2011-31689

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

[Rules and Regulations]

[Pages 78776-78803]

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

[FR Doc No: 2011-31689]

[[Page 78775]]

Vol. 76

Monday,

No. 243

December 19, 2011

Part III

Commodity Futures Trading Commission

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17 CFR Parts 1 and 30

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

Futures and Foreign Options Transactions; Final Rule

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

Rules and Regulations

[[Page 78776]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 30

RIN 3038-AC79

Investment of Customer Funds and Funds Held in an Account for

Foreign Futures and Foreign Options Transactions

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

is amending its regulations regarding the investment of customer

segregated funds subject to Commission Regulation 1.25 (Regulation

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

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

amendments reflect the implementation of new statutory provisions

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

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

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

transactions), a clarification of the liquidity requirement, the

removal of rating requirements, and an expansion of concentration

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

concentration restrictions. They also address revisions to the

acknowledgment letter requirement for investment in a money market

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

redemption requirement for MMMFs, the elimination of repurchase and

reverse repurchase agreements with affiliates, the application of

customer segregated funds investment limitations to 30.7 funds, the

removal of ratings requirements for depositories of 30.7 funds, the

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

certain technical changes.

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

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

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

(202) 418-5188, [email protected], or Jon DeBord, Special

Counsel, (202) 418-5478, [email protected], Division of Clearing and

Risk, Commodity Futures Trading Commission, Three Lafayette Centre,

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

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Regulation 1.25

B. Regulation 30.7

C. Advance Notice of Proposed Rulemaking

D. The Dodd-Frank Act

E. The Notice of Proposed Rulemaking

II. Discussion of the Final Rules

A. Permitted Investments--Regulation 1.25

1. Government Sponsored Enterprise Securities

2. Commercial Paper and Corporate Notes or Bonds

3. Foreign Sovereign Debt

4. In-House Transactions

B. General Terms and Conditions

1. Marketability

2. Ratings

3. Restrictions on Instrument Features

4. Concentration Limits

(a) Asset-Based Concentration Limits

(b) Issuer-based Concentration Limits

(c) Counterparty Concentration Limits

C. Money Market Mutual Funds

1. Acknowledgment Letters

2. Next-day Redemption Requirement

D. Repurchase and Reverse Repurchase Agreements

E. Regulation 30.7

1. Harmonization

2. Ratings

3. Designation as a Depository for 30.7 Funds

4. Technical Amendment

F. Implementation

III. Cost Benefit Considerations

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

Text of Rules

I. Background

A. Regulation 1.25

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

customer segregated funds may be invested in obligations of the United

States and obligations fully guaranteed as to principal and interest by

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

of any State or of any political subdivision thereof (municipal

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

the Commission substantially expanded the list of permitted investments

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

in general obligations issued by any enterprise sponsored by the United

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

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

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

In connection with that expansion, the Commission included several

provisions intended to control exposure to credit, liquidity, and

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

requirements that the investments satisfy specified rating standards

and concentration limits, and be readily marketable and subject to

prompt liquidation.\7\

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

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

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

Stat. 1376 (2010).

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

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

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

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

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

2005).

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

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

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

December 28, 2000).

\7\ Id.

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The Commission further modified Regulation 1.25 in 2004 and 2005.

In February 2004, the Commission adopted amendments regarding

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

maturity requirements for securities deposited in connection with

certain collateral management programs of derivatives clearing

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

related to standards for investing in instruments with embedded

derivatives, requirements for adjustable rate securities, concentration

limits on reverse repurchase agreements, transactions by futures

commission merchants (FCMs) that are also registered as securities

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

registration requirements for MMMFs, an auditability standard for

investment records, and certain technical changes.\9\

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

\9\ 70 FR 28190.

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

segregated funds must be invested in a manner that minimizes their

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

availability to customers and DCOs and to enable investments to be

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

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

prudential standard by requiring that all permitted investments be

``consistent with the objectives of preserving principal and

maintaining liquidity.'' \10\

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\10\ 17 CFR 1.25(b).

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

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

investments of Regulation 1.25 funds and 30.7 funds

[[Page 78777]]

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

strategies and practices and to assess whether any changes to the

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

all registered DCOs and FCMs carrying customer accounts provided

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

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

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

data previously gathered no longer reflected current market conditions.

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

1.25 was implemented in a more stable financial environment.

Additionally, recent events in the economy have underscored the

importance of conducting periodic reassessments and, as necessary,

revising regulatory policies to strengthen safeguards designed to

minimize risk, while retaining an appropriate degree of investment

flexibility and opportunities for capital efficiency for DCOs and FCMs

investing customer segregated funds.

B. Regulation 30.7

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

securities, and property associated with positions in foreign futures

and foreign options. Regulation 30.7 was issued pursuant to the

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

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

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

those funds to the investment limitations applicable to customer

segregated funds.

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\11\ 17 CFR 30.7.

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

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

Although Regulation 1.25 investments offer a safe harbor, the

Commission does not currently limit investments of 30.7 funds to

permitted investments under Regulation 1.25. Appropriate depositories

for 30.7 funds currently include certain financial institutions in the

United States, financial institutions in a foreign jurisdiction meeting

certain capital and credit rating requirements, and any institution not

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

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

Commission.

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

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

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

obligations to customers and the requirement that the secured amount

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

cover all obligations to such customers. Regulation 1.25 investments

would be appropriate, as would investments in any other readily

marketable securities.'').

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C. Advance Notice of Proposed Rulemaking

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

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

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

was considering significantly revising the scope and character of

permitted investments for customer segregated funds and 30.7 funds. In

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

data regarding regulatory requirements that might better safeguard

customer segregated funds. It also sought comments, information,

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

Regulation 1.25 to investments of 30.7 funds.

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

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The Commission received twelve comment letters in response to the

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

Eleven of the 12 letters supported maintaining the current list of

permitted investments and/or specifically ensuring that MMMFs remain a

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

topic of MMMFs, providing detailed discussions of their usefulness to

FCMs. Several letters addressed issues regarding ratings, liquidity,

concentration, and portfolio weighted average time to maturity. The

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

controversial.

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

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

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

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

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

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

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

2009 letter.

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

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

Commission's objectives of preserving principal and maintaining

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

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

Regulation 1.25 permitted investments are actually used by the

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

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

recommended that the Commission eliminate asset classes not ``utilized

to any material extent.''

D. The Dodd-Frank Act

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

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

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

protection, promote transparency and improve disclosure.

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

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

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

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

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

2010.''

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

review their respective regulations and make appropriate amendments in

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

requires the Commission to conduct this review within one year after

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

changes to Regulations 1.25 and 30.7 that remove provisions setting

forth credit rating requirements. Separate rulemakings addressed the

removal of credit ratings from Commission Regulations 1.49 and 4.24

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

reference to credit ratings).\20\

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

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

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

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E. The Notice of Proposed Rulemaking

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

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

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

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

closed on December 3, 2010.\21\

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

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

3, 2011).

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The Commission invited comments related to topics covered by

Regulations 1.25 and 30.7, including the scope of permitted

investments, liquidity, marketability, ratings, concentration limits,

portfolio weighted average maturity requirements, and the applicability

of Regulation 1.25 standards to foreign futures accounts. The

Commission received 32 comment letters.\22\

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

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

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

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

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

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

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

Banks Funding Corporation (FFCB), Federal Housing Finance Authority

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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[[Page 78778]]

II. Discussion of the Final Rules

A. Permitted Investments--Regulation 1.25

In finalizing amendments to Regulation 1.25, the Commission seeks

to impose requirements on the investment of customer segregated funds

with the goal of enhancing the preservation of principal and

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

Commission has endeavored to tailor its amendments to achieve these

goals, while retaining an appropriate degree of investment flexibility

and opportunities for attaining capital efficiency for DCOs and FCMs

investing customer segregated funds.

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

of investment choices in order to eliminate the potential use of

portfolios of instruments that may pose an unacceptable level of risk

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

Regulation 1.25 investments by promoting diversification.

Below, the Commission details its decisions regarding the proposals

in the NPRM. The Commission has decided to:

Retain investments in U.S. agency obligations, including

implicitly backed GSE debt securities, and impose limitations on

investments in debt issued by the Federal National Mortgage Association

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

Mac);

Remove corporate debt obligations not guaranteed by the

United States from the list of permitted investments;

Eliminate foreign sovereign debt as a permitted

investment; and

Eliminate in-house and affiliate transactions.

1. Government Sponsored Enterprise Securities

In the NPRM, the Commission proposed to amend Regulation

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

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

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

obligations must be fully guaranteed as to principal and interest by

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

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

impermissible as Regulation 1.25 investments since no GSE debt

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

Commission received 14 comment letters discussing GSEs. Thirteen of

those 14 comment letters opposed the proposal.

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

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

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

guarantee, although they are considered by some to have an

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

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

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

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

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

explicit federal guarantee, in the NPRM the Commission concluded

that GSE securities should remain on the list of permitted

investments in the event this status changes in the future.

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

performance during the financial crisis, and the detrimental,

unintended consequences of the proposal. In addition, there were

several letters from organizations related to the Farm Credit System

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

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

1.25 investment.

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

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

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

Exchange Commission (SEC) has retained GSE debt securities as

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

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

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

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

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\25\ MF Global/Newedge letter at 4.

\26\ 17 CFR 270.2a-7.

\27\ FFCB letter at 3.

\28\ BlackRock letter at 6.

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

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

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

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

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

any bank or corporation.\30\

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

\30\ RJO letter at 5.

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Commenters averred that the safety of GSEs is further proven by

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

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

well during the financial crisis.\31\

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

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

FFCB Federal Home Loan Banks and Federal Agricultural Mortgage

Corporation as examples of GSEs that performed well during the

financial crisis.

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Limiting investments to only those agency obligations backed by the

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

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

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

that specific criteria for eligible investments is preferable to

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

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

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

\33\ FHFA letter at 1.

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Several commenters were concerned that the Commission's proposal

would have the unintended consequence of harming the broader market for

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

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

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

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

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

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

FFCB letter at 3.

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

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Most commenters recommended that GSE debt securities, including

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

permitted investments to varying extents. There were a range of

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

Global/Newedge suggested that GSEs with implicit guarantees should have

a 50 percent asset-based concentration limit along

[[Page 78779]]

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

meeting specific outstanding float standards should be allowed. MF

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

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

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

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

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

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

Commission should permit investments in Fannie Mae and Freddie Mac

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

FIA/ISDA recommended that investments in GSE securities be permitted

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

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

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

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

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

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

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

percent issuer limitation on GSEs.\40\

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\36\ MF Global/Newedge letter at 5.

\37\ CME letter at 3.

\38\ RJO letter at 5.

\39\ FIA/ISDA letter at 5.

\40\ BlackRock at 6.

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

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

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

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

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

securities performed well throughout the financial crisis. FHLB stated

that it maintained funding capabilities even during the most severe

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

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

Credit debt securities remained safe during the recent period of market

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

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

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

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

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

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

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

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

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

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

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

if any, problems during the crisis.\47\

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

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

cooperative Federal Home Loan Banks created by Congress to provide

support for housing finance and community development through member

financial institutions. The 12 Federal Home Loan Banks issue debt

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

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

collateralized loans. See FHLB letter at 1-3.

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

associations which provide credit and financial services to farmers,

ranchers, and similar agricultural enterprises by issuing debt (Farm

Credit debt securities) through the FFCB.

\43\ FHLB letter at 1-3.

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

securities are regulated by the FCA and insured by an independent

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

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

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

See Farm Credit Council letter at 2.

\45\ FFCB letter at 1.

\46\ Id.

\47\ RJO letter at 4.

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

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

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\48\ CIEBA letter at 3.

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After reviewing the comments, the Commission has concluded that

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

Commission acknowledges the fact, mentioned by several commenters, that

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

The Commission believes it appropriate to include a limitation for

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

perform well during the recent financial crisis. Both entities failed

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

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

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

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

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

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

appropriate to preserve and conserve the assets and property of each

entity.\49\

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

conservatorships are to help restore confidence in the entities,

enhance their capacity to fulfill their mission, mitigate the

systemic risk that contributed directly to instability in financial

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

mortgage market role until their future is determined through

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

Freddie Mac is directed toward minimizing losses, limiting risk

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

services to adequately address their costs and risk.

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In consideration of the above comments, the Commission is amending

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

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

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

permitted as long as these entities are operating under the

conservatorship or receivership of FHFA.

2. Commercial Paper and Corporate Notes or Bonds

In order to simplify Regulation 1.25 by eliminating rarely-used

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

posed by corporate debt securities, the Commission proposed amending

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

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

and corporate notes or bonds that are federally guaranteed as to

principal and interest under the Temporary Liquidity Guarantee Program

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

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

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

\52\ Commercial paper would remain available as a direct

investment for MMMFs and corporate notes or bonds would remain

available as indirect investments for MMMFs by means of a repurchase

agreement.

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The NPRM supported this proposal by noting the credit, liquidity

and market risks associated with corporate notes or bonds and

referenced that information obtained during the 2007 Review indicated

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

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

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

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

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

for its entire term.\54\

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

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

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

period.

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

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

15. 2010) (TLGP Letter).

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Seven comment letters discussed commercial paper and corporate

notes

[[Page 78780]]

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

favor of retaining commercial paper and corporate notes or bonds to

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

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

of the 2007 Commission review of customer funds investments.

According to three commenters, limiting commercial paper and

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

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

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

available supply and therefore might not be a viable option for

investment.\56\

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

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

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

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

sufficiently safe and liquid for use as a Regulation 1.25

investment. See TLGP Letter.

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There was general support for maintaining corporate notes or bonds

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

as trading in the relevant security remains highly liquid, such

securities should continue to be eligible investments under Regulation

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

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

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

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

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

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

instances of an FCM unable to meet its obligations under Regulation

1.25 as a result of investment losses it suffered involving corporate

notes or commercial paper. They believe that commercial paper and

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

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

to invest only in corporate notes or commercial paper issued by

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

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

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

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

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

from reaching that limit.\60\

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\57\ FIA/ISDA letter at 5.

\58\ RJO letter at 6.

\59\ RJO letter at 5.

\60\ BlackRock letter at 6.

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Commenters rejected the Commission's contention that the lack of

investment in commercial paper and corporate notes or bonds illustrated

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

the investment review is outdated and is inadequate to justify removing

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

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

relevant period because investments in such instruments were not as

safe during that time frame.\62\

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\61\ MF Global/Newedge at 8.

\62\ RJO letter at 5.

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The Commission does not find the arguments in favor of retaining

corporate notes and bonds to be persuasive. While the Commission

encourages FCMs and DCOs to increase or decrease their holdings of

certain permitted instruments depending on market conditions, the

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

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

threaten customer principal. The Commission recognizes that certain

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

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

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

paper and notes meeting certain standards. To the extent that

commenters suggested that the 2007 Report does not accurately reflect

the volume of investment of customer segregated funds in commercial

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

2007 Report contains sufficiently accurate information reflective of

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

relative paucity of investment in such instruments, the Commission

believes that the investment of customer funds in such instruments runs

counter to the overarching objective of preserving principal and

maintaining liquidity of customer funds.

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

Regulation 1.25 investments from more recent years, the Commission

believes that investment in commercial paper and corporate notes or

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

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

segregated funds were primarily invested in government securities

and MMMFs, while investments in other instruments were

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

contradict its position.

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

useful to include commercial paper and corporate notes or bonds that

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

as permitted investments. This would permit continuing investment in

TLGP debt securities, even though the Commission has otherwise

eliminated commercial paper and corporate notes or bonds from the list

of permitted investments. Therefore, the Commission is adopting the

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

commercial paper and corporate notes or bonds that can qualify as

permitted investments to only those guaranteed as to principal and

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

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

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

that commercial paper and corporate notes or bonds must be federally

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

criteria for federally backed commercial paper and corporate notes or

bonds.\65\

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

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

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

which permits adjustable rate securities as limited under that

paragraph. As proposed, Regulation 1.25 would have only permitted

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

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

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

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

rulemaking, the Commission has decided not to adopt the proposed

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

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3. Foreign Sovereign Debt

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

foreign country to the extent it has balances in segregated accounts

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

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

Commission proposed to remove foreign sovereign debt as a permitted

investment in the interests of both simplifying the regulation and

safeguarding customer funds in light of

[[Page 78781]]

recent crises experienced by a number of foreign sovereigns. The

Commission requested comment on whether foreign sovereign debt should

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

requirements or limitations might be imposed in order to minimize

sovereign risk.

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

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

the Federal Reserve Bank of Chicago requesting that the Commission

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

foreign sovereign debt of the currency so denominated. The

Commission agreed in its final rule, explaining that an FCM

investing deposits of foreign currencies would be required to

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

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

currency fluctuation risk, unless it incurred the additional expense

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

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Thirteen comment letters discussed foreign sovereign debt. Twelve

of the 13 suggested retaining foreign sovereign debt to varying

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

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

foreign currency exposure as well as the unintended consequences of the

proposal were cited frequently by commenters as reasons to retain

foreign sovereign debt as a permitted investment.

Six commenters discussed the need to mitigate the risks associated

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

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

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

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

mitigate this exposure by investing customer funds in foreign sovereign

debt securities denominated in the relevant currency.\67\

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

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

4.

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The benefits of increased diversification and liquidity were

mentioned by three commenters. FOA and ADM noted that outside

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

financial crisis, in maintaining liquidity and demand in such

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

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

investment in foreign sovereign debt, there are opportunities to add

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

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

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

preserve principal and maintain liquidity.\70\

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

\69\ BlackRock letter at 6.

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

6.

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Several commenters predicted harmful unintended consequences if the

proposal to remove foreign sovereign debt as a permitted investment

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

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

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

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

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

sovereign debt, and would have the unintended consequence of increasing

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

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

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

\71\ CME letter at 3.

\72\ FOA letter at 3.

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

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

Most commenters supported retaining foreign sovereign debt to some

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

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

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

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

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

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

LCH also noted that DCOs have conservative investment policies in place

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

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

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

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

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

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

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

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

explanation.\80\

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

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

\75\ LCH letter at 2.

\76\ Id.

\77\ RJO letter at 6.

\78\ NGX letter at 3.

\79\ ADM letter at 2.

\80\ CIEBA letter at 3.

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The Commission has considered the comments and has decided to adopt

the proposed amendment, thereby eliminating foreign sovereign debt from

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

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

of foreign sovereign debt in the current economic environment and the

varying degrees of financial stability of different issuers make

foreign sovereign debt inappropriate for hedging foreign currency risk.

The Commission also is not persuaded that foreign sovereign debt is

used with sufficient frequency to justify the commenters' claims that

foreign sovereign debt assists with diversification of customer fund

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

other jurisdictions or increased market volatility requires a different

outcome.

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

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

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

global and regional financial crises have illustrated that

circumstances may quickly change, negatively impacting the safety of

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

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

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

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

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

returned to the customer immediately, and an FCM holding illiquid

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

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

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

avoid foreign currency risk by not accepting collateral that is not

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

customer agreement that the customer will bear any currency

exposure.\81\

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\81\ Additionally, the Commission believes that it is

appropriate to note that Regulation 1.25 does not dictate the

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

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

clearing member FCMs, respectively, may continue to post foreign

currency or foreign sovereign debt as collateral.

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Second, the Commission is not persuaded by commenters' assertions

that investment in foreign sovereign debt has increased the

diversification of customer funds in any meaningful way. The Commission

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

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

any commenter suggesting that investment in foreign sovereign debt has

materially increased since the 2007 Review.

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\82\ 75 FR 67642, 67645.

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Third, the Commission does not believe that eliminating foreign

sovereign debt as a permitted investment of customer funds will cause

the market or jurisdictional problems claimed by commenters. As

discussed above, no commenter has demonstrated that foreign sovereign

debt is widely used, so its elimination should not

[[Page 78782]]

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

The foregoing points notwithstanding, the Commission is aware that

FCMs and DCOs have varying collateral management needs and investment

policies. The Commission also recognizes that the safety of sovereign

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

and that investment in certain sovereign debt might be consistent with

the objectives of preserving principal and maintaining liquidity, as

required by Regulation 1.25.

Therefore, the Commission is amenable to considering applications

for exemptions with respect to investment in foreign sovereign debt by

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

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

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

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

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

foreign sovereign debt to petition the Commission pursuant to Section

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

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

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

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

serves to preserve principal and maintain liquidity of customer funds

as required for all other investments of customer funds under

Regulation 1.25.

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

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

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

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

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

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

domiciled outside of the United States.

4. In-house Transactions

The Commission allowed in-house transactions as a permitted

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

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

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

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

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

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

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

that the recent events in the economy underscored the importance of

conducting periodic reassessments and refocused its review of permitted

investments, including in-house transactions.\87\

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\84\ 70 FR 28190, 28193.

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

\86\ 70 FR 28190, 28193.

\87\ 74 FR 23963, 23964.

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

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

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

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

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

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

requested comment on the impact of this proposal on the business

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

commenters present scenarios in which a repurchase or reverse

repurchase agreement with a third party could not be satisfactorily

substituted for an in-house transaction.

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\88\ 75 FR 67642, 67646.

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

Six commenters discussed in-house transactions. Four requested that

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

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

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

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

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

be more than sufficient to assure that the customer segregated account

and the foreign futures and foreign options secured amount are

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

that FCM efficiency relies heavily on in-house transactions,

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

further stated that relying entirely on third party repurchase

agreements will materially increase operational risk in an area where

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

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

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

\90\ MorganStanley letter at 2-3.

Because the in-house transaction can be effected and recorded

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

can be accomplished through automated internal processes that are

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

of third-party repurchase arrangements, which often involve greater

time lags than do in-house transactions between execution and

settlement and also typically require more manual processing than

their in-house counterparts.\91\

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

\91\ Morgan Stanley letter at 2.

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

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

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

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

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

through entities and personnel with whom they have created an

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

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

\92\ MorganStanley letter at 3-4.

\93\ MF Global/Newedge letter at 7.

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

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

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

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

in-house transactions to be satisfactory substitutes for separately

capitalized affiliates or third parties.\95\

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

\94\ RJO letter at 3.

\95\ Id.

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

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

currently are permitted under Regulation 1.25. MorganStanley suggested

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

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

the Commission is determined to eliminate in-house transactions,

raising the proposed concentration limit for reverse repurchase

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

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

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

from the list of permitted investments.\97\

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

\96\ MorganStanley letter at 4.

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

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

Many commenters to the NPRM similarly suggest that the benefits of

repurchase and reverse repurchase agreements can also be realized by

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

funds. The Commission rejects this position. The Commission believes

that in-house transactions are fundamentally different than repurchase

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

reverse repurchase agreement, the transaction is similar to a

collateralized loan whereby customer cash is exchanged for unencumbered

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

agreement is transacted at arms-length (often by

[[Page 78783]]

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

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

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

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

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

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

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

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

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

therefore cannot be legally documented, since an entity cannot contract

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

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

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

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

if a firm entered into a repurchase or reverse repurchase transaction

with an unaffiliated third party, the accounting of that transaction

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

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

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

achieving greater capital efficiency and in accomplishing important

risk management goals, including internal diversification targets.''

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

DCOs with their balance sheet maintenance. The purpose of Regulation

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

that preserves principal and maintains liquidity.

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

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

The Commission reiterates that customer segregation is the

foundation of customer protection in the commodity, futures and swaps

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

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

segregated funds must be invested in a manner which preserves principal

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

the Commission must be vigilant in narrowing the scope of Regulation

1.25 if transactions that were once considered sufficiently safe later

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

the Commission now believes that in-house transactions present an

unacceptable risk to customer segregated funds under Regulation 1.25.

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

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\99\ 17 CFR 1.20.

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

considered to be unacceptably risky may later prove to be

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

circumstances warrant reconsideration of the deletion of paragraph

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

Commission for an amendment in accordance with the procedures set

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

proposed conditions to the listing of in-house transactions as

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

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

entity, potential for conflicts of interest in handling customer

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

to eliminate in-house transactions as permitted investments at this

time.

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

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

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

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

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

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

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

acceptable and are unaffected by the elimination of in-house

transactions.

In addition, the Commission wishes to distinguish in-house

transactions from collateral exchanges for the benefit of the customer.

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

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

discretion of the dually registered entity. However, a dually

registered FCM/broker-dealer receiving customer collateral not

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

collateral for acceptable collateral held by its dually registered

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

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

may also engage in collateral exchanges for the benefit of customers

with affiliates or third parties.

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B. General Terms and Conditions

FCMs and DCOs may invest customer funds only in enumerated

permitted investments ``consistent with the objectives of preserving

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

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

specific requirements designed to minimize credit, market, and

liquidity risk. Among them are requirements that the investment be

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

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

issuer concentration limits. The Commission proposed and has decided to

amend these standards to facilitate the preservation of principal and

maintenance of liquidity by establishing clear, prudential standards

that further investment quality and portfolio diversification and to

remove references to credit ratings. The Commission notes that an

investment that meets the technical requirements of Regulation 1.25,

but does not meet the overarching prudential standard, cannot qualify

as a permitted investment.

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\102\ 17 CFR 1.25(b).

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1. Marketability

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

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

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

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

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

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

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

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

the Commission offered a calculable standard, in which an instrument

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

conclude that, under stable financial conditions, the instrument has

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

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

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

``ready market'').

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

The Commission requested comment on whether the proposed definition

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

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

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

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

alternative ``highly liquid'' standards.

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

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

noted that under the alternative standard, even some Treasuries would

likely fall outside of the scope of permitted investments. No

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

calculable option.

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

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

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

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

Certain commenters requested additional clarification. FIA/ISDA

wrote

[[Page 78784]]

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

the Commission confirm that, in determining whether a security is

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

directly comparable, particularly for those issuers with many classes

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

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

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

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

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

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

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

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\105\ FIA/ISDA letter at 3.

\106\ Id.

\107\ JAC letter at 2.

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

The Commission has considered the comments received and concludes

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

should be removed as it creates an overlapping and confusing standard

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

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

interchangeable concepts, they have distinctly different origins and

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

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

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

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

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

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

securities than debt securities. The Commission is therefore adopting

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

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

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

day, without a material discount in value.

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

determining whether a security which does not trade every day is

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

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

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

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

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

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

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

Regulation 1.25 purposes only. This standard will not be substituted

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

time.

2. Ratings

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

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

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

BlackRock cautioned that complete removal of ratings criteria as a risk

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

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

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

their regulations for references to or requirements of credit

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

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

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

reliance on credit ratings and to substitute in such regulation such

standard of credit-worthiness as each respective agency shall

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

(Nov. 2, 2010).

\109\ BlackRock letter at 2.

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The Commission notes that the removal of references to ratings does

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

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

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

provide a safe harbor for investments that do not satisfy the

objectives of preserving principal and maintaining liquidity.

3. Restrictions on Instrument Features

In the NPRM, the Commission proposed to amend Regulation

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

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

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

to accrued interest earned according to its written terms. Five

commenters discussed restrictions on the instrument features of CDs.

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

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

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

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

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

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

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

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

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

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

suggested that brokered CDs are liquid despite an inactive secondary

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

institutional size transactions. RJO also predicted that this proposal

could severely limit the quantity and quality of banks willing to

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

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

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

CDs to maturity. Id.

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

proposal does not alter Regulation 1.25 with regard to penalties;

therefore the Commission views this concern as unwarranted.

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MF Global/Newedge recommended that brokered CDs remain permitted;

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

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

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

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

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

Commission consider allowing brokered CDs with puts. Such an instrument

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

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

the Commission restrict the allowable issuers of CDs using guidelines

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

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

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

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

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

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

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

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

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

simple interest. CIEBA recommended eliminating investments in both

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

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\113\ MF Global/Newedge letter at 8.

\114\ Id.

\115\ ADM letter at 2.

\116\ Farr Financial letter at 3.

\117\ CIEBA letter at 3.

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The Commission is adopting the proposed amendment to Regulation

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

to only

[[Page 78785]]

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

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

interest earned according to its written terms. The preservation of

customer principal and the maintenance of liquidity are the two

overriding determining factors in the permissibility of a CD for

purposes of Regulation 1.25.

Customer principal can be threatened by market fluctuations and

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

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

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

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

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

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

result in a significant loss of principal. Penalties for early

redemption may cut into customer principal unless such penalties are

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

accrued interest.\118\

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

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

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

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

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

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

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

funds for the purpose of making margin calls.

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

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

issuing bank is an acceptable investment, assuming that the issuing

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

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

of the CD.

4. Concentration Limits

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

concentration limits for direct investments, other than MMMFs, and

securities subject to repurchase or reverse repurchase agreements and

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

asset-based concentration limits for direct investments and a

counterparty concentration limit for reverse repurchase agreements in

addition to amending its issuer-based concentration limits and

rescinding concentration limits applied to in-house transactions.

(a) Asset-Based Concentration Limits

The Commission's proposed asset-based concentration limits would

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

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

held in segregation.

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

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

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

obligations fully guaranteed as to principal and interest by the United

States; a 25 percent concentration limit for TLGP guaranteed commercial

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

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

securities; and a 10 percent concentration limit for interests in

MMMFs.

The Commission requested comment on whether asset-based

concentration limits are an effective means for facilitating investment

portfolio diversification and whether there are other methods that

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

what alternative asset-based concentration limit might be appropriate

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

10 percent, what corresponding issuer-based concentration limit should

be adopted. The Commission also solicited comment on whether MMMFs

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

whether MMMF investments satisfy the overall objective of preserving

principal and maintaining liquidity, the Commission specifically

requested comment on whether changes in the settlement mechanisms for

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

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

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

those MMMFs that have portfolios consisting only of permitted

investments under Regulation 1.25.\121\

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

75 FR at 67646.

\120\ Id.

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

75 FR at 67649.

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Eighteen comment letters discussed MMMFs. The overwhelming majority

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

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

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

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

the activities largely confined to the financial services sector that

precipitated the domino effect of the failure of a large systemically

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

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

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

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

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

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

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

the appropriate concentration limits for MMMFs, and potential problems

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

other comments.

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\122\ ICI letter at 2.

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

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

the enumerated requirements of Regulation 1.25 and at one point was

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

September 2008, called attention to the risk to principal and

potential lack of sufficient liquidity of any MMMF investment.

\124\ Federate I letter at 6.

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

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

approximately 25 percent of the total assets in registered investment

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

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

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

the dollar, respectively).\126\

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

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

6.

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

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

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According to many of the comment letters, the recent enhancements

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

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

heightened credit quality and shortened maturity limits increase

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

cash, Treasuries or securities that

[[Page 78786]]

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

transparency of MMMFs by requiring that MMMFs provide portfolio

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

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

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

market conditions.\128\

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

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

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

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

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

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

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

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

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

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

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

or more other permitted investments. Six commenters averred that MMMFs

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

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

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

MMMFs compared favorably with CDs.\132\

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

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

essay at 8).

\130\ Dreyfus letter at 4.

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

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

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

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Third, many commenters suggested that a 10 percent MMMF limitation

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

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

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

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

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

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

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

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

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

government funds should not be subject to any concentration limits.

Federated also recommended that the Commission require that MMMFs

maintain certain minimum financial thresholds in order to qualify as a

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

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

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

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

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

would have maturities of longer than those required of MMMFs.

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

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

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

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

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

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

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

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

that an overreliance on Treasuries and government securities would

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

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

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

during such a circumstance, FCMs may experience a loss in

principal.\140\

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\133\ CME letter at 6.

\134\ ICI letter at 8.

\135\ Federated III letter at 2-3.

\136\ Dreyfus letter at 2.

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

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

\138\ Farr Financial letter at 2.

\139\ BlackRock letter at 2, 5.

\140\ Id.

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Fourth, several commenters highlighted other potential difficulties

that could result from the proposed 10 percent concentration limit,

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

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

the Commission risks decreasing diversification rather than increasing

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

diversified than the portfolio of bank CDs or municipal securities that

FCMs or DCOs would be permitted to hold under the proposed

amendments.\142\

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\141\ NFA letter at 2.

\142\ ICI letter at 10.

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Three commenters discussed the problems that arise from self-

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

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

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

CDs and municipals require asset management skills that FCMs and DCOs

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

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

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

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

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

difficult to maintain sufficient liquid assets without the use of

MMMFs.\144\

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

3.

\144\ ADM letter at 1.

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

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

implemented, ICI wrote that the changes would allow sellers in tri-

party repurchase agreements to repurchase the underlying securities

later in the afternoon. Previously, such sellers would repurchase

securities in the morning using funds borrowed from their clearing

banks. The proposed changes should not, according to ICI, adversely

affect an MMMF's ability to pay redemptions by the end of each day.

Because the repurchases would occur while the Fedwire system is open,

MMMFs can transfer the proceeds to their transfer agents to cover daily

redemptions.\145\

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\145\ ICI letter at 12.

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The NPRM also requested comment on whether, or to what extent,

MMMFs ought to be limited to Treasury funds. Dreyfus stated that it

would not support such a limitation, as it believes that Government,

prime, and municipal MMMFs are subject to sufficient risk-limiting

constraints that merit their availability to FCMs and DCOs.\146\

Treasury funds are traditionally smaller in size and less liquid than

prime MMMFs, according to FIA/ISDA.\147\ RJO wrote that because

Treasury funds lag interest rate movements for significant periods of

time, they are likely not viable options for FCMs in upward interest

rate environments or over long periods of time.\148\ Taking a different

position, BlackRock suggested that Treasury MMMFs should be exempt from

any asset-based limitations instituted by the Commission.\149\ In

addition, BlackRock recommended that the Commission require investment

decision-makers at FCMs to perform periodic assessments of their MMMF

providers.\150\

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\146\ Dreyfus letter at 2.

\147\ FIA/ISDA letter at 8.

\148\ RJO letter at 8.

\149\ BlackRock letter at 4.

\150\ BlackRock letter at 2, 5.

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CIEBA would support limiting MMMFs to only those funds which invest

in securities that would be permitted investments under Regulation

1.25.\151\ CIEBA did not include further discussion or explanation.

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\151\ CIEBA letter at 3.

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[[Page 78787]]

As noted above, the Commission proposed a 10 percent asset-based

concentration limit for investments in MMMFs. In response to comments,

the Commission has decided to revise the rule language that was

proposed. Specifically, the Commission will impose different

concentration limits for investments in Treasury-only funds than for

investments in all other MMMFs. The Commission also will distinguish

between funds that do not have both $1 billion in assets and a

management company that has at least $25 billion in MMMF assets under

management (small MMMFs) and those that do (large MMMFs). Federated, as

noted above, recommended that asset thresholds for MMMFs be set at $10

billion and $50 billion, respectively. However, the Commission

believes, at this time, that such thresholds may needlessly constrain

the pool of MMMFs available for investment and result in an unsafe

concentration of customer funds in a limited number of MMMFs. The

modifications to the proposed rule text discussed below reflect the

Commission's consideration of the comments received on the proposed

concentration limit for investments in MMMFs, in light of the

overarching objective of preserving principal and maintaining liquidity

of customer funds.

First, an FCM or DCO may invest all of its customer segregated

funds in Treasury-only MMMFs, subject to the limitation on investment

in small MMMFs discussed below. The Commission agrees with commenters

that since an FCM or DCO may invest all of its funds in Treasuries

directly, an FCM or DCO therefore should be able to make the same

investment indirectly via an MMMF.

Second, for all other MMMFs, the Commission believes that a 50

percent asset-based concentration limit is appropriate, subject to the

limitation on investment in small MMMFs discussed below. After

considering the views presented by market participants, Commission

staff and other regulators, the Commission has determined that a 50

percent asset-based concentration limit strikes the right balance

between providing FCMs and DCOs with sufficient Regulation 1.25

investment options and, at the same time, encouraging adequate

portfolio diversification.

MMMFs' portfolio diversification, administrative ease, and the

heightened prudential standards recently imposed by the SEC, continue

to make them an attractive investment option. However, their volatility

during the 2008 financial crisis, which culminated in one fund

``breaking the buck'' and many more funds requiring infusions of

capital, underscores the fact that investments in MMMFs are not without

risk. The Commission is persuaded to increase the proposed asset-based

concentration limit for MMMFs, other than Treasury-only MMMFs, from 10

percent to 50 percent in part by commenters who noted that MMMFs are

safe and liquid relative to other permitted investments.\152\

Commenters were persistent in reminding the Commission that, aside from

Reserve Primary, no MMMFs had ``broken the buck'' during the 2008

financial crisis and aftermath. The Commission is also cognizant that

decreasing the number of investment options might have the unintended

consequence of over-concentrating customer funds into a small universe

of viable investments. Further, these concentration limits provide FCMs

and DCOs with the ability to delegate investment decisions for their

entire portfolio of customer segregated funds to MMMFs, should the FCMs

and DCOs not wish to make such decisions on their own.

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\152\ Although MMMFs allow FCMs and DCOs to indirectly invest in

instruments which would not be permitted under Regulation 1.25 as

direct investments, the Commission believes that the credit quality,

maturity limitations and liquidity required by the SEC make prime

MMMFs acceptable investments, subject to the concentration limits

imposed by paragraph (b)(3).

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To the extent that an FCM or DCO invests customer segregated funds

in an MMMF, subject to the asset-based concentration limits outlined

above, the FCM or DCO may only invest up to 10 percent of its

segregated funds in small MMMFs. The Commission believes that

distinguishing between small MMMFs and large MMMFs is a necessary

corollary to increasing the concentration limits proposed in the NPRM,

since large MMMFs have capital bases better capable of handling a high

volume of redemption requests in the event of a market event. To the

extent that an FCM or DCO invests customer segregated funds in small

MMMFs, the 10 percent asset-based concentration limit in the final rule

is unchanged from the concentration limit set forth in the NPRM.

However, having considered the comments received on this issue, the

Commission has determined it appropriate to elevate the asset-based

concentration limits from what had been proposed--both for Treasury-

only MMMFs and for all other MMMFs--to the extent that an FCM or DCO

invests in large MMMFs.

Accordingly, the Commission is amending Regulation 1.25 by adding

new paragraphs (b)(3)(i)(E)-(G), which implement the changes described

above. The addition of these paragraphs enables the Commission to

increase the concentration limits originally proposed without

undermining the protection of customer funds and reduction of systemic

risk, while addressing the concerns specifically raised in the

comments.

The Commission has concluded that all other asset-based

concentration limits remain as proposed in the NPRM. The 50 percent

asset-based limitation on U.S. agency obligations \153\ and the 25

percent asset-based limitation on each of TLGP corporate notes or bonds

and TLGP commercial paper,\154\ are consistent with commenter

recommendations. Therefore, the Commission is amending Regulation

1.25(b)(3)(i), as proposed, to reflect the asset-based concentration

limits described above.

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\153\ See Section II.A.1. CME recommended 25 percent, BlackRock

recommended 30 percent, and FIA/ISDA and MF Global/Newedge both

recommended 50 percent.

\154\ See Section II.A.2. MF Global/Newedge recommended 25

percent and BlackRock recommended 25 percent-50 percent. The

Commission is aware that MF Global/Newedge's recommendation was for

all corporate notes or bonds and commercial paper--not merely those

which are TLGP debt. Regardless, such a recommendation is helpful in

establishing a percentage that will allow for ample investment in

instrument categories while still promoting diversification.

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With respect to the calculation of concentration limits, ADM wrote

that concentration limits should be calculated by aggregating

Regulation 1.25 funds and 30.7 funds.\155\ ADM explained, by way of

example, that if there is a 50 percent concentration limit for

investment X, along with $5 billion in the segregated account and $1

billion in the 30.7 account, that the maximum amount that could be

invested in X would be $3 billion. From this comment, the Commission

concludes that ADM would like the choice of investing up to 60 percent

of its segregated account funds in investment X, as long as that

amount, when combined with the size of the 30.7 account, does not

exceed 50 percent of the cumulative size of the segregated and 30.7

account. However, the Commission has determined that concentration

limits are to be calculated on a fund-by-fund basis. In the example

above, the maximum amount of segregated funds that could be invested in

X would be $2.5 billion, and the maximum amount of 30.7 funds that

could be invested in X would be $0.5 billion. ADM presented no

compelling argument as to why the aggregation of

[[Page 78788]]

funds held in Regulation 1.25 and 30.7 accounts should be permitted.

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

\155\ ADM letter at 2.

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(b) Issuer-Based Concentration Limits

The Commission proposed to amend its issuer-based limits for direct

investments to include a 2 percent limit for an MMMF family of funds,

expressed as a percentage of total assets held in segregation.

Currently, there is no concentration limit applied to MMMFs. Under the

NPRM, the 25 percent issuer-based limitation for GSEs (now proposed to

be encompassed within the term ``U.S. agency obligations'') and the 5

percent issuer-based limitation for municipal securities, commercial

paper, corporate notes or bonds, and CDs would remain in place.

Commenters expressed doubts over whether issuer-based concentration

limits, on individual or families of MMMFs, would have a meaningful,

positive effect on the safety of customer funds. Adverse market

conditions would probably affect all funds, according to ICI, and

therefore issuer concentration limits would do little to mitigate these

risks.\156\

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\156\ ICI letter at 11.

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BlackRock, ICI and Dreyfus suggested that limits on family of funds

may not achieve increased safety of customer funds as each MMMF in a

family is managed on an individual basis and will not necessarily share

risks with other MMMFs managed by the same adviser. Dreyfus wrote that

it sees ``no benefit * * * to requiring FCMs to have to potentially

invest in a [prime MMMF] with one provider and a [government or

Treasury MMMF] with another provider, on the basis that such an

arrangement is safer than if the FCM invested in each of these types of

funds with a single provider.'' \157\ BlackRock also noted that MMMF

complexes do not typically aggregate and publish consolidated family

data on a daily basis.\158\

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

\157\ Dreyfus letter at 5. See also ICI letter at 10.

\158\ BlackRock letter at 4.

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

Commenters also questioned the effectiveness of issuer-based

limitations on individual funds. Dreyfus asserted that the operations

and results of one fund do not impact the operation and results of

another fund.\159\ ICI propounded that similar types of MMMFs often

have common holdings. Thus, according to ICI, limiting investments in

individual funds will have a marginal effect on the diversification of

underlying credit risks.\160\

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\159\ Dreyfus letter at 5.

\160\ ICI letter at 10-11.

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Taken as a whole, these arguments, that concentration limits will

not increase the safety of customer funds, are untenable. The

commenters assert that neither family-of-funds limits nor issuer-based

limits will increase the diversification and safety of customer funds.

If believed, this leads to the conclusion that it would be safer and

more diverse (or at least as safe and diverse) for an FCM, investing

the maximum amount in MMMFs, to invest all customer cash in one fund

than it would be for that FCM to invest that customer cash among five

funds in three families. As such, the Commission is not persuaded by

the arguments.\161\

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\161\ In response to Dreyfus and ICI's comment regarding limits

on family of funds, the Commission believes that a failure of, or a

run on, an individual fund would likely cause a run on other funds

in the family due to investors' reputational concerns.

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The Commission has considered the comments received on this issue,

and is mindful of the comments and Commission analysis of the asset-

based concentration limits discussed in the preceding section. Having

considered the arguments raised, the Commission has decided to revise

the rule language that was proposed. Specifically, the Commission has

determined that there will be no family-of-funds or issuer-based

concentration limit for MMMFs that consist entirely of Treasuries, and

a 25 percent family of funds issuer-based limitation as well as a 10

percent individual fund issuer-based limitation for all other MMMFs.

Investments in Treasury-only funds are not to be combined with

investments in other MMMFs for purposes of calculating either family-

of-funds or issuer-based concentration limits. The increase in the

family of funds issuer-based concentration limit is related to the

increase in the asset-based concentration limit and addresses the

recommendations of commenters. The introduction of the 10 percent

individual fund issuer-based concentration limit serves to add an

additional layer of diversification and also aligns with

recommendations of commenters.

(c) Counterparty Concentration Limits

In the NPRM, the Commission proposed a counterparty concentration

limit of 5 percent of total assets held in segregation for securities

subject to reverse repurchase agreements. Seven commenters discussed

counterparty concentration limits. All expressed their belief that the

5 percent concentration limit was too low and that such a limit would

greatly increase administrative risks and costs. Most commenters

favored a 25 percent concentration limit, in the event that a

concentration limit was imposed.

FIA/ISDA, LCH, MF Global/Newedge, J.P. Morgan and RJO expressed

similar views that a 5 percent concentration limit might actually

decrease liquidity and increase operational and systemic risk. LCH and

MF Global/Newedge wrote that a counterparty concentration limit would

unnecessarily restrict a very liquid and secure investment that has

provided flexibility and reasonable returns to FCMs and their

customers.\162\ According to FIA/ISDA, because clearing members are

often required to execute and unwind reverse repurchase agreements

intraday and within a brief period of time, and because DCOs strictly

define the securities they will accept as collateral, an FCM must

review the securities received under reverse repurchase transactions to

ensure that they are both eligible for delivery to the DCO and in

compliance with applicable concentration limits.\163\ Several

commenters observed that requiring an FCM to effect reverse repurchase

transactions with multiple counterparties under tight time frames will

substantially increase an FCM's operational risk and invite

errors.\164\ By way of example, INTL/FCStone noted that it currently

has one counterparty and would potentially need to open 20 reverse

repurchase accounts were the proposed rule enacted.\165\ Further, two

commenters wrote that a critical factor to consider is that, in the

event of a counterparty's default, all amounts are collateralized with

permitted investments under Regulation 1.25.\166\

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\162\ LCH letter at 3, MF Global/Newedge letter at 6.

\163\ FIA/ISDA letter at 9-10.

\164\ FIA/ISDA letter at 9-10, MF Global/Newedge letter at 7,

J.P. Morgan letter at 2, LCH letter at 3, RJO letter at 3.

\165\ INTL/FCStone at 2.

\166\ LCH letter at 3, MF Global/Newedge letter at 7.

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INTL/FCStone \167\ and FIA/ISDA \168\ recommended a 25 percent

counterparty concentration limit. RJO wrote that limits are

unnecessary--however if a limit were imposed, RJO recommended 25

percent.\169\ LCH suggested a 10 percent-20 percent limitation.\170\ MF

Global/Newedge recommended having no counterparty limits; however to

the extent that there must be, it recommended (a) limiting FCM

repurchase and reverse repurchase transactions to those external

counterparties maintaining a certain level of capital (such as $50 or

$100

[[Page 78789]]

million) or (b) setting counterparty concentration limits at 25

percent.\171\ ADM wrote that it does not believe any concentration

limit is necessary due to the collateralized nature of the loans.\172\

However, ADM stated that it would support only allowing certain

collateral, such as Treasuries and GSEs, in repurchase

transactions.\173\

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\167\ INTL/FCStone at 2.

\168\ FIA/ISDA letter at 10.

\169\ RJO letter at 3.

\170\ LCH letter at 3.

\171\ MF Global/Newedge letter at 7.

\172\ ADM letter at 2.

\173\ Id.

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As noted above, the Commission proposed a 5 percent counterparty

concentration limit in the NPRM. Having considered the comments

submitted in response to the proposal, the Commission has determined

that a 25 percent counterparty concentration limit is appropriate.

The Commission continues to believe that counterparty concentration

limits are necessary for safeguarding customer funds. Under current

rules, an FCM or DCO could have 100 percent of its segregated funds

subject to one reverse repurchase agreement. The obvious concern in

such a scenario is the credit risk of the counterparty. This credit

risk, while concentrated, is significantly mitigated by the fact that

in exchange for cash, the FCM or DCO is holding Regulation 1.25-

permitted securities of equivalent or greater value. However, a default

by the counterparty would put pressure on the FCM or DCO to convert

such securities into cash immediately and would exacerbate the market

risk to the FCM or DCO, given that a decrease in the value of the

security or an increase in interest rates could result in the FCM or

DCO realizing a loss. Even though the market risk would be mitigated by

asset-based and issuer-based concentration limits, a situation of this

type could seriously jeopardize an FCM or DCO's overall ability to

preserve principal and maintain liquidity with respect to customer

funds.

The Commission is persuaded to increase the limit, from the

proposed level of 5 percent in the NPRM to 25 percent, primarily due to

comments expressing concern about the administrative costs and burdens

of a low counterparty concentration limit. Whereas a 5 percent

limitation would require an FCM reverse-repurchasing all of its

customer cash to have 20 counterparties, a 25 percent limitation

decreases the number of counterparties to four. Further, 25 percent is

in line with commenter recommendations, which ranged from 10 to 25

percent.\174\

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\174\ As noted above, certain commenters wished to have no

counterparty concentration limits, a position with which the

Commission does not agree.

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C. Money Market Mutual Funds

The Commission has decided to make two technical amendments to

paragraph (c) of Regulation 1.25. First, the Commission is clarifying

the acknowledgment letter requirement under paragraph (c)(3); and

second, the Commission is revising and clarifying the exceptions to the

next-day redemption requirement under paragraph (c)(5)(ii).

1. Acknowledgment Letters

In the NPRM, the Commission sought to clarify that the intent of

Regulation 1.25(c)(3) is to require that an FCM or DCO obtain an

acknowledgment letter from a party that has substantial control over a

fund's assets and has the knowledge and authority to facilitate

redemption and payment or transfer of the customer segregated funds

invested in shares of the MMMF. The Commission concluded that in many

circumstances, the fund sponsor, the investment adviser, or fund

manager would satisfy this requirement. The Commission also proposed to

remove the current language in Regulation 1.25(c)(3) relating to the

issuer of the acknowledgment letter when the shares of the fund are

held by the fund's shareholder servicing agent. This revision was

designed to eliminate any confusion as to whether the acknowledgment

letter requirement is applied differently based on the presence or

absence of a shareholder servicing agent.

The Commission requested comment on whether the proposed standard

for entities that may sign an acknowledgment letter is appropriate and

whether there are other entities that could serve as examples. The

Commission requested comment on whether removal of the ``shareholder

servicing agent'' language helps clarify the intent of Regulation

1.25(c)(3).

Three commenters discussed this proposal. CME, BBH and FIA/ISDA

support the proposal, and FIA/ISDA and BBH had additional comments and

suggested changes as well.\175\

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\175\ CME letter at 7, FIA/ISDA letter at 13, BBH letter at 2.

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BBH and FIA/ISDA requested that the Commission confirm that, in

those circumstances in which an FCM deposits customer funds with a bank

or other depository and thereafter instructs the bank to invest such

customer funds in an MMMF, the bank is the appropriate entity from

which the FCM should obtain the acknowledgment letter.\176\ BBH

explained that such settlement banks are ``universally recognized, both

by regulation and standard contractual terms, as an entity that

exercises legitimate control and authority over assets deposited both

directly with it or held in an account at a third party depository or

fund.'' \177\

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\176\ BBH letter at 2, FIA/ISDA letter at 13.

\177\ BBH letter at 2.

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The Commission is amending Regulation 1.25(c)(3) to reflect that an

FCM or DCO must obtain an acknowledgment letter from a party that has

substantial control over MMMF shares purchased with customer segregated

funds and has the knowledge and authority to facilitate redemption and

payment or transfer of the customer segregated funds invested in shares

of the MMMF and is removing the current language in Regulation

1.25(c)(3) relating to the issuer of the acknowledgment letter when the

shares of the fund are held by the fund's shareholder servicing agent.

In response to FIA/ISDA and BBH, the Commission agrees that when an FCM

deposits customer funds in a bank or other depository and thereafter

instructs the depository to invest such customer funds in an MMMF, the

acknowledgment letter may come from the depository if it is acting as a

custodian for the fund shares owned by the FCM or DCO. The Commission

therefore clarifies in the rule text that a ``depository acting as

custodian for fund shares'' is an appropriate entity to issue an

acknowledgment letter.

2. Next-Day Redemption Requirement

Regulation 1.25(c) requires that ``[a] fund shall be legally

obligated to redeem an interest and to make payment in satisfaction

thereof by the business day following a redemption request.'' \178\

This ``next-day redemption'' requirement is a significant feature of

Regulation 1.25 and is meant to ensure adequate liquidity.\179\

Regulation 1.25(c)(5)(ii) lists four exceptions to the next-day

redemption requirement, and incorporates by reference the emergency

conditions listed in Section 22(e) of the Investment Company Act

(Section 22(e)).\180\ The Commission has, on occasion, fielded

questions from FCMs regarding Regulation 1.25(c)(5), particularly

because the exceptions listed in paragraph (c)(5)(ii) overlap with some

of those appearing in Section 22(e).

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\178\ 17 CFR 1.25(c)(5)(i).

\179\ See 70 FR 5585 (noting that ``[t]he Commission believes

the one-day liquidity requirement for investments in MMMFs is

necessary to ensure that the funding requirements of FCMs will not

be impeded by a long liquidity time frame'').

\180\ 15 U.S.C. 80a-22(e).

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[[Page 78790]]

In order to expressly incorporate SEC Rule 22e-3 into the permitted

exceptions for purposes of clarity, and to otherwise clarify the

existing exceptions to the next-day redemption requirement, the

Commission proposed to amend paragraph (c)(5)(ii) of Regulation 1.25 by

more closely aligning the language of that paragraph with the language

in Section 22(e) and specifically including a reference to Rule 22e-3.

The Commission proposed to include, as an appendix to the rule text

(Regulation 1.25 Appendix), safe harbor language that could be used by

MMMFs to ensure that their prospectuses comply with Regulation

1.25(c)(5).

The Commission requested comment on all aspects of its proposed

amendments to the provisions regarding MMMFs in paragraph (c) of

Regulation 1.25. The Commission sought comment specifically on any

proposed regulatory language that commenters believe requires further

clarification. In addition, commenters were invited to submit views on

the usefulness and substance of the proposed safe harbor language

contained in the proposed Regulation 1.25 Appendix.

Only one commenter, ICI, mentioned this aspect of the NPRM. ICI

supported this proposal to clarify exemptions from next-day redemption

and to include safe harbor language.\181\ Therefore, the Commission

amends paragraph (c)(5)(ii) of Regulation 1.25 by more closely aligning

the language of that paragraph with the language in Section 22(e) and

specifically including a reference to Rule 22e-3. The Commission is

also adding the Regulation 1.25 Appendix to the rule text, in order to

provide MMMFs with safe harbor language to ensure that their

prospectuses comply with Regulation 1.25(c)(5).

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\181\ ICI letter at 11.

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D. Repurchase and Reverse Repurchase Agreements

The Commission proposed specifically eliminating repurchase and

reverse repurchase transactions with affiliate counterparties.

Repurchase and reverse repurchase transactions are functionally similar

to collateralized loans, whereby cash is exchanged for unencumbered

collateral. In the NPRM, the Commission explained its view that the

concentration of credit risk increases the likelihood that the default

of one party could exacerbate financial strains and lead to the default

of its affiliate. The Commission used the example of Bear Stearns

Companies, Inc. (Bear Stearns) in 2008 \182\ to illustrate that even

possession and control of liquid securities may be insufficient to

alleviate concerns relating to transactions with financially troubled

affiliated counterparties.

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\182\ See SEC Press Release No. 2008-46, ``Answers to Frequently

Asked Investor Questions Regarding the Bear Stearns Companies,

Inc.'' (Mar. 18, 2008), available at http://www.sec.gov/news/press/2008/2008-46.htm (noting that rumors of liquidity problems at Bear

Stearns caused their counterparties to become concerned, creating a

``crisis of confidence'' which led to the counterparties'

``unwilling[ness] to make secured funding available to Bear Stearns

on customary terms'').

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The Commission received four comment letters discussing this topic.

CME and FIA/ISDA both suggested that FCMs have much greater certainty

and are exposed to substantially less counterparty risk to the extent

that they enter into transactions with affiliates.\183\ FIA/ISDA stated

that funds held in affiliate accounts are at no greater risk in the

event of a default than they would be in the event of a default of a

non-affiliate. In both cases, the requirements of Regulation 1.25(d)

are the same. Further, FIA/ISDA wrote that the Bear Stearns example

used by the Commission in the NPRM relates to Bear Stearns' abilities

to enter into agreements with third parties, not its affiliates.\184\

RJO noted that affiliates should be judged as acceptable if the

affiliate meets or exceeds the capital base or some other methodology

deemed satisfactory for adding an arms-length counterparty.\185\ MF

Global/Newedge wrote that removing repurchase agreements with

affiliates would not reduce FCM risk, ``since FCMs would be unable to

enter into and execute such transactions with and through entities and

personnel with whom they have created an effective, efficient and

liquid settlement framework.'' \186\

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\183\ CME letter at 3, FIA/ISDA letter at 9-11.

\184\ FIA/ISDA letter at 10-11.

\185\ RJO letter at 4.

\186\ MF Global/Newedge letter at 7.

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The Commission is not persuaded by these comments. In particular,

while the Commission acknowledges that affiliates have a legal status

that may distinguish such transactions from in-house transactions, the

concentration of credit risk and the potential for conflicts of

interest during times of crisis remain significant concerns. Indeed,

the Commission's reference to Bear Stearns in the preamble was intended

to serve as an illustration of how an elevated concentration of credit

risk may produce broad, unforeseen consequences.

Further, as discussed in the NPRM, the interest of consistency of

the regulation weighs in favor of disallowing repurchase agreements

between affiliates. The Commission finds it incongruous that an

investment in the debt instrument of an affiliate (effectively a

collateralized loan between affiliates) could be prohibited by

paragraph (b)(6) while a repurchase agreement between affiliates (which

is the functional equivalent of a short-term collateralized loan

between affiliates) could be allowed.

Finally, the Commission believes that firms engage in repurchase

agreements with affiliates for purposes of balance sheet maintenance.

Repurchase agreements with affiliates may cause a consolidated balance

sheet to appear smaller than it would if the same transaction occurred

with an unaffiliated third party because such transactions, while they

may appear on sub-ledgers, are typically eliminated on the consolidated

balance sheet. While FCMs and DCOs may prefer to use such transactions

to manage their balance sheets, as mentioned in the context of in-house

transactions in Section II.A.4 of this release, the purpose of

Regulation 1.25 is not to assist FCMs and DCOs with managing their

balance sheets. Rather, the purpose of Regulation 1.25 is to permit

FCMs and DCOs to invest customer funds in a manner that preserves

principal and maintains liquidity. Because of the concerns expressed

above, particularly with respect to the potential for conflicts of

interest, the Commission believes that the interests of protecting

customer funds are best served by eliminating repurchase agreements

with affiliates. Therefore, the Commission is amending paragraph (d) as

proposed.\187\

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\187\ See supra n. 100 (discussing petition procedures set forth

in Regulation 13.2, 17 CFR 13.2).

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E. Regulation 30.7

1. Harmonization

In the NPRM, the Commission proposed to harmonize Regulation 30.7

with the investment limitations of Regulation 1.25 by adding new

paragraph (g) to Regulation 30.7. As noted above, the Commission had

not previously restricted investments of 30.7 funds to the permitted

investments under Regulation 1.25, although Regulation 1.25 limitations

can be used as a safe harbor for such investments.\188\

[[Page 78791]]

The Commission now believes that it is appropriate to align the

investment standards of Regulation 30.7 with those of Regulation 1.25

because many of the same prudential concerns arise with respect to both

segregated customer funds and 30.7 funds. Such a limitation should

increase the safety of 30.7 funds and provide clarity for the FCMs,

DCOs, and designated self-regulatory organizations. Two comment

letters, from JAC and FIA/ISDA discussed this subject and both

supported the amendment.

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\188\ See Commission Form 1-FR-FCM Instructions at 12-9 (Mar.

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

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

obligations to customers and the requirement that the secured amount

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

cover all obligations to such customers. Regulation 1.25 investments

would be appropriate, as would investments in any other readily

marketable securities.'').

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2. Ratings

In the NPRM, the Commission proposed to remove all rating

requirements from Regulation 30.7. This amendment is required by

Section 939A of the Dodd-Frank Act and further reflects the

Commission's views on the unreliability of ratings as currently

administered and its interest in aligning Regulation 30.7 with

Regulation 1.25.\189\ The Commission requested comment on this proposal

including whether there existed any sound alternatives to credit

ratings.

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\189\ See supra Section II.B.2 regarding the Commission's policy

decision to remove references to credit ratings from Regulation 1.25

and other regulations.

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One comment letter, from FIA/ISDA, discussed the topic and

supported the proposal. No comments provided an alternative to credit

ratings. As proposed, the Commission is removing paragraph

(c)(1)(ii)(B) of Regulation 30.7 as it views a nationally recognized

statistical rating organization (NRSRO) rating as unreliable to gauge

the safety of a depository institution for 30.7 funds. This change also

serves to align Regulation 30.7 with Regulation 1.25 on the topic of

NRSROs.

3. Designation as a Depository for 30.7 Funds

As proposed, the Commission will no longer allow a customer to

request that a bank or trust company located outside the United States

be designated as a depository for 30.7 funds. Previously, under

Regulation 30.7(c)(1)(ii)(C), a bank or trust company that did not

otherwise meet the requirements of paragraph (c)(1)(ii) could still be

designated as an acceptable depository by request of its customer and

with the approval of the Commission. However, the Commission never

allowed a bank or trust company located outside the United States to be

a depository through these means, and has decided that it is

appropriate to require that all depositories meet the regulatory

capital requirement under paragraph (c)(1)(ii)(A).

FIA/ISDA and ADM both supported this amendment in their comment

letters. Based on the foregoing, the Commission is amending Regulation

30.7, as proposed, by deleting paragraph (c)(1)(ii)(C).

4. Technical Amendments

JAC recommended reinserting ``foreign board of trade'' in

Regulation 30.7(c)(1), believing it was inadvertently omitted in

February of 2003.\190\ The Commission agrees that the February 2003

Federal Register final rule notice contained a clear administrative

error, and to address that administrative error, the Commission is

reinserting ``[t]he clearing organization of any foreign board of

trade'' in the rule text as new paragraph (c)(1)(v) and renumbering

subsequent paragraphs accordingly.\191\

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\190\ JAC letter at 2.

\191\ Prior to 2003, Regulation 30.7(c) permitted an FCM to

maintain 30.7 funds in, among other depositories, ``[t]he clearing

organization of any foreign board of trade.'' ``Foreign Futures and

Foreign Options Transactions,'' 52 FR 28980, 29000 (Aug. 5, 1987).

In 2002, the Commission requested comment, in an NPRM, on whether

the list of depositories enumerated in Regulation 30.7(c) should be

expanded. ``Denomination of Customer Funds and Location of

Depositories,'' 67 FR 52641, 52645 (Aug. 13, 2002). The Commission

determined it appropriate to expand the list; however, in publishing

the final rule, the Commission inadvertently failed to include

``[t]he clearing organization of any foreign board of trade'' on the

list. See ``Denomination of Customer Funds and Location of

Depositories,'' 68 FR 5545, 5550 (Feb. 4, 2003) (``Rule 30.7 will be

amended to provide that the funds of foreign futures or options

customers may, in addition to those depositories already enumerated

* * *.'' (emphasis added)). The technical amendment set forth in

this notice corrects that administrative error.

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F. Implementation.

RJO, FIA/ISDA, CME, JAC and NFA suggest a phased implementation

period of 180 days.\192\ The Commission has determined to allow an

implementation period of 180 days following the publication of the

final rules.

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\192\ CME letter at 7, JAC letter at 3, FIA/ISDA letter at 13,

NFA letter at 3, RJO letter at 3.

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III. Cost Benefit Considerations

Section 15(a) of the Act requires the Commission to consider the

costs and benefits of its action before promulgating a regulation.\193\

In particular, costs and benefits must be evaluated in light of five

broad areas of market and public concern: (1) Protection of market

participants and the public; (2) efficiency, competitiveness, and

financial integrity of futures markets; (3) price discovery; (4) sound

risk management practices; and (5) other public interest

considerations. The Commission may in its discretion give greater

weight to any one of the five enumerated areas, depending upon the

nature of the regulatory action.

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\193\ 7 U.S.C. 19(a).

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Section 4d of the Act \194\ limits the investment of customer

segregated funds to obligations of the United States and obligations

fully guaranteed as to principal and interest by the United States

(U.S. government securities), and general obligations of any State or

of any political subdivision thereof (municipal securities). The

Commission has exercised its authority to grant exempt relief under

Section 4(c) of the Act to permit additional investments beyond those

prescribed in Section 4d. Regulation 1.25 sets out the list of

permissible investments, which the Commission has expanded

substantially over the years.\195\ As detailed in the discussion above,

the final rules narrow the scope of investment choices in order to

reduce risk and to increase the safety of Regulation 1.25 investments,

consistent with the statute. Further, certain changes to the rule

relating to the elimination of credit ratings are mandated by Section

939A of the Dodd-Frank Act.

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\194\ 7 U.S.C. 6(d).

\195\ 7 U.S.C. 6(c).

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FCMs currently hold over $170 billion in segregated customer funds

and $40 billion in funds held subject to Regulation 30.7.\196\ The

funds are held as performance bond for the purpose of meeting margin

calls and Commission regulations allow these funds to be invested by

the FCMs and DCOs in enumerated investments subject to various

restrictions. Through this rulemaking, the Commission has determined

that certain investments are no longer permitted as they may not

adequately meet the statute's paramount goal of protecting customer

funds.

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\196\ Based on CFTC data as of April 30, 2011. See CFTC Web

site, Market Reports, Financial Data for FCMs at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

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The Commission recognizes that restricting the type and form of

permitted investments could result in certain FCMs and DCOs earning

less income from their investments of customer funds. The Commission is

unable to determine the magnitude of such income reduction, if any,

because information was not provided to allow the Commission to

estimate any such income reduction. No commenter provided information

about the composition of the portfolio in which customer segregated

funds are invested.

[[Page 78792]]

As noted above, the list of permitted investments under the rules,

notwithstanding the restrictions instituted herein, still represent a

significantly wider selection of investment options than those

permitted by the Act. Further, in most cases, the amended rules allow

for investment in many of the same instruments as previously permitted,

subject to asset-based and issuer-based concentration limits.

In issuing these final rules, the Commission has considered the

costs and benefits of each aspect of the rules, as well as alternatives

to them. In addition, the Commission has evaluated comments received

regarding costs and benefits in response to its proposal.\197\ Where

quantification has not been reasonably estimable due to lack of

necessary underlying information, the Commission has considered the

costs and benefits of the final rules in qualitative terms.\198\

Generally, as discussed more specifically below with respect to the CEA

section 15(a) factors, the Commission believes that the restrictions on

segregated customer funds and Regulation 30.7 fund investments promote

important benefits. These include greater security for customer funds

and enhanced stability for the financial system as a whole.

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\197\ The commenters cost/benefit concerns fall in two

categories, summarized below with the Commission's corresponding

response.

Potentially reduced investment income may cause

increases in customer fee. Some public commenters suggested that a

loss of investment income on customer segregated funds and those

funds held pursuant to Regulation 30.7 potentially attributable to

the rules' investment choice limitations, might incentivize FCMs and

DCOs to raise customer fees to make up for reduced investment

income. No objective evidence was provided to predict the likelihood

of this speculated outcome. The Commission believes that the

corresponding benefit--i.e., substantially reduced risk and greater

protection of customer segregated funds--justifies this speculative

cost, particularly given that the purpose of the segregated funds is

not investment income, but customer fund protection. Moreover, as

discussed herein, two factors mitigate the magnitude of concern for

the significance of any such a potential income reduction. First,

under the final rules, most asset classes are still available to

managers and are only subject to concentration limits. All other

types of investments remain permitted, including Treasuries,

municipals, other U.S. agency obligations, foreign sovereign debt

and MMMFs. Second, the comment letters do not specify how

extensively FCMs and DCOs actually directly invest in those assets

classes the rules will exclude. Rather, comments expressing that

limitations on direct investments in MMMFs would occasion extra cost

and additional investment expertise, suggest that FCMs and DCOs have

eschewed investment in these products, at least to some degree.

Potentially increased portfolio management costs.

Multiple commenters focused on the additional expense FCMs and DCOs

might incur to acquire additional investment staff and expertise

needed to manage portfolios under the new rules. Particular areas of

concern related to the investment process in light of the removal of

credit ratings from that process and portfolio management subject to

the percentage limitations with regard to asset-type, issuer, and

counterparty. Removal of credit ratings is not within Commission

discretion. Moreover, the Commission believes the burden of on-

boarding and risk managing additional counterparties, as well as the

tracking of investments across more issuers, are offset by the

benefit of increased portfolio diversification and more limited

exposure to large credit and counterparty risk profiles.

\198\ In the NPRM, the Commission invited the public ``to submit

any data or other information that may have quantifying or

qualifying the costs and benefits of the Proposal with their comment

letters.'' The Commission received no such quantitative data or

information with respect to these rules.

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A discussion of the costs and benefits of this rule and the

relevant comments is set out immediately below. The remainder of this

Section III considers the costs and benefits of this rule under Section

15(a) of the CEA, organized by (i) impact on each class of permitted

investment, (ii) certain other limitations on permitted investments,

and (iii) Regulation 30.7.

Municipal Securities

Municipal securities are permitted investments pursuant to the Act.

For the reasons discussed above, the final rule restricts the

percentage of total customer segregated funds that may be held by an

FCM or DCO in municipal securities to 10 percent. This is in addition

to the 5 percent limitation of total customer segregated funds that

previously existed for the investment in the municipal securities of

any individual issuer.

The Commission has determined that the overall benefits of the

concentration limitations for municipal securities and the resultant

portfolio risk reductions--as compared to those without such

limitations--are compelling, notwithstanding any related costs.

(1) Protection of Market Participants and the Public

The public has a strong interest in the stability of the nation's

financial system, a goal of the Dodd-Frank Act. The new asset-based

concentration limitation for municipal securities will protect market

participants and the public by limiting losses to customer segregated

funds in the event of a crisis in the municipal bond markets.

The Commission believes that such restrictions are appropriate and

will benefit the public and market participants by safeguarding

customer funds.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that this rule promotes market efficiency,

competitiveness and financial integrity in an important way. Imposing

portfolio concentration limits lowers the risk of FCMs and DCOs

suffering losses and/or being unable to liquidate assets to meet margin

calls. This type of liquidity loss may operate to undermine market

integrity and public confidence in the absence of this rule. While

there may be some potential for ``forced sale'' losses for FCMs and

DCOs on investments that may now be subject to restrictions, the

Commission cannot gauge the magnitude and believes that it has taken

measures appropriate to the circumstances to mitigate any potential

costs. More specifically, the Commission is not in a position to know,

with any precision, the portfolio holdings of FCMs and DCOs with

respect to municipal securities, nor can the Commission predict the

prevailing market conditions if FCMs and DCOs must sell municipal

securities. Consequently, the Commission cannot quantify this cost.

Further, as mentioned above, the Commission does not believe that FCMs

or DCOs invest heavily in municipal securities, so ``forced sales,'' if

necessary, should be of little impact. However, to reduce any potential

impact, slight though it may be, the rules allow for a 180 day phase-in

period, giving FCMs and DCOs ample time to adjust their portfolios to

the extent necessary to comply with the regulations. Since municipal

securities remain eligible investments for FCMs and DCOs and may be

held either directly or indirectly through MMMFs,\199\ the Commission

believes that any potential impact on municipal securities markets

generally also should be mitigated. Accordingly, the Commission

believes that the significant benefits of having portfolios less

concentrated in municipal securities justify any cost, as mitigated

under the rules.

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\199\ These investments, of course, remain subject to the

``highly liquid'' requirement in these rules. To be a permitted

investment, a municipal security must have the ability to be

converted into cash within one business day, without a material

discount in value.

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(3) Price Discovery

The Commission has considered the restrictions on municipal

securities and has determined that the final rules should not have an

impact on price discovery.

(4) Sound Risk Management Practices

As previously noted, the rules enhance risk management practices by

reducing vulnerability to municipal securities defaults by the

introduction of additional investment restrictions in the

[[Page 78793]]

form of asset-based concentration limits. However, given that the list

of permitted investments remains relatively unchanged and that there is

believed to be little investment in municipal securities at this time,

there should be little or no additional resources required to comply

with the final rule and the existing risk management strategies and

systems should be largely unaffected.

(5) Other Public Interest Considerations

The greatest potential impact of this rule on public interest

considerations stem from the increased stability of the financial

system as a whole. The inclusion of asset-based concentration limits

for municipal securities contributes to financial stability by

encouraging sound investment strategies for customer segregated funds.

For FCMs and DCOs, the expenses associated with managing within these

limitations and the potential for reduced investment return

opportunities are costs. As discussed above, municipal securities are

not a widely used investment, however. Further, as a general matter,

FCMs and DCOs still have a great deal of flexibility and the Commission

believes that any added expense associated with a more active

management of the investment portfolios should be minor relative to the

benefits fostered.

U.S. Agency Obligations

U.S. agency obligations will continue to be permitted investments

pursuant to the Commission's authority under Section 4(c), subject to

certain restrictions under the rules. In addition to the existing 25

percent limitation on the securities of any single U.S. agency being

held with customer segregated funds, the new rules limit this asset

class in aggregate to 50 percent of the total customer segregated funds

held by the FCM or DCO. The rules also condition investment in debt

issued by Fannie Mae and Freddie Mac only while these entities are

operating under the conservatorship or receivership of the FHFA.

(1) Protection of Market Participants and the Public

In response to concerns regarding the safety of GSE debt

securities, highlighted by the 2008 failures of both Fannie Mae and

Freddie Mac, these additional restrictions are designed to protect

market participants and the public from the excessive risk that

concentrated investment in these assets might present. The reduction of

credit risk and the portfolio diversification requirements set forth by

the amendment will provide greater security for customer funds, and

ultimately to the FCMs and DCOs that rely on those funds.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that this rule promotes market efficiency,

competitiveness and financial integrity in an important way. Imposing

portfolio concentration limits lowers the risk the risk of FCMs and

DCOs suffering losses and/or being unable to liquidate assets to meet

margin calls. This type of liquidity loss may operate to undermine

market integrity and public confidence in the absence of this rule.

While there may be some potential for ``forced sale'' losses for

FCMs and DCOs on investments that may now be subject to restrictions,

the Commission cannot gauge the magnitude and believes that it has

taken measures appropriate to the circumstances to mitigate any

potential costs. More specifically, the Commission is not in a position

to know, with any precision, the portfolio holdings of FCMs and DCOs

with respect to U.S. agency obligations, nor can the Commission predict

the prevailing market conditions if FCMs and DCOs must sell U.S. agency

obligations. Consequently, the Commission cannot quantify this cost.

However, to reduce any potential cost, the rules contemplate a 180 day

implementation period, giving FCMs and DCOs ample time to liquidate

portfolios to the extent necessary to comply with the regulations.

Since investments in U.S. agency obligations remain available for

indirect investment through MMMFs, the Commission believes any impact

on the markets for U.S. agency obligations generally also should be

mitigated. Accordingly, the Commission believes that the significant

potential benefits of having portfolios less concentrated in U.S.

agency obligations justify any cost, as mitigated under the rules.

(3) Price Discovery

The Commission has considered the restrictions on U.S. agency

obligations and has determined that the final rules should not have an

impact on price discovery.

(4) Sound Risk Management Procedures

The greatest costs relative to sound risk management procedures

have been mentioned previously. The introduction of additional

investment restrictions for U.S. agency obligations in the form of

asset-based and issuer-based concentration limits may require FCMs and

DCOs to enhance their investment management and portfolio monitoring

resources. However, given that investments in U.S. agency obligations--

including GSE debt securities--are currently permitted, the risk

management strategies and systems should largely be in place already.

The Commission continues to believe that the overall benefits of

the restrictions and concentration limits on U.S. agency obligations,

as compared to those based on a regulatory standard without such

limitations, are compelling, notwithstanding attendant costs of the

restrictions and concentration limits. By limiting the concentration of

an FCM's or DCO's investment in U.S. agency obligations, the Commission

is encouraging a diverse portfolio that is more likely to withstand a

crisis in the GSE debt securities market or a failure of one or more

GSEs.

(5) Other Public Interest Considerations

The greatest potential effect of this rule on public interest

considerations stem from the implications of these rules on the overall

stability of the financial system. The inclusion of asset-based and

issuer-based limits on U.S. agency obligations contributes to financial

stability by reducing concentration risk for funds held in customer

segregated accounts. For FCMs and DCOs, the expenses associated with

administration and the potential for lost upside investment

opportunities are costs. However, as discussed above, notwithstanding

the limitations on U.S. agency obligations, FCMs and DCOs still have a

great deal of flexibility to invest in such instruments and the added

expense associated with a more active management of the investment

portfolios should be minor relative to the benefits fostered.

Certificates of Deposit

CDs will continue to be permitted investments pursuant to the

Commission's authority under Section 4(c), subject to certain

restrictions under the rules. In addition to the current issuer-based

limitation of 5 percent, the new rules impose a 25 percent asset-based

limitation. The rules also condition investment in CDs to those that

are redeemable at the issuing bank within one day, or are brokered CDs

that have embedded put options.

(1) Protection of Market Participants and the Public

This rulemaking continues to allow CDs as a permitted investment

for FCMs and DCOs while ensuring that such instruments adequately

preserve the customers' principal and maintain liquidity. The costs of

this rulemaking

[[Page 78794]]

include the administrative costs of moving from non-permitted CDs to

permitted CDs (or other permitted investments) and potential lost

upside investment opportunities from the inability to invest in non-

permitted CDs. The Commission is unable to determine the reduction in

income, if any, because it does not know the composition of the

portfolio in which customer segregated funds are invested. The

Commission believes that there is a strong benefit in creating a

framework for CDs in which such instruments must be able to be

redeemed, within one business day, at the issuing bank, however. The

Commission believes that any cost brought about by this amendment is

justified by a more diversified risk structure as a result of

concentration limits. Further, given the availability of indirect

investment in CDs generally through MMMFs, any income loss resulting

from these limitations should be minor.

Like other asset types, FCMs and DCOs may need additional resources

and expertise, and incur the related expense, to manage a portfolio

subject to the percentage limitations of the rules with regard to

asset-type and issuer. With sizeable allowances for MMMFs, FCMs and

DCOs will be able to continue to leverage the expertise of fund

managers and access indirect investment in otherwise restricted asset

types.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that this rule promotes financial integrity

in an important way. Imposing portfolio concentration limits lowers the

risk of FCMs and DCOs suffering losses and/or being unable to liquidate

assets to meet margin calls. This type of liquidity loss may operate to

undermine market integrity and public confidence in the absence of this

rule.

While there may be some potential for ``forced sale'' losses for

FCMs and DCOs on CDs now subject to restrictions, the Commission cannot

gauge the magnitude and believes that it has taken measures appropriate

to the circumstances to mitigate any potential costs. More

specifically, the Commission is not in a position to know, with any

precision, the portfolio holdings of FCMs and DCOs with respect to CDs,

nor can the Commission predict the prevailing market conditions if FCMs

and DCOs must sell CDs. Consequently, the Commission cannot quantify

this cost. However, to reduce any potential cost, the rules contemplate

a 180 day implementation period, giving FCMs and DCOs ample time to

liquidate portfolios to the extent necessary to comply with the

regulations. Since CDs remain eligible investments for FCMs and DCOs

and may be held either directly or indirectly through MMMFs, the

Commission believes that any potential impact on CD markets generally

also should be mitigated. Accordingly, the Commission believes that the

significant potential benefits of having portfolios less concentrated

in CDs justify any cost, as mitigated under the rules.

(3) Price Discovery

The Commission has reviewed the restrictions on CDs and determined

that the final rules should not have an impact on price discovery.

(4) Sound Risk Management Procedures

The greatest costs relative to sound risk management procedures

have been mentioned previously. The introduction of additional

investment restrictions to CDs in the form of asset-based concentration

limits may require FCMs and DCOs to enhance their investment management

and portfolio monitoring resources. However, the risk management

strategies and systems should largely be in place already.

The Commission believes that the overall benefits of the

concentration limitations and other restrictions on CDs and the

resultant reductions in risk to portfolios, as compared to those based

on a regulatory framework without such limitations, mitigate the costs.

(5) Other Public Interest Considerations

The greatest potential impact of this rule on public interest

considerations stem from the implications of these rules on the

stability of the financial system as a whole. The inclusion of asset-

based limitations on CDs, as well as the restriction that all CDs must

be redeemable at the issuing bank, contributes to financial stability

by reducing concentration risk for funds held in customer segregated

accounts. For FCMs and DCOs, the expenses associated with managing to

these limitations on CDs and the potential for reduced upside

investment return on CD investments are costs. However, as discussed

above, notwithstanding these limitations, FCMs and DCOs may still

invest directly in CDs and may invest indirectly through MMMFs. The

added expense associated with a more active management of the

investment portfolios should be minor relative to the benefits

fostered.

Commercial Paper and Corporate Debt

Some commercial paper and corporate notes or bonds will continue to

be permitted investments pursuant to the Commission's authority under

Section 4(c), subject to certain restrictions under the rules. In

addition to the existing 5 percent limitation on the securities of any

single issuer of such instruments being held with customer segregated

funds, the new rules limit these asset classes in aggregate to 25

percent, respectively, of the total customer segregated assets held by

the FCM or DCO. The rules also restrict investment in commercial paper

and corporate notes or bonds to those that are federally guaranteed as

to principal and interest under the TLGP.

(1) Protection of Market Participants and the Public

The lack of liquidity that impacted these markets during the recent

financial crisis, and which necessitated the federal guarantee under

TLGP, highlights the concerns of permitting FCMs and DCOs unrestricted

investment of customer funds in these assets. The limits imposed by

this rule will protect customer funds from being invested in

concentrated pools of unrated commercial paper and corporate notes or

bonds. While the requirement that these instruments be guaranteed by

TLGP may, in effect, severely limit investment in these instruments by

FCMs and DCOs, the actual costs of this limitation for FCMs and DCOs

are unclear, given that there is little data evidencing the extent of

their use as an investment option, and the fact that indirect

investment is still permitted through the use of MMMFs.

Like other asset types, FCMs and DCOs may need additional resources

and expertise, and incur the related expense, to manage a portfolio of

TLGP corporate notes or bonds and/or commercial paper subject to the

percentage limitations of the rules and the TLGP restrictions. With

sizeable allowances for MMMFs, FCMs and DCOs will be able to continue

to leverage the expertise of fund managers and access indirect

investment in otherwise restricted asset types.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that this rule promotes financial integrity

in an important way. Imposing portfolio concentration limits lowers the

risk of FCMs and DCOs suffering losses and/or being unable to liquidate

assets to meet margin calls. This type of liquidity loss may operate to

undermine market integrity and public confidence in the absence of this

rule.

While there may be some potential for ``forced sale'' losses for

FCMs and DCOs

[[Page 78795]]

on commercial paper and corporate debt now subject to restrictions, the

Commission cannot gauge the magnitude and believes that it has taken

measures appropriate to the circumstances to mitigate any potential

costs. More specifically, the Commission is not in a position to know,

with any precision, the portfolio holdings of FCMs and DCOs with

respect to commercial paper and corporate debt, nor can the Commission

predict the prevailing market conditions if FCMs and DCOs must sell

commercial paper and corporate debt. Consequently, the Commission

cannot quantify this cost. However, to reduce any potential cost, the

rules contemplate a 180 day implementation period, giving FCMs and DCOs

ample time to liquidate portfolios to the extent necessary to comply

with the regulations. Since investments in commercial paper and

corporate debt remain available for indirect investment through MMMFs,

the Commission believes any impact on commercial paper and corporate

debt markets also should be mitigated. Accordingly, the Commission

believes that the significant potential benefits of having portfolios

less concentrated in commercial paper and corporate debt justify any

cost, as mitigated under the rule.

(3) Price Discovery

The Commission has reviewed the restrictions on commercial paper

and corporate notes or bonds and determined that the final rules should

not have an impact on price discovery.

(4) Sound Risk Management Procedures

The greatest costs relative to sound risk management procedures

have been mentioned previously. The introduction of additional

investment restrictions in the form of asset-based concentration limits

and the TLGP restriction may require FCMs and DCOs to enhance their

investment management and portfolio monitoring resources. However, the

risk management strategies and systems should largely be in place

already.

The Commission believes that the overall benefits of the

concentration limits and TLGP restrictions on commercial paper and

corporate notes or bonds, and the resultant reductions in risk to

portfolios, as compared to those based on a regulatory framework

without such limitations, are compelling, notwithstanding attendant

costs of the restrictions and concentration limits. By adding

restrictions and increasing diversification through concentration

limits, customer segregated funds should be better protected in the

event of a crisis in the broader financial market.

(5) Other Public Interest Considerations

The greatest potential impact of this rule on public interest

considerations stem from the implications of these rules for the

stability of the financial system as a whole. The inclusion of asset-

based limits on commercial paper and corporate notes or bonds, as well

as the exclusion of corporate instruments that are not guaranteed by

the TLGP, will contribute to financial stability by increasing the

safety of funds in customer segregated accounts. For FCMs and DCOs, the

expenses associated with managing these limitations and the potential

for reduced upside investment opportunities are costs. However, as

discussed above, notwithstanding the limitations on commercial paper

and corporate notes or bonds, FCMs and DCOs still have a great deal of

flexibility and the added expense associated with a more active

management of the investment portfolios should be minor relative to the

benefits fostered.

Foreign Sovereign Debt

Foreign sovereign debt is eliminated as a permitted investment in

this rulemaking. However, the Commission invites FCMs or DCOs to

request an exemption pursuant to the Commission's authority under

Section 4(c), allowing them to invest in foreign sovereign debt: (1) To

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

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

country's currency; and (2) to the extent that investment in such

foreign sovereign debt would serve to preserve principal and maintain

liquidity of customer funds, as required by Regulation 1.25. Upon an

appropriate demonstration, the Commission has noted that it may be

amenable to granting such an exemption.

(1) Protection of Market Participants and the Public

The recent sovereign debt crises highlight the concerns of

permitting FCMs and DCOs to invest customer funds in foreign sovereign

debt. The restriction of this investment class will protect customer

funds from being invested in risky or illiquid foreign sovereign debt.

While this rule eliminates investment in these instruments by FCMs and

DCOs, the actual costs of this restriction on FCMs and DCOs are

unquantifiable, in large part because the extent to which DCOs invest

in foreign sovereign debt is uncertain.

Certain commenters argued that investment in foreign sovereign debt

is necessary to hedge currency risk, and a prohibition on doing so may

be costly. While the Commission recognizes that the restriction may

impose costs, such costs are mitigated by the ability of an entity to

seek an exemption from the Commission. Further, in a scenario where a

market event has caused a currency devaluation and/or the illiquidity

of a country's sovereign debt, the Commission believes that customers'

best interests are served by an FCM holding a devalued currency, which

(albeit devalued) can be delivered immediately to the customer as

opposed to an illiquid foreign sovereign debt issuance, which may not

be able to be exchanged for any currency in a reasonably short

timeframe.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that this rule promotes financial integrity

in an important way. Eliminating unpredictable and potentially risky

instruments lowers the risk of FCMs and DCOs suffering losses and/or

being unable to liquidate assets to meet margin calls. This type of

liquidity loss may operate to undermine market integrity and public

confidence in the absence of this rule.

While there may be some potential for ``forced sale'' losses for

FCMs and DCOs on foreign sovereign debt now prohibited, the Commission

cannot quantify any such losses and believes that through the exemption

process under Section 4(c), it has mitigated any such potential costs.

Moreover, the Commission is not in a position to know, with any

precision, the portfolio holdings of FCMs and DCOs with respect to

foreign sovereign debt, nor can the Commission predict the prevailing

market conditions if FCMs and DCOs must sell such instruments.

Consequently, the Commission cannot quantify this cost. However, to

mitigate any such potential cost, the rules contemplate a 180-day

implementation period, giving FCMs and DCOs ample time to liquidate

portfolios to the extent necessary to comply with the regulations and/

or allowing FCMs and DCOs the opportunity to request an exemption.

(3) Price Discovery

The Commission does not believe that the restrictions on foreign

sovereign debt will have an impact on price discovery.

[[Page 78796]]

(4) Sound Risk Management Procedures

The restriction on foreign sovereign debt is intended to require an

FCM or DCO to protect against currency exposure in a way that fosters

sound risk management, particularly the protection of customer funds.

(5) Other Public Interest Considerations

The prohibition on investment in foreign sovereign debt will

contribute to financial stability by increasing the safety of funds in

customer segregated accounts. For FCMs and DCOs, any expense associated

with the elimination of foreign sovereign debt is a cost. However, as

discussed above, notwithstanding the elimination of this investment

class, the Commission believes that the benefits to the public and

market participants of this provision of the rule are significant.

Money Market Mutual Funds

MMMF investments will continue to be permitted pursuant to the

Commission's authority under Section 4(c), albeit with some

restrictions. First, an FCM or DCO may invest all of its customer

segregated funds in Treasury-only MMMFs, but for all other MMMFs, as

discussed below, the Commission believes that a 50 percent asset-based

concentration is appropriate. In addition, an FCM or DCO may invest up

to 10 percent of its assets in segregation in funds that do not have

both $1 billion in assets and a management company that has at least

$25 billion in MMMF assets under management (small MMMFs), while,

subject to the caveats described above, an FCM or DCO may invest up to

50 percent of its assets in segregation in funds that do (large MMMFs).

In arriving at these concentration limits, in addition to its own

staff research, the Commission took into consideration information

presented in meetings with the market participants, comment letters and

discussions with other regulators. The Commission decided to allow

investment without asset- or issuer-based limitations for Treasury-only

MMMFs due to the fact that Regulation 1.25 allows direct investments

entirely in Treasuries. Indirect investment in Treasuries via a

Treasury-only MMMF is essentially the risk equivalent of a direct

investment in Treasuries, while allowing an FCM or DCO the

administrative ease of delegating the management of its portfolio to a

MMMF. The Commission decided upon a 50 percent asset-based

concentration limit for large prime MMMFs, as it remains concerned

that, in another crisis, a run on a prime MMMF may threaten both the

liquidity and principal of customer segregated funds. After weighing

the information described above, the Commission determined that a 50

percent asset-based limitation struck the right balance between

providing FCMs and DCOs with sufficient Regulation 1.25 investment

options and, at the same time, encouraging adequate portfolio

diversification. The issuer-based limitation reflects the view that the

Commission seeks to protect FCMs and DCOs from runs on particular funds

and families of funds. As a necessary corollary for increasing the

asset-based concentration limits, the Commission decided to implement

the fund and fund family size requirements in order to ensure that

MMMFs invested in heavily by FCMs and DCOs were large enough to handle

a high volume of redemption requests while still allowing for limited

investment in small MMMFs.

Finally, the Commission notes that these restrictions are such that

an FCM could invest all of its customer funds in MMMFs, by, as

examples, investing entirely in a large Treasury-only MMMF or by

investing 50 percent of its funds in large prime MMMFs (spread out

among five individual funds and three fund families) and 50 percent in

a large Treasury-only MMMF. The Commission believes that this should

alleviate the concerns of FCMs that expressed, in their comment

letters, a reluctance to manage their own portfolios and instead wished

to delegate those responsibilities entirely to fund managers.

(1) Protection of Market Participants and the Public

The recent financial crisis exposed the risks attendant to MMMFs--

in particular, their susceptibility to runs. Though only one fund broke

the buck, many others were supported by their sponsors and/or

affiliates during the crisis. In response, the SEC has made a number of

changes to Rule 2a-7 to address the risks inherent in MMMFs. The

changes are aimed at reducing the perceived credit and liquidity risks

of the MMMFs' underlying portfolios. However, as the President's

Working Group on Financial Markets has noted, systemic risks remain in

the MMMF market, notwithstanding the SEC's recent reforms.\200\ Absent

further changes in the way MMMF shares are valued, redeemed and/or

supported through private or public sector guarantees, future runs on

MMMFs cannot be ruled out.

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\200\ President's Working Group on Financial Markets, Money

Market Fund Reform Options, at 16-18 (2010). The full report may be

accessed at http://www.treasury.gov/press-center/press-releases/Documents/10.21%20PWG%20Report%20Final.pdf.

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The minimum $1 billion asset requirement for individual fund and

$25 billion asset requirement for family of funds of large MMMFs are

designed to ensure that customer funds are typically invested in

sufficiently large funds with diversified portfolios of holdings that

are better positioned to withstand unexpected redemptions requests.

Limited investment in small MMMFs was retained from the NPRM in order

to provide flexibility for FCMs and DCOs and to promote

diversification. The new asset-based concentration limitations for non-

Treasury MMMFs in aggregate, by family and by individual fund will

provide additional protection for customer segregated funds in the

event of both runs on MMMFs generally, and more targeted runs that may

affect a specific family of funds or an individual fund. The portfolio

diversification requirements set forth by the amendment will provide

greater security for customer funds, and ultimately to the FCMs and

DCOs that rely on those funds.

Individual FCMs and DCOs may need additional resources and

expertise, and incur the related expense, to manage a portfolio subject

to the percentage limitations of the rules with regard to asset-type,

issuer and size. However, with sizeable allowances for MMMFs, FCMs and

DCOs will be able to continue to leverage the expertise of fund

managers. The Commission notes that under this rule, an FCM or DCO is

able to invest all of their customer segregated funds in one or more

MMMFs. Therefore, FCMs or DCOs not wishing to manage their portfolios

may delegate entirely to MMMF managers.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that this rule promotes financial integrity

in an important way. Imposing portfolio concentration limits lowers the

risk of FCMs and DCOs suffering losses and/or being unable to liquidate

assets to meet margin calls. This type of liquidity loss may operate to

undermine market integrity and public confidence in the absence of this

rule.

While there may be some potential for ``forced sale'' losses for

FCMs and DCOs on MMMFs that are above the concentration limits or not

meet the asset requirements, the Commission cannot gauge the magnitude

and believes that it has taken measures appropriate to the

circumstances to mitigate any potential costs. More specifically, the

Commission is not in a

[[Page 78797]]

position to know, with any precision, the portfolio holdings of FCMs

and DCOs with respect to MMMFs, nor can the Commission predict the

prevailing market conditions if FCMs and DCOs must sell MMMFs.

Consequently, the Commission cannot quantify this cost. However, to

reduce any potential cost, the rules contemplate a 180 day

implementation period, giving FCMs and DCOs ample time to liquidate

portfolios to the extent necessary to comply with the regulations.

Since investments in MMMFs remain available, the Commission believes

any impact on MMMF markets generally also should be mitigated.

Accordingly, the Commission believes that the significant potential

benefits of having portfolios less concentrated in a small number of

MMMFs justify any cost, as mitigated under the rules.

(3) Price Discovery

The final rules should not have an impact on price discovery.

(4) Sound Risk Management Procedures

The greatest costs relative to sound risk management procedures

have been mentioned previously. The introduction of additional

investment restrictions on MMMFs in the form of asset-based and issuer-

based concentration limits may require FCMs and DCOs to enhance their

investment management and portfolio monitoring resources. However, to

the extent that FCMs and DCOs had invested in MMMFs previously, the

risk management strategies and systems should largely be in place

already.

(5) Other Public Interest Considerations

The greatest potential benefit of this rule on public interest

considerations stem from the implications of these rules on the

stability of the financial system as a whole. The inclusion of asset-

based concentration limitations on non-Treasury MMMFs, placing

limitations on families of funds and on individual funds, and allowing

only limited investment in funds not meeting certain asset limits

contributes to financial stability by promoting the diversification of

investment for funds held in customer segregated accounts. For FCMs and

DCOs, the expenses associated with managing their MMMF investments and

the potential for lost upside investment opportunities are costs.

However, as discussed above, notwithstanding the limitations on the

permitted investments, FCMs and DCOs may still invest all customer

segregated funds in a portfolio of MMMFs, and the added expense

associated with a more active management of the MMMF portfolio should

be minor.

Other Investment Limitations

The final rules also include other limitations and restrictions on

those investments that are permitted for customer segregated funds by

FCMs and DCOs, including the elimination of in-house transactions and

repurchase agreements with affiliates as well as a 25 percent

counterparty concentration limit on repurchase agreements.

(1) Protection of Market Participants and the Public

As stated above, the guiding investment principle for customer

funds is that investments are liquid and preserve principal. The

lessons of the recent financial crisis highlighted the contagion that

can occur in the financial markets from a single failure or default. As

such, the new rules are designed to broadly spread counterparty risk,

such that customer funds are protected and may be liquidated quickly,

notwithstanding select failures in the marketplace. In-house

transactions and repurchase agreements with affiliates have been

eliminated due to the conflicts of interest that can arise during

periods of crisis, the concentration risk associated with engaging in

such transactions within an FCM-broker dealer entity (in the case of an

in-house transaction) and within an affiliate structure (in the case of

a repurchase agreements with affiliates), among other reasons. The 25

percent counterparty-concentration limit has been introduced to ensure

that an FCM or DCO does not have all of its customer funds subject to

the risk profile of a single counterparty.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The Commission believes that these additional limitations promote

financial integrity in an important way. By broadly spreading

counterparty risk and enhancing customer fund protections and

liquidity, the risk of FCMs and DCOs suffering losses and/or being

unable to liquidate assets to meet margin calls is decreased. This type

of liquidity loss may operate to undermine market integrity and public

confidence in the absence of this rule.

Moreover, to the extent there are potential costs noted below,

offsetting benefits justify them. Any decrease in efficiency resulting

from the elimination of in-house transactions and repurchase agreements

with affiliates need be considered in light of the benefits of the

increased certainty of arms-length transactions between two legally

distinct, unaffiliated parties. And, a crucial benefit offsets the

administrative costs associated with having five counterparties rather

than one: Reduced counterparty risk.

(3) Price Discovery

The final rules should not have an impact on price discovery.

(4) Sound Risk Management Procedures

There may be additional expense associated with the on-boarding and

risk managing additional counterparties, but the scale of this

additional burden does not appear large and is justified by the

benefits of improved counterparty concentration limits.

(5) Other Public Interest Considerations

The greatest potential impact of this rule on public interest

considerations stem from the increased stability of the financial

system as a whole. The inclusion of counterparty concentration limits,

in particular, contributes to financial stability by reducing risk for

funds held in customer segregated accounts.

Regulation 30.7

The Commission has decided to harmonize Regulation 30.7 with the

investment limitations of Regulation 1.25. The Commission had not

previously restricted investments of 30.7 funds to the permitted

investments under Regulation 1.25. The Commission now believes that it

is appropriate to align the investment standards given the similar

prudential concerns that arise with respect to both segregated customer

funds and 30.7 funds. The Commission has also removed the credit

ratings requirements for depositories of 30.7 funds and eliminated the

option of customers to designate, with the permission of the

Commission, a depository not otherwise meeting the standards to be a

depository of 30.7 funds.

(1) Protection of Market Participants and the Public

The public has a strong interest in the stability of the nation's

financial system, a goal of the Dodd-Frank Act. Applying Regulation

1.25 standards to 30.7 funds will better insulate them against the

negative shocks of future financial crises, thereby enhancing

protection to market participants and the public. Also, no benefit

justifies applying a different standard for 30.7 funds than for

segregated customer funds. FCMs and DCOs traditionally have used

Regulation 1.25 as a safe harbor for 30.7 funds; accordingly, there is

no basis to anticipate material additional expense

[[Page 78798]]

as a result of extending these requirements to 30.7 funds.

The removal of credit ratings from Regulation 30.7 was necessitated

by Section 939A of the Dodd-Frank Act and is in line with the

Commission's removal of credit ratings under Regulation 1.25. The

removal of the designation option for depositories stemmed from the

fact that the Commission had never entertained such a request and from

the belief that a depository should meet the capital requirements for

depositories in order to hold 30.7 funds.

(2) Efficiency, Competitiveness and Financial Integrity of the Markets

The investments made with 30.7 funds generally have been similar to

those made under Regulation 1.25. Accordingly, the Commission believes

that harmonization of Regulation 30.7 with Regulation 1.25 promotes

financial integrity in the same important ways and relative to less

significant cost as discussed in the above. Specifically, imposition of

the restrictions discussed above with respect to Regulation 1.25 asset

classes lowers the risk of FCMs and DCOs suffering losses and/or being

unable to liquidate assets to meet margin calls. This type of liquidity

loss may operate to undermine market integrity and public confidence in

the absence of this rule.

The Commission does not expect the removal of credit ratings to

have a significant impact on choice of depositories for 30.7 funds. The

Commission expects the elimination of the designation option to have no

impact, since it has never been used.

(3) Price Discovery

The final rules regarding Regulation 30.7 should not have an impact

on price discovery.

(4) Sound Risk Management Procedures

As mentioned above, most FCMs and DCOs have used Regulation 1.25 as

a safe harbor for 30.7 funds. As such, the incremental costs associated

with applying the additional investment restrictions in the form of

asset-based and issuer-based concentration limits should not be

substantial. The risk management strategies and systems should largely

be in place already, and will now be applied to 30.7 funds.

The Commission believes that the overall benefits of applying

Regulation 1.25 standards to 30.7 funds, as compared to those based on

a regulatory framework without such limitations, justify the less

significant costs. By adding restrictions and increasing

diversification through concentration limits, 30.7 funds should be

better protected in the event of a crisis in the broader financial

market. The removal of credit ratings for depositories and the removal

of the designation option should not have a significant impact on risk

management practices because depositories must still meet the capital

requirements in order to qualify under Regulation 30.7 and, as

mentioned, no depositories have ever qualified through designation. The

only cost associated with the former would be the administrative cost

of moving funds from one depository to another, in the event that a

previously qualifying depository now no longer qualifies.

(5) Other Public Interest Considerations

The greatest potential impact of this rule on public interest

considerations stem from the implications of these rules for the

stability of the financial system as a whole. The application of

Regulation 1.25 standards to 30.7 funds will contribute to financial

stability by reducing concentration risk for 30.7 funds. For FCMs and

DCOs, the expenses associated with managing these limitations and the

potential for lost upside investment opportunities are costs. However,

as discussed above, the added expense associated with a more active

management of the investment portfolios should be minor.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) \201\ requires federal

agencies, in promulgating rules, to consider the impact of those rules

on small businesses. The rule amendments contained herein will affect

FCMs and DCOs. The Commission has previously established certain

definitions of ``small entities'' to be used by the Commission in

evaluating the impact of its rules on small entities in accordance with

the RFA.\202\ The Commission has previously determined that registered

FCMs \203\ and DCOs \204\ are not small entities for the purpose of the

RFA. Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman, on behalf

of the Commission, certifies that the final rules will not have a

significant economic impact on a substantial number of small entities.

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

\201\ 5 U.S.C. 601 et seq.

\202\ 47 FR 18618 (Apr. 30, 1982).

\203\ Id. at 18619.

\204\ 66 FR 45604, 45609 (Aug. 29, 2001).

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B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (PRA) imposes certain

requirements on federal agencies (including the Commission) in

connection with their conducting or sponsoring any collection of

information as defined by the PRA. The final rules do not require a new

collection of information on the part of any entities subject to the

rule amendments. Accordingly, for purposes of the PRA, the Commission

certifies that these rule amendments, promulgated in final form, do not

impose any new reporting or recordkeeping requirements.

Lists of Subjects

17 CFR Part 1

Brokers, Commodity futures, Consumer protection, Reporting and

recordkeeping requirements.

17 CFR Part 30

Commodity futures, Consumer protection, Currency, Reporting and

recordkeeping requirements.

In consideration of the foregoing and pursuant to the authority

contained in the Commodity Exchange Act, in particular, Sections 4d,

4(c), and 8a(5) thereof, 7 U.S.C. 6d, 6(c) and 12a(5), respectively,

the Commission hereby amends Chapter I of Title 17 of the Code of

Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0

1. The authority citation for part 1 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a-1, 16, 16a, 19, 21, 23, and 24, as amended by the Dodd-Frank

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

Stat. 1376 (2010).

0

2. Section 1.25 is revised to read as follows:

Sec. 1.25 Investment of customer funds.

(a) Permitted investments. (1) Subject to the terms and conditions

set forth in this section, a futures commission merchant or a

derivatives clearing organization may invest customer money in the

following instruments (permitted investments):

(i) Obligations of the United States and obligations fully

guaranteed as to principal and interest by the United States (U.S.

government securities);

(ii) General obligations of any State or of any political

subdivision thereof (municipal securities);

(iii) Obligations of any United States government corporation or

enterprise sponsored by the United States government (U.S. agency

obligations);

(iv) Certificates of deposit issued by a bank (certificates of

deposit) as defined

[[Page 78799]]

in section 3(a)(6) of the Securities Exchange Act of 1934, or a

domestic branch of a foreign bank that carries deposits insured by the

Federal Deposit Insurance Corporation;

(v) Commercial paper fully guaranteed as to principal and interest

by the United States under the Temporary Liquidity Guarantee Program as

administered by the Federal Deposit Insurance Corporation (commercial

paper);

(vi) Corporate notes or bonds fully guaranteed as to principal and

interest by the United States under the Temporary Liquidity Guarantee

Program as administered by the Federal Deposit Insurance Corporation

(corporate notes or bonds); and

(vii) Interests in money market mutual funds.

(2)(i) In addition, a futures commission merchant or derivatives

clearing organization may buy and sell the permitted investments listed

in paragraphs (a)(1)(i) through (vii) of this section pursuant to

agreements for resale or repurchase of the instruments, in accordance

with the provisions of paragraph (d) of this section.

(ii) A futures commission merchant or a derivatives clearing

organization may sell securities deposited by customers as margin

pursuant to agreements to repurchase subject to the following:

(A) Securities subject to such repurchase agreements must be

``highly liquid'' as defined in paragraph (b)(1) of this section.

(B) Securities subject to such repurchase agreements must not be

``specifically identifiable property'' as defined in Sec. 190.01(kk)

of this chapter.

(C) The terms and conditions of such an agreement to repurchase

must be in accordance with the provisions of paragraph (d) of this

section.

(D) Upon the default by a counterparty to a repurchase agreement,

the futures commission merchant or derivatives clearing organization

shall act promptly to ensure that the default does not result in any

direct or indirect cost or expense to the customer.

(3) Obligations issued by the Federal National Mortgage Association

or the Federal Home Loan Mortgage Association are permitted while these

entities operate under the conservatorship or receivership of the

Federal Housing Finance Authority with capital support from the United

States.

(b) General terms and conditions. A futures commission merchant or

a derivatives clearing organization is required to manage the permitted

investments consistent with the objectives of preserving principal and

maintaining liquidity and according to the following specific

requirements:

(1) Liquidity. Investments must be ``highly liquid'' such that they

have the ability to be converted into cash within one business day

without material discount in value.

(2) Restrictions on instrument features. (i) With the exception of

money market mutual funds, no permitted investment may contain an

embedded derivative of any kind, except as follows:

(A) The issuer of an instrument otherwise permitted by this section

may have an option to call, in whole or in part, at par, the principal

amount of the instrument before its stated maturity date; or

(B) An instrument that meets the requirements of paragraph

(b)(2)(iv) of this section may provide for a cap, floor, or collar on

the interest paid; provided, however, that the terms of such instrument

obligate the issuer to repay the principal amount of the instrument at

not less than par value upon maturity.

(ii) No instrument may contain interest-only payment features.

(iii) No instrument may provide payments linked to a commodity,

currency, reference instrument, index, or benchmark except as provided

in paragraph (b)(2)(iv) of this section, and it may not otherwise

constitute a derivative instrument.

(iv)(A) Adjustable rate securities are permitted, subject to the

following requirements:

(1) The interest payments on variable rate securities must

correlate closely and on an unleveraged basis to a benchmark of either

the Federal Funds target or effective rate, the prime rate, the three-

month Treasury Bill rate, the one-month or three-month LIBOR rate, or

the interest rate of any fixed rate instrument that is a permitted

investment listed in paragraph (a)(1) of this section;

(2) The interest payment, in any period, on floating rate

securities must be determined solely by reference, on an unleveraged

basis, to a benchmark of either the Federal Funds target or effective

rate, the prime rate, the three-month Treasury Bill rate, the one-month

or three-month LIBOR rate, or the interest rate of any fixed rate

instrument that is a permitted investment listed in paragraph (a)(1) of

this section;

(3) Benchmark rates must be expressed in the same currency as the

adjustable rate securities that reference them; and

(4) No interest payment on an adjustable rate security, in any

period, can be a negative amount.

(B) For purposes of this paragraph, the following definitions shall

apply:

(1) The term adjustable rate security means, a floating rate

security, a variable rate security, or both.

(2) The term floating rate security means a security, the terms of

which provide for the adjustment of its interest rate whenever a

specified interest rate changes and that, at any time until the final

maturity of the instrument or the period remaining until the principal

amount can be recovered through demand, can reasonably be expected to

have market value that approximates its amortized cost.

(3) The term variable rate security means a security, the terms of

which provide for the adjustment of its interest rate on set dates

(such as the last day of a month or calendar quarter) and that, upon

each adjustment until the final maturity of the instrument or the

period remaining until the principal amount can be recovered through

demand, can reasonably be expected to have a market value that

approximates its amortized cost.

(v) Certificates of deposit must be redeemable at the issuing bank

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

to any accrued interest earned according to its written terms.

(vi) Commercial paper and corporate notes or bonds must meet the

following criteria:

(A) The size of the issuance must be greater than $1 billion;

(B) The instrument must be denominated in U.S. dollars; and

(C) The instrument must be fully guaranteed as to principal and

interest by the United States for its entire term.

(3) Concentration--(i) Asset-based concentration limits for direct

investments. (A) Investments in U.S. government securities shall not be

subject to a concentration limit.

(B) Investments in U.S. agency obligations may not exceed 50

percent of the total assets held in segregation by the futures

commission merchant or derivatives clearing organization.

(C) Investments in each of commercial paper, corporate notes or

bonds and certificates of deposit may not exceed 25 percent of the

total assets held in segregation by the futures commission merchant or

derivatives clearing organization.

(D) Investments in municipal securities may not exceed 10 percent

of the total assets held in segregation by the futures commission

merchant or derivatives clearing organization.

(E) Subject to paragraph (b)(3)(i)(G) of this section, investments

in money market mutual funds comprising only

[[Page 78800]]

U.S. government securities shall not be subject to a concentration

limit.

(F) Subject to paragraph (b)(3)(i)(G) of this section, investments

in money market mutual funds, other than those described in paragraph

(b)(3)(i)(E) of this section, may not exceed 50 percent of the total

assets held in segregation by the futures commission merchant or

derivatives clearing organization.

(G) Investments in money market mutual funds comprising less than

$1 billion in assets and/or which have a management company comprising

less than $25 billion in assets, may not exceed 10 percent of the total

assets held in segregation by the futures commission merchant or

derivatives clearing organization.

(ii) Issuer-based concentration limits for direct investments. (A)

Securities of any single issuer of U.S. agency obligations held by a

futures commission merchant or derivatives clearing organization may

not exceed 25 percent of total assets held in segregation by the

futures commission merchant or derivatives clearing organization.

(B) Securities of any single issuer of municipal securities,

certificates of deposit, commercial paper, or corporate notes or bonds

held by a futures commission merchant or derivatives clearing

organization may not exceed 5 percent of total assets held in

segregation by the futures commission merchant or derivatives clearing

organization.

(C) Interests in any single family of money market mutual funds

described in paragraph (b)(3)(i)(F) of this section may not exceed 25

percent of total assets held in segregation by the futures commission

merchant or derivatives clearing organization.

(D) Interests in any individual money market mutual fund described

in paragraph (b)(3)(i)(F) of this section may not exceed 10 percent of

total assets held in segregation by the futures commission merchant or

derivatives clearing organization.

(E) For purposes of determining compliance with the issuer-based

concentration limits set forth in this section, securities issued by

entities that are affiliated, as defined in paragraph (b)(5) of this

section, shall be aggregated and deemed the securities of a single

issuer. An interest in a permitted money market mutual fund is not

deemed to be a security issued by its sponsoring entity.

(iii) Concentration limits for agreements to repurchase--(A)

Repurchase agreements. For purposes of determining compliance with the

asset-based and issuer-based concentration limits set forth in this

section, securities sold by a futures commission merchant or

derivatives clearing organization subject to agreements to repurchase

shall be combined with securities held by the futures commission

merchant or derivatives clearing organization as direct investments.

(B) Reverse repurchase agreements. For purposes of determining

compliance with the asset-based and issuer-based concentration limits

set forth in this section, securities purchased by a futures commission

merchant or derivatives clearing organization subject to agreements to

resell shall be combined with securities held by the futures commission

merchant or derivatives clearing organization as direct investments.

(iv) Treatment of customer-owned securities. For purposes of

determining compliance with the asset-based and issuer-based

concentration limits set forth in this section, securities owned by the

customers of a futures commission merchant and posted as margin

collateral are not included in total assets held in segregation by the

futures commission merchant, and securities posted by a futures

commission merchant with a derivatives clearing organization are not

included in total assets held in segregation by the derivatives

clearing organization.

(v) Counterparty concentration limits. Securities purchased by a

futures commission merchant or derivatives clearing organization from a

single counterparty, subject to an agreement to resell to that

counterparty, shall not exceed 25 percent of total assets held in

segregation by the futures commission merchant or derivatives clearing

organization.

(4) Time-to-maturity. (i) Except for investments in money market

mutual funds, the dollar-weighted average of the time-to-maturity of

the portfolio, as that average is computed pursuant to Sec. 270.2a-7

of this title, may not exceed 24 months.

(ii) For purposes of determining the time-to-maturity of the

portfolio, an instrument that is set forth in paragraphs (a)(1)(i)

through (vii) of this section may be treated as having a one-day time-

to-maturity if the following terms and conditions are satisfied:

(A) The instrument is deposited solely on an overnight basis with a

derivatives clearing organization pursuant to the terms and conditions

of a collateral management program that has become effective in

accordance with Sec. 39.4 of this chapter;

(B) The instrument is one that the futures commission merchant owns

or has an unqualified right to pledge, is not subject to any lien, and

is deposited by the futures commission merchant into a segregated

account at a derivatives clearing organization;

(C) The derivatives clearing organization prices the instrument

each day based on the current mark-to-market value; and

(D) The derivatives clearing organization reduces the assigned

value of the instrument each day by a haircut of at least 2 percent.

(5) Investments in instruments issued by affiliates. (i) A futures

commission merchant shall not invest customer funds in obligations of

an entity affiliated with the futures commission merchant, and a

derivatives clearing organization shall not invest customer funds in

obligations of an entity affiliated with the derivatives clearing

organization. An affiliate includes parent companies, including all

entities through the ultimate holding company, subsidiaries to the

lowest level, and companies under common ownership of such parent

company or affiliates.

(ii) A futures commission merchant or derivatives clearing

organization may invest customer funds in a fund affiliated with that

futures commission merchant or derivatives clearing organization.

(6) Recordkeeping. A futures commission merchant and a derivatives

clearing organization shall prepare and maintain a record that will

show for each business day with respect to each type of investment made

pursuant to this section, the following information:

(i) The type of instruments in which customer funds have been

invested;

(ii) The original cost of the instruments; and

(iii) The current market value of the instruments.

(c) Money market mutual funds. The following provisions will apply

to the investment of customer funds in money market mutual funds (the

fund).

(1) The fund must be an investment company that is registered under

the Investment Company Act of 1940 with the Securities and Exchange

Commission and that holds itself out to investors as a money market

fund, in accordance with Sec. 270.2a-7 of this title.

(2) The fund must be sponsored by a federally-regulated financial

institution, a bank as defined in section 3(a)(6) of the Securities

Exchange Act of 1934, an investment adviser registered under the

Investment Advisers Act of 1940, or a domestic branch of a foreign bank

insured by the Federal Deposit Insurance Corporation.

(3) A futures commission merchant or derivatives clearing

organization shall maintain the confirmation relating to

[[Page 78801]]

the purchase in its records in accordance with Sec. 1.31 and note the

ownership of fund shares (by book-entry or otherwise) in a custody

account of the futures commission merchant or derivatives clearing

organization in accordance with Sec. 1.26. The futures commission

merchant or the derivatives clearing organization shall obtain the

acknowledgment letter required by Sec. 1.26 from an entity that has

substantial control over the fund shares purchased with customer

segregated funds and has the knowledge and authority to facilitate

redemption and payment or transfer of the customer segregated funds.

Such entity may include the fund sponsor or depository acting as

custodian for fund shares.

(4) The net asset value of the fund must be computed by 9 a.m. of

the business day following each business day and made available to the

futures commission merchant or derivatives clearing organization by

that time.

(5)(i) General requirement for redemption of interests. A fund

shall be legally obligated to redeem an interest and to make payment in

satisfaction thereof by the business day following a redemption

request, and the futures commission merchant or derivatives clearing

organization shall retain documentation demonstrating compliance with

this requirement.

(ii) Exception. A fund may provide for the postponement of

redemption and payment due to any of the following circumstances:

(A) For any period during which there is a non-routine closure of

the Fedwire or applicable Federal Reserve Banks;

(B) For any period:

(1) During which the New York Stock Exchange is closed other than

customary week-end and holiday closings; or

(2) During which trading on the New York Stock Exchange is

restricted;

(C) For any period during which an emergency exists as a result of

which:

(1) Disposal by the company of securities owned by it is not

reasonably practicable; or

(2) It is not reasonably practicable for such company fairly to

determine the value of its net assets;

(D) For any period as the Securities and Exchange Commission may by

order permit for the protection of security holders of the company;

(E) For any period during which the Securities and Exchange

Commission has, by rule or regulation, deemed that:

(1) Trading shall be restricted; or

(2) An emergency exists; or

(F) For any period during which each of the conditions of Sec.

270.22e-3(a)(1) through (3) of this title are met.

(6) The agreement pursuant to which the futures commission merchant

or derivatives clearing organization has acquired and is holding its

interest in a fund must contain no provision that would prevent the

pledging or transferring of shares.

(7) The Appendix to this section sets forth language that will

satisfy the requirements of paragraph (c)(5) of this section.

(d) Repurchase and reverse repurchase agreements. A futures

commission merchant or derivatives clearing organization may buy and

sell the permitted investments listed in paragraphs (a)(1)(i) through

(vii) of this section pursuant to agreements for resale or repurchase

of the securities (agreements to repurchase or resell), provided the

agreements to repurchase or resell conform to the following

requirements:

(1) The securities are specifically identified by coupon rate, par

amount, market value, maturity date, and CUSIP or ISIN number.

(2) Permitted counterparties are limited to a bank as defined in

section 3(a)(6) of the Securities Exchange Act of 1934, a domestic

branch of a foreign bank insured by the Federal Deposit Insurance

Corporation, a securities broker or dealer, or a government securities

broker or government securities dealer registered with the Securities

and Exchange Commission or which has filed notice pursuant to section

15C(a) of the Government Securities Act of 1986.

(3) A futures commission merchant or derivatives clearing

organization shall not enter into an agreement to repurchase or resell

with a counterparty that is an affiliate of the futures commission

merchant or derivatives clearing organization, respectively. An

affiliate includes parent companies, including all entities through the

ultimate holding company, subsidiaries to the lowest level, and

companies under common ownership of such parent company or affiliates.

(4) The transaction is executed in compliance with the

concentration limit requirements applicable to the securities

transferred to the customer segregated custodial account in connection

with the agreements to repurchase referred to in paragraphs

(b)(3)(iii)(A) and (B) of this section.

(5) The transaction is made pursuant to a written agreement signed

by the parties to the agreement, which is consistent with the

conditions set forth in paragraphs (d)(1) through (13) of this section

and which states that the parties thereto intend the transaction to be

treated as a purchase and sale of securities.

(6) The term of the agreement is no more than one business day, or

reversal of the transaction is possible on demand.

(7) Securities transferred to the futures commission merchant or

derivatives clearing organization under the agreement are held in a

safekeeping account with a bank as referred to in paragraph (d)(2) of

this section, a derivatives clearing organization, or the Depository

Trust Company in an account that complies with the requirements of

Sec. 1.26.

(8) The futures commission merchant or the derivatives clearing

organization may not use securities received under the agreement in

another similar transaction and may not otherwise hypothecate or pledge

such securities, except securities may be pledged on behalf of

customers at another futures commission merchant or derivatives

clearing organization. Substitution of securities is allowed, provided,

however, that:

(i) The qualifying securities being substituted and original

securities are specifically identified by date of substitution, market

values substituted, coupon rates, par amounts, maturity dates and CUSIP

or ISIN numbers;

(ii) Substitution is made on a ``delivery versus delivery'' basis;

and

(iii) The market value of the substituted securities is at least

equal to that of the original securities.

(9) The transfer of securities to the customer segregated custodial

account is made on a delivery versus payment basis in immediately

available funds. The transfer of funds to the customer segregated cash

account is made on a payment versus delivery basis. The transfer is not

recognized as accomplished until the funds and/or securities are

actually received by the custodian of the futures commission merchant's

or derivatives clearing organization's customer funds or securities

purchased on behalf of customers. The transfer or credit of securities

covered by the agreement to the futures commission merchant's or

derivatives clearing organization's customer segregated custodial

account is made simultaneously with the disbursement of funds from the

futures commission merchant's or derivatives clearing organization's

customer segregated cash account at the custodian bank. On the sale or

resale of securities, the futures commission merchant's or derivatives

clearing organization's customer segregated cash account at the

custodian bank must receive same-day funds credited to such segregated

[[Page 78802]]

account simultaneously with the delivery or transfer of securities from

the customer segregated custodial account.

(10) A written confirmation to the futures commission merchant or

derivatives clearing organization specifying the terms of the agreement

and a safekeeping receipt are issued immediately upon entering into the

transaction and a confirmation to the futures commission merchant or

derivatives clearing organization is issued once the transaction is

reversed.

(11) The transactions effecting the agreement are recorded in the

record required to be maintained under Sec. 1.27 of investments of

customer funds, and the securities subject to such transactions are

specifically identified in such record as described in paragraph (d)(1)

of this section and further identified in such record as being subject

to repurchase and reverse repurchase agreements.

(12) An actual transfer of securities to the customer segregated

custodial account by book entry is made consistent with Federal or

State commercial law, as applicable. At all times, securities received

subject to an agreement are reflected as ``customer property.''

(13) The agreement makes clear that, in the event of the bankruptcy

of the futures commission merchant or derivatives clearing

organization, any securities purchased with customer funds that are

subject to an agreement may be immediately transferred. The agreement

also makes clear that, in the event of a futures commission merchant or

derivatives clearing organization bankruptcy, the counterparty has no

right to compel liquidation of securities subject to an agreement or to

make a priority claim for the difference between current market value

of the securities and the price agreed upon for resale of the

securities to the counterparty, if the former exceeds the latter.

(e) Deposit of firm-owned securities into segregation. A futures

commission merchant shall not be prohibited from directly depositing

unencumbered securities of the type specified in this section, which it

owns for its own account, into a segregated safekeeping account or from

transferring any such securities from a segregated account to its own

account, up to the extent of its residual financial interest in

customers' segregated funds; provided, however, that such investments,

transfers of securities, and disposition of proceeds from the sale or

maturity of such securities are recorded in the record of investments

required to be maintained by Sec. 1.27. All such securities may be

segregated in safekeeping only with a bank, trust company, derivatives

clearing organization, or other registered futures commission merchant.

Furthermore, for purposes of Sec. Sec. 1.25, 1.26, 1.27, 1.28, and

1.29, investments permitted by Sec. 1.25 that are owned by the futures

commission merchant and deposited into such a segregated account shall

be considered customer funds until such investments are withdrawn from

segregation.

Appendix to Sec. 1.25--Money Market Mutual Fund Prospectus Provisions

Acceptable for Compliance With Section 1.25(c)(5)

Upon receipt of a proper redemption request submitted in a

timely manner and otherwise in accordance with the redemption

procedures set forth in this prospectus, the [Name of Fund] will

redeem the requested shares and make a payment to you in

satisfaction thereof no later than the business day following the

redemption request. The [Name of Fund] may postpone and/or suspend

redemption and payment beyond one business day only as follows:

a. For any period during which there is a non-routine closure of

the Fedwire or applicable Federal Reserve Banks;

b. For any period (1) during which the New York Stock Exchange

is closed other than customary week-end and holiday closings or (2)

during which trading on the New York Stock Exchange is restricted;

c. For any period during which an emergency exists as a result

of which (1) disposal of securities owned by the [Name of Fund] is

not reasonably practicable or (2) it is not reasonably practicable

for the [Name of Fund] to fairly determine the net asset value of

shares of the [Name of Fund];

d. For any period during which the Securities and Exchange

Commission has, by rule or regulation, deemed that (1) trading shall

be restricted or (2) an emergency exists;

e. For any period that the Securities and Exchange Commission,

may by order permit for your protection; or

f. For any period during which the [Name of Fund,] as part of a

necessary liquidation of the fund, has properly postponed and/or

suspended redemption of shares and payment in accordance with

federal securities laws.

PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS

0

3. The authority citation for part 30 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6c, and 12a, unless otherwise

noted.

0

4. In Sec. 30.7, revise paragraph (c) and add paragraph (g) to read as

follows:

Sec. 30.7 Treatment of foreign futures or foreign options secured

amount.

* * * * *

(c)(1) The separate account or accounts referred to in paragraph

(a) of this section must be maintained under an account name that

clearly identifies them as such, with any of the following

depositories:

(i) A bank or trust company located in the United States;

(ii) A bank or trust company located outside the United States that

has in excess of $1 billion of regulatory capital;

(iii) A futures commission merchant registered as such with the

Commission;

(iv) A derivatives clearing organization;

(v) The clearing organization of any foreign board of trade;

(vi) A member of any foreign board of trade; or

(vii) Such member or clearing organization's designated

depositories.

(2) Each futures commission merchant must obtain and retain in its

files for the period provided in Sec. 1.31 of this chapter an

acknowledgment from such depository that it was informed that such

money, securities or property are held for or on behalf of foreign

futures and foreign options customers and are being held in accordance

with the provisions of these regulations.

* * * * *

(g) Each futures commission merchant that invests customer funds

held in the account or accounts referred to in paragraph (a) of this

section must invest such funds pursuant to the requirements of Sec.

1.25 of this chapter.

Issued in Washington, DC, on December 5, 2011 by the Commission.

David A. Stawick,

Secretary of the Commission.

Appendices to Investment of Customer Funds and Funds Held in an Account

for Foreign Futures and Foreign Options Transactions--Commission Voting

Summary and Statements of Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler, Commissioners Sommers,

Chilton, O'Malia and Wetjen voted in the affirmative; no

Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the final rule to enhance customer protections

regarding where derivatives clearing organizations (DCOs) and

futures commission merchants (FCMs) can invest customer funds. I

believe that this rule is critical for the safeguarding of customer

money.

The Commodity Exchange Act in section 4d(a)(2) prescribes that

customer funds can only be placed in a set list of permitted

investments. From 2000 to 2005, the

[[Page 78803]]

Commission granted exemptions to this list, loosening the rules for

the investment of customer funds. These exemptions allowed FCMs to

invest customer funds in AAA-rated sovereign debt, as well as to

lend customer money to another side of the firm through repurchase

agreements.

This rule prevents such in-house lending through repurchase

agreements. I believe there is an inherent conflict of interest

between parts of a firm doing these transactions. The rule also

would limit an FCM's ability to invest customer money in foreign

sovereign debt.

In addition, this rule fulfills a Dodd-Frank requirement that

the CFTC remove all reliance on credit ratings from its regulations.

[FR Doc. 2011-31689 Filed 12-16-11; 8:45 am]

BILLING CODE P

Last Updated: December 19, 2011