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

    CHS Hedging and RJ O'Brien cited the difficulty of a small or mid-

    size FCM having a separate unit for risk management personnel, noting

    it to be impracticable operationally or financially and not cost

    effective.\616\ Frontier Futures generally commented that the costs

    associated with requiring FCMs to increase risk management standards

    for the purpose of protecting an FCM's customers from losses caused by

    fellow customers, would be prohibitive to smaller FCMs being able

    [[Page 68586]]

    to continue operations, and is an area that FCMs were adept at and

    already have a large incentive to properly manage.\617\ FIA asked for

    clarification that Sec. 1.11 does not require formal structured risk

    management units, provided that the FCM is able to identify all

    personnel responsible for required risk management activities in order

    to comply with the line reporting requirements and independence from

    supervision by the business unit.\618\

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

    \616\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013); RJ

    O'Brien Comment Letter at 9-10 (Feb. 15, 2013).

    \617\ Frontier Futures Comment Letter at 2 (Feb. 14, 2013).

    \618\ FIA Comment Letter at 55 (Feb. 15, 2013).

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

    The Commission understands the general concerns of commenters

    regarding the costs of the requirements of Sec. 1.11, along with the

    other new provisions being adopted herein by the Commission. The

    Commission did provide clarity in section II.B. as requested by FIA,

    which is intended to make clear the amount of flexibility available in

    complying with the separation of duties of risk management adopted in

    Sec. 1.11. However, the Commission notes that such separation as a

    fixed requirement is particularly important to the protection of market

    participants, as the Commission continues to believe conflicts of

    interest to be a significant risk to the protection of customer funds

    during periods of financial or operational stress absent such clear

    reporting and accountability lines being established.

    Section 1.12 Maintenance of Minimum Financial Requirements by Futures

    Commission Merchants and Introducing Brokers

    The changes to Sec. 1.12 alter the notice requirements so that it

    is no longer acceptable to give ``telephonic notice to be confirmed, in

    writing, by facsimile.'' Instead, all notices from FCMs must be made in

    writing and submitted through an electronic submission protocol in

    accordance with instructions issued or approved by the Commission

    (currently, WinJammer).

    In addition, the amendments to Sec. 1.12 require that if an FCM

    has a shortfall in net capital, but is unable to accurately compute its

    current financial condition, the FCM should not delay reporting the

    under capitalization to the Commission. The FCM must communicate each

    piece of information (knowledge of the shortfall and knowledge of the

    financial condition of the FCM) to the Commission as soon as it is

    known.

    The Commission proposed requirements in paragraphs (i), (j), (k)

    and (l) of Sec. 1.12 to identify additional circumstances in which the

    FCM must provide immediate written notice to the Commission, relevant

    SRO, and to the SEC if the FCM is also a BD. Those circumstances were:

    (1) If an FCM discovers that any of the funds in segregated accounts

    are invested in investments not permitted under Sec. 1.25; (2) if an

    FCM does not have sufficient funds in any of its segregated accounts to

    meet its targeted residual interest; (3) if the FCM experiences a

    material adverse impact to its creditworthiness or ability to fund its

    obligations; (4) whenever the FCM has a material change in operations

    including changes to senior management, lines of business, clearing

    arrangements, or credit arrangements that could have a negative impact

    on the FCM's liquidity; and (5) if the FCM receives a notice,

    examination report, or any other correspondence from a DSRO, the SEC,

    or a securities industry SRO, the FCM must notify the Commission, and

    provide a copy of the communication as well as a copy of its response

    to the Commission. The Commission adopted the proposed additional

    notification requirements with some changes in response to commenters,

    narrowing the scope of certain of the new notification requirements.

    Last, the Commission adopted a new paragraph (n) of Sec. 1.12 that

    requires that every notice or report filed with the Commission pursuant

    to Sec. 1.12 include a discussion of how the reporting event

    originated and what steps have been, or are being taken, to address the

    event.

    Costs and Benefits

    The benefits of requiring that notice to the Commission be given in

    written form via specified forms of electronic communication not only

    adapt the rule to account for modern forms of communication, but also

    reduce the possibility of notification being delayed in reaching

    appropriate Commission staff. Ensuring that important regulatory

    notices go directly through electronic systems will result in

    appropriate staff being alerted as soon as possible and that there are

    no unnecessary delays to regulatory attention to the notice, which

    should benefit the protection of market participants and the financial

    integrity of futures markets, potentially significantly depending on

    the importance of the issue being addressed.

    For example, with respect to the adopted change in Sec.

    1.12(a)(2), if an FCM knows that it does not have adequate capital to

    meet the requirements of Sec. 1.17 or other capital requirements, and

    is also not able to calculate or determine its financial condition, it

    is likely that the FCM is in a period of extraordinary stress. In these

    circumstances, time is of the essence for the solvency of the FCM and

    for the protection of its customers and counterparties. Therefore, it

    is important that the Commission, DSRO, and SEC (if the FCM is also a

    BD) be notified immediately so that they can begin assessing the FCM's

    condition, and if necessary, make preparations to allow the transfer of

    the customers' positions to another FCM in the event that the FCM

    currently holding those positions has insufficient regulatory capital.

    These preparations help to ensure that the customers' funds are

    protected in the event of the FCM's default, and that the positions of

    its customers are transferred expeditiously to another FCM where those

    customers may continue to hold and control those positions without

    interruption.

    The situations enumerated as adopted in Sec. 1.12(i) and (j) are

    more specific indicators of potential or existing problems in the

    customer segregated funds accounts. Notifying the Commission in such

    circumstances enables it to monitor steps the FCM is taking to address

    a shortfall in targeted residual interest, or to direct the FCM as it

    takes steps to address improperly invested segregated funds. In either

    case, the Commission will be able to closely monitor the FCM's actions,

    benefiting the continued protection of customer segregated funds.

    The Commission also asked questions in the NPRM regarding whether

    public availability of Sec. 1.12 notices would enhance customer

    protection, but did not propose to make the notifications public as it

    did other additional disclosures relevant to customer funds, such as

    the various segregation schedules. Comments were received both in favor

    of and in opposition to public availability. One commenter, FHLB,

    posited that the costs of public availability would be negligible

    because the reporting would already be done and be done electronically,

    and the benefit substantial, so that the Commission should require

    public availability.\619\ However, other commenters, including RJ

    O'Brien and FIA, raised concerns about potential detrimental market

    impacts on FCMs from the public availability of Sec. 1.12 notices, at

    odds with FHLB's assertion that FCMs could not be impacted by a ``run

    on the bank'' scenario and that costs would be negligible, with RJ

    O'Brien believing a main risk of public availability being precisely a

    possibly disorderly and erroneous ``run on the bank'' scenario.\620\

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

    \619\ FHLB Comment Letter at 3 (Feb. 15, 2013).

    \620\ FIA Comment Letter at 37 (Feb. 15, 2013); RJ O'Brien

    Comment Letter at 10 (Feb. 15, 2013).

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

    [[Page 68587]]

    The Commission, although in most circumstances believing there to

    be substantial benefits to greater availability of public information

    concerning segregated funds, declined to adopt any requirement for

    public availability of Sec. 1.12 notices, weighing the comments

    received, and recognizing an additional benefit to maintaining

    equivalence of treatment with the SEC for joint registrants, whose

    similar notices are not made public. The Commission agrees that the

    risk of the possibility of a disorderly ``run on the bank'' scenario

    from Sec. 1.12 notices being made immediately public would be too

    great relative to the benefit of such publication. The possibility of

    that result could exacerbate a potentially solvable problem at an FCM

    and not result in the best protection of market participants. The

    Commission is adopting other types of additional customer disclosures

    required of FCMs under Sec. 1.55, which it believes are more

    beneficial to the protection of customers and appropriate to the

    disclosure purposes than the public availability of Sec. 1.12 notices.

    The situations enumerated that were proposed in Sec. 1.12(k)

    through (l) are circumstances indicating that the FCM is undergoing

    changes that could indicate or lead to financial strain. Alerting the

    Commission and relevant SROs in such circumstances will benefit the

    protection of market participants by fostering their ability to monitor

    such FCMs more closely in order to ensure that any developing problems

    are identified quickly and addressed proactively by the FCM with the

    oversight of the Commission and the relevant SROs. In response to

    commenters who proposed alternatives, believing the proposals to be

    overly broad and difficult to clearly comply with, the Commission

    adopted the requirements but narrowed and provided additional detail

    for the circumstances under which such notices would be required. The

    Commission believes the requirements as adopted continue to provide the

    intended benefits to the protection of market participants.

    The proposed Sec. 1.12(m) requirement that the FCM notify the

    Commission whenever it receives a notice or results of an examination

    from its DSRO, the SEC, or a securities-industry SRO, was intended to

    ensure that the Commission is aware of any significant developments

    affecting the FCM that have been observed or communicated by other

    regulatory bodies. Such communications could prompt the Commission to

    heighten its monitoring of specific FCMs, or create an opportunity for

    the Commission to work collaboratively and proactively with other

    regulators and self-regulatory organizations to address any concerns

    about how developments in the FCM's business could affect customer

    funds.

    The Commission adopted Sec. 1.12(m), with changes to address the

    requests of commenters that the scope of the requirement needed to be

    narrowed in order to provide the benefit intended without potentially

    overly burdensome costs. TD Ameritrade, in particular, commented that

    the volume of its filings with securities regulators would make the

    Sec. 1.12(m) requirement both overly costly with respect to the

    intended benefit, and also not likely to result in the benefit as

    intended.\621\ The Commission believes the narrowed language adopted

    for Sec. 1.12(m) should appropriately address the comment and provide

    the benefit intended without overly burdensome costs.

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

    \621\ TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).

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

    The requirement that notifications to the Commission pursuant to

    Sec. 1.12 include a discussion of what caused the reporting event and

    what has been, or is being done about the event, would provide

    additional information to Commission staff that would help them quickly

    gauge the potential severity of related problems that have been or are

    developing at the reporting FCM, IB, or SRO. The benefit of requiring

    the additional information is that it will assist Commission or SRO

    staff in determining whether the situation is likely to be corrected

    quickly or to continue deteriorating. Commission staff may be best able

    to protect market participants with appropriate and timely

    intervention, with more information received initially regarding how a

    potential regulatory problem is being handled.

    The Commission made quantitative estimates of costs for the

    amendments to Sec. 1.12 in the NPRM, including the new notice

    requirements, the additional information required to be included in

    notices, and monitoring that would be necessary in order for FCMs to

    submit notices and received no comments specific to those estimates.

    The Commission estimated the costs of requiring electronic filing of

    notices for FCMs to be negligible as the filing system is already in

    place, and received no comment on that estimate. The Commission asked

    specific questions regarding costs for the additional notice

    requirements and did not receive any response to such questions from

    commenters.

    Section 1.16 Qualifications and Reports of Accountants

    The adopted changes to Sec. 1.16 require that in order for an

    accountant to be qualified to conduct an audit of an FCM, the

    accountant would have to be registered with the PCAOB, and have

    undergone inspection by the PCAOB. In addition, the amendments also

    would require that the governing body of the FCM ensure that the

    accountant engaged for an audit is duly qualified, and specifies

    certain qualifications that must be considered when evaluating an

    accountant for such purpose. Finally, the amendments require the public

    accountant to state in the audit opinion that the audit was conducted

    in accordance with the auditing standards adopted by the PCAOB.

    Costs and Benefits

    The Commission adopted amendments to Sec. 1.16 primarily to obtain

    the benefits of quality control and oversight of accountants and higher

    standards to apply to certified audits of FCMs, for the greater

    protection of market participants, and to increase the financial

    integrity of futures markets. In at least one circumstance of FCM

    failure, which was an impetus for the package of additional protections

    to customer funds contained in the Proposal, the experience and quality

    of the FCM auditor contributed to the audit failure and the inability

    of an audit to be an effective additional check on the compliance and

    financial integrity of FCMs and customer funds.\622\

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

    \622\ See In the Matter of Jeannie Veraja-Snelling, CFTC Docket

    No. 13-29, available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfverajaorder082613.pdf.

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

    The Commission also considers the newly adopted requirement for the

    governing body of the FCM to have accountability for assessing auditor

    qualifications to be an appropriate tool to ensure responsibility for a

    lack of conflicts, true independence and a quality audit by experienced

    auditors to be connected back to the FCM's governing body and to be

    clearly understood to be a responsibility of that governing body. The

    Commission believes this enhanced accountability will benefit the

    protection of market participants and promote the financial integrity

    of futures markets by contributing to ensuring audit quality of FCMs.

    In the NPRM, the Commission did not quantitatively estimate costs

    associated with the amendments to Sec. 1.16, however, it qualitatively

    considered the

    [[Page 68588]]

    likelihood that PCAOB registered accountants would be expected, all

    else being equal, to have higher audit fees, thereby incurring

    additional costs. The Commission requested, but did not receive,

    quantitative information from commenters to better assess these costs.

    However, the Commission did receive several comments regarding the

    proposed amendments to Sec. 1.16 and the Commission altered some of

    the proposed Sec. 1.16 requirements in response to such comments, as

    discussed in section II.E. above.

    One commenter, the AICPA, proposed that the Commission consider a

    practice monitoring program, such as the AICPA peer review, as an

    alternative to the PCAOB inspection requirement.\623\ The AICPA stated

    it did not believe the PCAOB inspection requirement would have the

    benefit of enhancing audit engagements in situations where inspections

    are not required (i.e., non-issuer FCMs).\624\ The Commission does

    believe the PCAOB inspection requirement will enhance audit quality

    over time, particularly as inspections become required for the audits

    of SEC registered BDs.

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

    \623\ AICPA Comment Letter at 3 (Feb. 11, 2013).

    \624\ Id. at 2-3.

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

    However, in considering the practical impediments to registering

    and becoming inspected by the PCAOB, the Commission made several

    clarifications in adopting the amendments.\625\ Most notably, the

    Commission extended the compliance date for inspection by the PCAOB

    until December 31, 2015. As noted above in section II.E., based on the

    Commission's most recent review, currently there are only seven CPA

    firms (auditing fifteen FCMs) that would not meet this requirement. Six

    of those firms are registered with the PCAOB as and indicate that they

    will be subject to the PCAOB BD inspection program and will presumably

    receive a PCAOB inspection in the future. Therefore, the Commission is

    adopting the inspection requirement as proposed but has extended the

    compliance date to December 31, 2015 in order to provide additional

    time for accountants to be subject to PCAOB inspections.

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

    \625\ See additional discussion at section II.E. above.

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

    The Commission received no comments addressing costs associated

    with an anticipated increase in audit fees for PCAOB registration. Nor

    did the Commission receive comment as to any increased costs associated

    with becoming PCAOB registered. Nonetheless, the Commission believes

    that currently only one FCM audit firm is not PCAOB registered, and

    would therefore be required to register to continue to conduct audits

    of FCMs. Currently, a public accountant that audits less than 49 public

    issuers is required to pay the PCAOB a registration fee of $500.\626\

    Annual fees for public accountants with less 200 issuers also are $500

    per year.\627\ Therefore, any costs associated with registering the one

    and only existing accounting firm which would not be in compliance, or

    any firm in the future that will need to register with the PCAOB, will

    be nominal.

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

    \626\ See http://pcaobus.org/Registration/rasr/Pages/AnnualFees.aspx.

    \627\ Id.

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

    Section 1.17 Minimum Financial Requirements for Futures Commission

    Merchants and Introducing Brokers

    Section 4f(b) of the Act provides that no person may be registered

    as an FCM unless such person meets the minimum financial requirements

    that the Commission has established by regulation. The Commission's

    minimum capital requirements for FCMs are set forth in Sec. 1.17

    which, among other things, provides that an FCM must cease operating as

    an FCM and transfer its customers' positions to another FCM if the FCM

    is not in compliance with the minimum capital requirements, or is

    unable to demonstrate its compliance with the minimum capital

    requirements. The Commission proposed to amend Sec. 1.17 by adding a

    new provision that will authorize the Commission to require an FCM to

    cease operating as an FCM and transfer its customer accounts if the FCM

    is not able to certify and demonstrate sufficient access to liquidity

    to continue operating as a going concern. Additionally, FCMs that are

    also registered BDs will be allowed to use the SEC's BD approach \628\

    to evaluate the credit risk of securities that the FCM invests in and

    assign smaller haircuts \629\ to those that are deemed to be a low

    credit risk.\630\ The Commission's amendment to Sec. 1.17(c)(5)(v)

    allows FCMs that are not dual registrants to use the same approach.

    Finally, the Commission has adopted amendments revising the period of

    time that an FCM is permitted to wait before taking an undermargined

    capital charge from three business days after the call is issued on a

    customer's account to one business day, and from two business days

    after the call is issued on a noncustomer or omnibus account to one

    business day.

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

    \628\ Under the SEC proposal, a BD may impose the default

    haircuts of 15 percent of the market value of readily marketable

    commercial paper, convertible debt, and nonconvertible debt

    instruments or 100 percent of the market value of nonmarketable

    commercial paper, convertible debt, and nonconvertible debt

    instruments. A BD, however, may impose lower haircut percentages for

    commercial paper, convertible debt, and nonconvertible debt

    instruments that are readily marketable, if the BD determines that

    the investments have only a minimal amount of credit risk pursuant

    to its written policies and procedures designed to assess the credit

    and liquidity risks applicable to a security. A BD that maintains

    written policies and procedures and determines that the credit risk

    of a security is minimal is permitted under the SEC proposal to

    apply the lesser haircut requirement currently specified in the SEC

    capital rule for commercial paper (i.e., between zero and \1/2\; of

    1 percent), nonconvertible debt (i.e., between 2 percent and 9

    percent), and preferred stock (i.e., 10 percent).

    \629\ In computing its adjusted net capital, an FCM is required

    to reduce the value of proprietary futures and securities positions

    included in its liquid assets by certain prescribed amounts or

    percentages of the market value (otherwise known as ``haircuts'') to

    discount for potential adverse market movements in the securities.

    \630\ The adoption of the Commission's rule is conditional upon

    the SEC adoption as final its proposed rule to eliminate references

    to credit ratings.

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

    Costs and Benefits

    In the NPRM, the Commission provided a detailed discussion of the

    benefits the changes to Sec. 1.17 would provide. Regarding the

    potential transfer of customer accounts if the FCM was unable to

    certify and demonstrate sufficient access to liquidity to continue

    operating as a going concern, several commentators stated that the

    Commission should not adopt the rule before clearly articulated

    objective standards were established and exigent circumstances that

    would give the Commission authority to require an FCM to cease

    operating were defined. The Commission understands the concerns of

    commenters regarding the process by which the Commission, or the

    Director of the Division of Swap Dealer and Intermediary Oversight

    acting pursuant to delegated authority under Sec. 140.91(6), could

    require immediate cessation of business as an FCM and the transfer of

    customer accounts.

    However, that same authority currently exists should a firm fail to

    meet its minimum capital requirement. The Commission believes the

    ability to certify, and if requested, demonstrate with verifiable

    evidence, sufficient liquidity to operate as a going concern to meet

    immediate financial obligations, is a minimum financial requirement

    necessary to ensure an FCM will continue to meet its obligations as a

    registrant under the Act. Moreover, because liquidity difficulties will

    not be made transparent to the FCM's customers pursuant to 1.12, it is

    especially important that the Commission be permitted to act.

    [[Page 68589]]

    Regarding the proposed amendment to Sec. 1.17(c)(5)(v) revising

    the capital charge (or haircut) procedures for FCMs, the Commission

    notes that it only impacts FCMs that are not dual registrants. Because

    FCMs that are not dual registrants do not typically invest in

    securities that would be subject to reduced haircuts under the SEC's

    proposed rules, the change should not have a significant impact on the

    capital requirements for such FCMs. The CFA believes that capital

    models should be established by the relevant regulatory agencies for

    use by FCMs or BDs and has serious concerns that internal models used

    for calculating minimum capital requirements are prone to failure in

    crisis.\631\ The Commission appreciates the CFA's concerns, however,

    the Commission notes that for securities positions, Sec. 1.17

    incorporates by reference the securities haircuts that a BD is required

    to take in computing its net capital under the SEC's regulations.\632\

    This is a result of the Commission's determination to defer to the SEC

    in areas of its expertise, specifically with respect to market risk and

    appropriate haircuts on securities positions.\633\ For FCMs that are

    dually-registered as BDs, any changes adopted by the SEC to these

    securities haircuts will be applicable under Sec. 1.17(c)(5)(v) unless

    the Commission specifically provides an alternate treatment for

    FCMs.\634\ The Commission's amendment merely allows FCMs that are not

    dual registrants to follow the same rules as those that are dual

    registrants. This change would harmonize the regulation of FCMs with

    respect to minimal financial requirements and would place FCMs that are

    not dual registrants on a more level playing field with those that are

    dual registrants, which improves the competition between FCMs. The FCMs

    that use their own internal models will also be subject to review by

    regulators, including the SEC, SROs, or securities SROs.

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

    \631\ CFA Comment Letter at 4-5 (Feb. 13, 2013).

    \632\ Commission Regulations 1.17(c)(5)(v) and 1.32(b) both

    incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.

    \633\ See 43 FR 15072, 15077 (Apr. 10, 1978) and 43 FR 39956,

    39963 (Sept. 8, 1978).

    \634\ See discussion adopting Sec. 1.17(c)(5)(vi) for options

    haircuts, with respect to the applicability of provisions

    incorporating by reference and referring to the rules of the SEC for

    securities broker dealers also registered as futures commission

    merchants. 43 FR 39956, 39964.

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

    Regulation 1.17(c)(5)(viii) required an FCM to take a capital

    charge if a customer account is undermargined for three business days

    after the margin call is issued. Likewise, Sec. 1.17(c)(5)(ix)

    required an FCM to take a capital charge for noncustomer and omnibus

    accounts that are undermargined for two business days after the margin

    call is issued. These timeframes were appropriate when the capital

    rules were adopted in the 1970s, when the use of checks and the mail

    system were more prevalent for depositing margin with an FCM. They are

    obsolete, however, in today's markets with the use of wire transfers to

    meet margin obligations. Therefore, the Commission has amended Sec.

    1.17(c)(5)(viii) and (ix) to require an FCM to take capital charges for

    undermargined customer, noncustomer, and omnibus accounts that are

    undermargined for more than one business day after a margin call is

    issued.

    FIA stated that while institutional and many commercial market

    participants generally meet margin calls by means of wire transfers,

    the proposal creates operational problems because it does not consider

    delays arising from accounts located in other time zones that cannot

    settle same day, or ACH settlements, or the requirement to settle or

    convert certain non-U.S. dollar currencies.\635\ FIA also stated that a

    substantial number of customers that do not have the resources of large

    institutional customers (in particular members of the agricultural

    community) depend on financing from banks to fund margin requirements,

    which may require more than one day to obtain.\636\

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

    \635\ FIA Comment Letter at 26 (Feb. 15, 2013).

    \636\ Id.

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

    RJ O'Brien objected to the proposed amendment because many

    customers that use the markets to hedge commercial risk still meet

    margin calls by check or ACH because of the impracticality and

    costliness of wire transfers to their circumstances.\637\ RJ O'Brien

    stated that in many cases, the costs of a wire transfer would exceed

    the transaction costs paid by the client to its FCMs, and additionally,

    that some customers in the farming and ranching community finance their

    margin calls, which can require additional time to arrange for delivery

    of margin call funds due to routine banking procedures.\638\ RJ O'Brien

    also stated that if the proposal is adopted, FCMs that service non-

    institutional clients will struggle to remain competitive and the

    proposal may result in fewer clearing FCMs and greater systemic risk to

    the marketplace.\639\ RJ O'Brien further stated that a loss of such

    smaller FCMs will result in fewer options available to these ranchers,

    farmers and other commercial market participants that wish to hedge

    their commercial risks.\640\

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

    \637\ RJ O'Brien Comment Letter at 3-4 (Feb. 15, 2013).

    \638\ Id.

    \639\ Id.

    \640\ Id.

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

    Other commenters expressed the general concern that the proposal

    will harm the customers it is meant to protect by requiring more

    capital to be kept in customer accounts, possibly forcing users to hold

    funds at FCMs well in excess of their margin requirements.\641\ Those

    commenters argued that such pre-funding could add significant financial

    burdens to trading as customers find themselves having to provide

    excess funds to their brokers which could increase their risk with

    regard to the magnitude of funds potentially at risk in the event of

    future FCM insolvencies.\642\ The commenters generally expressed

    significant concerns that reducing margin calls to one day will harm

    many customers as: (1) Many small businesses, farmers, cattle producers

    and feedlot operators routinely pay by check and forcing them to use

    wire transfers increases their cost of doing business; (2) clients who

    make margin calls by ACH payments instead of wire transfers because ACH

    is cheaper, would no longer be able to do so because there is a one-day

    lag in availability of funds; and (3) foreign customers would not be

    able to make margin calls due to time zone differences, the time

    required to convert certain non-USD currencies, and for whom banking

    holidays fall on different days.\643\

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

    \641\ NPPC Comment Letter at 2 (Feb. 14, 2013); NGFA Comment

    Letter at 3 (Feb. 15, 2013); NEFI/PMAA Comment Letter at 3 (Jan. 14,

    2013); AIM Comment Letter at 15 (Jan. 24, 2013); Amarillo Comment

    Letter at 1 (Feb. 14, 2013); NCFC Comment Letter at 1 (Feb. 15,

    2013); NFA Comment Letter at 12-13 (Feb. 15, 2013); FCStone Comment

    Letter at 3 (Feb. 15, 2013); Advantage Comment Letter at 1-2 (Feb.

    15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); CCC Comment

    Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15,

    2013); AIM resubmitted the comment letters of Premier Metal

    Services, NEFI/PMAA, and the ISRI and indicated its support for the

    recommendations therein (Jan. 14, 2013).

    \642\ Id.

    \643\ Id.

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

    The CCC stated that the proposed amendment to the capital rule

    places an undue burden on the FCMs, which will likely result in FCMs

    demanding that customers prefund trades to prevent market calls and

    potential capital charges.\644\ The CCC also stated that the proposal

    could result in forced liquidations of customer positions to ensure

    that the FCM does not incur a capital charge.\645\

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

    \644\ CCC Comment Letter at 2-3 (Feb. 15, 2013).

    \645\ Id.

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

    FIA and RJ O'Brien suggested alternatives to the Commission's

    [[Page 68590]]

    proposal. Both FIA and RJ O'Brien offered that an FCM be required to

    take a capital charge for any customer margin deficit exceeding

    $500,000 that is outstanding for more than one business day.\646\ FIA

    further suggested that if the customer's margin deficit is $500,000 or

    less, the FCM should take a capital charge if the margin call is

    outstanding two business days or more after the margin call is

    issued.\647\ RJ O'Brien also stated that the Commission should provide

    at least a one year period of time for any changes to the timeframe for

    taking a capital charge for undermargined accounts to be effective, and

    that the Commission should require futures exchanges to increase their

    margin requirements to 135% of maintenance margin to reduce the number

    and frequency of margin calls.\648\

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

    \646\ FIA Comment Letter at 27 (Feb. 27, 2013); RJ O'Brien

    Comment Letter at 4 (Feb. 15, 2013).

    \647\ FIA Comment Letter at 27 (Feb. 15, 2013).

    \648\ RJ O'Brien Comment Letter at 4 (Feb. 15, 2013).

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

    The NFA and FIA stated that if the Commission adopts the amendments

    regarding residual interest as proposed, then the Commission should

    consider whether a capital charge for undermargined accounts remains

    necessary at all because the FCM will have already accounted for an

    undermargined account by maintaining a residual interest sufficient at

    all times to exceed the sum of all margin deficits; hence the capital

    charges related to an undermargined account appear to impose an

    additional financial burden without any necessary financial

    protection.\649\

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

    \649\ NFA Comment Letter at 13 (Feb. 15, 2013).

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

    The Commission has considered the comments and is adopting the

    amendments to Sec. 1.17(c)(5)(vii) and (ix) as proposed. The revised

    regulation will provide the intended benefits to customers and the

    marketplace. Commenters have stated that the proposal would increase

    customer costs by requiring the prefunding of margin calls, which will

    also potentially expose more customer funds to FCM control. Commenters,

    however, did not provide any quantitative estimates or provide any

    substantive analysis in support of their statements. In addition, the

    Commission notes that much of this argument is based on the assumption

    that FCMs would not be able to support the additional capital charge

    through their existing excess capital. In addition, many FCMs utilize a

    variety of funding sources from which additional capital may be

    obtained, if required, and therefore costs could vary significantly

    from one FCM to another FCM. Without quantitative estimates as to how

    much excess capital FCMs typically maintain, would be required to

    maintain, or the difference of these costs in relation to aged margin

    calls between one and three days, the Commission cannot quantify any

    increase in costs associated with this amendment.

    Moreover, the Commission believes that the benefits of the final

    regulation will enhance the protection of the markets and customers.

    The Commission notes that the timely collection of margin is a critical

    component of an FCM's risk management program and is intended to ensure

    that an FCM holds sufficient funds deposited by account owners to meet

    potential obligations to a DCO. As guarantor of the financial

    performance of the customer accounts that it carries, the FCM is

    financially responsible if the owner of an account cannot meet its

    margin obligations to the FCM and ultimately to a DCO.

    Regulation 39.13(g)(2) requires that a sufficient amount of funds

    is maintained in an account to cover 99 percent of the observed market

    moves over a specified period of time. Customers that maintain fully

    margined accounts are exposed to greater risk to the safety of their

    funds if some of the accounts of their fellow customers are

    undermargined. The intent of the proposed amendment is to encourage an

    FCM to require customers to promptly fund margin deficiencies, or to

    reserve a sufficient amount of capital to cover the amount of the

    deficiencies. As a consequence, the risk that a debit balance could

    develop in a customer's account due to tardy margin call payments would

    be reduced, and the amount of residual interest that the FCM would need

    to maintain in the segregated accounts in order to protect against the

    possibility that such debit balances could cause them to have less that

    is required in their segregated accounts would also be reduced. This

    provides benefits for the FCM by reducing the amount of capital that it

    must contribute to the customer segregated accounts. Customers also

    benefit by FCMs requiring more prompt payments on undermargined

    accounts, as it is less likely that FCMs would close out the positions

    of customers failing to meet margin obligations more quickly, reducing

    the potential losses that would be passed on to non-defaulting

    customers in the event of a default of a customer and a default of a

    clearing member.

    Section 1.20 Futures Customer Funds To Be Segregated and Separately

    Accounted for

    The amendments to Sec. 1.20 reorganize the section and alter the

    substance of the section's requirements in certain places.

    The final Sec. 1.20 includes Appendix A and Appendix B, which set

    forth the Template Letters for the written acknowledgments that FCMs

    and DCOs, respectively, must obtain from any depository with which they

    open an account to hold futures customer funds. The rule requires FCMs

    and DCOs to use the applicable Template Letter to obtain the required

    acknowledgment before depositing any funds with a depository.

    Regulation 1.20 also requires FCMs, DCOs, and depositories to file the

    written acknowledgment with the Commission within three business days

    of executing the letter, and to update the written acknowledgment

    within 120 days of any changes to the business name, address, or

    account numbers referenced in the letter.

    The Commission received 15 comment letters related to the proposed

    acknowledgment letter requirements. Some commenters addressed the costs

    and benefits associated with these requirements; none of them, however,

    provided any data to aid the Commission in estimating costs. In the

    sections that follow, the Commission considers the benefits and costs

    arising from the adoption of the acknowledgment letter requirements.

    The Commission also discusses the corresponding comments accordingly.

    Benefits

    Regulation 1.20(d)(2) requires an FCM to use the Template Letter in

    Appendix A to obtain a written acknowledgment from any depository that

    holds futures customer funds. A depository accepting customer funds is

    required to: (1) Acknowledge that the funds are customer segregated

    funds subject to section 4d of the Act and the Commission's regulations

    thereunder; (2) acknowledge and agree that the funds cannot be used to

    secure any obligation of the FCM to the depository or used by the FCM

    to secure or obtain credit from the depository; (3) agree to reply

    promptly and directly to any request from the Commission or the FCM's

    DSRO for confirmation of account balances or provision of any other

    information regarding or related to an account; (4) agree that the

    depository will allow the Commission and the FCM's DSRO to examine the

    accounts at any reasonable time; and (5) acknowledge and agree that the

    [[Page 68591]]

    depository will provide the Commission with technological connectivity

    necessary to permit read-only electronic access to the accounts.

    Regulation 1.20(g)(4) requires a DCO to use the Template Letter in

    Appendix B to obtain a written acknowledgment from any depository that

    holds futures customer funds. The DCO Template Letter is largely the

    same as the FCM Template Letter except that: (1) It does not require

    read-only electronic access; and (2) it does not require the depository

    to agree to Commission or DSRO examination of customer accounts.

    These acknowledgments and commitments would result in important

    benefits. First, by acknowledging that the funds are subject to the Act

    and CFTC regulations, the depository recognizes that it must comply

    with relevant statutory and regulatory requirements related to its

    handling of those funds. Second, the depository acknowledges that

    neither the FCM (or DCO) nor the depository is permitted to use

    customer funds as belonging to any person other than the customer which

    deposited them, i.e., an FCM or DCO cannot use customer funds to secure

    its obligations to the depository. Third, the Template Letter for FCMs

    constitutes written permission by the depository to allow Commission or

    DSRO officials to examine the FCM's customer accounts at any reasonable

    time and to provide the Commission with read-only electronic access to

    those accounts. As a consequence, the Template Letters would enable

    both the Commission and the DSRO to monitor actual balances at the

    depository more readily. This would help to ensure that any discrepancy

    between balances reported by the FCM on its daily customer segregation

    account reports and balances actually held by the depository would be

    identified quickly by the Commission or the DSRO. Moreover, with the

    explicit agreement from the depository permitting the examination of

    customer segregated accounts, both the Commission and DSRO would be

    better able to move quickly to resolve a problem.

    By requiring FCMs and DCOs to submit copies of the executed

    Template Letters to both the Commission and, as applicable, an FCM's

    DSRO, the Commission and DSROs would be better able to act quickly to

    protect customer funds because the necessary legal permissions will be

    in place. In addition, the Template Letters provide account information

    such as account numbers, essential for management of an FCM or DCO

    bankruptcy situation. Also, requiring that the Template Letters be

    retained for five years past the time when customer segregated funds

    are no longer held by a depository helps ensure that proper

    documentation of all relevant acknowledgments and commitments is in the

    possession of each party that relies upon the existence of those

    commitments.

    Commenters were generally supportive of adopting the Template

    Letters. The Depository Bank Group stated that ``the acknowledgment

    letters will help to facilitate a more efficient process for the

    establishment and maintenance of customer segregated accounts by FCMs

    and DCOs and serve to clarify the rights and responsibilities of

    depository institutions holding customer segregated funds.'' \650\

    Eurex expressed their appreciation for ``the potential convenience and

    increases in certainty and transparency that such a standardized

    approach would likely afford.'' \651\ CME stated its support for ``the

    Commission's efforts to strengthen and standardize the form of

    acknowledgment letters.'' \652\

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

    \650\ Depository Bank Group Comment Letter at 2 (Feb.15, 2013).

    \651\ Eurex Comment Letter at 1 (Aug. 1, 2013).

    \652\ CME Comment Letter at 7 (Feb. 15, 2013).

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

    Costs

    To date, FCMs and DCOs have negotiated each acknowledgment letter

    with depositories; accordingly, the use of standardized non-negotiable

    language in the Template Letter may result in cost savings. However,

    FCMs and DCOs are likely to bear some initial and ongoing costs as a

    result of the requirement to use the Template Letters. Regarding

    initial costs, some depositories may not be willing to sign the

    Template Letter, which would require the FCM or DCO to move any

    customer funds held by that depository to a different depository,

    creating certain due diligence and operational costs. These cost

    concerns were discussed in the comment letters from MGEX and RCG.\653\

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

    \653\ MGEX Comment Letter at 3 (Feb. 18, 2013) and RCG Comment

    Letter at 7 (Feb. 12, 2013).

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

    In the NPRM, the Commission estimated that the cost of obtaining a

    new acknowledgment letter from each existing depository is between

    $1,300 and $4,200.\654\ The Commission estimated that FCMs and DCOs

    would have approximately 1 to 30 depositories each, from which they

    would need to obtain a new acknowledgment letter. Therefore, the

    Commission estimated that the cost of obtaining new acknowledgment

    letters from existing depositories would be between $2,700 and $82,000

    per FCM or DCO.\655\ In addition, the Commission estimated that the

    process of identifying new potential depositories, conducting necessary

    due diligence, formalizing necessary agreements, opening accounts, and

    transferring funds to a new depository would likely take between three

    to six months and would likely require support from compliance

    attorneys, as well as operations, risk management, and administrative

    personnel. In the NPRM, the Commission estimated that the cost of

    moving accounts from an existing depository that is not willing to sign

    the letter would be between $50,000 and $102,000.\656\

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

    \654\ This estimate assumed 10-40 hours of time from a

    compliance attorney and 10-20 hours from an office services

    supervisor. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The

    average compensation for an office services supervisor is $40.15/

    hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per

    hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures

    were taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    \655\ Total figures are taken from previous calculation.

    ($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and

    $2,735.99*30 = $82,079.69.

    \656\ This estimate assumed one compliance attorney working

    full-time for 3-6 months, 50-200 hours from an office services

    supervisor, 80-160 hours of time from a risk management specialist,

    and 40-60 hours from an intermediate accountant. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *40

    hours/week*4 weeks/month*3 months = $40,966.54 and $85.35 *40 hours/

    week*4 weeks/month*6 months = $81,933.07. The average compensation

    for an office services supervisor is $40.15/hour [$61,776.00 per

    year/(2000 hours per year)*1.3 is $40.15 per hour]; $40.15*50 =

    $2,007.72 and $40.15*200 = $8,030.88. The average compensation for a

    risk management specialist is $65.33/hour [$100,500 per year/(2000

    hours per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and

    $268.84*160 = $10,452.00. The average compensation for an

    intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

    hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and

    $34.11*60 = $2,046.88. These figures were taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

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

    There may be additional operational costs associated with any

    changes that would necessitate updating the letter. The per-entity cost

    of obtaining the letter from new depositories is likely to be the same

    as it would be for obtaining the letter from existing depositories

    (i.e., $1,300 and $4,200). In the NPRM, the Commission estimated that

    the cost associated with changes that would require the acknowledgment

    letter to be updated would be between $1,100 and $2,800 per year.\657\

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

    \657\ This assumed 20-50 hours per year from an office manager

    for operational costs. The average compensation for an office

    manager is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 =

    $55.82/hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This

    figure was taken from the 2011 SIFMA Report on Management and

    Professional Earnings in the Securities Industry.

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

    [[Page 68592]]

    RCG discussed the need to develop policies and procedures as well

    as train personnel.\658\ These costs were considered in the NPRM and

    are discussed above. MGEX asserted, based on the Commission's estimates

    in the NPRM, that the costs of using the Template Letters would

    outweigh the benefits of using them. It did not, however, provide

    further analysis as to the basis for its conclusion.\659\ In the NPRM,

    the Commission quantified some of the potential costs and only

    discussed the benefits qualitatively. Consequently, there is no direct

    comparison between the costs and benefits based on the Commission's

    estimates in the NPRM.

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

    \658\ RCG Comment Letter at 8 (Feb. 12, 2013).

    \659\ MGEX Comment Letter at 3 (Feb.18. 2013).

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

    The Depository Bank Group, FIA, and Schwartz & Ballen expressed

    concern that the Template Letters' standard of liability provision

    would shift significant amount of risk onto depository institutions and

    would likely increase the costs incurred in both monitoring for

    violations and maintaining customer segregated accounts.\660\ As

    discussed in the preamble, the Commission revised the language in the

    Template Letters to address these concerns. FCStone and Schwartz &

    Ballen commented that the proposed restriction on depositories placing

    liens on customer accounts when there is an overdraft in an account

    would likely lead to losses to depositories. As discussed in the

    preamble, the Template Letter clarifies that liens on accounts are

    permitted only in certain limited circumstances and that a depository

    may not take a lien against a customer account to cover overdrafts. The

    final Template Letters do not deny a depository the right to recover

    funds advanced in the form of cash transfers, lines of credit,

    repurchase agreements or other similar liquidity arrangements made in

    lieu of liquidating non-cash assets held in an account or in lieu of

    converting cash in one currency to cash in a different currency.

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

    \660\ Depository Bank Group Comment Letter at 2 (Feb. 15, 2013),

    FIA Comment Letter at 40 (Feb. 15, 2013) and Schwartz & Ballen

    Comment Letter at 6 (Feb. 15, 2013).

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

    The requirement, embedded in the FCM Template Letter, that

    depositories provide the Commission with read-only electronic access to

    customer accounts would create certain costs for depositories that

    would likely be passed onto FCMs. ICI noted that the read-only access

    requirement would result in a process that might be burdensome.\661\

    The Commission does not have adequate data to estimate the cost for

    establishing such a system and no data was provided by commenters to

    aid the Commission in estimating such costs.\662\ The Commission also

    has decided not to adopt the read-only electronic access requirement

    for DCOs.\663\

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

    \661\ ICI Comment Letter at 5 (Jan. 14, 2013). Although ICI's

    comments focused on MMMFs, some of the costs they discussed apply

    generally to read-only access requirements.

    \662\ The Commission intends to rely primarily on other means of

    obtaining account information from depositories, and would activate

    the read-only electronic access only in situations where it was

    deemed necessary. The Commission will generally seek to obtain

    account information from the NFA and CME automated daily segregation

    confirmation system and/or from depositories directly prior to

    requesting a depository to activate electronic access.

    \663\ DCOs hold omnibus customer segregated accounts that do not

    reflect funds attributable to individual clearing members or

    customers.

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

    FCStone asserted that the ultimate costs of requiring Template

    Letters will be borne by customers of FCMs.\664\ ICI noted that the

    costs with respect to a MMMF Template Letter requirements would be

    borne by all investors in a MMMF and not just by the FCMs.\665\ The

    Commission, however, is unable to forecast how these costs will

    ultimately be allocated.

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

    \664\ FCStone Comment Letter at (Feb. 15, 2013).

    \665\ ICI Comment Letter at 5 (Jan. 14, 2013).

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

    Section 1.22 Use of Customer Funds Restricted

    Under current regulations, an FCM is not permitted to use one

    customer's funds to purchase, margin, secure, or settle positions for

    another customer. However, prior regulations did not specify how FCMs

    should demonstrate compliance with this requirement. Revised regulation

    1.22(c) provides such a mechanism.

    Section 1.22(c)(1) defines the undermargined amount for an account.

    Sections 1.22(c)(2) and (c)(4) require FCMs to compute, based on the

    information available to the FCM as of the close of each business day,

    (i) the undermargined amounts, based on the clearing initial margin

    that will be required to be maintained by that FCM for its futures

    customers, at each DCO of which the FCM is a member or FCM through

    which the FCM clears, at the point of the daily settlement (as

    described in 39.14) that will complete during the following business

    day for each such DCO (or FCM through which the FCM clears) less (ii)

    any debit balances referred to in 1.20(i)(4) included in such

    undermargined amounts.

    Moreover, under section 1.22(c)(3), an FCM is required to, prior to

    the Residual Interest Deadline defined in section 1.22(c)(5), have

    residual interest in the segregated account in an amount that is at

    least equal to the computation set forth in section 1.22(c)(2).\666\

    The amount of residual interest that an FCM must maintain may be

    reduced to account for payments received from or on behalf of

    undermargined futures customers between the close of the previous

    business day and the Residual Interest Deadline.

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

    \666\ See note 395 above regarding the operation of the

    requirement in Sec. 1.22(c)(3) where an FCM is subject to multiple

    Residual Interest Deadlines.

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

    Section 1.22(c)(5) defines the Residual Interest Deadline. During

    an initial phase-in period, the Residual Interest Deadline is 6:00 p.m.

    Eastern Time on the date of the settlement referenced in (c)(2)(i) or

    (c)(4). On December 31, 2018, which is the expiration of the phase-in

    period, the Residual Interest Deadline shifts to the time of the

    settlement referenced in (c)(2)(i) or (c)(4). In the interim, paragraph

    1.22(c)(5)(iii) requires Commission staff to solicit further public

    comment and conduct further analysis in a report (the ``Report'') for

    publication in the Federal Register regarding the practicability of

    moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on

    the date of settlement to the time of settlement (or to some other time

    of day). The Report will discuss whether and on what schedule it would

    be feasible to move the Residual Interest Deadline, and the cost and

    benefits of such potential requirements. In addition, staff is

    instructed to, using the Commission's Web site, solicit public comment

    and conduct a public roundtable regarding specific issues to be covered

    by the Report. Paragraph 1.22(c)(5)(iii)(B) provides that the

    Commission may, taking into account the Report, (1) terminate the

    phase-in period, in which case the phase-in shall end as of a date

    established by Commission order published in the Federal Register,

    which date shall be no less than one year after the date of such

    Commission order, or (2) determine that it is necessary and appropriate

    in the public interest to propose through rulemaking a different

    Residual Interest Deadline. In that event, the Commission shall

    establish by order published in the Federal Register, a phase-in

    schedule.

    Costs and Benefits

    The requirement in Sec. 1.22(c) benefits customers whose accounts

    are not undermargined by reducing the risk that their segregated funds

    would be used to cover a shortfall in customer funds due

    [[Page 68593]]

    to a ``double default.'' \667\ When combined with the reporting

    requirements in Sec. Sec. 1.10, 1.32, 22.2, and 30.7, the requirement

    in Sec. 1.22(c) will further provide the Commission and the public

    with information that should allow them to determine whether FCMs are

    using one customer's funds to purchase, margin, secure or settle

    positions for another customer.\668\

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

    \667\ See discussion of double defaults in sections I.D. and

    II.G.9. above.

    \668\ See the discussion in section II.G.9. above.

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

    It would be difficult to quantify these benefits reliably. An

    estimate would depend on the expected value of losses due to a double

    default (i.e., a default of both a customer and the FCM) which, in

    turn, depend on the probability of a double default and the magnitude

    of deficits that would exist in customer accounts compared to the

    amount of residual interest at the time of the double default. Given

    the small number of historical examples, it is unlikely that any

    estimate of probability would be reliable. Moreover, the magnitude of

    the impact of a loss of customer funds is dependent on an estimate of

    the amount of funds lost, a number that is also difficult to predict

    with any reliability, as well as the loss of market confidence (which

    may be even more important), which is also difficult to estimate

    reliably.

    As discussed above, the Commission has revised the residual

    interest requirements in the final rule by adopting a point in time

    approach.\669\ As a consequence, once the requirement in Sec. 1.22(c)

    is phased in, FCMs will have several hours between the close of

    business on a particular day (the point in time upon which the

    calculation is based), and the time of day when the requisite amount of

    residual interest must be held in segregation (that is, the time of the

    daily settlement). Moreover, during the phase-in period described in

    Sec. 1.22(c)(5), FCMs will initially have a longer period (until 6:00

    p.m. Eastern Time on the following business day) to ensure that the

    requisite amount of residual interest is held in segregation.

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

    \669\ See the discussion in section II.G.9. above.

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

    These adjustments to the final rule will avoid the need for FCMs

    continuously to monitor whether they are maintaining residual interest

    in their segregated customer accounts that is sufficient to cover the

    sum of the undermargined amounts in customers' accounts. Instead, FCMs

    will have to ensure that they are able to cover the sum of the

    undermargined amounts in customers' accounts by the Residual Interest

    Deadline. This should significantly reduce the amount of residual

    interest that an FCM must maintain in segregated accounts on an ongoing

    basis. In the absence of information regarding what specific changes

    various market participants might make to their systems and operations

    in order to expedite margin payments, it is not possible for the

    Commission to provide an estimate of the costs of such technical

    changes.

    Moreover, the FCM's funding requirement will be reduced to the

    extent that customers are able to reduce the undermargined amount in

    their accounts prior to the Residual Interest Deadline. The Commission

    expects that FCMs will work with customers during the phase-in period

    to develop the systems and operational patterns that will be necessary

    to facilitate more prompt margin calls and payments. As a consequence,

    those FCMs' customers that do not already have the capability to make

    margin payments before the Residual Interest Deadline may develop that

    capability, which will further reduce the funding burden borne by FCMs.

    The cost associated with maintaining sufficient residual interest

    to cover undermargined amounts will also depend upon the policies and

    procedures that FCMs put into place to meet the targeted residual

    interest requirement set forth in Sec. 1.11. To the extent that the

    undermargined amount is greater than the targeted residual interest

    amount that an FCM maintains in its customer accounts, the FCM would

    have to increase the amount of residual interest it maintains in the

    customer segregated account by the time it is obligated to make

    settlement payments to the DCO. Some FCMs may seek to avoid this

    situation by requiring their customers to pre-fund (i.e., require

    customers to provide initial margin for a position before the FCM sends

    the position to a DCO to be cleared, and provide sufficient excess

    margin to the FCM to reduce any undermargined amount). If the FCM

    elects to increase the amount of residual interest that it maintains in

    the customer segregated accounts, this would likely reduce the range of

    investment options the FCM has for those additional funds and may

    prompt the FCM to hold additional capital to meet operational needs.

    Similarly, if the FCM requires additional margin from customers, that

    will result in capital costs to those customers.

    On the other hand, to the extent the FCM would otherwise maintain

    targeted residual interest (i.e., to the extent the targeted residual

    interest is greater than or is included within the undermargined

    amount), then the rule would not create any additional funding costs.

    Despite these revisions to the proposed rule, the Commission

    recognizes that the requirements of final rule Sec. 1.22(c) will

    create significant additional costs for FCMs and their customers.

    Developing and implementing the systems and operational changes

    necessary to facilitate more rapid margin payments will create costs

    for FCMs and their customers. Those costs are likely to vary

    significantly across FCMs depending on the infrastructure and

    operational patterns that each FCM already has in place, and depending

    on the specifications of the revised systems and operational patterns

    that FCMs and customers develop in order to facilitate more rapid

    margin payments.\670\

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

    \670\ In the absence of information regarding what specific

    changes various market participants might make to their systems and

    operations in order to expedite margin payments, it is not possible

    for the Commission to provide an estimate of these costs.

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

    In addition, the Commission expects that some FCMs may choose to

    require some customers to increase the amount of margin they maintain

    in their accounts. This is more likely for those customers who are

    presently not able to make their margin payments prior to the Residual

    Interest Deadline. Customers subject to increased pre-funding

    requirements will bear costs from their cost of capital resulting from

    pre-funding multiplied by the amount of the increased pre-funding

    requirement. The cost of capital for each customer depends on the

    investment strategy of the individual customer, and the amount of

    increased pre-funding requirement is likely to vary depending on the

    ability of the customer to respond to margin calls promptly and the

    FCM's ability to cover the customer's deficits through increased

    residual interest contributions.\671\

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

    \671\ Commenters did not provide, and the Commission does not

    have, data characterizing the range of investment strategies used by

    FCM customers, its impact on their cost of capital for additional

    margin, the extent to which customers will not be able to develop

    the ability to make more rapid margin payments, or the extent of the

    margin requirements for those customers. In the absence of this

    information it is not possible at this time to estimate the

    additional cost associated with pre-funding requirements that some

    customers may bear. These are subjects that may be addressed in the

    Report.

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

    Last, whatever undermargined amounts are not addressed through

    customer payments prior to the Residual Interest Deadline will have to

    be covered through increased residual interest contributions from the

    FCM.

    The Commission expects that in order to comply with the

    requirements of Sec. 1.22(c), FCMs may need to maintain

    [[Page 68594]]

    additional residual interest in order to cover the sum of undermargined

    amounts in customers' accounts that still remain by the Residual

    Interest Deadline on ordinary trading days, and are likely to acquire

    and maintain access to additional liquidity that can be accessed

    rapidly to meet the sum of customers' gross undermargined amounts in a

    worst-case-scenario. Therefore, in order to estimate the cost of

    additional residual interest that FCMs will maintain, it is necessary

    to estimate the amount of additional residual interest that FCMs will

    need to maintain in their segregated accounts during ordinary trading

    days, the amount of additional residual interest that will be needed on

    highly volatile trading days, the ratio of ordinary to highly volatile

    trading days on an annual basis, the cost of capital for the additional

    funds that are deposited into residual interest, and the cost to

    maintain a revolving credit facility or some other source of funding

    that can be accessed quickly and that is sufficient to cover the

    projected largest undermargined amount in aggregate for customers'

    accounts.

    As discussed further below, the Commission believes that the point

    in time approach adopted in this final rule will significantly reduce

    the amount of additional residual interest that FCMs need to maintain

    in their segregated accounts on an ongoing basis in order to comply

    with Sec. 1.22(c).

    Several commenters provided estimates of the cost of the ``at all

    times'' portion of the proposal. FIA estimated that compliance with the

    ``at all times'' portion of the proposal would require FCMs or their

    customers to deposit significantly in excess of $100 billion into

    customer funds accounts beyond the sum required to meet initial margin

    requirements, and that the annual financing costs for these increased

    deposits will range from $810 million to $8.125 billion.\672\ FIA

    estimated the highest single day customer margin deficits per FCM would

    likely be between $196 million to $6.1 billion per FCM, depending on

    the size and composition of the FCM's customer accounts.\673\ Jefferies

    estimated that it would be required to increase its own residual

    interest by $15 million (non-peak) or $30 million (peak),

    respectively.\674\ Jefferies also stated that the industry would be

    required to increase its residual interest by $49 billion (non-peak) or

    $83 billion (peak) at a cost of approximately $2 billion (non-peak) or

    $5 billion (peak), respectively.\675\ ISDA estimated that the highest

    single day sum of gross customer margin deficits would likely be

    approximately $73.2 billion for all FCMs combined, with a long term

    funding impact of $335 billion.\676\

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

    \672\ FIA Comment Letter at 14, 16 (Feb. 15, 2013).

    \673\ See FIA Comment Letter at 2-3 (June 20, 2013).

    \674\ Id. at 8.

    \675\ Id.

    \676\ See ISDA Comment Letter at 4 (Feb. 15, 2013). ISDA used

    market data for FCMs (November 30, 2012) available at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

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

    While the Commission expects that the residual interest requirement

    will create additional capital costs for most FCMs, the Commission

    believes that the estimates presented by commenters include certain

    assumptions that may lead to overstated costs. First, residual interest

    that is not needed to be pledged as collateral for customers may be

    invested overnight and during the day in investments that are

    consistent with the requirements of Commission Regulation 1.25 (``Sec.

    1.25 investments'').\677\ The return on residual interest would offset

    a portion of the cost of funds. That is, the additional funds that FCMs

    place in residual interest will both incur costs and generate returns

    for the FCM. Estimates of the effective cost of the additional funds

    that must be used to increase residual interest must account for

    both.\678\ The returns on Sec. 1.25 investments have the potential to

    reduce the effective cost of funds.

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

    \677\ 17 CFR 1.25.

    \678\ For example, FIA cited a historical cost of funds of

    8.125% in January 1990. At that time, the constant maturity one

    month Treasury yield was 7.86%, see http://mortgage-x.com/general/indexes/cmt_tcm_history.asp?f=m. Thus, using the cost of funds

    proxy from the commenter, the cost of funds would be closer to

    0.365% (calculated as 8.125% - 7.86% + 0.10% (for underwriting and

    administrative overhead)).

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

    Second, both FIA and ISDA confound total residual interest with

    additional residual interest by assuming that the total amount of

    residual interest that would be required by the proposed rule is equal

    to the additional amount of additional interest that would be required

    by the rule. FCMs, in general, maintained some residual interest prior

    to this rule, and are required to do so to comply with Sec. 1.23.\679\

    Therefore, it is only the additional residual interest that is

    necessary because of rule 1.22(c) that is relevant for consideration

    here.

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

    \679\ See section II.G.10. above.

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

    Third, the Commission agrees with FIA that U.S. Treasury securities

    are an appropriate proxy for the marginal cost of capital for a low-

    risk project, such as funds to be placed in residual interest. FIA and

    Jefferies did not explain why they chose long-dated maturities on the

    yield curve for their estimates. Presumably, an FCM could borrow funds

    at a much shorter maturity than five years, for example, a month or

    less, potentially lowering borrowing costs substantially.

    The Commission notes, and discusses further below, that FCMs might

    mitigate costs by maintaining a credit facility that is sufficient to

    cover most of their additional residual interest needs on unusually

    volatile trading days, but that is not used on the majority of trading

    days. This approach would not only lower the amount of capital needed,

    but would also reduce the amount of time during which the capital is

    borrowed. As discussed further below, the Commission is not able to

    estimate accurately what fees banks would charge. However, the

    Commission has considered that FCMs would bear an ongoing cost

    associated with maintaining an open credit facility that is able to

    provide rapid access to sufficient liquidity to meet any additional

    residual interest requirements on highly volatile days.

    As noted above, several commenters requested the Commission revise

    the proposal to require that the residual interest calculation be made

    once a day, specifically by the end of the business day.\680\ These

    commenters suggested an alternative (the ``Industry Commenters'

    Alternative'') by which, at this point in time, an FCM would be

    required to maintain a residual interest in its customer funds accounts

    at least equal to its customers' aggregate margin deficits for the

    prior trade date. ISDA stated this alternative ``would rationally

    reduce'' FCMs cost of compliance \681\ and that ``[f]or an FCM with

    robust credit risk management systems, covering end-of-day customer

    deficits should not be a significant cost.'' \682\ ISDA also noted that

    at the end of the day ``typically, all customer calls have been met,

    and all customer gains have been paid out; all achieved without the FCM

    having recourse to its own funding resources.'' \683\ FIA asserted that

    it would ``achieve the Commission's regulatory goals without imposing

    the

    [[Page 68595]]

    damaging financial and operational burdens on FCMs, and the resulting

    financial burdens on customers.'' \684\

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

    \680\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment

    Letter at 23-25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5

    (Jan. 25, 2013); Paul/Weiss Comment Letter at 4-5 (Feb. 15, 2013);

    RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).

    \681\ ISDA Comment Letter at 6 (Feb. 15, 2013).

    \682\ ISDA Comment Letter at 2 (May 8, 2013).

    \683\ Id. ISDA further observed that many FCM customers use

    custodians across the world, and ``many customers cannot assure

    payment of their morning FCM call before the end of the New York

    day,'' and therefore recommended that Commission study the

    feasibility of reducing the time in which customers have to meet

    margin calls, if that is ``imperative.'' Id. at 3. This will be

    addressed in the Report.

    \684\ FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA

    Comment Letter at 4 (May 8, 2013).

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

    ISDA and FIA evaluated the costs associated with requiring FCMs to

    perform the residual interest calculation once each day at the close of

    business on the first business day following the trade date.\685\ ISDA

    estimated that ``removing the predictive element of FCM funding

    requirements'' of the ``at all times'' method in favor of the Industry

    Commenters' Alternative would permit markets to ``reap the efficiencies

    of end-of-day accounting,'' \686\ thereby reducing the overall cost of

    compliance with the regulation. ISDA estimated that for exchange-traded

    futures, the costs associated with the alternative would be the cost of

    covering the outstanding margin deficits of between 2% and 5% of an

    FCM's futures customers, and thus that approach would impose only

    ``incremental funding requirements'' on FCMs.\687\ ISDA estimated that

    the costs of the alternative would be even smaller for cleared swaps,

    due to the ``more professional'' nature of the market.\688\ FIA

    acknowledged that if FCMs were given until the end of the following

    business day to ensure that the requisite amount of residual interest

    was maintained, that approach would eliminate approximately 90-95% of

    the anticipated additional residual interest that larger FCMs would

    need to maintain in order to meet an at all times requirement.\689\ FIA

    estimated the financing costs to FCMs of complying with the Industry

    Commenters' Alternative, and concluded that the costs associated with

    an at all times residual interest requirement would be approximately

    ten times the costs associated with the Industry Commenters'

    Alternative.\690\ Finally, the FIA concluded that the Industry

    Commenters' Alternative would not ``impos[e] damaging financial and

    operational burdens on FCMs . . . and the resulting financial burdens

    on customers'' that would result from the at all times approach.\691\

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

    \685\ ISDA Comment Letter at 1-2 (May 8, 2013); FIA Comment

    Letter at 8-10 (June 20, 2013).

    \686\ ISDA Comment Letter at 3 (May 8, 2013).

    \687\ Id. at 3-4.

    \688\ Id. at 4.

    \689\ See FIA Comment Letter at 3 (June 20, 2013).

    \690\ See FIA Comment Letter at 8-10 (June 20, 2013). While the

    rates used by FIA in this exercise may be conservative, and the

    Commission does not adopt these precise estimates, the exercise is

    nevertheless illustrative and useful for the purpose of comparing

    the costs of the at all times approach and the Industry Commenters'

    Alternative.

    \691\ Id. at 9.

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

    However, the point in time approach adopted in final rule Sec.

    1.22(c) gives FCMs until the time of settlement with the DCO (typically

    the beginning of the following business day for end of day margin calls

    from the DCO), and also provides an extended phase-in period, during

    which FCMs have until 6:00 p.m. Eastern Time on the date of such

    settlement. After the phase-in period, and absent further Commission

    action following the Report, the final rule does not provide FCMs until

    the end of the following business day to ensure that the requisite

    amount of residual interest is held, as would be the case in the

    Industry Commenters' Alternative. Therefore, the Commission expects

    that the point in time approach adopted by the Commission will reap

    much, but not all, of the cost reduction discussed by the industry

    commenters.\692\

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

    \692\ FIA estimated that the Industry Commenters' Alternative

    would reduce the amount of additional residual interest that is

    necessary by 90-95% when compared to the at all times approach. See

    id. at 3 (June 20, 2013). See also ISDA Comment Letter at 1-2 (May

    8, 2013).

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

    During the phase-in period, FCMs would be subject to Industry

    Commenters' Alternative (and, thus, all of those cost savings would be

    realized).

    The following analysis assumes that the Commission does not take

    further action to modify the Residual Interest Deadline after

    considering the results of the Report. It refers to estimates of

    ongoing costs and benefits that only would be incurred and realized

    after the end of the phase-in period.

    The Commission expects that the post-phase-in form of Sec.

    1.22(c)--with a point in time requirement corresponding to the time of

    settlement--will achieve some, but not all of the cost reductions

    associated with Industry Commenters' Alternative. Moreover, during the

    phase-in period, the Commission anticipates that customers and FCMs

    will improve their abilities to submit and receive margin payments

    prior to the FCM's settlement with the DCO, and the Commission will be

    examining this issue further in the Report. In light of these factors,

    the Commission believes it is reasonable to suppose that the settlement

    time approach will significantly reduce--perhaps by 25% to 50%--the

    amount of additional residual interest that is needed on highly

    volatile trading days, and by a greater amount on ordinary trading

    days.

    In order to reasonably estimate the potential range of the amount

    of additional capital that is necessary on highly volatile trading

    days, the Commission uses ISDA's formulation for the aggregate gross

    deficit across all customers. ISDA estimated that on high volatility

    days, the aggregate amount of all customers' gross margin deficits for

    all FCMs would be equal to 60% of initial margin required by all

    customers' positions. This estimate is based on an assumption that all

    of an FCM's customers will be holding positions in the same commodity

    (or that all commodities in which customers hold positions will move in

    unison) and that either shorts or longs will predominate.\693\ This

    approach is conservative because it does not take into account

    diversification effects. For example, while some customers may hold

    positions in energy products, which may be volatile on a particular

    day, others may predominately hold positions in interest rates, which

    may not be volatile on the same day. Moreover, because of the point in

    time approach adopted by the Commission, FCMs will have time to react

    to such changes.

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

    \693\ See ISDA Comment Letter at 4-5 (Feb. 15, 2013).

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

    The Commission's cost estimates for the amount of additional

    residual interest that will be required reflect an effort to make a

    reasonable assumption regarding the potential range of additional

    residual interest that could be necessary on a volatile trading day.

    The amount of additional residual interest that could reasonably be

    expected to be necessary on an ordinary trading day would be much lower

    because the aggregate of all customers' gross undermargined amounts

    would be significantly lower on such days. However, commenters only

    estimated the aggregate of customers' gross undermargined amounts on

    highly volatile days. They did not estimate or provide data regarding

    the aggregate of customers' gross undermargined amounts on ordinary

    trading days. In the absence of either data or estimates from

    commenters regarding undermargined amounts in customers' accounts on

    ordinary trading days, the Commission is not able to quantify the

    amount of additional residual interest needed by FCMs in ordinary

    trading conditions, but believes that it is significantly less than

    what is estimated above for volatile trading days.

    Commenters did not identify what level of volatility they had in

    view when offering estimates for additional residual interest that

    would be necessary for a ``volatile'' trading day. For example,

    commenters may have had in mind days that were volatile relative to

    market conditions over the last year or two, or that are volatile

    relative to the range of all possible outcomes. Context suggests

    [[Page 68596]]

    the latter assumption, since commenters asserted elsewhere that FCMs

    would have to anticipate market movements in order to maintain

    sufficient residual interest at all times to cover the sum of

    customers' undermargined amounts during a highly volatile trading

    day.\694\ Given this, the Commission notes that highly volatile days

    are only a small fraction of all total trading days, and therefore, the

    costs associated with additional residual interest required on such

    highly volatile days would only accrue on a correspondingly small

    fraction of the total trading days in a given year.

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

    \694\ See, e.g., LCH.Clearnet Comment Letter at 4-5 (Jan. 25,

    2013) (noting that ``regardless of the amount of capital an FCM

    dedicated to continuous compliance, FCMs would still be at risk of a

    violation''). See also CMC Comment Letter at 2 (Feb. 15, 2013); CME

    Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4, 13, 15

    (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); NPPC

    Comment Letter at 2 (Feb. 15, 2013); TD Ameritrade Comment Letter at

    4-5 (Feb. 15, 2013).

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

    FCMs would, however, bear an ongoing cost associated with

    maintaining an open credit facility or some other source of funds that

    is able to provide rapid access to sufficient liquidity to meet any

    additional residual interest requirements when highly volatile days do

    occur. The Commission does not have adequate data to estimate the cost

    of this credit facility. Since it is not feasible to estimate the costs

    to FCMs to cover the need for additional residual interest between the

    times of the daily settlement and the end-of-day by obtaining intraday

    lines of credit from lenders, the Commission has taken a conservative

    approach, and has assumed, for the sake of quantification, that firms

    will raise capital sufficient to meet their residual interest needs on

    highly volatile trading days, and will keep that amount of capital on

    all days, holding it either in residual interest or in liquid assets

    that are available to be deposited into segregation.

    The Commission is aware that the top-10 largest FCMs (ranked by

    total amount of customer funds in section 4d(a)(2) segregated accounts

    and 30.7 accounts as of November 30, 2012) are contained in bank

    holding companies.\695\ Most of these bank holding companies have

    short-term credit ratings of Moody's P-1, Standard & Poor's A-1, and

    Fitch F1, while a few have holding companies with P-2, A-2, and F2

    ratings. The FCM subsidiary usually derives its credit standing from

    the bank holding company, with the rating of the FCM subsidiary being

    often the same or sometimes one credit grade lower than the holding

    company. To estimate the interest rate that a bank holding company

    would charge its FCM subsidiary for funding additional residual

    interest, the Commission is using as a proxy for the costs of these

    funds the historical average of 30-day AA-financial commercial paper

    (consonant with the short-term credit ratings of the bank holding

    companies) minus the yield on the 4-week constant maturity U.S.

    Treasury bill (to account for the return that FCMs will earn on

    investments permitted under Regulation 1.25) and is adding 0.10% for

    underwriting and administrative overhead costs to issue commercial

    paper.\696\ This results in an average cost of funds of 0.35% for the

    top-10 largest FCMs from July 2001 to July 2013. For the remaining

    FCMs, the Commission is using as a proxy for the costs of funds the

    difference between the prime rate and the yield on the 4-week constant

    maturity U.S. Treasury bill. This results in an average cost of funds

    of 3.25% from July 2001 to July 2013.\697\ The Commission is using

    historical FCM data from November 30, 2012, even though there is more

    recent data available, to be consistent with the data ISDA used in the

    analysis in its comment letter.\698\ As of November 30, 2012, there was

    approximately $147.1 billion in customer funds in section 4d(a)(2)

    segregated accounts (excluding excess amounts contributed by

    FCMs).\699\ The top-10 FCMs held approximately $111.7 billion in

    section 4d(a)(2) segregated accounts,\700\ and the remaining FCMs held

    approximately $35.4 billion in section 4d(a)(2) segregated

    accounts.\701\

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

    \695\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

    \696\ The Commission computes the average yields from July 2001

    to July 2013. The constant maturity 4-week Treasury yield time

    series with month observations begins in July of 2001. See http://www.federalreserve.gov/releases/H15/data.htm.

    \697\ The Commission recognizes that there may be some FCMs with

    weak credit ratings that would have to pay even more than the prime

    interest rate to secure additional residual interest. See id.

    \698\ The Commission believes that the November 30, 2012 FCM

    data is typical. Moreover, this permits comparison with other

    estimates in the comment letter.

    \699\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

    \700\ See id.

    \701\ Id.

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

    ISDA estimated the potential future FCM funding requirement for

    futures arising from the residual interest proposal by subtracting the

    existing customer excess. ISDA estimated the futures excess to be

    between $40-$70 billion and employed the midpoint of this range, $55

    billion in its calculations. Using ISDA's point estimate for existing

    customer excess of $55 billion, the Commission estimates there was, at

    the top-10 FCMs, (55/177.1) (i.e., 31%) times $111.7 billion or

    approximately $34.7 billion in existing customer excess in section

    4d(a)(2) segregated accounts. Similarly, for the remaining FCMs, the

    Commission estimates that there was approximately $11 billion in

    customer excess in section 4d(a)(2) segregated accounts.\702\

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

    \702\ That is, 31% of $35.4 billion and $2.3 billion,

    respectively.

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

    First, the Commission performs its calculations for the residual

    interest projected in the section 4d(a)(2) segregated accounts based on

    ISDA's assumption that residual interest were required ``at all

    times.'' For the top-10 FCMs, the Commission subtracts $34.7 billion

    from $111.7 billion giving approximately $77 billion in required

    margin. The Commission uses ISDA's suggestion for additional residual

    interest needed by FCMs and takes 60% of this figure, approximately

    $46.2 billion, as the estimate for total residual interest needed. As

    of November 30, 2012, the top-10 FCMs held approximately $6.5 billion

    in residual interest.\703\ Using these figures, the top-10 FCMs would

    need to fund approximately $39.7 billion in additional residual

    interest. At a cost of funds of 0.35%, this would result in an annual

    cost of $139 million for the top-10 FCMs based on the historical costs

    of funds.

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

    \703\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

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

    For the remaining FCMs, the Commission subtracts $11 billion

    (excess margin) from $35.4 billion (balance in 4d(a)(2) accounts)

    leaving approximately $24.4 billion (required margin in 4d(a)(2)

    accounts). Again, using ISDA's 60% formulation gives $14.6 billion in

    total residual interest needed under an at all times approach. The

    remaining FCMs are holding approximately $3.9 billion in residual

    interest.\704\ Consequently, the remaining FCMs would need to fund

    approximately $10.7 billion ($14.6 billion-$3.9 billion) in additional

    residual interest. At a cost of funds of 3.25%, this gives the

    historical annual cost of approximately $348 million.

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

    \704\ See id.

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

    For all FCMs, the aggregate annual cost is approximately $487

    million (that is, $139 million plus $348 million) to fund the

    additional residual interest needed by FCMs due to Sec. 1.22 if

    residual interest were required at all times.

    However, these figures change significantly if residual interest is

    not required until the daily settlement. As

    [[Page 68597]]

    noted above, both FIA and ISDA estimate that the residual interest

    requirement would be reduced by 90% or more if it were required to be

    present at the end-of-day on the following business day. As discussed

    above, the Commission estimates that using the point in time approach

    with morning settlement (rather than end-of-day) will reduce the need

    for additional residual interest by 25-50%. The midpoint of this range

    is 37.5%. A reduction of 37.5% (as a consequence of moving to the point

    in time approach) leaves a multiplier of 62.5%. Multiplying 62.5% by

    ISDA's estimate (for the at all times approach) of 60% of required

    margin results in a product of 37.5%.\705\ For the top-10 FCMs, the

    Commission multiplies the $77 billion in required margin by 37.5%

    giving approximately $28.9 billion in residual interest needed. The

    top-10 FCMs are currently holding approximately $6.5 billion in

    residual interest. The top-10 FCMs would be required to fund

    approximately $22.4 billion ($28.9 billion-$6.5 billion) in additional

    residual interest. At a cost of funds of 0.35%, this would result in an

    annual cost of approximately $78 million for the top-10 FCMs.

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

    \705\ The fact that the reduction of 37.5% (the midpoint of 25%

    and 50%) multiplied by ISDA's estimate of 60% results in a product

    that is also 37.5% is coincidental.

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

    For the remaining FCMs, the Commission multiplies $24.4 billion

    (required margin in 4d(a)(2) accounts) by 37.5% giving approximately

    $9.2 billion. The remaining FCMs are holding $3.9 billion in residual

    interest.\706\ Consequently, the remaining FCMs would be required to

    fund approximately $5.3 billion ($9.2 billion-$3.9 billion) in

    additional residual interest. At a cost of funds of 3.25%, this would

    result in an annual cost of approximately $171 million with current

    economic conditions. This result in a total annual cost of

    approximately $249 million to fund the additional residual interest

    needed by FCMs due to Sec. 1.22 using the Commission's assumption of

    37.5% of initial margin needed for residual interest.

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

    \706\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

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

    As explained above, the final rule does not require FCMs to take

    this approach. Instead, the Commission believes that firms are likely

    to manage margin calls to reduce the sum of customers' gross

    undermargined amounts prior to the time of settlement. They may also

    mitigate costs by using revolving credit facilities or other temporary

    sources of liquidity to meet, in part, the need for additional residual

    interest on volatile trading days. The Commission received comments on

    the proposed costs and benefits of Sec. 1.22. Several commenters

    supported the proposal, noting that it would prevent customer funds

    from being used to subsidize an FCM's obligations, reduce systemic

    risk, and enhance customer protection, especially in the event of an

    FCM bankruptcy.\707\ In particular, SIFMA stated that the proposal,

    ``in effect, shifts the costs and burdens of a margin shortfall from

    customers with excess margin to customers with deficits, where it

    properly belongs.'' \708\ In addition, Vanguard argued that the

    ``proposed changes correctly shift the risk to customers in deficit and

    away from any excess margin transferred by other customers.'' \709\

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

    \707\ See, e.g., CFA Comment Letter at 5-6 (Feb. 13, 2013);

    CIEBA Comment Letter at 2-3 (Feb. 20, 2013); ICI Comment Letter at 3

    (Jan. 14, 2013); Franklin Comment Letter at 2 (Feb. 15, 2013); Paul/

    Weiss Comment Letter at 3 (Feb. 15, 2013); SIFMA Comment Letter at 2

    (Feb. 21, 2013); Vanguard Comment Letter at 7-8 (Feb. 22, 2013).

    \708\ SIFMA Comment Letter at 2 (Feb. 21, 2013).

    \709\ Vanguard Comment Letter at 7 (Feb. 22, 2013).

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

    On the other hand, a number of commenters interpreted the ``at all

    times'' language to require FCMs to continuously calculate their

    customers' aggregate margin deficits and stated that they believe such

    a requirement is infeasible.\710\ As a result of this interpretation of

    the proposal, these commenters argued that the proposal would

    dramatically increase costs and create liquidity issues for FCMs and

    their customers.\711\ Many commenters asserted that the proposal would

    therefore result in FCMs requiring customers to pre-fund their

    positions.\712\ FHLB cautioned that ``[w]hile it cannot be disputed

    that a residual interest buffer should lower the risk that an FCM will

    fall out of compliance with its segregation requirements, there will

    likely be a real economic cost associated with maintaining whatever

    residual interest buffers is established by an FCM.'' \713\ FHLB

    further noted that the ``funds maintained by an FCM as residual

    interest can reasonably be expected to earn less than the FCM's

    unrestricted funds,'' thus, the proposal ``represents a real cost to

    FCMs'' that will be passed on to customers.\714\ ISDA stated that the

    proposal will make customers ``self-guaranteeing'' and diminish

    reliance on the FCM, and that, while this would diminish overall risk

    of FCM default, it comes at a very significant cost to market

    participants, market volumes, and liquidity.\715\ CHS Hedging observed

    that ``pre-funding accounts concentrates additional funds at FCMs,

    which seems to contradict the spirit of the'' customer protection

    rules.\716\

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

    \710\ See, e.g. Advantage Comment Letter at 6-8 (Feb. 15, 2013);

    CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5

    (Feb. 15, 2013); FIA Comment Letter at 4, 7-8, 13 (Feb. 15, 2013);

    LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MFA Comment

    Letter at 8 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb. 18,

    2013); Newedge Comment Letter at 2 (Feb. 15, 2013); NPPC Comment

    Letter at 2 (Feb. 15, 2013; RCG Comment Letter at 3 (Feb. 12, 2013);

    TD Ameritrade Comment Letter at 4-5 (Feb. 15, 2013).

    \711\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013)

    (``The avalanche of buying or selling that this rule will induce

    contradicts decades of effort by the industry to thwart market

    panics and provide markets with liquidity and stability.''); CMC

    Comment Letter at 2 (Feb. 15, 2013) (stating that the proposal

    ``could create liquidity issues and increase costs for FCMs and end

    users. Such a decrease in liquidity could be substantial, and limit

    the number and type of transactions FCMs clear, the number of

    customers they service and the amount of financing they provide.'');

    CME Comment Letter at 5-6 (Feb. 15, 2013) (``We believe that this

    will be a significant and unnecessary drain on liquidity that will

    make trading significantly more expensive for customers to hedge

    financial or commercial risks. The liquidity drain will be

    exacerbated to the extent that the demand for excess margin will

    increase the costs and limit the activities of market makers.'').

    \712\ See, e.g., FIA Comment Letter at 17 (Feb. 15, 2013); MFA

    Comment Letter at 8 (Feb. 15, 2013); Newedge Comment Letter at 2

    (Feb. 15, 2013).

    \713\ FHLB Comment Letter at 3-4 (Feb. 15, 2013).

    \714\ Id. at 4 n.5.

    \715\ ISDA Comment Letter at 3 (Feb. 15, 2013) (noting that

    ``[e]ffectively doubling margins will damage futures and swaps

    markets by destroying the value proposition for many liquidity

    providers essential to the market's efficiency.''). See also ISDA

    Comment Letter at 2-3 (May 8, 2013) (stating that the proposal would

    cause customers to pre-fund margin, which ``would remake the cleared

    swaps and futures markets into one exclusively for `self-

    guaranteeing' customers,'' which ``would be damaging to markets by

    destroying the incentives for continued participation by liquidity

    providers essential to the markets' efficiency.'').

    \716\ Id.

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

    As noted above, the Commission recognizes that some FCMs may

    require their customers, or some subset of their customers, to increase

    the margin they maintain in their accounts in order to cover possible

    deficits that could materialize during the period of time it would

    typically take that customer to respond to a margin call. This is

    particularly the case if and when the Residual Interest Deadline moves

    to the time of the daily settlement. However, the Commission expects

    that the number of customers and the amount of additional margin

    required from those customers would be significantly less than was

    asserted by some of the commenters because of modifications made to the

    final rule. As noted above, the final version of the rule allows FCMs

    to meet the gross sum of the undermargined amounts several hours after

    (and, during the phase-in period, at the end of the next business day

    after)

    [[Page 68598]]

    the undermargined amount is calculated, which is expected to

    significantly mitigate the need for FCMs to maintain a ``preventative

    buffer'' of residual interest or additional customer margin that is

    sufficient to cover customers' potential undermargined amounts in a

    worst case scenario. Moreover, in cases where customers develop the

    ability to submit margin payments prior to the Residual Interest

    Deadline, there will not be any need for additional customer margin on

    an ongoing basis. It is therefore likely that FCMs will require

    additional customer margin on an ongoing basis in situations only where

    (1) a particular customer is not be able to routinely make margin

    payments prior to the Residual Interest Deadline, and (2) the sum of

    the undermargined amounts in customers' accounts that cannot be

    collected before the Residual Interest Deadline is a relatively large

    compared to the amount of residual interest that the FCM otherwise

    chooses to maintain.\717\

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

    \717\ The Commission expects that this would happen on normal

    trading days. On highly volatile trading days, the Commission

    expects that customers' gross undermargined amounts would likely be

    covered by residual interest acquired through a line of credit or

    credit facility, as discussed above, rather than through customer

    pre-funding since the costs of the former are likely to be

    considerably less than the costs of the latter.

    However, the Commission does not, at this time, have data

    regarding individual customers' historical gross undermargined

    amounts and therefore does not have adequate information to estimate

    the number of FCM and customer combinations where additional

    customer margin would be required on an ongoing basis.

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

    The Commission does not agree that increased residual interest

    requirements are contrary to the spirit of the customer protection

    rules. The rules are intended to provide additional protections to

    funds held at FCMs, not to reduce the amount of funds held at FCMs. The

    likelihood of customer defaults leading to an FCM default is reduced.

    So, additional customer funds at FCMs are better protected with the

    increased residual interest requirements in place.

    Several commenters argued that the costs associated with the

    proposal would decrease competition between FCMs.\718\ In particular,

    FIA stated that the proposal may force a number of small to mid-sized

    FCMs out of the market, which will decrease access to the futures

    markets and increase costs for IBs, hedgers and small traders.\719\ In

    addition, FIA argued that the proposal would significantly impair the

    price discovery and risk management functions served by the

    market.\720\ JSA argued that the proposal would be ``punitive in a

    highly competitive environment that already places the midsize operator

    at a disadvantage to his better capitalized multinational

    competitors.'' \721\ Moreover, JSA stated that the cost of the proposal

    would result in a higher cost of hedging, which would be prohibitive

    and prompt agricultural users to walk away from the futures

    market.\722\ The Congressional Committees requested that the Commission

    consider these effects in drafting the final rule.\723\

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

    \718\ See, e.g., CHS Hedging Comment Letter at 2 (Feb. 15,

    2013); CME Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter

    at 17 (Feb. 15, 2013); Frontier Futures Comment Letter at 3 (Feb.

    15, 2013); Jefferies Comment Letter at 7 (Feb. 15, 2013); JSA

    Comment Letter at 1-2 (Feb. 15, 2013); NCFC Comment Letter at 2

    (Feb. 15, 2013); NIBA Comment Letter at 1 (Feb. 15, 2013).

    \719\ See FIA Comment Letter at 17 (Feb. 15, 2013).

    \720\ See id. at 4, 17.

    \721\ JSA Comment Letter at 1 (Feb. 15, 2013).

    \722\ Id. at 2.

    \723\ See Congressional Committees Letter at 1 (Sept. 25, 2013).

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

    Other commenters argued that the proposal would disproportionately

    burden smaller FCMs and the customers of smaller FCMs.\724\ CME

    asserted that, given this increase in cost, some customers may transfer

    their accounts to the larger, better-capitalized FCMs to reduce the

    cost of trading,\725\ but that agricultural customers ``likely will not

    be able to transfer to the larger FCMs because they do not fit their

    customer profile,'' thereby making these customers bear more of the

    cost burden.\726\ Frontier Futures asserted that many small customers,

    including most farmers, do not watch markets constantly. Therefore, it

    would be difficult for them to meet margin calls on a moment's notice,

    thereby causing FCMs to require significantly higher margins or to

    liquidate customer positions where margin calls cannot be immediately

    met.\727\ Frontier Futures also asserted that the proposal ``may force

    a number of small to mid-sized FCMs out of the market,'' making it more

    expensive, if not impossible, for IBs and small members to clear their

    business, removing ``significant capital from the futures industry,''

    and ``reducing stability to the markets as a whole.''\728\ RJ O'Brien

    stated that the proposed residual interest requirement is impractical

    because many farmers and agricultural clients still use checks and ACH

    to meet margin calls.\729\ RJ O'Brien also stated that if the proposal

    is adopted, FCMs that service non-institutional clients will struggle

    to remain competitive and the proposal may result in fewer clearing

    FCMs and greater systemic risk to the marketplace.\730\ Similarly, CME

    stated that the proposed residual interest requirement would lead to

    consolidation among FCMs, which will ``actually increase[ ] systemic

    risk by concentrating risk among fewer market participants.'' \731\

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

    \724\ See, e.g., CME Comment Letter at 5-6 (Feb. 15, 2013);

    FCStone Comment Letter at 3 (Feb. 15, 2013); Global Commodity

    Comment Letter at 1 (Feb. 13, 2013); Randy Fritsche Comment Letter

    at 1 (Feb. 15, 2013); JSA Comment Letter at 1 (Feb. 15, 2013); NCBA

    Comment Letter at 2 (Feb. 15, 2013); NCFC Comment Letter at 2 (Feb.

    15, 2013); RJ O'Brien Comment Letter at 3 (Feb. 15, 2013); ICA

    Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment Letter at 2

    (Feb. 15, 2013).

    \725\ CME Comment Letter at 6 (Feb. 15, 2013).

    \726\ Id.

    \727\ See Frontier Futures Comment Letter at 2-3 (Feb. 14,

    2013).

    \728\ Id.

    \729\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013). See also

    ICA Comment Letter at 1-2 (Feb. 15, 2013).

    \730\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013).

    \731\ CME Comment Letter at 6 (Feb. 15, 2013) (emphasis in

    original).

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

    The Commission recognizes that smaller FCMs may have more

    difficulty than large FCMs in absorbing the additional costs created by

    the requirements in Sec. 1.22. In general, it is likely that smaller

    FCMs have a larger percentage of customers who do not have requisite

    personnel or systems to receive margin calls and make margin payments

    in a matter of hours, thus creating a disproportionate need for pre-

    funding or additional residual interest at smaller FCMs. Smaller FCMs

    are also likely to have higher borrowing costs than larger FCMs, so the

    impact of obtaining additional capital to meet increased residual

    interest needs may be more significant for them. If increased costs

    force some smaller FCMs out of the market, it is possible, though not

    certain, that smaller customers could have difficulty finding

    alternative FCMs to service their needs. However, as noted above, the

    Commission believes that the changes made to Sec. 1.22(c), and the

    extended phase-in period, in the final rule substantially reduce the

    costs to FCMs and their customers when compared to the proposed version

    of the requirement. By reducing the costs, these changes have also

    reduced some of the associated burdens that would potentially be

    disproportionately borne by smaller FCMs. The Commission does not agree

    that a reduced number of FCMs would necessarily reduce competition in a

    way that impacts the price of services. Any increases in costs to

    customers are more likely the result of increased costs to the FCM that

    are passed on to customers, which are the costs that have been

    mitigated by changes to the final rule. Moreover, the Commission is

    cognizant of the cost of an FCM failure where customers suffer a loss

    of segregated funds, both in terms

    [[Page 68599]]

    of costs to the customers who lose such funds (or, if such funds are

    ultimately recovered, the use of such funds) as well as the industry-

    wide cost associated with a loss in confidence in the safety of

    customer funds. These costs support the importance of increasing the

    safety of the system. Moreover, the Commission will closely review

    these issues as part of considering the Report.

    The Commission disagrees with the comments that there would be a

    consolidation of FCMs that would cause the rule to have a net effect of

    increasing systemic risk. Instead, the Commission expects that the

    overall effect of the final rule will be to significantly reduce

    systemic risk. For example, as noted by CIEBA,\732\ the residual

    interest requirement will likely reduce systemic risk by enabling FCMs

    to ensure that they can meet all customer obligations at any time

    without using another customer's funds to do so. Moreover, larger,

    well-capitalized FCMs are more likely to be able to absorb losses than

    less well-capitalized FCMs. To the extent that FCMs that are affiliated

    with large financial institutions take on additional business as a

    result of a potential reduction in the number of FCMs, the increase in

    risk to these financial institutions is expected to be small relative

    to their existing risk and to not materially increase the systemic risk

    associated with these financial institutions. Finally, some of the

    costs that commenters asserted could lead to a reduction in the number

    of FCMs under the proposed rule have been mitigated by changes to the

    final rule.

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

    \732\ See CIEBA Comment Letter at 3 (Feb. 20, 2013).

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

    Several commenters also observed that the proposal would mark a

    significant departure from current market practice and could have a

    material adverse impact on the liquidity and smooth functioning of the

    futures and swaps markets.\733\ The Commission has chosen to provide an

    extended phase-in period for the requirement in Sec. 1.22(c) and

    therefore does not expect that smooth functioning of the futures and

    swap markets will be disrupted. If customers withdraw from the futures

    and swap markets as a consequence of the additional costs, liquidity

    could be negatively affected. However, the Commission believes that by

    allowing FCMs several hours (and, during the phase-in period, until the

    end of the next business day) after customer accounts become

    undermargined to ensure that the requisite amount of residual interest

    is on deposit, the costs associated with the requirement have been

    mitigated, which reduces the likelihood that customers will be prompted

    to withdraw from the markets due to related expenses.

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

    \733\ See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA

    Comment Letter at 3 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb.

    15, 2013).

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

    The Commission also considered several additional alternative

    proposals raised by the commenters.

    Newedge suggested that the Commission consider less costly

    alternatives to the proposed rule, such as allowing the FCM ``to count

    guaranty fund deposits with [DCOs] as part of their residual interest''

    or limiting the residual interest amount that an FCM must carry to only

    a limited number of its largest customers.\734\ The Commission

    believes, however, that the latter proposal is not consistent with the

    statutory requirement that ``one customer's funds may not be used to

    margin, guarantee, or pay another customer's obligations'' and

    therefore did not adopt this suggestion. Regarding the former

    alternative, guarantee funds held at the DCO are a critical part of the

    waterfall that covers losses in the event of an FCM's default. One of

    the primary purposes of the customer protection regime is to protect

    customers from the risk of losses in the event that their FCM defaults.

    Using funds that may be used to cover the FCM's proprietary losses

    (i.e., the guarantee fund) to guarantee customers' funds could expose

    customer funds to the FCM's losses in a double default scenario. The

    Commission, therefore, does not believe that this alternative is

    consistent with the goals of the customer protection regime.

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

    \734\ Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ

    O'Brien Comment Letter at 5 (Feb. 15, 2013).

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

    Frontier Futures suggested that firm firewalls be put in place

    between customer funds and an FCM's proprietary funds in the form of

    approval by an independent agency for an FCM to transfer customer

    funds.\735\ Frontier Futures also recommended that FCMs ``do their

    proprietary trading through another FCM thereby engaging the risk

    management of a third party.'' \736\ The Commission has chosen not to

    require FCMs to seek external approval before pulling excess residual

    interest out of a customer segregated account, or to conduct their

    proprietary trading through another FCM. The Commission expects that

    the requirements in Sec. 1.23 will accomplish some of the same

    benefits--ensuring that FCMs only withdraw significant portions of

    excess residual interest when they have adequate information to ensure

    that it is truly excess and that senior management is accountable for

    such decisions--with greater efficiency and less operational costs.

    Internal verification of residual interest balances and obtaining

    signatures from individuals inside the organization is likely to be

    considerably faster, and therefore more efficient and less costly.

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

    \735\ See Frontier Futures Comment Letter at 3 (Feb. 14, 2013).

    \736\ Id.

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

    Regarding the second proposal, it is not clear how the commenter

    expected the third party FCM to augment the first FCM's risk management

    or what specific type of risk would be addressed by such an

    arrangement. A third party FCM would be responsible for collecting

    margin and for making payments to the DCO for positions related to the

    first FCM's proprietary positions. But this arrangement would not help

    protect customers at the first FCM from ``fellow customer risk.''

    Finally, some commenters requested that the Commission refrain from

    adopting the proposal until it conducts further analysis with the

    industry regarding the costs and benefits of such proposal.\737\

    Further, the Congressional Committees requested that the Commission

    weigh the costs and benefits of the final rule, and in particular

    ``carefully consider the consequences of changing the manner or

    frequency in which `residual interest' . . . is calculated.'' \738\ The

    ``point in time'' approach adopted by the Commission in this final rule

    and the extended phase-in period will significantly reduce (as compared

    to the proposed rule) the amount of additional residual interest that

    FCMs need to maintain in their segregated accounts on an ongoing basis

    in order to comply with Sec. 1.22(c). As noted above, the final rule

    will mitigate some, though not all of the costs associated with pre-

    funding obligations that commenters expressed concern about, while

    simultaneously ensuring that the statutory obligations are met and that

    the corresponding protection from ``fellow customer risk'' is achieved.

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

    \737\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC

    Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at

    2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF

    Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9

    (Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA

    Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.

    15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment

    Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.

    18, 2013).

    \738\ Congressional Committees Comment Letter at 1 (Sept. 25,

    2013).

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

    In light of these concerns and in response to the commenters'

    requests, the Commission is directing staff to, within thirty months of

    the publication

    [[Page 68600]]

    of this release, solicit further public comment, hold a public

    roundtable, and conduct further analysis regarding the practicability

    of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on

    the date of settlement to the time of settlement (or to some other time

    of day). The Report should include an analysis of whether and on what

    schedule it would be feasible to move the Residual Interest Deadline,

    and the costs and benefits of such potential requirements. All of this

    will take place well before the expiration of the phase-in period. The

    Commission will consider the Report and within nine months after the

    publication of the Report may take additional action regarding the

    phase-in period by Commission order and may change the Residual

    Interest Deadline by rulemaking.

    Section 1.23 Interest of Futures Commission Merchants in Segregated

    Funds; Additions and Withdrawals

    Revised Sec. 1.23 places new restrictions regarding an FCM's

    withdrawal of residual interest funds not for the benefit of customers.

    As adopted, an FCM cannot withdraw any residual interest funds not for

    the benefit of customers unless it has prepared the daily segregation

    calculation from the previous day and has adjusted the segregation

    calculation for any activity or events that may have decreased residual

    interest since the close of business the previous day. In addition, an

    FCM is permitted to withdraw more than 25 percent of its residual

    interest for purposes other than the benefit of customers within one

    day only if it: (1) Obtains a signature from the CEO, CFO or other

    senior official as described in Sec. 1.23(c)(1) confirming approval to

    make such a withdrawal; and (2) sends written notice to the Commission

    and the firm's DSRO indicating that the requisite approvals from the

    CEO, CFO or other senior official have been obtained, providing reasons

    for the withdrawal, listing the names and amounts of funds provided to

    each recipient, and providing an affirmation from the signatory

    indicating that he or she has knowledge and reasonable belief that the

    FCM is still in compliance with segregation requirements after the

    withdrawal.

    In addition, if the FCM drops below its target threshold for

    residual interest because of a withdrawal of residual interest not for

    the benefit of customers, the next day it must either replenish

    residual interest sufficient to surpass its target, or if senior

    leadership believes that the original target is excessive, the FCM may

    revise its target in accordance with its policies and procedures

    established in Sec. 1.11. The amendments to Sec. 1.23 were also made

    for Cleared Swaps and foreign futures at Sec. 22.17, and Sec. 30.7(g)

    respectively, and the costs and benefits considerations of those

    amendments are considered to be substantively the same.

    Costs and Benefits

    Restrictions on withdrawals of residual interest provide the

    benefit of an additional layer of protection for customer funds

    contained in segregated accounts. An FCM may withdraw residual interest

    as long as it always maintains sufficient FCM funds in the account to

    cover any shortfall that exists in all of its customers' segregated

    accounts. However, as a practical matter, the segregation requirements

    fluctuate constantly with market movements, and customer surpluses or

    deficits also fluctuate depending on the speed with which customers

    meet margin calls. As a consequence, the amount of residual interest an

    FCM has in a segregated account similarly fluctuates. A sufficient

    amount of residual interest to cover deficiencies in customers'

    accounts at one point in time may appear insufficient by the next

    settlement cycle in extreme market conditions. Therefore, it is

    important for an FCM to maintain sufficient residual interest to cover

    both current deficiencies in customer accounts as well as any

    additional deficiencies that could develop over a relatively short

    period of time. Restrictions on withdrawals of residual interest help

    to ensure that the FCM maintains a stable base of residual interest and

    not withdraw it for other liquidity needs when doing so may result in

    jeopardizing customer funds in the segregated account if market

    conditions change quickly.

    Prohibiting any withdrawal of residual interest until the customer

    segregation account calculations are complete for the previous day and

    requiring the FCM take into account any subsequent developments in the

    market or the account that could impact the amount of residual interest

    before withdrawing funds protects customer funds by reducing the

    likelihood that lack of current information could cause the FCM to make

    a withdrawal from customer funds that is large enough to cause the

    account to fall below its segregated funds requirement.

    The adopted amendments require FCMs to take several steps in order

    to remove more than 25 percent of their residual interest in a single

    day. Large, single-day withdrawals of the FCM's residual interest in

    the customer segregated account could be an indication of current or

    impending capital or liquidity strains at the FCM. The additional steps

    ensure that senior management is knowledgeable of and accountable for

    such withdrawals, that no shortfall in the customer segregated accounts

    is created by the withdrawals, and that the CFTC and DSRO are both

    alerted to allow them to monitor the FCM and its segregated accounts

    closely over subsequent days and weeks. Additional monitoring will help

    to ensure that the integrity and sufficiency of the FCM's customer

    segregated accounts are protected. In addition, notifying the CFTC and

    DSRO gives both an opportunity to ask questions about the FCM's

    reasonable reliance on its estimations of the adequacy of its funds

    necessary to meet segregation requirements. Such questions may give the

    Commission and DSRO comfort that the transaction does not indicate any

    strain on the FCM's financial position, or conversely, may raise

    additional questions and alert the CFTC and DSRO to the need for

    heightened monitoring of the FCM or further investigation of its

    activities. The amendment also adds protection by ensuring that the

    Commission has records regarding the name and address of parties

    receiving funds from any withdrawal of residual interest in segregated

    funds not for the benefit of customers. Also, requiring an FCM to

    replenish its residual funds the following day any time a withdrawal

    causes it to drop below the FCM's target amount helps to ensure that

    residual interest is not used by the firm to address liquidity needs in

    other parts of the firm unless those needs are very short-term in

    nature (i.e., less than 24 hours). Finally, the amendments are

    consistent with rules imposed on all FCMs by the DSROs.

    In the NPRM, the Commission qualitatively analyzed that the

    amendments to Sec. 1.23 would create costs for FCMs and quantitatively

    estimated costs associated with obtaining management approvals for

    withdrawals exceeding 25 percent of the prior day's residual interest.

    The restrictions on withdrawals were anticipated to potentially prevent

    an FCM from withdrawing funds quickly in order to meet certain

    operational needs, or to take advantage of specific investment

    opportunities, and in general could be expected to result in an FCM

    needing to hold additional capital outside of residual interest in

    order to meet operational needs.

    The Commission did not receive comments on its quantitative

    estimates of the costs of obtaining management approvals. However, the

    Commission

    [[Page 68601]]

    did receive comments on its qualitative analysis of costs, and also

    received comments that the use of the prior day's actual residual

    interest as the amount applicable to the restriction would provide a

    disincentive to FCMs holding additional funds at DCOs as residual

    interest, which commenters posited as less beneficial to the protection

    of customers. Several commenters, including FIA and Jefferies suggested

    the Commission utilize the targeted residual amount as the threshold

    for notifications and withdrawal restrictions, in order to not

    discourage FCMs from holding additional funds as residual

    interest.\739\ FIA suggested that the qualitative analysis of the costs

    was not sufficient and that the amendments would impose a tremendous

    operational and financial burden on the industry, requiring the

    development and implementation of entirely new systems to assure

    compliance and detrimentally impacting liquidity.\740\ The Commission

    believes however, that this comment is not directed to the withdrawal

    restrictions as adopted or the necessity to replenish the targeted

    residual interest amount, but instead directed at requirements with

    respect to holding residual interest sufficient to cover customer under

    margined amounts, which is addressed separately in the cost benefit

    considerations for Sec. 1.22.

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

    \739\ See FIA Comment Letter at 29 (Feb. 15, 2013); Jefferies

    Comment Letter at 4 (Feb. 15, 2013).

    \740\ FIA Comment Letter at 13 (Feb. 15, 2013).

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

    Jefferies provided some quantitative estimates of the costs of

    holding increased residual interest, specifically positing that even a

    five percent increase in residual interest could cost Jefferies

    $500,000.\741\ FIA posited that FCMs currently may increase residual

    interest day-to-day for expected events, including during stressed

    market conditions and for the purpose of currency facilitation, and to

    impose withdrawal restrictions based on the actual, as opposed to

    targeted, excess would reduce the actual likelihood of FCMs infusing of

    additional proprietary funds in those circumstances.\742\

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

    \741\ Jefferies Comment Letter at 5 (Feb. 15, 2013).

    \742\ FIA Comment Letter at 27-29 (Feb. 15, 2013).

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

    The Commission understands that establishing a target and holding

    residual interest does have costs, but disagrees with the underlying

    assumptions of the cost estimates provided by Jefferies. The cost

    estimates provided by Jefferies imply the cost of holding additional

    residual interest is the same as the FCM's cost of capital. However,

    the cost considered for the amendments should be the difference in what

    can be earned by more conservative investments permitted for segregated

    funds versus otherwise if held by FCMs as unrestricted capital, unless

    the targeted residual amount exceeds an FCM's minimum net capital

    requirement. The costs of holding some amount of residual interest is

    an existing cost of doing business as an FCM because, practically

    speaking, there is a need to hold some amount of residual interest on a

    day to day basis to remain in segregation compliance. Significant

    minimum net capital requirements exist for FCMs, currently. Unless the

    targeted residual interest in fact exceeds a firm's minimum net capital

    requirement, the requirement to hold capital as residual interest in

    customer segregated accounts is not a separate additional capital

    requirement. Therefore, Jefferies' contention with respect to the costs

    of the withdrawal restrictions being represented by the costs of

    additional required capital for a firm is not persuasive. Such cost is

    only an incremental cost of the newly adopted requirements of

    establishing or publicizing targets or imposing withdrawal

    restrictions. Further, the withdrawal restrictions adopted require a

    one day delay, and management approval and regulatory notifications.

    These are not absolute restrictions to the withdrawal of residual

    interest funds and the costs considered and incentives or disincentives

    created should not be analyzed as if they were. Even the replenishment

    requirement adopted, with respect to withdrawals not for the benefit of

    customers resulting in residual interest dropping below the target for

    residual interest, in order to maintain the targeted residual amount,

    provides an FCM with the flexibility to reassess the target as an

    alternative. However, all these processes must be transparent to the

    Commission, including the FCM's management's accountability for such

    processes.

    The Commission is not persuaded that the reduced incentives to

    provide added funds to residual interest would be a reason to adopt an

    alternative of using the targeted residual as opposed to the actual

    prior day residual as the measurement for the 25 percent withdrawal

    restriction, which is a requirement for notice and approval, and

    therefore, not an absolute restriction. The rationales for adding funds

    specific to certain anticipated events could just as easily provide a

    clear basis for the management approval and notification process

    required for the subsequent withdrawal of funds after those

    circumstances, as opposed to making them unlikely to occur at all. The

    benefits of clear management accountability and regulatory transparency

    with respect to such practices and related operational risks (such as

    potentially more volatile cash flows through segregated accounts not

    for the benefit of customers) would still be obtained.

    Section 1.25 Investment of Customer Funds

    Regulation 1.25 sets forth the financial investments that an FCM or

    DCO may make with customer funds. Among other things, Sec. 1.25

    permits FCMs and DCOs to use customer funds to purchase securities from

    a counterparty under an agreement for the resale of the securities back

    to the counterparty. This type of transaction is referred to as a

    reverse repurchase agreement and in effect, is a collateralized loan by

    the FCM to its counterparty. Regulation 1.25(b)(3)(v) establishes a

    counterparty concentration limit, prohibiting FCMs and DCOs from using

    more than 25 percent of the total funds in the customer segregated

    account to conduct reverse repos with a single counterparty. The

    Commission's amendment expands the definition of a counterparty to

    include additional entities under common ownership or control. Thus, as

    adopted, the 25-percent counterparty concentration limit for reverse

    repurchase agreements applies not only to a single counterparty, but to

    all counterparties under common control or ownership. The additional

    adopted changes to Sec. 1.25 are conforming amendments proposed in

    order to harmonize this section with other amendments adopted in this

    release.

    Costs and Benefits

    In the NPRM, the Commission discussed how the expansion of the

    concentration limitation to counterparties under common control or

    ownership is consistent with the original intention of the

    concentration limitation, which was to mitigate the potential losses or

    disruptions due to the default of a counterparty. The Commission has

    elected to adopt the amendment as a further protection to customer

    funds, because a default by one counterparty that is under common

    control or ownership, may adversely impact all of the counterparties to

    the reverse repurchase agreement and hence adversely impact the FCM and

    the funds it holds for its customers. Because the amendment

    incorporates the Commission's interpretation of the existing rule, it

    does not alter the rule's meaning and, therefore, the amendment does

    not create any incremental costs or benefits. Likewise, the additional

    [[Page 68602]]

    changes to Sec. 1.25 are conforming amendments proposed in order to

    harmonize this section with other amendments proposed in this release,

    and, therefore, do not create any incremental costs or benefits.

    Because Sec. 1.25 sets forth the financial investments that an FCM

    or DCO may make with customer funds, several members of the public

    \743\ expressed their general opinions regarding the investment and

    handling of customer funds by FCMs and DCOs. In general, all of the

    commenters supported the position that FCMs and DCOs only be allowed to

    make safe/non-speculative investments of customer funds and not be

    allowed to add risk that customers are unaware of or do not sanction.

    In addition, some of the commenters \744\ proposed that the Commission

    amend its regulations to provide commodity customers with the ability

    to ``opt out'' of granting FCMs the ability to invest customer funds

    (including hypothecation and rehypothecation); seven \745\ of which

    further requested that the Commission mandate that an FCM cannot

    prevent a customer who so ``opts out'' from continuing to trade through

    that FCM merely because the customer elected to ``opt out.''

    Additionally, Vanguard requested that customers have immediate access

    to the reports indicating that FCMs have failed to comply with various

    mandates including compliance with Sec. 1.25 margin investment limits;

    and that customers have access on a twice monthly basis to reports on

    an FCM's actual investment of customer assets to determine whether such

    investments are concentrated in more or less liquid assets as allowed

    under Sec. 1.25.\746\ Although the Commission understands the concern

    of the public regarding the safety and investment of customer funds,

    because an ``opt out'' provision was not proposed by the Commission,

    and would in any case not be effective due to pro-rata distribution in

    an FCM bankruptcy, this alternative is not adopted in this final

    rulemaking.

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

    \743\ Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche

    Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14,

    2013), Strelitz/California Metal X Comment Letter (Jan. 15, 2013),

    Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI

    Comment Letter at 5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan.

    24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012),

    Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp.

    Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec.

    17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert

    Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment

    Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17,

    2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade

    Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec.

    17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff

    Schlink Comment Letter (Dec. 18, 2012), Sam Jelovich Comment Letter

    (Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark

    Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment

    Letter (Dec. 24, 2013), Po Huang Comment Letter (Dec. 24, 2012),

    Aarynn Krall Comment Letter (Jan. 8, 2013), Vael Asset Management

    Comment Letter (Jan. 10, 2013), Kos Capital Comment Letter (Jan. 11,

    2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns

    Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment Letter

    (Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013).

    \744\ NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal

    Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at

    5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke

    Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter

    (Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15,

    2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy

    Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec.

    17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew

    Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter

    (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012),

    Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders

    Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec.

    18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew

    Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter

    (Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2013), Po

    Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter

    (Jan. 8, 2013), Vael Asset Management Comment (Jan. 10, 2013), Kos

    Capital Comment (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13,

    2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island

    Coins Comment Letter (Jan. 14, 2013), and Clare Colreavy Comment

    Letter (Jan. 9, 2013).

    \745\ NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal

    Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at

    6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke

    Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter

    (Dec. 13, 2012); and Solomon Metals Corp. Comment Letter (Jan, 15,

    2013).

    \746\ Vanguard Comment Letter at 4-6 (Feb. 22, 2013).

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

    Section 1.26 Deposit of Instruments Purchased with Customer Funds

    Regulation 1.26 requires an FCM or DCO that invests futures

    customer funds in instruments described in Sec. 1.25 to obtain a

    written acknowledgment from any depository holding such instruments.

    The FCM or DCO must use the Template Letters in the appendices to Sec.

    1.20, in accordance with the requirements established in Sec. 1.20.

    The specifics of those requirements, as well as the costs and benefits

    of them, are detailed in the discussion of costs and benefits for Sec.

    1.20. If, however, an FCM or DCO invests funds with a money market

    mutual fund (MMMF), the FCM or DCO must use the Template Letters in the

    appendices of Sec. 1.26 rather than the acknowledgment letters in the

    appendices of Sec. 1.20.\747\ The content of the Template Letters in

    the appendices to Sec. 1.26 is identical to those in the appendices to

    Sec. 1.20 except that they include three additional provisions related

    specifically to funds held by the MMMF or its custodian. Specifically,

    the Template Letters set out the requirements established in Sec.

    1.25(c) that: (1) the value of the fund must be computed and made

    available to the FCM or DCO by 9:00 a.m. on the following business day;

    (2) the fund must be legally obligated to redeem shares and make

    payments to its customers (i.e., the FCM or DCO) by the following

    business day; and (3) the MMMF does not have any agreements in place

    that would prevent the FCM or DCO from pledging or transferring fund

    shares.

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

    \747\ Further, per Sec. 1.25(c)(3), the FCM or DCO shall obtain

    the Sec. 1.26 Template Letter from ``an entity that has substantial

    control over the [MMMF] shares purchased with customer funds and has

    the knowledge and authority to facilitate redemption and payment or

    transfer of the customer funds. Such entity may include the [MMMF]

    sponsor or depository acting as custodian for [MMMF] shares.''

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

    Benefits

    The benefits are largely the same as for the Template Letters

    required under Sec. 1.20, described above in the cost-and-benefit

    section related to Sec. 1.20. However, there are benefits to requiring

    FCMs and DCOs to obtain a different Template Letter from MMMFs with

    respect to customer funds invested in MMMFs. Specifically, MMMFs or

    their custodians (as applicable) are required to acknowledge their

    additional obligations under Sec. 1.25(c).

    Costs

    The costs are largely the same as for the Template Letters required

    under Sec. 1.20. The general concerns raised by commenters regarding

    the costs arising from the Template Letters as well as the Commission's

    responses are detailed in the discussion of costs for Sec. 1.20.

    Section 1.29 Gains and Losses Resulting From Investment of Customer

    Funds

    Regulation 1.29 provides that an FCM or DCO may keep as its own any

    interest or other gain resulting from the investment of customer funds

    in financial instruments permitted under Sec. 1.25; however, the FCM

    or DCO must manage the permitted investments consistent with the

    objectives of preserving principal and maintaining liquidity. The

    Commission's amendment also explicitly provides that although an FCM or

    DCO is not required to pass the earnings on the investment of customer

    funds back to its futures customers, the FCM or DCO is solely

    responsible for any losses that result from its investment of customer

    funds.

    [[Page 68603]]

    Costs and Benefits

    In the NPRM, the Commission discussed how the amendment clarifies

    that the allocation of losses on the investment of customer funds by an

    FCM or DCO to its customers would result in the use of customer funds

    in a manner that is not consistent with section 4d(a)(2) and Sec.

    1.20, as customer funds can only be used for the benefit of futures

    customers and limits withdrawals from futures customer accounts, other

    than for the purpose of engaging in trading, to certain commissions,

    brokerage, interest, taxes, storage or other fees or charges lawfully

    accruing in connection with futures trading. This change was supported

    by FIA, which stated its belief that the FCM's or DCO's responsibility

    for losses in Sec. 1.25 investments ``is clear and is implicit in the

    Act and the Commission's rules.'' \748\ The Commission believes that

    market participants already recognize this responsibility and

    obligation and direct the investment of customer funds accordingly.

    Therefore, the Commission does not believe that the amendment to Sec.

    1.29(b) will create any additional costs; however, the marketplace will

    benefit in that the amendment provides clarity as to the FCM's or DCO's

    sole responsibility for any losses resulting from the investment of

    customer funds in the financial instruments listed under Sec. 1.25.

    FIA filed a comment supporting the proposed amendments to Sec.

    1.29.\749\ No other comments were received. The Commission has adopted

    the amendments to Sec. 1.29 as proposed.

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

    \748\ FIA, ``Initial Recommendations for Customer Funds

    Protection'' available at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

    \749\ FIA Comment Letter at 30-31 (Feb. 15, 2013).

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

    Section 1.30 Loans by Futures Commission Merchants; Treatment of

    Proceeds

    The Commission adopted amendments to Sec. 1.30 to clarify that,

    while an FCM may provide secured loans to a customer with adequate

    collateral, it may not make loans to a customer on an unsecured basis

    or use a customer's futures or options positions as security for a loan

    from the FCM to that customer.

    Costs and Benefits

    The amendments prohibiting FCMs from providing unsecured loans to

    customers and from using a customer's positions to secure loans made to

    such customers reduce counterparty risk borne by the FCM. The former

    prohibition prevents the FCM from accumulating exposures to customers

    that have not margined their positions, while the latter prevents the

    additional exposure that otherwise would result from using the same

    collateral to secure two different risks (i.e., the risks associated

    with the open positions and the risks associated with the secured

    loan). Additionally, to the extent that the amendments would force

    certain customers to obtain loans from another lender, it diversifies

    the counterparty risk across multiple entities. The amendments also are

    comparable to rules of the CME for its member firms.

    The Commission did not quantitatively estimate the potential

    increase to customers' operational costs due to the inability of

    customers who need or desire to use borrowed funds to meet initial and

    maintenance margin requirements to obtain loans necessary to fund their

    futures or options positions from a third party lender. The Commission

    requested, but did not receive, comments regarding the prevalence of

    FCMs' extension of loans to customers and the potential costs customers

    might bear if it were necessary to obtain loans from third parties

    rather than from the FCMs with whom their segregated customer accounts

    are held. Neither were any comments received generally suggesting a

    qualitative burden in complying with the amendments.

    Section 1.32 Reporting of Segregated Account Computation and Details

    Regarding the Holding of Customer Funds

    The adopted amendments to Sec. 1.32 allow an FCM that is not a

    dual registrant to follow the same procedures as dual registrants (FCM/

    BDs) when assessing a haircut to securities purchased with customer

    funds if the FCM determines that those securities have minimal credit

    risk. This is the same change as adopted in Sec. 1.17, except that in

    Sec. 1.17 the amendment is with respect to the haircut for securities

    purchased by an FCM with its own capital, whereas this amendment

    applies to the haircut ascribed to the collateral value of securities

    deposited by customers for the purpose of securing customer net debits.

    The cost benefit considerations are the same as those analyzed with the

    corresponding amendment to Sec. 1.17.

    In addition, the adopted amendments (1) require FCMs to submit

    their daily Segregation Schedules, Secured Amount Schedules, and

    Cleared Swaps Segregation Schedules to the Commission and their DSROs

    electronically by noon the following business day; (2) require that

    twice per month, each FCM submits a detailed list of all the

    depositories and custodians where customers' segregated funds are held,

    including the amount of customer funds held by each entity and a break-

    down of the different categories of Sec. 1.25 investments held by each

    entity, further identifying if any of the depositories are affiliated

    with the FCM; and (3) require that the detailed list of depositories be

    submitted to the Commission electronically by 11:59 p.m. the following

    business day and that both segregation and secured amount statements

    and the detailed listing of depositories be retained by the FCM in

    accordance with Sec. 1.31.

    Costs and Benefits

    Requiring FCMs to submit their daily segregation and secured amount

    calculations to the Commission and DSROs will enable the Commission and

    DSROs to better protect customer funds by more closely monitoring for

    any discrepancies between the assets in segregated accounts reported by

    the FCM and their depositories as reported to the DSRO and available to

    the Commission through an aggregator of depository balances. The

    ability of the Commission and DSRO to check for discrepancies more

    regularly, without notice, is likely to provide an additional deterrent

    to fraud. Moreover, it will enable both the Commission and DSROs to

    monitor for any trends that would indicate that operational or

    financial problems are developing at the FCM, which would give the

    Commission an opportunity to enhance its supervision and to intervene,

    if necessary, to protect customer segregated funds. In addition, the

    amendments are consistent with the rules of SROs that currently require

    each FCM to submit daily segregation and secured amount calculations to

    the SROs.

    The detailed list of depositories will provide additional

    information to the Commission and DSROs beyond what is required under

    Sec. Sec. 1.20, 1.26, and 30.7. First, the detailed list of

    depositories will provide additional account detail including the types

    of securities and investments that constitute each account's assets,

    rather than just the total value. Second, the reports will account for

    any pending transactions that would not necessarily be apparent from

    the daily balances submitted to an aggregator by the depositories.

    Third, FCMs will, in these reports, provide to the Commission and DSROs

    a reconciled balance, which will not be included with balances provided

    to the aggregator by depositories. Last, the FCM will be required to

    specifically

    [[Page 68604]]

    identify any depositories that are affiliated with the FCM. Each of

    these additional forms of information would enable the Commission and

    DSROs to provide better oversight and create additional accountability

    for the FCM, enhancing the protection of market participants.

    FCMs are already calculating segregated funds information daily and

    reporting the results to NFA via WinJammer by noon the following day.

    Similarly, the detailed list of depositories that would be required to

    be submitted twice per month is already required by NFA to be produced

    and submitted to NFA via WinJammer.\750\ Requiring FCMs to submit these

    reports to the Commission via the same platform is not expected to

    create any additional costs.

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

    \750\ See Segregated Investment Detail Report at http://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/fcm-reporting.pdf.

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

    FIA commented in support of the amendments to Sec. 1.32 and asked

    for clarification that on a daily basis, a single U.S. dollar

    equivalent, as opposed to multiple currency by currency schedules, is

    what is required to be filed.\751\ Jefferies commented that the

    amendments to Sec. 1.32 will not achieve the benefit of transparency

    to customers because of the way cash and investments are presented

    separately from balances at other FCMs and DCOs.\752\ However, this

    comment appears related to the requirements of disclosure to customers

    of NFA's publicly available information, not the requirements of Sec.

    1.32, which require similar information to be reported to the

    Commission and DSROs. The Commission believes the detailed information

    required, along with all the additional disclosures being provided to

    customers in the amendments to all rules contained herein, do provide

    sufficient transparency for customers to be able to assess the risks of

    depositing funds with FCMs. The specific detailed amounts of cash and

    securities held in segregation must be provided, by individual

    depository, including DCOs, under the amendment to Sec. 1.32. The

    Commission does not believe that customers will misinterpret the

    liquidity of cash held at DCOs as opposed to other types of

    depositories, and that therefore the requirements do not provide the

    transparency intended, although the Commission understands that

    Jefferies is concerned with the appearance of percentage calculations

    that are provided publicly on NFA's portal. The Commission notes,

    however, that the amendments to Sec. 1.32 do not require reporting of

    any percentage calculations. There were no comments received regarding

    the Commission's analysis that, due to the existing NFA requirements,

    the Commission's amendments to Sec. 1.32 were not expected to result

    in incremental costs for FCMs.

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

    \751\ FIA Comment Letter at 30-31 (Feb. 15, 2013).

    \752\ See Jefferies Comment Letter at 3 (Feb. 15, 2013).

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

    With respect to the adopted changes to allow FCMs to utilize lower

    haircuts applicable to the market value of customer securities, if such

    securities are determined to have minimal credit risk, in determining

    the allowance provided for securing net deficits of customers, the CFA

    specifically objected to the ability of FCMs to obtain the benefit of

    lower haircuts by utilizing the process of establishing credit risk

    proposed in the amendment to the SEC's rule 15c3-1.\753\ However, the

    Commission has determined that the ability of FCMs to utilize haircuts

    lower than the standard deduction of 15% otherwise applicable under SEC

    rule 15c3-1 should be equally available to FCMs along with jointly

    registered BD/FCMs under the Commission's adopted amendment to the net

    capital rule at Sec. 1.17, to promote equity and fairness of

    competition between FCMs and joint BD/FCMs and to maintain uniformity

    with the capital rule of the SEC for the treatment of securities as

    much as practicable. The Commission believes, despite the CFA's

    comments indicating the haircut could be manipulated, that the

    collateral value haircut for the same security for the purpose of

    securing net deficits should also be determined by reference to the net

    capital haircut for the same security, and notes both have always been

    determined by the SEC's net capital haircuts for securities. The

    Commission believes the benefits of continuing to have such uniformity

    are substantial. The alternative, which necessarily would be applying a

    very substantial standard haircut to a debt security with minimal

    credit risk collateralizing a short term obligation, would be overly

    harsh and not accurately reflect the market risk to such collateral for

    the stated purpose of valuing the extent to which the customer debit is

    adequately secured. The Commission further notes that the SEC's rule,

    which is the basis for these amendments at Sec. Sec. 1.17, 1.32 and

    30.7, and the formulation adopted in these amendments, still provides a

    standard, although lesser percentage, haircut, not a model-based

    haircut, and also provides for an audit trail of the BD/FCM's

    determinations supporting the determination of minimal credit risk,

    which should prevent the ability of FCMs to manipulate the haircut, as

    suggested by CFA.

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

    \753\ See CFA Comment Letter at 7 (Feb. 13, 2013).

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

    Section 1.52 Self-regulatory Organization Adoption and Surveillance of

    Minimum Financial Requirements

    The amendments to 1.52 revise the supervisory program that SROs are

    required to create and adopt. In addition, for SROs that choose to

    delegate the function to examine FCMs that are members of two or more

    SROs to a DSRO, the amended rules require a plan that establishes a

    Joint Audit Committee which, in turn, must propose, approve, and

    oversee the implementation of a Joint Audit Program. The amended rules

    specify a number of additional requirements for the SRO supervisory

    program as well as for the Joint Audit Program.

    Costs and Benefits

    The amendments adopted to Sec. 1.52 provide significant additional

    protection to market participants and customer of FCMs by helping to

    ensure that SRO examinations of member FCMs are thorough, effective and

    risk-based, and include evaluation and testing of internal controls as

    well as meeting, as applicable, other objective criteria from related

    professional audit standards. Specifically, an SRO's audit program must

    be risk-based (e.g., the scope and focus of such examinations would be

    determined by the risk profile that the SRO develops for each FCM) and

    address ``all areas of risk to which FCM can reasonably be foreseen to

    be subject,'' and that the examination itself includes both controls

    testing as well as substantive testing. Requiring regulatory

    examinations by SROs to include testing and review of internal controls

    will help ensure that each FCM is not only compliant with capital and

    segregation requirements at the time of the examination, but that they

    continue to operate in such a manner without undetected internal

    controls inadequacies that could jeopardize the FCM and its customers.

    By requiring that the supervisory program for an SRO to adhere to

    professional standards for auditing as applicable, the Commission is

    provided with additional assurance as to standards for aspects of an

    examination such as the adequacy of the evaluation of evidence obtained

    supporting examination conclusions; the training and proficiency of the

    examinations staff; due professional care in the performance of the

    work; consideration of fraud, audit risk and materiality in conducting

    an audit; planning and supervision; understanding the entity and its

    environment and assessing the

    [[Page 68605]]

    risk of material misstatement; communication with those charged with

    governance of the examined entity; and communicating internal control

    matters identified in an examination. These benefits are obtained by

    requiring SRO supervisory programs to include consideration of specific

    issues and be carried out in compliance with professional standards as

    may be applicable to non-financial audits. The Commission believes more

    rigorous requirements and the application of professional standards in

    carrying out such requirements will add additional protection to an

    FCM's counterparties and customers.

    The Commission also proposed to require SROs and as applicable the

    JAC, to obtain an evaluation of the SRO's or JAC's supervisory program

    at least once every two years from an examinations expert, defined as a

    nationally recognized accounting and auditing firm with substantial

    expertise in audits of FCMs, risk assessment and internal control

    reviews, and that is an accounting and auditing firm that is acceptable

    to the Commission (as delegated to the Director of the Division of Swap

    Dealer and Intermediary Oversight). The benefits of such evaluation by

    examinations experts were expected to be that the Commission would

    ensure that the supervisory program and SRO audits continue to build on

    best practices, which further promotes thorough and effective audits of

    FCMs. The Commission quantitatively estimated costs for making

    incremental changes to the requirements of the supervisory program for

    each SRO and members of the JAC in the NPRM. The Commission did not

    quantitatively estimate the ongoing costs of obtaining an evaluation by

    an examinations expert or requiring examinations to comply with

    professional standards, although the Commission did consider that

    requiring such an evaluation and requiring compliance with such

    standards and coverage of additional risks would add costs to

    examinations by SROs and members of the JAC.

    The Commission received many comment letters regarding the changes

    proposed to Sec. 1.52. Several of the commenters objected to the

    requirements for having a review of the examination program by an

    examinations expert.\754\ Specifically, PWC raised concern with the

    ability of nationally recognized accounting and auditing firms to be

    able to issue any type of assurance without a reporting framework.\755\

    NFA, MGEX, and CME all commented that costs would be prohibitive and

    that benefits would be reduced because such an evaluation would be

    duplicative to the functions of the Commission in review of the Joint

    Audit Program. NFA commented that it attempted to obtain cost estimates

    from a few nationally recognized firms but that such firms represented

    that they were unable to provide cost information without a better

    understanding of the type of review the Commission was proposing.\756\

    CME commented that the quantitative estimates of the Commission for

    revising the program were grossly underestimated.\757\ CME analogized

    that requiring adherence to professional standards would result in

    examination requirements similar to the average man hours applicable to

    private and public company audits, which were represented at 1,951 and

    17,457 respectively.\758\ CME represented that the costs of compliance

    with professional standards and expanding the program were

    prohibitively expensive and requested that only applicable provisions

    should be carried into JAC protocols.\759\ CME commented that any

    benefit from obtaining an evaluation from an examinations expert could

    be obtained at a much reduced cost by including representatives from

    such nationally recognized firms in the JAC meetings and in the current

    process to develop JAC protocols, without obtaining a formal

    assessment, which such firms would more likely to be willing to

    do.\760\ CME further posited that if such alternative was not adopted,

    the timeframe should be lengthened from two to three and a half

    years.\761\ MGEX further commented that if such report were to be

    required, highly qualified regional firms should be considered as well

    as nationally recognized firms, as more competition would likely result

    in more manageable costs.\762\

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

    \754\ CME, JAC, MGEX, NFA and PWC all commented objecting to or

    raising concern with this aspect of the amendment to Sec. 1.52.

    \755\ See PWC letter at 3 (Jan. 15, 2013).

    \756\ See NFA Comment Letter at 5 (Feb. 15, 2013).

    \757\ CME Comment Letter at 11 (Feb. 15, 2013).

    \758\ Id.

    \759\ Id.

    \760\ Id.

    \761\ See CME Comment Letter at 12-13 (Feb. 15, 2013).

    \762\ See MGEX letter at 4 (Feb. 18, 2013).

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

    In consideration of the concerns of commenters, the Commission has

    adopted revised amendments to the examinations expert requirement to

    Sec. 1.52, which extend the time between evaluations required to three

    years, and clarify that the standard for such evaluation should be that

    of a consulting services report. The Commission also has considered the

    comments of CME and others with respect to the costs and

    inapplicability of many aspects of the PCAOB auditing standards to

    regulatory examination and has adopted, in the revised amendments to

    the professional standards requirements, that only such standards as

    would be analogous to non-financial statement audits would be

    applicable.

    The JAC also filed an additional comment letter positing that the

    requirements of proposed Sec. 1.52, requiring review of risk

    management, would be duplicative to risk reviews required to be

    performed by DCOs.\763\ Although the Commission agrees there may be

    overlapping responsibilities between oversight performed by DCOs and

    SROs which could result in duplicated costs, the primary focus of DCO

    requirements are the protection of the DCO, not the protection of

    customers and market participants. The Commission notes that the same

    duplication could exist if an FCM were examined by each SRO of which it

    was a member. The Commission already permits the Joint Audit Committee,

    the Joint Audit Plan and the DSRO structure for the purpose of

    mitigating duplicative examination work and costs. As stated in the

    preamble, a DSRO may be able to fulfill parts of its examination

    program by incorporating aspects of risk reviews and work already

    performed by a DCO, but the DSRO would be responsible for ensuring any

    such work was adequately and specifically incorporated into the DSRO

    program, and oriented to ensuring the protection of customers and risks

    to the FCM.

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

    \763\ See JAC Comment Letter at 3-4 (July 25, 2013).

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

    Additionally, the Commission notes it was not feasible to quantify

    any costs associated with utilizing an examinations expert. This is

    largely because several nationally recognized accounting firms

    expressed their reluctance to provide such information.\764\ Such a

    response is not surprising given the fact that reviewing a DSRO's

    examination program is likely a unique and limited engagement for any

    firm, which would require fully understanding the scope and

    requirements of the review. Yet, the Commission notes there are several

    capable firms which would meet the definition of ``examinations

    expert'' and could perform the type of review required by the

    regulation. Thus, the costs for performing such a service will likely

    be competitive.

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

    \764\ See NFA Comment Letter at 5, n.2 (Feb. 15, 2013).

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

    [[Page 68606]]

    Section 1.55 Public Disclosures by Futures Commission Merchants

    Amended Sec. 1.55 significantly revises the disclosures that FCMs

    are required to provide to prospective customers and the public,

    detailed in Sec. 1.55(b). The new required provisions include a

    statement that: (1) Customer funds are not protected by insurance in

    the event of the bankruptcy or insolvency of the FCM, or if customer

    funds are misappropriated; (2) customer funds are not protected by

    SIPC, even if the FCM is a BD registered with the SEC; (3) customer

    funds are not insured by a DCO in the event of the bankruptcy or

    insolvency of the FCM holding the customer funds; (4) each customer's

    funds are not held in an individual segregated account by an FCM, but

    rather are commingled in one or more accounts; (5) FCMs may invest

    funds deposited by customers in investments listed in Sec. 1.25; and

    (6) funds deposited by customers may be deposited with affiliated

    entities of the FCM, including affiliated banks and brokers. The

    required additional disclosures must be provided as an addition to the

    generic risk disclosure statement if used by an FCM as permitted under

    Appendix A to Sec. 1.55.

    In addition, the amendments at Sec. 1.55(i), (j) and (k) require

    each FCM to provide a Firm Specific Disclosure Document that would

    address firm specific information regarding its business, operations,

    risk profile, and affiliates that would be material to a customer's

    decision to entrust funds to and do business with the FCM.

    The Firm Specific Disclosure Document is required to be made

    available electronically, which may be a link to the FCM's Web site,

    but must be provided in paper form upon request, and would provide

    material information about: (1) General firm contact information; (2)

    the names, business contacts, and backgrounds for the FCM's senior

    management and members of the FCM's board of directors; (3) a

    discussion of the significant types of business activities and product

    lines that the FCM engages in and the approximate percentage of the

    FCM's assets and capital devoted to each line of business; (4) the

    FCM's business on behalf of its customers, including types of accounts,

    markets traded, international businesses, and clearinghouses and

    carrying brokers used, and the FCM's policies and procedures concerning

    the choice of bank depositories, custodians, and other counterparties;

    (5) a discussion of the material risks of entrusting funds to the FCM

    and an explanation of how such risks may be material to its customers

    \765\; (6) the name and Web site address of the FCM's DSRO and the

    location of annual audited financial statements; (7) a discussion of

    any material administrative, civil, criminal, or enforcement actions

    pending or any enforcement actions taken in the last three years; (8) a

    basic overview of customer fund segregation, FCM collateral management

    and investments, and of FCMs and joint FCM/BDs; (9) information

    regarding how customers may file complaints about the FCM with the

    Commission or appropriate DSRO; (10) certain financial data from the

    most recent month-end when the disclosure document is prepared; and

    (11) a summary of the FCMs' current risk practices, controls and

    procedures. FCMs are required to update the Firm Specific Disclosure

    Document as and when necessary to make the information accurate and

    complete, but at least annually.

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

    \765\ The material risks addressed must include, without

    limitation, ``the nature of investments made by the futures

    commission merchant (including credit quality, weighted average

    maturity, and weighted average coupon); the futures commission

    merchant's creditworthiness, leverage, capital, liquidity, principal

    liabilities, balance sheet leverage and other lines of business;

    risks to the futures commission merchant created by its affiliates

    and their activities, including investment of customer funds in an

    affiliated entity; and any significant liabilities, contingent or

    otherwise, and material commitments.''

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

    The newly adopted Sec. 1.55(l) also requires FCMs to adopt

    policies and procedures reasonably designed to ensure that advertising

    and solicitation activities of such FCMs and any introducing brokers

    associated with the FCMs are not misleading in connection with their

    decision to entrust funds and do business with such FCMs.

    FCMs are further required by Sec. 1.55(o) to disclose on their Web

    sites their daily Segregation Schedule, daily Secured Amount Schedule,

    and daily Cleared Swaps Segregation Schedule. Each FCM must maintain 12

    months of such schedules on its Web site. Each FCM must disclose on its

    Web site summary schedules of its adjusted net capital, net capital,

    and excess net capital for the 12 most recent month-end dates, as well

    as the Statement of Financial Condition, Segregation Schedule, Secured

    Amount Schedule, Cleared Swaps Segregation Schedule, and all footnotes

    related to the above statements and schedules from its most current

    year-end annual report that is certified by an independent public

    accountant.

    Costs and Benefits

    Current regulations require FCMs to provide a risk disclosure to

    potential customers before accepting customer funds, which existing

    risk disclosure statement primarily provides a customer with disclosure

    of the market risks of engaging in futures trading. The revised

    disclosure requirements of Sec. 1.55 provide customers with additional

    information regarding certain non-firm-specific risks that have been

    relevant in recent FCM bankruptcies and that could be relevant in the

    event of future FCM bankruptcies or insolvencies.

    The Firm Specific Disclosure Document required by this amendments

    address firm-specific risk, which will give potential customers

    additional information that they may use when conducting due diligence

    and selecting an FCM. By requiring that the disclosure address several

    specific topics, the public comparability of information on such topics

    will be available, to potential customers conducting due diligence on

    potential FCMs. The non-firm specific additional disclosures will

    provide a significant benefit to the protection of market participants

    as many customers in the aftermath of recent FCM bankruptcies revealed

    fundamental misconceptions about the protection of their funds.

    Specifically, certain customers did not fully understand how FCMs held

    customer funds or the protections extended to such funds. Consequently,

    certain customers did not make informed choices to help themselves or

    to provide market discipline to their FCMs.

    In the NPRM, the Commission described how each additional specific

    risk disclosure was expected to benefit the protection of market

    participants by providing more transparency and equal access to

    information among all customers and the public, enhancing customer's

    ability to make comparisons in choosing the FCMs with which they do

    business. The specific benefits of each disclosure required by the

    amendments were described in the NPRM, but the essential benefits

    derived from each additional required disclosure, and the aggregate of

    all the additional disclosures, are that they will result in more

    educated consumers of FCM services, and that such consumers will,

    through the greater transparency resulting from the additional

    disclosures, be better able to enforce market discipline on aspects of

    FCM business that are directly relevant to the risks customers accept

    in dealing with and depositing funds with FCMs.

    The Commission quantitatively estimated expected costs of providing

    the additional general and firm specific disclosures in the NPRM and

    did not receive any comments about its specific estimates. However, the

    Commission

    [[Page 68607]]

    did receive many comments that supported the amendments to Sec. 1.55

    reiterating the benefits perceived from transparency resulting from the

    additional disclosures as are described at section II.P. and noting

    that these amendments were particularly cost effective at providing

    such benefits. FHLB stated ``[p]erhaps the most compelling argument for

    additional public disclosure of certain information addressed in the

    Proposed Customer Protection Rules is that the benefits should far

    exceed the additional cost associated with mandating such public

    disclosures.'' \766\ ACLI and the Commercial Energy Working Group both

    stated ``the Proposed Customer Protection Rules represent a very cost-

    effective approach/means to making FCMs more accountable to their

    customers by providing current information that will enable customers

    to conduct appropriate due diligence regarding prospective FCMs and to

    actively monitor the financial condition and regulatory compliance of

    the FCMs to which they have entrusted funds.'' \767\

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

    \766\ See FHLB Comment Letter at 3 (Feb. 15, 2013).

    \767\ See ACLI Comment Letter at 2 (Feb. 15, 2013); Commercial

    Energy Working Group Comment Letter at 2 (Feb. 13, 2013).

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

    FIA specifically commented with respect to the disclosures required

    under Sec. 1.55(k) that FCMs that are part of public companies, or

    dually registered BDs, or are part of a bank holding company, already

    have disclosure requirements and that the Commission should confirm

    that such an FCM may comply with this rule by making the annual reports

    and amendments thereto available on its Web site, in order to avoid

    duplicative or conflicting disclosure requirements.\768\ FIA further

    commented that the level of detail required of privately owned FCM's

    disclosure should be consistent with that provided in the annual

    reports of publicly-traded companies.\769\ Newedge commented that all

    FCMs should be required to disclose similar information in a standard

    format, and the proposal of FIA to satisfy disclosure requirements by

    linking to the annual report of a public company places firms without

    annual report preparation requirements at a competitive disadvantage

    and discriminates against smaller to mid-size FCMs.\770\

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

    \768\ See FIA Comment Letter at 43 (Feb. 15, 2013).

    \769\ Id. at 44.

    \770\ Newedge Comment Letter at 4 (Feb. 15, 2013).

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

    In the preamble discussion at section II.P., the Commission

    clarified both that disclosures could be satisfied by linking to

    appropriate existing relevant disclosures that were already required

    for the same matters, but that the disclosures required by the

    amendments are specific to the FCM and cannot be satisfied with more

    general disclosure at a holding company level. The Commission believes

    this clarification addresses the duplication concern raised by

    commenters.

    Several commenters posited concerns regarding the benefit of

    various aspects of the mandated disclosures. The comments addressed the

    disclosures of leverage, the targeted residual interest, customer

    write-offs, and that such disclosures could in certain circumstances be

    potentially misleading to customers.\771\ With respect to these

    comments the Commission notes that with all aspects of the mandated

    additional disclosures, appropriate explanations and additional

    information to ensure sufficient context should be provided if

    necessary to clarify anything that an FCM may regard as otherwise being

    misleading. Concerns raised by commenters that customers may

    inadequately assess risks particular to their FCM by inappropriately

    focusing on only one aspect of disclosure, such as leverage, or

    targeted residual interest, cannot be mitigated by declining wholesale

    to make relevant information publicly available. Furthermore, FCMs are

    free to supply additional context and information when they believe

    that any Firm Specific Disclosure is misleading.

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

    \771\ See FCStone Comment Letter at 4 (Feb. 15, 2013); Phillip

    Futures Inc. Comment Letter at 2 (Feb. 14, 2013); CHS Hedging

    Comment Letter at 2 (Feb. 15, 2013); RJ O'Brien Comment Letter at 6-

    9 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4 (Feb. 15,

    2013); Advantage Comment Letter at 4 (Feb. 15, 2013); RCG Comment

    Letter at 5-6 (Feb. 12, 2013).

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

    Certain commenters have requested that the Commission consider the

    alternative to further require all Sec. 1.12 notices to be made

    publicly available, which the Commission has declined to do as is

    discussed in the costs and benefits discussion of Sec. 1.12. By

    requiring FCMs to update the disclosures annually, as well as any time

    there is a ``material change to its business operation, financial

    condition and other factors material to the customer's decision to

    entrust the customer's funds and otherwise do business with the futures

    commission merchant,'' and requiring the FCM to provide each updated

    disclosure to its customers, Sec. 1.55(i) makes FCMs responsible to

    communicate with customers whenever such events occur. The Commission

    notes that there may be overlap in circumstances which give rise to

    notice obligations under Sec. 1.12 and which require updated public

    disclosure, although the two are distinct and separate requirements.

    This requirement helps to ensure that the FCM's financial condition,

    business operations, or other important factors do not change in

    material ways without customers being able to ascertain such changes,

    and would likely prompt some customers to conduct additional due

    diligence in such situations in order to determine whether their funds

    are at risk, which would provide additional accountability for FCMs.

    By requiring each FCM to adopt policies and procedures reasonably

    designed to ensure that its advertising and solicitation activities are

    not misleading to its FCM customers under Sec. 1.55(l), the Commission

    is strengthening accountability for communication related to an FCM's

    sales and solicitation activities which helps to ensure the purposes of

    the other requirements for disclosure are not frustrated.

    By requiring FCMs to provide their daily Segregation Schedules,

    daily Secured Amount Schedules, and daily Cleared Swaps Segregation

    Schedules, as well as the same schedules from the most recent certified

    annual report, the requirements under Sec. 1.55(o) facilitate

    transparency. Requiring each FCM to post the above schedules and data

    on its Web site will help to ensure that market participants are aware

    that it is available, and will improve the speed and efficiency of

    obtaining it. Similarly, by requiring FCMs to provide a link to the Web

    site of the NFA's Basic System facilitate transparency by promoting

    awareness of the additional information that is public regarding each

    FCM's investment of customer funds and by reducing the search costs for

    obtaining that information.

    Section 22.2 Futures Commission Merchants: Treatment of Cleared Swaps

    and Associated Cleared Swap Customer Collateral

    The adopted amendments to Sec. 22.2 incorporate changes with

    respect to protection of funds for customers trading cleared swaps that

    are identical to the changes proposed for protection of futures

    customer funds.\772\ Those changes include: (1) Incorporating the same

    change to haircutting procedures as adopted in Sec. 1.17 and Sec.

    1.32 but for Cleared Swaps; (2) requiring the FCM to

    [[Page 68608]]

    send daily Segregation Calculations for Cleared Swaps to the Commission

    and DSROs; and (3) requiring that segregated investment detail reports

    be produced twice per month, listing assets on deposit at each

    depository, and sent to Commission and DSROs electronically by 11:59

    p.m. the following business day. Records of both reports are required

    to be maintained in accordance with Sec. 1.31.

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

    \772\ As noted in section II.Q. above, the revisions to

    Sec. Sec. 22.2(a) and (f) merely clarify that the calculation set

    forth therein is the Net Liquidating Equity Method and thus, the

    revision is not intended to, and should not be read to, change

    current practice with respect to an FCM's residual interest

    requirements for Cleared Swaps as set forth in Commission

    regulations and JAC Update 12-03, and consistent with Staff

    Interpretation 12-31.

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

    Costs and Benefits

    As discussed above, amendments to Sec. 22.2(a) and (f) are not

    intended to change existing practice and thus do not introduce new

    costs. The other amendments to Sec. 22.2 noted above are substantively

    similar to amendments to corresponding part 1 regulations and the

    relevant costs and benefits are similar to the costs and benefits

    discussed in those sections.

    The amendments to Sec. 22.2 have the benefits of harmonizing the

    protection of customer funds between Cleared Swaps and futures and

    clarifying further the regulatory requirements for Cleared Swaps.

    Section 22.17 Policies and Procedures Governing Disbursements of

    Cleared Swaps Customer Collateral From Cleared Swap Customer Accounts

    The newly adopted Sec. 22.17 imposes restrictions on an FCM's

    withdrawal of its residual interest, and requires that if a withdrawal

    of residual interest not for the benefit of customers causes the FCM to

    fall below its targeted residual interest, that the funds be

    replenished the following business day or the residual interest target

    be lowered in accordance with its policies and procedures established

    under Sec. 1.11.

    Costs and Benefits

    The costs and benefits are similar to those created by Sec. Sec.

    1.23 and 1.11 but apply to customer funds in Cleared Swaps Customer

    Accounts rather than customer segregated accounts, and therefore are as

    described in Sec. Sec. 1.23 and 1.11, but incremental thereto with

    respect to Cleared Swaps Customer Accounts.

    Section 30.1 Definitions

    Amendments adopted to Sec. 30.1 establishes new definitions for

    ``30.7 customer,'' ``30.7 account,'' and ``30.7 customer funds.'' The

    first is defined as any foreign futures or foreign option customer,

    together with any foreign-domiciled person who trades in foreign

    futures or foreign options trough an FCM. ``30.7 account'' and ``30.7

    customer funds'' are then defined accordingly. These definitions relate

    to the existing terms ``foreign futures or foreign options customer,''

    ``foreign futures or foreign options customer account,'' and ``foreign

    futures or foreign options customer funds,'' respectively. The term

    ``foreign futures or foreign options customer'' only includes U.S.-

    domiciled customers that deposit funds with an FCM for use in trading

    foreign futures or foreign options. The new definitions, on the other

    hand, include both U.S. and foreign-domiciled customers that deposit

    funds with an FCM for use in trading foreign futures or foreign

    options.

    Costs and Benefits

    These definitions play a `gatekeeping' function with respect to

    other rules by determining what customers are included as ``30.7

    customers.'' However, the costs and benefits of these changes are

    attributable to the substantive requirements related to the

    definitions, and therefore are discussed in the cost benefit

    considerations related to Sec. 30.7.

    Section 30.7 Treatment of Foreign Futures or Foreign Options Secured

    Amount

    The adopted amendments to Sec. 30.7 (1) Incorporate the funds of

    foreign-domiciled investors deposited with an FCM for investment in

    foreign futures and foreign options within the protections provided in

    Sec. 30.7; (2) eliminate the Alternative Method and require the Net

    Equity Liquidation Method for calculating 30.7 customer segregation

    requirements; (3) add specificity to the written acknowledgments that

    FCMs and DCOs must obtain from their depositories by providing required

    templates; \773\ (4) add restrictions on withdrawing from residual

    interest not for the benefit of customers; \774\ (5) require that 30.7

    customer funds deposited in a bank must be available for immediate

    withdrawal at the request of the FCM; (6) clarify that the FCM is

    responsible for any losses related to investing 30.7 customer funds in

    investments that comply with Sec. 1.25; (7) add a prohibition against

    making unsecured loans to customers or using the funds in the

    customer's trading account as security for a loan; (8) require daily

    segregation reports and a detailed list of depositories to be submitted

    to the Commission and DSRO, and that targeted residual interest be

    included in both of those reports; (9) allow FCMs that are not dual

    registrants to use the BD procedure for assigning a smaller net capital

    haircut to investments of 30.7 customer funds in certain types of

    instruments with low default risk; (10) establish a limit on the amount

    of funds in a 30.7 account that can be held outside the U.S.; and (11)

    require FCMs to, at a specified point in time, maintain residual

    interest in 30.7 accounts that is at least equal to the sum of all

    undermargined amounts for 30.7 customers. With the exception of the

    requirements with respect to limiting funds held outside the U.S., the

    permissibility of certain depositories outside the U.S., and the

    requirement that FCMs comply with the highest equivalent custody

    requirement relevant in a different country, these requirements are

    substantially similar to equivalent requirements adopted in Sec. Sec.

    1.20, 1.22, 1.23, 1.29, 1.30, 1.32 and 22.2 and 22.17. As a result of

    the adopted changes with the noted exceptions, the rules in Sec. 30.7

    for the protection of 30.7 customer funds are substantially similar to

    the rules for the protection of segregated customer funds under 4d(a)

    and Sec. Sec. 1.11-1.32, and the rules for the protection of cleared

    swaps customer funds under 4d(f) and in part 22. However, portions of

    Sec. 30.7 are notably different from rules protecting futures customer

    funds and cleared swap customer funds. These are: (1) the definition of

    the minimum amount that must be deposited in a 30.7 account for each

    30.7 customer is different than in the corresponding requirements in

    Sec. Sec. 1.20 and 22.2, due to the possibility of a higher

    requirement under a foreign regulatory regime; (2) the list of

    acceptable depositories for 30.7 customer funds includes banks or

    trusts outside of the U.S. with more than $1 billion in regulatory

    capital, and various other participants of foreign boards of trade and

    their depositories; (3) Sec. 30.7 limits the amount of funds from a

    30.7 account that can be held outside the U.S; and (4) the Residual

    Interest Deadline for 30.7 funds is 6:00 p.m. Eastern Time, whereas the

    Residual Interest Deadline for futures customer funds will, after the

    phase-in period and absent further Commission action, move back to the

    time of the daily settlement.

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

    \773\ The additional specificity incorporates the same

    requirements for acknowledgment and agreement that are contained in

    the templates in the appendices of Sec. Sec. 1.20 and 1.26.

    \774\ The same requirements as are adopted for futures

    customers' funds and Cleared Swaps Customers' Collateral, including

    a requirement for the FCM to abide by its policies and procedures

    required by new Sec. 1.11.

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

    The third and fourth are the only substantive differences in the

    custody regime created by the adopted amendments compared to the

    custody regimes put in place in the corresponding sections for domestic

    [[Page 68609]]

    futures customer funds and cleared swaps customer funds.

    Costs and Benefits

    In the NPRM, the Commission stated it believed a significant

    benefit of the amendments adopted to Sec. 30.7 would be the likelihood

    that in an FCM insolvency, the full amount owed to customers trading

    foreign futures and foreign options, whether such customers were

    foreign or domestic domiciled, would be intact as required to be held

    separately in 30.7 accounts. The Commission did not receive comments

    objecting to the changes to the calculations or the required inclusion

    of foreign-domiciled customers. The adopted changes also established

    new regulations for the protection of customer funds deposited for

    trading in foreign futures and options that, with limited exceptions,

    are substantively identical to the new protections adopted for futures

    customer funds and cleared swaps customer funds. Therefore, many of the

    costs and benefits of the changes that are proposed are identical to

    those described above in the cost-benefit considerations related to

    Sec. Sec. 1.11-1.32 and part 22.

    Various regulations designed to ensure that the new calculation

    requirement for the segregation of 30.7 funds is met at all times would

    also apply, including the Sec. 30.7(g) restrictions on an FCM's

    withdrawal of its residual interest which is commingled with 30.7

    customer funds, and policies and procedures developed by the FCM

    pursuant to Sec. 1.11 that are designed to ensure safe handling of

    such funds. Application of the additional protections designed for

    customer funds will further ensure the protection of market

    participants and provide, as much as possible, equivalent protections

    between domestic and foreign futures trading with respect to the

    treatment of funds held by the FCMs. The Commission did not

    quantitatively estimate costs of the amendments to Sec. 30.7, but

    requested comment as to any costs to FCMs, including whether FCMs would

    need to obtain additional capital or obtain additional liquidity as a

    result of formally foreclosing their abilities to utilize the

    Alternative Method versus the Net Liquidating Equity segregation method

    in funding operations. The Commission did not receive comments

    addressing these questions, or addressing its analysis that costs and

    benefits would be incremental to the costs and benefits analyzed with

    respect to the same substantive provisions applicable to both 4d(a)

    (futures) and 4d(f) (Cleared Swaps) segregated funds. Moreover, the

    Commission believes any incremental costs associated with complying

    with these changes to be minimal, since much of the industry is already

    held to these standards as a result of previous rule changes made by

    NFA to its rulebook.\775\

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

    \775\ See NFA Interpretive Notice 9066 (Revised, July 1, 2013).

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

    In the NPRM, the Commission proposed in Sec. 30.7(c) a limitation

    on the amount of funds from a 30.7 account that can be held outside the

    U.S. Funds held overseas are subject to different regulatory and

    bankruptcy regimes that may not offer comparable protections for

    customer funds, creating additional repatriation risks to those funds.

    For example, if an FCM carrying 30.7 funds, some of which were held in

    depositories outside the U.S., were to default, it is possible that the

    Trustee would not be able to promptly recover sufficient funds to repay

    all the FCM's obligations to 30.7 customers. As noted above, this is

    especially true if the funds are deposited with a foreign affiliate of

    the FCM, as the likelihood of coincident bankruptcies of affiliated

    financial firms has been observed to be exceedingly high.\776\ In such

    an event, the funds held at the foreign affiliate would be distributed

    in accordance with the insolvency rules of the foreign jurisdiction. In

    such a case each 30.7 customer would likely receive a pro-rata share of

    the funds that the Trustee is able recover, when the Trustee is able to

    recover them. The proposed limit on the amount of funds that can be

    held outside the U.S. was intended to assure that as much of the

    customers' funds as possible remain subject to the U.S. regulatory and

    bankruptcy regimes, eliminating repatriation risk to those funds. By

    eliminating this risk for a larger percentage of the 30.7 funds, the

    proposed rule promotes higher recovery rates for 30.7 account funds if

    the FCM defaults, which helps ensure that 30.7 customers receive the

    largest (and most prompt) pro rata distribution possible.

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    \776\ See, e.g., Lehman, MFGI.

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    The Commission received comments from FIA, as well as others, that

    the proposed percentage limitation of 10% of required margin was not

    adequate in light of account volatility and other factors, and that the

    limitation should only be applicable to funds deposited with foreign

    brokers and that otherwise FCMs should be permitted to hold funds in a

    bank or trust company outside the U.S. to the same extent that an FCM

    may hold other customer segregated and Cleared Swaps Customer

    collateral outside the U.S.\777\ Commenters including Jefferies and

    Advantage stated that the limitations may inhibit FCMs from trading

    foreign futures and that customers may need to utilize non-U.S. brokers

    for their foreign futures business as a result, because they would not

    be able to accept customer securities outside the U.S. and customers

    would have to pre-fund with cash instead.\778\ In response to

    commenters and upon consideration, the Commission is increasing the

    limitation from 10% to 20%, but is declining to further expand the

    permissibility of holding 30.7 funds outside the U.S. due to the

    increased repatriation risk applicable to excess margin deposited

    outside the U.S. for 30.7 funds for foreign futures and foreign

    options.

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    \777\ FIA Comment Letter at 36-37 (Feb. 15, 2013); RJ O'Brien

    Comment Letter at 11 (Feb. 15, 2013).

    \778\ Jefferies Comment Letter at 6 (Feb. 15, 2013); Advantage

    Comment Letter at 9 (Feb. 15, 2013).

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