2013-26665

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

[Rules and Regulations]

[Pages 68505-68657]

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

[FR Doc No: 2013-26665]

[[Page 68505]]

Vol. 78

Thursday,

No. 220

November 14, 2013

Part II

Commodity Futures Trading Commission

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

Enhancing Protections Afforded Customers and Customer Funds Held by

Futures Commission Merchants and Derivatives Clearing Organizations;

Final Rule

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

Rules and Regulations

[[Page 68506]]

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COMMODITY FUTURES TRADING COMMISSION

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

RIN 3038-AD88

Enhancing Protections Afforded Customers and Customer Funds Held

by Futures Commission Merchants and Derivatives Clearing Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

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

to require enhanced customer protections, risk management programs,

internal monitoring and controls, capital and liquidity standards,

customer disclosures, and auditing and examination programs for futures

commission merchants (``FCMs'').

The regulations also address certain related issues concerning

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

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

market participants that: Customer segregated funds, secured amount

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

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

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

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

are strengthened to safeguard their continued operations; and the

auditing and examination programs of the Commission and the self-

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

FCMs in a prudent and thorough manner.

DATES: Effective date: January 13, 2014.

Compliance date: The applicable compliance dates are discussed in

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

FOR FURTHER INFORMATION CONTACT: Division of Swap Dealer and

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

[email protected]; Thomas Smith, Deputy Director, 202-418-5495,

[email protected];mailto: Jennifer Bauer, Special Counsel, 202-418-5472,

[email protected]; Joshua Beale, Attorney-Advisor, 202-418-5446,

[email protected], Three Lafayette Centre, 1155 21st Street NW.,

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

[email protected], 140 Broadway, 19th Floor, New York, NY 10005; or

Mark Bretscher, Special Counsel, 312-596-0529, [email protected], 525

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

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

[email protected]; Robert B. Wasserman, Chief Counsel, 202-418-

5092, [email protected]; Phyllis P. Dietz, Deputy Director, 202-418-

5449, [email protected]; M. Laura Astrada, Associate Chief Counsel, 202-

418-7622, [email protected], Eileen Donovan, Associate Director, 202-

418-5096, [email protected]; Kirsten V. K. Robbins, Special Counsel,

202-418-5313, [email protected]; or Shawn R. Durrani, Attorney-Advisor,

202-418-5048, [email protected], Three Lafayette Centre, 1155 21st

Street NW., Washington, DC 20581.

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

[email protected], 202-418-5911, Three Lafayette Centre, 1155 21st Street

NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. General Statutory and Current Regulatory Structure

B. Self-Regulatory Structure

C. Futures Commission Merchant Insolvencies and Failures of Risk

Management

D. Recent Commission Rulemakings and Other Initiatives Relating

to Customer Protection

E. The Proposed Amendments

II. Comments on the Notice of Proposed Rulemaking

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

and Introducing Brokers

1. Amendments of the Segregation and Secured Amount Schedules

With Respect to the Reporting of Residual Interest

2. New Cleared Swaps Segregation Schedules

3. Amendments to Form 1-FR-FCM

4. FCM Certified Annual Report Deadline

5. Leverage Ratio Calculation

6. Procedural Filing Requirements

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

Merchants

1. Applicability

2. Definitions

3. Approval of Policies and Procedures and Submission to the

Commission

4. Organizational Requirements of the Risk Management Program

a. Separation of Risk Management Unit From Business Unit

5. Components of the Risk Management Program

6. Annual Review, Distribution of Policies and Procedures and

Recordkeeping

7. CCO or CEO Certification

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

Futures Commission Merchants and Introducing Brokers

1. Timing of Notices

2. Undercapitalized FCMs and IBs

3. Insufficient Segregation of Funds of Cleared Swaps Customers

4. Investment of Customer Funds in Contravention of Regulation

1.25

5. Notice of Residual Interest Falling Below Targeted Level or

Undermargined Amounts

6. Events Causing Material Adverse Financial Impact or Material

Change in Operations

7. Notice of Correspondence From Other Regulatory Authorities

8. Filing Process and Content

9. Public Disclosure of Early Warning Notices

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

Commission Merchants

E. Sec. 1.16: Qualifications and Reports of Accountants

1. Mandatory PCAOB Registration Requirement

2. PCAOB Inspection Requirement

3. Remediation of PCAOB Inspection Findings by the Public

Accountant

4. Auditing Standards

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

Governing Body

6. Electronic Filing of Certified Annual Reports

F. Sec. 1.17: Minimum Financial Requirements for Futures

Commission Merchants and Introducing Brokers

1. FCM Cessation of Business and Transfer of Customer Accounts

if Unable To Demonstrate Adequate Liquidity

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

Undermargined Accounts to One Day after Margin Calls Are Issued

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

Procedures To Determine Creditworthiness

4. Revisions to Definitions in Regulation 1.17(b)

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

Separately Accounted for

1. Identification of Customer Funds and Due Diligence

2. Permitted Depositories

3. Limitation on the Holding of Futures Customer Funds Outside

of the United States

4. Acknowledgment Letters

a. Background

b. Technical Changes to the Template Letters

c. Federal Reserve Banks as Depositories

d. Foreign Depositories

e. Release of Funds Upon Commission Instruction

f. Read-Only Access and Information Requests

g. Requirement To File New Acknowledgment Letters

h. Standard of Liability

i. Liens

j. Examination of Accounts

5. Prohibition Against Commingling Customer Funds

6. Limitations on the Use of Customer Funds

7. Segregation Requirements for DCOs

[[Page 68507]]

8. Immediate Availability of Bank and Trust Company Deposits

9. Segregated Funds Computation Requirement

10. Segregation Regimes

H. Sec. 1.22: Use of Futures Customer Funds

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

Segregated Futures Customer Funds; Additions and Withdrawals

J. Sec. 1.25: Investment of Customer Funds

1. General Comments Regarding the Investment of Customer Funds

2. Reverse Repurchase Agreement Counterparty Concentration

Limits

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

Customer Funds

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

of Customer Funds

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

Customer Funds

2. FCM's Obligation in Event of Bank Default

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

of Proceeds

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

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

Segregated Account: Daily Computation and Record

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

Surveillance of Minimum Financial Requirements

1. Swap Execution Facilities Excluded From the Scope of

Regulation 1.52

2. Revisions to the Current SRO Supervisory Program

3. Auditing Standards Utilized in the SRO Supervisory Program

4. ``Examinations Expert'' Reports

P. Sec. 1.55: Public disclosures by Futures Commission

Merchants

1. Amendments to the Risk Disclosure Statement

a. Firm Specific Disclosure Document

i. General Requirements

ii. Specific Disclosure Information Required (by rule paragraph)

2. Public Availability of FCM Financial Information

Q. Part 22--Cleared Swaps

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

Treatment of Foreign Futures or Foreign Options Secured Amount

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

Secured Amount

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

3. Commingling of Positions in Foreign Futures and Foreign

Options Accounts

4. Further Harmonization With Treatment of Customer Segregated

Funds

5. Harmonization With Other Commission Proposals

S. Sec. 3.3: Chief Compliance Officer Annual Report

III. Compliance Dates

A. Financial Reports of FCMs: Sec. 1.10

B. Risk Management Program for FCMs: Sec. 1.11

C. Qualifications and Reports of Accountants: Sec. 1.16

D. Minimum Financial Requirements for FCMs

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

30.7

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

G. SRO Minimum Financial Surveillance: Sec. 1.52

H. Public Disclosures by FCMs: Sec. 1.55

IV. Cost Benefit Considerations

V. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

Appendix 1--Table of Comment Letters

Appendix 2--CFTC Form 1-FR-FCM

I. Background

A. General Statutory and Current Regulatory Structure

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

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

fundamental component of the Commission's disclosure and financial

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

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

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

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

contracts and options on futures contracts traded on designated

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

and deal with futures customer funds as belonging to the futures

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

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

the futures customer that deposited the funds.

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

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

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

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

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

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

such contract (excluding any proprietary accounts under Sec.

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

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

amended existing Commission regulations to incorporate swaps. The

Federal Register release adopting the final rules can be accessed at

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

CFR Ch. 1.

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

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

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

money, securities, and other property deposited by Cleared Swaps

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

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

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

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

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

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

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

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

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

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

person for whom the same are held.

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

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

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

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

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

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

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

Cleared Swaps Proprietary Account with respect to the Cleared Swaps

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

Cleared Swaps cleared on that DCO.

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

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

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

to safeguard funds deposited by futures customers and Cleared Swaps

Customers, respectively.

Regulation 1.20 requires each FCM and DCO to separately account for

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

or other property deposited by futures customers for trading on

designated contract markets. In addition, all futures customer funds

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

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

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

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

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

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

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

deposited under an account name that clearly identifies the funds as

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

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

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

obtain a written acknowledgment from a depository stating that the

depository was informed that the funds deposited are customer funds

being held in accordance with the Act.

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

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

use of, the

[[Page 68508]]

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

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

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

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

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

than in commodities or commodity options traded through the facilities

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

convenience, commingle and hold funds deposited as margin by multiple

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

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

funds in certain permitted investments under Sec. 1.25.

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

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

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

responsibilities imposed upon, an FCM may hold funds for futures

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

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

Cleared Swaps Customers as belonging to such Cleared Swaps Customers

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

22.4 provides that an FCM may deposit Cleared Swaps Customer Collateral

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

Regulation 22.6 requires that the account holding the Cleared Swaps

Customers Collateral must clearly identify the account as an account

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

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

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

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

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

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

Protection of Cleared Swaps Customer Contracts and Collateral;

Conforming Amendments to the Commodity Broker Bankruptcy Provisions,

77 FR 6336 (Feb. 7, 2012).

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

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

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

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

Cleared Swap.

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

Swaps Customer Collateral of one Cleared Swaps Customer to purchase,

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

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

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

Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers

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

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

In addition to holding funds for futures customers transacting on

designated contract markets and for Cleared Swaps Customers engaging in

Cleared Swaps, FCMs also hold funds for persons trading futures

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

provides that the Commission may adopt rules and regulations

proscribing fraud and requiring minimum financial standards, the

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

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

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

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

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

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

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

Commission adopted part 30 of its regulations to address foreign

futures and foreign option transactions.

The segregation provisions for funds deposited by foreign futures

or foreign options customers to margin foreign futures or foreign

options transactions under part 30, however, are significantly

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

customers trading on designated contract markets and part 22 for

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

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

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

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

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

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

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

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

foreign clearing organization. The account with the depository must be

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

foreign futures or foreign options customers of the FCM that are

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

the funds deposited by foreign futures or foreign option customers in

accordance with Sec. 1.25.

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

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

territories or possessions who trades in foreign futures or foreign

options, with the exception of accounts that are proprietary

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

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

or options transactions executed on a foreign board of trade.

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

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

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

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

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

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

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

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

received on foreign options (including any additional funds necessary

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

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

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

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

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

all times.

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

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

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

capital and financial reporting requirements that are intended to

ensure that such firms meet their financial obligations in a regulated

marketplace, including their financial obligations to customers and

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

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

firm's net equity as computed under generally accepted accounting

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

qualifying subordinated debt) and further excluding all assets that are

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

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

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

assets.

FCMs also are subject to financial recordkeeping and reporting

requirements. FCMs that carry customer accounts are required under

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

compliance with the segregation and secured amount requirements.

Regulation 1.32 requires the calculation to be performed by noon

[[Page 68509]]

each business day, reflecting the account balances and open positions

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

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

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

unaudited financial statements and an annual audited financial

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

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

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

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

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

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

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

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

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

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

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

other FCMs or DCOs.

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

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

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

to be primarily responsible for conducting ongoing financial

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

joint audit agreement submitted to and approved by the Commission

under Sec. 1.52.

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

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

on greater meaning in light of the devastating events experienced over

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

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

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

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

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

mitigated significantly by better risk management systems and controls,

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

the FCMs.

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

segregation for any particular FCM requires a full understanding of the

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

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

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

Further, appropriate care must be taken to avoid withdrawing such

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

purposes for which excess segregated and secured funds are maintained.

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

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

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

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

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

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

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

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

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

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

that result in an inappropriate withdrawal of customer funds.

Although the Commission's existing regulations provide an essential

foundation to fostering a well-functioning marketplace, wherein

customers are protected and institutional risks are minimized, recent

events have demonstrated that additional measures are necessary to

effectuate the fundamental purposes of the statutory provisions

discussed above. Further, concurrently with the enhanced

responsibilities for FCMs that were proposed by the Commission, the

oversight and examination systems must be enhanced to mitigate risks

and effectuate the statutory purposes.

B. Self-Regulatory Structure

The Commission's oversight structure provides that SROs are the

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

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

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

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

interests through a system of effective self-regulation of trading

facilities, clearing systems, market participants and market

professionals under the oversight of the Commission.''

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

conduct periodic examinations of member FCMs' compliance with

Commission and SRO financial and related reporting requirements,

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

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

performance of their duties. The Commission recently has moved to

conducting continuous reviews of the SROs' FCM examination program that

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

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

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

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

audits as accountants commonly use that term.

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

member FCMs, to avoid subjecting FCMs to duplicative examinations from

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

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

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

FCMs.

Under Commission regulations, FCMs must have their annual financial

statements audited by an independent certified public accountant

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

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

independent accountant also must conduct appropriate reviews and tests

to identify any material inadequacies in systems and controls that

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

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

FCM's DSRO and to the Commission.

C. Futures Commission Merchant Insolvencies and Failures of Risk

Management

The recent insolvencies of two FCMs demonstrate the need for

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

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

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

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

a liquidation proceeding under the Securities Investor Protection Act

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

The trustee appointed to oversee the liquidation of MFGI reported a

potential $900 million shortfall of funds necessary to repay the

account balances due to customers trading futures on designated

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

immediately available to repay the account balances of customers

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

segregated accounts was attributed by the MFGI Trustee to significant

transfers of funds

[[Page 68510]]

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

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

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

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

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

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In addition, the Commission filed a civil injunctive complaint in

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

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

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

that PFGI and Wasendorf, Sr. committed fraud by misappropriating

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

statements regarding the amount of funds in customer segregated

accounts in financial statements filed with the Commission. The

complaint states that in July 2012 during an NFA examination PFGI

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

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

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

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

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

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

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Recent incidents also have demonstrated the value of establishing

robust risk management systems within FCMs and enhanced early warning

systems to detect and address financial and regulatory issues. In

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

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

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

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

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

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

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

on designated contract markets and customers engaging in cleared

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

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

customers trading on foreign markets pursuant to part 30 of the

Commission's regulations.

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

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

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

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

represented much of the firm's capital).

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These recent incidents highlighted weaknesses in the customer

protection regime prescribed in the Commission's regulations and

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

arisen on the requirements surrounding the holding and investment of

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

futures customer segregated accounts and part 30 secured accounts.

Additionally, the incidents have underscored the need for additional

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

warning systems surrounding margin and capital requirements, and

enhanced public disclosures--to promote the protection of customer

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

market participants. Further questions have arisen on the system of

audits and examinations of FCMs, and whether the system functions

adequately to monitor FCMs' activities, verify segregated funds and

secured amount balances, and detect fraud.

D. Recent Commission Rulemakings and Other Initiatives Relating to

Customer Protection

Since late 2011, the Commission has promulgated rules directly

impacting the protection of customer funds. The Commission also has

studied the current regulatory framework surrounding customer

protection, particularly in light of the recent incidents outlined

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

Commission regulations protecting customer funds. The Commission's

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

participants. The proposed rule amendments were informed by the efforts

detailed below.

In December 2011, the Commission adopted final rule amendments

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

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

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

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

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

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

transactions.

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

Account for Foreign Futures and Foreign Options Transactions, 76 FR

78776 (Dec. 19, 2011).

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

mindful that customer segregated funds must be invested by FCMs and

DCOs in a manner that minimizes their exposure to credit, liquidity,

and market risks both to preserve their availability to customers and

DCOs, and to enable investments to be quickly converted to cash at a

predictable value in order to avoid systemic risk. The amendments are

consistent with the general prudential standard contained in Sec.

1.25, which provides that all permitted investments must be

``consistent with the objectives of preserving principal and

maintaining liquidity.''

The Commission also approved final regulations that require DCOs to

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

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

customer's margin requirement against another customer's margin

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

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

margin is posted by FCMs to the DCOs.

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

Clearing Organization General Provisions and Core Principles, 76 FR

69334 (Nov. 8, 2011).

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The Commission also approved regulations that impose requirements

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

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

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

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

situation where a futures customer defaults on its obligation to its

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

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

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

defaulting futures customer before applying its own capital or the

guaranty fund contributions of non-defaulting FCM members.

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

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The Commission approved an alternative model for Cleared Swaps.

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

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

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

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

permitted to access the collateral of the defaulting Cleared Swaps

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

defaulting Cleared Swaps Customers to cover a defaulting Cleared Swaps

Customer's losses.

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

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

maintains at a permitted depository for the Cleared Swaps (and

related collateral) of Cleared Swaps Customers.

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

segregation for uncleared swaps, approved by the Commission on October

30, 2013, implements the

[[Page 68511]]

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

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

such counterparties have a right to require that any initial margin

which they post to guarantee uncleared swaps be segregated at an

independent custodian. Where the counterparty elects segregation for

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

independent of both the counterparty and the SD or MSP.

The Commission also included customer protection enhancements in a

final rulemaking for designated contract markets issued in June 2012.

These enhancements codify into regulations staff guidance on minimum

requirements for SROs regarding their financial surveillance of

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

resources for effective rule enforcement and trade and financial

surveillance programs, including the authority to collect information

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

regulations also establish minimum financial standards for both member

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

expressly noted in the preamble of the Federal Register release that

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

setting capital requirements, conducting surveillance of the potential

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

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

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

customer funds, including the segregation of customer and proprietary

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

customer funds, intermediary default procedures and related

recordkeeping.

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\18\ See Core Principles and Other Requirements for Designated

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

\19\ Id. at 36646.

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In addition to the rulemaking efforts outlined above, the

Commission sought additional information through a series of

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

Commission solicited comments and held public roundtables to solicit

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

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

securities regulators, foreign clearing organizations, and

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

advisability and practicality of modifying the segregation models for

customer funds; alternative models for the custody of customer

collateral; enhancing FCM controls over the disbursement of customer

funds; increasing transparency surrounding an FCM's holding and

investment of customer funds; and lessons learned from recent commodity

brokerage bankruptcy proceedings.

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\20\ Further information on the public roundtable, including

video recordings and transcripts of the discussions, have been

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

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

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The Commission also hosted a public meeting of the Technology

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

members discussed potential technological solutions directed at

enhancing the protection of customer funds by identifying and exploring

technological issues and possible solutions relating to the ability of

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

funds held in customer segregated accounts.

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\21\ Additional information, including documents submitted by

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

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

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

to discuss SRO requirements for examinations of FCMs and Commission

oversight of SRO examination programs. The roundtable also focused on

the role of the independent public accountant in the FCM examination

process, and proposals addressing various alternatives to the current

system for segregating customer funds.

The Commission also considered industry initiatives to enhance

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

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

extent of the protections provided under the current regulatory

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

prepared by members of the FIA Law and Compliance Division addressing

the basics of segregation, collateral management and investments,

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

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

existing and potential customers with a better understanding of the

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

extent of the protections provided to customers and their funds under

the Act and Commission regulations.

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

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

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FIA also issued a series of initial recommendations for the

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

the Financial Management Committee, whose members include

representatives of FIA member firms, DCOs and depository institutions.

The initial recommendations address enhanced disclosure on the

protection of customer funds, reporting on segregated funds balances by

FCMs, FCM internal controls surrounding the holding and disbursement of

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

protections comparable to those provided for customers trading on

designated contract markets.

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

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

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

requirements proposed by the National Futures Association

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

related Interpretive Notice entitled ``NFA Financial Requirements

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

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

Funds Provisions'') were developed in consultation with Commission

staff.

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

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

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

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

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

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

targeted amount of excess funds in segregate accounts and part 30

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

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

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

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

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

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

whenever the withdrawal equals 25 percent or more of the excess

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

information regarding the depositories holding customer funds and the

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

[[Page 68512]]

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

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

and leverage information with NFA.

Significantly, NFA's Segregated Funds Provisions also require FCMs

to compute their part 30 secured amount requirement and compute their

targeted excess part 30 secured funds using the same Net Liquidating

Equity Method that is required by the Act and Commission regulations

for computing the segregation requirements for customers trading on

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

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

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

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

Net Liquidating Equity Method may result in NFA initiating a Membership

Responsibility Action against the firm.

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

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

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

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

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

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

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

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

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

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

policies and procedures.

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

FCMs to instruct each depository holding futures customer funds to

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

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

third-party vendor which received account balance information directly

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

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

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

and receives account information directly from all depositories holding

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

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

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

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

Customers engaging in Cleared Swaps.

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

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

Segregation, Secured, and Cleared Swaps Customer Account

Requirements.

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

amended rules, by developing programs that compare the daily balances

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

their daily segregation reports. An immediate alert is generated for

any material discrepancies.

E. The Proposed Amendments

The incidents outlined above, coupled with the information

generated through the recent efforts undertaken by the Commission and

industry participants, demonstrate the need for new rules and

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

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

the currently regulatory framework, evince a need for enhanced customer

protections, risk management programs, disclosure requirements, and

auditing and examination programs. To address these needs, the

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

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

to enhance customer protections.\26\

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

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The Proposal addressed six main issues. First, recognizing problems

surrounding the treatment of customer segregated funds and foreign

futures or foreign options secured amounts, the Commission proposed to

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

regulations to provide greater certainty to market participants that

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

address shortcomings in the risk management of FCMs, the Commission

proposed a new Sec. 1.11 that establishes robust risk management

programs. Third, the Commission determined that the current regulatory

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

forward-looking perspective, affording the Commission and SROs with

read-only access to accounts holding customer funds and additional

information on depositories and the customer assets held in such

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

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

capital that can result from such difficulties, the Commission proposed

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

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

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

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

administration and oversight, the Commission proposed to amend Sec.

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

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

recognizing the need to increase the information provided to customers

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

may choose to conduct business, the Commission proposed amendments to

Sec. 1.55 that enhance the disclosures provided by FCMs.

II. Comments on the Notice of Proposed Rulemaking

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

customer protection regime; (2) imposing risk management requirements

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

regarding material changes in their operations or financial condition;

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

the examination process of FCMs by both the SROs and public

accountants; and (6) requiring additional disclosures to customers

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

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

approximately 30 additional days at the request of various commenters

and in order to provide interested parties with an additional

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

on February 15, 2013.

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

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During the comment period the Commission held two public

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

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

FCMs, DCOs, SROs, securities regulators, foreign clearing

organizations, and academics. The Commission received more than 120

written submissions on the proposing release from a range of

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

least eight of the commenters and other

[[Page 68513]]

members of the public. Commenters represented a broad spectrum of

industry participants, trade organizations, law firms, accounting firms

and self-regulatory organizations. The majority of commenters supported

the overall principles proposed by the Commission although many raised

concerns or offered suggestions regarding certain proposal specifics.

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

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

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

citing to the comments received during the discussion of the

comments in this Section, the Commission used the abbreviations set

forth in the table in Appendix 1.

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The Commission also held a meeting of the Agricultural Advisory

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

the Proposal. The transcript of the Agricultural Advisory Committee

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

Commission has considered those comments in finalizing the regulations.

The Commission has carefully considered the comments received and

is adopting the Proposal herein subject to various amendments that

address certain concerns raised or suggestions made by commenters. Each

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

corresponding section of the Proposal, is discussed in greater detail

in the following sections.

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

Introducing Brokers

Regulation 1.10 requires each FCM to file with the Commission and

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

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

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

Operational Combined Uniform Single Report under the Securities

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

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

an annual financial report certified by an independent public

accountant.

The unaudited monthly and certified annual financial reports are

required to contain basic financial statements, including a statement

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

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

to include additional schedules designed to address specific regulatory

objectives to demonstrate that the FCM is in compliance with minimum

capital and customer funds segregation requirements. These additional

schedules include a statement of changes in liabilities subordinated to

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

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

statement of segregation requirements and funds in segregation for

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

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

separate accounts for foreign futures and foreign options customers

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

must contain a reconciliation of material differences between the

Capital Computation Schedule, the Segregation Schedule, and the Secured

Amount Schedule contained in the certified annual report and the

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

1. Amendments to the Segregation and Secured Amount Schedules With

Respect to the Reporting of Residual Interest

The Segregation Schedule and the Secured Amount Schedule generally

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

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

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

regulatory obligations to futures customers and foreign futures or

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

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

the reporting date. FCMs also deposit proprietary funds into customer

segregated and secured accounts to protect against becoming

undersegregated or undersecured by failing to hold a sufficient amount

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

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

interest'' in the customer segregated and secured accounts.

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

also disclose in the Segregation Schedule and in the Secured Amount

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

seeks to maintain in customer segregated accounts and secured accounts

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

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

of each FCM that carries customer funds to perform appropriate due

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

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

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

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

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

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

own liquidity and capital needs, historical trends in customer

segregation and secured account funds balances, and historical trends

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

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

procedures establishing the targeted amount of residual interest that

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

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

procedures must be designed to reasonably ensure that the FCM maintains

the targeted residual interest amount and remains in compliance with

its segregation requirements at all times.\31\

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

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

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

foreign-domiciled customers consistent with the proposed amendments

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

below. No comments were received regarding the revisions to the

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

adopting the revisions as proposed.

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

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

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

contracts. As explained further in the discussion in sections

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

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

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

in the final rule.

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

that FCMs maintain written policies and procedures identifying a

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

interest in customer segregated and secured accounts. See NFA Notice

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

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

interest in segregated or secured accounts will allow the Commission

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

funds in segregated and secured accounts in amounts sufficient to cover

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

maintain sufficient funds to cover the targeted residual interest

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

assess whether the FCM is experiencing financial issues that may

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

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

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

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

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

segregation or secured accounts and to

[[Page 68514]]

the size of the targeted residual interest maintained by other

comparable FCMs. This information will assist the Commission and DSROs

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

the potential risk that a firm may become undersegregated or

undersecured. This additional information will further enhance the

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

The Commission also proposed to amend the Segregation Schedule and

the Secured Amount Schedule to require each FCM filing such schedules

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

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

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

segregated and secured account exceeded the respective customer margin

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

and 1.23.

The Commission has considered the proposal and has determined not

to amend the Segregation Schedule and Secured Amount Schedule to

require the disclosure of the undermargined amounts. As further

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

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

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

secured accounts in excess of its undermargined amounts. The final

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

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

the computations reflected on the Segregation Schedule and the Secured

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

day. The reporting of the undermargined amount information on the

Segregation and Secured Amount Schedules would not be accurate as the

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

undermargined, at the time the undermargined amount calculations are

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

calls.\32\

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

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

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

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

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

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

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

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

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

residual interest to a level that is above the undermargined

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

below.

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The Commission has considered the comments and is adopting the

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

Segregation Schedule and the Secured Amount Schedule.

2. New Cleared Swaps Segregation Schedules

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

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

Segregation Requirements and Funds in Cleared Swap Customer Accounts

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

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

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

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

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

and segregate from its own assets Cleared Swaps Customers Collateral

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

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

Collateral deposited by a Cleared Swaps Customer as belonging to such

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

Cleared Swaps Customer Collateral to margin, secure or guarantee the

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

deposited the Cleared Swaps Customer Collateral. FCMs currently prepare

a schedule comparable to the Cleared Swaps Segregation Schedule for

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

Commission's proposal would codify existing practices.

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\33\ The Commission previously proposed a Cleared Swaps

Segregation Schedule as part of its proposed regulations to adopt

capital requirements for swap dealers and major swap participants.

See Capital Requirements of Swap Dealers and Major Swap

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

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

decision to revise the schedule by requiring FCMs to separately

disclose their targeted residual interest in Cleared Swaps Customer

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

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

regulations requiring FCMs to hold in segregated accounts funds

received from customers engaging in Cleared Swaps to margin, secure

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

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

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The Commission received one comment on the proposed Cleared Swaps

Segregation Schedule. The Students at the SUNY Buffalo Law School

supported the development of the Cleared Swaps Segregation

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

determined to adopt the Cleared Swaps Segregation Schedule as

proposed.\35\

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

\35\ The Commission will revise the Cleared Swaps Segregation

Schedule consistent with the revisions to the Segregation Schedule

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

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

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

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

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

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

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

include a Segregation Schedule and a Secured Amount Schedule in the

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

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

Cleared Swaps Segregation Schedule to their Focus Report filings.

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

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

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

disclosure for purposes of the Freedom of Information Act and the

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

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

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

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

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

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

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

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

certified annual financial report and the Segregation Schedule and

Secured Amount Schedule are public documents.

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

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

Cleared Swaps Segregation Schedule to the list of documents that are

publicly available. The only comment that the Commission received

regarding making the Cleared Swaps Segregation Schedule public was

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

the SUNY Buffalo Law School supported the development and

implementation of the Cleared Swaps Segregation Schedule as a

regulatory tool for the Commission to receive additional information

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

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

Segregation Schedule and other financial information could

[[Page 68515]]

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

Stearns as examples of how public panic can rapidly accelerate a

company's collapse by exacerbating the effects of financial injuries

that might otherwise be manageable.\39\

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

\38\ Id. at 8-9.

\39\ Id.

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The Commission notes that the monthly Segregation Schedules and

Secured Amount Schedules have been available to the public for many

years and provide important information that allows customers to

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

Commission believes that making the Cleared Swaps Segregation Schedule

publicly available will benefit customers and potential customers by

providing greater transparency on the status of the Cleared Swaps

Customer Collateral held by FCMs. This disclosure allows customers and

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

regulatory obligations to safeguard customer funds. The disclosure of

the Cleared Swaps Segregation Schedule also will provide a certain

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

Collateral, which customers and potential customers will be able to

assess as part of their risk management process.

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

obligation to segregate customer funds, coupled with the additional

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

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

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

regarding the risks of entrusting their funds and engaging in

transactions with particular FCMs. The Commission believes that these

benefits to customers outweigh any potential adverse market impact

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

Commission's experience in making FCMs' Segregation Schedules and

Secured Amount Schedules publicly available. The Commission has,

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

proposed.

3. Amendments to Form 1-FR-FCM

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

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

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

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

accounts for customers trading on designated contract markets (Line

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

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

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

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

the FCM in segregated accounts for Cleared Swaps Customers. This

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

which requires the segregation of Cleared Swaps Customer Collateral and

the proposed adoption of the Cleared Swaps Segregation Schedule as part

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

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

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The Commission also proposed to amend the Statement of Financial

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

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

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

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

Cleared Swaps Customers, is consistent with the reporting required on

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

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

Statement of Financial Condition to require an FCM to disclose

separately its obligation to retail forex customers. Currently, an

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

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

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

will provide greater transparency on the Statement of Financial

Condition regarding the firm's obligations to its retail counterparties

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

the Commission's direct jurisdiction over such activities when

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

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

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NFA filed the only comment addressing the proposed amendments to

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

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

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

Commission consider amending the asset section of the Statement of

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

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

to cover its obligations to retail forex customers as required by

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

result in more accurate reporting and is consistent with the reporting

for customer segregated funds.\43\

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

\43\ Id.

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The Commission has considered the comment and has determined to

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

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

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

to separately disclose the assets held in qualifying accounts in excess

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

Commission Regulation 5.8.

Regulation 5.8 requires each FCM and RFED offering or engaging in

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

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

total obligation to its retail forex customers at qualifying

institutions set forth in the Regulation. The requirement of Regulation

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

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

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

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

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

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

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

amount of funds held in qualifying accounts to meet its total

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

disclosure will provide greater transparency as to the firm's

compliance with Commission regulations.

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

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4. FCM Certified Annual Report Deadline

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

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

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

required to submit the annual certified financial statements within 90

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

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

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

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

are not

[[Page 68516]]

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

FCMs and dual registrant FCMs/BDs.

The Commission received one comment on the proposal. NFA supported

the proposal noting that the amendment will provide both the Commission

and DSROs with more timely information for monitoring the financial

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

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

Commission also is cognizant of the fact that public accountants are

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

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

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

currently in process, the Commission is establishing a compliance date

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

compliance date also will align the revised reporting deadline with the

auditing amendments to the auditing standards that public accountants

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

Compliance dates are discussed further in section III below.

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

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

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5. Leverage Ratio Calculation

The Commission proposed to add a new requirement in Sec.

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

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

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

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

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

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

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

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

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

provide information regarding the amount of assets supported by the

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

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

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

The Commission received three comments with respect to this

proposal. Commenters were concerned that the leverage metrics proposed

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

leverage definition was not consistent with those of other regulatory

authorities. NFA noted that while the leverage definition proposed by

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

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

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

calculation method and encouraged the Commission to defer codifying a

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

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

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

a registered futures association rather than including a specific

definition in the Commission's regulations.\48\

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

\47\ Id. at 7.

\48\ Id. at 8.

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

FIA indicated that it supported the proposed amendment, but stated

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

consistent among regulatory authorities with supervision over FCMs and

encouraged the Commission to coordinate with the SEC and the relevant

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

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

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

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

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

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

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

customers for trading commodity interests, and that the leverage ratio

computed under the proposed regulation does not properly reflect the

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

Commission work with NFA to develop a more meaningful metric and

further recommended that the Commission not permit or require public

disclosure of FCM leverage ratios under the current methodology because

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

information.\52\

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

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

\51\ Id.

\52\ Id.

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The Commission has considered the comments and has determined to

adopt a final regulation requiring FCMs to submit to the Commission

monthly balance sheet leverage information. As noted above, such

information will enhance the Commission's ability to conduct financial

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

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

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

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

definition of leverage.\53\

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

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

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

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

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

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

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

identical to the current NFA definition contained in its Financial

Requirement Section 16. Such an approach will enhance the consistency

in how the Commission and the SROs impose leverage reporting

requirements on FCMs and in how leverage is monitored by the

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

Commission intends to work with NFA and other regulators going forward

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

consistent a definition as practicable.

6. Procedural Filing Requirements

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

FCMs to electronically file with the Commission their monthly unaudited

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

reports. FCMs currently file their monthly unaudited financial

statements with the Commission electronically using the WinJammer

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

codify current practices.\54\

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

maintained jointly by the Chicago Mercantile Exchange and the NFA.

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

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

financial information and regulatory notices to the Commission and

to the SROs.

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

FCM annual financial reports are filed in paper form with the

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

WinJammer system to electronically file its certified financial report

as a ``PDF'' document.

No comments were received on the proposed amendments to Sec.

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

The Commission also is adopting a proposed technical amendment to

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

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

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

[[Page 68517]]

when received by the Commission Regional office with jurisdiction over

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

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

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

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

with the correct Commission Regional office.

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

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

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

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

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

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

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

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

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

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

Program.

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

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

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

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

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

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

Commission has considered the comments received and is adopting Sec.

1.11 as proposed, with the following observations and clarifications.

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

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

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

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

(Feb. 15, 2013).

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

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1. Applicability

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

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

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

trades or contracts that result from soliciting or accepting orders for

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

or hold customer funds to margin, guarantee or secure commodity

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

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

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

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

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

business model to begin accepting customer funds.

The Commission also requested comment on whether different risk

management requirements for FCMs should be based upon some measurable

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

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

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

the Commission could establish minimum risk management standards for

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

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

those programs in place.\57\

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

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

The Commission has considered the comment and has determined that

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

management program that is appropriate to its business operations. To

develop specific requirements for different business activities would

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

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

meet its business activities using the general framework established by

Sec. 1.11.

The Commission received no additional comments on proposed Sec.

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

2. Definitions

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

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

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

are designed to ensure that there is accountability at the highest

levels for the FCM's key internal controls and processes regarding the

FCM's responsibility to meet its obligations as a futures market

participant, including acting as an intermediary for customer

transactions, and its obligation to safeguard customer funds.

The term ``business unit'' was proposed to include generally any

department, division, group or personnel of an FCM or any affiliate

involved in soliciting orders and handling customer money, including

segregation functions, and personnel exercising direct supervisory

authority over the performance of such activities. The definition was

intended to delineate clearly the separation of the risk management

unit required by the regulation from the other personnel of an FCM from

whom the risk management must be independent.

The term ``customer'' was proposed broadly to include futures

customers (as defined in Sec. 1.3) trading futures contracts, or

options on futures contracts listed on designated contract markets,

30.7 customers (as proposed to be defined in Sec. 30.1) trading

futures contracts or options on futures contracts listed on foreign

contract markets, and Cleared Swaps Customers (as defined in Sec.

22.1) engaging in Cleared Swaps.

The term ``governing body'' was proposed to be defined as the sole

proprietor, if the FCM is a sole proprietorship; a general partner, if

the FCM is a partnership; the board of directors, if the FCM is a

corporation; and the chief executive officer, chief financial officer,

the manager, the managing member, or those members vested with the

management authority if the FCM is a limited liability company or

limited liability partnership. The term ``senior management'' was

proposed to mean any officer or officers specifically granted the

authority and responsibility to fulfill the requirements of senior

management under proposed Sec. 1.11 by the governing body.

The term ``segregated funds'' was proposed to mean money,

securities, or other property held by an FCM in separate accounts

pursuant to Sec. 1.20 for futures customers, pursuant to Sec. 22.2

for Cleared Swaps Customers, and pursuant to Sec. 30.7 for 30.7

customers. The proposed definition of ``segregated funds'' makes clear

that the requirements of Sec. 1.11 apply to all customer funds that

may be held by an FCM. The Act and Commission regulations currently

require FCMs to hold each type of segregated funds in separate accounts

and to segregate such segregated funds from the FCM's own funds and to

segregate each class of segregated funds from each other type, except

if otherwise permitted by Commission rule, regulation or order.\58\

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\58\ See 7 U.S.C. 6d(a)(2) and 7 U.S.C. 6d(f).

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

The Commission did not receive any comments regarding the proposed

definitions in Sec. 1.11(b) and is adopting the amendments as

proposed.

3. Approval of Policies and Procedures and Submission to the Commission

The Commission proposed Sec. 1.11(c) to require each FCM to

establish, maintain, and enforce a system of risk management policies

and procedures

[[Page 68518]]

designed to monitor and manage the risks associated with the activities

of the FCM as an FCM.\59\ The policies and procedures are collectively

referred to as the FCM's Risk Management Program.

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\59\ Because Sec. 1.11 applies to all FCMs that accept money,

securities, or property (or extend credit in lieu thereof) from

customers, it necessarily applies to any risks generated by the FCMs

customers' trading activities. See, e.g., In re FCStone LLC, CFTC

Docket 13-24, (May 29, 2013), where a customer's trading activities

and the FCM's inadequate risk management practices caused the firm

to lose over $127,000,000.

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Under proposed Sec. 1.11, the FCM's governing body is required to

approve in writing the FCM's Risk Management Program and any material

changes to the Risk Management Program. The FCM also is required to

provide a copy of the Risk Management Program to the Commission and to

the FCM's DSRO upon application for registration or upon request by the

Commission or by the FCM's DSRO. The filing of the Risk Management

Program is intended to allow the Commission and the FCM's DSRO to

monitor the status of risk management practices among FCMs.

Several commenters expressed general support for the requirement

that an FCM implement a risk management program.\60\ The Commission

received no other comments on proposed Sec. 1.11(c) and is adopting

the amendments as proposed.

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\60\ See Franklin Comment Letter at 2 (Feb. 15, 2013); AIMA

Comment Letter at 1 and 4 (Feb. 15, 2013); TIAA-CREF Comment Letter

at 3 (Feb. 15, 2013).

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4. Organizational Requirements of the Risk Management Program

a. Separation of Risk Management Unit from Business Unit

The Commission proposed Sec. 1.11(d), requiring an FCM to

establish a risk management unit that is independent from the FCM's

business unit to administer the Risk Management Program. As part of the

Risk Management Program, each FCM must establish and maintain a risk

management unit with sufficient authority, qualified personnel, and

financial, operational, and other resources to carry out the Risk

Management Program. The risk management unit is required to report

directly to senior management.

Several commenters opposed the separation of the risk management

unit from the business unit. RCG stated that requiring FCMs to separate

the risk management function from the ``business unit'' is unnecessary,

counterproductive, and will likely result in increased risk to the FCM

and its customers.\61\ RCG argued that the proposed requirement removes

a valuable, mature talent pool from participating in risk management,

and the proposal is counterproductive in that it has the potential of

blocking the flow of historical and financial information about a

customer from the business side of the FCM to the risk management side

of the FCM, information that is crucial to evaluating risk.\62\

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\61\ RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip

Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

\62\ RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip

Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

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Phillip Futures Inc. stated that the proposed separation of the

business unit from the risk management unit will lead to a decrease in

the timeliness of decision making as decisions will have to be filtered

through new supervisory employees that the proposal will ultimately

create, which will hinder each FCM's ability to assess risk.\63\

Phillip Futures Inc. stated that so long as internal controls, senior

leadership, and training programs of a firm are created with the proper

checks and balances which ensure proper supervision of activities

conducted by the business unit and the risk management unit, the

respective units need not be independent from each other.\64\ Phillip

Futures Inc. also asserted that the separation of duties required by

the regulation would require it to hire multiple employees who would

have limited job responsibilities.\65\

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

\63\ Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

\64\ Id.

\65\ Id.

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

CHS Hedging stated that it would not be realistic or cost effective

for smaller FCMs to establish an entirely separate risk management

unit, and argued that if supervisory risk management personnel report

to senior management separately from the business side to avoid a

conflict of interest, a standalone unit should not be required.\66\

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\66\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

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

RJ O'Brien also argued that requiring FCMs to create a separate

risk management unit is not operationally or financially practical for

all FCMs, particularly small to midsized FCMs, and needlessly increases

the costs of compliance for most firms without producing significant

benefits.\67\ RJ O'Brien stated that supervisors at many small to mid-

sized FCMs have the knowledge and expertise that can be essential to

maintaining a strong risk management program at their firm, however,

such supervisors also may have a role in the business unit

activities.\68\ They proposed that the Commission revise the proposed

regulation such that supervisors of business unit personnel are

permitted to be part of the risk management unit provided that such

supervisors are not compensated in connection with soliciting or

accepting orders for the purchase or sale of any commodity

interest.\69\

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\67\ RJ O'Brien Comment Letter at 9 (Feb. 15, 2013).

\68\ Id.

\69\ Id.

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The Commission notes that, as stated above, only employees involved

in soliciting orders and handling customer money (including the

segregation functions), and employees directly supervising such

activities would fall within the definition of ``business unit'' under

Sec. 1.11(b)(1). Therefore, the Commission does not agree with the

assertion that a large pool of employees will be barred from

participating in the risk management unit. Further, the Commission

observes that the independence of the risk management unit required by

proposed Sec. 1.11 does not require FCMs to establish information

partitions between the risk management unit and members of the business

unit, and disagrees with commenters that such independence requirement

would block the flow of historical and financial information about a

customer from the business side of the FCM to the risk management side

of the FCM. In any event, the Commission believes that the freedom from

conflicts of interests that the independence of the risk management

unit provides is critically important to the protection of customer

funds in the custody of the FCM.

The FIA commented that in adopting the rules governing risk

management programs for SDs and MSPs, the Commission clarified the

interpretation of certain provisions, and asked that the Commission

confirm that such clarifications apply equally to the provisions of

Sec. 1.11.\70\ In general, the FIA requested the Commission to

confirm, subject to certain exceptions or requirements, that the

requirements of Sec. 1.11:

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\70\ See 77 FR 20128 (April 3, 2012).

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(1) Do not prescribe rigid organization structures;

(2) do not require an FCM's risk management unit to be a formal

division in the FCM's organizational structure, provided that the FCM

will be able to identify all personnel responsible for required risk

management activities

[[Page 68519]]

even if such personnel fulfill other functions; and

(3) Allow FCMs to establish dual reporting lines for risk

management personnel performing functions in addition to their risk

management duties, provided that Sec. 1.11 would not permit a member

of the risk management unit to report to any officer in the business

unit for any non-risk management activity.\71\

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\71\ FIA Comment Letter at 54-55 (Feb. 15, 2013).

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The FIA further commented that the ``policies and procedures''

approach provides an adequate amount of flexibility that will allow the

FCMs to rely upon any existing compliance or risk management

capabilities to meet the requirements of the rule.\72\

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\72\ Id. at 52.

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The Commission generally agrees with the FIA in that, while the

requirements of Sec. 1.11 represent prudent risk management practices,

they do not prescribe rigid organizational structures. The Commission

also believes that the ``policies and procedures'' approach provides an

adequate amount of flexibility that will allow FCMs to rely upon any

existing compliance or risk management capabilities to meet the

requirements of the final rule. The Commission further believes that

nothing in Sec. 1.11 would prevent FCMs from relying upon existing

compliance and risk management programs to a significant degree.

As the Commission confirmed in its final rulemaking discussing

Sec. 23.600(b) regarding the risk management program for SDs and MSPs,

the Commission also confirms that Sec. 1.11(d) does not require a

registrant's risk management unit to be a formal division in the

registrant's organizational structure, provided that the FCM will be

able to identify all personnel responsible for required risk management

activities as its ``risk management unit'' even if such personnel

fulfill other functions in addition to their risk management

activities; and permits FCMs to establish dual reporting lines for risk

management personnel performing functions in addition to their risk

management duties, but this rule would not permit a member of the risk

management unit to report to any officer in the business unit for any

non-risk management activity.\73\ Such dual reporting invites conflicts

of interest and would violate Sec. 1.11's risk management unit

independence requirement.

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\73\ 77 FR 20128 (April 3, 2012).

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The Commission notes that the formal independence of the risk

management unit from the business unit does not relieve an FCM from the

duty to resolve other conflicts of interest that may have an adverse

effect on the effectiveness of the FCM's risk management program. An

FCM's CCO is required under Sec. 3.3(d)(2) to resolve any conflicts of

interest that may arise, in consultation with the FCM's board of

directors or its senior officer. Thus, the Commission would expect an

FCM to recognize and eliminate or appropriately mitigate any conflict

of interest between the FCM's business interests and its duty to

establish and maintain an effective risk management program.

Having considered the comments regarding Sec. 1.11(d), the

Commission is adopting the provision as proposed.

5. Components of the Risk Management Program

The Commission's proposed Sec. 1.11(e) provides for a non-

exclusive list of the elements that must be a part of the Risk

Management Program of an FCM. Those elements include: (1) Identifying

risks (including risks posed by affiliates, all lines of business of

the FCM, and all other trading activity of the FCM) and setting of risk

tolerance limits; (2) providing periodic risk exposure reports to

senior management and the governing body; (3) operational risk

controls; (4) capital controls; and (5) establishing a risk management

program that takes into account risks associated with the safekeeping

and segregation of customer funds.

Proposed Sec. 1.11(e)(1)(ii) requires the Risk Management Program

to take into account risks posed by affiliates, all lines of business

of the FCM, and all other trading activity engaged in by the FCM. The

FIA asked the Commission to confirm its position that, to the extent

that many FCMs are part of a larger holding company structure that may

include affiliates that are engaged in a wide array of business

activities, the Commission understands that, in some instances, the top

level company in the holding company structure, which has the benefit

of an organization-wide view, is in the best position to evaluate the

risks that an affiliate of an FCM may pose to the FCM.\74\ Therefore,

to the extent an FCM is part of a holding company within an integrated

risk management program, the FCM may address affiliate risks and comply

with Sec. 1.11 through its participation in a consolidated entity risk

management program provided that such program does in fact assess the

risks posed to the FCM by its affiliated entities.\75\

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\74\ FIA Comment Letter at 55 (Feb. 15, 2013).

\75\ Id.

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The Commission recognizes that some FCMs will be part of a larger

holding company structure that may include affiliates that are engaged

in a wide array of business activities. The Commission understands with

respect to these entities, that in some instances, the top level

company in the holding company structure is in the best position to

evaluate the risks that an affiliate of an FCM may pose to the

enterprise, as it has the benefit of an organization-wide view and

because an affiliate's business may be wholly unrelated to an FCM's

activities. Therefore, to the extent an FCM is part of a holding

company with an integrated risk management program, the Commission

would allow an FCM to address affiliate risks and comply with Sec.

1.11(e)(1)(ii) through its participation in a consolidated entity risk

management program.

In regard to customer funds, the Commission notes that FCMs are

required by the Act and Commission regulations to segregate and

safeguard funds deposited by customers for trading commodity interests.

Recent events have emphasized that it is essential that FCMs maintain

adequate systems of internal controls, involving the participation and

review of the firm's senior management, in order to properly safeguard

customer funds. Accordingly, Sec. 1.11(e)(3)(i) requires that the risk

management policies and procedures of an FCM related to the risks

associated with safekeeping and segregation of customer funds must

include: (1) The evaluation and monitoring of depositories; \76\ (2)

account opening procedures that ensure the FCM obtains the

acknowledgment required under Sec. 1.20 from the depository and that

the account is properly titled as belonging to the customers of the

FCM; \77\ (3) establishing

[[Page 68520]]

and maintaining an adequate targeted amount of excess funds in customer

accounts reasonably designed to ensure the FCM is at all times in

compliance with the segregation requirements for customer funds under

the Act and Commission regulations, as discussed further below; (4)

controls ensuring that the withdrawal of cash, securities, or other

property from accounts holding customer funds not for the benefit of

customers are in compliance with the Act and Commission regulations;

\78\ (5) procedures for assessing the appropriateness of investing

customer funds in accordance with Sec. 1.25; \79\ (6) the valuation,

marketability, and liquidity of customer funds and permitted

investments made with customer funds; (7) the appropriate separation of

duties of personnel responsible for compliance with the Act and

Commission regulations relating to the protection and financial

reporting of customer funds; \80\ (8) procedures for the timely

recording of transactions in the firm's books and records; and (9)

annual training of personnel responsible for compliance with the Act

and Commission regulations relating to the protection and financial

reporting of customer funds.

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\76\ The evaluation process must include documented criteria

that any depository will be assessed against in order to qualify to

hold funds belonging to customers. The criteria must address a

depository's capitalization, creditworthiness, operational

reliability, and access to liquidity. The criteria must also address

risks associated with concentration of customer funds in any

depository or group of depositories, the availability of deposit

insurance, and the regulation and supervision of depositories. The

evaluation criteria is intended to ensure that the FCM adopts an

evaluation process which reviews potential depositories against

substantive criteria relevant to the safe custody of customer funds

and that the FCM's process for evaluating and selecting depositories

can be reviewed by regulators and auditors. The FCM also must

maintain a documented process addressing the ongoing monitoring of

selected depositories, including a thorough due diligence review of

each depository at least annually.

\77\ As required by Sec. 1.20, such account opening

documentation is necessary to ensure that the depositories are aware

of their obligations regarding the accounts and the statutory and

regulatory protections afforded the funds held in the accounts due

to their status as segregated funds.

\78\ The controls must include the conditions for pre-approval

and the notice to the Commission for such withdrawals required by

Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.

\79\ The FCM's assessment must take into consideration the

market, credit, counterparty, operational, and liquidity risks

associated with the investments.

\80\ The policies and procedures must provide for the separation

of duties among personnel that are responsible for customer trading

activities, and approving and overseeing cash receipts and

disbursements (including investment and treasury operations). The

policies and procedures must further require that any movement of

funds to affiliated companies or parties be approved and documented.

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

Regarding the requirement that FCMs establish and maintain an

adequate targeted amount of excess funds in customer accounts, the

Commission notes that FCMs currently deposit proprietary funds into

both customer segregated accounts and part 30 secured accounts as a

buffer to minimize the possibility of the firm being in violation of

its segregated and secured fund obligations at any time. Under the

final rule, the senior management of the FCM must perform appropriate

due diligence in setting the amount of this buffer and must consider

the nature of the FCM's business including the type and general

creditworthiness of its customer base, the types of markets and

products traded by the firm's customers, the proprietary trading

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

products traded by the customers and the FCM, the FCM's own liquidity

and capital needs, and historical trends in customer segregation and

secured account funds balances, customer debits, and margin deficits

(i.e., undermargined amounts). The FCM also must reassess the adequacy

of the targeted residual interest quarterly.

The Commission believes that each FCM must set the amount of excess

segregated and secured funds required utilizing a quantitative and

qualitative analysis that reasonably ensures compliance at all times

with segregated and secured fund obligations. Such analysis must take

into account the various factors that could affect segregated and

secured balances, and must be sufficiently described in writing to

allow the DSRO of the FCM and the Commission to duplicate the

calculations and test the assumptions. The analysis must provide a

reasonable level of assurance that the excess is at an appropriate

level for the FCM.\81\ A failure to adopt or maintain appropriate risk

management policies and procedures or to implement, monitor and enforce

controls required by Sec. 1.11 may result in a referral to the

Commission's Division of Enforcement for appropriate action.

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\81\ Separate from requiring the establishment of a target for

residual interest, the Commission is further requiring, as discussed

in more detail under sections II.G.9., II.H., and II.I. for

Sec. Sec. 1.20, 1.22, and 1.23, respectively, that residual

interest exceed the sum of outstanding undermargined amounts to

provide a mechanism for ensuring compliance with the prohibition of

the funds of one customer being used to margin or guarantee the

positions of another customer under the Act and existing

regulations.

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Proposed Sec. 1.11(e)(3)(i)(G) requires the appropriate separation

of duties among individuals responsible for compliance with the Act and

Commission regulations relating to the protection and financial

reporting of segregated funds, including the separation of duties among

personnel that are responsible for advising customers on trading

activities, approving or overseeing cash receipts and disbursements

(including investment operations), and recording and reporting

financial transactions. Phillip Futures Inc. stated that such a

separation of duties would require it to hire multiple employees that

would have limited job responsibilities, and suggested that as long as

internal controls are adequate and supervisory personnel are properly

registered with the Commission and NFA, the separation of duties is not

necessary.\82\

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\82\ Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013).

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Regulation 1.11(e)(3)(i)(I) requires that the written policies and

procedures include procedures for the reporting of suspected breaches

of the policies and procedures to the CCO, without fear of retaliation,

and the consequences of failing to comply with the segregation

requirements of the Act and regulations. Chris Barnard recommended that

the procedures for reporting breaches should allow and stress the

complete anonymity of the reporting party (whistleblower).\83\ The

Commission takes note of Mr. Barnard's comments related to

whistleblowers as sound practices. The Commission notes, however, that

such additional requirements were not proposed and, in any event, are

outside the scope of this rulemaking.\84\

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\83\ Chris Barnard Comment Letter at 2 (Dec. 18, 2012).

\84\ The Commission further notes that it maintains a

whistleblower program that provides for the anonymous reporting of

violations of the Act and Commission regulations. See part 165 of

the Commission's regulations.

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Also, to ensure the effectiveness of a Risk Management Program,

Sec. 1.11(e)(4) requires that the Risk Management Program include a

supervisory system that is reasonably designed to ensure that the risk

management policies and procedures are diligently followed.

The Commission has considered the comments received on the proposal

and, for the reasons stated above, is adopting Sec. 1.11(e) as

proposed.

6. Annual Review, Distribution of Policies and Procedures and

Recordkeeping

The Commission's proposal also includes: (1) Sec. 1.11(f) which

requires an annual review and testing of the adequacy of each FCM's

Risk Management Program by internal audit staff or a qualified

external, third party service; (2) Sec. 1.11(g) which requires the

timely distribution of written risk management policies and procedures

to relevant supervisory personnel; and (3) Sec. 1.11(h) which

discusses recordkeeping and availability of records. The Commission

received no comments on paragraphs (f), (g), and (h) of Sec. 1.11 and

is adopting the paragraphs as proposed.

7. CCO or CEO Certification

Regulation 3.3 requires the CCO or CEO of an FCM to provide an

annual report to the Commission that must review each applicable

requirement under the Act and Commission regulations, and with respect

to each

[[Page 68521]]

applicable requirement, identify the policies and procedures that are

reasonably designed to ensure compliance with the requirement, and

provide an assessment of the effectiveness of the policies and

procedures.\85\ The annual report also must include a certification by

the CCO or CEO that, to the best of his or her knowledge and reasonable

belief, and under penalty of law, the information contained in the

annual report is accurate and complete.

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\85\ Such report is mandated by Sec. 3.3 of the Commission's

regulations; See Swap Dealer and Major Swap Participant

Recordkeeping, Reporting, and Duties Rules; Futures Commission

Merchant and Introducing Broker Conflicts of Interest Rules; and

Chief Compliance Officer Rules for Swap Dealers, Major Swap

Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,

2012 (promulgating final rules concerning the CCOs of FCMs, swap

dealers, and major swap participants); see also Sec. 4d(d) of the

Act, 7 U.S.C. 6d(d).

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The Commission requested comment on whether the standard for the

CCO's or CEO's certification in the annual report (i.e., based on the

CCO's or CEO's knowledge and reasonable belief) required under Sec.

3.3 is adequate for a certification of the FCM's compliance with

policies and procedures for the safeguarding of customer funds.

Specifically, the Commission requested comment on whether Sec. 1.11

should contain a separate CCO or CEO certification requirement that

would impose a higher duty of strict liability or some other higher

obligation on a CCO or CEO.

The Commission received three comments in this regard. NFA and FIA

believed that the ``knowledge and reasonable belief'' standard in Sec.

3.3 remains appropriate for a CCO's/CEO's certification regarding an

FCM's customer funds safeguards.\86\ That is, the CCO or CEO should not

be liable for matters that are beyond the CCO's/CEO's knowledge and

reasonable belief. Further, NFA stated that the Commission should

reconsider whether the CCO's/CEO's annual report should contain a

separate certification (with the ``knowledge and reasonable belief

language'') executed by the FCM's CEO or CFO regarding the adequacy of

the FCM's customer funds safeguards.\87\ Newedge opposed the imposition

of a strict liability standard on a CCO/CEO for the annual

certifications because the CCO/CEO is relying on internal

representations from other FCM employees that are far more expert

regarding these matters.\88\ Newedge stated that such a standard would

make it difficult to recruit qualified persons to serve as a CCO/

CEO.\89\

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\86\ FIA Comment Letter at 11 (Feb. 15, 2013); NFA Comment

Letter at 10 (Feb. 15, 2013).

\87\ NFA Comment Letter at 10 (Feb. 15, 2013).

\88\ Newedge Comment Letter at 3 (Feb. 15, 2013).

\89\ Id.

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In response to these comments, the Commission is not requiring a

separate CCO/CEO certification requirement imposing a higher duty of

strict liability or other standard for the segregation of customer

funds. The Commission also is not imposing a separate certification by

the FCM's CEO or CFO at this time. Commission staff will monitor the

role of the CCO/CEO as the regulation is implemented and propose to the

Commission any amendments to the CCO's/CEO's standard for certifying

compliance as deemed appropriate based upon staff's experiences.

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

Commission Merchants and Introducing Brokers

The regulatory notices required under Sec. 1.12 are intended to

provide the Commission and SROs with prompt notice of potential adverse

conditions at FCMs that may indicate a possible threat to the financial

condition of the firm or to the safety of customer funds held by the

FCM. Regulation 1.12 currently obligates FCMs to provide notice to the

Commission and to the respective DSROs if certain specified reportable

events occur. Reportable events include: Failing to maintain the

minimum level of required regulatory capital (Sec. 1.12 (a)); failing

to maintain current books and records (Sec. 1.12(c)); and failing to

comply with the requirements to properly segregate customer funds

(Sec. 1.12(h)). As discussed further below, the Commission proposed to

amend Sec. 1.12 to include several additional reportable events and to

revise the process for submitting reportable events to the Commission

and DSROs.

1. Timing of Notices

The proposed new reportable events, discussed individually below,

will require immediate notice to the Commission and the firm's DSRO

upon the occurrence of the relevant event. FIA commented that while it

is not opposed to a requirement for FCMs to provide prompt notice of a

reportable event, it questioned the need for ``immediate'' notice as

proposed by the Commission.\90\ FIA recommended that if the Commission

determined to adopt the proposed early warning notices that it allow 24

hours if the event is financial in nature and 48 hours for business-

related events in order to afford FCMs time to determine the cause of

the event and take an appropriate corrective action.\91\

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\90\ FIA Comment Letter at 37-38 (Feb. 15, 2013).

\91\ Id.

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The purpose of the ``early warning'' notice system established

under Sec. 1.12 is to provide the Commission and an FCM's DSRO with

adequate and prompt notice of a reportable event in order to allow

Commission staff to assess the situation and to consult with the

registrant and the SROs to determine if further action is necessary in

order to protect customer funds or to determine if the FCM can continue

to meet its obligations to the marketplace and clearing process. The

filing of a notice is often the first step where the Commission staff

is alerted to a potential issue at a firm. The Commission also

initiates a dialogue with the firm and the firm's DSRO, as necessary,

upon receipt of a Sec. 1.12 notice.

Given the critical role that notices play in the Commission's and

DSRO's surveillance of FCMs, the Commission believes that immediate

notice is necessary when a reportable event is financial in nature

(e.g., the FCM is not in compliance with the Commission's capital or

segregation requirements). In such situations, the firm should file

immediate notice with the Commission. If a firm needs additional time

to assess the cause of the reportable event, or if additional time is

needed to document what steps the FCM will take to remedy the situation

causing the reportable event, it may file an amendment to its initial

notice with the Commission. In addition, in a situation where the

registrant is reporting that it is undercapitalized or undersegregated,

the Commission and DSRO will have initiated an ongoing dialogue whereby

the Commission and the DSRO will be in frequent communication with the

registrant and will receive updated information as the registrant

becomes aware of the facts.

Reportable events that are not related to an FCM's ability to meet

its financial obligations or not directly related to the protection of

customer funds may not be subject to the same sense of immediacy and

the Commission is revising its proposed regulations accordingly. The

revisions to the proposed amendments are discussed in the appropriate

sections below with the comments received on the proposed new notice

provisions.

2. Undercapitalized FCMs and IBs

Regulation 1.12(a) requires an FCM or IB that fails to maintain the

minimum level of adjusted net capital required by Sec. 1.17 to provide

immediate notice to

[[Page 68522]]

the Commission and to the entity's DSRO. The notice must include

additional information to adequately reflect the FCM's or IB's current

capital condition as of any date that the entity is undercapitalized.

The Commission proposed to amend Sec. 1.12(a) to clarify that if

the FCM or IB cannot compute or document its actual capital at the time

it knows that it is undercapitalized, it must still provide the written

notice required by Sec. 1.12(a) immediately and may not delay filing

the notice until it has adequate information to compute its actual

level of adjusted net capital.

NFA commented in support of the Commission's proposal noting that

in situations where an FCM is in potential distress, it may be even

more important for the Commission and the firm's DSRO to become

immediately aware of the situation so that the Commission and DSRO

staff can assist in determining the firm's current, accurate financial

condition.\92\ The Commission agrees that it is imperative that an FCM

or IB provide immediate notice if the firm is undercapitalized and,

accordingly is adopting the amendment as proposed.

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\92\ NFA Comment Letter at 10 (Feb. 15, 2013).

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3. Insufficient Segregation of Funds of Cleared Swaps Customers

Regulation 1.12(h) currently requires an FCM that fails to hold

sufficient funds in segregated accounts to meet its obligations to

futures customers, or that fails to hold sufficient funds in separate

accounts for foreign futures or foreign options customers, to provide

immediate notice to the Commission and to the FCM's DSRO. The

Commission proposed to amend paragraph (h) to include an explicit

requirement that an FCM provide immediate notice to the Commission and

to its DSRO if the FCM fails to hold sufficient funds in segregated

accounts for Cleared Swaps Customers to meet its obligation to such

customers.\93\ The amendment will ensure immediate notification of a

failure to hold sufficient funds in segregation for Cleared Swaps

Customers so that the Commission and the firm's DSRO can promptly

assess the financial condition of an FCM and determine if there are

threats to the safety of the Cleared Swaps Customers Collateral held by

the FCM. The amendment also harmonizes the notice requirements whenever

an FCM fails to hold in proper segregated or secured accounts

sufficient funds to meet its total obligations to futures customers,

30.7 customers, and Cleared Swaps Customers.

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\93\ Commencing November 13, 2012, the compliance date for

certain Commission part 22 regulations, FCMs are required under

Sec. 22.2 to hold a sufficient amount of funds in Cleared Swaps

Customer Accounts to meet the Net Liquidating Equity of each Cleared

Swaps Customer. 77 FR 6336 (Feb. 7, 2012).

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The Commission did not receive any comments on proposed Sec.

1.12(h). The Commission is adopting the amendments to paragraph (h) as

proposed.

4. Investment of Customer Funds in Contravention of Regulation 1.25

The Commission also proposed to amend Sec. 1.12 by adding new

paragraph (i) to require an FCM to provide immediate notice whenever it

discovers or is informed that it has invested funds held for customers

in investments that are not permitted investments under Sec. 1.25, or

if the FCM holds permitted investments in a manner that is not in

compliance with the provisions of Sec. 1.25, such as the investment

concentration limitations contained in Sec. 1.25(b)(3). The proposal

applies to funds held for futures customers, 30.7 customers, and

Cleared Swaps Customers.

The Commission received no comments on the proposed amendments to

Sec. 1.12(i). The Commission is adopting paragraph (i) as proposed.

5. Notice of Residual Interest Falling Below Targeted Level or

Undermargined Amounts

The Commission proposed to amend Sec. 1.12 to provide a new

paragraph (j) to require an FCM to provide immediate notice to the

Commission and to the firm's DSRO if the FCM does not hold an amount of

funds in segregated accounts for futures customers or for Cleared Swaps

Customers, or if the FCM does not hold sufficient funds in secured

accounts for 30.7 customers, sufficient to meet the firm's targeted

residual interest in one or more of these accounts as computed under

proposed Sec. 1.11, which is being adopted herein, or if its residual

interest in one or more of these accounts is less than the sum of

outstanding margin deficits (i.e., undermargined amounts) for such

accounts. Regulation 1.11, as adopted herein, also requires each FCM

that carries customer funds to calculate an appropriate amount of

excess funds (i.e., proprietary funds) to hold in segregated or secured

accounts to mitigate the possibility of the FCM being undersegregated

or undersecured due to a withdrawal of proprietary funds from a

segregated or secured account.

FIA questioned the necessity of the proposed provision noting that

under the proposed amendments to Sec. 1.32 each FCM holding customer

funds is required to file a report with the Commission on a daily basis

that will disclose if the FCM's residual interest has fallen below the

FCM's targeted amount or if the residual amount is less than the sum of

the customers' margin deficits.\94\ FIA also noted that under current

regulations an FCM's residual interest will frequently fall below its

targeted amount and that if the Commission adopts its proposed

amendments to Sec. Sec. 1.20, 22.2 and 30.7 to require an FCM to use

proprietary funds to cover margin deficits, withdrawals in excess of 25

percent of the firm's residual interest will likely be a daily event

requiring daily notices to be filed with the Commission and with the

FCM's DSRO.\95\

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\94\ FIA Comment Letter at 38 (Feb. 15, 2013). The Commission is

proposing to require each FCM to file with the Commission and with

the firm's DSRO a daily: (1) Segregation Schedule (Sec. 1.32); (2)

Secured Amount Schedule (Sec. 30.7); and, (3) Cleared Swaps

Segregation Schedule (Sec. 22.2)). The Commission proposed to

include information disclosing the FCM's targeted residual interest

and whether the amount of the actual residual interest exceeds the

targeted residual interest and the total amount of the FCM's margin

deficiencies in the Segregation Schedule, Secured Amount Schedule,

and the Cleared Swaps Segregation Schedule.

\95\ Id.

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One of the primary objectives of the proposed amendments to Sec.

1.12 is to ensure that the Commission and DSROs receive notice of

potential financial or operational issues at an FCM, or of rule

violations by an FCM, in as timely a manner as possible such that the

Commission and the FCM's DSRO will be in a position to assess the

issues and the potential impact on the FCM's ability to meet its

regulatory obligations and its ability to safeguard customer funds.

While the proposed amendments to Sec. 1.32 do require each FCM holding

customer funds to file on a daily basis a Segregation Schedule, Secured

Amount Schedule, and Cleared Swaps Segregation Schedule (as

appropriate) that includes information concerning the amount of the

firm's actual and targeted residual interests, the notice required by

Sec. 1.12(j) requires the firm to include a discussion of the cause of

the event, and what steps the firm will take to increase the residual

interest. The notice will assist the Commission and the DSROs in

determining what, if any, additional steps may be necessary in order to

mitigate potential market disruptions if the FCM cannot meet its

regulatory obligations, and will enhance the overall safety of customer

funds. In addition, the Commission believes that the filing of a notice

by an FCM will focus greater attention by management at the firm on the

fact that the firm's

[[Page 68523]]

actual residual interest is below its targeted residual interest, which

should result in further reflection by management on the adequacy of

the target amount and/or any changes in operations that may be

appropriate, including increasing the firm's residual interest or using

other sources of liquidity.

The Commission also notes that an FCM's obligation under Sec.

1.12(j) to file a notice when the firm's residual interest is less than

the sum of the undermargined amounts in its customer accounts is

determined at the point in time that the firm is required to maintain

as residual interest the undermargined amounts under Sec. 1.22, Sec.

22.2, and Sec. 30.7. In addition, the Commission further notes that

the obligation to file a notice under Sec. 1.12(j) when the firm's

residual interest is less than the sum of the undermargined amounts in

its customer accounts commences as of the respective compliance dates

for Sec. 1.22, Sec. 22.2, and Sec. 30.7 established by the

Commission and discussed further in section III below.

The Commission has considered the comments and has determined to

adopt new paragraph 1.12(j) as proposed and as clarified above.

6. Events Causing Material Adverse Financial Impact or Material Change

in Operations

The Commission proposed new paragraphs (k) and (l) to Sec. 1.12.

Proposed paragraphs (k) and (l) will require an FCM to provide notice

to the Commission and to the firm's DSRO in the event of a material

adverse impact in the financial condition of the firm or a material

change in the firm's operations. Proposed paragraph (k) will require an

FCM to provide immediate notice if the FCM, its parent, or a material

affiliate, experiences a material adverse impact to its

creditworthiness or its ability to fund its obligations. Indications of

a material adverse impact of an FCM's creditworthiness may include a

bank or other financing entity withdrawing credit facilities, a credit

rating downgrade, or the FCM being placed on ``credit watch'' by a

credit rating agency.

Proposed paragraph (l) will require an FCM to provide immediate

notice of material changes in the operations of the firm, including: A

change in senior management; the establishment or termination of a

material line of business; a material change in the FCM's clearing

arrangements; or a material change in the FCM's credit arrangements.

Paragraph (l) is intended to provide the Commission with notice of

material events, such as the departure of the FCM's CCO, CFO, or CEO.

Two comments were received on the proposal. FIA stated that the

proposed amendments do not provide an FCM sufficient guidance on the

circumstances that would require notice and requested that the

Commission define more precisely the events that would require

notice.\96\ RJ O'Brien similarly stated its concern that the term

``creditworthiness'' as used in proposed Regulation 1.12(k) is

ambiguous and subjective and requires a clearer definition to afford

FCMs the ability to reasonably ascertain their reporting duties and

obligations.\97\

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

\96\ Id.

\97\ RJ O'Brien Comment Letter at 10 (Feb. 15, 2013).

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FIA also recommended that the Commission coordinate with the SEC

and the banking regulators to establish a uniform standard identifying

``material adverse'' changes or impacts.\98\ Finally, FIA noted that it

does not believe that a change in senior management at an FCM should

require an early warning notice of any kind because such notice is

already provided to NFA in the ordinary course.\99\

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

\98\ FIA Comment Letter at 38 (Feb. 15, 2013).

\99\ Id.

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

The Commission has considered the comments and has determined to

adopt the amendments to Sec. 1.12(k) and (l) as proposed, with the

revision that the notices required by Sec. 1.12(l) must be filed

promptly, but not later than 24 hours after the event, instead of

immediately. By adopting this revision, the Commission acknowledges

that immediate notice is not necessary in all situations.

An FCM should report Sec. 1.12(l) notices in a punctual or prompt

manner, but may do so without the expediency required by an immediate

notice provision that is required, for example, when a firm is

undercapitalized or undersegregated, which may indicate that immediate

Commission or DSRO action is required to assess the financial condition

of the FCM or the safety of customer funds. This revision provides the

appropriate balance between the receipt of timely notices and the

ability of the FCM to document an explanation of the events that

trigger the notice.

As noted above, the Commission proposed additional notice

provisions under Sec. 1.12 in order to ensure that the Commission and

DSROs receive timely information regarding certain events that should

be assessed by the Commission and the DSROs as part of the overall

oversight and risk assessment of FCMs. Regulation 1.12(k) will require

an FCM to provide notice if the FCM or its parent or material affiliate

experiences a material adverse impact to its creditworthiness or its

ability to fund its obligations. Regulation 1.12(l) will require an FCM

to provide notice if there is a material change in the firm's

operations, senior management, clearing arrangements, or a material

line of business.\100\ The purpose of paragraphs (k) and (l) is to

provide the Commission and the relevant DSRO with an opportunity to

initiate a dialogue with the firm regarding any potential adverse

impact that such a material change may have on the ability of the FCM

to meet its obligations as a market intermediary and on the protection

of the customer funds held by the FCM.

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\100\ Regulation 1.12(k) and (l) both require an FCM to report a

material change in the firm's creditworthiness or its ability to

fund its obligations. Accordingly, the Commission is removing the

reference to the FCM's credit arrangements in Sec. 1.12(l).

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

The Commission is cognizant of the commenters' desire for more

precise guidance on when notices must be filed under Sec. 1.12(k) and

(l). However, FCMs represent a broad range of entities, with diverse

business models. In this regard, some FCMs are small operations with a

minimum level of capital, and others are highly capitalized entities

with more sophisticated operations. Some FCMs focus on retail and/or

agricultural clients, and others focus exclusively on institutional

clients. Some FCMs are standalone entities that do not engage in

proprietary or securities trading, and others are dually-registered

with the SEC as BDs and engage in a significant amount of securities

transactions for both their proprietary and customer accounts.

With FCMs covering such a broad and diverse spectrum of business

organizations and models, the Commission does not believe that it would

be appropriate to define by regulation the scenarios that are material

to an FCM and would automatically require the filing of a regulatory

notice. Instead, the regulation has been developed to allow each FCM to

assess whether any particular or unique event is material to the

specific firm. In making this determination, each FCM should assess the

potential impact that an event may have on the FCM. This would include

whether new lines of business would result in a significant increase in

the firm's capital requirement or otherwise result in a significant

additional financial or operational risk to the FCM's existing

business, or whether the change in credit terms will significantly

impact

[[Page 68524]]

the liquidity resources available to the FCM.

The Commission also considered the comment that FCMs should not be

required to report to the Commission changes in senior management as

such information is reported to NFA. The Commission does not agree with

this comment. As previously noted, the Sec. 1.12 notice provisions are

intended to provide the Commission and DSROs with prompt notice of

material events at FCMs that will allow the Commission and DSROs to

monitor the impact of such material events on FCMs and to factor such

events into the risk assessment of the firm as part of their respective

surveillance programs. The resignation or appointment of a new chief

executive officer or chief risk officer at an FCM is a material change

at an FCM and is information that should be reported to enhance the

Commission's and DSRO's understanding of the firm's operations and the

assessment of risk at the FCM.

7. Notice of Correspondence From Other Regulatory Authorities

The Commission proposed to add a new paragraph (m) to Sec. 1.12 to

require an FCM that receives a notice, examination report, or any other

correspondence from a DSRO, the SEC, or a securities self-regulatory

organization to immediately file a copy of such notice, examination

report, or correspondence with the Commission. The Commission stated in

proposing Sec. 1.12(m) that the receipt of such notices, examination

reports, or correspondence is necessary for the Commission to conduct

appropriate oversight of FCMs.

The Commission received several comments that expressed a general

concern that the language of the proposal is overbroad.\101\ FIA noted

that FCMs receive regular, and often routine, correspondence from their

DSROs and that the amount of correspondence is multiplied for FCMs that

are also registered as BDs and receive similar correspondence from

their securities SROs and the SEC.\102\ NFA agreed with the Commission

that notices of material regulatory actions would provide the

Commission and the DSROs with important information to carry out their

oversight responsibilities, but also encouraged the Commission to

reconsider the breadth of the proposal.\103\ NFA noted that with

respect to futures examinations reports, it already files such reports

with the Commission's Division of Swap Dealer and Intermediary

Oversight.\104\ NFA also requested that the Commission clarify that

FCMs would not have to file notices of public regulatory actions taken

by futures SROs against an FCM because NFA already provides the

complaint associated with these actions to the Commission and makes the

action available on NFA's BASIC system.\105\ TD Ameritrade recommended

that the Commission limit notification to items that pertain to

financial responsibility rules.\106\

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\101\ FIA Comment Letter at 39 (Feb. 15, 2013); TD Ameritrade

Comment Letter at 3 (Feb. 15, 2013); RCG Comment Letter at 7 (Feb.

12, 2013); CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

\102\ FIA Comment Letter at 39 (Feb. 15, 2013).

\103\ NFA Comment Letter at 10 (Feb. 15, 2013).

\104\ Id. at 11.

\105\ Id.

\106\ TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).

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The Commission notes that it was not its intention to require an

FCM to file with the Commission routine or non-material correspondence

from regulators or SROs. Regulation 1.12 in general is intended to

provide the Commission with information regarding an FCM's interaction

with its other regulators regarding the regulators' examinations and

other material communications with FCMs. The Commission would use such

information to enhance its understanding of the firm and its compliance

with regulatory requirements to assess the operations of the firm and

learn of events that may present a potential adverse impact on the

firm, including its ability to properly operate in a regulated

environment or otherwise safeguard customer funds.

The Commission is revising final Sec. 1.12(m) to require an FCM to

file notice with the Commission: (1) if the FCM is informed by the SEC

or a SRO that it is the subject of a formal investigation; (2) if the

FCM is provided with an examination report issued by the SEC or a SRO,

and the FCM is required to file a copy of such examination report with

the Commission; and (3) if the FCM receives notice of any

correspondence from the SEC or a securities SRO that raises issues with

the adequacy of the FCM's capital position, liquidity to meet its

obligations or otherwise operate its business, or internal controls.

The Commission believes that the revised regulation will provide the

Commission with information necessary for the effective oversight of

FCMs and will minimize the notices that dual-registrant FCMs/BDs will

have to file with the Commission.

8. Filing Process and Content

The Commission proposed to amend the process that an FCM uses to

file the notices required by Sec. 1.12. Currently, Sec. 1.12 requires

an FCM to provide the Commission and DSROs with telephonic and

facsimile notice in some situations, and to provide written notice by

mail in other situations. An FCM also is permitted, but not required,

to file notices and written reports with the Commission and with its

DSRO using an electronic filing system in accordance with instructions

issued by, or approved by, the Commission.

The Commission proposed to amend Sec. 1.12(n) to require that all

notices and reports filed by an FCM with the Commission or with the

FCM's DSRO must be in writing and submitted using an electronic filing

system.\107\ Each FCM currently uses WinJammer to file regulatory

notices with the Commission and with the firm's DSRO. The proposed

regulation further provides that if the FCM cannot file a notice due to

the electronic system being inoperable, or for any other reason, it

must contact the Commission's Regional office with jurisdiction over

the firm and make arrangements for the filing of the regulatory notices

with the Commission via electronic mail at a specially designated email

address established by the Commission; [email protected] The

Commission also proposed to amend Sec. 1.12(n) to require that each

notice filed by an FCM, IB, or SRO under Sec. 1.12 include a

discussion of what caused the reportable event, and what steps have

been, or are being taken, to address the reportable event. Additional

amendments to Sec. 1.12(b), (d), (e), (f) and (g) were proposed that

were necessary and technical in nature, and primarily revise internal

cross-references to the filing requirements in Sec. 1.12(n).

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

\107\ The Commission's proposed amendment to require the

electronic filing of reports applies to both registered FCMs and

applicants for registration as FCMs. Applicants for FCM registration

currently file regulatory notices with NFA using WinJammer.

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

The Commission received one comment on the proposed amendments to

Regulation 1.12(n), specifically with respect to the requirement that

notices under the regulation include a discussion of what caused the

reportable event and what steps have been or will be taken to address

the event.\108\ CHS Hedging stated its concern that requiring such a

discussion in the notice is at odds with the requirement that notices

be filed immediately.\109\

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

\108\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

\109\ Id.

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The Commission has determined to adopt the amendments to Sec.

1.12(n) and the technical and related amendments

[[Page 68525]]

in Sec. 1.12(b), (d), (e), (f) and (g) as proposed. In the

Commission's experience, in many cases an FCM has sufficient

information to provide a notice of reportable event and the remedial

steps that can be taken to mitigate future issues upon learning of the

reportable event or very shortly thereafter. The Commission does not

believe that the requirement to provide such information is at odds

with the need to provide the information immediately. In the event that

an FCM does not possess complete information on what caused the event,

or the steps that have been taken or are being taken to address the

event, it may revise its notice at a later date when it has more

complete or accurate information. It is essential, however, that the

Commission receives timely notice of early warning events, and

compliance with the relevant notice time period should be an FCM's

first priority. Accordingly, as noted in the Proposal, even if such

information is not immediately readily available, the reporting entity

may not delay the reporting of a reportable event.

9. Public Disclosure of Early Warning Notices

The Commission requested comment as to whether reportable events

should be made public by the Commission, SROs, or FCMs and what the

benefits and/or negative impact from public disclosure of such events

would be. The Commission received several comments regarding the public

disclosure of reportable events. Several commenters, including FHLB,

the ICI, ACLI, BlackRock, and SIFMA believed that the Commission should

mandate public disclosure of such information.\110\ Two commenters, FIA

and NFA, believed that such events should not be made public.\111\ NFA

did not believe any of the filings should be public, but emphasized

that those events that are not subject to a formal public action

particularly should not be subject to public disclosure.\112\ FIA was

concerned that without context, public disclosure of the notices would

be subject to misinterpretation and could create an adverse market

event.\113\

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\110\ FHLB Comment Letter at 10 (Feb. 15, 2013); ICI Comment

Letter at 7-8 (Jan. 14, 2013); ACLI Comment Letter at 4 (Feb. 15,

2013); BlackRock Letter at 3 (Feb. 15, 2013); and SIFMA Comment

Letter at 2 (Feb. 21, 2013).

\111\ NFA Comment Letter at 11 (Feb. 15, 2013); FIA Comment

Letter at 38 (Feb. 15, 2013).

\112\ NFA Comment Letter at 11 (Feb. 15, 2013).

\113\ FIA Comment Letter at 38 (Feb. 15, 2013).

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

The Commission has considered the comments and has determined that

regulatory notices filed under Sec. 1.12 should not be made publicly

available. The notices required under Sec. 1.12 provide a mechanism

whereby Commission and SRO staff are alerted to potential issues at an

FCM. In order to fully assess the potential impact of a reportable

event, Commission and SRO staff generally must contact the firm to

obtain additional information, including up to date information on how

the firm is addressing the matter that caused the reportable event to

develop. If reportable events were disclosed to the public, they may

not provide complete or current information. For example, an FCM may be

required to file immediate notice that it was undersegregated at a

point in time, but the notice may not contain information that the FCM

has taken corrective action and is no longer in violation of the

segregation requirements. The Commission also recognizes that many of

the Sec. 1.12 notices are required to be filed as a result of one-off

processing errors or timing differences that trigger a reportable event

but are immediately rectified by the FCM and do not indicate a failure

of the FCM's control system nor the firm's ability to effectively

operate as an FCM.

In addition, under Sec. 1.12 FCMs that are dually registered BDs

with the SEC are required to file with the Commission copies of certain

regulatory notices that they are required to file with the SEC. The

SEC, however, does not make such notices public. The Commission

believes it is important to ensure consistency such that information

that a firm must file with the SEC and that is otherwise not publicly

disclosed is not made public by the Commission as a result of the firm

also being required to file a notice with the Commission under Sec.

1.12.

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

Commission Merchants

Regulation 1.15 currently requires each FCM subject to the risk

assessment reporting requirements to file certain financial reports

with the Commission within 120 days of the firm's year end. The risk

assessment filings include FCM organizational charts; financial,

operational, and risk management policies, procedures, and systems

maintained by the FCM; and, fiscal year-end consolidated and

consolidating financial information for the FCM and its highest level

material affiliate.

The Commission proposed to amend Sec. 1.15 to require the

financial information to be filed in electronic format. The Commission

received no comments on the proposed amendments to Sec. 1.15. The

Commission is adopting the amendments as proposed. The Commission also

has revised the final regulation to provide that the risk assessment

filings should be filed via transmission using a form of user

authentication assigned in accordance with procedures established by or

approved by the Commission, and otherwise in accordance with

instructions issued by or approved by the Commission. The Commission

will provide direction regarding how FCMs should file the risk

assessment reports in a secure manner with the Commission prior to the

effective date of the regulation.

E. Sec. 1.16: Qualifications and Reports of Accountants

Regulation 1.16 addresses the minimum requirements a public

accountant must meet in order to be recognized by the Commission as

qualified to conduct an examination for the purpose of expressing an

opinion on the financial statements of an FCM. Regulation 1.16(b)

currently provides that the Commission will recognize a person as

qualified if such person is duly registered and in good standing as a

public accountant under the laws of the place of the accountant's

principal office or principal residence.

The Commission proposed several amendments to enhance the

qualifications that a public accountant must meet in order to conduct

an examination of an FCM. Specifically, the Commission proposed to

require that the public accountant must: (1) Be registered with the

Public Company Accounting Oversight Board (``PCAOB''); (2) have

undergone an examination by the PCAOB; and, (3) have remediated to the

satisfaction of the PCAOB any deficiencies identified during the

examination within three years of the PCAOB issuing its report.

The Commission also sought to enhance the quality of the public

accountant's examination of an FCM by proposing to require that the

examination be conducted in accordance with U.S. GAAS after full

consideration of the auditing standards issued by the PCAOB. The

Commission further sought to ensure that the FCM's governing body took

an active role in the assessment and appointment of the public

accountant by imposing an obligation on the governing body to evaluate,

among other things, the accountant's experience auditing FCMs; the

adequacy of the accountant's knowledge of the Act and Commission

regulations; the depth of the accountant's staff; and, the independence

of the accountant.

Additionally, the Commission proposed technical amendments to

[[Page 68526]]

Sec. 1.16. The Commission proposed to amend Sec. 1.16(f)(1)(i)(C) to

require each FCM to submit its certified annual report to the

Commission in an electronic format. The Commission also proposed to

amend Sec. 1.16(c)(2) to remove the requirement that the accountant

manually sign the accountant's report, which would facilitate the

electronic filing of the FCM's certified annual report with the

Commission.

The proposed amendments to Sec. 1.16, including a discussion of

the comments received, are discussed below.

1. Mandatory PCAOB Registration Requirement

Regulation 1.16(b)(1) would continue to require a public accountant

to be registered and in good standing under the laws of the place of

the accountant's principal office or principal residence in order to be

qualified to conduct examinations of FCMs. The Commission proposed to

enhance the qualifications of public accountants by further requiring

the public accountant to be registered with the PCAOB.

The PCAOB is a nonprofit corporation established by Congress under

the Sarbanes-Oxley Act of 2002 (``SOX'') to oversee the audits of

public companies and BDs of securities registered with the SEC in order

to protect investors and the public interest by promoting informative,

accurate, and independent audit reports.\114\ The SEC has oversight

authority over the PCAOB, including the approval of the PCAOB's rules,

auditing and other standards, and budget.\115\

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\114\ Public Law 107-204, 116 Stat. 745 (July 30, 2002). See

also section 101 of SOX.

\115\ Sections 107 and 109 of SOX.

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

The Commission received several comments on the proposed amendments

to Regulation 1.16, which are discussed below. The commenters, however,

did not oppose the proposed PCAOB registration requirement. In

addition, the Commission does not anticipate that the PCAOB

registration requirement will present a significant issue to FCMs or

public accountants. In this regard, only one public accountant that

currently conducts examinations of FCMs is not registered with the

PCAOB. PCAOB-registered public accountants conducted the examinations

of 103 of the 104 registered FCMs based upon a review of the most

current annual reports submitted by FCMs to the Commission.

Accordingly, after considering the comments, the Commission is adopting

the PCAOB registration requirement as proposed.

2. PCAOB Inspection Requirement

The Commission proposed to amend Sec. 1.16(b)(1) to require that a

public accountant must have undergone a PCAOB examination in order to

be qualified to conduct examinations of FCMs. Section 104 of SOX

requires the PCAOB to conduct an annual inspection of each registered

public accountant that regularly provides audit reports for more than

100 public issuers each year.\116\ Section 104 further requires public

accountants that provide audit reports for 100 or fewer issuers to be

inspected by the PCAOB no less frequently than once every three

years.\117\

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

\116\ Section 104(b)(1)(A) of SOX.

\117\ Section 104(b)(1)(B) of SOX.

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

In addition, the Dodd-Frank Act amended SOX and vested the PCAOB

with new oversight authority over the audits of BDs registered with the

SEC.\118\ The PCAOB was provided with the authority, subject to SEC

approval, to determine the scope and frequency of the inspection of

public accountants of BDs. The SEC also approved a PCAOB temporary rule

implementing an inspection program for BDs.\119\

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\118\ Section 982 of the Dodd-Frank Act.

\119\ See Public Company Oversight Board; Order Approving

Proposed Temporary Rule for an Interim Program of Inspection Related

to Audits of Brokers and Dealers, 76 FR 52996 (Aug. 24, 2011).

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

Several commenters raised issues with, or objected to, the

proposal. Ernst & Young requested clarification that the term

``examination'' in proposed Sec. 1.16(b)(1) referred to the

``inspections'' that are required under section 104 of SOX.\120\ The

Commission confirms that the term ``examination'' in proposed Sec.

1.16 was intended to refer to the ``inspections'' required under

section 104 of the SOX, and has revised the regulation accordingly.

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\120\ Section 104 of SOX requires the PCAOB to conduct a

continuing program of inspections to assess the degree of compliance

of each registered public accounting firm and associated persons of

that firm with the provisions of the SOX, the rules of the PCAOB,

the rules of the SEC, or professional standards, in connection with

its performance of audits, issuance of audit reports, and related

matters involving public issuers.

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Several commenters stated that the proposed inspection requirement

would disqualify public accountants that were registered with the

PCAOB, but had not yet undergone an inspection.\121\ These commenters

stated that the proposal would disqualify accounting firms that

recently registered with the PCAOB, but due to the triennial

inspections schedule may not be subject to a PCAOB inspection for

almost three years.\122\ Commenters also noted that certain PCAOB

registered accounting firms may audit non-issuer BDs and may be subject

to inspection under the PCAOB's temporary or permanent inspection

program, but may not have been selected yet for inspection by the

PCAOB.\123\ The AICPA stated that, while any public accounting firm can

register with the PCAOB, by law only accountants that audit public

issuers or audit certain non-issuer BDs may be inspected by the

PCAOB.\124\ KPMG also stated that the requirement that accounting firms

auditing an FCM must have undergone an inspection makes the rules

governing the audits of FCMs more restrictive than the SEC rules

governing the audits of BDs.\125\ KPMG suggests that the Commission

align the standards required of auditors of FCMs and BDs.\126\

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\121\ Center for Audit Quality Comment Letter at 2 (Jan. 14,

2013); Deloitte Comment Letter at 2 (Jan. 14, 2013); Ernst & Young

Comment Letter at 2 (Jan. 14, 2013).

\122\ Id.

\123\ Center for Audit Quality Comment Letter at 2 (Jan. 14,

2013); Deloitte Comment Letter at 2 (Jan 14, 2013).

\124\ AICPA Comment Letter at 2 (Feb. 11, 2013).

\125\ KPMG Comment Letter at 2 (Jan. 11, 2013).

\126\ Id.

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The AICPA also stated that the Commission should permit a practice

monitoring program (such as the AICPA peer review program) that

evaluates and opines on an accounting firm's system of quality control

relevant to the firm's non-issuer accounting and auditing practice as

an alternative to the PCAOB inspection requirement.\127\ The AICPA also

stated that a robust process, such as the AICPA's peer review program,

whereby a team of certified public accountants conducts a comprehensive

evaluation of a public accountant's system of quality control and whose

work is subject to the oversight and approval by a separate group of

certified public accountants should be required rather than having one

certified public accountant review another.\128\

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

\127\ AICPA Comment Letter at 3 (Feb 11, 2013).

\128\ Id.

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The NFA also supported a temporary alternative to the PCAOB

inspection requirement in order to ensure that public accountants that

are unable to obtain a PCAOB inspection within the time period required

by the Commission will not automatically be prohibited from conducting

FCM examinations.\129\ NFA recommended that the Commission specifically

designate the AICPA's peer review program as the only peer review

program that will be acceptable to alleviate any uncertainty as to

whether a certified public

[[Page 68527]]

accountant is ``qualified'' to conduct the peer review.\130\

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

\129\ NFA Comment Letter at 11 (Feb. 15, 2013).

\130\ Id.

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As noted in the proposal, FCMs are sophisticated financial market

participants that are entrusted with more than $182 billion of

customers' funds.\131\ FCMs intermediate futures customers activities

and guarantee customers' financial performance to DCOs, other FCMs, and

foreign brokers. In addition, FCMs are anticipated to hold significant

amounts of Cleared Swaps Customer Collateral deposited to margin,

secure or guarantee Cleared Swaps as more provisions of the Dodd-Frank

Act are implemented. FCMs also may conduct proprietary futures and

securities transactions, and handle business for securities customers

in addition to futures customers. The sophistication of the futures

markets and the Commission's regulations, coupled with the critical

role played by FCMs in the futures market (and in the case of many of

the largest FCMs, the securities markets) necessitates the engagement

of competent and experienced accountants to conduct the examinations of

FCMs.

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

\131\ The customer funds information is based upon the 1-FR-FCM

reports and FOCUS Reports filed by FCMs for the month ending April

30, 2013.

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The Commission believes that registration with the PCAOB and being

subject to the PCAOB inspection program will help to ensure that

accounting firms engaged to conduct audits of FCMs remain competent and

qualified. The PCAOB inspection program involves the review of the

accounting firm's compliance with PCAOB issued audit, quality control,

independence and ethics standards.

In addition, the purpose of the PCAOB registration and inspection

requirement in the final rule is not to ensure that the accounting

firm's audits of FCMs are subject to inspection by the PCAOB. The

Commission acknowledges that the PCAOB's primary jurisdiction and

inspections are directed toward the audits of public issuers and BDs.

However, the Commission's objective is to reasonably ensure the quality

and competence of the public accountants engaged in the audits of FCMs.

The Commission believes that such quality and competence may be

assessed by the PCAOB inspecting the accounting firms' audit process

for issuers and BDs, and is not dependent solely upon the inspection of

the accounting firms' audits of FCMs.

The Commission further believes that its proposed PCAOB inspection

requirement is consistent with the SEC's audit requirements for BDs.

Any auditor of an SEC-registered BD must register with the PCAOB and

will be subject to the PCAOB inspection program.

Moreover, the Commission believes that the imposition of a PCAOB

inspection requirement provides several benefits over a peer review

program. The PCAOB is an entity that was created by Congress and

charged with improving audit quality, reducing the risks of audit

failures in the U.S. public securities markets and promoting public

trust. As previously noted, the PCAOB is subject to oversight by the

SEC, which approves the PCAOB's rules, auditing and other standards,

and budget. A peer review program, while providing many benefits in the

oversight of the accounting profession, is overseen by the accounting

industry and is not subject to oversight by a federal regulator, which

the Commission believes is a key advantage of the PCAOB in the

furtherance of the protection of customer funds.

The Commission also does not anticipate a significant impact on

existing FCMs from the imposition of the PCAOB inspection requirement

on public accountants. As noted above, 103 of the 104 FCMs currently

are subject to examination by public accountants that are registered

with the PCAOB. In addition, only six of the PCAOB-registered public

accountants that conduct examinations of fourteen FCMs have not been

subject to a PCAOB inspection at this time. However, all six of these

firms have indicated in their PCAOB filings that they conduct audits of

BDs and, therefore, will be subject at a future date to the PCAOB

inspection program for the inspection of accountants that conduct

audits of BDs.

The Commission, based upon the analysis above and further

consideration of the comments, has determined to adopt the regulation

as proposed. The Commission recognizes, however, that the audits of

many FCMs with a year-end date of December 31, 2013 or later have

already been initiated. Accordingly, the Commission has determined that

the PCAOB registration requirement will apply for audit reports issued

for the year ending June 1, 2014 or later so as not to unnecessarily

interrupt the examinations that currently are in progress. The

Commission also is adopting a December 31, 2015 compliance date for a

PCAOB inspection. The deferred compliance date will provide public

accountants with additional time to register with, and to be inspected

by, the PCAOB. The compliance dates are discussed further in section

III below.

3. Remediation of PCAOB Inspection Findings by the Public Accountant

The Commission proposed in Sec. 1.16(b)(1) that any deficiencies

noted during a PCAOB inspection must be successfully remediated to the

satisfaction of the PCAOB within three years.

KPMG, the Center for Audit Quality, Deloitte, the AICPA, and PWC

generally argued that it is not clear how the requirement that any

deficiencies noted during the PCAOB exam must have been remediated to

the satisfaction of the PCAOB would work or what it means.\132\ The

commenters also noted that the Commission's proposed requirement that

the public accountant remediate any deficiencies noted in a PCAOB

inspection report is more stringent than the SEC's requirements for

auditors of BDs and public issuers. KPMG also asked who would make a

determination of remediation as there is no procedure for the PCAOB to

communicate such determinations to the public accountant or the

public.\133\ PWC also stated that reliance on the PCAOB inspection

results was misplaced and that the PCAOB inspection comments are issued

in the context of a constructive dialogue to encourage Certified Public

Account (``CPA'') firms to improve their practices and procedures.\134\

PWC further noted that disciplinary sanctions such as revocation of the

firm's right to audit a public company or BD can only be made in the

context of an adjudicative process in which the firm is afforded

procedural rights.\135\ Lastly, PWC asserted that the Commission's

proposal would disqualify a firm without providing any of the

procedural rights or safeguards established by SOX.\136\

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\132\ KPMG Comment Letter at 2-3 (Jan. 11, 2013); Center for

Audit Quality Comment Letter at 2-3 (Jan. 14, 2013); Deloitte

Comment Letter at 2-3 (Jan. 14, 2013); AICPA Comment Letter at 2

(Feb. 11, 2013); PWC Comment Letter at 2 (Jan. 15, 2013).

\133\ KPMG Comment Letter at 2 (Jan. 11, 2013).

\134\ See PWC Comment Letter at 2 (Jan. 15, 2013).

\135\ Id.

\136\ Id.

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The Commission has considered the comments and recognizes that the

PCAOB inspection process does not involve a formal process for

communicating that a public accountant has adequately remediated

deficiencies identified during the PCAOB's last inspection. In

addition, the Commission understands that the PCAOB may not always

issue a report at the conclusion of an inspection, or that the report

may contain both public and non-public sections.

In light of these comments, the Commission has determined to revise

[[Page 68528]]

the final regulation by removing the requirement that a public

accountant must remediate any deficiencies identified during a PCAOB

inspection to the satisfaction of the PCAOB within three years of the

inspection. The Commission is further revising Sec. 1.16(b)(1) to

provide that a public accountant that, as a result of the PCAOB

disciplinary process, is subject to a sanction that would permanently

or temporarily bar the public accountant from engaging in the

examination of a public issuer or BD may not conduct the examination of

an FCM. The Commission notes that the PCAOB has the authority to

initiate a disciplinary action against a firm and its associated

persons for failing to adequately address inspection findings or for

other transgressions.

The Commission also is revising Sec. 1.16(b)(4) to require the

governing body of the FCM to review and consider the PCAOB's inspection

reports of the public accountant as part of the governing body's

assessment of the qualifications of the public accountant to perform an

audit of the FCM. The governing body is in a position to request

information from the public accountant regarding the PCAOB inspections

and general oversight of the public accountant and should use such

information in assessing the competency of the accountant to conduct an

examination of the FCM. An FCM's governing body should be concerned if

the PCAOB inspection reports indicate that the public accountant has

significant deficiencies and should take such information into

consideration in assessing the qualifications of the public accountant.

4. Auditing Standards

The Commission proposed to amend Sec. 1.16(c)(2) to require that

the public accountant's report of its examination of an FCM must state

whether the examination was done in accordance with generally accepted

auditing standards promulgated by the Auditing Standards Board of the

AICPA (i.e., U.S. GAAS), after giving full consideration to the

auditing standards issued by the PCAOB. Commenters raised issues with

the proposal noting that there is no existing reporting framework that

requires the application of one set of auditing standards and the

consideration of another set of auditing standards.\137\ Deloitte noted

that public accountants may be specifically engaged to conduct an audit

of an entity under both PCAOB auditing standards and U.S. GAAS, but

that there is no reporting framework for an audit under one set of

auditing standards, after giving ``full consideration'' to a separate

set of auditing standards.\138\

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\137\ Ernst & Young Comment Letter at 3 (Jan. 14, 2013);

Deloitte Comment Letter at 1 (Jan. 14, 2013); PWC Comment Letter at

3 (Jan. 15, 2013); AICPA Comment Letter at 2 (Feb. 11, 2013); and

KPMG Comment Letter at 3 (Jan. 11, 2013).

\138\ Deloitte Comment Letter at 1 (Jan. 14, 2013).

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The Commission has reviewed the comments and has determined to

revise the final regulation to provide that the accountant's report

must state whether the examination of the FCM was conducted in

accordance with the auditing standards issued by the PCAOB. The

Commission acknowledges the fact that there is no reporting framework

for public accountants to report on one set of auditing standards after

giving full consideration to another set of auditing standards. Also,

the Commission recognizes that the SEC has recently adopted final

regulations to its Rule 17a-5 to require public accountants to use

PCAOB standards in the examination of the financial statements of

BDs.\139\ Therefore, the Commission's amendments to Sec. 1.16(c)(2) to

require public accountants to use PCAOB standards in conducting the

examination of the financial statements of an FCM is consistent with

the SEC's revisions to its Rule 17a-5. The Commission also is setting a

compliance date for public accountants to use PCAOB auditing standards

for all FCM examinations with a year-end date of June 1, 2014 or later.

The extended compliance date allows FCMs currently subject to an

examination by a public accountant to complete the examination cycle

without having the public accountant adjust the examination for the new

PCAOB standards requirement. The June 1, 2014 compliance date also is

consistent with the SEC's compliance date for revisions to Rule 17a-5

and, therefore, will allow FCMs that are dually-registered as FCMs/BDs

to be subject to uniform CFTC and SEC requirements.\140\ Compliance

dates are discussed further in section III below.

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\139\ Broker Dealer Reports, 78 FR 51910 (Aug. 21, 2013).

\140\ Id.

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

Body

The Commission proposed to amend Sec. 1.16(b) by adding new

paragraph (4) which would require the FCM's governing body to ensure

that a public accountant engaged to conduct an examination of the FCM

is duly qualified to perform the audit. The proposed new paragraph

further provided that the evaluation should include, among other

things, the public accountant's experience in auditing FCMs, the public

accountant's knowledge of the Act and Commission regulations, the depth

of the public accountant's staff, and the public accountant's size and

geographical location. The proposed requirements are intended to ensure

that the FCM's governing body takes an active role in the assessment

and appointment of the public accountant.

PWC requested clarification of the Commission's expectations for

the criteria that would be expected to be used by the FCM's governing

body for determining qualification. PWC stated that such clarification

may be helpful so that a consistent framework for determining the

qualifications is used across the industry and FCM governing

bodies.\141\

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

\141\ PWC Comment Letter at 3 (Jan. 15, 2013).

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The Commission has considered the comments and has determined to

adopt the amendments as proposed. FCMs represent a diverse group of

entities and business models. Some FCMs focus primarily on

institutional clients and engage in securities transactions as their

primary business. Other FCMs focus on retail customers and engage in no

proprietary or securities transactions.

With such a wide range of business models, the Commission believes

that it is not practical to provide a uniform set of criteria that each

governing body of each FCM should use to assess the qualifications of a

public accountant. In fact, such a standard list would go against the

Commission's objective of ensuring that the governing body is actively

reviewing the qualifications of the public accountant relative to the

FCM's particular business model. The requirement is not intended to

exclude regional or smaller public accountants from being qualified to

conduct examinations, provided that the governing body is satisfied

that the public accountant has the appropriate skill, knowledge, and

other resources to effectively conduct an examination, and is otherwise

in compliance with the qualification requirements in Sec. 1.16.

The Commission also is revising final Sec. 1.16(b)(4) in response

to the comments received on proposed Sec. 1.16(b)(1) that would have

required that a public accountant remediate any findings issued by the

PCAOB in its inspection report within 3 years of the issuance of the

inspection report. As stated above, commenters noted that there is no

formal mechanism to assess whether a public accountant has remediated

any inspection findings to the satisfaction of

[[Page 68529]]

the PCAOB. Accordingly, the Commission is revising Sec. 1.16(b)(4) to

provide that the governing body of the FCM should review the inspection

report of the public accountant and discuss inspection findings as

appropriate with the public accountant. Such reviews and discussions

will provide additional information to the governing body that will

allow it to better assess the qualifications of the public accountant

to conduct an audit of the FCM.

6. Electronic Filing of Certified Annual Reports

The Commission proposed to amend Sec. 1.16(f)(1)(i)(C) to require

each FCM to submit its certified annual report to the Commission in an

electronic format. The Commission also proposed to amend Sec.

1.16(c)(2) to remove the requirement that the accountant manually sign

the account's report, which will facilitate the electronic filing of

the FCM's certified annual report with the Commission. The Commission

received no comments on the above amendments and is adopting the

amendments as proposed.

F. Sec. 1.17: Minimum Financial Requirements for Futures Commission

Merchants and Introducing Brokers

1. FCM Cessation of Business and Transfer of Customer Accounts if

Unable To Demonstrate Adequate Liquidity

Section 4f(b) of the Act provides that no person may be registered

as an FCM unless it meets the minimum financial requirements that the

Commission has established as necessary to ensure that the FCM meets

its obligations as a registrant at all times, which would include its

obligations to customers and to market participants, including DCOs.

The Commission's minimum capital requirements for FCMs are set forth in

Sec. 1.17 which, among other things, currently provides that an FCM

must cease operating as an FCM and transfer its customers' positions to

another FCM if the FCM is not in compliance or is not able to

demonstrate its compliance with the minimum capital requirements.

The proposed amendments to Sec. 1.17 authorize the Commission to

request certification in writing from an FCM that it has sufficient

liquidity to continue operating as a going concern. If an FCM is not

able to immediately provide the written certification, or is not able

to demonstrate adequate access to liquidity with verifiable evidence,

the FCM must transfer all customer accounts and immediately cease doing

business as an FCM.

The FIA stated that it agreed with the regulatory purpose

underlying this proposed amendment, but stated that the Commission

should not adopt the rule before it clearly articulates the objective

standards by which it will determine that an FCM has ``sufficient

liquidity.'' \142\ Similarly, FCStone requested clarity with respect to

the exigent circumstances that would give the Commission authority to

require an FCM to cease operating.\143\

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\142\ FIA Comment Letter at 8 (Feb. 15, 2013).

\143\ FCStone Comment Letter at 4 (Feb. 15, 2013).

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

The Commission understands the concerns of commenters regarding the

process by which the Commission, or the Director of the Division of

Swap Dealer and Intermediary Oversight acting pursuant to delegated

authority under Sec. 140.91(6), could require immediate cessation of

business as an FCM and the transfer of customer accounts; however, that

same authority currently exists should a firm fail to meet its minimum

capital requirement. The Commission believes the ability to certify,

and if requested, demonstrate with verifiable evidence, access to

sufficient liquidity to operate as a going concern to meet immediate

financial obligations is a minimum financial requirement necessary to

ensure an FCM will continue to meet its obligations as a registrant as

set forth under section 4f(b) of the Act. Further, the Commission notes

that the ``going concern'' standard is well defined in accounting

literature and practice, and generally means an ability to continue

operating in the near term.

The proposed liquidity provision is intended to cover circumstances

that require immediate attention and would provide the Commission with

a means of addressing exigent circumstances by requiring an FCM to

produce a written analysis showing the sources and uses of funds over a

short period of time not to exceed one week. The purpose of the

provision is to address situations where an FCM may currently be in

compliance with minimum financial requirements, but lacks liquidity to

meet pending, non-discretionary obligations such that the firm's

ability to continue operating in the near term is in serious jeopardy.

In such a situation, it is expected that the Commission and the FCM's

DSRO and applicable DCOs would be in frequent communication with the

firm to review the FCM's options and plans to continue operating as a

going concern and to assess what actions were necessary to ensure the

firm continues to meet its obligations as a market intermediary and to

protect customer funds. If an FCM's management cannot in good faith

certify that the FCM has sufficient liquidity to permit it to operate

throughout the following week, then the FCM has failed to meet its

minimum financial requirements necessary to ensure that the firm will

continue to meet its obligations as a registrant and the Commission

would have to determine how to minimize the impact of a potential FCM

insolvency or default.

The Commission has considered the comments and has determined to

adopt the amendments as proposed.

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

Undermargined Accounts to One Day After Margin Calls Are Issued

Regulation 1.17 requires an FCM to incur a charge to capital for

customer and noncustomer accounts that are undermargined beyond a

specified period of time.\144\ Regulation 1.17(c)(5)(viii) currently

requires an FCM to reduce its capital (i.e., take a capital charge) if

a customer account is undermargined for three business days after the

margin call is issued.\145\ Regulation 1.17(c)(5)(ix) requires an FCM

to take a capital charge for noncustomer and omnibus accounts that are

undermargined for two business days after the margin call is issued.

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

\144\ Noncustomers are defined in Sec. 1.17(b)(4) as accounts

carried by the FCM that are not customer accounts or proprietary

accounts. Noncustomer accounts are generally accounts carried by an

FCM for affiliates and certain employees of the FCM.

\145\ For purposes of these Commission regulations, a margin

call is presumed to be issued by the FCM the day after an account

becomes undermargined.

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

The Commission proposed to amend Sec. 1.17(c)(5)(viii) and (ix) to

require an FCM to take capital charges for undermargined customer,

noncustomer, and omnibus accounts that are undermargined for more than

one business day after a margin call is issued. Thus, for example,

under the proposal, if an account carried by an FCM became

undermargined on Monday, the operation of the regulation assumes that

the FCM would issue a margin call on Tuesday, and the FCM would have to

incur a capital charge at the close of business on Wednesday if the

margin call was still outstanding.

Vanguard commented that it supported the Commission's proposal,

stating that the accelerated timetable makes sense given modern trading

and asset transfer timing.\146\ Vanguard further stated that each

customer must stand up for its trades and promptly post margin, and it

further stated that it believes the overall market may be weakened to

the extent an FCM is

[[Page 68530]]

extending significant amounts of credit over an extended period to

cover a customer's margin deficit.\147\

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

\146\ Vanguard Comment Letter at 7 (Feb. 22, 2013).

\147\ Id.

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MFA objected to the proposal noting that, while in the ordinary

course of business, few margin calls remain outstanding for more than

two business days, the proposal does recognize the practical reasons

why a margin call may be outstanding more than 2 business days after

the call issued.\148\ MFA cited disputes between an FCM and its

customer as to the appropriate level of margin, and good faith errors

that may cause a delay beyond 2 days for a margin call to be met.\149\

MFA also stated that an increase in costs resulting from the regulation

will ultimately be passed on the customers.

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

\148\ MFA Comment Letter at 7 (Feb. 15, 2013).

\149\ Id.

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

The NCBA stated that the proposal may require market participants

to use wire transfers in lieu of checks, which will increase the costs

and impose a significant financial burden to the cattle industry.\150\

The NCBA also stated that the proposal will cause customers to prefund

their accounts for anticipated margin requirements, which will reduce

customers' capital and impede their other business operations.\151\ The

NCBA further noted that the proposal is not related to the MFGI and

PFGI failures, which were not caused by customers failing to meet

margin calls.\152\

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\150\ NCBA Comment Letter at 2 (Feb. 15, 2013).

\151\ Id.

\152\ Id. See also JSA Comment Letter at 2 (Feb. 15, 2013) and

ICA Comment Letter at 1-2 (Feb. 15, 2013).

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

JSA stated that an effective increase in a capital charge for

undermargined customer accounts could cause an increase in requirements

for customers to prefund their accounts, which would be punitive in a

highly competitive environment that already places midsized FCMs and

FCMs that are not affiliated with a banking institution at a

disadvantage to larger, more highly capitalized firms, or FCMs that are

affiliated with banking institutions.\153\ JSA also stated that if

smaller FCMs are forced out of the market, larger FCMs or FCMs

affiliated with banks may not be willing to service customers that are

farmers, ranchers, retail, or introduced brokerage accounts, for which

they have historically shown little interest.\154\

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

\153\ JSA Comment Letter at 2 (Feb. 15, 2013). See also Frontier

Futures Comment Letter at 2-3 (Feb. 14, 2013).

\154\ Id.

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FIA stated that while institutional and many commercial market

participants generally meet margin calls by means of wire transfers,

the proposal, creates operational problems because it does not consider

delays arising from accounts located in other time zones that cannot

settle same day, or ACH settlements, or the requirement to settle or

convert certain non-U.S. dollar currencies.\155\ FIA also stated that a

substantial number of customers that do not have the resources of large

institutional customers (in particular members of the agricultural

community) depend on financing from banks to fund margin requirements,

which may require more than one day to obtain.\156\

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

\155\ FIA Comment Letter at 26 (Feb. 15, 2013).

\156\ Id.

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

RJ O'Brien stated that it recognized that the collection of margin

is a critical component of an FCM's risk management program, however,

it objected to the proposed amendment.\157\ RJ O'Brien stated that as

the largest independent FCM serving a client base that includes a great

number of farmers and ranchers, it is well aware that many customers

that use the markets to hedge commercial risk still meet margin calls

by check or ACH because of the impracticality and costliness of wire

transfers in their circumstances.\158\ RJ O'Brien stated that in many

cases, the costs of a wire transfer would exceed the transaction costs

paid by the client to its FCMs, and additionally, that some customers

in the farming and ranching community finance their margin calls, which

can require additional time to arrange for delivery of margin call

funds due to routine banking procedures.\159\

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\157\ RJ O'Brien Comment Letter at 3-4 (Feb. 15, 2013).

\158\ Id. See also RCG Comment Letter at 5 (Feb. 12, 2013). RCG

also recommended that the Commission implement a pilot program that

requires FCMs to provide the Commission with daily undermargined

reports. The Commission does not believe that a pilot program is

necessary for gathering additional information.

\159\ Id.

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

RJ O'Brien also stated that if the proposal is adopted, FCMs that

service non-institutional clients will struggle to remain competitive

and the proposal may result in fewer clearing FCMs and greater systemic

risk to the marketplace.\160\ RJ O'Brien further stated that many of

the larger FCM/BDs likely have little interest in servicing smaller

rancher and farmer clients, as was evidenced in the wake of MFGI's

failure, and that a loss of such smaller FCMs will result in fewer

options available to these ranchers, farmers and other commercial

market participants that wish to hedge their commercial risks.\161\

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

\160\ Id.

\161\ Id.

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TD Ameritrade stated that it did not support the proposed

amendments to Sec. 1.17(c)(5)(viii) and (ix) as it would impose

financial hardships on customers that the Proposal was intended to

protect.\162\ TD Ameritrade stated that a large number of retail

customers do not currently use wire transfers to meet a margin

requirement in one business day.\163\ TD Ameritrade also noted that

non-U.S. customer accounts are faced with time zone differences and

inherent delays in meeting margin calls.\164\

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

\162\ TD Ameritrade Comment Letter at 3-4 (Feb. 15, 2013).

\163\ Id.

\164\ Id.

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

Other commenters expressed the general concern that the proposal

will harm the customers it is meant to protect by requiring more

capital to be kept in customer accounts, possibly forcing users to hold

funds at FCMs well in excess of their margin requirements, or resulting

in certain segments of the market to forego the futures markets to

hedge their commercial operations.\165\ Those commenters argued that

such pre-funding could add significant financial burdens to trading as

customers find themselves having to provide excess funds to their

brokers which could increase their risk with regard to the magnitude of

funds potentially at risk in the event of future FCM insolvencies.\166\

The commenters general expressed significant concerns that reducing

margin calls to one day will harm many customers as: (1) Many small

businesses, farmers, cattle producers and feedlot operators routinely

pay by check and forcing them to use wire transfers increases their

cost of doing business; (2) clients who make margin calls by ACH

payments instead of wire transfers because ACH is cheaper, would no

longer be able to do so because there is a one-day lag in availability

of funds; and (3) foreign customers would not be able to make margin

calls due to time zone differences, the time required to convert

certain non-USD currencies, and for

[[Page 68531]]

whom banking holidays fall on different days.\167\

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

\165\ NPPC Comment Letter at 2 (Feb. 14, 2013); RCG Comment

Letter at 4-5 (Feb. 12, 2013); NGFA Comment Letter at 3 (Feb. 15,

2013); NEFI/PMAA Comment Letter at 3 (Jan. 14, 2013); AIM Comment

Letter at 15 (Jan. 24, 2013); Amarillo Comment Letter at 1 (Feb. 14,

2013); NCFC Comment Letter at 1 (Feb. 15,2013); NFA Comment Letter

at 12-13 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15,

2013); Advantage Comment Letter at 1-2 (Feb. 15, 2013); AFBF Comment

Letter at 2 (Feb. 15, 2013); CCC Comment Letter at 2 (Feb. 15,

2013); Steve Jones Comment Letter at 1 (Feb. 14, 2013); ICA Comment

letter at 1-2 (Feb. 15, 2013);TCFA Comment Letter at 1-2 (Feb. 15,

2013); CME Comment Letter at 5 (Feb. 15, 2013). AIM resubmitted the

comment letters of Premier Metal Services, NEFI/PMAA, and the ISRI

and indicated its support for the recommendations therein (Jan. 14,

2013).

\166\ Id.

\167\ Id.

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

The CCC stated that the proposed amendment to the capital rule

places an undue burden on the FCMs, which will likely result in FCMs

demanding that customers prefund trades to prevent market calls and

potential capital charges.\168\ The CCC also stated that the proposal

could result in forced liquidations of customer positions to ensure

that the FCM does not incur a capital charge.\169\

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

\168\ CCC Comment Letter at 2-3 (Feb. 15, 2013).

\169\ Id.

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

FIA and RJ O'Brien provided alternatives to the Commission's

proposal. Both FIA and RJ O'Brien offered that an FCM be required to

take a capital charge for any customer margin deficit exceeding

$500,000 that is outstanding for more than one business day.\170\ FIA

further suggested that if the customer's margin deficit is $500,000 or

less, the FCM should take a capital charge if the margin call is

outstanding two business days or more after the margin call is

issued.\171\ RJ O'Brien's comment letter does not address the timing of

the capital charge for accounts with a margin deficit of $500,000 or

less.

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

\170\ FIA Comment Letter at 27 (Feb. 27, 2013); RJ O'Brien

Comment Letter at 4 (Feb. 15, 2013).

\171\ FIA Comment Letter at 27 (Feb. 15, 2013).

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

NFA, FIA, MFA and AIMA stated that if the Commission adopts the

amendments regarding residual interest as proposed, then the Commission

should consider whether a capital charge for undermargined accounts

remains necessary at all because the FCM will have already accounted

for an undermargined account by maintaining a residual interest

sufficient at all times to exceed the sum of all margin deficits; hence

the capital charges related to an undermargined account appear to

impose an additional financial burden without any necessary financial

protection.\172\

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

\172\ NFA Comment Letter at 13 (Feb. 15, 2013); FIA Comment

Letter at 26 (Feb. 15, 2013); MFA Comment Letter at 6-7 (Feb. 15,

2013); and AIMA Comment Letter at 3 (Feb. 15, 2013).

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

RJ O'Brien also stated that the Commission should provide at least

a one-year period of time for any changes to the timeframe for taking a

capital charge for undermargined accounts to be effective.\173\ RJ

O'Brien stated that FCMs will need to educate and develop systems to

assist their clients in meeting margin calls in an expedited

timeframe.\174\ Lastly, RJ O'Brien stated that the Commission should

require futures exchanges to increase their margin requirements to 135%

of maintenance margin to reduce the number and frequency of margin

calls.\175\

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

\173\ RJ O'Brien Comment Letter at 4 (Feb. 15, 2013).

\174\ Id.

\175\ Id.

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With respect to the reduction of the timeframe in Sec.

1.17(c)(5)(viii) for an FCM to incur a capital charge for undermargined

customer accounts, the Commission has considered the comments and has

determined to adopt the amendments as proposed. The timely collection

of margin is a critical component of an FCM's risk management program

and is intended to ensure that an FCM holds sufficient funds deposited

by customers to meet their potential obligations to a DCO. As guarantor

of the financial performance of the customer accounts that it carries,

the FCM is financially responsible if the owner of an account cannot

meet its margin obligations to the FCM and ultimately to a DCO.

The timeframe for meeting margin calls currently provided in Sec.

1.17(c)(5)(viii) was established in the 1970s when the use of checks

and the mail system were more prevalent for depositing margin with an

FCM. However, in today's markets, with the increasing use of

technology, 24-hour-a-day trading, and the use of wire transfers to

meet margin obligations, the Commission believes that the timeframe for

taking a capital charge should be reduced both to give an incentive to

FCMs to exercise prudent risk management and to strengthen the

financial protections of FCMs, and to enhance the safety of the

clearing systems and other customers by requiring FCMs to reserve

capital for undermargined customer accounts that fail to meet a margin

call on a timely basis.

Several commenters have stated that the proposal would harm

customers by increasing costs to customers or by exposing more of the

customers' funds to the FCM.\176\ The Commission notes that the final

regulation provides for at least two full days from the point in time

that a customer's account is undermargined to the time the FCM is

required to incur a capital charge for the undermargined account. Under

the regulation, if a customer's account becomes undermargined at some

point before close of business on Monday, the FCM will have until the

close of business on Wednesday before it is required to take a capital

charge. Customers are responsible for monitoring the activity in their

account and should have information that would allow them to determine

that their trading account is undermargined prior to the close of

business on Monday.

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

\176\ See, e.g., NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA

Comment Letter at 3-4 (Feb. 15, 2013).

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

The alternative proposed by FIA and RJ O'Brien is premised on their

belief that the regulation would not provide an adequate amount of time

for a customer to meet a margin call before the FCM would have to take

a capital charge for an undermargined account. As noted above, the

Commission believes that the regulation, which provides at least two

full business days for a customer to fund its undermargined account,

does provide an adequate period of time for margin calls to be met. In

situations involving customers located in foreign jurisdictions and the

associated issues of time zone differences and differences in banking

holidays, the Commission believes that the FCM should include such

factors in its risk management program and operating procedures with

such customers in an effort to ensure compliance with the regulations.

The Commission believes that the time period provided in Sec.

1.17(c)(5)(viii) is adequate in most situations for a customer to

receive and fund a margin call. The intent of margin is to ensure that

a customer maintains a sufficient amount of funds in its account to

cover 99 percent of the observed market moves of its portfolio of

positions over a specified period of time. Customers that maintain

fully margined accounts are exposed to greater risk to the safety of

their funds if other customer accounts carried by the FCM are

undermargined. In order to provide greater protection to the customers

that are fully margined or maintain excess margin on deposit, and to

provide greater assurance that the FCM can continue to meet its

financial obligations to DCOs, the Commission believes that the FCM

should maintain a sufficient amount of capital to cover the potential

shortfall in undermargined customers' accounts.

The Commission also has considered the comments on the proposed

amendments to Sec. 1.17(c)(5)(ix), which reduce the timeframe for an

FCM to incur a capital charge on an undermargined noncustomer or

omnibus account from two days after the call was issued to one day

after the call was issued. The Commission notes that the majority of

the comments addressed the undermargined charge on customer accounts,

but considered the comments generally in reviewing the proposed

amendments to Sec. 1.17(c)(5)(ix).

The Commission has considered the proposal and is adopting the

amendments to Sec. 1.17(c)(5)(ix) as

[[Page 68532]]

proposed. As noted above, Sec. 1.17(c)(5)(ix) applies to noncustomers

and omnibus accounts carried by an FCM. Many of the concerns raised by

the comments regarding the ability to fund a margin call under Sec.

1.17(c)(5)(viii) do not apply to accounts held by an affiliate or an

omnibus accounts. Such accounts should pay margin calls promptly and by

wire transfer to reduce the potential exposure to the FCM resulting

from undermargined accounts.

The Commission also believes that the amendments to Sec.

1.17(c)(5)(viii) and (ix) are appropriate even if the Commission amends

its regulations to require an FCM to maintain residual interest in

segregated accounts in excess of the undermargined amount of customer

accounts. The purpose of the capital rule is to ensure that an FCM

maintains sufficient liquid assets to meet its obligations as a going

concern. Proprietary funds held in segregated accounts that exceed the

total obligation to customers are included in an FCM's capital

computation. However, in situations where the FCM's residual interest

in segregated accounts is covering an undermargined customer account, a

capital charge is appropriate because the FCM's residual interest is

necessary to cover potential market losses on the undermargined

accounts.

3. Permit an FCM That Is Not a BD To Develop Policies and Procedures To

Determine Creditworthiness

The Commissions proposed to amend Sec. 1.17(c)(v) to permit an FCM

that is not a BD to develop a framework to establish, maintain and

enforce written policies and procedures for determining

creditworthiness of commercial paper, convertible debt, and

nonconvertible debt instruments that are readily marketable. In

recommending the proposal, the Commission noted that the SEC proposed

to permit a BD to establish written policies and procedures to assess

the credit risk of commercial paper, convertible debt, and

nonconvertible debt instruments that are readily marketable.\177\

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\177\ The SEC has proposed rule amendments to implement the

Dodd-Frank Act requirement to remove references to credit ratings in

its regulations and substitute a standard for creditworthiness

deemed appropriate. See 76 FR 26550 (May 6, 2011).

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

Under both the Commission's proposal and the SEC's proposal, an FCM

or BD would assess the security's credit risk using the following

factors, to the extent appropriate:

Credit spreads (i.e., whether it is possible to

demonstrate that a position in commercial paper, nonconvertible debt,

and preferred stock is subject to a minimal amount of credit risk based

on the spread between the security's yield and the yield of Treasury or

other securities, or based on credit default swap spreads that

reference the security);

Securities-related research (i.e., whether providers of

securities-related research believe the issuer of the security will be

able to meet its financial commitments, generally, or specifically,

with respect to securities held by the FCM or BD);

Internal or external credit risk assessments (i.e.,

whether credit assessments developed internally by the FCM or BD or

externally by a credit rating agency, irrespective of its status as an

NRSRO, express a view as to the credit risk associated with a

particular security);

Default statistics (i.e., whether providers of credit

information relating to securities express a view that specific

securities have a probability of default consistent with other

securities with a minimal amount of credit risk);

Inclusion on an index (i.e., whether a security, or issuer

of the security, is included as a component of a recognized index of

instruments that are subject to a minimal amount of credit risk);

Priorities and enhancements (i.e., the extent to which a

security is covered by credit enhancements, such as

overcollateralization and reserve accounts, or has priority under

applicable bankruptcy or creditors' rights provisions);

Price, yield and/or volume (i.e., whether the price and

yield of a security or a credit default swap that references the

security are consistent with other securities that the FCM or BD has

determined are subject to a minimal amount of credit risk and whether

the price resulted from active trading); and

Asset class-specific factors (e.g., in the case of

structured finance products, the quality of the underlying assets).

An FCM that maintains written policies and procedures and

determines that the credit risk of a security is minimal is permitted

under the proposal to apply the lesser haircut requirement currently

specified in the SEC capital rule for commercial paper (i.e., between

zero and \1/2\ of 1 percent), nonconvertible debt (i.e., between 2

percent and 9 percent), and preferred stock (i.e., 10 percent).

The CFA does not believe it is appropriate for FCMs to use internal

models to determine minimum required capital.\178\ The CFA believes

that capital models should be established by the relevant regulatory

agencies for use by FCMs or BDs.\179\ It has serious concerns that

internal models used for calculating minimum capital requirements are

prone to failure in a crisis.\180\ The CFA states that the regulatory

agency should provide an objective and clear minimum risk-based capital

baseline.\181\

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\178\ CFA Comment Letter at 4-5 (Feb. 13, 2013).

\179\ Id.

\180\ Id.

\181\ Id.

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As noted above, the SEC has proposed amendments to its net capital

rule to allow BDs to take a lower net capital charge on certain

securities based on the BDs' own determinations that certain securities

have minimal credit risk, pursuant to the BDs having protocols for

assessing the credit risk and maintaining appropriate documentations.

If the SEC approves the proposal, the SEC capital charges would apply

to an FCM that is dually-registered as an FCM/BD. In the absence of the

Commission adopting a similar provision, certificates of deposit,

bankers acceptances, commercial paper and nonconvertible debt

securities held by standalone FCMs that have very low credit and market

risk securities would be subject to the minimum default securities

haircut of 15 percent.

The Commission proposed that standalone FCMs be permitted the same

flexibility as FCM/BDs with respect to taking a lower capital charges

for certain securities that may be determined to have minimal credit

risk. The Commission also notes that based upon a review of Forms 1-FR-

FCM filed with the Commission, standalone FCMs generally have limited

investments in the types of securities that would be subject to the

internal models, and such haircuts are not material to most standalone

FCM's adjusted net capital.

The Commission has considered the proposal and is adopting the

amendments as proposed.

4. Revisions to Definitions in Regulation 1.17(b)

The Commission proposed technical amendments to certain definitions

in Sec. 1.17(b)(2) and (7) to reflect proposed changes the term ``30.7

customer'' and to remove surplus language due to other revisions to the

regulations. No comments were received on these proposed changes and

the Commission is adopting the proposal as final.

Regulation 1.17(a) requires each FCM, in computing its minimum

capital requirement, to include 8 percent of the risk margin required

on futures and over the counter derivative instruments that the FCM

carries in customer and non-

[[Page 68533]]

customer accounts. Regulation 1.17(b)(9) defines the term ``over the

counter derivative instruments'' as those instruments set forth in 12

U.S.C. 4421. Section 740 of the Dodd-Frank Act, however, repealed 12

U.S.C. 4421.

The Commission, however, has not revised its capital requirements

and continues to require FCMs to include over the counter derivative

instruments that it carries in customer and non-customer accounts in

their minimum capital computations. The Commission interprets Sec.

1.17(b)(9) to require an FCM to include the types of derivative

transactions or instruments that were previously set forth in 12 U.S.C.

4421 in its computation of its minimum capital requirement. The

Commission also has directed staff to develop a rulemaking to amend

Regulation 1.17(b)(9) to account for the repeal of 12 U.S.C. 4421.

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

Accounted for

Regulation 1.20 imposes obligations on FCMs, DCOs, and other

depositories regarding the holding, and accounting for, customer funds.

The Commission proposed to reorganize the structure of Sec. 1.20 by

providing additional subparagraphs to the existing specific

requirements, and by applying headings to the regulation to assist in

the reading and understanding of the regulation. The Commission also

proposed new provisions discussed below to enhance the protection of

customer funds.

1. Identification of Customer Funds and Due Diligence

The Commission proposed to amend Sec. 1.20(a) to more clearly

define the requirements regarding how FCMs must hold customer funds.

Proposed paragraph (a) of Sec. 1.20 requires an FCM to separately

account for all futures customer funds and to segregate futures

customer funds from its own funds. The proposed amendments further

provide that an FCM shall deposit customer funds with a depository

under an account name that clearly identifies the funds as futures

customer funds and shows that the funds are segregated as required by

the Act and Commission regulations. Proposed paragraph (a) also

provides that an FCM must perform due diligence of each depository

holding customer segregated funds (including depositories affiliated

with the FCM), as required by new Sec. 1.11, and to update its due

diligence on at least an annual basis.

Proposed paragraph (a) also provides that an FCM must maintain at

all times in the separate account or accounts funds in an amount at

least sufficient in the aggregate to cover its total obligations to all

futures customers. Proposed paragraph (a) further provides that an FCM

computes its ``total obligations'' to futures customers as the

aggregate amount of funds necessary to cover the Net Liquidating

Equities of all futures customers as set forth in paragraph Sec.

1.20(i).

The Commission stated in the Proposal that it is not sufficient for

an FCM to be in compliance with its segregation requirement at the end

of a business day, but fail to hold sufficient funds in segregation to

meet the Net Liquidating Equities of each of its customers on an intra-

day basis. This provision explicitly clarifies the Commission's long-

standing interpretation of existing statutory and regulatory

requirements on how FCMs must hold customer funds. Section 4d(a)(2) of

the Act requires an FCM to treat and deal with all money, securities,

and property received by the FCM to margin, guarantee, or secure the

trades or contracts of any customer of the FCM, or accruing to such

customer as the result of such trades or contracts, as belonging to

such customer. Section 4d(a)(2) further provides that funds belonging

to a customer must be separately accounted for by the FCM and may not

be commingled with the funds of the FCM or be used to margin or

guarantee the trades or contracts, or extend the credit, of any

customer or person other than the customer for whom the FCM holds the

funds. The separate treatment of customer funds is further set forth in

Sec. 1.22 which provides that no FCM shall use, or permit the use of,

the funds of one customer to purchase, margin, or settle the trades,

contracts, or commodity options of, or to secure or extend the credit

of, any person other than such customer. Therefore, the current

statutory and regulatory regime requires an FCM to maintain at all

times a sufficient amount of funds in segregation to cover the full

amount of the firm's obligations to its customers (i.e., the aggregate

Net Liquidating Equity of each customer) to prevent the FCM from using

the funds of one customer to margin or guarantee the commodity

interests of other customers, or to extend credit to other customers.

In its letter, the FIA stated that ``[t]he Commission has stated,

and [FIA] agrees, that FCMs are required to comply with the segregation

provisions of the Act at all times.'' \182\ FIA further cited to a

Commission 1998 rulemaking where the Commission stated the segregation

rules require compliance at all times.\183\ If an FCM is not in

compliance with its obligation to maintain a sufficient amount of funds

in segregation to meet the Net Liquidating Equities of all of its

customer on an intra-day basis, the FCM would be using the funds of one

customer to margin positions of another customer, or to cover the

losses of another customer in violation of section 4d of the Act and

Commission regulations.

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\182\ FIA Comment Letter at 2 (Jun 20, 2013). In addition, FIA

expressed its agreement with the existing requirement for an FCM to

maintain sufficient funds in segregation at all times to cover its

total obligation to its customers.

\183\ Id. (citing 63 FR 2188, 2190 (Jan. 14, 1998)).

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The Commission did not receive any comments on revised paragraph

(a) and is adopting the amendments as proposed.

2. Permitted Depositories

Proposed paragraph (b) of Sec. 1.20 lists the permitted

depositories for futures customer funds as any bank, trust company,

DCO, or another FCM, subject to compliance with the FCM's risk

management policies and procedures required in new Sec. 1.11. The

Commission did not propose changes to the list of permitted

depositories for FCMs. The Commission did not receive any comments on

paragraph (b) and is adopting the amendments as proposed.

3. Limitation on the Holding of Futures Customer Funds Outside of the

United States

Proposed paragraph (c) of Sec. 1.20 provides that an FCM may hold

futures customer funds in depositories outside of the U.S. only in

accordance with the current provisions of Sec. 1.49. The Commission

received no comments on paragraph (c) and is adopting the amendments as

proposed.

4. Acknowledgment Letters

a. Background

Proposed paragraph (d) of Sec. 1.20 would require an FCM to obtain

a written acknowledgment from each bank, trust company, DCO, or FCM

with which the FCM opens an account to hold futures customer funds,

with the exception of a DCO that has Commission-approved rules

providing for the segregation of such funds. Similarly, proposed Sec.

1.20(g)(4) would require a DCO to obtain a written acknowledgment from

each depository prior to or contemporaneously with the opening of a

futures customer funds account. Paragraphs (d) and (g) further

enumerate requirements for acknowledgment letters, expanding upon the

requirements set forth in current Sec. 1.20. Proposed Sec. 1.26,

which would require an FCM or DCO that

[[Page 68534]]

invests customer funds in instruments described in Sec. 1.25 to obtain

an acknowledgment letter from the depository holding such

instruments,\184\ and proposed Sec. 30.7(c)(2), which would require an

FCM to obtain an acknowledgment letter from each depository with which

it opens an account to hold funds on behalf of its foreign futures and

foreign options customers, are consistent with proposed Sec. 1.20(a)

and (g)(4). The Commission proposed to repeal and replace Sec.

30.7(c)(2), but retain the requirement to obtain an acknowledgment

letter in proposed Sec. 30.7(d).

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\184\ Section 22.5 applies the written acknowledgment

requirements of Sec. Sec. 1.20 and 1.26 to FCMs and DCOs in

connection with depositing Cleared Swaps Customer Collateral in an

account at a permitted depository.

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

The Commission has proposed amendments to the acknowledgment letter

requirements in Sec. Sec. 1.20, 1.26, and 30.7 in three separate

notices of proposed rulemaking, the first being published on February

20, 2009 (the ``Original Proposal'').\185\ The Original Proposal set

out specific representations that would have been required to be

included in all acknowledgment letters in order to reaffirm and to

clarify the obligations that depositories incur when accepting customer

funds.

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

\185\ 74 FR 7838 (Feb. 20, 2009).

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

In light of the comments on the Original Proposal, in 2010 the

Commission re-proposed the amendments with several changes made in

response to comments (the ``First Revised Proposal'').\186\ As part of

the First Revised Proposal, the Commission proposed the required use of

standard template acknowledgment letters, which were included as

Appendix A to each of Sec. Sec. 1.20 and 1.26, and Appendix E to part

30 of the Commission's regulations (referred to herein as the

``Template Letters'').

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

\186\ 75 FR 47738 (Aug. 9, 2010).

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

The Commission received nine comment letters on the First Revised

Proposal. In general, the commenters were supportive of the First

Revised Proposal and, in particular, were very supportive of requiring

the use of Template Letters. It was noted by certain commenters that

use of a standard letter would simplify the process of obtaining an

acknowledgment letter. In addition, commenters were in agreement that

uniformity of acknowledgment letters would provide consistency and

greater legal certainty across the commodities and banking industries.

The Commission proposed further refinements to the acknowledgment

letter requirements in 2012 to address several issues that had arisen

in the context of the MFGI and PFGI failures and their adverse impact

on customers of those FCMs (``Second Revised Proposal'').\187\ In the

Second Revised Proposal, the Commission also addressed comments it had

received in response to the First Revised Proposal and incorporated

related changes to the Template Letters.

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

\187\ 77 FR 67866 (Nov. 14, 2012).

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

The Commission received 15 comment letters related to the Template

Letters in response to the Second Revised Proposal.\188\ Again, the

commenters were generally supportive of the Commission's proposal and,

in particular, were supportive of the mandatory use of Template

Letters. The Depository Bank Group commented that the Template Letters

will help ``facilitate a more efficient process for the establishment

and maintenance of customer segregated accounts'' and clarify the

rights and responsibilities of depositories.\189\ Eurex noted that it

appreciated the ``potential convenience'' and increased certainty and

transparency afforded by the Template Letters.\190\ CME supported the

Commission's efforts to ``strengthen and standardize'' the Template

Letters.\191\

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\188\ Letters were submitted by Schwartz & Ballen, FIA,

LCH.Clearnet, MGEX, the Federal Reserve Banks, NYPC, CME, the

Depository Bank Group, Eurex, RJ O'Brien, RCG, NFA, FCStone, ICI,

and Katten-FIA.

\189\ Depository Bank Group Comment Letter at 2 (Feb. 15, 2013).

\190\ Eurex Comment Letter at 1 (Aug. 1, 2013).

\191\ CME Comment Letter at 7 (Feb. 15, 2013).

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

While many of the comments were supportive of the Template Letters,

FCStone expressed the view that ``prescriptive rules'' could drive

participants out of the futures industry.\192\ MGEX commented that the

required use of a Template Letter appeared to be a ``dramatic shift''

from the current requirements and questioned whether depositories would

be willing to sign the Template Letter due to the ``access and timing

information requirements.'' \193\ RCG stated that early indications

were that many depositories ``with extensive experience servicing

FCMs'' are unwilling to sign the Template Letter and expressed concern

that if such depositories refuse to sign, customer funds will become

concentrated with depositories ``less experienced in carrying FCM

accounts.'' \194\

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\192\ FCStone Comment Letter at 5 (Feb. 15, 2013).

\193\ MGEX Comment Letter at 3 (Feb. 18, 2013).

\194\ RCG Comment Letter at 7 (Feb. 12, 2013).

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Regulation 1.20 in its current form already requires FCMs and DCOs

to obtain acknowledgment letters, and the Commission believes that use

of a standardized Template Letter will reduce negotiation costs, create

efficiencies for Commission registrants as well as non-registrant

depositories, provide greater legal certainty as to the rights and

obligations of parties under the Act and CFTC regulations, and

facilitate consistent treatment of customer funds across FCMs, DCOs,

and depositories. In addition, the use of a standardized letter is the

approach that has been proposed by the Financial Conduct Authority

(``FCA'') in the United Kingdom (``U.K.'').\195\

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\195\ See Financial Conduct Authority, ``Review of the client

assets regime for investment business,'' Consultation Paper CP13/5

(July 2013).

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The Commission has taken into consideration the comments and

recommendations provided by FCMs, DCOs, and depositories, and it

believes the final rules and Template Letters largely address the

concerns they have expressed. The Commission's response to comments on

the major issues raised by commenters is discussed by subject matter,

below.

b. Technical Changes to the Template Letters

Proposed paragraphs (d)(2) and (g)(4)(ii) of Sec. 1.20 would

require FCMs and DCOs, respectively, to use the Template Letter set

forth in Appendix A to Sec. 1.20 when opening a customer segregated

account with a depository. In response to the comments, and in

recognition of the different functions FCMs and DCOs perform in

relation to customer funds, the Commission has determined to finalize

different versions of the Template Letters for FCMs and DCOs. The

Template Letter specific to FCMs is being adopted as Appendix A to

Sec. 1.20, and the Template Letter for DCOs is being adopted as

Appendix B to Sec. 1.20. Paragraph (g)(4)(ii) has been revised to

require DCOs to use the Template Letter in Appendix B.

Another change concerns the full account name as it appears in the

Template Letter. Proposed Sec. 1.20(a) and (g)(1) provides in part

that customer funds shall be deposited ``under an account name that

clearly identifies them as futures customer funds and shows that such

funds are segregated as required by sections 4d(a) and 4d(b) of the Act

and [part 1 of the Commission's regulations].'' Schwartz & Ballen noted

that operational constraints limit the number of characters available

for account names, and requested additional flexibility with regard to

account titles ``so long as the accounts are clearly identified as

custodial

[[Page 68535]]

accounts held for the benefit of the FCM's customers.'' \196\

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\196\ Schwartz & Ballen Comment Letter at 8 (Feb. 15, 2013).

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

The Commission has modified the Template Letters to accommodate a

depository's account titling conventions. The Commission will permit a

depository to abbreviate the account name when the full name as set

forth in the Template Letter is too long for a depository's operational

system to include all characters, provided that (i) the Template Letter

includes both the full and abbreviated account name(s) and (ii) the

abbreviated account name clearly identifies the account as a

Commission-regulated segregated/secured account that holds customer

funds (e.g., ``segregated'' may be shortened to ``seg;'' ``customer''

may be shortened to ``cust;'' ``account'' to ``acct;'' etc.).

FIA recommended several modifications to the Template Letters,

including the addition of a clause to address banking practices used to

provide third-party access to account information. As a result, the

Commission has added the following language to the FCM Template Letter

(and similar language to the other Template Letters): ``The parties

agree that all actions on your part to respond to the above information

and access requests will be made in accordance with, and subject to,

such usual and customary authorization verification and authentication

policies and procedures as may be employed by you to verify the

authority of, and authenticate the identity of, the individual making

any such information or access request, in order to provide for the

secure transmission and delivery of the requested information or access

to the appropriate recipient(s).''

In addition, the proposed Template Letters, as well as proposed

Sec. Sec. 1.20(d)(4) and (g)(4)(iv) and 30.7(d)(4), would require the

depository to agree to provide a copy of the executed acknowledgment

letter to the Commission at a specific email address. The email address

has been deleted from the Template Letters, and the depository is now

required to provide a copy to the Commission via electronic means in a

format and manner determined by the Commission. The rule text has been

revised accordingly (and Sec. 1.20(g)(4)(iv) has been renumbered as

Sec. 1.20(g)(4)(iii)).

Finally, the Commission has made minor technical revisions to the

Template Letters in the form of grammatical and stylistic changes to

clarify meaning and provide consistency among the letters.

c. Federal Reserve Banks as Depositories

Pursuant to Sec. 806(a) of the Dodd-Frank Act, the Board of

Governors of the Federal Reserve System (the ``Board'') may authorize a

Federal Reserve Bank to establish and maintain an account for

systemically important DCOs (``SIDCOs'') that have been designated by

the Financial Stability Oversight Council (``FSOC'') as systemically

important financial market utilities (``Designated FMUs'').\197\ In

their comment letter, the Federal Reserve Banks stated: ``Absent

clarification, the [Federal] Reserve Banks must assume that we would be

treated as depository institutions under the proposed rules if we were

to hold Designated FMU customer funds.'' The Federal Reserve Banks

commented that they do not believe that they can accept all of the

terms of the Template Letters given the ``unique nature of the

[Federal] Reserve Banks and of Designated FMUs.'' \198\

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\197\ Section 806(a) of the Dodd-Frank Act; see also Federal

Reserve Banks Comment Letter at 1 (Feb. 22, 2013).

\198\ Federal Reserve Banks Comment Letter at 2 (Feb. 22, 2013).

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

The Federal Reserve Banks raised specific concerns with two terms

of the Template Letters: (1) The provision authorizing the Commission

to order the immediate release of customer funds; and (2) the provision

that allows a depository to presume legality for any withdrawal of

customer funds, provided the depository has no knowledge of, or could

not reasonably know of, any violation of the law. The Federal Reserve

Banks suggested that under ``exceptional circumstances, such as a

prospective insolvency of the SIDCO that threatens customer funds,'' a

Commission-authorized withdrawal would need to be considered in the

context of a larger coordinated effort, which would include FSOC.\199\

The Federal Reserve Banks further asserted that, due to their dual

roles as both supervisory bodies and providers of financial services,

coupled with the Board prohibition on sharing supervisory information

with personnel performing financial services, the standard of liability

leaves them in the ``untenable position of not being able to rely on

the presumption of legality.'' \200\

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\199\ Id. at 1.

\200\ Id. at 2.

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The Commission is adopting, as proposed, Sec. 1.20(g)(2), which

confirms that the Federal Reserve Banks are depositories for purposes

of section 4d of the Act and Commission regulations thereunder.

Accordingly, a Federal Reserve Bank would be required to execute a

written acknowledgment when it accepts customer funds from a SIDCO or

other DCO for which it holds customer funds. However, the Commission

recognizes the unique role of the Federal Reserve Bank and is therefore

modifying proposed Sec. 1.20(g)(4)(ii) to provide an exception for

Federal Reserve Banks from the requirement that depositories accepting

customer funds from DCOs execute the Template Letter in Appendix B to

Sec. 1.20. Rather, a Federal Reserve Bank will be required only to

execute a written acknowledgment that: (1) It was informed that the

customer funds deposited therein are those of customers who trade

commodities, options, swaps, and other products and are being held in

accordance with the provisions of section 4d of the Act and Commission

regulations thereunder; and (2) it agrees to reply promptly and

directly to any request from the director of the Division of Clearing

and Risk or the director of the Division of Swap Dealer and

Intermediary Oversight, or any successor divisions, or such directors'

designees, for confirmation of account balances or provision of any

other information regarding or related to an account.

The Commission is modifying proposed Sec. 1.20(g)(2) from ``A

[DCO] may deposit futures customer funds with a bank or trust company,

which shall include a Federal Reserve Bank with respect to deposits of

a systemically important [DCO]'' to ``A [DCO] may deposit futures

customer funds with a bank or trust company, which may include a

Federal Reserve Bank with respect to deposits of a [DCO] that is

designated by the Financial Stability Oversight Council to be

systemically important.'' Changing the phrase ``which shall include a

Federal Reserve Bank'' to ``which may include a Federal Reserve Bank,''

avoids possible ambiguity as to whether the DCO is required to deposit

futures customer funds with a Federal Reserve Bank. By revising the

description of the DCO, the Commission has effectively captured any

DCO, such as one that is also registered with the SEC as a clearing

agency and has been designated to be systemically important in that

capacity, which could hold customer funds at a Federal Reserve

Bank.\201\

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\201\ For example, The Options Clearing Corporation is a

registered DCO that has been designated as ``systemically

important'' but is not a SIDCO as defined in Sec. 39.2 of the

Commission's regulations. A Federal Reserve Bank would be required

to segregate customer funds and provide an acknowledgment letter

under Sec. 1.20 with respect to any customer account subject to

section 4d of the Act and opened by The Options Clearing Corporation

in its capacity as a DCO.

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[[Page 68536]]

d. Foreign Depositories

In its comment letter, Eurex questioned whether foreign

depositories could fully comply with the proposed regulations and

execute the Template Letters, noting the probability of ``strong

resistance'' by foreign depositories to providing the Commission with

read-only electronic access to account information.\202\ Eurex pointed

to the ``detailed nature of the representations'' in the Template

Letters and further expressed its belief that foreign depositories

would not be permitted to legally execute the Template Letters.\203\

Eurex recommended that the Commission consider alternative methods for

achieving the goal of the Template Letters, such as authorizing

Commission staff to ``accept alternate language'' from foreign

depositories.\204\ FIA commented that it had not discussed the Template

Letters with foreign depositories and thus did not know whether the

Template Letters would ``cause concern'' under a foreign jurisdiction's

laws.\205\

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\202\ Eurex Comment Letter at 1 (Aug. 1, 2013).

\203\ Id. at 2.

\204\ Id.

\205\ FIA Comment Letter at 40 (Feb. 15, 2013).

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The Commission appreciates these perspectives related to foreign

depositories, but notes that the comments are of a general nature and

do not provide any specific examples to support the commenters'

assertions. The Commission did not receive a comment letter from any

foreign depository holding customer funds.

As noted above, the FCA recently proposed the use of template

acknowledgment letters for purposes of satisfying FCA acknowledgment

letter requirements. The proposed letters are similar in many respects

to the Template Letters the Commission is adopting herein, and FCA

regulations would require both U.K. and non-U.K. depositories to

execute the template acknowledgment letters.

The Commission recognizes that there may be valid reasons why some

foreign depositories would require modifications to the Template

Letters. In such circumstances, the Commission would consider

alternative approaches, including no-action relief, on a case-by-case

basis.

e. Release of Funds Upon Commission Instruction

As proposed, the Template Letters would require a depository to

release funds immediately upon instruction from the director of the

Division of Clearing and Risk, the director of the Division of Swap

Dealer and Intermediary Oversight, or any successor divisions, or such

directors' designees. The purpose of this provision was to enable the

Commission to expeditiously carry out measures to protect customer

funds in exceptional circumstances, such as the imminent bankruptcy of

an FCM. Commenters expressed concerns about this requirement, citing

liability that might arise from a depository acting or failing to act

``immediately,'' \206\ and the need for the depository to implement

proper security and authorization procedures in connection with acting

upon instructions from the Commission rather than the account

holder.\207\

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\206\ Depository Bank Group Comment Letter at 10.

\207\ Id. at 11; Schwartz & Ballen Comment Letter at 2 (Feb. 15,

2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013).

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With respect to DCOs in particular, NYPC pointed out that a DCO

normally holds customer funds in a segregated account without further

subdivision by customer or clearing member and, as a result, a DCO

would effectuate a transfer of customer funds from a defaulting

clearing member to a non-defaulting clearing member by book entry on

the DCO's books and records.\208\ NYPC noted that no transfer of funds

may be required if the DCO holds the funds at the same depository.

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

\208\ NYPC Comment Letter at 2 (Feb. 15, 2013).

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The Depository Bank Group commented that the term ``immediately''

may subject a depository to potential claims by FCMs, DCOs or the

Commission in the event of a delay in the transfer of customer funds,

even if such delay is the result of reasonable actions or events beyond

the control of the depository.\209\ As previously noted, the Federal

Reserve Banks commented that during such ``exceptional circumstances''

in which instructions to transfer funds from a SIDCO's account would

likely be made, the FSOC would be involved.\210\ The Depository Bank

Group, FIA, and Schwartz & Ballen all commented that the proposal is

``inconsistent'' with a depository's security policies and

procedures.\211\ CME requested that the Commission clarify the

exceptional circumstances that would give rise to the Commission's

request for an immediate release of customer funds and the impact such

an instruction could have on the timely payment of obligations to a

DCO.\212\

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\209\ Depository Bank Group Comment Letter at 10 (Feb. 15,

2013).

\210\ Federal Reserve Banks Comment Letter at 1 (Feb. 22, 2013).

\211\ Id. at 11; Katten-FIA Comment Letter at 2 (Aug. 2, 2013);

and Schwartz & Ballen Comment Letter at 5 (Feb. 15, 2013).

\212\ CME Comment Letter at 7 (Feb. 15, 2013).

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After considering the concerns raised by the commenters, the

Commission has determined not to require depositories to agree to

release or transfer customer funds upon its instruction. The Commission

notes that in exceptional circumstances such as the imminent bankruptcy

of an FCM, Commission staff would be in regular communication with the

FCM, its DSRO, DCOs, and depositories in an effort to protect customer

funds.

f. Read-Only Access and Information Requests

Proposed paragraphs (d)(3) and (g)(4)(iii) of Sec. 1.20, proposed

Sec. 30.7(d)(3), and the proposed Template Letters, including the

Template Letters for Sec. 1.26 investments in money market mutual

funds, would require depositories to provide the Commission with 24-

hour, read-only electronic access to accounts holding customer funds.

The Commission received eight comment letters on this requirement.

As a preliminary matter, FIA noted that significant time for

development would be necessary to implement such a requirement.\213\

Schwartz & Ballen observed that the read-only access approach conflicts

with bank procedures used to provide account information to third

parties, which typically involve allowing the customer to grant access

to a third party, rather than the bank doing so.\214\ The Depository

Bank Group and FIA also pointed out that Commission staff would be

required to comply with the depository's security policies and

procedures.\215\ The Depository Bank Group recommended that the

Template Letters expressly authorize the depository to provide access

to the Commission and suggested language that could be incorporated

into the Template Letters.\216\ RJ O'Brien agreed with the Depository

Bank Group's position on read-only access.\217\

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\213\ FIA Comment Letter at 40 (Feb. 15, 2013).

\214\ Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013).

\215\ Depository Bank Group Comment Letter at 13 (Feb. 15,

2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013).

\216\ Depository Bank Group Comment Letter at 13 (Feb. 15,

2013).

\217\ RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).

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FCStone noted that time differences and geographic locations may

make it difficult for foreign commodity brokers to satisfy the 24-hour-

a-day requirement and respond promptly to requests made

[[Page 68537]]

by the Commission.\218\ The Depository Bank Group commented that often

a bank denies access during routine maintenance to technology systems,

and asked that the Commission remove the ``24-hour'' requirement.\219\

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\218\ FCStone Comment Letter at 5 (Feb. 15, 2013).

\219\ Depository Bank Group Comment Letter at 13 (Feb. 15,

2013).

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NYPC commented that, because DCOs hold customer funds on behalf of

all their clearing members in omnibus accounts that are not further

subdivided by each customer, the account information to which the

Commission would have access at a DCO's depository ``would not provide

the level of detail that would permit reconciliation between either the

DCO's FCM clearing members or those clearing members' underlying

customers.'' \220\ In addition, Schwartz & Ballen contended that the

requirement would not achieve the Commission's goal of quickly

identifying discrepancies between FCM-reported balances and balances at

a depository because the depository typically posts all credits and

debits after the close of business.\221\

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\220\ NYPC Comment Letter at 2 (Feb. 15, 2013).

\221\ Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013).

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LCH.Clearnet recommended that the Commission consider ``alternative

approaches'' for routine access to account balance information at

depositories holding customer funds. For central banks, LCH.Clearnet

suggested that the Commission should accept confirmation of balance

information directly from the central bank in a form acceptable to the

central bank, but it did not explain why central banks should be

treated differently than other depositories. For other depositories,

LCH.Clearnet believes the Commission should consider ``following the

lead of the [NFA].'' \222\

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\222\ LCH.Clearnet Comment Letter at 3 (Jan. 25, 2013).

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NFA pointed out that its board of directors had adopted a financial

requirements rule in August 2012.\223\ NFA explained that instead of

adopting a read-only access provision of its own in this rule, it

instead chose to use, in conjunction with CME, an automated daily

segregation confirmation system to monitor customer segregated and

secured amount accounts and their balances.\224\ NFA requested that the

Commission rescind its proposed read-only access requirement.\225\

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\223\ NFA Comment Letter at 6 (Feb. 15, 2013).

\224\ Id.

\225\ Id. at 7.

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With the goal of achieving the highest degree of customer

protection, the Commission has determined to adopt, with certain

modifications, the requirement that a depository agree to provide the

Commission with read-only access to accounts maintained by an FCM.

Regulations 1.20(d)(3) and 30.7(d)(3) require the depository to agree

to provide the Commission with ``the technological connectivity, which

may include provision of hardware, software, and related technology and

protocol support, to facilitate direct, read-only electronic access to

transaction and account balance information.'' In the Template Letters,

the parties further acknowledge and agree that the connectivity has

either been provided (in the case of a new letter that covers existing

accounts) or will be provided promptly following the opening of the

account(s) (with respect to new accounts). However, the Commission is

not requiring read-only electronic access for an FCM's DSRO, as

proposed. The Commission was advised by the DSROs that they intend to

rely on the NFA and CME automated daily segregation confirmation

system.

The Commission does not anticipate that its staff would access FCM

accounts on a regular basis to monitor account activity; rather, staff

would make use of the read-only access only when necessary to obtain

account balances and other information that staff could not obtain via

the NFA and CME automated daily segregation confirmation system, or

otherwise directly from the depositories, as discussed below. In this

regard, the CME and NFA will provide the Commission on a daily basis

with the account balances reported to them by each depository holding

customer funds, under the CME and NFA's daily confirmation process. In

addition, as discussed in section N below, each FCM that completes a

daily Segregation Schedule, Secured Amount Schedule, and/or Cleared

Swaps Segregation Schedule will be required to file such schedules with

the Commission on a daily basis. The Commission anticipates that the

combination of receipt of daily account balances reported by

depositories and the Commission's ability to confirm account balances

and transactions directly with depositories will diminish the need to

rely upon direct electronic access to account information at

depositories.

With respect to depositories holding customer funds in accounts

maintained by a DCO, the Commission has decided not to adopt the

electronic access requirement. Given that DCOs hold omnibus customer

accounts that are not subdivided by clearing member or individual

customer, read-only access to a DCO's customer account would not

provide the kind of information that would identify inaccuracies in FCM

reporting. Accordingly, proposed Sec. 1.20(g)(4)(iii), which would

require a DCO to deposit futures customer funds only with a depository

that provides read-only access to the Commission, is not being adopted,

and the remaining subparagraphs of Sec. 1.20(g)(4) are renumbered

accordingly.

The Commission also is adopting Sec. Sec. 1.20(d)(6),

1.20(g)(4)(iv), and 30.7(d)(6), which require an FCM or DCO to deposit

customer funds only with a depository that agrees to reply promptly and

directly to any request from the director of the Division of Swap

Dealer and Intermediary Oversight, the director of the Division of

Clearing and Risk, or any successor divisions, or such directors'

designees,\226\ (or, in the case of an FCM, an appropriate officer,

agent or employee of the FCM's DSRO), for confirmation of account

balances or provision of any other information regarding or related to

an account, without further notice to or consent from the FCM or

DCO.\227\ For DCOs, the Commission believes that this ability, in

addition to the daily reporting of various accounts by customer origin

pursuant to Sec. 39.19(c)(1), will enable it to verify DCO account

balances with a depository as necessary.

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\226\ Proposed Sec. Sec. 1.20(d)(5) and (g)(4)(v) and

30.7(d)(5) would require the depository to reply promptly and

directly to ``the Commission's'' requests, and the authority to make

such requests was delegated to the director of the Division of Swap

Dealer and Intermediary Oversight and the director of the Division

of Clearing and Risk under proposed Sec. 140.91(a)(7) and (11). The

proposed Template Letters would require the depository to agree ``to

respond promptly and directly to requests for confirmation of

account balances and other account information from an appropriate

officer, agent, or employee of the CFTC'' and ``immediately upon

instruction by the director of the Division of Swap Dealer and

Intermediary Oversight of the CFTC or the director of the Division

of Clearing and Risk of the CFTC, or any successor divisions, or

such directors' designees . . . provide any and all information

regarding or related to the Funds or the Accounts as shall be

specified in such instruction and as directed in such instruction.''

The Commission is revising the rule text and the Template Letters so

that all such requests will come from the director of the Division

of Swap Dealer and Intermediary Oversight or the director of the

Division of Clearing and Risk, or any successor divisions, or such

directors' designees.

\227\ To assist a depository in verifying authority and

authenticating identity in connection with a request for information

or electronic access, the Commission intends to post on its Web site

an up-to-date list of names (including title and contact

information) of the directors of the Division of Swap Dealer and

Intermediary Oversight and the Division of Clearing and Risk, or any

successor divisions, and the directors' designees, if any, for the

relevant purpose.

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[[Page 68538]]

g. Requirement To File New Acknowledgment Letters

Proposed paragraphs (d)(7) and (g)(4)(vii) of Sec. 1.20 and

proposed Sec. 30.7(d)(7) would require FCMs and DCOs to file amended

acknowledgment letters with the Commission upon a change to a

depository's name or other information specified in the regulation. The

Commission received three comments on this requirement. Schwartz &

Ballen recommended that the Commission remove this requirement from the

Template Letters and instead include ``binding effect'' language to

ensure that the counterparties remain subject to the terms of the

acknowledgment letter even if a party's name has changed.\228\

LCH.Clearnet recommended a six-month timeframe after the publication of

these rules by which DCOs and FCMs must obtain acknowledgment

letters.\229\ NYPC commented that the proposed requirements impose ``an

onerous periodic validation process with depositories'' and, given

this, it suggested that depositories provide written notice to a DCO of

a name or address change no later than 30 days after any such change in

order to permit a DCO to execute a new Template Letter.\230\

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\228\ Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013).

\229\ LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013).

\230\ NYPC Comment Letter at 4 (Feb. 15, 2013).

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

The Commission believes that acknowledgment letters should be as

current and up-to-date as possible in order to maintain the clear legal

status of the customer account, which will better protect customers in

the event of an FCM failure. Accordingly, the Commission is adopting

(renumbered) Sec. Sec. 1.20(d)(8) and (g)(4)(vi) and 30.7(d)(8) as

proposed, except that instead of providing for an ``amended'' letter,

the regulation requires that a ``new'' letter be executed. The purpose

of this technical change is to avoid problems in locating the accounts

covered by a single letter that has been amended multiple times to

reflect various changes. The Commission expects that a depository would

notify account holders of a name change as a matter of practice and

does not believe that it is too burdensome to expect a DCO or FCM to be

aware of such changes. Any new acknowledgment letter reflecting a

change enumerated in the regulation must be executed within 120 days of

such changes, and then filed with the Commission within three business

days of executing the new letter.

The Commission also is adopting (renumbered) Sec. Sec. 1.20(d)(7)

and (g)(4)(v) and 30.7(d)(7), which require an FCM or DCO to submit a

copy of the acknowledgment letter to the Commission within three

business days of the opening of an account or obtaining a new

acknowledgment letter for an existing account; and Sec. Sec.

1.20(d)(4) and (g)(4)(iii) and 30.7(d)(4), which require an FCM or DCO

to deposit customer funds only with a depository that agrees to provide

a copy of the acknowledgment letter to the Commission (and, in the case

of an FCM, the FCM's DSRO) within the same time frame.\231\ The

Commission is, however, giving FCMs, DCOs, and depositories 180 days

from the effective date of the final rules to replace existing

acknowledgment letters with new ones that conform to the Template

Letters.

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\231\ The acknowledgment letter must be executed upon the

opening of the account, regardless of when customer funds are

deposited in the account.

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

As an additional matter, the Commission advises that it expects an

FCM or DCO to follow customary authorization verification and signature

authentication policies and procedures to ensure that an acknowledgment

letter is executed by an individual authorized to bind the depository

to the terms of the letter, and that the signature that appears on the

letter is authentic. For example, an FCM or DCO may request from the

depository a list of authorized signatories, a duly executed power of

attorney, or other such documentation.

h. Standard of Liability

The proposed Template Letters would provide that a depository ``may

conclusively presume that any withdrawal from the Account(s) and the

balances maintained therein are in conformity with the Act and CFTC

regulations without any further inquiry, provided that [the depository

has] no notice of or actual knowledge of, or could not reasonably know

of, a violation of the Act or other provision of law by [the FCM or

DCO]; and [the depository] shall not in any manner not expressly agreed

to [in the letter] be responsible for ensuring compliance by [the FCM

or DCO] with the provisions of the Act and CFTC regulations.''

The Depository Bank Group commented that this ``standard of

liability'' provision would impose a burden beyond that currently

expected of depository institutions.\232\ In this regard, the

Depository Bank Group asserted that the phrase ``violation of the Act

or other provision of law'' encompasses much more than section 4d of

the Act and would effectively require that the depository monitor and

ensure the FCM's or DCO's compliance with all other laws, even those

unrelated to the deposit of customer funds.\233\ The Depository Bank

Group further contended that the proposed standard, ``could not

reasonably know of a violation'' would likely be read to require

depositories to ``perform some undefined level of diligence'' which

would be highly problematic.\234\ The Depository Bank Group also stated

that this requirement would likely delay transfers or withdrawals, and

result in depositories passing on related costs to FCMs and DCOs and,

in turn, to their clients, although the Depository Bank Group did not

quantify the costs.\235\ FIA similarly expressed concern that the

requirement could cause delays and increased costs, again, without

providing specific details and quantifying costs.\236\

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\232\ Depository Bank Group Comment Letter at 3 (Feb. 15, 2013).

See also RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).

\233\ Depository Bank Group Comment Letter at 5 (Feb. 15, 2013).

See also Katten-FIA Comment Letter at 2 (Aug. 2, 2013); Schwartz &

Ballen Comment Letter at 6 (Feb. 15, 2013); and CME Comment Letter

at 7 (Feb. 15, 2013).

\234\ Depository Bank Group Comment Letter at 3 (Feb. 15, 2013).

\235\ Id. at 5.

\236\ FIA Comment Letter at 40 (Feb. 15, 2013).

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Schwartz & Ballen asserted that banks have no ability to determine

what uses an FCM is making of funds it withdraws from the account.\237\

As noted above, the Federal Reserve Banks, which may act as

depositories for Designated FMUs, commented that the ``actual

knowledge'' standard, which typically imputes knowledge to a legal

person as a whole, is not feasible for them because of the Board policy

to not share supervisory information with Federal Reserve Bank

personnel performing financial services.

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\237\ Schwartz & Ballen Comment Letter at 6 (Feb. 15, 2013).

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

In response to concerns expressed by commenters, the Commission

clarifies that it does not intend to use the Template Letters as means

to expand the scope of a depository's liability to FCM or DCO account

holders, or to alter the responsibility that an FCM or DCO bears for

its own compliance with the customer funds segregation requirements

under the Act and Commission regulations. The use of standardized

acknowledgment letters is intended to promote a uniform understanding

among FCMs, DCOs, and depositories as to their obligations under the

Act and Commission regulations with respect to the proper treatment of

customer funds. In light of the public comments, the Commission is

revising the language in the Template

[[Page 68539]]

Letters to more precisely articulate the intended scope of the

depository's responsibility.

The provision, as adopted, reads as follows: ``You [the depository]

may conclusively presume that any withdrawal from the Account(s) and

the balances maintained therein are in conformity with the Act and CFTC

regulations without any further inquiry, provided that, in the ordinary

course of your business as a depository, you have no notice of or

actual knowledge of a potential violation by us of any provision of the

Act or CFTC regulations that relates to the segregation of customer

funds; and you shall not in any manner not expressly agreed to [in the

letter] be responsible to us [the FCM or DCO] for ensuring compliance

by us with the provisions of the Act and CFTC regulations; however, the

aforementioned presumption does not affect any obligation you may

otherwise have under the Act or CFTC regulations.'' Changes from the

proposed language are discussed below.

The Depository Bank Group recommended inserting the phrase ``in the

ordinary course of your business as a depository,'' and the Commission

has accepted this recommendation to clarify the context in which the

presumption of the FCM's or DCO's compliance is effective. As proposed,

the presumption would be effective so long as the depository has ``no

notice of or actual knowledge of, or could not reasonably know of, a

violation.'' Given the concerns expressed by commenters as to the

implications of the ``reasonably know'' standard, the Commission has

determined to eliminate that clause in the final Template Letters.

In considering the various circumstances in which the conclusive

presumptions would no longer be effective, the Commission has

determined that the proposed reference to notice or actual knowledge of

a ``violation,'' does not adequately capture all of the relevant

circumstances. This is because the depository might receive information

that calls into question the conduct of the FCM or DCO account holder,

but it might not be apparent whether or not the activity rises to the

level of being an actual violation of the law. Indeed, some actions

will not be deemed to be ``violations'' until a judicial decision is

rendered. As a result, the Commission has revised the language to refer

to a ``potential violation'' so as not to inadvertently exclude

circumstances which would warrant further inquiry by a depository.

The Commission agrees that the broad reference to ``the Act and

CFTC regulations'' should be narrowed with respect to the description

of the potential violation. Therefore, the Commission is adopting the

Depository Bank Group's suggestions that the reference to the violation

specify that it is limited to ``any provision of the Act or the CFTC

regulations that relates to the segregation of customer funds.'' The

Commission has made a similar change in the 30.7 Template Letters,

referring to ``any provision of the Act or Part 30 of the CFTC

regulations that relates to the holding of customer funds.'' This more

precisely identifies the legal requirements that are the subject of the

parties' obligations and the acknowledgment letter as a whole.

As an additional matter, the Commission has added to the standard

of liability provision the following proviso: ``however, the

aforementioned presumption does not affect any obligation you may

otherwise have under the Act or CFTC regulations.'' This statement

affirms the depository's understanding that its statutory and

regulatory obligations with respect to the customer funds on deposit

are not limited by the presumption upon which it relies in its dealings

with FCM or DCO account holders.

The Commission notes that a depository's obligation to comply with

the segregation requirements under section 4d of the Act is explicitly

imposed upon depositories by section 4d(b) of the Act,\238\ and legal

precedent has established a standard of liability to which the

Commission holds depositories and which is not dependent upon

affirmation in the Template Letters. The Commission reaffirms its long-

held position that the depository will be held liable for the improper

transfers of customer funds by an FCM or DCO if it knew or should have

known that the transfer was improper.\239\

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\238\ Section 4d(b) of the Act explicitly provides that it is

unlawful for any clearing agency of a contract market and any

depository that has received customer funds to hold, dispose of, or

use any such funds as belonging to the depositing FCM or any person

other than the customers of such FCM. See also section 4d(f)(6) of

the Act (applying the same requirement to Cleared Swaps Customer

Collateral).

\239\ See, e.g., CFTC Interpretative Ltr. No. 79-1, [1977-1980

Transfer Binder] Comm. Fut. L. Rep. (CCH) ]20,835 (May 29, 1979) at

page 2. As long ago as 1979, the Commission found that ``if a bank,

with prior notice, permits or acquiesces in the withdraw [sic] or

use of customers' funds by a futures commission merchant for an

unlawful purpose, the bank would violate or be aiding and abetting a

violation of the Act.''

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

The Commission recognizes that a depository's treatment of customer

funds may be limited in particular circumstances on the basis of what

it knows or reasonably should know of a violation of the Act that would

preclude it from obtaining rights to such funds superior to those of

one or more customers of the defaulting FCM.\240\ Such a violation

could occur, for example, in circumstances in which the depository

received particular margin funds with actual knowledge, or in

circumstances in which it is reasonable to conclude that the depository

should have known, that the depositing FCM or DCO has breached its duty

under section 4d. The depository's participation in such use of

customer funds could subject it to liability for violating section 4d

or aiding and abetting a violation of the Act under section 13(a) of

the Act (7 U.S.C. 13c).\241\

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\240\ See CFTC Interpretative Ltr. No. 86-9, [1986-1987 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ]23,015 (April 21, 1986) (limiting

a bank's treatment of customer margin funds ``in particular

circumstances by reason of what it knows or reasonably should know

of a violation of the Act or other provision of law that would

preclude it from obtaining rights to such funds superior to those of

one or more customers of the defaulting FCM.'').

\241\ Id. See also CFTC Interpretative Statement. No. 85-3

[1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ]22,703 (Aug.

12, 1985). A DCO's rights with respect to the use of customer margin

funds may be limited in particular circumstances by reason of the

clearing organization's knowledge of or participation in a violation

of the Act or other provision of law that precludes it from

obtaining rights to such funds superior to those of one or more

customers of the defaulting clearing member. The letter provides

that a DCO could be subject to aiding and abetting liability under

section 13(a) of the Act if the DCO knowingly participates in a

violation of the Act.

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The Commission emphasizes that while the depository has no

affirmative obligation to police or monitor an FCM or DCO account

holder's compliance with the Act or Commission regulations, the

depository cannot ignore signs of wrongdoing. Should a depository know

or suspect that funds held in a customer account have been improperly

withdrawn or otherwise improperly used in violation of section 4d of

the Act or the Commission's regulations related to segregation of

customer funds, the Commission expects the depository to immediately

report its concern to the Division of Swap Dealer and Intermediary

Oversight, the Division of Clearing and Risk, the Division of

Enforcement, or the Commission's Whistleblower Office.\242\

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\242\ See CFTC Interpretative Ltr. No. 79-1 (stating ``if a bank

subsequently becomes aware of an unauthorized withdrawal or use of

customers' funds by an FCM, we would expect the bank to notify the

Commission immediately'').

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i. Liens

The proposed Template Letters would include the following language:

``Furthermore, [the depository]

[[Page 68540]]

acknowledge[s] and agree[s] that such Funds may not be used by [the

depository] or by [the FCM or DCO] to secure or guarantee any

obligations that [the FCM or DCO] might owe to [the depository], nor

may they be used by [the FCM or DCO] to secure credit from [the

depository]. [The depository] further acknowledge[s] and agree[s] that

the Funds in the Account(s) shall not be subject to any right of offset

or lien for or on account of any indebtedness, obligations or

liabilities [the FCM or DCO] may now or in the future have owing to

[the depository]. This prohibition does not affect [the depository's]

right to recover funds advanced in the form of cash transfers [the

depository] make[s] in lieu of liquidating non-cash assets held in the

Account(s) for purposes of variation settlement or posting initial

(original) margin.'' This language is consistent with section 4d(b) of

the Act, which states: ``It shall be unlawful for any person, including

but not limited to . . . any depository, that has received any money,

securities, or property for deposit in a separate account as provided

in [section 4d(a)(2) of the Act], to hold, dispose of, or use any such

money, securities, or property as belonging to the depositing [FCM] or

any person other than the customers of such [FCM].''

Schwartz & Ballen asserted that because many FCMs hold only cash

assets in the accounts, the language in the letter should be expanded

to permit banks to recover funds they advance that result in overdrafts

in the accounts.\243\ Schwartz & Ballen further stated that the failure

to permit banks to recover such advances whether or not there are non-

cash assets in the account will likely lead to banks incurring

losses.\244\ FCStone elaborated on this issue, explaining that a

customer receives a margin call through an account statement, which is

transmitted overnight, and the customer wires funds the following

day.\245\ The DCO, however, automatically drafts the funds from the

FCM's account at 9:00 a.m. on the basis of a depository's intraday

daylight overdraft.\246\ Without granting a depository a lien on

customer funds, FCStone stated that an FCM would be required to

``front'' all funds for customers until the customer has wired funds to

the FCM.\247\ FCStone contended that a change of this sort could

``threaten the continued operations of small to mid-sized FCMs not

affiliated with banks'' and cause a substantial liquidity strain.\248\

The Depository Bank Group additionally warned that a depository may not

be willing to provide intraday advances to the customer segregated

account without the right to take a lien on the account or the right to

set off between multiple customer segregated accounts and would,

therefore, not be in a position to provide liquidity.\249\ As a result,

an FCM or DCO would likely need to maintain a buffer of its own funds

in the segregated customer accounts to fully pre-fund transactions

related to such accounts.\250\ The Depository Bank Group contended that

the impact on small- to mid-sized FCMs would be that of a lesser

ability to enter into ``everyday transactions'' for the customer

segregated account, which could result in exclusion from the

industry.\251\ The Depository Bank Group cited as support a comment

letter that staff of the Federal Reserve Bank of Chicago submitted in

2010.\252\

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\243\ Schwartz & Ballen Comment Letter at 6-7 (Feb. 15, 2013).

\244\ Id.

\245\ FCStone Comment Letter at 4.

\246\ Id.

\247\ Id. at 5.

\248\ Id.

\249\ Depository Bank Group Comment Letter at 7 (Feb. 15, 2013).

\250\ Id.

\251\ Id.

\252\ Comment letter from David A. Marshall, Federal Reserve

Bank of Chicago, dated September 8, 2010.

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The Commission recognizes that a depository may not want to provide

unsecured overdraft coverage. However, a depository taking a lien on a

customer account to facilitate intraday payments presents a serious

problem if an FCM's customer does not satisfy a margin call and the

FCM, in turn, cannot cover the call and becomes insolvent before the

depository can be repaid.

The Commission interprets the requirements of section 4d of the Act

to prohibit a lien on customer funds to satisfy an intraday extension

of credit to an FCM to meet margin requirements at a DCO. As an

alternative to taking a lien on the customer account, the depository

could take a lien on a proprietary account held by the FCM at the

depository, or the FCM could add its own funds to the segregated

account or collect more margin from its customers in order to provide a

more substantial financial cushion. It is not the Commission's

intention to disadvantage mid-size and smaller FCMs in applying this

standard across all FCMs, regardless of size.

The Commission notes that no commenter has proffered information or

data that would indicate intraday advances are a commonplace, routine

occurrence. Indeed, it may be cause for concern if a large number of

FCMs cannot meet intraday margin calls for customer accounts on a

regular basis.

Without expressing a view of the Commission's position concerning

section 4d of the Act, FIA recommended expanding the circumstances in

which a depository could impose a lien with respect to customer

funds.\253\ FIA recommended revising the language to read: ``You

further acknowledge and agree that the Funds in the Account(s) shall

not be subject to any right of offset or lien for or on account of any

indebtedness, obligations or liabilities we may now or in the future

have owing to you except to recover from the Account(s) (or from any

other CFTC Regulation 1.20 Customer Segregated Account(s) we have with

you), Funds you may advance from time to time to facilitate

transactions by or on behalf of, or on account of, or otherwise for the

benefit of, the Account(s) or our customers whose Funds are held in the

Account(s).'' \254\ The Commission confirms that a depository can

possess a lien across multiple accounts of the same FCM as long as the

accounts are of the same account class (i.e., 4d(a) cash and custodial

accounts). However, the Commission believes FIA's suggested

modification is overbroad and has the potential to be interpreted to

permit a depository's imposition of a lien in a greater number of

circumstances than section 4d of the Act allows.

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

\253\ Katten-FIA Comment Letter at 2 (Aug. 2, 2013).

\254\ Id.

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NYPC urged the Commission to clarify that DCOs have the right to

transform non-cash customer funds into cash to satisfy liquidity needs

related to the customer account of a defaulting FCM clearing member not

only through the sale of such assets, but also through the use of

liquidity arrangements, such as lines of credit and repurchase

agreements.\255\ NYPC recommended that the Commission modify the last

sentence in the ``lien'' paragraph as follows: ``The prohibitions

contained in this paragraph do not affect your right to recover funds

advanced by you in the form of cash transfers, lines of credit,

repurchase agreements or other similar liquidity arrangements in lieu

of the liquidation of non-cash assets held in the Account(s) for

purposes of variation settlement or posting initial (original) margin

with respect to the Account(s).'' The Commission recognizes that

liquidity arrangements are an important aspect of a DCO's default

management plan and agrees that the use of lines of

[[Page 68541]]

credit or repurchase agreements are acceptable alternatives to the

liquidation of non-cash assets held in a customer account. As a result,

the Commission has determined to modify the sentence in a manner

similar to that recommended by NYPC.

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

\255\ NYPC Comment Letter at 3 (Feb. 15, 2013).

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

In response to the other comments, the Commission notes that it has

always interpreted and applied section 4d of the Act in a manner

consistent with the language in the proposed Template Letters. With

respect to a depository's right of setoff against a customer account,

the Commission has long recognized only one very limited circumstance.

CFTC Interpretative Letter No. 86-9 allows, with certain

limitations,\256\ a bank's right of setoff against a customer cash

account that does not have sufficient available balances to meet a

margin call, where there exists an affiliated custodial account that

contains securities purchased with funds from the customer cash

account.\257\ In this case, there is no extension of credit because the

accounts, when aggregated, have enough assets to support the cash

advance.

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\256\ See CFTC Interpretative Ltr. No. 86-9, [1986-1987 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ]23,015 (April 21, 1986) (limiting

a bank's treatment of customer margin funds ``in particular

circumstances by reason of what it knows or reasonably should know

of a violation of the Act or other provision of law that would

preclude it from obtaining rights to such funds superior to those of

one or more customers of the defaulting FCM.'').

\257\ Id.

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The Depository Bank Group raised a question about similar

circumstances in which a depository might set off amounts owed to a

customer segregated account holding U.S. dollars, with amounts held in

foreign currency in another customer segregated account.\258\ To the

extent that a depository advances cash in lieu of exchanging foreign

currency held in a related 4d account, the same rationale that serves

as the basis for CFTC Interpretative Letter No. 86-9 would apply, i.e.,

the advancement of funds does not represent an extension of credit

secured by customer funds. The Commission confirms that a depository

holding customer funds in one segregated account may set off amounts

withdrawn from another account in cases where the depository advances

funds in lieu of converting cash in one currency to cash in a different

currency.

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\258\ Id. at 8.

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The Template Letters provide for a depository's right of setoff

against the customer account consistent with Interpretative Letter No.

86-9. The Commission believes that expanding the scope of a

depository's right of setoff to support extensions of credit to an FCM

would violate the requirements of section 4d of the Act and notes that

none of the commenters provided a legal analysis that would refute this

position.

The Commission recognizes, however, that there may be situations

similar to those specifically enumerated in the proposed Template

Letters for which an advancement of cash and the related imposition of

a lien in lieu of liquidating non-cash assets or converting cash in one

currency to cash in a different currency may be permissible. To

accommodate this, the Commission is revising the language to remove the

concluding clause, ``for the purposes of variation settlement or

posting initial (original) margin.'' This change preserves the intended

meaning and purpose of the provision without unintentionally limiting

its application in other similar circumstances.

Accordingly, the Commission is adopting the proposed ``lien''

language of the Template Letters, modified to include a reference to

the depository's right to recover funds related to certain liquidity

arrangements and to eliminate specific examples of circumstances in

which imposition of a lien would be permissible. FCMs, DCOs, and

depositories are reminded that any permissible advancement of cash and

related imposition of a lien on a customer account must be properly

documented and recorded in compliance with all applicable recordkeeping

requirements.

j. Examination of Accounts

As proposed, the Template Letters for both FCMs and DCOs would

require a depository to agree that accounts holding customer segregated

funds could be ``examined at any reasonable time'' by the Commission

or, as applicable, an FCM's DSRO, and they further provide that the

acknowledgment letter ``constitutes the authorization and direction of

the undersigned to permit any such examination or audit to take

place.'' Schwartz & Ballen commented that the provision should also

provide for the Commission or DSRO to give the depository advance

notice before being permitted to examine FCM accounts.\259\ The

Commission is not including this recommended precondition because an

examination of this type is likely to be conducted only in response to

exigent circumstances and the ``reasonable time'' provision is

sufficient evidence of the Commission's intent to proceed in a

commercially reasonable manner under the particular circumstances.

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

\259\ Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013).

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

The Commission is retaining the examination provision in the FCM

Template Letters but is not including it in the DCO Template Letters.

Consistent with the Commission's determination regarding electronic

access to DCO account information, the Commission believes that

authorization to examine a DCO's customer segregated account at a

depository is not necessary because of the Commission's ability to

obtain account information directly from the depository upon request,

and directly from the DCO through daily reporting under Sec.

39.19(c)(1).

As a technical matter, the Commission is eliminating use of the

term ``audit'' to clarify that the examination will be targeted and is

not intended to be an audit, as that term is used in the field of

accounting.

5. Prohibition against Commingling Customer Funds

The Commission proposed to amend Sec. 1.20(e) to explicitly

address the commingling of customer funds. Proposed Sec. 1.20(e)(1)

provides that an FCM may, for convenience, commingle the funds that it

receives from, or on behalf of, multiple futures customers in a single

account or multiple accounts with one or more of the permitted

depositories set forth in Sec. 1.20(b).

Proposed Sec. 1.20(e)(2) prohibits an FCM from commingling futures

customers funds with any proprietary funds of the FCM, or with any

proprietary account of the FCM. Proposed Sec. 1.20(e)(2), however,

provides that the prohibition on the commingling of futures customer

funds and the FCM's proprietary funds does not prohibit an FCM from

depositing proprietary funds into segregated accounts in accordance

with proposed Sec. 1.23 as a buffer to prevent the firm from becoming

undersegregated due to normal business activities, such as daily margin

payments by the FCM to a DCO.

Proposed Sec. 1.20(e)(3) further prohibits an FCM from commingling

futures customer funds with funds deposited by 30.7 customers for

trading foreign futures or foreign option positions in accordance with

part 30 of the Commission's regulations, or with Cleared Swaps Customer

Collateral deposited by Cleared Swaps Customers for Cleared Swaps under

part 22 of the Commission's regulations. Proposed Sec. 1.20(e)(3)

permits, however, the commingling of futures customer funds with 30.7

customer funds and/or Cleared Swaps Customer funds if expressly

permitted by a Commission

[[Page 68542]]

regulation or order, or by a DCO rule approved in accordance with Sec.

39.15(b)(2) of the regulations.\260\

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\260\ Regulation 22.2(c)(2) regarding cleared swaps customer

accounts already prohibits commingling.

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

Similarly, a proposed amendment to Sec. 30.7 would prohibit an FCM

from commingling funds required to be deposited in a foreign futures

and foreign options secured amount account with funds required to be

deposited in a customer segregated account or cleared swaps customer

account.\261\

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\261\ Proposed Sec. 30.7(e)(3).

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The Commission received one comment on the proposed amendments to

Sec. 1.20(e). FIA stated that it fully supported the proposed

amendments, which implement the segregation provisions of section 4d(a)

and 4d(f) of the Act.\262\

---------------------------------------------------------------------------

\262\ FIA Comment Letter at 36 (Feb. 15, 2013).

---------------------------------------------------------------------------

FIA further requested that the Commission confirm that the proposed

amendments would not prohibit a customer that engages in futures

transactions on a designated contract market, foreign futures or

options transactions on foreign boards of trade, and Cleared Swaps

through a single FCM, from meeting its margin obligations for the three

different segregation accounts by making a single payment to the

FCM.\263\ FIA states that such practice is common in the industry

today, reduces the FCM's credit risk, is operationally more efficient

for both the FCM and its customers, and indirectly reduces customer

settlement risk.\264\

---------------------------------------------------------------------------

\263\ Id.

\264\ Id.

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The Commission confirms, subject to the following conditions, that

a receipt of funds from a customer that wishes to meet its multiple

margin obligations by making a single deposit payment to the FCM is not

prohibited by Sec. 1.20. The FCM, however, must initially receive the

customer's funds into the customer's section 4d(a)(2) segregation

account. The funds may not be directly deposited into the customer's

Sec. 30.7 secured account or Cleared Swaps Segregation Account, as

such accounts may present different risks than the section 4d(a)(2)

account, and the Commission would like to standardize operationally the

practice of how customer funds are received by FCMs by authorizing one

approach that would be applicable to all customers to minimize the

possibility of transactional errors.

In addition, the FCM must simultaneously record the book entry

credit to the customer's Sec. 30.7 secured account and the customer's

Cleared Swaps Account (as applicable) as directed by the customer upon

the receipt and recording of the cash into the customer's 4d(a)(2)

segregation account. Also, the FCM must ensure at the time the book

entry credit is made to the customer's account, that the credit does

not result in the FCM having obligations to 30.7 customers or Cleared

Swaps Customers that are in excess of the total assets held in such

accounts for such customers. Failure of the FCM to hold a sufficient

amount of excess funds in the 30.7 customer accounts and Cleared Swaps

Customer Accounts at any time to meet its obligations to such customers

would be a violation of the Act and the Commission's regulations.

Furthermore, if the FCM permits customers to use one wire transfer

to fund more than one account class, the FCM's policy and procedures

for assessing the appropriate amount of targeted residual interest

required under Sec. 1.11 must take this practice into consideration

and should include appropriate adjustments and estimates to reflect

this practice. Finally, the Commission hereby clarifies that all prior

guidance concerning the receipt of customer deposits at branch

locations or otherwise deposited into the FCM's proprietary accounts,

regardless of excess funds held in segregation, is repealed and

withdrawn and such practice is not permitted under Sec. 1.20 as

adopted.\265\

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\265\ Previous guidance permitted a branch office of an FCM to

deposit customer funds into an unsegregated bank account if the main

office of the FCM on the same day deposited the same amount of its

funds into a segregated bank account, and kept records fully

explaining the transactions. See Commodity Exchange Authority

Administrative Determination No. 203 (December 1, 1966). See also

CFTC Interpretative Letter No. 90-7 (Secured Amount Account for

Foreign Futures and Options, May 1, 1990). This practice is now

prohibited.

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The Commission adopts the amendment as proposed.

6. Limitations on the Use of Customer Funds

Proposed Sec. 1.20(f) requires FCMs to treat and deal with the

funds of a futures customer as belonging to such futures customer. In

addition, the Commission proposed to prohibit an FCM from using, or

permitting the use of, the funds of futures customer for any person

other than for futures customers, subject to certain limited

exceptions. Proposed Sec. 1.20(f) also states that an FCM may obligate

futures customers' funds to a DCO or another FCM solely to purchase,

margin, or guarantee futures and options positions of futures

customers, and that no person, including any DCO or any depository,

that has received futures customer funds for deposit in a segregated

account, may hold, dispose of, or use any such funds as belonging to

any person other than the futures customers of the FCM that deposited

such funds.

The Commission did not receive any comments regarding proposed

Sec. 1.20(f). However, as discussed above, the FIA stated that it

agrees that FCMs are required to comply with the segregation provisions

of the Act at all times, and expressed general support for the

Commissions efforts to implement the Act's segregation provision.\266\

The Commission notes that the language in proposed Sec. 1.20(f)

largely mirrors the language set forth in current Sec. 1.20, which

language was, and continues to be, intended to further implement the

segregation provisions of the Act.\267\ Thus, the Commission is

adopting the provision as proposed.

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\266\ FIA Comment Letter at 2 (June 20, 2013). See also section

II.G.1. above for a further discussion of an FCM's obligation to be

in compliance with its segregation obligation at all times.

\267\ Accordingly, relevant prior Commission orders and guidance

will continue to apply to Sec. 1.20(f). For example, in In re

JPMorgan Chase Bank CFTC 12-17 (April 4, 2012), the Commission

simultaneously initiated and settled an action against a depository

for violating Sec. 1.20(a) and (c) because it unlawfully used

customer funds as belonging to someone other than the customers of

an FCM. Specifically, the Commission found that a depository's

intra-day extension of credit to an FCM (Lehman Brothers) based upon

customer funds the FCM had deposited with a bank (JPMorgan Chase)

violated Sec. 1.20(a) and (c). Regulation 1.20(f) would continue to

prohibit such use of customer funds, as well as any other type of

disposal, holding or use the Commission has previously identified as

unlawful.

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7. Segregation Requirements for DCOs

Proposed Sec. 1.20(g) provides segregation requirements applicable

to DCOs, as opposed to FCMs. Proposed paragraph (g)(2) lists the

permitted depositories for futures funds received by a DCO as any bank

or trust company, and clarifies that the term ``bank'' includes a

Federal Reserve Bank. The necessity for this proposed amendment is

highlighted by section 806(a) of the Dodd-Frank Act, which provides

that a Federal Reserve Bank may establish and maintain a deposit

account for a ``financial market utility'' (in the present case, a DCO)

that has been designated as systemically important by the Financial

Stability Oversight Council. Proposed paragraph (g)(3) requires DCOs to

comply with the provisions of Sec. 1.49 with respect to holding

segregated funds outside the U.S. Regulation 1.20(g)(5) prohibits a DCO

from commingling futures customer funds with the DCO's proprietary

funds or with any proprietary account of any of its clearing members,

and prohibits the DCO from commingling funds held for futures customers

with funds deposited by clearing members on behalf of their

[[Page 68543]]

Cleared Swaps Customers. DCOs would be permitted to commingle the funds

of multiple futures customers in a single account or accounts for

operational convenience. The Commission adopts the amendment as

proposed.

8. Immediate Availability of Bank and Trust Company Deposits

The Commission proposed a paragraph (h) to Sec. 1.20 to require

that all futures customer funds deposited with a bank or trust company

must be deposited in accounts that do not impose any restrictions on

the ability of the FCM or DCO to withdraw such funds upon demand. An

FCM or DCO may not deposit customer funds in any account with a bank or

trust company that does not, by the terms of the account or operation

of banking law, provide for the immediate availability of such deposits

upon the demand of the FCM or DCO.

Paragraph (h) codifies a long-standing interpretation of the

Commission's Division of Swap Dealer and Intermediary Oversight and

predecessor divisions derived from an Administration Determination by

the Commission's predecessor, the Commodity Exchange Authority of the

U.S. Department of Agriculture.\268\ The requirement, as proposed, is a

practical necessity to the effective functioning of FCMs and futures

markets. In this regard, customer funds deposited with a bank must be

maintained in accounts that allow for the immediate availability of the

funds in order for the FCM to be assured of meeting its obligation to

make any necessary transfers of customer funds to a DCO or to return

funds to customers upon their request. The Commission is adopting

paragraph (h) as proposed.\269\

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\268\ See Administrative Determination No. 29 of the Commodity

Exchange Authority dated Sept. 28, 1937 stating, ``the deposits, by

a futures commission merchant, of customers' funds * * * under

conditions whereby such funds would not be subject to withdrawal

upon demand would be repugnant to the spirit and purposes of the

Commodity Exchange Act. All funds deposited in a bank should in all

cases be subject to withdrawal on demand.''

\269\ CIEBA noted it is comment letter that industry groups are

involved in various initiatives to provide customers with the option

for full physical segregation of margin collateral, and requested

confirmation that Sec. 1.20(h) would not prohibit the use of a full

segregation model if developed. See CIEBA Comment Letter at 4 (Feb.

20, 2013). The Commission encourages industry groups to continue to

assess alternatives to the current segregation structure in an

effort to provide greater protection of customer funds and to ensure

the effective operation of the clearing and settlement functions.

Regulation 1.20(h) is intended to prohibit situations where an FCM

or DCO deposits customer funds into an account that by law or

operation limits or potentially limits the FCM's or DCO's ability to

withdraw the funds from the account for the use intended (i.e., as

performance bond). The Commission would consider any future

amendments to Sec. 1.20(h) based upon the developments of

alternative segregation modes.

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9. Segregated Funds Computation Requirement

The Commission proposed to add a new paragraph (i), which mirrored

the requirements recently adopted in part 22 for Cleared Swaps

Customers. Proposed paragraph (i) was designed to implement, with

increased detail, the Net Liquidating Equity Method of calculating

segregation requirements. A customer may have positive Net Liquidating

Equity (i.e., a credit balance) in his or her account, requiring

segregation of his or her funds, but may have insufficient Net

Liquidating Equity to cover the margin required for that customer's

open positions.

Accordingly, the Commission proposed to require an FCM to record in

the accounts of its futures customers the amount of margin required for

each customers' open positions, and to calculate margin deficits (i.e.,

undermargined amounts) for each of its customers. Moreover, the

Commission proposed to require that an FCM maintain residual interest

in segregated accounts in an amount that exceeds the sum of all futures

customers' margin deficits (``the Proposed Residual Interest

Requirement'').\270\

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\270\ See discussion in note 30 above. Therefore, under the

Proposed Residual Interest Requirement an FCM would have to maintain

at all times in segregated account a sufficient amount of funds to

cover the Net Liquidating Equities of each customer and a sufficient

amount of residual interest to cover the undermargined amounts of

each customer.

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In addition, the Commission proposed an amendment to Sec.

1.22.\271\ Regulation 1.22 is a longstanding regulation\272\ and

currently provides that an FCM may not use the cash, securities or

other property deposited by one futures customer to purchase, margin or

settle the trades, contracts, or other positions of another futures

customer, or to extend credit to any other person.\273\ This

``requirement is designed not only to prevent disparate treatment of

customers by an FCM, but also to insure that there will be sufficient

money in segregation to pay all customer claims if the FCM becomes

insolvent.'' \274\ Regulation 1.22 further provides that an FCM may not

use the funds deposited by a futures customer to carry trades or

positions, unless the trades or positions are traded through a

DCM.\275\

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\271\ 77 FR 67886.

\272\ See, e.g., 13 FR, 7820, 7837 (Dec. 18, 1948).

\273\ 17 CFR 1.22.

\274\ 46 FR 11668, 11669 (Feb. 10, 1981).

\275\ 17 CFR 1.22.

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The Commission proposed an amendment to Sec. 1.22 to clarify that

it is not permissible for an FCM to be undersegregated at any point in

time during the day. As stated in the Proposal, section 4d(a)(2)

expressly requires an FCM to segregate futures customers' funds from

its own funds, and prohibits an FCM from using the funds of one

customer to margin or extend credit to any other futures customer or

person.\276\ Moreover, to review compliance with these proposed

requirements, the Commission proposed that the sum of all margin

deficits (i.e., undermargined amounts) be reported on the Segregation

Schedule (as discussed previously in section II.A. with respect to

amendments to Sec. 1.10) and on the daily segregation

calculation.\277\

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\276\ 77 FR 67886.

\277\ Id.

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The Commission requested comment on all aspects of the Proposed

Residual Interest Requirement, including the costs and benefits of this

proposed regulation.\278\

---------------------------------------------------------------------------

\278\ See 77 FR 67882, 67916. The Commission also specifically

requested comments on the following: Whether the Proposed Residual

Interest Requirement would serve to increase the protections to

customer funds in the event of an FCM bankruptcy? To what extent

would the Proposed Residual Interest Requirement increase costs to

FCMs and/or futures customers? To what extent would the Proposed

Residual Interest Requirement benefit futures customers and/or FCMs?

To what extent would the Proposed Residual Interest Requirement

increase or mitigated market risk? To what extent would the Proposed

Residual Interest Requirement lead to FCMs requiring customers to

provide margin for their trades before placing them? To what extent

is the Proposed Residual Interest Requirement likely to lead to a

re-allocation of costs from customers with excess margin to

undermargined customers? For purposes of margin deficit

calculations, whether the Commission should address issues

surrounding the timing of when an FCM must have sufficient funds in

the futures customer account to cover all margin deficits? If so,

how should the Commission address such issues? See 77 FR at 67882.

With regards to the costs and benefits, the Commission asked the

following questions: Whether FCMs typically maintain residual

interest in their customer segregated account that is greater than

the sum of their customer margin deficits, and data from which the

Commission may quantify the average difference between the amount of

residual interest an FCM maintains in customer segregated accounts

and the sum of customer margin deficit. How much additional residual

interest would FCMs need to hold in their customer segregated

accounts in order to comply with the Proposed Residual Interest

Requirement? What is the opportunity cost to FCMs associated with

increasing the amount of capital FCMs place in residual interest,

and data that would allow the Commission to replicate and verify the

calculated estimates provided. Information regarding the additional

amount of capital that FCMs would likely maintain in their customer

segregated accounts, if any, to comply with the Proposed Residual

Interest Requirement. What is the average cost of capital for an

FCM? See 77 FR at 67916.

The Commission also specifically requested that commenters

provide data and calculations that would allow the Commission to

replicate and verify the cost of capital that commenters estimate.

See id.

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[[Page 68544]]

The Commission has received and has considered a wide variety of

public comments regarding the Proposed Residual Interest Requirement,

including comments from panelists made during public roundtables and

written submissions from commenters.

Several commenters supported the Commission's Proposed Residual

Interest Requirement. CIEBA stated that it strongly supported the

Proposed Residual Interest Requirement, arguing that the proposed

regulations are consistent with Congressional intent and the

Commission's historical interpretations of the Act and sound economic

and systemic risk policy. Highlighting section 4d(a)(2) of the Act and

its directive that FCMs ``keep collateral and funds of each individual

customer distinct from that of customers and the FCM,'' CIEBA argued

that ``permitting FCMs to use customer funds to cover margin deficits

of a different customer and thereby subsidize the FCM's obligations

would'' contravene well established statutory policy.\279\ In addition,

CIEBA noted that the Dodd-Frank Act was adopted to increase regulatory

protections for customers.\280\ CIEBA also noted several benefits

resulting from the Proposed Residual Interest Requirement, including

the reduction of systemic risk, competitive benefits for those FCMs

that do not use customer excess to meet the obligations of other

clients, and the enhancement of customer protection in the event of an

FCM bankruptcy.\281\ ICI also stated that it supported the Proposed

Residual Interest Requirement on the basis that it would provide

additional protections to customer funds.\282\ SIFMA asserted that it

strongly supported the Proposed Residual Interest Requirement because

it preserves the sanctity of each customer's margin account by

maintaining segregation between customer margin accounts through the

incorporation of appropriate safeguards to protect customer funds.\283\

SIFMA stated that the proposal, ``in effect, shifts the costs and

burdens of a margin shortfall from customers with excess margin to

customers with deficits, where it properly belongs.'' \284\ Paul/Weiss

supported the Proposed Residual Interest Requirement ``[i]n

principle.'' \285\ Vanguard stated that it was ``particularly

supportive'' of the Proposed Residual Interest Requirement.\286\ Noting

that while an FCM would either have to have its customers pre-fund

margin requirements for pending trades or ``lend'' such customers

margin ahead of a margin transfer, Vanguard argued that the ``proposed

changes correctly shift the risk to customers in deficit and away from

any excess margin transferred by other customers.'' \287\ Vanguard also

argued that, in its opinion, comments at the public roundtable that

``suggested same-day margin transfers were overly complicated to

achieve and the accelerated capital charge would therefore impose

significant added costs to an FCM and, by extension, to its

customers,'' seem overstated particularly because same-day margin

transfer is ``the norm in the OTC swap market.'' \288\ In fact,

Vanguard stated that ``same-day margin transfer is required in

Vanguard's futures and options agreements, consistent with the long-

standing market practice.'' \289\ Vanguard encouraged the Commission to

avoid weakening customer protection, ``at least a weakening beyond the

need to maintain segregation on no less than a once-a-day basis, with

the possibility for clearing house initiated intra-day calls (and

corresponding segregation maintenance) as needed in periods of market

stress.'' \290\ CFA also supported the Proposed Residual Interest

Requirement, asserting its belief ``that no futures customer should be

under-segregated at any time during the day for any reason.'' \291\

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\279\ CIEBA Comment Letter at 2 (Feb. 20, 2013).

\280\ Id.

\281\ Id. at 3. On this point, CIEBA further noted that allowing

an FCM to use customer excess to support other customer's positions

could lead to improper or complex recordkeeping, which can, in turn,

jeopardize the ability of a trustee to facilitate the return of

customer funds and the porting of positions to a solvent FCM.

\282\ ICI Comment Letter at 3 (Jan. 14, 2013). See also Franklin

Comment Letter at 2 (Feb. 15, 2013) (writing in support of the

positions taken in the ICI Comment Letter).

\283\ SIFMA Comment Letter at 2 (Feb. 21, 2013).

\284\ Id.

\285\ Paul/Weiss Comment Letter at 3 (Feb. 15, 2013).

\286\ Vanguard Comment Letter at 7 (Feb. 22, 2013).

\287\ Id.

\288\ Id.

\289\ Id.

\290\ Id. at 7-8.

\291\ CFA Comment Letter at 5-6 (Feb. 13, 2013).

---------------------------------------------------------------------------

A number of commenters opposed the Proposed Residual Interest

Requirement on the basis that the requirement appeared wholly unrelated

to the MFGI and PFGI bankruptcies,\292\ with other commenters observing

that the Proposed Residual Interest Requirement is unnecessary to

achieve the regulatory goals, including assuring compliance with

section 4d of the Act, in light of other Commission regulations.\293\

---------------------------------------------------------------------------

\292\ See, e.g., CHS Hedging Comment Letter at 1 (Feb. 15,

2013); NFA Comment Letter at 12 (Feb. 15, 2013); JSA Comment Letter

at 2 (Feb. 15, 2013); Paragon Comment Letter at 1 (Feb. 15, 2013);

NIBA Comment Letter at 2 (Feb. 15, 2013); ICA Comment Letter at 1

(Feb. 15, 2013).

\293\ See, e.g., FIA Comment Letter at 18-21 (Feb. 15, 2013).

See also FIA Comment Letter at 2-5 (June 20, 2013).

---------------------------------------------------------------------------

In addition, several commenters commented on the lack of

feasibility of the proposal, interpreting the ``at all times'' language

to require FCMs to continuously calculate the sum of their customers'

margin deficits, and to continuously act on those calculations. For

example, RCG stated that it would be virtually impossible for FCMs to

satisfy the Proposed Residual Interest Requirement because an accurate

assessment of aggregate customer margin deficiencies would be difficult

given that (1) ``the underlying markets operate on a 24-hour basis and

customer fund transfers occur repeatedly throughout each business

day,'' and (2) ``omnibus account offsets are not provided to clearing

FCMs until the end of the trading day or, in some instances, the next

business day.'' \294\ MGEX also argued that ``at all times''

requirement in the Proposed Residual Interest Requirement may be

impracticable as it is a constantly moving target,\295\ and TD

Ameritrade argued that because the firm calculates margin calls after

it receives its nightly downloads, ``it would be difficult, if not

impossible, to assess customer margin deficiencies at any moment in

time, because the markets have not closed and the margin requirements

are not always known.'' \296\ In addition, CME stated that there does

not appear to be a system that currently exists or that could be

constructed in the near future that will permit FCMs to accurately

calculate customer margin deficiencies, at all times.\297\ CMC asserted

that the ``at all times'' portion of the Proposed Residual Interest

Requirement would ``create liquidity issues and increase costs for FCMs

and end users,'' possibly ``limit the number and type of transactions

FCMs clear, the number of customers they service and the amount of

financing they provide,'' and ``require executing FCMs to collect

collateral for give-ups so that customer positions are fully margined

in the event a trade is rejected by a clearing

[[Page 68545]]

FCM,'' \298\ which ``may force many end users to decrease or

discontinue hedging and risk management practices.'' \299\ Advantage

opposed the Proposed Residual Interest Requirement asserting that it

was ``extremely prejudicial to small and midsize firms and their

customers.'' \300\ Advantage also stated that the Proposed Residual

Interest Requirement would result in FCMs more quickly liquidating

customer positions during extreme market moves, which would make

markets more volatile.\301\ Advantage also maintained that calculations

of margin for omnibus accounts cannot be determined prior to the

receipt of offsets, which may not be obtained until late in the day,

thereby adversely impacting an FCM's ability to assess customer margin

deficiencies.\302\

---------------------------------------------------------------------------

\294\ RCG Comment Letter at 3 (Feb. 12, 2013).

\295\ See MGEX Comment Letter at 2 (Feb. 18, 2013). See also

NPPC Comment Letter at 2 (Feb. 15, 2013) (stating that the ``at all

times'' portion of the Proposed Residual Interest Requirement is

``burdensome'', and that changing margin procedures ``to anticipate

future market movements, pre-fund margin calls, [or] make margin

call deposits throughout the day based on current market movements

is impractical.'').

\296\ TD Ameritrade Comment Letter at 4-5 (Feb. 15, 2013).

\297\ See CME Comment Letter at 5 (Feb. 15, 2013).

\298\ CMC Comment Letter at 2 (Feb. 15, 2013).

\299\ Id.

\300\ Advantage Comment Letter at 8 (Feb. 15, 2013).

\301\ See id. at 7-8.

\302\ See id. at 7.

---------------------------------------------------------------------------

FIA and LCH.Clearnet opposed the Proposed Residual Interest

Requirement, and focused particularly on the ``at all times'' portion

of the requirement.\303\ FIA stated that the Proposed Residual Interest

Requirement may force a number of small to mid-sized FCMs out of the

market, which will decrease access to the futures markets and increase

costs for IBs, hedgers, and small traders.\304\ In addition, FIA argued

that the Proposed Residual Interest Requirement would significantly

impair the price discovery and risk management purposes of the

market.\305\ Moreover, FIA stated that the Proposed Residual Interest

Requirement ``would impose a tremendous operational and financial

burden on the industry, requiring the development and implementation of

entirely new systems to assure compliance'' with the ``at all times''

portion of the requirement.\306\ FIA also averred that the ``provisions

of section 4d of the Act prohibiting an FCM from using the fund of one

customer `to margin or guarantee the trades or contracts, or to secure

or extend the credit, of any customer or person other than the one for

whom the same are held,' has been the lynchpin of customer funds

protection since the Commodity Exchange Act was enacted in 1936.''

\307\ In addition, FIA stated that they were not aware that the

Commission has interpreted the statute to require the real time

calculation of margin deficits.\308\

---------------------------------------------------------------------------

\303\ See FIA Comment Letter at 4-5, 12-26 (Feb. 15, 2013);

LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013).

\304\ See FIA Comment Letter at 17 (Feb. 15, 2013).

\305\ See id. at 4, 17.

\306\ Id. at 4. See also id. at 13.

\307\ FIA Comment Letter at 2 (June 20, 2013).

\308\ Id.

---------------------------------------------------------------------------

Several commenters requested that the Commission refrain from

adopting the Proposed Residual Interest Requirement until it conducted

further analysis with the industry regarding the costs and benefits of

such proposal,\309\ with others stating that the Proposed Residual

Interest Requirement would mark a significant departure from current

market practice and could have a material adverse impact on the

liquidity and smooth functioning of the futures and swaps markets.\310\

---------------------------------------------------------------------------

\309\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC

Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at

2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF

Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9

(Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA

Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.

15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment

Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.

18, 2013).

\310\ See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA

Comment Letter at 2 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb.

15, 2013); AFMP Group Comment Letter at 1-2 (Sept. 18, 2013); Rice

Dairy LLC Comment Letter at 1 (Feb. 13, 2013).

---------------------------------------------------------------------------

In addition, the Commission received several specific comments on

the potential costs and benefits of the Proposed Residual Interest

Requirement. The Congressional Committees requested that the Commission

consider the benefits in light of ``both the costs to America's farmers

and ranchers and the potential impact on consolidation in the FCM

industry,'' and in particular the ``consequences of changing the manner

or frequency in which `residual interest'--the capital an FCM must hold

to cover customer positions--is calculated.'' \311\

---------------------------------------------------------------------------

\311\ Congressional Committees Comment Letter at 1 (Sept. 25,

2013).

---------------------------------------------------------------------------

FIA noted that FCMs would look to avoid the need to use their own

resources by seeking to make sure that their customers would not be

undermargined, and that this process would involve the FCM collecting

greater amounts of collateral from each customer.\312\ FIA averred that

collecting greater amounts of collateral from customers would be

contrary to the desire of the market to reduce the amount of funds

maintained with FCMs following the failures of MFGI and PFGI.\313\

Moreover, FIA estimated that compliance with the Proposed Residual

Interest Requirement would require FCMs or their customers to

contribute significantly in excess of $100 billion into customer funds

accounts beyond the sum required to meet initial margin requirements,

and that the annual financing costs for these increases will range from

$810 million to $8.125 billion.\314\

---------------------------------------------------------------------------

\312\ FIA Comment Letter at 17 (Feb. 15, 2013).

\313\ Id. at 17. See also AFMP Group Comment Letter at 1 (Sept.

18, 2013) (arguing that ``[m]uch more customer money--maybe twice as

much--will be at risk in the event of another FCM insolvency.'').

\314\ FIA Comment Letter at 16 (Feb. 15, 2013).

---------------------------------------------------------------------------

MFA asserted that applying the Proposed Residual Interest

Requirement continuously to FCMs ``could significantly increase the

operational burdens and costs on FCMs and their customers,'' and that

``any pre-funding obligation is an unacceptable imposition on

customers'' because ``[i]t would create margin inefficiencies by

causing customers to reserve assets to pre-fund their obligations . . .

, and thus, reduce the amount of assets that customers have to use for

investment or other purposes.'' \315\ FHLB cautioned that ``[w]hile it

cannot be disputed that a residual interest buffer should lower the

risk that an FCM will fall out of compliance with its segregation

requirements, there will likely be a real economic cost associated with

maintaining whatever residual interest buffers is established by an

FCM'' and that ``the prospects of funding an additional residual

interest buffer may discourage FCMs from appropriately demanding

collateral from customers in excess of DCO requirements.'' \316\ FHLB

further noted that the ``funds maintained by an FCM as residual

interest can reasonably be expected to earn less than the FCM's

unrestricted funds,'' thus, the proposal ``represents a real cost to

FCMs'' that will be passed on to customers.\317\ Jefferies stated that

the Proposed Residual Interest Requirement will result in more assets

being held at FCMs' custodial facilities at a time when ``the

Commission has been enacting changes that have been shifting capital

away from FCMs towards DCO facilities. . . .'' \318\ Newedge also

stated that the Proposed Residual Interest Requirement ``will result in

many FCMs requiring customers to pre-fund and over-margin their

positions, which will increase

[[Page 68546]]

their exposure to FCMs'' and ``have a significant impact on customers'

own liquidity.'' \319\

---------------------------------------------------------------------------

\315\ MFA Comment Letter at 8 (Feb. 15, 2013).

\316\ FHLB Comment Letter at 3-4 (Feb. 15, 2013).

\317\ Id. at 4 n.5.

\318\ Jefferies Comment Letter at 7 (Feb. 15, 2013). See also

CCC Comment Letter at 2 (Feb. 15, 2013) (arguing that ``the

practical effect'' of the Proposed Residual Interest Requirement

``is that FCMs would require commodity customers to contribute

significantly more property to their FCM in order to meet new margin

requirements far in excess of exchange margin requirements,'' and

expressing concern over any requirement that would require customers

``to contribute even more capital to a system [CCC] believe[s] is

flawed.'')

\319\ Newedge Comment Letter at 2 (Feb. 15, 2013).

---------------------------------------------------------------------------

Steve Jones expressed the view that ``[w]ith more funds on deposit,

a corrupt FCM CEO (or other staff with access to the funds) will simply

be more tempted to `misappropriate' the funds.\320\ In addition,

Jefferies stated that requiring an FCM to maintain this level of

residual interest ``at all times'' ``would impose tremendous financial

and operational difficulties'' on FCMs, which would result in

tremendous increases to necessary liquidity, and ``negatively impact

competitiveness within the industry. . . .'' \321\ Jefferies further

stated that the Proposed Residual Interest Requirement would impose

heavy costs, and that, under the proposal, Jefferies would be required

to increase its residual interest by $15 million (non-peak) or $30

million (peak), respectively.\322\ Jefferies also stated that the

industry would be required to increase its residual interest by $49

billion (non-peak) or $83 billion (peak) at a cost of approximately $2

billion (non-peak) or $5 billion (peak), respectively.\323\

---------------------------------------------------------------------------

\320\ Steve Jones Comment Letter at 1 (Feb. 15, 2013).

\321\ Jefferies Comment Letter at 7 (Feb. 15, 2013).

\322\ Id. at 8.

\323\ Id.

---------------------------------------------------------------------------

ISDA asserted that the Proposed Residual Interest Requirement will

make customers ``self-guaranteeing'' and diminish reliance on the FCM,

and that, while this would diminish overall risk of FCM default, it

comes at a very significant cost to market participants, market volumes

and liquidity.\324\ ISDA estimated the funding needed to comply with

``at all times'' portion of the Proposed Residual Interest Requirement

to be $73.2 billion, with a long term impact of $335 billion.\325\ CHS

Hedging argued that the Proposed Residual Interest Requirement ``would

substantially increase the amount of capital an FCM would need on hand

at all times.'' \326\ Further, CHS Hedging stated that ``[i]n the

current economic environment, the difference between the cost of

capital and the return an FCM could reasonably expect through

investment of funds in a compliant and prudent manner would result in a

material effect on the business of all FCMs.'' \327\ CHS Hedging also

stated that FCMs ``could require that customers pre-fund their accounts

in anticipation of adverse market movement,'' which ``would likely

result in hardship with regard to working capital and may encourage

customers to seek alternative methods to hedge their risk. . . .''

\328\ CHS Hedging is also of the view that ``pre-funding accounts

concentrates additional funds at FCMs, which seems to contradict the

spirit of the'' customer protection rules.\329\

---------------------------------------------------------------------------

\324\ ISDA Comment Letter at 3 (Feb. 15, 2013). See also ISDA

Comment Letter at 2-3 (May 8, 2013).

\325\ ISDA Comment Letter at 4-5 (Feb. 15, 2013).

\326\ CHS Hedging Comment Letter at 2 (Feb. 15, 2013).

\327\ Id.

\328\ Id.

\329\ Id.

---------------------------------------------------------------------------

Other commenters argued that the Proposed Residual Interest

Requirement would be more burdensome on smaller FCMs and customers.

Some commenters stated that forcing FCMs to ask customers to pre-fund

positions will cause many futures industry participants, including

agricultural producers and other customers to suffer a financial burden

by tying up capital that is better used in other areas, such as the

operation of the feedlot, stocker operation or cow/calf operation,\330\

with two commenters asserting that increased costs associated with the

use of wire transfers, rather than checks, would have a similar

impact.\331\ Moreover, NCFC stated that in addition to increased costs

for hedgers, the Proposed Residual Interest Requirement ``would be more

burdensome to firms like farmer cooperative-owned FCMs'' because they

``are largely homogenous, with virtually all of their commercial

customers going deficit at the same time.'' \332\ NCFC also asserted

that ``[t]o require all deficits to be covered immediately would be

overly stringent on these FCMs given the low-risk profile of their

customers as hedgers,'' \333\ while NIBA noted that the Proposed

Residual Interest Requirement ``will actually limit or deny market

access to many customers'' (such as farmers, ranchers and other

agricultural organizations) ``who use the markets to hedge their

financial and commercial risks'' because the proposal ``could raise the

cost of hedging product to prohibitive levels.'' \334\ NIBA also stated

that if small to mid-sized FCMs are forced out of business, market

access ``will become limited and more expensive for IBs and their

smaller hedge and speculative clients.'' \335\ JSA argued that the

Proposed Residual Interest Requirement would be ``punitive in a highly

competitive environment that already places the midsize operator at a

disadvantage to his better capitalized multinational competitors.''

\336\ JSA also asserted that the resulting consolidation would cause

``the loss of competitive forces, [the] loss of significant numbers of

jobs, and the loss of transparency and liquidity required for a highly

functioning hedging environment.'' \337\ Moreover, JSA stated that the

cost of the Proposed Residual Interest Requirement would result in a

higher cost of hedging, which would be become prohibitive and prompt

agricultural users to walk away from the futures market.\338\ CME

averred that mid-sized and smaller FCMs will not have the capital

required by the Proposed Residual Interest Requirement and that

customers will be required to pre-fund potential margin

obligations.\339\ CME asserted that, given this increase in cost, some

customers may transfer their accounts to the larger, better-capitalized

FCMs to reduce the cost of trading,\340\ but that agricultural

customers ``likely will not be able to transfer to the larger FCMs

because they do not fit their customer profile,'' thereby making these

customers bear more of the cost burden.\341\ CME also stated that the

Proposed Residual Interest Requirement will lead to consolidation among

FCMs, which will ``actually increase[] systemic risk by concentrating

risk among fewer market participants.'' \342\ Frontier Futures argued

that the Proposed Residual Interest Requirement does not give an FCM

time to collect margin from customers if the market moves against a

customer's position.\343\ Because many small customers, including most

farmers, do not watch markets constantly, it would be difficult for

them to meet margin calls on a

[[Page 68547]]

moment's notice, thereby causing FCMs to require significantly higher

margins or to liquidate customer positions where margin calls cannot be

immediately met.\344\ Frontier Futures also asserted that the proposal

``may force a number of small to mid-sized FCMs out of the market,''

making it more expensive, if not impossible, for IBs and small members

to clear their business, removing ``significant capital from the

futures industry,'' and ``reducing stability to the markets as a

whole.'' \345\ RJ O'Brien stated that the Proposed Residual Interest

Requirement is impractical because many farmers and agricultural

clients still use checks and ACH to meet margin calls.\346\

---------------------------------------------------------------------------

\330\ TCFA Comment Letter at 2 (Feb. 15, 2013); NCBA Comment

Letter at 2 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15,

2013); Randy Fritsche Comment Letter at 1 (Feb. 15, 2013); Global

Commodity Comment Letter at 1 (Feb. 13, 2013); AFMP Group Comment

Letter at 1-2 (Sept. 18, 2013).

\331\ TCFA Comment Letter at 1 (Feb. 15, 2013); NCBA Comment

Letter at 1 (Feb. 15, 2013).

\332\ NCFC Comment Letter at 2 (Feb. 15, 2013).

\333\ Id.

\334\ NIBA Comment Letter at 1 (Feb. 15, 2013).

\335\ Id. at 1-2. NIBA also asserted that ``[t]ransferring

accounts between brokerage houses would become very difficult to

accomplish'' because open positions would ``need to be margined at

the receiving house as well as the transferring one,'' thereby

restraining Brokers ``to remain with one FCM, or completely close

customers' positions in order to start up again with a different

FCM.'' Id. at 2.

\336\ JSA Comment Letter at 1 (Feb. 15, 2013).

\337\ Id. at 1-2.

\338\ Id. at 2.

\339\ CME Comment Letter at 5-6 (Feb. 15, 2013).

\340\ Id. at 6.

\341\ Id.

\342\ Id. (emphasis in original). CME also maintained that

``those customers who qualify as [ECPs] can move to the uncleared

and less regulated swaps space and decline to use centralized

clearing.'' Id. at 6-7.

\343\ Frontier Futures Comment Letter at 3 (Feb. 15, 2013).

\344\ Id.

\345\ Id.

\346\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013). See also

ICA Comment Letter at 1-2 (Feb. 15, 2013).

---------------------------------------------------------------------------

Several commenters presented alternative proposals for the

Commission's consideration. For example, two commenters argued that the

Commission should consider less costly alternatives to the current

residual interest proposal, such as allowing the FCM ``to count

guaranty fund deposits with [DCOs] as part of their residual

interest,'' \347\ with others stating that the residual interest amount

that an FCM must carry should only apply to a limited number of its

largest customers.\348\

---------------------------------------------------------------------------

\347\ Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ

O'Brien Comment Letter at 5 (Feb. 15, 2013). Cf. Frontier Futures

Comment Letter at 3 (Feb. 15, 2013) (suggesting further that firm

firewalls be put in place between customer funds and an FCM's

proprietary funds in the form of approval by an independent agency

for an FCM to transfer customer funds and that FCMs ``do their

proprietary trading through another FCM thereby engaging the risk

management of a third party.'')

\348\ See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013).

---------------------------------------------------------------------------

Moreover, and as discussed more fully below, other commenters urged

the Commission to conform the final version of proposed Rules

1.20(i)(4), 22.2(f)(6), and 30.7(a) to the current method of

calculating residual interest buffer for Cleared Swaps by dropping the

words ``at all times.'' \349\ For example, ISDA and FIA further urged

consideration of an alternative under which the residual interest

calculations would be made once a day and that, by the end of a

business day, an FCM would be required to maintain a residual interest

in its customer funds accounts at least equal to its customers'

aggregate margin deficits for the prior trade date.\350\ ISDA stated

this alternative ``would rationally reduce'' FCMs cost of

compliance\351\ and that ``[f]or an FCM with robust credit risk

management systems, covering end-of-day customer deficits should not be

a significant cost.'' \352\ ISDA also noted that at the end of the day

``typically, all customer calls have been met, and all customer gains

have been paid out; all achieved without the FCM having recourse to its

own funding resources.'' \353\ FIA asserted that it would ``achieve the

Commission's regulatory goals without imposing the damaging financial

and operational burdens on FCMs, and the resulting financial burdens on

customers.'' \354\ LCH.Clearnet argued that customer collateral can be

protected by performing the ``LSOC Compliance Calculation'' once per

day, prior to settlement at a DCO, because ``prior to meeting a call

for an increased requirement, a customer may be under collateralized,

but is not collateralized by another customer.'' \355\ ISDA and FIA

evaluated the costs associated with requiring FCMs to perform the

residual interest calculation once each day at the close of business on

the first business day following the trade date.\356\ ISDA estimated

that ``removing the predictive element of FCM funding requirements'' of

the ``at all times'' method in favor of the alternative approach would

permit markets to ``reap the efficiencies of end-of-day accounting,''

\357\ thereby significantly reducing the overall cost of compliance

with the regulation. ISDA estimated that for futures, the costs

associated with the would be the cost of covering the out-standing

margin deficits of between 2 and 5% of its futures customers, and thus

would impose only ``incremental funding requirements'' on FCMs.\358\

ISDA estimated that the costs of the alternate proposal would be even

smaller for cleared swaps, due to the ``more professional'' nature of

the market.\359\ FIA estimated the financing costs to FCMs of complying

with FIA's proposed alternative and concluded that the costs associated

with the Proposed Residual Interest Requirement would be approximately

ten times the costs associated with the FIA proposal.\360\ FIA also

concluded that their proposal would not ``impos[e] damaging financial

and operational burdens on FCMs . . . and the resulting financial

burdens on customers.''\361\

---------------------------------------------------------------------------

\349\ See, e.g., LCH.Clearnet Comment Letter at 5 (Feb. 15,

2013); ISDA Comment Letter at 6 (Feb. 15, 2013); RJ O'Brien Comment

Letter at 5 (Feb. 15, 2013).

\350\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment

Letter at 23-25 (Feb. 15, 2013).

\351\ ISDA Comment Letter at 6 (Feb. 15, 2013).

\352\ ISDA Comment Letter at 2 (May 8, 2013).

\353\ Id. ISDA further recommended that because many FCM

customers use custodians across the world, ``many customers cannot

assure payment of their morning FCM call before the end of the New

York day,'' and therefore recommended that Commission study the

feasibility of reducing the time in which customers have to meet

margin calls, if that is ``imperative.'' Id. at 3.

\354\ FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA

Comment Letter at 4 (May 8, 2013).

\355\ LCH.Clearnet Comment Letter at 5 (Feb. 15, 2013).

\356\ ISDA Comment Letter at 1-2 (May 8, 2013); FIA Comment

Letter at 8-10 (June 20, 2013).

\357\ Id. at 3.

\358\ ISDA Comment Letter at 3-4 (May 8, 2013).

\359\ Id. at 4.

\360\ See FIA Comment Letter at 8-10 (June 20, 2013). While the

rates used by FIA in this exercise may be conservative, and thus the

Commission does not purport to opine on the precise estimates

reached, the exercise is nevertheless illustrative and useful for

the purpose of comparing the costs of the Residual Interest

Proposal, the alternate proposal, and the final rule.

\361\ Id. at 9.

---------------------------------------------------------------------------

RJ O'Brien also recommended that the Commission drop the ``at all

times'' requirement and that the residual interest calculation be done

once each day at the close of business on the first business day

following the trade date.\362\ RJ O'Brien asserted that ``this

alternative will reduce the substantial financial burdens'' on

customers ``while further enhancing the protection of customer funds.''

\363\

---------------------------------------------------------------------------

\362\ RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).

\363\ Id.

---------------------------------------------------------------------------

MFA stated that the Commission should modify the proposed FCM

residual interest requirement in Sec. 1.20(i)(4) so that it is a

``point of time'' obligation that requires FCMs to ensure they maintain

sufficient residual interest ``as of the close of business EST on the

business day after the FCM issues a customer's margin call.'' \364\ MFA

argued that this alternative would ``reduce the stress on the market''

and ``eliminate[] the need for customer pre-funding or intraday margin

calls, while also ensuring that * * * FCMs will hold sufficient funds

to protect against customer shortfalls.'' \365\

---------------------------------------------------------------------------

\364\ MFA Comment Letter at 8-9 (Feb. 15, 2013).

\365\ Id.

---------------------------------------------------------------------------

Paul/Weiss stated that the Commission should clarify that the

residual interest amount an FCM is required to maintain must be

determined ``at the time of any end-of-day, intra-day or special call

payment by an FCM to derivatives clearing organization (or other

clearing house or clearing intermediary). . . .''\366\ Paul/Weiss

argued that these payments are ``the relevant points in time at which

[[Page 68548]]

the FCM is obligated to transfer'' customer margin.\367\

---------------------------------------------------------------------------

\366\ Paul/Weiss Comment Letter at 4 (Feb. 15, 2013).

\367\ Id.

---------------------------------------------------------------------------

As a threshold matter, and as noted above, the Commission

reiterates that the Act expressly prohibits an FCM from using the

collateral of one customer to margin, secure, or guarantee the trades

or contracts of other customers.\368\ Congress specifically added this

prohibition in response to concerns that certain customers were

carrying the risks and obligations of other favored customers.\369\ By

this token, any customer that is undermargined is being favored over

the customers with excess margin, in contravention of section 4d(a)(2)

when other customers' funds are being used to cover the undermargined

amounts.\370\

---------------------------------------------------------------------------

\368\ The Commission further notes that current Commission

regulations also include such prohibitions. Namely, Sec. 1.22

states that ``No futures commission merchant shall use, or permit

the use of, the futures customer funds of one futures customer to

purchase, margin, or settle the trades, contracts, or commodity

options of, or to secure or extend the credit of, any person other

than such futures customer,'' and Sec. 22.2(d)(1) states that ``No

futures commission merchant shall use, or permit the use of, the

Cleared Swaps Customer Collateral of one Cleared Swaps Customer to

purchase, margin, or settle the Cleared Swaps or any other trade or

contract of, or to secure or extend the credit of, any person other

than such Cleared Swaps Customer.''

\369\ See 80 Cong. Rec. 6159, 6162 (1936) (statement of Sen.

James. P. Pope) (``It further appears that certain favored dealers

have not been required actually to put up the money for margins, and

have been extended credit in that respect. This gives these favored

dealers an advantage. In some instances, large commission firms have

become bankrupt and the funds placed with them by a large number of

dealers were lost.''); ``Regulation of Grain Exchanges: Before the

H. Comm. on Agriculture,'' 73 Cong. 31 (1934) (statement of Dr. J.

W. T. Duvel, Chief Grain Futures Admin. Dept. of Agriculture) (``On

the commodities exchanges certain classes of speculators and others

are able to secure credit but in many cases the credit so extended

represents margin money taken from one class of customers and used

to extend credit on [sic] margin the trades of others. Our aim is to

protect the customers' margin money and thereby protect the market

as a whole.'').

\370\ As some commenters report, institutional customers in

particular are typically undermargined. This could mean that

institutional customers are being favored over individual customers.

See, e.g., FIA Comment Letter at 15 (Feb. 15, 2013).

---------------------------------------------------------------------------

Moreover, there is an inescapable mathematical fact: When an FCM

meets the DCO's margin requirements, the property used to meet those

requirements can only come from one of three sources: the responsible

customer, the FCM, or other customers. If the property does not come

from the customer whose positions generated the margin requirement or

loss, or the FCM itself (that is, the FCM's residual interest), then it

must, of necessity, come from other customers.\371\ In reviewing the

Commission's customer protection rules in light of MFGI and PFGI, staff

identified market practices that were in tension with the plain

language of the Act, and, as such, the Commission attempted to clarify

acceptable practices with respect to these existing statutory

requirements with the Proposed Residual Interest Requirement.

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\371\ As recognized by the Commission previously, the obligation

to ensure that one customer's property is not used to margin or

settle the trades or contracts of another customer rests with the

FCM. See 46 FR 11668, 11669. (stating that ``section [4d(a)(2)] of

the Act and Sec. Sec. 1.20 and 1.22 of the Commission's regulations

require an FCM to add its own money into segregation in an amount

equal to the sum of all customer deficits.''). See also CFTC Letter

00-106 (Nov. 22, 2000) (stating that ``each FCM must segregate

sufficient funds to cover any amounts it owes to its customers in

connection with commodity interest transactions. The funds of

multiple customers may be commingled in a single account for the

benefit of the customers as a group. If, however, the balance of any

one of those customers falls into a deficit, the FCM is obligated to

restore the amount of such deficit out of its own funds or property

in order to avoid the use of the funds or property or any other

customer to meet the obligations of the customer in deficit. The

Commission requires FCM's [sic] to maintain minimum levels of

capital to help assure that, among other things, they are able to

meet such obligations.'').

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As noted above, several commenters strongly supported the Proposed

Residual Interest Requirement, noting it is consistent with

Congressional intent and the Commission's historical interpretations of

the Act. In general, these commenters argued that the proposal

correctly shifts the risk of loss to customers with margin deficiencies

and away from customers with excess margin. Some of these commenters

questioned market cost estimates and statements regarding the technical

challenges associated with same-day margin transfers, and urged the

Commission to avoid unnecessarily weakening customer protection.

On the other hand, many commenters expressed concern regarding the

costs associated with the Proposed Residual Interest Requirement. In

particular, commenters stated that requiring the FCM to be in

compliance with residual interest requirements ``at all times'' would

disparately impact agricultural producers, small and mid-size FCMs, and

hedgers; decrease market liquidity; cause market consolidation; and

increase systemic risk. Moreover, the Commission notes that many of the

estimates of the amount of additional capital required as a result of

the Proposed Residual Interest Requirement seem to result from a

particular interpretation of the meaning of the ``at all times''

portion of the proposal, and seemed to range from $49 billion (non-

peak) and $83 billion (peak),\372\ to $73.2 billion,\373\ to upwards of

$100 billion.\374\ Further, commenters asserted that the ``at all

times'' portion of the Proposed Residual Interest Requirement would be

operationally unachievable, and argued that the Proposed Residual

Interest Requirement would curtail competition, concentrate capital in

FCMs at a time when the market would like to reduce the amount of

customer collateral held at the FCM, and reduce the number of viable

FCMs, thereby negatively impacting overall market risk and market

access for smaller customers and agricultural hedgers. Commenters also

argued that the Proposed Residual Interest Requirement is unnecessary

because in their view, customer funds are not at risk when fellow

customer accounts are undermargined.\375\

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\372\ See Jefferies Comment Letter at 8-9 (Feb. 15, 2013).

Jefferies states that the proposal would require them to increase

residual interest by $15 million (non-peak) to $30 million (peak).

\373\ See ISDA Comment Letter at 4-5 (Feb. 15, 2013). ISDA

argued that the long term impact of the ``at all times'' portion of

the proposal could be as high as $335 billion.

\374\ See FIA Comment Letter at 15-17 (Feb. 15, 2013). FIA also

estimated that the annual financing costs associated with the $100

billion cost could range from $810 million to $8.125 billion.

\375\ See Transcript, U.S. Commodity Futures Trading Commission

Agricultural Advisory Committee Meeting held on July 25, 2013,

available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/aac_transcript072513.pdf.

_____________________________________-

Many of the commenters interpreted the proposal to require FCMs to

continuously calculate and monitor the margin deficits of their

customers. In the final rulemaking, the Commission is, in general,

following the concept advanced by Paul/Weiss and LCH.Clearnet--that is,

what is required is that the FCM not ``use'' one customer's property to

margin another customer's positions. For an interim phase-in period,

the Commission is adopting the alternative proposal recommended by

several commenters, including FIA. Thus, for the reasons set forth

below, by the Residual Interest Deadline, which is defined in Sec.

1.22(c)(5), an FCM would be required to maintain a residual interest in

its customer funds accounts at least equal to its customers' aggregate

margin deficits for the prior trade date.\376\ The commenters asserted,

and the Commission agrees that this alternative would significantly and

materially reduce the financial burdens that would otherwise be imposed

on

[[Page 68549]]

customers and FCMs alike under the Commission's Proposed Residual

Interest Requirement \377\ because, among other things, this alternate

approach would not cause an extreme drain on market liquidity, market

consolidation, increase in systemic risk, and detrimental effect on

agricultural producers, small and mid-size FCMs, and hedgers.\378\

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\376\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013);

CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5-6

(Feb. 15, 2013); FIA Comment Letter at 4-5 (Feb. 15, 2013);

LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MGEX Comment

Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15,

2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O'Brien Comment

Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4-5

(Feb. 15, 2013).

\377\ The Commission notes that representatives from FIA, ISDA,

and ADM Investor Services have all indicated in meetings with

Commission staff that such an alternative would better protect

customers, benefit FCMs risk management practices, and materially

reduce many costs associated with the Commission's original

proposal.

\378\ See ISDA Comment Letter at 3 (May 8, 2013) (noting that a

substantial majority of customer margin calls are met by 5:00 p.m.

on the day the calls are issued and therefore the this approach

would not impose the costs and cause the problems associated with

the Proposed Residual Interest Requirement); FIA Comment Letter at 9

(June 20, 2013) (estimating that the alternative approach would be

10 times less costly for FCMs to finance). See also MFA Comment

Letter at 8-9 (Feb. 15, 2013); RJ O'Brien Comment Letter at 5 (Feb.

15, 2013).

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After careful consideration of the comments and the applicable

statutory provisions, the Commission has decided to adopt the Proposed

Residual Interest Requirement with modifications.

Section 4d(a)(2) of the Act expressly states that the money,

securities, and property received by an FCM from a customer to margin,

guarantee, or secure the trades or contracts of that customer shall be

separately accounted for and shall not be commingled with the funds of

such commission merchant or be used to margin or guarantee the trades

or contracts, or to secure or extend the credit, of any customer or

person other than the one for whom the same are held.\379\ Moreover,

the Commission notes that when section 22 of the rules and regulations

of the Secretary of Agriculture under the Act (the predecessor of Sec.

1.22) was adopted in 1937,\380\ the year after adoption of the Act, it

expressly stated that ``No futures commission merchant shall use, or

permit the use of, the money, securities, or property of one customer

to margin or settle the trades or contracts, or to secure or extend the

credit, of any person other than such customer. The net equity of one

customer shall not be used to carry the trades or contracts or to

offset the net deficit of any other customer or person or to carry the

trades or offset the net deficit of the same customer in goods or

property not included in the term `commodity' as defined herein.''

\381\ This language addresses, by its terms, more than net deficits,

and appears to have remained substantively unchanged for the next four

decades.

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\379\ See also section 4d(f)(2) of the Commodity Exchange Act,

as well as Sec. 1.22 of this section and Sec. 22.2(d)(1) of this

chapter.

\380\ 2 FR 1223, 1225 (July 16, 1937).

\381\ Id. at 1225 (emphasis supplied).

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In 1981, in its Regulation of Domestic Exchange-Traded Commodity

Options, the Commission revised Sec. 1.22 to combine segregation

requirements for options with existing segregation requirements for

futures.\382\ In doing so, the Commission generalized the regulatory

language and deleted specific references to ``net equity.'' However,

neither the adopting release nor the proposing release for the

``Regulation of Domestic Exchange-Traded Commodity Options'' rulemaking

indicated an intent to alter or modify the existing segregation

requirements for futures.\383\

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\382\ See 46 FR 54500 (Nov. 3, 1981).

\383\ See id. at 54508 (Final Release) (stating that because the

Commission did not receive any comments on its proposed regulations

relating to segregation of customer funds, it was adopting the

amendments essentially as proposed). In addition, in stating that

``the Commission is now proposing that the option segregation

requirements be combined with the existing segregation requirements

for futures,'' the proposing release noted that certain definitions

``have also been added or modified to permit defined terms to be

used in the sections, as amended, and thereby simplify the

regulations.'' See 46 FR 33293-01, 33298 (June 29, 1981).

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The current version of Sec. 1.22 states that ``[n]o futures

commission merchant shall use, or permit the use of, the futures

customer funds of one futures customer to purchase, margin, or settle

the trades, contracts, or commodity options of, or to secure or extend

the credit of, any person other than such futures customer.''

The Commission's Proposed Residual Interest Requirement was

intended to ensure compliance with section 4d(a)(2) and Sec. 1.22 by

shifting the risk of loss in the event of a double default back to the

customer whose positions incurred the loss and away from those

customers with excess margin at the FCM. Contrary to the assertion of

certain commenters, whenever an FCM uses the funds of customers with

excess margin to collateralize the positions of undermargined

customers, the customers with excess funds are subject to heightened

risk, and diminished availability of those excess funds for transfer in

the event the FCM is in financial distress.

Nonetheless, commenters asserted that there is ambiguity regarding

(1) the point at which an FCM has ``used'' or ``permitted the use'' of

the futures customer funds of one futures customer to purchase, margin,

or settle the trades, contracts, or commodity options of, or to secure

or extend the credit of, another futures customer, and (2) what an FCM

is required to do to comply with this requirement. Accordingly, the

Commission is adopting proposed Sec. Sec. 1.20(i) and 1.22 with

certain modifications.

First, the Commission is revising proposed Sec. 1.20(i) by

removing the Proposed Residual Interest Requirement from paragraph

(i)(4). In addition, the Commission is revising the language in Sec.

1.22 to add an amended residual interest requirement and additional

technical corrections to Sec. 1.20(i) as described further below.

Moreover, the Commission is reorganizing proposed Sec. 1.22 as

follows: (1) The sentence that reads ``No futures commission merchant

shall use, or permit the use of, the futures customer funds of one

futures customer to purchase, margin, or settle the trades, contracts,

or commodity options of, or to secure or extend the credit of, any

person other than such futures customer.'' will be in paragraph (a);

(2) the remaining language in proposed paragraph (a) will be deleted;

(3) the sentence that reads ``Futures customer funds shall not be used

to carry trades or positions of the same futures customer other than in

contracts for the purchase of sale of any commodity for future delivery

or for options thereon traded through the facilities of a designated

contract market.'' will remain in paragraph (b); and (4) as discussed

below, a new paragraph (c) will be added to address the revised

residual interest requirements.

As highlighted above, several commenters questioned the ability of

FCMs to measure compliance on a continuous and real-time basis,\384\

and argued that the potential cost associated with a continuous

residual interest requirement would have an adverse impact on the

market.\385\ The Commission is persuaded that continuous calculation

and monitoring requirements are not technologically feasible at this

time. The Commission is also persuaded that it would not be practical

to make such calculations in the futures markets based on intra-day

[[Page 68550]]

changes.\386\ However, as discussed in more detail below, the

Commission is persuaded that the calculations required by the residual

interest requirement are feasible using a point in time approach.

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\384\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013);

CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5-6

(Feb. 15, 2013); FIA Comment Letter at 4-5 (Feb. 15, 2013);

LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MGEX Comment

Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15,

2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O'Brien Comment

Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4-5

(Feb. 15, 2013).

\385\ See, e.g., CMC Comment Letter at 2 (Feb. 15, 2013); CME

Comment Letter at 5 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb.

18, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RJ O'Brien

Comment Letter at 4 (Feb. 15, 2013).

\386\ See, e.g., Advantage Comment Letter at 7 (Feb. 15, 2013);

CME Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4,

15, 21-22 (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013);

NPPC Comment Letter at 2 (Feb. 15, 2013); RCG Comment Letter at 3

(Feb. 12, 2013); TD Ameritrade at 4-5 (Feb. 15, 2013). Cf. ISDA

Comment Letter at 1-2 (Aug. 27, 2013).

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As noted above, the Commission is moving the Proposed Residual

Interest Requirement from proposed Sec. 1.20(i) to new paragraph (c)

in Sec. 1.22. Moreover, and as suggested by commenters,\387\ the

Commission agrees that a point in time approach to the determination of

the adequate size of the residual interest amount would ``ensure that

an FCM has appropriately sized the residual interest buffer to cover

the aggregated gross margin deficiencies in respect of customer

transactions in the relevant origin.'' \388\ Further, the Commission

agrees that this approach is consistent with the Act and Commission

regulations, and would help ensure that the collateral of one customer

is never used to margin the positions of another customer.\389\

Moreover, the Commission notes that a point in time approach is

consistent with the current practice with respect to residual interest

buffer calculations for Cleared Swaps and with the approach set forth

in JAC Update 12-03.\390\

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\387\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment

Letter at 23-25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5

(Feb. 15, 2013); Paul/Weiss Comment Letter at 4-5 (Feb. 15, 2013);

RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).

\388\ Paul/Weiss Comment Letter at 4 (Feb. 15, 2013).

\389\ See generally id.; FIA Comment Letter at 23 (Feb. 15,

2013); ISDA Comment Letter at 4 (May 8, 2013).

\390\ Joint Audit Committee Regulatory Update 12-03,

Part 22 of CFTC Regulations--Treatment of Cleared Swaps Customer

Collateral--Legally Segregated Operationally Commingled (``LSOC'')

Compliance Calculation (Oct. 18, 2012).

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Accordingly, the Commission is revising the Proposed Residual

Interest Requirement as follows. Regulation 1.22 (c)(1) defines the

undermargined amount for a futures customer's account as the amount, if

any (i.e., the amount must be greater than or equal to zero), by which

(i) the total amount of collateral required for that futures customer's

positions \391\ in that account, at the time or times referred to in

Sec. 1.22(c)(2), exceeds (ii) the value of the net liquidating equity

for that account, as calculated in Sec. 1.20(i)(2). An FCM is required

to perform the calculation set forth in Sec. 1.22(c)(1) on a customer

by customer basis. Regulation 1.22(c)(2) requires an FCM to perform a

residual interest buffer calculation, at the close of each business

day, based on the information available to the FCM at that time,\392\

by calculating (i) the undermargined amounts, based on the clearing

initial margin that will be required to be maintained by that FCM for

its futures customers, at each DCO of which the FCM is a member, at the

point of the daily settlement (as described in Sec. 39.14) that will

complete during the following business day for each such DCO less (ii)

any debit balances referred to in Sec. 1.20(i)(4) included in such

undermargined amounts.\393\

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\391\ For purposes of this calculation, the FCM should include

as ``positions'' any trade or contract that (i) would be required to

be segregated pursuant to 4d(f) of the Act or (ii) would be subject

to Sec. 30.7 of this chapter, but which is, in either case,

pursuant to a Commission rule, regulation, or order (or a

derivatives clearing organization rule approved in accordance with

Sec. 39.15(b)(2) of this chapter), commingled with a contract for

the purchase or sale of a commodity for future delivery and any

options on such contracts in an account segregated pursuant to

section 4d(a) of the Act and should exclude as ``positions'' any

trade or contract that, pursuant to a Commission rule, regulation,

or order, is segregated pursuant to section 4d(f) of the Act. This

requirement is intended to be analogous to the definition of Cleared

Swap in Sec. 22.1 of this chapter.

\392\ An FCM is not expected to account for changes in

circumstances that occur after the close of business and prior to

the next business day's settlement, outside of normal end-of-day

reconciliation processes. In other words, an FCM may use the

information (such as position and value information) available to it

at the close of each business day for this calculation.

\393\ This subtraction is intended to address the potential

double-counting of deficit balances that was pointed out in a number

of comments. See, e.g., Vanguard Comment Letter at 8 (Feb. 22,

2013).

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An FCM is required to perform the calculation in Sec. 1.22(c)(2)

once per day, based on the information at the close of business on that

day, so that it can determine the amount of customer funds which will

be needed to avoid using the funds of one customer to margin,

guarantee, or secure the positions of another customer. Consistent with

this revised residual interest requirement, Sec. 1.20(i)(4) is being

amended to state that the amount of funds an FCM is holding in

segregation may not be reduced by any debit balances that the futures

customers of the FCM have in their accounts. In addition, Sec.

1.20(i)(2)(ii) is being removed because this requirement is now set

forth in Sec. 1.22(c). Consistent with Federal Register requirements,

Sec. 1.20(i)(2) is being renumbered and, for clarity, the first

sentence will be revised to read as follows ``The futures commission

merchant must reflect in the account that it maintains for each futures

customer the net liquidating equity for each such customer, calculated

as follows: the market value of any futures customer funds that it

receives from such customer, as adjusted by: . . . .'' \394\ Further,

under Sec. 1.22(c)(3), an FCM is required, prior to the Residual

Interest Deadline, as defined in Sec. 1.22(c)(5), to have residual

interest in the segregated account in an amount that is at least equal

to the computation set forth in Sec. 1.22(c)(2).\395\ However, the

amount of residual interest that an FCM must maintain may be reduced to

account for payments received from or on behalf of (net of

disbursements made to or on behalf of) undermargined futures customers

between the close of the previous business day and the Residual

Interest Deadline.

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\394\ As noted in the preamble to the proposal, the purpose of

the amendments to 1.20(i) is to ``provid[e] more detail implementing

the Net Liquidating Method of calculating segregation

requirements.'' 77 FR at 67882.

\395\ Following the completion of the phase-in period, when the

Residual Interest Deadline moves to the time of settlement, an FCM

may be subject to multiple Residual Interest Deadlines, in which

case the FCM must maintain residual interest prior to the Residual

Interest Deadline in an amount that is at least equal to the portion

of the computation set forth in Sec. 1.22(c)(2) attributable to the

clearing initial margin required by the DCO making such settlement.

Thus, where an FCM is a member of more than one DCO and the DCOs

conduct their daily settlement cycles at different times, an FCM

would be required, at the time of the daily settlement for each DCO,

to maintain the proportionate share of residual interest in the

futures customer account.

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Regulation 1.22(c)(4) provides that for purposes of Sec.

1.22(c)(2), an FCM should include, as ``clearing initial margin,''

customer initial margin that the FCM will be required to maintain, for

that FCM's futures customers, at another FCM, and, for purposes of

Sec. 1.22(c)(3), must do so prior to the Residual Interest Deadline.

In other words, Sec. 1.22(c)(4) is intended to make clear that the

requirements with respect to futures customer funds used by an FCM that

clears through another FCM are parallel to the requirements applied

with respect to futures customer funds used when an FCM clears through

a DCO.

Regulation 1.22(c)(5) defines the Residual Interest Deadline.

Paragraph (c)(5)(i) sets forth that except during the phase-in period

defined in paragraph (c)(5)(ii), the Residual Interest Deadline shall

be the time of the settlement referenced in paragraph (c)(2)(i), or, as

appropriate, (c)(4). However, in response to the comments that urge

that achieving compliance with these requirements may take time, and in

order to mitigate some of the cost concerns raised by commenters,

paragraph (c)(5)(ii) provides that the Residual Interest Deadline

during the phase-in period shall be 6:00 p.m.

[[Page 68551]]

Eastern Time on the date of the settlement referenced in paragraph

(c)(2)(i) or, as appropriate, (c)(4). The phased compliance schedule

for Sec. 1.22(c) is set forth in Sec. 1.22(c)(5)(iii). However, the

Residual Interest Deadline of 6:00 p.m. Eastern Time in Sec.

1.22(c)(5)(ii) shall begin one year following the publication of this

rule in the Federal Register.\396\

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\396\ For further discussion regarding the phase-in schedule for

the requirements in Sec. 1.22(c), see section III.F.

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Additionally, in further response to the commenters' request for

additional study,\397\ in paragraph (c)(5)(iii)(A), the Commission is

directing staff to complete and publish for public comment a report

(``the Report''), no later than 30 months following the date of

publication of this release, addressing, to the extent information is

practically available, the practicability (for both FCMs and customers)

of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on

the date of the settlement referenced in Sec. 1.22(c)(2)(i) to the

time of that settlement (or to some other time of day), including

whether and on what schedule it would be feasible to do so. The Report

is also expected to address cost and benefit considerations of such

potential alternatives. Moreover, staff shall, using the Commission's

Web site, solicit public comment and shall conduct a public roundtable

regarding specific issues to be covered by the Report. Paragraph

(c)(5)(iii)(B) sets forth that within nine months after the publication

of the Report, the Commission may (but shall not be required to) do

either of the following: (1) terminate the phase-in period, in which

case the phase-in shall end as of a date established by order published

in the Federal Register, which date shall be no less than one year

after the date such order is published, or (2) determine that it is

necessary or appropriate in the public interest to propose through

rulemaking a different Residual Interest Deadline, in which event, the

Commission shall establish, by order published in the Federal Register,

a phase-in schedule. Finally, paragraph (c)(5)(iii)(C) provides that if

the phase-in schedule has not been amended pursuant to Sec.

1.22(c)(5)(iii)(B), then the phase-in period shall end on December 31,

2018.

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\397\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC

Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at

2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF

Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9

(Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA

Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.

15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment

Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.

18, 2013).

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With respect to the suggestion that a portion (i.e., that portion

attributable to customer business) of the funds contributed to an

exchange's guaranty fund by an FCM should be considered in that FCM's

residual interest calculations,\398\ the Commission notes that

contributions to a guarantee fund are not segregated for the benefit of

customers. Rather, they are, by design, available to meet the defaults

of other clearing members, and thus cannot be counted as customer

segregated funds. As such, the Commission declines to adopt this

suggestion.

---------------------------------------------------------------------------

\398\ See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013); RJ

O'Brien Comment Letter at 5 (Feb. 15, 2013).

---------------------------------------------------------------------------

The Commission also received several requests for clarifications.

CIEBA stated that ``while futures market participants may be familiar

with terms such as `residual interest' and the technical features of

the proposed rule, other market participants may not appreciate the

full scope of the rule and the additional protections provided without

further explanation.'' \399\ CIEBA requested that the Commission

clarify ``how this requirement is intended to work with examples of its

application so as to more broadly communicate the Commission's intent

to bolster the depth of customer protections to minimize customer risk

and promote confidence in the markets.'' \400\ The Commission

recognizes CIEBA's concern and, as discussed above, has provided

clarification in this release regarding the mechanism by which FCMs

measure compliance with the statutory requirement of 4d(a)(2). However,

the Commission also recognizes that FCMs engage in a broad range of

acceptable business practices and should be given flexibility in how

best to tailor their businesses to comply with such requirement.

---------------------------------------------------------------------------

\399\ CIEBA Comment Letter at 3 (Feb. 15, 2013).

\400\ Id.

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AIMA requested clarification that Sec. Sec. 1.17(c)(5) and

1.20(i)(4) are not duplicative and therefore does not require FCMs to

``double count'' residual interest.\401\ The Commission reiterates that

Sec. 1.17(c)(5) and the residual interest requirement now set forth in

1.22(c)(2) are two separate requirements. As discussed above, Sec.

1.17 sets forth the Commission's minimum capital requirements for FCMs

and requires, among other things, an FCM to incur a charge to capital

for customer and noncustomer accounts that are undermargined beyond a

specified period of time.\402\ The residual interest requirements, on

the other hand, are intended to help make sure that the collateral of

one customer is never used to margin the positions of another customer.

These requirements are, therefore, not duplicative, and the Final Rule

does not actually require an FCM to double count the residual interest

amount.\403\

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\401\ See AIMA Comment Letter at 3 (Feb. 15, 2013).

\402\ See section II.F. above.

\403\ See section II.F. above regarding the requirement set

forth Sec. 1.17(c)(5).

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Paul/Weiss requested that the Commission confirm that the

requirements of jurisdiction and denomination in Sec. 1.49 do not

apply to an FCM's cash management procedures for meeting its residual

interest obligation.\404\ Paul/Weiss noted that JAC Update 12-03,\405\

provides that the denomination and jurisdiction requirements set forth

in Sec. 1.49 do not apply to the extent that an FCM deposits

additional funds in order to cover margin deficiencies in the Cleared

Swaps Customer Account prior to a \406\ DCO's settlement.\407\ The

Commission agrees that, for purposes of meeting any undermargined

amount in a customer account with a deposit of additional funds prior

to payment to any DCO, the requirements of Commission Sec. 1.49 with

respect to denomination or jurisdiction should not apply, and

accordingly, they will not.

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\404\ Paul/Weiss Comment Letter at 6 (Feb. 15, 2013).

\405\ This update provides that, for purposes of meeting any

margin deficiency in the cleared swaps customer account with a

deposit of additional funds prior to payment to any DCO, the

requirements of Commission Sec. 1.49 with respect to denomination

or jurisdiction will not apply.

\406\ Paul/Weiss Comment Letter at 5-6 (Feb. 15, 2013).

\407\ Paul/Weiss Comment Letter at 5-6 (Feb. 15, 2013).

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FCStone asked the Commission to set price limits at levels equal to

or below the margin requirement in all commodities to mitigate the

potential for under margined customer positions.\408\ NPPC requested

that the Commission give ``customers the opportunity to `opt out' of

allowing segregated funds to be used outside of the customer

accounts,'' so that ``customers can proactively protect their funds

from being used for potentially fraudulent purposes'' and when

``coupled with higher fees to help balance the trade off, customers

could determine the level of risk to which they are comfortable

subjecting their funds.'' \409\ The Commission notes that

[[Page 68552]]

these comments are outside the scope of this rulemaking.

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\408\ FCStone Comment Letter at 6 (Feb. 15, 2013).

\409\ NPPC Comment Letter at 2 (Feb. 15, 2013).

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FCStone objected to proposed Sec. 1.20(i), believing that the

Commission was mandating changing a customer's account balance to

record margin deficits, which they believe would impact the tax

treatment of customers' accounts.\410\ The Commission clarifies that

the proposed amendments were not intended to require any additional

charges to individual customer accounts, but to ensure that the FCM

separately tracked the sum of such amounts to ensure it was holding

residual interest in its segregated accounts greater than the gross

total of such undermargined amounts.

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\410\ FCStone Comment Letter at 4 (Feb. 15, 2013).

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10. Segregation Regimes

Several commenters proposed that language contained in customer

account agreements used by certain FCMs should be restricted by the

Commission. These commenters referred to clauses permitting customer

collateral to be pledged, liquidated or transferred by the FCM and

asked that the account agreements be viewed as contracts of adhesion

due to the necessity to agree to such clauses in order to open a

commodity futures trading account.\411\ These commenters, among other

issues, requested that the Commission limit the ability of FCMs to

require such contractual language.

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\411\ See Premier Metal Services Comment Letter at 2-3 (Jan. 1,

2013) and ISRI Comment Letter at 4-5 (Dec. 4, 2012), which letters

were cited and supported by several other commenters. See also Pilot

Flying J Comment Letter at 2 (Feb. 14, 2013), which stated that FCMs

should not be permitted to use customer funds for outside

investments, capitalization or collateralization.

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The Commission notes that any such contractual language does not

limit the applicability of the Act and Commission regulations with

respect to the treatment of customer property by FCMs. The customer

protection regime applies to all segregated customer funds regardless

of any broader contractual terms.

The specific ability of an FCM to pledge, liquidate or transfer

customer collateral is constrained by the Act and Commission

regulations regardless of any reference in a customer agreement to such

applicable law, or a lack of reference thereto. Section 4d is the

relevant provision of the Act that addresses how FCMs must hold

customer funds. Section 4d(a)(2) of the Act provides that each FCM must

treat and deal with all money, securities, and property received by the

FCM to margin, guarantee, or secure the trades or contracts of any

customer of the FCM, or accruing to such customer as the result of such

trades or contracts, as belonging to the customer. Section 4d(a)(2)

further provides that customer funds must be separately accounted for

and may not be commingled with the funds of the FCM, or be used to

margin or guarantee the trades or contracts, or to secure or extend

credit, of any customer or person other than the customer that

deposited the funds.

Commission regulations also set requirements on how customer funds

may be held. Regulation 1.20(a) provides that all customer funds must

be separately accounted for by the FCM and segregated as belonging to

commodity or option customers. The funds, when deposited with a bank,

trust company, clearing organization, or another FCM must be deposited

under an account name that clearly identifies the funds as belonging to

customers and shows that the funds are segregated from the FCM's own

funds as required by Section 4d(a)(2) of the Act. Regulation 1.20(c)

provides that each FCM must treat and deal with the customer funds of a

customer as belonging to the customer. The FCM must separately

accounted for customer funds and may not commingle the funds with the

FCM's own funds, or use the funds to margin, guarantee, or secure

futures positions of any person, or extend credit to any person, other

than the customer that owns the funds.

Regulation 1.25 sets forth requirements on how FCMs may invest

customer funds. Pursuant to Sec. 1.25, an FCM is permitted to use

customer funds to purchase permitted investments. The investments,

however, are required to be separately accounted for by the FCM under

Sec. 1.26, and segregated from the FCM's own assets in accounts that

designate the funds as belonging to customers of the FCM and held in

segregation as required by the Act and Commission regulations.

FCMs also may sell customer deposited securities under agreements

to repurchase the securities pursuant to Sec. 1.25(a)(2)(ii).

Regulation 1.25(d)(9) provides that the cash transferred to the

segregation account for customer-owned securities sold under a

repurchase agreement must be on a payment versus delivery basis, and

the customer segregated funds account must receive same-day funds

credited to the segregated account simultaneously with the delivery or

transfer of the securities from the customer segregated accounts. A

customer, however, may condition its deposits of securities with an FCM

by requiring that that FCM not engage in reverse repurchase

transactions with the customer's collateral.

Accordingly, FCMs do not have an unfettered ability to pledge,

rehypothecate, or otherwise use customer funds (including customer

deposited securities) for their own benefit or purposes. However, FCMs

also have the ability, as limited by all such applicable law and

regulation for the benefit of customers, to liquidate customer

securities if the customer that deposited the securities fails to meet

a margin call. FCMs also may pledge customer deposited securities to

DCOs as margin for the customer accounts carried by the FCM. The

customer collateral pledged to a DCO, however, also must be held in

customer segregated accounts.

Even if transformed as permissible under the Act and regulations

and contemplated by customer agreements, such collateral maintains its

character as segregated customer property and remains subject to the

customer protection regime. Commission staff has further confirmed that

there is variability in the FCM community regarding the specific

language included in customer account agreements and that not all

agreements include broad authorities to the FCM for the use of customer

collateral. However, as noted above, the contractual terms and

conditions could not result in an FCM holding or using customer funds

in a manner that was not in conformity with the Act and Commission

regulations.

Several commenters also requested that the Commission provide

alternatives to the current segregation regime, including individual

segregation, the ability to use third-party custodial accounts, or the

ability to opt-out of segregation.\412\ While these issues are beyond

the scope of the Proposal, the Commission notes that in adopting the

final regulations for the protection of Cleared Swaps Customer

Collateral in February 2012, it stated that the issue of alternative

segregation regimes raise important risk management and cost

externality issues, particularly in ensuring that deposited collateral

is immediately available to the FCM or DCO in the event of the default

of the customer or FCM.\413\ The Commission directed staff to continue

to analyze different proposals with the goal of developing a proposal

to provide additional or enhanced customer protection.\414\ In this

regard, staff is continuing to review and meet with

[[Page 68553]]

industry representatives regarding alternative segregation regimes.

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\412\ See, e.g., ISRI Comment Letter at 6 (Dec. 4, 2013); AIM

Comment Letter at 2-7 (Jan. 24, 2013); MFA Comment Letter at 9 (Feb.

15, 2013); State Street Comment Letter at 2 (Jan. 16, 2013).

\413\ 77 FR 6336, 6343 (Feb. 7, 2012).

\414\ Id.

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In addition, the Commission noted that customer funds held in

third-party custodial accounts constitute customer property within the

meaning of the Bankruptcy Code. As such, positions and collateral held

in third-party accounts are subject to the U.S. Bankruptcy Code and

applicable provisions of the Act, which provide for the pro rata share

of available customer property. The Commission also received several

comments requesting specific and defined protections for funds provided

to an FCM by retail counterparties engaged in off-exchange foreign

currency transactions.\415\ The Proposal, however, focused on customer

protection issues in the futures market, and the issue of the

protection of funds held by an FCM for retail foreign currency

counterparties is beyond the scope of the Proposal.

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\415\ See forex form letter group: Michael Krall; David Kennedy;

Robert Smith; Michael Carmichael; Andrew Jackson; Donald Blais;

Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink; Sam

Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po Huang;

Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe; Tracy

Burns; Treasure Island Coins; Clare Colreavy, Brandon Shoemaker.

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H. Sec. 1.22: Use of Futures Customer Funds

RCG commented that the proposed amendments to Sec. Sec. 1.22,

1.23, 30.7(f) and 30.7(g) are inconsistent as to when an FCM should use

its own funds to cover margin deficits with Sec. 1.30, which provides

that an FCM cannot make an unsecured loan to a customer.\416\ The

Commission does not believe that the regulations are inconsistent.

Regulation Sec. 1.30 provides that an FCM may not make a loan to a

customer, unless such loan is done a fully secured basis. Regulations

1.22 and 30.7(f) provide that an FCM cannot use the funds of one

customer to secure or extend credit to another customer. Regulations

1.23 and 30.7(g) impose conditions upon when an FCM may withdraw

proprietary funds from segregated accounts.

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\416\ RCG Comment Letter at 7 (Feb. 12, 2013).

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As discussed in greater detail in section II.G.9. above, the

Commission has considered the comments and has revised and reorganized

Sec. 1.22.

I. Sec. 1.23: Interest of Futures Commission Merchant in Segregated

Futures Customer Funds; Additions and Withdrawals

The Commission proposed amending Sec. 1.23 to require additional

safeguards with respect to an FCM withdrawing futures customer funds

from segregated accounts that are part of the FCM's residual interest

in such accounts.

Proposed Sec. 1.23(a) provides that an FCM may deposit

unencumbered proprietary funds, including securities from its own

inventory that qualify as permitted investments under Sec. 1.25, into

segregated futures customer accounts in order to provide a buffer or

cushion of funds to protect against the firm failing to maintain

sufficient funds in such accounts to meet its total obligations to

futures customers.

Under proposed Sec. 1.23(a), an FCM has access to its own funds

deposited into futures customer accounts to the extent of the FCM's

residual interest in such funds, subject to the restriction on

withdrawal of residual interest required to cover undermargined

amounts. However, proposed Sec. 1.23(b) prohibits an FCM from

withdrawing its residual interest or excess funds from futures customer

accounts (any withdrawal not made to or for the benefit of futures

customers would be considered a withdrawal of the FCM's residual

interest) on any given business day unless the FCM had completed the

daily calculation of funds in segregation pursuant to Sec. 1.32 as of

the close of the previous business day, and the calculation showed that

the FCM maintained excess segregated funds in the futures customer

accounts as of the close of business on the previous business day.

Proposed Sec. 1.23(b) further requires that the FCM adjust the excess

segregated funds reported on the daily segregation calculation to

reflect other factors, such as overnight and current day market

activity and the extent of current customer undermargined or debit

balances, to develop a reasonable basis to estimate the amount of

excess funds that remain on deposit since the close of business on the

previous day prior to initiating a withdrawal.

The Commission proposed additional required layers of authorization

and documentation if the withdrawal exceeds, individually or in the

aggregate with other such withdrawals, 25 percent or more of the FCM's

residual interest computed as of the close of business on the prior

business day. Proposed Sec. 1.23(c) prohibits an FCM from withdrawing

more than 25 percent of its residual interest in futures customer

accounts unless the FCM's CEO, CFO, or other senior official that is

listed as a principal on the firm's Form 7-R registration statement and

is knowledgeable about the FCM's financial requirements (``Financial

Principal'') pre-approves the withdrawal in writing.

Regulation 1.23(c) requires the FCM to immediately file a written

notice with the Commission and with the firm's DSRO of any withdrawal

that exceeds 25 percent of its residual interest. The written notice

must be signed by the CEO, CFO, or Financial Principal that pre-

approved the withdrawal, specifying the amount of the withdrawal, its

purpose, its recipient(s), and contain an estimate of the residual

interest after the withdrawal. The written notice also must contain a

representation from the person that pre-approved the withdrawal that to

such person's knowledge and reasonable belief, the FCM remains in

compliance with its segregation obligations. Regulation 1.23 further

requires that the official, in making this representation, specifically

consider any other factors that may cause a material change in the

FCM's residual interest since the close of business on the previous

business day, including known unsecured futures customer debits or

deficits, current day market activity, and any other withdrawals. The

written notice would be required to be filed with the Commission and

with the FCM's DSRO electronically.

Proposed Sec. 1.23(d) requires an FCM to deposit proprietary funds

sufficient to restore the residual interest targeted amount when a

withdrawal of funds from segregated futures customer accounts, not for

the benefit of the firm's customers, causes the firm to fall below its

targeted residual interest in such accounts. The FCM must deposit the

proprietary funds into such segregated accounts prior to the close of

the next business day. Alternatively, the FCM may revise its targeted

residual interest amount, if appropriate, in accordance with its

written policies and procedures for establishing, documenting, and

maintaining its target residual interest, in accordance with the

requirements of proposed Sec. 1.11. Proposed Sec. 1.23 also stated

that should an FCM's residual interest, however, be exceeded by the sum

of the FCM's futures customers' margin deficits (i.e., undermargined

amounts), an amount necessary to restore residual interest to that sum

must be deposited immediately. Identical requirements with respect to

procedures required for withdrawals of residual interest in Cleared

Swaps Customer Collateral Accounts and 30.7 secured accounts were

proposed in Sec. Sec. 22.17(c) and 30.7(g), respectively.

NFA commented recommending that the Commission revise the language

in Sec. 1.23 to keep it consistent with the language in NFA Financial

Requirements Section 16 (prohibiting withdrawals that are made ``not

for the benefit of commodity and option customers and foreign futures

and

[[Page 68554]]

foreign options customers'').\417\ NFA commented that without a

definition of ``proprietary use'' a withdrawal that may not be for an

FCM's own proprietary use may still be a withdrawal that is not for the

benefit of customers and, therefore, would trigger NFA's approval and

notice requirements pursuant to NFA Financial Requirements Section 16,

but not the Commission's approval and notice requirements pursuant to

Sec. 1.23.\418\ NFA also commented that the Commission should remove

proposed Sec. 1.23(d)'s reference to ``business days'' in order to

ensure that FCMs understand that the requirements related to

withdrawals of 25 percent or more apply at all times.\419\

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\417\ NFA Comment Letter at 14 (Feb. 15, 2013).

\418\ Id.

\419\ Id.

---------------------------------------------------------------------------

The Commission has considered NFA's comment and is revising Sec.

1.23 to remove the term ``proprietary use'' and is replacing it with

the concept of withdrawals that are not made to or for the benefit of

customers. The Commission also is revising Sec. 1.23 to remove the

reference to ``business days.'' The revisions will more closely align

the Commission's and NFA's regulations governing an FCM's withdrawal of

proprietary funds from a segregated account by making the language and

conditions more consistent. This consistency of the Commission and NFA

requirements is appropriate as it will allow FCMs to operate under one

set of conditions, while also retaining the overall policy goals of the

Commission to limit an FCM's ability to withdraw funds from segregated

accounts until the FCM can be reasonably assured that the funds are

excess, proprietary funds.\420\

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\420\ The Commission also is making comparable revisions to

Sec. Sec. 22.17(c) and 30.7(g) in light of NFA's comments.

---------------------------------------------------------------------------

NFA further requested the Commission to clarify that pre-approval

of a series of transactions that in the aggregate exceeded the 25

percent threshold would not require after the fact approvals of the

first transactions of the series, but only approvals of the

transactions resulting in the 25 percent threshold being exceeded.\421\

The Commission confirms that an FCM would need to obtain the necessary

approvals only for the transaction that caused the withdrawals to

exceed the 25 percent threshold.

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\421\ Id.

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Jefferies commented that it generally supported proposed amendments

to Sec. 1.23, but stated that requiring FCMs to report when they draw

down more than 25 percent of their residual interest will discourage an

FCM from voluntarily adding to its residual interest.\422\ Jefferies

commented that FCMs should be permitted to withdraw any residual

interest amount in excess of their target level and to withdraw up to

25 percent of the target level before providing notice, or if the last

calculated residual interest was below the target level, the

calculation should be 25 percent of the lower amount.\423\ LCH.Clearnet

and the FIA also recommended revising Sec. Sec. 1.23(d) and 22.17(c)

to apply only to withdrawal of FCM funds in excess of 25 percent of the

FCM's targeted residual interest, rather than on 25 percent of the

total residual interest in the customer segregated account,

specifically to ensure that FCMs have no disincentive to maintain

significant excess funds above the targeted residual interest

segregation at DCOs for swaps clearing.\424\

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\422\ Jefferies Comment Letter at 4-6 (Feb. 15, 2013).

\423\ Id.

\424\ LCH.Clearnet Comment Letter at 7 (Jan. 25, 2013); FIA

Comment Letter at 6 (Feb. 15, 2013).

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The Commission does not believe that substituting the targeted

residual amount for the actual residual interest amount would

appropriately focus management attention on significant withdrawals

relative to the actual, not just target, excess, as well as clearly

establish a chain of responsibility for such withdrawals, as is the

intended purpose of the proposed regulation. The Commission clarifies

that pre-approval would be required, with respect to a series of

transactions, for the transactions which would result in the threshold

being exceeded and not earlier transactions in the series. Accordingly,

the Commission is adopting Sec. 1.23 and the conforming provisions in

Sec. Sec. 22.17 and 30.7(g), with changes as recommended by NFA

substituting language ``not for the benefit of customers'' (with

description of customer as applicable to each such provision) for

``proprietary use'' and eliminating the reference to business

days.\425\

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\425\ See NFA Comment Letter at 14 (Feb. 15, 2013).

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In addition, and in light of the changes discussed herein with

respect to the residual interest requirements set forth in Sec. Sec.

1.22, 22.2, and 30.7, the Commission is amending Sec. 1.23 and the

conforming provisions in Sec. Sec. 22.17 and 30.7(g) to make clear

that if an FCM's residual interest is less than the amounts required to

be maintained in Sec. 1.22, 22.2(f)(6), or 30.7(f), as applicable, at

any particular point in time, the FCM must immediately restore the

residual interest to exceed the sum of such amounts.

J. Sec. 1.25: Investment of Customer Funds

1. General Comments Regarding the Investment of Customer Funds

Regulation 1.25 sets forth the financial investments that an FCM or

DCO may make with customer funds. The Commission received 32 comment

letters regarding the investment and handling of customer funds by FCMs

and DCOs.\426\ In general, all of the commenters supported the position

that FCMs and DCOs only be allowed to make safe/non-speculative

investments of customer funds and not be allowed to add risk that

customers are unaware of or do not sanction. More specifically, 29 of

the commenters proposed that the Commission amend its regulations to

provide commodity customers with the ability to ``opt out'' of granting

FCMs permission to invest their funds (including hypothecation and

rehypothecation).\427\ Additionally,

[[Page 68555]]

seven of the 29 commenters requested that the Commission also mandate

that an FCM cannot prevent a customer who so ``opts out'' from

continuing to trade through that FCM merely because the customer

elected to ``opt out.'' \428\

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\426\ Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche

Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14,

2013), Strelitz/California Metal X Comment (Jan. 15, 2013), Premier

Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment

Letter at 5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24,

2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba

Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter

(Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David

Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter

(Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012),

Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment

Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17,

2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders

Comment Letter (Dec. 17, 2012), Jeff Schlink Comment (Dec. 18,

2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman

Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec.

22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po Huang

Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter (Jan. 8,

2013), Vael Asset Management Comment Letter (Jan. 10, 2013), Kos

Capital Comment Letter (Jan. 11, 2013), James Lowe Comment Letter

(Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013),

Treasure Island Coins Comment Letter (Jan. 14, 2013), and Clare

Colreavy Comment Letter (Jan. 9, 2013).

\427\ NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal

Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at

5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke

Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter

(Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15,

2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy

Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec.

17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew

Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter

(Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012),

Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders

Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec.

18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew

Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter

(Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po

Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter

(Jan. 8, 2013), Vael Asset Management Comment Letter (Jan. 10,

2013), Kos Capital Comment Letter (Jan. 11, 2013), James Lowe

Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14,

2013), Treasure Island Coins Comment Letter (Jan. 14, 2013), and

Clare Colreavy Comment Letter (Jan. 9, 2013).

\428\ NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal

Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at

6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke

Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter

(Dec. 13, 2012); and Solomon Metals Corp Comment Letter (Jan, 15,

2013).

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The Commission did not propose to amend the list of permitted

investments set forth in Sec. 1.25, and believes that the current

investments and regulatory requirements establish an appropriate

balance between providing investment opportunities for FCMs with the

overall objective of protecting customer funds. As further discussed in

section II.L. below, the Commission also is amending Sec. 1.29 to

explicitly provide that an FCM is responsible for any losses resulting

from the investment of customer funds under Sec. 1.25.

The Commission further notes that the current regulatory structure

does not provide for a system whereby customers can elect to ``opt-

out'' of segregation or Sec. 1.25. In the event of the insolvency of

an FCM, where there also was a shortfall in customer funds, customers

would be entitled to a pro-rata distribution of customer property under

section 766 of the U.S. bankruptcy code.\429\ Therefore, even if a

customer was permitted by the FCM to ``opt-out'' of segregation, the

funds held by the FCM would be pooled with other customer funds and

distributed on a pro-rata basis to all customers participating in that

account class.

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\429\ 11 U.S.C. 766.

---------------------------------------------------------------------------

2. Reverse Repurchase Agreement Counterparty Concentration Limits

Regulation 1.25 provides that FCMs and DCOs may use customer funds

to purchase securities from a counterparty under an agreement for the

resale of the securities back to the counterparty (``reverse repurchase

agreements''). Regulation 1.25 places conditions on reverse repurchase

agreements, including, limiting counterparties to certain banks and

government securities brokers or dealers, and prohibiting an FCM or DCO

from entering into such agreements with an affiliate. Regulation

1.25(b)(3)(v) also imposes a counterparty concentration limit on

reverse repurchase agreements that prohibits an FCM or DCO from

purchasing securities from a single counterparty that exceeds 25

percent of the total assets held in segregation by the FCM or DCO.

The Commission proposed to amend Sec. 1.25(b)(3)(v) to require an

FCM or DCO to aggregate the value of the securities purchased under

reverse repurchase agreements if the counterparties are under common

control or ownership. The aggregate value of the securities purchased

under a reverse repurchase agreement from the counterparties under

common ownership or control could not exceed 25 percent of the total

assets held in segregation by the FCM or DCO. The Commission proposed

the amendment as it believed that the expansion of the counterparty

concentration limitation to counterparties under common ownership or

control is consistent with the original intent of the regulation, and

to minimize potential losses or disruptions due to the default of a

counterparty.

The Commission received comments from LCH.Clearnet and CFA in

support of the proposed amendments.\430\ No other comments were

received. The Commission is adopting the amendments as proposed.

---------------------------------------------------------------------------

\430\ LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013); CFA

Comment Letter at 6 (Feb. 13, 2013).

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K. Sec. 1.26: Deposit of Instruments Purchased With Futures Customer

Funds

Regulation 1.26 requires each FCM or DCO that invests customer

funds in instruments listed under Sec. 1.25 to separately account for

such instruments and to segregate the instruments from its own funds.

An FCM or DCO also must deposit the instruments under an account name

which clearly shows that they belong to futures customers and that the

instruments are segregated as required by the Act and Commission

regulations. The FCM or DCO also must obtain and retain in its files a

written acknowledgment from the depository holding the instruments

stating that the depository was informed that the instruments belong to

futures customers and that the instruments are being held in accordance

with the provisions of the Act and Commission regulations.

The Commission proposed amending Sec. 1.26 to specify how direct

investments by FCMs and DCOs in money market mutual funds (``MMMFs'')

that qualify as permitted investments under Sec. 1.25 must be held,

and to adopt a Template Letter to be used with respect to direct

investments in qualifying MMMFs. Like the proposed Template Letters for

Sec. Sec. 1.20 and 30.7, the proposed Template Letter for Sec. 1.26

contained provisions providing for read-only access and release of

shares upon instruction from the director of the Division of Clearing

and Risk, the director of the Division of Swap Dealer and Intermediary

Oversight, or any successor divisions, or such directors' designees.

With respect to the Template Letter for MMMFs, ICI noted that costs

to create electronic access to FCM accounts at an MMMF would be ``borne

by all investors and not just by FCMs,'' which likely only constitute a

small percentage of an MMMF's investors.\431\ As an alternative, ICI

proposed that the Template Letter be amended to require the MMMF to

provide FCM account data promptly (i.e., within 48 hours) upon

request.\432\ ICI also commented that the Commission should confirm:

(1) The ``examination or audit'' of the accounts authorized by the

acknowledgment letter is limited to verification of account balances

and that further inspection of an MMMF itself would be referred to the

SEC as primary regulator; and (2) the proposal would require only those

MMMFs in which FCMs directly invest customer funds (as opposed to those

held through intermediated positions like omnibus accounts or

intermediary-controlled accounts) to agree to provide FCM account

information.\433\

---------------------------------------------------------------------------

\431\ ICI Comment Letter at 4-5 (Jan. 14, 2013).

\432\ Id. at 5.

\433\ Id. at 4-6 (Jan.14, 2013).

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The Commission originally proposed one Template Letter, Appendix A

to Sec. 1.26, to be used by both FCMs and DCOs when investing customer

funds in an MMMF. However, as noted above in the discussion of the

Sec. 1.20 Template Letters, the Commission has determined to eliminate

the read-only access requirement for DCOs. Therefore, the Commission is

adopting different Template Letters for FCMs and DCOs in Sec. 1.26.

The Template Letter specific to FCMs is now set forth in Appendix A to

Sec. 1.26, and the Template Letter for DCOs is set forth in Appendix B

to Sec. 1.26. The Commission has made other modifications to the Sec.

1.26 Template Letters consistent with the modifications to the Sec.

1.20 Template Letters.

The Commission also confirms that examination of accounts

authorized by the acknowledgment letter would not involve regulation or

examination of the MMMF itself, over which the Commission does not have

supervisory or regulatory authority. The examination would be limited

to

[[Page 68556]]

verification of the account shares of the FCM or DCO, and the Template

Letters required under Sec. 1.26 are solely applicable to directly-

held investments in MMMFs. For the purpose of clarification, an FCM or

DCO that holds shares of an MMMF in a custodial account at a depository

(not directly with the MMMF or its affiliate) is required to execute

the Template Letter set forth in Appendix A or B of Regulation 1.20, as

applicable. In addition, a MMMF would be required to provide the

Commission with read-only access to accounts holding customer funds

only if the FCM directly deposits customer funds with the MMMF.

Proposed paragraph (b) of Sec. 1.26 has been modified to include a

reference to Appendix B to Sec. 1.20. Otherwise, the Commission is

adopting Sec. 1.26 as proposed.

L. Sec. 1.29: Increment or Interest Resulting From Investment of

Customer Funds

1. FCM's Responsibility for Losses Incurred on the Investment of

Customer Funds

Regulation 1.29 currently provides that an FCM or DCO is not

required to pass the earnings from the investment of futures customer

funds to the futures customers. An FCM or DCO may retain any interest

or other earnings from the investment of futures customer funds.

The Commission proposed to amend Sec. 1.29 to explicitly provide

that an FCM or DCO is responsible for any losses incurred on the

investment of customer funds. Investment losses cannot be passed on to

futures customers. As the Commission noted in the Proposal, an FCM may

not charge or otherwise allocate investment losses to the accounts of

the FCM's customers. To allocate losses on the investment of customer

funds would result in the use of customer funds in a manner that is not

consistent with section 4d(a)(2) and Sec. 1.20, which provides that

customer funds can only be used for the benefit of futures customers

and limits withdrawals from futures customer accounts, other than for

the purpose of engaging in trading, to certain commissions, brokerage,

interest, taxes, storage or other fees or charges lawfully accruing in

connection with futures trading.\434\ Section 4d(b) of the Act also

provides that it is unlawful for a DCO to use customer funds as

belonging to any person other than the customers of the FCM that

deposited the funds with the DCO. Accordingly, such investment losses

are the responsibility of the FCM or DCO, as applicable. Similar

regulations were proposed for Cleared Swaps Customer Collateral under

part 22 (Sec. 22.2(e)(1)), and for 30.7 customer funds under part 30

(Sec. 30.7(i)).

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\434\ 77 FR 67866, 67888.

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FIA and CFA supported the proposed amendments to Sec. 1.29.\435\

No other comments were received. The Commission adopts the amendments

to Sec. Sec. 1.29, 22.2(e)(1), and 30.7(i) as proposed.

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\435\ FIA Comment Letter at 30-31 (Feb. 15, 2013); CFA Comment

Letter at 6 (Feb. 13, 2013).

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2. FCM's Obligation in Event of Bank Default

The Commission requested comment on the extent of an FCM's

responsibility to cover losses in the event of a default of by a bank

holding customer funds. The CFA commented that FCM's should be

responsible as such an obligation will require that FCMs conduct

adequate due diligence on the banks in which they place customers'

funds, a factor that should limit the effect of a related future bank

failure.\436\

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\436\ CFA Comment Letter at 6 (Feb. 13, 2013).

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The FIA noted that the Commodity Exchange Authority issued an

Administrative Determination in 1971 setting out the appropriate

standard of liability for an FCM in the event of a bank default.\437\

The FIA also stated that the deposit of customer funds in a bank or

trust company is not an investment of customer funds under Sec. 1.25,

but is a requirement by the Act and Commission regulations.\438\ The

FIA stated that FCMs should not be strictly liable for a bank's

failure, and that to hold FCMs to such a standard would presume that

FCMs have the ability to know more about a bank than the regulatory

authorities responsible for overseeing the banks.\439\

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\437\ FIA Comment Letter at 32-33 (Feb. 15, 2013). The

Administrative Determination applies to both FCM and DCO deposits at

banks, and provides as follows:

To: Associate Administrator

Division Directors

Regional Directors

If a futures commission merchant or a clearing association

deposits regulated commodity customers' funds in a bank and the bank

is later closed and unable to repay the funds, the liability of the

futures commission merchant or clearing association would depend

upon the manner in which the account was handled. It would not be

liable if it had used due care in selecting the bank, had not

otherwise breached its fiduciary responsibilities toward the

customers, and had fully complied with the requirements of the

Commodity Exchange Act and the regulations thereunder relating to

the handling of customers' funds. If two banks were available in a

particular city only one of which was a member of FDIC and the

futures commission merchant or clearing association without a

compelling reason elected to use the nonmember bank, we would

contend that it had not used due care in its selection.

Administrative Determination No. 230 issued by Alex Caldwell,

Administrator, Commodity Exchange Authority (Nov. 23, 1971).

\438\ FIA Comment Letter at 32-33 (Feb. 13, 2013).

\439\ Id.

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The FIA further stated that the Commission's new Sec. 1.11 will

require each FCM to establish and enforce written policies and

procedures reasonably designed to assure compliance with the

segregation requirements. The policies and procedures also must include

a process for the evaluation of depositories, and a program to monitor

a depository on an ongoing basis, including a thorough due diligence

review of each depository at least annually. FIA notes that the

policies and procedures will be subject to Commission and DSRO review,

and that either the Commission or DSRO can direct the FCM to make any

changes to address identified weaknesses in the policies or procedures,

or in their enforcement.\440\

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\440\ Id.

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Advantage stated that the deposit of customer funds into a bank is

not an investment of the funds, and FCMs should be able to assume that

banks are properly vetted by the relevant banking and futures

regulatory authorities.\441\

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\441\ Advantage Comment Letter at 3 (Feb. 15, 2013).

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The Commission has considered the issue and believes the issue of

depository risk raises important legal and policy issues that were not

addressed in the Administrative Determination. There are considerable

reasons to question whether the Administrative Determination is

consistent with the CEA and the Commission's regulations thereunder.

Customers entrust their funds to FCMs, who are required by the Act and

Commission regulations to treat the funds as belonging to the

customers, to segregate the funds from the FCM's own funds, and to hold

such funds in specially designated accounts that clearly state that the

funds belong to commodity customers of the FCM and are being held as

required by the Act and Commission regulations. Customers do not select

the depositories to hold these funds; FCMs do. FCMs are responsible for

conducting the initial due diligence and ongoing monitoring of

depositories holding customer funds. Moreover, as a practical matter,

FCMs are in a better position than customers to perform these

functions, as well as in a better position than the customers

individually to make claim in the insolvency proceeding for the

depository.\442\

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\442\ By a parity of reasoning, this would also apply to

relationships between DCOs and FCMs. Indeed, it would be difficult

to see how a DCO would be liable for such losses, but an FCM would

not.

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[[Page 68557]]

Importantly, the AD fails to address the question of precisely

which customers are exposed to depository losses, and how much should

be allocated to each such customer. This question is particularly

important in the context of omnibus customer accounts permitted in the

futures industry. Would losses be allocated to persons who are

customers at the point the depository becomes insolvent, to persons who

were customers at any point the FCM maintained funds at the depository,

or to persons who were customers at the point the losses were

crystalized? Would losses be allocated to all customers, or could

certain favored customers avoid such exposure by negotiation? If the

depository lost only securities, would customers who deposited only

cash share in the loss? If the depository lost only cash, would

customers who deposited only securities share in the loss? Would

customers whose margin was all used to cover requirements at the DCO

share in losses of funds at a depository other than a DCO? Moreover,

would customers to whom losses were allocated share in dividends

recovered from the estate of the defaulting depository? How would such

customers have the practical opportunity to demonstrate their claims in

such a proceeding? How and when would such recoveries be distributed to

such customers? These practical questions, none of which was answered

in the Administrative Determination, call its wisdom into

question.\443\

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\443\ This discussion does not apply to funds that have been

deposited with a third-party depository selected by a customer.

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Accordingly, the Commission has directed staff to inquire into

these issues, and to develop an appropriate proposed rulemaking.

M. Sec. 1.30: Loans by Futures Commission Merchants: Treatment of

Proceeds

Regulation 1.30 provides that an FCM may lend its own funds to

customers on securities and property pledged by such customers, and may

repledge or sell such securities and property pursuant to specific

written agreement with such customers. This provision generally allows

customers to deposit non-cash collateral as initial and variation

margin. Absent the provision, an FCM may be required to liquidate the

non-cash collateral if the customer was subject to a margin call that

could not be met with other assets in the customer's account.

Regulation 1.30 further provides that the proceeds of loans used to

margin the trades of customers shall be treated and dealt with by an

FCM as belonging to such customers, in accordance with and subject to

the provisions of the Act and regulations.

The Commission proposed to amend Sec. 1.30 by adding that an FCM

may not lend funds to a customer for margin purposes on an unsecured

basis, or secured by the customer's trading account. The Commission

stated in the Proposal that it did not believe that FCMs extended

unsecured credit as a common practice, as the FCM would be required to

take a 100 percent charge to capital for the value of the unsecured

loan under Sec. 1.17. The Commission also noted that a trading account

did not qualify as collateral for the loan under Sec. 1.17 and the FCM

would have to take a charge to capital for the full value of the

unsecured loan. The Commission further noted that the proposed

amendment to Sec. 1.30 was consistent with CME Rule 930.G, which

provides that a clearing member may not make loans to account holders

to satisfy their performance bond requirements unless such loans are

secured by readily marketable collateral that is otherwise unencumbered

and which can be readily converted into cash.\444\

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\444\ See CME rulebook at www.cmegroup.com/rulebook/CME/I/9/9.pdf.

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RCG commented that it believes that the proposal prohibiting an FCM

from making unsecured loans to customers contradicts proposed Sec.

1.22 as it applies to funding customers' margin deficits.\445\ The

Commission notes that the requirement in Sec. 1.22 for an FCM to cover

an undermargined account with its own funds is intended to ensure that

the FCM complies with section 4d of the Act by not using the funds of

one futures customer to margin or guarantee the commodity interests of

another customer. The FCM is obligated under section 4d to maintain

sufficient funds in segregation to cover undermargined accounts. The

FCM, however, is not loaning funds to a particular customer as

performance bond is contemplated by Sec. 1.30. When the FCM deposits

proprietary funds into segregated accounts under Sec. 1.22, the FCM is

not loaning any particular customer funds, and the customers with an

undermargined account are not credited with an increase in their cash

balance.

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\445\ RCG Comment Letter at 4 (Feb. 12, 2013).

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Newedge also requested confirmation the proposed prohibition in

Sec. 1.30 preventing an FCM from loaning unsecured funds to a customer

to finance such customer's trading would not prohibit an FCM, when

computing a customer's margin requirement, from giving credit for the

customer's long option value. The Commission confirms that an FCM may

continue to consider a customer's long option value when computing such

customer's overall account value and margin requirements.\446\

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\446\ Newedge Comment Letter at 5 (Feb. 15, 2013).

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The Commission is adopting the amendments to Sec. 1.30 as

proposed.

N. Sec. 1.32: (Sec. 22.2(g) for Cleared Swaps Customers and Sec.

30.7(l) for Foreign Futures and Foreign Options Customers): Segregated

Account: Daily Computation and Record

The Commission proposed to amend Sec. 1.32 to require additional

safeguards with respect to futures customer funds on deposit in

segregated accounts, and to require FCMs to provide twice each month a

detailed listing to the Commission of depositories holding customer

funds.\447\

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\447\ The Commission also proposed amendments to Sec. 22.2(g)

and Sec. 30.7(l) to impose requirements for Cleared Swaps and

foreign futures and foreign options transactions, respectively, that

correspond to the proposed amendments for Sec. 1.32. The comments

for Sec. Sec. 1.32, 22.2(g), and 30.7(l) are addressed in this

section.

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Regulation 1.32 requires an FCM to prepare a daily record as of the

close of business each day detailing the amount of funds the firm holds

in segregated accounts for futures customers trading on designated

contract markets, the amount of the firm's total obligation to such

customers computed under the Net Liquidating Equity Method, and the

amount of the FCM's residual interest in the futures customer

segregated accounts. In performing the calculation, an FCM is permitted

to offset any futures customer's debit balance by the market value

(less haircuts) of any readily marketable securities deposited by the

particular customer with the debit balance as margin for the account.

The amount of the securities haircuts are as set forth in SEC Rule

15c3-1(c)(vi).

FCMs are required to perform the segregation calculation prior to

noon on the next business day, and to retain a record of the

calculation in accordance with Sec. 1.31. Both the CME and NFA require

their respective member FCMs to file the segregation calculations with

the CME and NFA, as appropriate, each business day. FCMs, however, are

only required to file a segregation calculation with the Commission at

month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-

registrant FCM/BDs). Regulation 1.12, as discussed in section II.C.

above, requires the FCM to provide immediate notice to the Commission

and to the firm's DSRO if the FCM is undersegregated at any time.

[[Page 68558]]

The Commission proposed to amend Sec. 1.32 to require each FCM to

file its segregation calculation with the Commission and with its DSRO

each business day. The Commission also proposed to amend Sec. 1.32 to

require FCMs to use the Segregation Schedule contained in the Form 1-

FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document its

daily segregation calculation.\448\

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\448\ Each FCM currently already submits a daily Segregation

Schedule to its DSRO pursuant to rules of the CME and NFA.

Therefore, the Commission's amendments are codifying current

regulatory practices for each FCM.

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As previously noted, the CME and NFA require their respective

member FCMs to file their segregation calculations with them on a daily

basis. The CME and NFA also require the FCMs to document their

segregation calculation using the Segregation Schedule contained in the

Form 1-FR-FCM. Therefore, the additional requirement of filing a

Segregation Schedule with the Commission is not a material change to

the regulation and is consistent with current practices.\449\

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\449\ In fact, since FCMs file the Segregation Schedules with

the CME and NFA via WinJammer, the Commission already has access to

the filings, and the amendment will not require an FCM to change any

of its operating procedures.

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The Commission stated in the Proposal that the filing of daily

Segregation Schedules by FCMs will enhance its ability to monitor and

protect customer funds as the Commission will be able to determine

almost immediately upon receipt of the Segregation Schedule whether a

firm is undersegregated and immediately take steps to determine if the

firm is experiencing financial difficulty or if customer funds are at

risk.\450\

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\450\ Each Form 1-FR-FCM and FOCUS Report is received by the

Commission via WinJammer. The financial forms are automatically

electronically reviewed within several minutes of being received by

the Commission and if a firm is undersegregated an alert is

immediately issued to Commission staff members via an email notice.

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The Commission also proposed to require an FCM to file its

Segregation Schedule with the Commission and with the FCM's DSRO

electronically using a form of user authentication assigned in

accordance with procedures established or approved by the Commission.

The Commission currently receives the Segregation Schedule

electronically via the WinJammer filing system and the proposal would

continue to require FCMs to submit the forms using WinJammer.

The Commission also proposed to amend Sec. 1.32(b) to provide that

in determining the haircuts for commercial paper, convertible debt

instruments, and nonconvertible debt instruments deposited by customers

as margin, the FCM may develop written policies and procedures to

assess the credit risk of the securities as proposed by the SEC and

discussed more fully in section II.F. above. If the FCM's assessment of

the credit risk is that it is minimal, the FCM may apply haircut

percentages that are lower than the 15 percent default percentage under

SEC Rule 15c3-1(c)(2)(vi).

The Commission also proposed to amend Sec. 1.32 by requiring each

FCM to file detailed information regarding depositories and the

substance of the investment of customer funds under Sec. 1.25.

Proposed paragraphs (f) and (j) of Sec. 1.32 require each FCM to

submit to the Commission and to the firm's DSRO a listing of every

bank, trust company, DCO, other FCM, or other depository or custodian

holding customer funds. The listing must specify separately for each

depository the total amount of cash and Sec. 1.25 permitted

investments held by the depository for the benefit of the FCM's

customers. Specifically, each FCM must list the total amount of cash,

U.S. government securities, U.S. agency obligations, municipal

securities, certificates of deposit, money market mutual funds,

commercial paper, and corporate notes held by each depository, computed

at current market values. The listing also must specify: (1) If any of

the depositories are affiliated with the FCM; (2) if any of the

securities are held pursuant to an agreement to resell the securities

to a counterparty (reverse repurchase agreement) and if so, how much;

and (3) the depositories holding customer-owned securities and the

total amount of customer-owned securities held by each of the

depositories.

Each FCM is required to submit the listing of the detailed

investments to the Commission and to the firm's DSRO twice each month.

The filings must be made as of the 15th day of each month (or the next

business day, if the 15th day of the month is not a business day) and

the last business day of the month. The filings are due to the

Commission and to the firm's DSRO by 11:59 p.m. on the next business

day.

Proposed paragraph (k) of Sec. 1.32 requires each FCM to retain

the Segregation Statement prepared each business day and the detailed

investment information, together with all supporting documentation, in

accordance with Sec. 1.31.

FIA generally supported the proposal.\451\ FIA noted that proposed

Sec. 1.32(a) requires an FCM to compute its daily segregation

requirement on a currency-by-currency basis, and requested that the

Commission confirm that a single Segregation Schedule can be completed

for each account class (i.e., futures customers funds, Cleared Swaps

Customers funds, and Sec. 30.7 customer funds) on a U.S. dollar-

equivalent basis. FIA further stated that the detail regarding the

investment of customer funds provided by NFA on its Web site is the

appropriate level of detail that should be made public because

additional detail would disclose proprietary financial and business

information.\452\

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\451\ FIA Comment Letter at 30 (Feb. 15, 2013).

\452\ Id. at 31.

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Jefferies supported the proposal, and recommended that the listing

of detailed investments should include all investments, including cash

and other investments, regardless of where the investments are held,

and should provide greater transparency for the FCMs' customers.\453\

MFA supported the proposed amendments to Sec. 1.32 to require FCMs to

provide the Commission and their DSROs with: (1) Daily reporting of the

segregation and part 30 secured amount computations; and (2) semi-

monthly reporting of the location of customer funds and how such funds

are invested under Sec. 1.25.\454\

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\453\ Jefferies Comment Letter at 4 (Feb. 15, 2013).

\454\ MFA Comment Letter at 3 (Feb. 15, 2013).

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The Commission has considered the comments and is adopting the

amendments to Sec. Sec. 1.32, 22.2(g), and 30.7(l) as proposed. In

response to Jefferies comment, the Commission notes that the proposed

and final regulation require an FCM to report all investments,

including cash and other investments, regardless of where the

investments are held.

In response to FIA's comment, the Commission does not believe that

a full disclosure of the investment of customer funds would disclose

proprietary information of the FCM. The Commission would require the

disclose of investment information in a manner consistent with the

current NFA disclosures, which includes, for each FCM, the percentage

of the invested customer funds that are held by banks, or invested in

U.S. government securities, bank certificates of deposit, money market

funds, municipal securities, and U.S. government sponsored enterprise

securities. The Commission, however, further believes that FCMs also

should disclose the amount of customer funds that are held by clearing

organizations and brokers. The Commission also believes that FCMs

should disclose the amount of customer-owned securities that are on

deposit as margin collateral, and information regarding repurchase

[[Page 68559]]

transactions involving customer funds or securities. The additional

disclosures will provide customers and the market with additional

information that may be relevant to their assessment of the risks of

placing their funds with a particular FCM. The Commission further notes

that it plans to work with the SROs to determine the most efficient and

effective method to disclose this information to the public.

The Commission also confirms that an FCM satisfies the requirement

of Sec. 1.32 if it prepares and submits to the Commission, and to its

DSRO, a consolidated Segregation Schedule for each account class on a

U.S. dollar-equivalent basis. The FCM, however, must prepare

segregation records on a daily basis on a currency-by-currency basis to

ensure compliance with Sec. 1.49, which governs how FCMs may hold

funds in foreign depositories. The FCM is not required under Sec. 1.32

to file the currency-by-currency segregation records with the

Commission or with its DSRO.

O. Sec. 1.52: Self-regulatory Organization Adoption and Surveillance

of Minimum Financial Requirements

SROs are required by the Act and Commission regulations to monitor

their member FCMs for compliance with the Commission's and SROs'

minimum financial and related reporting requirements. Specifically, DCM

Core Principle 11 provides, in relevant part, that a board of trade

shall establish and enforce rules providing for the financial integrity

of any member FCM and the protection of customer funds.\455\ In

addition, section 17 of the Act requires NFA to establish minimum

capital, segregation, and other financial requirements applicable to

its member FCMs, and to audit and enforce compliance with such

requirements.\456\

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\455\ 7 U.S.C. 7(d)(11).

\456\ 7 U.S.C. 21(p).

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The Commission also has established in Sec. 1.52 minimum elements

that each SRO financial surveillance program must contain to satisfy

the statutory objectives of Core Principle 11 and section 17 of the

Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt

and to submit for Commission approval rules prescribing minimum

financial and related reporting requirements for member FCMs. The rules

of the SRO also must be the same as, or more stringent than, the

Commission's requirements for financial statement reporting under Sec.

1.10 and minimum net capital under Sec. 1.17.

In addition, the Commission adopted final amendments to Sec. 1.52

on May 10, 2012, to codify previously issued CFTC staff guidance

regarding the minimum elements of an SRO financial surveillance

program.\457\ In order to effectively and efficiently allocate SRO

resources over FCMs that are members of more than one SRO, Sec.

1.52(c) currently permits two or more SROs to enter into an agreement

to establish a joint audit plan for the purpose of assigning to one of

the SROs (the DSRO) of the joint audit plan the function examining

member FCMs for compliance with minimum capital and related financial

reporting obligations. The audit plan must be submitted to the

Commission for approval. Currently all active SROs are members of a

joint audit plan that was approved by the Commission on March 18,

2009.\458\

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\457\ 77 FR 36611 (June 19, 2012).

\458\ The original signatories of the joint audit plan approved

on March 18, 2009 are as follows: Board of Trade of the City of

Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,

LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile

Exchange Inc.; Commodity Exchange, Inc.; ELX Futures, L.P.;

HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,

L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;

National Futures Association; New York Mercantile Exchange, Inc.;

NYSE Liffe US, L.L.C.; and One Chicago, L.L.C.

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The Commission proposed additional amendments to Sec. 1.52 to

enhance and strengthen the minimum requirements that SROs must abide by

in conducting financial surveillance. As the Commission explained in

the Proposal, these amendments are intended to minimize the chances

that FCMs engage in unlawful activities that result, or could result,

in the loss of customer funds or the inability of the firms to meet

their financial obligations to market participants. Proposed Sec.

1.52(a) added a definitions section identifying the terms

``examinations expert,'' ``material weakness,'' and ``generally

accepted auditing standards.''

The term ``examinations expert'' was defined as a ``nationally

recognized accounting and auditing firm with substantial expertise in

audits of futures commission merchants, risk assessment and internal

control reviews, and is an accounting and auditing firm that is

acceptable to the Commission.'' The Commission received several

comments regarding the opinion that the examinations expert is required

to provide on its review of the SRO programs, which is addressed in

section II.O.4 below. The Commission did not, however, receive comments

regarding the defined term ``examinations expert'' and is adopting the

definition as proposed.

The term ``material weakness'' was defined as ``as a deficiency, or

a combination of deficiencies, in internal control over financial

reporting such that there is a reasonable possibility that a material

misstating of the entity's financial statements and regulatory

computations will not be prevented or detected on a timely basis by the

entity's internal controls.'' The Commission has determined not to

adopt the definition of material weakness to eliminate the concern that

the SROs examinations are intended to replicate the financial statement

audits performed by public accountants under Sec. 1.16.

Proposed Sec. 1.52(b) requires each SRO to adopt rules prescribing

minimum financial and related reporting requirements, and requires its

member FCMs to establish a risk management program that is at least as

stringent as the risk management program required of FCMs under Sec.

1.11. Proposed amendments to Sec. 1.52 (c) requires each SRO to

establish a supervisory program to oversee their member FCMs'

compliance with SRO and Commission minimum capital and related

reporting requirements, the obligation to properly segregated customer

funds, risk management requirements, financial reporting requirements,

and sales practices and other compliance requirements. The supervisory

program must address: (1) Levels and independence of SRO examination

staff; (2) ongoing surveillance of member FCMs; (3) procedures for

identifying high-risk firms; (4) on-site examinations of member firms;

and (5) the documentation of all aspects of the supervisory program.

The supervisory program also must be based on an understanding of the

internal control environment to determine the nature, timing, and

extent of controls testing and substantive testing to be performed and

must address all areas of risk to which the FCM can reasonably be

foreseen to be subject. Proposed Sec. 1.52(c) also requires that all

aspects of the SRO's supervisory program must, at a minimum, conform to

generally accepted auditing standards after consideration to the

auditing standards issued by the PCAOB.

Proposed Sec. 1.52(c) also requires each SRO to engage an

``examinations expert'' at least once every two years to evaluate the

quality of the supervisory oversight program and the SRO's application

of the supervisory program. The SRO must obtain a written report from

the examinations expert with an opinion on whether the supervisory

program is reasonably likely to identify a material weakness in

internal controls over financial and/or regulatory reporting, and in

any of the other areas

[[Page 68560]]

that are subject to the supervisory program.

Proposed Sec. 1.52(d) provides that two or more SROs may enter

into an agreement to delegate the responsibility of monitoring and

examining an FCM that is a member of more than one SRO to a DSRO. The

DSRO would monitor the FCM for compliance with the Commission's and

SROs' minimum financial and related reporting requirements, and risk

management requirements, including policies and procedures relating to

the receipt, holding, investing and disbursement of customer funds.

The Commission received several comments on the proposed amendments

to Sec. 1.52 and, with the exception of the issues discussed below,

has determined to adopt the amendments as proposed.\459\

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\459\ MGEX stated that the Commission's Proposal generally

supports the current DSRO program by requiring FCMs to file various

reports and notices with the Commission and with the firms' DSROs.

MGEX further stated that the Commission should not create a

regulatory monopoly and should recognize that an SRO may not wish to

join the JAC. The Commission believes that each SRO has a right to

elect to perform the financial surveillance required under Sec.

1.52 directly or to participate in a joint audit agreement with

other SROs. In addition, Sec. 38.604 requires each SRO to have

rules in place that require member FCMs to submit financial

information to the SRO.

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1. Swap Execution Facilities Excluded From the Scope of Regulation 1.52

The Commission is revising the final Sec. 1.52 by adding a new

defined term, ``self-regulatory organization,'' to paragraph (a). The

term ``self-regulatory organization'' is defined in paragraph (a) to

mean, for purpose of Sec. 1.52 only, a contract market, as defined in

Sec. 1.3(h), or a registered futures association. The term ``self-

regulatory organization'' is further defined in paragraph (a) to

explicitly exclude a swap execution facility (``SEF''), as defined in

Sec. 1.3(rrrr).

The revision to definition of self-regulatory organization in Sec.

1.52 is necessary due to the recent amendments to the definition of

``self-regulatory organization'' set forth in Sec. 1.3(ee), which

defines the term as a contract market, as defined in Sec. 1.3(h), a

SEF, as defined in Sec. 1.3(rrrr), or a registered futures association

under section 17 of the Act.\460\ Therefore, since Sec. 1.52 applies

to each SRO, without including a definition for the term ``self-

regulatory organization'' under Sec. 1.52(a) that excludes SEFs, the

full provisions of Sec. 1.52 would apply to SEFs.

---------------------------------------------------------------------------

\460\ 77 FR 66288 (Nov. 2, 2012). Regulation 1.3 is the general

definitions provision of the Commission's regulations.

---------------------------------------------------------------------------

In adopting new regulations implement core principles and other

requirements for SEFs, the Commission did not require SEFs to adopt

minimum capital and related financial reporting requirements for its

member firms.\461\ The Commission further stated that a SEF's

obligation to monitor its member for financial soundness extended only

to a requirement to ensure that the members continue to qualify as

eligible contract participants as defined in section 1a(18) of the

Act.\462\ Therefore, the Commission previously has determined that the

extensive oversight program required of SROs that are contract markets

or registered futures associations by Sec. 1.52 is not applicable to

SEFs.

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\461\ 78 FR 33476 (June 4, 2013).

\462\ Id.

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2. Revisions to the Current SRO Supervisory Program

The Commission received several comments concerning the proposed

amendments to Sec. 1.52, many of which varied in support and context.

The NFA stated that it fully supports the requirement that the

supervisory program include both controls testing and substantive

testing, and that the examinations process be driven by the risk

profile of the FCM.\463\ NFA noted that it has been modifying its

procedures to enhance its examination of FCM internal controls as well

as substantive testing, and also has updated its risk system to create

risk profiles of each of its FCMs.\464\ NFA also agreed that SROs

should identify those FCMs that pose a high degree of potential risk so

that the SRO can increase its monitoring of those firms and that the

examinations should focus on the higher risk areas at each FCM.\465\

---------------------------------------------------------------------------

\463\ NFA Comment Letter at 3 (Feb. 15, 2013). See also Paul/

Weiss Comment Letter at 2 (Feb. 15 2013), BlackRock Letter at 3

(Feb. 15. 2013), and MFA Comment Letter at 4 (Feb. 15, 2013)

expressing general support for the proposed enhancements to the SRO

examinations program.

\464\ Id.

\465\ Id.

---------------------------------------------------------------------------

The CME and JAC generally did not support the proposed amendments

to Sec. 1.52, stating that the current limited role of regulatory

exams is appropriate as its purpose is not intended to give the same

level of assurances to the FCM, the FCM's investors, or third parties

as that which external auditors provide in conducting financial

statement audits of FCMs.\466\ The CME also stated that regulatory

reviews are not designed to protect investors in FCMs, nor should they

be.\467\ In addition, the CME believes that SROs and DSROs play

regulatory roles, and it is no more appropriate to have them report to

an audit committee of an FCM than it would be to have the Commission

itself report to that audit committee.\468\

---------------------------------------------------------------------------

\466\ CME Comment Letter at 8-9 (Feb. 15, 2013); JAC Comment

Letter at 2-4 (Feb. 14, 2013); JAC Comment Letter 2-4 (July 25,

2013).

\467\ CME Comment Letter at 11 (Feb. 15, 2013).

\468\ Id.

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The JAC stated that the SRO examinations are compliance reviews

focused on the particular and distinctive regulatory requirements and

associated risks of the futures industry, including whether FCMs are in

compliance with customer regulations and net capital requirements to

protect customers and the functioning of the futures industry.\469\ The

JAC further stated that incorporating the full risk management

requirements of Sec. 1.11 into the SRO's examinations of FCMs, and the

requirement that the SRO audit program address all areas of risk to

which FCMs can reasonably be foreseen to be subject, are overly broad

requirements that are impractical, and virtually impossible to

meet.\470\

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\469\ JAC Comment Letter at 2 (July 25, 2013).

\470\ Id. See also JAC Comment Letter at 5 (Feb. 14, 2013).

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The JAC further stated that proposed Sec. 1.52 imposes potential

duplicative oversight of FCM risk management policies and procedures by

SROs and DCOs. The JAC noted that Sec. 39.13(h)(5) requires a DCO to

review the risk management policies, procedures, and practices of each

of its clearing members.\471\ The JAC requested clarification on the

oversight responsibilities of SROs and DCOs to address potential

duplicative requirements.\472\ Lastly, the JAC stated that expanding

the SRO oversight program to include operational and technical risks

will require additional expertise, time and resources to perform such

reviews and will result in increased costs.\473\

---------------------------------------------------------------------------

\471\ Id.

\472\ Id.

\473\ Id. The JAC noted that the examination of the controls and

risk management policies and procedures over an FCM's technology

systems would require particular expertise that is different from

the knowledge and expertise or regulatory staff, and that SROs will

have to hire specialized examiners to conduct such reviews.

---------------------------------------------------------------------------

The Commission believes that the CME, NFA, JAC, SROs and DSROs play

a critical role in examining FCMs and other registrants under the self-

regulatory structure of the futures industry. Recent events, however,

demonstrate that the SROs' current focus on CFTC and SRO regulatory

requirements, including segregation and net capital computations, are

not in and of themselves adequate to assess risk and protect customers

of the FCM. For instance, a failure in an FCM's non-futures operations

may pose risks to

[[Page 68561]]

futures customers and the operation of an FCM. In addition, technology

failures at an FCM also may pose risks to the operation of an FCM and

the overall protection of customer funds. Accordingly, to properly

monitor and assess risks to the FCM, the SRO must be aware of non-

futures related activities of the FCM.

Recent events also demonstrate that the examinations of FCMs must

be risk based and that the testing must be based on an understanding of

the registrant's internal control environment to determine the nature,

timing and extent of the necessary tests. In order to help ensure an

appropriate risk based exam is performed, an examiner must take into

account the risk profile of the firm and build the examination program

accordingly. For example, if a firm has weak controls over cash, the

risk of inaccurate accounting for cash movements is greater and

therefore more detailed substantive testing of cash transactions and

balances is necessary to provide the examiner with sufficient assurance

that reported balances are accurate. To the contrary, if controls are

good over cash then less substantive testing is needed.

The Commission acknowledges that revised Sec. 1.52 imposes new

obligations on SROs by requiring their supervisory programs to include

an assessment of whether member FCMs comply with the risk management

requirements of Sec. 1.11. However, Sec. 1.52 also requires that the

SRO's examination of FCMs be performed on a risk-based approach. The

scope of the examinations should be based upon the SRO's assessment of

risk at the FCM and full, detailed testing is not mandated by Sec.

1.52 in each area. Lastly, the Commission recognizes that DCOs impose

certain risk management requirements on clearing FCMs and are required

to review the operation of such risk management requirements. While

Sec. 39.13(h)(5) is directed at risk that an FCM may pose to a DCO

and, therefore, is more narrowly focused than the risk management

requirements in Sec. 1.11, SROs may coordinate with a DCO to ensure

that duplicative work is not being performed by the separate

organizations.\474\

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\474\ Under the current JAC structure, the CME is the only

entity that is both an SRO that performs periodic examinations of

FCMs and a DCO that has responsibilities under Sec. 39.13(h)(5) to

perform risk management on clearing FCMs.

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3. Auditing Standards Utilized in the SRO Supervisory Program

Proposed Sec. 1.52(c)(2)(ii) and (d)(2)(ii)(F) require all aspects

of an SRO's or DSRO's, supervisory program to conform, at a minimum, to

U.S. GAAS after giving full consideration to the auditing standards

issued by the PCAOB. NFA, CME, and JAC questioned what is meant by the

term ``after giving full consideration of auditing standards prescribed

by the PCAOB.'' \475\ NFA, CME, and JAC did not agree with basing the

SRO Supervisory Program framework on either U.S. GAAS or PCAOB

standards, largely because the DSRO does not issue a report that

expresses an opinion with respect to the FCM's financial statements or

issue an Accountant's Report on Material Inadequacies.\476\

Additionally, CME noted that invoking U.S. GAAS and PCAOB standards

opens up a complex and detailed regulatory structure, which includes a

framework allowing auditor's to rely on interpretive publications,

professional journals and auditing publications from state CPA

societies, none of which were designed to address the regulatory

function played by an SRO or DSRO.\477\ However, NFA acknowledged that

certain U.S. GAAS and PCAOB accounting standards and practices should

be followed by DSROs in performing their regulatory examinations (e.g.,

those standards focusing on recordkeeping, training and experience, the

scope of the examination and testing, the confirmation process, and

other related examination practices).\478\

---------------------------------------------------------------------------

\475\ NFA Comment Letter at 3 (Feb. 15, 2013); CME Comment

Letter at 9-10 (Feb. 15, 2013); JAC Comment Letter at 2-3 (Feb 14,

2013).

\476\ Id.

\477\ CME Comment Letter at 9-10 (Feb. 15, 2013).

\478\ NFA Comment Letter at 3-4 (Feb. 15, 2013).

---------------------------------------------------------------------------

The Commission notes that the objective of the Proposal was to

ensure that the SRO examinations are conducted consistent with the

professional standards that CPAs and others are subject to in

conducting their examinations. The Commission recognizes that certain

U.S. GAAS principles and PCAOB principles would not be applicable to

the SRO examinations (such as principles addressing reporting, which

provide that the CPA must state whether the financial statements are

prepared in accordance with Generally Accepted Accounting Principles).

However, other U.S. GAAS and PCAOB standards would be relevant to SRO

examinations. Such principles include standards addressing the

competency and proficiency of the examinations staff and the obtaining

and documenting of adequate audit evidence to support the examiner's

conclusions.

The Commission has considered these comments and has revised the

proposed language to state that at a minimum, an examination should

conform to PCAOB auditing standards to the extent such standards

address non-financial statement audits. While it is acknowledged that

PCAOB audit standards are directed at financial statement audits, the

concept of many of the standards are just as applicable to an

examination performed by an SRO or DSRO, and as such should be adopted

in that light. The relevant PCAOB standards would include, but are not

limited to, the training and proficiency of the auditor, due

professional care in the performance of the work, consideration of

fraud in an audit, audit risk, consideration of materiality in planning

and performing an audit, audit planning, identifying and assessing

risks of material misstatement, the auditor's responses to the risk of

material misstatement, audit documentation, evaluating the audit

results, communications with audit committees, and due professional

care in the performance of work. In developing the supervisory program,

consideration should also be given to other related guidance such as

the standards adopted by the Institute of Internal Auditors (Standards

& Guidance--International Professional Practices Framework) and the

Policy Statement and Supplemental Policy Statement on the Internal

Audit Function and its Outsourcing issued by the Board of Governors of

the Federal Reserve System, and generally accepted auditing standards

issued by the American Institute of Certified Public Accountants.\479\

---------------------------------------------------------------------------

\479\ The Commission is revising final Sec. 1.52 to remove from

paragraph (a) a definition for the term ``U.S. Generally accepted

auditing standards'' as that term is no longer contained in the

final regulation.

---------------------------------------------------------------------------

4. ``Examinations Expert'' Reports

Proposed Sec. 1.52(c)(2)(iv) and (d)(2)(ii)(I) require each SRO

and DSRO, respectively, to engage an examinations expert to evaluate

the SROs or DSROs programs and to express an opinion as to whether the

program is reasonably likely to identify a material deficiency in

internal controls over financial and/or regulatory reporting and in any

of the other areas that are subject to SRO or DSRO review under the

programs. The JAC, CME, Center for Audit Quality, Ernst & Young, and

PWC did not support the ``examinations expert'' requirement.\480\

Several of these commenters expressed concern that the term

``examinations expert'' as defined

[[Page 68562]]

by Sec. 1.52 imposes a criterion that most CPA firms may not possess

or would not be willing to issue such a report.\481\ Moreover, NFA,

JAC, and MGEX stated that requiring an ``examinations expert'' is

unnecessary and duplicative of already existing Commission

responsibilities, noting that the JAC provides the examination programs

to the Commission annually, and that the Commission can perform a

review of the examination programs.\482\

---------------------------------------------------------------------------

\480\ JAC Comment Letter at 3-4 (Feb. 14, 2013); Center for

Audit Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young

Comment Letter at 3-4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan.

15, 2013).

\481\ CME Comment Letter at 13 (Feb. 15, 2013); Center for Audit

Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young Comment

Letter at 3-4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan. 15,

2013).

\482\ NFA Comment Letter at 4-5 (Feb. 15, 2013); JAC Comment

Letter at 4 (Feb. 14, 2013) MGEX Comment Letter at 3-4 (Feb. 18,

2013).

---------------------------------------------------------------------------

NFA and JAC suggested, as cost effective and more practical

solution, inviting individuals meeting the ``examinations expert''

designation to participate in the already existing JAC audit committee

meetings.\483\ CME suggested that if the proposed structure is adopted,

the time frame for review be extended from 18 months to 3\1/2\ years,

matching that required by the AICPA in its Peer Review program.\484\

---------------------------------------------------------------------------

\483\ NFA Comment Letter at 4-5 (Feb. 15, 2013); JAC Comment

Letter at 4 (Feb. 14, 2013).

\484\ CME Comment Letter at 13 (Feb. 15, 2013).

---------------------------------------------------------------------------

The Commission has taken these comments into consideration and has

revised the final regulation by providing that the report of the

examinations expert should conform to the consulting services standards

of the AICPA. The Commission recognizes that generally accepted

auditing standards do not provide a reporting framework by which a

certified public accountant can issue an audit opinion consistent with

the requirements contained in Sec. 1.52. Accordingly, the Commission

has revised the final regulation by removing the requirement that the

examinations expert provide an audit opinion.

The Commission also does not believe that it is in a position to

perform the type of review of the SRO examination reports required by

Sec. 1.52 given its limited resources. Furthermore, the examinations

expert is an independent party with expert knowledge of risk assessment

and internal controls reviews and will be able to provide more thorough

and detailed review of the joint audit program than Commission staff

can currently devote to such a review. In addition, the Commission

staff has communicated to the JAC that it would be very supportive of

having the accounting and auditing experts join the JAC meetings to

discuss current industry issues.

The Commission has also considered the impact of performing such a

review every two years and has modified the proposal to require such a

report on a three year basis. This reflects the fact that the DSROs

will be updating their programs as needed and therefore the program

should not be stagnant during the intervening years. Finally, it was

pointed out that given the nature of the report and to facilitate an

open and frank dialogue amongst the examinations expert, the DSROs, and

the Commission, such report should be considered confidential. The

Commission is revising the regulation to provide that the report is

confidential, which is consistent with how the PCAOB conducts its

reviews of CPA firms.

P. Sec. 1.55: Public Disclosures by Futures Commission Merchants

Regulation 1.55(a) currently requires an FCM, or an IB in the case

of an introduced account, to provide a customer with a separate written

risk disclosure statement prior to opening the customer's account

(``Risk Disclosure Statement''). Regulation 1.55(a) also provides that

the Risk Disclosure Statement may contain only the language set forth

in Sec. 1.55(c) (with an exception for non-substantive additions such

as captions), except that the Commission may authorize the use of Risk

Disclosure Statements approved by foreign regulatory agencies or self-

regulatory organizations if the Commission determines that such Risk

Disclosure Statements are reasonably calculated to provide the

disclosures required by the Commission under Sec. 1.55.\485\

Regulation 1.55(a) further requires the FCM or IB to receive a signed

and dated statement from the customer acknowledging his or her receipt

and understanding of the Risk Disclosure Statement.\486\

---------------------------------------------------------------------------

\485\ The Commission has previously approved an alternative

``generic'' risk disclosure statement for use in the United Kingdom,

Ireland and the U.S.

\486\ FCMs and IBs are permitted to open commodity futures

accounts for ``institutional customers'' pursuant to Sec. 1.55(f)

without furnishing such institutional customers with a Risk

Disclosure Statement or obtaining the written acknowledgment

required by Sec. 1.55. The term ``institutional customer'' is

defined by Sec. 1.3(g) and section 1a of the Act as an eligible

contract participant. The Commission did not propose to amend Sec.

1.55(f) to require FCMs or IBs to furnish institutional customers

with Risk Disclosure Statements.

---------------------------------------------------------------------------

The Commission reviewed the adequacy of the current prescribed Risk

Disclosure Statement in light of its experience with customer

protection issues during the recent failures of two FCMs, MFGI and

PFGI. In this regard, in responding to questions and issues raised

primarily by non-institutional market participants, including market

participants from the agricultural community and retail market

participants, the Commission recognized that such market participants

would benefit from several additional disclosures regarding the

potential general risks of engaging in futures trading through an FCM,

and the potential specific risks resulting from the bankruptcy of an

FCM. In addition to proposing new general risk disclosures, the

Commission proposed to also require each FCM to provide customers and

potential customers with information about the FCM, including its

business, operations, risk profile, and affiliates. The firm specific

disclosures are intended to provide customers with access to material

information regarding an FCM to allow the customers to independently

assess the risk of entrusting funds to the firm or to use the firm for

the execution of orders.

1. Amendments to the Risk Disclosure Statement

The mandatory Risk Disclosure Statement currently addresses the

risks of engaging in commodity futures trading. The risks that must be

disclosed include: (1) The risks that a customer may experiences losses

that exceed the amount of funds that he or she contributed to trading

and that the customer may be responsible for losses beyond the amount

of funds deposited for trading; (2) the risks that under certain market

conditions, a customer may find it difficult or impossible to liquidate

a position, such as when a market has reached a daily price move limit;

(3) the risks that placing certain contingent orders (such as a stop

limit order) may not necessarily limit the customer's losses; (4) the

risks associated with the high degree of leverage that may be

obtainable from the futures markets; and (5) the risks of trading on

non-U.S. markets, which may not provide the same level of protections

provided under Commission regulations.

As noted above, the Commission proposed several additional

disclosures based upon its experience in working with customers,

particularly retail and other non-institutional market participants,

during the recent failures of MFGI and PFGI. Specifically, the

Commission proposed to amend the Risk Disclosure Statement to provide

market participants with more information regarding the risks

associated with an FCM holding customer funds. In this regard, certain

market participants believed that the fact that their funds were

segregated from the FCM's proprietary funds protected them from loss in

the event of

[[Page 68563]]

an FCM bankruptcy. Other customers believed that a DCO guaranteed

customer losses, and other customers believed that funds deposited for

futures trading were protected by the Securities Investor Protection

Corporation in the event of an FCM/BD bankruptcy.

To provide greater clarity as to the how customer funds are held

and the potential risks associated with FCMs holding customer funds,

the Commission proposed to revise the Risk Disclosure Statement by

amending Sec. 1.55(b) to include new paragraphs (2) through (7) as

follows:

(2) The funds you deposit with an FCM for trading futures positions

are not protected by insurance in the event of the bankruptcy or

insolvency of the futures commission merchant, or in the event your

funds are misappropriated due to fraud;

(3) The funds you deposit with an FCM for trading futures positions

are not protected by the Securities Investor Protection Corporation

even if the futures commission merchant is registered with the SEC as a

BD;

(4) The funds you deposit with an FCM are not guaranteed or insured

by a DCO in the event of the bankruptcy or insolvency of the FCM, or if

the FCM is otherwise unable to refund your funds;

(5) The funds you deposit with an FCM are not held by the FCM in a

separate account for your individual benefit. FCMs commingle the funds

received from customers in one or more accounts and you may be exposed

to losses incurred by other customers if the FCM does not have

sufficient capital to cover such other customers' trading losses;

(6) The funds you deposit with an FCM may be invested by the FCM in

certain types of financial instruments that have been approved by the

Commission for the purpose of such investments. Permitted investments

are listed in Commission Regulation 1.25 and include: U.S. government

securities; municipal securities; money market mutual funds; and

certain corporate notes and bonds. The FCM may retain the interest and

other earnings realized from its investment of customer funds. You

should be familiar with the types of financial instruments that an FCM

may invest customer funds in; and

(7) FCMs are permitted to deposit customer funds with affiliated

entities, such as affiliated banks, securities brokers or dealers, or

foreign brokers. You should inquire as to whether your FCM deposits

funds with affiliates and assess whether such deposits by the FCM with

its affiliates increases the risks to your funds.

The Commission received several comments on the proposed amendment

to the Risk Disclosure Statement. NFA stated that it fully supported

the Commission's goal of ensuring that customers receive a full

description of the risk associated with futures trading, and agreed

with the Commission that it is important to update the Risk Disclosure

Statement to provide information on the extent to which customer funds

are protected when deposited with an FCM as margin or to guarantee

performance for trading commodity interest.\487\

---------------------------------------------------------------------------

\487\ NFA Comment Letter at 15 (Feb. 15, 2013).

---------------------------------------------------------------------------

The FIA generally supported the proposed amendments to the general

Risk Disclosure Statement set forth in Sec. 1.55(b) and outlined

above.\488\ The FIA stated that many of the Commission's proposed

amendments are consistent with FIA's recommendations to enhance

disclosures set forth in its paper, ``Initial Recommendations for the

Protection of Customer Funds,'' which was published on February 28,

2012 (``Initial Recommendations'') in response to MFGI.\489\ FIA also

stated that its document, ``Protection of Customer Funds--Frequently

Asked Questions,'' is being used by FCMs to provide customers with

increased disclosures on the scope of how the laws and regulations

protect customers in the futures market.\490\

---------------------------------------------------------------------------

\488\ FIA Comment Letter at 41 (Feb. 15, 2013).

\489\ FIA Comment Letter at 2 (Feb. 15, 2013). The FIA formed a

special committee to develop and recommend specific measures that

could be implemented by both the industry best practices and

regulatory change to address the issues arising from the bankruptcy

of MFGI.

\490\ Id. FIA's ``Protection of Customer Funds--Frequently Asked

Questions'' provides information covering five broad areas: (1)

segregation of customer funds; (2) collateral management and

investments; (3) basic information on FCMs, such as the purpose of

capital requirements and margin processing: (4) issues for joint

FCM/BDs; and (5) the role of the DCO guarantee fund.

---------------------------------------------------------------------------

With respect to the Commission's proposed amendments to Sec.

1.55(b), FIA recommended that the Commission delete the phrase ``due to

fraud'' in Sec. 1.55 (b)(2) because customer funds may be

misappropriated for any reason.\491\ Additionally, FIA suggested the

disclosure in Sec. 1.55(b)(4) be revised to take account of the CME

Group Family Farmer and Rancher Protection Fund established in the wake

of MFGI as this fund will provide up to $25,000 to qualifying

individual farmers and ranchers and $100,000 to co-ops that hedge their

risk in CME futures markets.\492\

---------------------------------------------------------------------------

\491\ Id. at 41.

\492\ Id. at 41-42.

---------------------------------------------------------------------------

The Commission has considered FIA's comments and had determined to

revise the proposal. The Commission recognizes that customer funds may

be misappropriated as a result of wrongful conduct that does not rise

to the level of fraud. Accordingly, the Commission is revising Sec.

1.55(b)(4) by removing the phrase ``due to fraud'' so that the

disclosure provides that customers' funds are not covered by insurance

in the event of the insolvency of the FCM or in the event the funds are

misappropriated.

The Commission also is revising final Sec. 1.55(b)(4) in response

to FIA's comment to provide an overall statement that customer funds

generally are not insured by DCOs. The Commission is further revising

final Sec. 1.55(b)(4) to include in the disclosure the fact that a DCO

may offer an insurance program, and that a customer should inquire of

the FCM the extent of any DCO insurance programs and whether the

customer would qualify for coverage and understand the limitations and

benefits of the coverage. The Commission believes that this approach is

more flexible to address future developments in this area than a direct

reference to specific DCO insurance programs that currently are

available.

NEFI/PMAA questioned whether or not existing and proposed

disclosures are sufficient, and further stated that disclosure of

customer protections are equally important as the disclosure of

potential risks to ensure customer confidence.\493\ Pilot Flying J

stated FCMs must be required to disclose information to their customers

on how their accounts and positions will be managed, as well as

associated risks and what kinds of financial protections are afforded

to customers by the firm, exchange, and the Commission.

---------------------------------------------------------------------------

\493\ NEFI/PMAA Comment Letter at 2 (Jan. 14, 2013).

---------------------------------------------------------------------------

The Commission agrees with NEFI/PMAA and Pilot Flying J that a

customer's understanding of the protections is as important as

understanding the risks. The Risk Disclosure Statement is the minimum

information that an FCM should provide to prospective customers, and is

intended to provide a high level summary of the general risk of trading

commodity interests. FCMs should provide additional information as

necessary to ensure that customers have adequate information. The

Commission believes that FIA's Initial Recommendation and FAQ, which

includes the types of information that NEFI/PMAA and Pilot Flying J are

requesting, should be made available to all potential customers. FIA

should revise the documents, as appropriate, in

[[Page 68564]]

response to changing market events or other factors.

The Commission also requested comment on whether and how the new or

revised Risk Disclosure Statement should be provided to existing

customers at the effective date of the regulation. Particularly, the

Commission requested comment on whether FCMs should be required to

obtain new signature acknowledgments from existing customers.

FIA stated that it was not opposed to a requirement that FCMs

provide the revised Risk Disclosure Statement to existing customers

that are otherwise required to receive the disclosure document.\494\

FIA stated, however, that FCMs should not be required to obtain a

written acknowledgment from existing customers. FIA further stated that

it should be sufficient if the FCM makes each customer aware of the

revised Risk Disclosure Statement by any appropriate means, consistent

with the means by which the FCM normally communicates important

information to customers, including but not limited to, a separate

mailing.\495\ The CFA stated that it is very important for FCMs and

their DSROs to ascertain whether existing and potential customers have

acknowledged receipt of the Risk Disclosure Statement, and FCMs should

keep records of acknowledgments that the Risk Disclosure Statements

were received.\496\ NGFA noted that providing updated risk disclosure,

with signed acknowledgment of such to the FCM, is a sound concept.\497\

---------------------------------------------------------------------------

\494\ FIA Comment Letter at 42-43 (Feb. 15, 2013).

\495\ Id.

\496\ CFA Comment Letter at 8 (Feb. 13, 2013).

\497\ NGFA Comment Letter at 5 (Feb. 15, 2013).

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Regulation 1.55(a) will continue to require FCMs to obtain and

retain signed acknowledgments from new customers that they received and

understand the Risk Disclosure Statement. With respect to existing FCM

customers on the effective date of the regulation, the Commission

believes that it is adequate for an FCM to provide each of the

customers with a revised Risk Disclosure Statement via its normal means

of communicating with customers, including the use of a separate

mailing, or providing a link on the firm's Web site to the revised Risk

Disclosure Statement, provided that the FCM provides a paper copy of

the Risk Disclosure Statement upon the request of a customer. The

communication of the revised Risk Disclosure Statement to customers

must be highlighted by the FCM in such a manner to reasonably ensure

that the customers are adequately apprised of the revised Risk

Disclosure Statement.

FIA also noted that the Commission previously approved, pursuant to

Sec. 1.55(c), an alternative risk disclosure statement for use in the

U.S., the United Kingdom, and Ireland.\498\ The alternative risk

disclosure statement is set forth in Appendix A to Sec. 1.55. FIA

requested that the Commission confirm whether FCMs may continue to use

the alternative risk disclosure statement and further encouraged the

Commission to coordinate with other derivatives regulatory authorities

to revise the alternative risk disclosure statement to meet its

regulatory objectives.\499\

---------------------------------------------------------------------------

\498\ FIA Comment Letter at 43 (Feb. 15, 2013).

\499\ Id.

---------------------------------------------------------------------------

Regulation 1.55(c) provides that the Commission may approve for use

in lieu of the standard Risk Disclosure Statement required by Sec.

1.55(b) a risk disclosure statement approved by one or more foreign

regulatory agencies or self-regulatory organizations if the Commission

determines that such risk disclosure statement is reasonably calculated

to provide the disclosure required by the standard Risk Disclosure

Statement. As noted above, the Commission proposed amendments to the

Risk Disclosure Statement due to its recent experiences with the MFGI

and PFGI insolvencies where certain customers, particularly less

sophisticated customers, did not fully comprehend the nature of the

protections of customer funds. Based upon this recent experience, the

Commission does not believe that the disclosures in the alternative

risk disclosure statement contained in Appendix A provide sufficient

detailed disclosures to customers regarding the risk of trading futures

transactions. Accordingly, the Commission is revising Sec. 1.55(c) to

provide that an FCM may continue to use the alternative risk disclosure

statement provided that the FCM also provides each customer required to

receive a disclosure document with the revised Risk Disclosure

Statement and receives such customer's written acknowledgment that it

has received and understands the Risk Disclosure Statement. This will

allow FCMs to continue to have a common risk disclosure statement with

the United Kingdom and Ireland, and also ensure that customers receive

additional risk disclosures to enhance their understanding of engaging

in futures trading.

a. Firm Specific Disclosure Document

i. General Requirements

The Commission proposed new paragraphs (i) and (k) to Sec. 1.55 to

provide that an FCM may not enter into a customer account agreement or

accept funds from a customer unless the FCM discloses to the customer

all information about the FCM, including its business, operations, risk

profile, and affiliates, that would be material to the customer's

decision to entrust such funds to such FCM and otherwise necessary for

full and fair disclosure to customers (``Firm Specific Disclosure

Document'').

The Firm Specific Disclosure Document is intended to enable

customers to make informed judgments regarding the appropriateness of

selecting an FCM by providing information for the meaningful

comparisons of business models and risks across FCMs. Such information

will greatly enhance the due diligence that a customer can conduct both

prior to opening an account and on an ongoing basis, as the proposal

will require the FCM to update the Firm Specific Disclosure Document at

least once every 12 months and as and when necessary to keep it

accurate and complete. The Commission believes that the proposed firm

specific Firm Specific Disclosure Document, coupled with the existing

Risk Disclosure Statement, will provide customers with a more complete

perspective regarding the risks of participating in the futures markets

and of opening an account with a particular firm.

Proposed Sec. 1.55(j) requires an FCM to make the Firm Specific

Disclosure Document available to customers and to the general public by

posting the Firm Specific Disclosure Document on the FCM's Web site. An

FCM may, however, use an alternative electronic means to provide the

Firm Specific Disclosure document to its customers provided that the

electronic version is presented in a format that is readily

communicated to the customers. Paper copies of the Firm Specific

Disclosure Document also must be available upon the request of a

customer. The Commission also proposed that each FCM disclose certain

financial information on its Web site to provide the public with

additional information on the firm and the customer funds that it

holds. The additional financial disclosures are set forth in Sec.

1.55(o) and are discussed below.

SIFMA stated that the public disclosure requirements will help

empower its members to choose safe and trustworthy FCMs, and that the

[[Page 68565]]

disclosures will hold FCMs accountable to their customers, allowing the

customers to conduct due diligence efficiently, actively monitor FCMs'

financial condition and regulatory compliance, and make informed

decisions when selecting and doing business with FCMs.\500\ Vanguard

expressed the view that the best protection for customers is their own

due diligence, and that the proposed additional enhancements add

significant, and much needed, protections and transparency.\501\ The

FHLB supported the proposal with respect to the publication of the Firm

Specific Disclosure Document and strongly endorsed the requirement that

the FCM update the document as circumstances warrant.\502\

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\500\ SIFMA Comment Letter at 2 (Feb. 21, 2013).

\501\ Vanguard Comment Letter at 4 (Feb. 2, 2013). See also,

Prudential Comment Letter at 2 (Jun. 9, 2013) and Security Benefit

Comment Letter at 2 (Jan. 11, 2013 supporting the additional

disclosures proposed under Sec. 1.55(i).

\502\ FHLB Comment Letter at 10 (Feb. 15, 2013).

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FIA stated that it supports enhancing disclosures to customers

regarding the FCM through which the customer may elect to trade.\503\

FIA requested that the Commission confirm that an FCM that is part of a

publicly-traded company, whether U.S. or non-U.S., or is otherwise

required to prepare and to make public an annual report including

information comparable to that required by the Firm Specific Disclosure

Document under the proposed regulation, may comply with the regulation

by making such annual report, and any amendments thereto, available on

its Web site.\504\ FIA noted that the Management Discussion and

Analysis (``MD&A'') required under SEC rules (17 C.F.R. 229.303)

requires publicly traded companies to discuss essentially the same

topics required to be discussed under the Commission's proposal. FIA

stated that the topics include business environment; critical

accounting policies; use of estimates; results of operations; balance

sheet and funding sources; off-balance sheet arrangements and

contractual obligations; overview and structure of risk management;

liquidity risk management; market risk management; credit risk

management; operational risk management; recent accounting

developments; and certain risk factors that may affect the company's

business.\505\ FIA estimated that approximately 90 percent of customer

funds are held by FCMs that are also SEC registered or part of a bank

holding company or publicly-traded company and believes this position

is necessary to avoid customer confusion in certain circumstances and

to assure that FCMs are not subject to duplicative and, perhaps

conflicting, disclosure requirements.\506\

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\503\ FIA Comment Letter at 41 (Feb. 15, 2013).

\504\ FIA Comment Letter at 43-44 (Feb. 15, 2013).

\505\ Id.

\506\ Id.

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FIA further requested that the Commission confirm the level of

detail required to be provided by privately-held FCM companies should

be consistent with that provided in the annual reports of publicly-

traded companies.\507\ Additionally, FIA stated that privately-held

companies would need a period of time to develop the required

disclosures and requested that the Commission make the compliance date

of the regulation no sooner than six months after the effective date of

the regulation.\508\

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\507\ Id. at 44.

\508\ Id.

---------------------------------------------------------------------------

The Commission has considered the comments and is adopting Sec.

1.55(i) and (j) as proposed. In response to FIA's comments, the

Commission confirms that beyond the requirements stated in Sec. 1.55,

the Commission is not mandating the form in which the required

information is conveyed, provided it is responsive to the information

requirements of Sec. 1.55 and provides such information in a clear,

concise, and understandable matter. Accordingly an FCM that is part of

a publicly traded company, or is otherwise required to prepare and make

public an annual report including information comparable to the

information required by proposed Sec. 1.55(k), may satisfy the

disclosure requirements in Sec. 1.55 by making an annual report, and

any amendments thereto, available on its Web site; provided that such

annual report provides the information required by Sec. 1.55 in a

manner that is clear, concise and understandable. The Commission is

similarly confirming that a privately-held company may satisfy the

requirements in Sec. 1.55 by making an annual report, and any

amendments thereto, available on its Web site; provided that such

annual report provides the information required by Sec. 1.55 in a

manner that is clear, concise and understandable.

In assessing whether the annual report contains the necessary

information required by Sec. 1.55 in a clear, concise and

understandable manner, the FCM must ensure that the disclosures

specifically address the risks at the FCM and are not so general in

nature that they reflect that the FCM's business may not be material to

the public or private company for which the annual report is prepared.

An FCM is not in compliance with Sec. 1.55 if the annual report

information does not disclose the information required by Sec. 1.55 as

it relates to the FCM. The objective of the disclosures is to provide

prospective and existing customers of the FCM with material information

that could have an impact on their decision to engage in a relationship

with the FCM. If the annual report does not include information

regarding the FCM, or such information is not clear concise and

understandable, the FCM would have to enhance the disclosure by

providing supplemental material or otherwise making the required

disclosures available to customers and the public in a manner that is

clear, concise and understandable. In addition, in order to provide

customers with clear, concise and understandable disclosures, an FCM

may be required to extract information from various sections of its

annual report and provide such information in an easy to read format.

If customers are required to search through detailed annual reports to

locate the required Sec. 1.55 disclosures, the FCM is not providing

the information in a clear, concise and understandable manner.

ii. Specific Disclosure Information Required (by Rule Paragraph)

Proposed Sec. 1.55(k)(1) requires an FCM to disclose contact

information for the firm including the address of its principal place

of business and its phone number. No comments were received on the

proposed Sec. 1.55(k)(1) and the Commission is adopting the amendments

as proposed.

Proposed Sec. 1.55(k)(2) requires an FCM to disclose the name and

business addresses of the FCM's senior management, including business

titles and background, areas of responsibility and nature of duties of

each person. The FIA recommended the disclosure be limited to those

individuals identified as principals on the NFA BASIC system.\509\

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\509\ FIA Comment Letter at 51 (Feb. 15, 2013).

---------------------------------------------------------------------------

The term ``principal'' is defined in Sec. 3.1 to mean, with

respect to an FCM: (1) The proprietor and chief compliance officer if

the FCM is organized as a sole proprietorship; (2) any general partner

and chief compliance officer if the FCM is organized as a partnership;

(3) any director, the president, chief executive officer, chief

operating officer, chief financial officer, chief compliance officer,

and any person in charge of a principal business unit, division or

function subject to regulation by the Commission if the FCM is

organized as

[[Page 68566]]

a corporation; (4) any director, the president, chief executive

officer, chief operating officer, chief financial officer, chief

compliance officer, the manager, managing member or those members

vested with the management authority for the entity, and any person in

charge of a principal business unit, division or function subject to

regulation by the Commission if the FCM is organized as a limited

liability company or limited liability partnership; and (5) in

addition, any person at the FCM occupying a similar status or

performing similar functions as described above, having the power,

directly or indirectly, through agreement or otherwise, to exercise a

controlling influence over the entity's activities that are subject to

regulation by the Commission.

The Commission agrees with FIA's comment and is revising the final

regulation to require an FCM to disclose persons that are defined as

``principals'' of the FCM under Sec. 3.1.

Proposed Sec. 1.55(k)(3) requires an FCM to disclose the

significant types of activities and product lines that the FCM engages

in and the approximate percentage of assets and capital that are

contributed to each type of business activity or product line. FIA

recommended that an FCM be required to update the description in its

annual report, only if it adds a new business activity or product line

that requires higher minimum capital under applicable capital rules

because the approximate percentage of the FCM's assets and capital used

in each type of activity can change frequently.\510\

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\510\ Id. at 45.

---------------------------------------------------------------------------

The Commission believes that FIA is defining the requirements of

Sec. 1.55(k)(3) too narrowly. The regulation is intended to provide

the public with information concerning the major businesses activities

that an FCM engages in to provide information regarding the benefits

and risks of using such firm to conduct transactions in commodity

interests. Minimum capital requirements are generally driven by

regulated business, such a being registered as a BD. While such

information is material to potential customers and is required to be

disclosed under Sec. 1.55(k)(3), the regulation also requires the

disclosure of non-regulated business that a firm may engage in.

The Commission also recognizes that an FCM's assets and capital

contributed to different business activities can change frequently, but

such information may be material for the public in determining to

entrust funds with the firm and to perform effective due diligence in

monitoring the firm. Each FCM will need to assess the materiality of

changes and use its judgment to determine whether the Firm Specific

Disclosure Document should be revised. In addition, the Commission

notes that Sec. 1.55(i) requires that the Firm Specific Disclosure

Document must be revised as and when necessary, but at least annually,

to keep the information accurate and complete. The Commission has

considered the comments and is adopting the amendments as proposed.

Proposed Sec. 1.55(k)(4) requires an FCM to disclose its business

on behalf of customers, including types of accounts, markets traded,

international business, and clearinghouses and carrying brokers used,

and its policies and procedures concerning the choice of bank

depositories, custodians, and other counterparties. FIA requested the

Commission confirm that: (1) The disclosure required under this

paragraph is limited to the activities of the FCM in its capacity as

such; (2) the term ``accounts'' means ``customers''; and (3) the term

``counterparties'' is limited to counterparties for Sec. 1.25

investments.\511\

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\511\ Id. at 47-48.

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Regulation 1.55(k)(4) is intended to provide customers and the

public with information regarding the FCM operating its FCM's business.

Accordingly, the Commission confirms that the disclosures required

under Sec. 1.55(k)(4) are limited to the activities of the FCM acting

in its capacity as an FCM. The term ``types of accounts'' in Sec.

1.55(k)(4) should be ``types of customers,'' and requires the FCM to

disclose the nature of its customer base in the futures markets (i.e.,

institutional, retail, agricultural, hedgers,) to provide the public

with information regarding the firm's experiences with different types

of markets and market participants. The Commission also confirms that

the term ``counterparties'' is limited to Sec. 1.25 counterparties.

The Commission is revising final Sec. 1.55(k)(4) accordingly.

Proposed Sec. 1.55(k)(5) requires an FCM to discuss the material

risks, accompanied by an explanation of how such risks may be material

to its customers, of entrusting funds to the FCM, including, without

limitation, the nature of investments made by the FCM (including credit

quality, weighted average maturity, and weighted average coupon); the

FCM's creditworthiness, leverage, capital, liquidity, principal

liabilities, balance sheet leverage and other lines of business; risks

to the FCM created by its affiliates and their activities, including

investment of customer funds in an affiliated entity; and any

significant liabilities, contingent or otherwise, and material

commitments.

FIA commented that the word ``risks'' in Sec. 1.55(k)(5) should be

replaced with the word ``information,'' and that the Commission remove

the phrase ``accompanied by an explanation of how such risks may be

material to its customers.'' \512\ FIA believed it sufficient that an

FCM present the required information to the customer and that it is the

customer's responsibility to analyze this information and determine the

extent to which it is important or relevant to the customer's decision

to open or maintain an account with the FCM.\513\ FIA further stated

that if the Commission believes FCMs should provide guidance to

customers regarding the potential importance of specific information,

FIA believes this guidance should be provided by means of a generic

statement.\514\ In addition, FIA asked the Commission to confirm that

the term ``investments'' is limited to investments of customer funds,

and does not include all investments made by the FCM as an entity.\515\

Additionally, FIA requested that the Commission delete the term

``creditworthiness,'' stating that such reference is incongruous with

instructions under section 939A of the Dodd-Frank Act.\516\ Moreover,

FIA opined that the only lines of business that an FCM should be

required to disclose are those that would require higher minimum

capital under applicable capital rules, and that this information

should only be required to be updated annually.\517\ Additional

clarification was requested by FIA regarding the phrase ``investment of

customer funds with an affiliated entity,'' and whether that phrase

refers to the ``deposit of customer funds in an affiliated bank.''

\518\ Further clarification was requested regarding the types of

liabilities and commitments requiring disclosure under this section and

whether this information should updated no more often than

semiannually, consistent with comparable disclosures applicable to

[[Page 68567]]

BDs.\519\ Finally, FIA, while not opposed to providing leverage

information, believed that disclosure should not be required until it

is certain the calculation provides the most appropriate measure of

risk.\520\

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\512\ FIA Comment Letter at 45 (Feb. 15, 2013).

\513\ Id.

\514\ Id.

\515\ Id.

\516\ Section 939A required that the Commission, ``remove any

reference to or requirement of reliance on credit ratings and to

substitute in such regulations such standard of creditworthiness as

each respective agency shall determine as appropriate for such

regulations.'' FIA Comment Letter at 46 (Feb. 15, 2013).

\517\ FIA Comment Letter at 46 (Feb. 15, 2013).

\518\ Id. at 51.

\519\ Id. at 46.

\520\ Id. at 34.

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The Commission believes that it is appropriate that Sec.

1.55(k)(5) requires an FCM to identify material risks and to explain

how such risks may be material to customers. The Commission further

believes, based upon its experiences during MFGI, that customers

(particularly retail and less sophisticated customers) would benefit

from an FCM providing its assessment of the risks of the firm,

accompanied by an explanation of such risks.

The Commission notes, in response to FIA's comments, that Sec.

1.55(k)(5) requires an FCM to provide information regarding its general

investments and is not limited to the investment of customer funds. The

disclosures contemplated by Sec. 1.55(k)(5) go to the full operation

of the FCM and not just its regulated or futures activities. In

addition, limiting the disclosures only to investments that result in

an increase in minimum capital requirements may result in the non-

disclosure of significant operations that may impact a customer's

decision to do business with an FCM.

The Commission also notes that the requirement in Sec. 1.55(k)(5)

for FCMs to disclose leverage information would be met by an FCM

providing the leverage information that each FCM is required to

calculate under Sec. 1.10 and in accordance with the regulations of

the NFA. An FCM should define the leverage calculation in the

Disclosure Document and may provide any other information necessary to

make the information meaningful for the public, but if materially

different from the then prevailing NFA methodology, should provide an

explanation of the differences therefrom.

Proposed Sec. 1.55(k)(6) requires an FCM to disclose the name of

its DSRO and the DSRO's Web site, and the location of where the FCM's

annual financial statements are available. The Commission received no

comments on proposed Sec. 1.55(k)(6) and is adopting the regulation as

proposed.

Proposed Sec. 1.55(k)(7) requires an FCM to disclose any material

administrative, civil, enforcement, or criminal action then pending,

and any enforcement actions taken in the last three years. FIA

requested that the Commission confirm that a ``pending'' action is an

action that has been filed but not concluded, and recommended the

Commission confirm that the disclosure required under this paragraph

would be limited to matters required to be disclosed in accordance with

Sec. 4.24(l)(2).\521\

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\521\ Regulation 4.24(l)(2) requires a CPO to disclose in a

disclosure document for a commodity pool certain material

administrative, civil, or criminal actions against an FCM that the

CPO engages to trade futures.

---------------------------------------------------------------------------

The Commission agrees with FIA that the regulation should require

an FCM to disclose administrative, civil, enforcement, and criminal

actions that have been filed but not concluded. The proposal was not

intended to cover open or closed investigations that have not resulted

in the filing of a complaint. The Commission is revising Sec.

1.55(k)(7) as appropriate to reflect this concept.

The Commission, however, does not agree with FIA's comment that

disclosures under proposed Sec. 1.55(k)(7) should be limited to

administrative, civil, enforcement, or criminal matters that would be

required to be disclosed under Sec. 4.24(l)(2). Regulation 4.24(l)(2)

provides that an action will be deemed material if: (1) The action

would be required to be disclosed in the footnotes to a commodity

pool's financial statements under generally accepted accounting

principles as adopted in the U.S.; (2) the action was brought by the

Commission, provided that if the matter was concluded and did not

result in a civil monetary penalty in excess of $50,000, it does not

need to be disclosed; and (3) the action was brought by any other

federal or state regulatory agency, a non-U.S. regulatory agency, or an

SRO and involved allegations of fraud or other willful misconduct. The

Commission believes that the regulation's requirement to disclose

material actions is appropriate in the context of disclosures so that a

customer can perform adequate due diligence to assess the risk of

engaging an FCM to conduct futures business and in entrusting funds to

the FCM. In this regard, the Commission believes that FCMs should

disclose Commission disciplinary actions that are pending or have been

concluded against the FCM without regard to the amount of the civil

monetary penalty that may have been imposed. In addition, the

Commission believes that there may be circumstances in addition to

fraud or other willful misconduct that should be disclosed to customers

to allow customers to better appreciate the potential risks of entering

into a business relationship with an FCM.

Proposed Sec. 1.55(k)(8) requires the Firm Specific Disclosure

Document to contain a basic overview of customer fund segregation,

collateral management and investments, FCMs, and dual registrant FCM/

BDs. The disclosures included under Sec. 1.55(k)(8) should not only

include information regarding the segregation of funds for trading on

designated contract markets, but should also include information

regarding the risk to customers of engaging in foreign futures and

foreign options trading. In conjunction with Sec. 1.55(k)(4), which

requires an FCM to provide a profile of its customer business,

including its international business and clearinghouses and carrying

brokers used, an FCM in order to comply with Sec. 1.55(k)(8) should

disclose the risks of engaging in trading on foreign markets. The

disclosures required by Sec. 1.55(k)(8) should include information

that in the event of the insolvency of the FCM, or the insolvency of a

foreign broker or foreign depository that is holding customer funds,

customer funds held in foreign jurisdictions may be subject to a

different bankruptcy regime and legal system than if the funds were

held in the U.S. In addition, an FCM should disclose that a customer

also is subject to fellow customer risk in foreign jurisdictions and

that, for purposes of bankruptcy protection, a customer that trades

only in one country or in one market is also exposed to fellow customer

risk from losses that may be incurred in other countries and other

markets. The Commission did not receive comment on Sec. 1.55(k)(8) and

is adopting the amendments as proposed.

Proposed Sec. 1.55(k)(9) requires the FCM to include in the Firm

Specific Disclosure Document information on how a customer may obtain

information regarding filing a complaint with the Commission or the

firm's DSRO. The Commission did not receive comment on Sec. 1.55(k)(9)

and is adopting the amendments as proposed.

Proposed Sec. 1.55(k)(10) requires the Firm Specific Disclosure

Document to include the following financial information for the most

recent month end: (1) The FCM's total equity, regulatory capital, and

net worth, all computed in accordance with U.S. Generally Accepted

Accounting Principles and the Commission's capital rule, Sec. 1.17;

(2) the dollar value of the FCM's proprietary margin requirements as a

percentage of the aggregated margin requirements for futures customers,

Cleared Swaps Customers, and 30.7 customers; (3) the number of futures

customers, Cleared Swaps Customers, and 30.7 customers that comprise 50

percent of the funds held for such customers, respectively; (4) the

aggregate notional value, by asset class, of all non-hedged, principal

over-the-counter transactions into which the

[[Page 68568]]

FCM has entered; (5) the amount, generic source and purpose of any

unsecured lines of credit or similar short term funding the FCM has

obtained but not yet drawn upon; (6) the aggregated amount of financing

the FCM provides for customer transactions involving illiquid financial

products for which it is difficult to obtain timely and accurate

prices; and (7) the percentages of futures customers, Cleared Swaps

Customers, and 30.7 customers receivable balances that the FCM had to

write-off as uncollectable during the past 12 months, as compared to

the current balance held for such customers.

CMC generally supported proposed Sec. 1.55(k)(10), as it would

enhance transparency to the public.\522\ NFA provided a general comment

supporting the Commission's objective of providing customers with

meaningful information, but expressed concern that much of the

information proposed to be disclosed under Sec. 1.55(k)(10) may not be

understandable to smaller and less sophisticated customers.\523\ NFA

specifically questioned whether such customers would comprehend: (1)

The dollar value of the FCM's proprietary margin requirements as a

percentage of the aggregate margin requirements for futures customers,

Cleared Swaps Customers, and 30.7 customers; (2) the number of futures

customers, Cleared Swaps Customers, and 30.7 customers that comprise 50

percent of the funds held for such customers, respectively; (3) the

aggregate notional value, by asset class, of all non-hedged, principal

over-the-counter transactions into which the FCM has entered; (4) the

amount, generic source and purpose of any unsecured lines of credit or

similar short term funding the FCM has obtained but not yet drawn upon;

(5) the aggregate amount of financing the FCM provides for customer

transactions involving illiquid financial products for which it is

difficult to obtain timely and accurate prices; and (6) the percentages

of futures customers, Cleared Swaps Customers, and 30.7 customers

receivable balances that the FCM had to write-off as uncollectable

during the past 12 months, as compared to the current balance held for

such customers.\524\ NFA noted that as one of its responses to MFGI,

its Board of Directors formed a special committee on the protection of

customer funds (``Special Committee'') that was comprised of NFA's

public directors.\525\ NFA stated that the Special Committee spent a

significant amount of time reviewing information that FCMs should make

available to customers, while focusing on the needs of smaller, less

sophisticated customers, and concluded that much of the information in

Sec. 1.55(k)(10) is complicated and not meaningful for less

sophisticated customers.\526\ NFA also noted that more sophisticated

institutional customers could request and would likely receive this

information directly from an FCM.\527\

---------------------------------------------------------------------------

\522\ CMC Comment Letter at 2 (Feb. 15, 2013).

\523\ NFA Comment Letter at 15-16 (Feb. 15, 2013).

\524\ Id.

\525\ Id. at 1.

\526\ Id. at 16.

\527\ Id.

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The Commission understands that not all customers would have the

same use for the detailed information required by Sec. 1.55(k)(10). In

developing the proposal, the Commission sought to balance the

information needs of all types of customers and their respective levels

of sophistication. While certain customers may not use the full amount

of information in assessing risks, the Commission anticipates that

other customers will incorporate all or most of the information into

their risk management process and will benefit from the disclosures in

performing their due diligence. The Commission also believes that the

information should be available to all customers without the need for

customers to specifically request the Sec. 1.55(k)(10) disclosures

from the FCM.

FIA agrees that customers should be advised whether an FCM engages

in proprietary futures trading but does not believe that FCMs should be

required to disclose the dollar value of their proprietary margin

requirements as a percentage of customer margin requirements as

proposed in Sec. 1.55(k)(10(ii) as such percentages will change

frequently.\528\ FIA also questions the implication that customers may

be at greater risk if an FCM carries proprietary futures positions

noting, for instances, that the FCM's funds to margin its proprietary

positions would be available to cover a potential customer

default.\529\ RJ Obrien, however, noted that it is important that

customers be aware of the nature and extent of a firm's proprietary

trading.\530\

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\528\ FIA Comment Letter at 48 (Feb. 15, 2013).

\529\ Id.

\530\ RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).

---------------------------------------------------------------------------

The Commission believes that information regarding an FCM's

proprietary trading is necessary for customers to appropriately assess

the risks of entrusting their funds to an FCM. The risk profile of an

FCM is certainly different if it acts primarily as an agent in handling

customer funds, or if it acts as agent for customers and also engages

in proprietary trading. The Commission further believes that customers

would benefit from some measure of the FCM's proprietary trading rather

than a simple statement that the firm does or does not engage in

proprietary trading. The dollar value of the FCM's margin requirements

for its proprietary trading listed as a percentage of its customer

margin requirements provides a means of measuring how active and

extensive a firm's proprietary trading may be relative to its customer

business, which will factor into the public's risk profile of the firm.

FIA requested confirmation that the requirement in Sec.

1.55(k)(10)(iii) for an FCM to disclose the number of futures

customers, cleared swap customers, and 30.7 customers that comprise 50

percent of the FCM's total funds held for such customers, respectively,

should be based upon the smallest number of customers that comprise the

50 percent threshold.\531\ The Commission confirms that FIA's

assumption is correct and is revising the final regulation accordingly.

A purpose of the disclosure is to provide information on the extent to

which a firm may have customers with large positions relative to the

FCM's general customer base.

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\531\ FIA Comment Letter at 46-47 (Feb. 15, 2013).

---------------------------------------------------------------------------

FIA stated that the requirement in Sec. 1.55(k)(10)(iv) for an FCM

to disclose the aggregate notional value, by asset class, of its non-

hedged, principal over-the-counter transactions would require the FCM

to disclose proprietary information. In addition, FIA stated that

providing such information is not practical as firms generally do not

manage their books this way and the categorization of a swap

transaction as being hedged or not hedged would change each day.

The objective of Sec. 1.55(k)(10)(iv) is for an FCM to disclose

the extent of the risk it is exposed to from over-the-counter

transactions that are not hedged or for which the FCM does not hold

margin from the counterparty sufficient to cover the exposure. While

the Commission recognizes that such information may change frequently,

Sec. 1.55 only requires an FCM to update the information on an annual

basis, or more frequently if the changes are material. The information

also is in the aggregate, which should minimize the risk of disclosing

detailed proprietary information. After considering the comments, the

Commission is adopting the regulation as proposed.

FIA stated that the Commission should distinguish between committed

[[Page 68569]]

and uncommitted lines of credit in the requirement in Sec.

1.55(k)(10)(v), which requires an FCM to disclose the amount, generic

source and purpose of any unsecured lines of credit it has obtained but

not yet drawn upon.\532\ The Commission agrees that it would be more

appropriate to disclose committed lines of credit and to exclude lines

of credit that could be withdrawn by the potential lender. The

Commission is revising the final regulation to reflect this change. In

addition, the Commission is clarifying that the provision in Sec.

1.55(k)(10)(v) that requires the disclosure of the amount, source and

purpose of any unsecured lines of credit or similar short-term funding

would include secured and unsecured short-term funding.

---------------------------------------------------------------------------

\532\ Id.

---------------------------------------------------------------------------

Regulation 1.55(k)(10)(vi) requires an FCM to disclose the

aggregated amount of financing the FCM provides for customer

transactions involving illiquid financial products for which it is

difficult to obtain timely and accurate prices. FIA requested that the

Commission define the type of financing covered by the regulation, and

also requested that the Commission define the term ``illiquid financial

products'' and confirm whether the information should include secured

as well as unsecured financing.\533\

---------------------------------------------------------------------------

\533\ Id.

---------------------------------------------------------------------------

The Commission notes that the purpose of the disclosure is to

provide the public with information regarding the possible extent of

exposures an FCM may have if customers failed to meet their financial

obligations to the FCM. The Commission is adopting the requirement as

proposed. FCMs are required to provide the necessary information in the

Disclosure Document, and may explain the factors it uses to determine

if a financial product is liquid or illiquid and the extent to which

transactions are secured or unsecured.

Regulation 1.55(k)(10)(vii) requires an FCM to disclose the

percentage of futures customer, Cleared Swaps Customer, and 30.7

customer receivable balances that the FCM had to write-off as

uncollectable during the past 12 months, as compared to the current

balances of funds held for such customers.

Newedge and RJ O'Brien commented that providing this information

would provide customers with valuable insight into the strength of an

FCM's credit policies, which benefits all customers.\534\ FIA, however,

commented that it did not recognize the relevance of the requested

information, which may be misleading without the proper context (such

as whether the losses were caused by one or two large customers or an

aggregate of small customers).\535\ FIA further stated that if the

Commission were to adopt the rule, normal business write-offs should be

excluded, and the Commission should establish a de minimis threshold

were reporting would not be required.

---------------------------------------------------------------------------

\534\ Newedge Comment Letter at 4 (Feb. 15, 2013); RJ O'Brien

Comment Letter at 11 (Feb. 15, 2013).

\535\ FIA Comment Letter at 50 (Feb. 15, 2013).

---------------------------------------------------------------------------

The Commission has considered the comments and is adopting the

regulation as proposed. The Commission believes that the disclosure of

the amount of write-offs an FCM had to incur as a result of customers

failing to pay receivable balances will provide information regarding

the credit policies of the FCM. The Commission does not believe that

there should be any de minimis level or threshold amount before the

disclosure of the information becomes a requirement. In response to

FIA's comments that the information may be misleading if not provided

in context, the Commission notes that FCMs may include explanatory text

in the Disclosure Document provided such information is not misleading.

Finally, proposed Sec. 1.55(k)(11) requires a summary of the FCM's

current risk practices, controls and procedures. FIA asked for

confirmation that the discussion of the FCM's current risk practices,

controls and procedures may be general in nature, noting that the

Commission has recognized that an FCM's risk practices, controls and

procedures may include proprietary information.\536\ The Commission

confirms that the discussion of the current risk practices, controls

and procedures may be general in nature so that it does not disclose

confidential proprietary information.

---------------------------------------------------------------------------

\536\ FIA Comment Letter at 50 (Feb. 15, 2013).

---------------------------------------------------------------------------

2. Public Availability of FCM Financial Information

Proposed Sec. 1.55(o) requires each FCM to make the following

information available to the public on its Web site: (1) The daily

Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps

Segregation Schedule for the most current 12-month period; (2) a

summary schedule of the FCM's adjusted net capital, net capital, and

excess net capital, all computed in accordance with Sec. 1.17 and

reflecting balances as of the month-end for the 12 most recent months;

and, (3) the Statement of Financial Condition, the Segregation

Schedule, Secured Amount Schedule, and Cleared Swaps Segregation

Schedule and all related footnotes contained in the FCM's most recent

certified annual financial report. Regulation 1.55(o) also requires

each FCM to include a statement on its Web site that additional

financial information on the firm and other FCMs may be obtained from

the NFA and the Commission, and to include hyperlinks to the NFA and

Commission Web sites.

MFA, SIFMA, Prudential, Security Benefit, CoBank, and the FHLBs

supported the requirement for FCMs to post their daily Segregation

Schedule, Secured Amount Schedule, and Cleared Swaps Segregation

Schedule on their Web site each day, stating that the disclosure of

such information would place customers in a better position to assess

an FCM's stability, and if customers identify concerns and deem

appropriate, to transfer their positions and funds to a different

FCM.\537\ MFA, SIFMA, Prudential, Security Benefit, CoBank, and the

FHLBs also stated that the Commission should require FCMs to disclose

additional information, including the FCM's monthly Segregation

Schedule, Secured Amount Schedule, and Cleared Swaps Segregation

Schedule, and monthly summary balance sheet and income statement

information, for the most recent 12-month period.\538\ MFA noted that

each FCM's monthly Segregation Schedule, Secured Amount Schedule, and

Cleared Swaps Segregation Schedule are publicly available under Sec.

1.10, and suggested that each FCM should be required to disclose the

schedules to the public without the public having to request such

statements from the firms as is currently required under Sec.

1.10.\539\

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\537\ MFA Comment Letter at 4 (Feb. 15, 2013); SIFMA Comment

Letter at 2 (Feb. 21, 2013); Prudential Comment Letter at 2 (Jun. 9,

2013); Security Benefit Comment Letter at 2 (Jan. 11, 2013); CoBank

Comment Letter at 2 (Jan. 14, 2013); FHLB Comment Letter at 7 (Feb.

15, 2013).

\538\ Id. See also The Commercial Energy Working Group Comment

Letter at 2-3 (Feb. 12, 2013).

\539\ MFA Comment Letter at 4-6 (Feb. 15, 2013); SIFMA Comment

Letter at 2 (Feb. 21, 2013).

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The ACLI encouraged the Commission to make public as much

information as possible regarding FCMs' financial condition, treatment

of customer funds, and regulatory compliance.\540\ The ACLI also noted

that access to these categories of information should be

straightforward and simple.\541\ TIAA-CREF supported the proposed

enhanced financial disclosures and encouraged the Commission to require

the prompt public disclosure of relevant FCM

[[Page 68570]]

information.\542\ TIAA-CREF stated that such disclosures would be a

positive step towards ensuring a level playing field between each FCM

and its customers and among FCMs themselves, and supported the

Commission's efforts to require FCMs to disclose information regarding

the FCM's segregation of customer property (e.g., the Cleared Swaps

Segregation Schedule), financial health and creditworthiness and would

also support efforts by the Commission to cause such disclosures to be

posted on the relevant FCM's Web site, in lieu of requiring customers

to make a request to the Commission to receive such information (which

may be administratively burdensome).\543\

---------------------------------------------------------------------------

\540\ ACLI Comment Letter at 2-3 (Feb. 15, 2013).

\541\ Id.

\542\ ACLI Comment Letter at 2-3 (Feb. 15, 2013).

\543\ TIAA-CREF Comment Letter at 2-3 (Feb. 15, 2013).

---------------------------------------------------------------------------

FXCM noted that currently the Commission's monthly ``net capital''

reports is the only publicly available way to determine how much money

an FCM or RFED has set aside for net capital, but this provides very

little insight into how the firm is doing financially.\544\ FXCM stated

that FCMs and RFEDs should be required to publish quarterly

consolidated balance sheets and income statements, including holding

company financials, for the trading public so they will know the level

of risk involved in dealing with a firm.\545\

---------------------------------------------------------------------------

\544\ FXCM Comment Letter at 2-3 (Dec. 14, 2013).

\545\ Id. See also forex form letter group: Michael Krall; David

Kennedy; Robert Smith; Michael Carmichael; Andrew Jackson; Donald

Blais; Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink;

Sam Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po

Huang; Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe;

Tracy Burns; Treasure Island Coins; Clare Colreavy, Brandon

Shoemaker.

---------------------------------------------------------------------------

FIA stated that the daily segregation, secured amount, and cleared

swaps customer account calculations should not be made publicly

available. FIA noted that NFA currently makes this information

available on its Web site as of the 15th and last business day of each

month and believes disclosure twice each month should be sufficient. If

the Commission concludes more frequent disclosure is necessary, FIA

recommended that disclosure should be required no more often than

weekly, i.e., as of the close of business each Friday (or the last

business day of the week if Friday is a holiday).

Phillip Futures Inc. proposed that the Commission limit the

financial data made public to that which is most appropriate for the

average customer to make an educated decision regarding his choice of

broker.\546\ It further stated that rather than making the financial

information public, it should only be provided to customers at their

request.\547\

---------------------------------------------------------------------------

\546\ Phillip Futures Inc. Comment Letter at 3 (Feb. 14, 2013).

\547\ Id.

---------------------------------------------------------------------------

RCG stated that if the Commission makes the Segregation Schedule,

Secured Amount Schedule, and Cleared Swaps Segregation Schedule public,

the public will only see a targeted residual interest amount, without

realizing and comprehending the many factors that have impacted a

particular firm's determination of its target.\548\

---------------------------------------------------------------------------

\548\ RCG Comment Letter at 6 (Feb. 12, 2013).

---------------------------------------------------------------------------

TD Ameritrade expressed its concern regarding the public disclosure

of the firm's targeted residual interest computation.\549\ TD

Ameritrade stated that the public would not be privy to any of the

internal discussions and analysis that goes into the development and

setting of the firm's targeted residual interest, and that any changes

to its target could cause market upheaval, volatility, and unintended

consequences.\550\

---------------------------------------------------------------------------

\549\ TD Ameritrade Comment Letter at 4 (Feb. 15, 2013).

\550\ Id.

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The Commission has considered the comments and is adopting the

regulations as proposed, with the revision to Sec. 1.55(o) to require

each FCM to disclose on its Web site its monthly Segregation Schedule,

Secured Amount Schedule, and Cleared Swaps Segregation Schedule for the

12 most recent month-end dates.

The Commission currently discloses FCM financial data on its Web

site. Specifically, Sec. 1.10(g) provides that the Form 1-FR-FCM (or

FOCUS Report) is exempt from mandatory public disclosure under the

Freedom of Information Act and the Government in the Sunshine Act,

except for the following information: (1) The amount of the FCM's

adjusted net capital under Sec. 1.17 as of the reporting date, the

amount of adjusted net capital maintained by the firm on the reporting

date, and the amount of excess net capital on the reporting date; (2)

the Segregation Schedule and Secured Amount Schedule as of the

reporting date; and (3) the Statement of Financial Condition in the

certified annual report and related footnote disclosures. The

Commission summarizes the FCM's segregation, secured amount and capital

information each month and makes such information available to the

public on its Web site.

The Commission believes that customers should have access to

sufficient financial information for each FCM to allow such customers

to adequately assess and monitor the financial condition of firms. The

disclosure of the daily segregation and secured amount computations

will provide customers with additional information to assess the

adequacy of an FCM's targeted residual interest given the firm's

business operations and amount of customer funds held in segregated or

secured accounts. The Commission also believes that the expanded

disclosures required under Sec. 1.55 offer each FCM with the ability

to provide an explanation describing the rationale and business

justification for its computation of the target residual interest to

better inform the public. The reporting of segregated and secured

account balances on a daily basis also will provide customers with

information regarding any trends developing with particular reported

balances that the customers may wish to consider as part of their risk

assessment of the FCMs.

The Commission further believes that customers should have access

to an FCM's financial information by reviewing such information

directly on the FCM's Web site as part of the Firm Specific

Disclosures. By reviewing the Firm Specific Disclosures and having

access to financial data of the FCM, customers will be able to better

assess the risks of engaging a particular FCM. The Commission also

believes that customers would benefit from being informed that

additional financial information on each FCM is available from the NFA

and Commission, and by requiring the FCMs to maintain a hyperlink to

the Commission's and NFA's Web sites. NFA and Commission data provide

historical information that allows customers to assess financial trends

on a customer-by-customer basis, and provides sufficient financial

information such that customers can compare financial data across FCMs

as part of their risk management program. The NFA also discloses

additional information regarding how FCMs are holding customer funds

and investing customer funds under Sec. 1.25, which is material

information for customers in assessing risk at particular FCMs.

Regulation 1.10(g) currently requires a customer to request from

the FCM monthly Segregation Schedules and Secured Amount Schedules, as

well as the Statement of Financial Condition contained in the FCM's

certified annual report. In response to several of the comments, the

Commission is revising Sec. 1.55(o) to require each FCM to post such

financial information on its Web site. The Commission agrees with the

commenters that FCMs should disclose this information, which is

currently

[[Page 68571]]

publicly available under Sec. 1.10(g), without requiring each customer

or member of the public having to specifically request such information

from the FCM.

The Commission is not expanding the required disclosures to include

summary income statement information or balance sheet information as

requested by several commenters. As noted above, Sec. 1.10(g)

currently provides that the Form 1-FR-FCM and FOCUS Reports are not

subject to mandatory public disclosure under the Freedom of Information

Act or the Government in the Sunshine Act, and the Commission did not

propose to amend Sec. 1.10(g) in the Proposal. In addition, the

comments addressing quarterly financial statements and consolidated

financial statements for FCMs and RFEDs are beyond the scope of the

Proposal as the Commission did not propose to amend the regulations to

require an FCM or RFED to prepare or file with the Commission quarterly

financial statements on either an individual or consolidated basis.

Accordingly, the Commission is not revising final Sec. 1.55(o) to

require such disclosures.

Q. Part 22--Cleared Swaps

As discussed above, the Commission adopted final regulations in

part 22 that implement certain provisions of the Dodd Frank Act and

impose requirements on FCMs and DCOs regarding the treatment of Cleared

Swaps Customer contracts (and related collateral).\551\ Although

substantive differences in the segregation regimes between futures and

cleared swaps exist at the clearing level under the final part 22

regulations, requirements with respect to collateral which is not

posted to clearinghouses and maintained by FCMs for Cleared Swaps

Customers replicate or incorporate by reference many of the same

regulatory requirements applicable to the segregation of futures

customer funds under section 4d(a)(2) of the Act and Commission

regulations (for example, holding funds separate and apart from

proprietary funds, limitations on the FCM's use of customer funds,

titling of depository accounts, Acknowledgment Letter from depository

requirements, and limitations on investment of swap customers' funds,

are currently contained in both part 1 and part 22 regulations).

---------------------------------------------------------------------------

\551\ See discussion in section I.A. above.

---------------------------------------------------------------------------

The determination that appropriate enhancements are necessary with

respect to the regulatory requirements discussed above for segregated

futures customer funds under section 4d(a)(2) of the Act is equally

applicable to Cleared Swaps Customer Collateral. In this regard, the

risk management program that each FCM that holds customer funds is

required to implement under Sec. 1.11 encompasses the firm's business

with futures customers, Cleared Swaps Customers, and 30.7 customers.

In addition, the Commission proposed amendments to Sec. 22.2(d)(1)

and (f)(6) that require an FCM to maintain at all times sufficient

residual interest in Cleared Swaps Customer Accounts to exceed the sum

of the margin deficits (i.e., undermargined amounts) of all of its

Cleared Swaps Customers. The proposed amendments to Sec. 22.2(e)(1)

that explicitly provide that an FCM shall bear sole responsibility for

any losses resulting from the investment of Cleared Swaps Customer

Funds in Sec. 1.25 compliant instruments is consistent with the

amendments adopted for Sec. 1.29(b) that require an FCM to bear sole

responsibility for any losses resulting from the investment of futures

customers funds in Sec. 1.25 compliant instruments. The proposed

amendments to Sec. 22.2(f)(4) provide that an FCM must be in

compliance at all times with its segregation requirements for Cleared

Swaps Customers is consistent with amendments adopted in Sec. 1.20(a)

that require an FCM to be in compliance at all times with its

segregation requirements for futures customers. The proposed amendments

in Sec. 22.2(f)(5)(iii)(B) permit an FCM to develop its own program to

assess credit risk for purposes of computing haircuts on securities

securing a Cleared Swaps Customer's deficit account is consistent with

the amendments adopted in 1.32 for computing haircuts on securities

securing a futures customer's deficit account. The proposed amendments

to Sec. 22.2(g)(2), (3), and (5) require an FCM to prepare and submit

to the Commission and the FCM's DSRO a daily Cleared Swap Segregation

Schedule and twice monthly listing of the holding of Cleared Swaps

Customer funds is consistent with the amendments adopted to Sec. 1.32

that require an FCM to prepare and submit to the Commission and the

FCM's DSRO a daily Segregation Schedule and twice monthly listing of

the holding of futures customer funds.

Comments on the substantive provisions being adopted by the

Commission under part 22 have been considered and addressed in large

part in the discussion of the related substantive provisions in part 1

with respect to futures customer segregated funds. The Commission has

considered those comments and, with the exception of the proposed

amendments to Sec. 22.2(a) and (f)(6), is adopting the amendments to

part 22 as proposed.

In addition, several commenters, including MFA, CIEBA and Franklin

urged the Commission to adopt a full physical segregation option

specific for Cleared Swaps Customer Collateral.\552\ This comment is

outside of the scope of the proposal. The Commission, however, has

previously clarified the ability of FCMs to employ third party

custodial accounts for Cleared Swaps Customer Collateral, while

reiterating that as customer property, in the event of an FCM

insolvency, any funds held in such a third party custodial account

would be subject to pro-rata distribution along with all other customer

property.\553\ Commission staff is also continuing to explore

alternative collateral custody arrangements as directed by the

Commission.\554\

---------------------------------------------------------------------------

\552\ MFA Comment Letter at 9 (Feb. 15, 2013); CIEBA Comment

Letter at 3-4 (Feb. 20, 2013); Franklin Comment Letter at 2 (Feb.

15, 2013).

\553\ 77 FR 6336, 6343.

\554\ Id. at 6343-6344.

---------------------------------------------------------------------------

As discussed in more detail above, several commenters objected to

proposed residual interest requirements under Sec. Sec. 1.20(i) and

22.2(f).\555\ Of those commenters, a number focused on the proposed

residual interest requirements for Cleared Swaps and highlighted the

inconsistency of the ``at all times'' requirement with the Commission's

analysis in the part 22 final rules.\556\ LCH.Clearnet, ISDA, Paul/

Weiss, and other commenters specifically stated that the inclusion of

the language ``at all times'' is inconsistent with the LSOC requirement

to calculate such deficits at the time of a margin call by a DCO to its

clearing FCMs, and with the requirement to have sufficient residual

interest to cover such deficit by the time the clearing FCMs are

required to meet such payment obligations.\557\ These commenters argued

that when the Commission adopted the part 22 final rules, it considered

this point in time

[[Page 68572]]

approach to be consistent with the Act and sufficient to ensure that

the collateral of one Cleared Swaps Customer is never used to margin

the positions of another customer.\558\

---------------------------------------------------------------------------

\555\ See section II.G.9. above.

\556\ See LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013);

FIA Comment Letter at 22-23 (Feb. 15, 2013).

\557\ See, e.g., LCH.Clearnet Comment Letter at 4-5 (Jan. 25,

2013); Paul/Weiss Comment Letter at 3-5 (Feb. 15, 2013); ISDA

Comment Letter at 2-3 (Feb. 15, 2013). ISDA further argued that

variation margin payments are not ``used'' until the point of

settlement. See ISDA Comment Letter at 1-2 (Aug. 27, 2013) (citing

CFTC Letter No. 12-31, ``Staff Interpretation Regarding Part 22,''

(November 1, 2012) (``Part 22 Staff Interpretation'') and arguing

that the use restriction set forth in 4d(f)(2)(B) of the CEA ``is

driven by the meaning of `property . . . received' '' and that

```received' in this context cannot be intended to include variation

margin fluctuations pre-settlement because it is only upon

settlement that an item of property will have been received by the

FCM.'').

\558\ See LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013);

FIA Comment Letter at 22-23 (Feb. 15, 2013); ISDA Comment Letter at

2-3 (Feb. 15, 2013).

---------------------------------------------------------------------------

In response to these comments, the Commission notes that the

proposed amendments to Sec. 22.2(a) and (f)(6) were meant to capture

the current practice with respect to residual interest buffer

calculations for Cleared Swaps using language that was consistent with

the Proposed Residual Interest Requirement for futures. In other words,

the Commission did not intend to alter the current residual interest

requirements, as set forth in the part 22 final rules.\559\ Indeed, the

Commission notes that Staff guidance from November 1, 2012, states that

``FCMs are prohibited from `us[ing] or permit[ing] the use of, the

Cleared Swaps Customer Collateral of one Cleared Swaps Customer to

purchase, margin, or settle the Cleared Swaps or any other trade or

contract of, or to secure or extend the credit of, any person other

than such Cleared Swaps Customer.' Where a Cleared Swaps Customer is

undermargined, then the FCM must ensure that, to the extent of such

shortfall, its own money, securities, or other property--and not that

of other Cleared Swaps Customers--is used to cover a margin call

(whether initial or variation) attributable to that Cleared Swaps

Customer's portfolio of rights and obligations.'' \560\

---------------------------------------------------------------------------

\559\ See also Part 22 Staff Interpretation.

\560\ See id. at 2 (answer to Question 2.1).

---------------------------------------------------------------------------

Because of the confusion expressed by commenters regarding the

residual interest requirements for Cleared Swaps, the Commission is

revising Sec. 22.2(a) and (f). The Commission is revising proposed

Sec. 22.2(a) by deleting the last sentence. The Commission is revising

Sec. 22.2(f)(6) by replacing the language from the proposal with new

language which sets forth the residual interest requirements for

Cleared Swaps in a manner that is consistent with current market

practice and that parallels the language used in Sec. 1.22. To be

clear, and as requested by several commenters, the Commission confirms

that the language in Sec. 22.2(f)(6) is not intended to, and thus

should not be read to, change current practice with respect to an FCM's

residual interest requirements for Cleared Swaps as set forth in

Commission regulations and JAC Update 12-03, and consistent with Staff

Interpretation 12-31. Thus, ``where a Cleared Swaps Customer is

undermargined,\561\ the FCM must ensure that, to the extent of such

shortfall, its own money, securities, or other property--and not that

of other Cleared Swaps Customers--is used to cover a margin call

(whether initial or variation) attributable to that Cleared Swaps

Customer's portfolio of rights and obligations.'' \562\ Consistent with

this revised residual interest requirement, Sec. 22.2(f)(4) is being

amended to state that the amount of funds an FCM is holding in

segregation may not be reduced by any debit balances that the futures

customers of the futures commission merchants have in their accounts.

Finally, Sec. 22.2(f)(2) is being revised, consistent with 1.20(i)(2)

and current market practice, to clarify that the calculation set forth

therein is the Net Liquidating Equity Method.

---------------------------------------------------------------------------

\561\ In this context, a Cleared Swaps Customer is undermargined

to the extent that (a) the minimum margin requirement, attributable

to that Cleared Swaps Customer's portfolio of rights and

obligations, at the DCO (for an FCM that is clearing such Cleared

Swaps Customer's positions directly) or at the Collecting FCM (for a

Depositing FCM) exceeds (b) the customer's net liquidating value,

including securities posted at margin value.

\562\ See Part 22 Staff Interpretation at 2.

---------------------------------------------------------------------------

R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of

Foreign Futures or Foreign Options Secured Amount

Part 30 of the Commission's regulations was adopted in 1987 and

governs the offer and sale in the U.S. of futures contracts and options

traded on or subject to the rules of a foreign board of trade.\563\ The

Commission proposed to amend several regulations in part 30 to provide

a more coordinated approach to the regulations governing the offer and

sales of futures contracts traded on foreign boards of trade and the

comparable regulations governing the offer and sale of futures

contracts traded on designated contract markets. Aligning the

regulations, including regulations governing how an FCM holds funds for

customers trading on non-U.S. markets with the requirements for

customers trading on U.S. markets, will greatly enhance the protection

of customer funds, and avoid competitive imbalances between trading on

domestic and foreign contract markets that might result in regulatory

arbitrage. The Commission's Proposal, along with the comments received,

is discussed in the sections below.

---------------------------------------------------------------------------

\563\ 52 FR 28980 (Aug. 5, 1987).

---------------------------------------------------------------------------

1. Elimination of the ``Alternative Method'' for Calculating the

Secured Amount

Regulation 30.7(a) requires an FCM to set aside in separate

accounts for the benefit of its ``foreign futures or foreign options

customers'' an amount of funds defined as the ``foreign futures or

foreign options secured amount.'' The term ``foreign futures or foreign

options customer'' is defined in Sec. 30.1 as any person located in

the U.S., its territories, or possessions who trades in foreign futures

or foreign options. The term ``foreign futures or foreign options

secured amount'' is defined in Sec. 1.3(rr) as the amount of funds

necessary to margin the foreign futures or foreign options positions

held by the FCM for its foreign futures or foreign options customers,

plus or minus any gains or losses on such open positions. The

calculation of the foreign futures or foreign options secured amount as

defined in Sec. 1.3(rr) is referred to as the ``Alternative Method.''

Requirements concerning the collateral of foreign futures or

foreign options customers are substantially less robust for funds

deposited with an FCM under the Alternative Method than requirements

concerning the collateral of futures customers deposited with an FCM

under section 4d(a)(2) of the Act or Cleared Swaps Customer Funds

deposited under section 4d(f) of the Act. Section 4d(a)(2) of the Act

and Sec. Sec. 1.20 and 1.22 require an FCM to hold in accounts

segregated for the benefit of futures customers a sufficient amount of

funds to satisfy the full account equities of all of the FCM's futures

customers trading on designated contract markets.\564\ Section 4d(f)

and Sec. 22.2 require an FCM to segregate for the benefit of Cleared

Swaps Customers a sufficient amount of funds to satisfy the full

account equities of all of the FCM's Cleared Swaps Customers. The

calculations required under sections 4d(a)(2) and 4d(f) of the Act are

referred to as the ``Net Liquidating Equity Method.''

---------------------------------------------------------------------------

\564\ The Commission is also adopting as final amendments to

Sec. 1.20(a) that clarify and provide explicitly that an FCM is

required to hold funds in segregated accounts in an amount at all

times in excess of its total obligations to all futures customers.

See section II.G.9. above for a discussion of the amendments to

Sec. 1.20.

---------------------------------------------------------------------------

The Alternative Method contrasts with the Net Liquidating Equity

Method in that the Alternative Method obligates an FCM to set aside in

separate accounts for the benefit of its customers an amount of funds

sufficient to cover only the margin required on open foreign futures

and foreign option positions, plus or minus any unrealized gains or

losses on such positions. Any funds deposited by foreign futures or

foreign options customers in excess of the amount required to be set

aside in separate accounts may be held by the

[[Page 68573]]

FCM in operating cash accounts and may be used by the FCM as if it were

its own capital. Since an FCM is not required under the Alternative

Method to set aside in separate accounts an amount of funds sufficient

to repay the full account balances of each of its foreign futures or

foreign options customers, the FCM may not be in a financial position

to return 100 percent of the account equities (or transfer such account

equities to another FCM) of each foreign futures or foreign options

customer in the event of the insolvency of the FCM.

In addition Sec. 30.7 further differs from the regulations

governing how FCMs hold funds for futures customers and Cleared Swap

Customers in that Sec. 30.7 requires an FCM to set aside in a separate

account funds only for ``foreign futures or foreign options

customers.'' As previously stated, the term ``foreign futures or

foreign options customer'' is defined in Sec. 30.1 as any person

located in the U.S., its territories, or possessions who trades in

foreign futures or foreign options. Thus, an FCM is not required to set

aside in separate accounts funds for foreign-domiciled customers

trading on foreign futures markets. Regulation 30.7 permits an FCM to

set aside funds for foreign futures customers located outside of the

U.S., but an FCM is not obligated under the regulations to do so.

Requiring FCMs to include foreign-domiciled customers' funds in

segregated accounts benefits all customers placing funds on deposit for

use in trading foreign futures and foreign options. Neither Subchapter

IV of Chapter 7 of the Bankruptcy Code nor the Commission's part 190

regulations discriminate between foreign-domiciled and domestic-

domiciled customers. Thus, any deficiency arising from the reduced

requirements will impact both foreign and domestic customers pro rata.

The Commission proposed various amendments to the part 30

regulations to eliminate the Alternative Method and to require FCMs to

use the Net Liquidating Equity Method to compute the amount of funds

they must set aside in separate accounts for the benefit of foreign

futures or foreign options customers. The Commission also proposed to

extend the protections of part 30 to foreign-domiciled customers

trading on foreign markets through an FCM. The intent of the proposed

amendments is to provide 30.7 customers with equivalent protections

available to futures customers and Cleared Swaps Customers by requiring

each FCM to hold in secured accounts sufficient funds to cover the full

Net Liquidating Equity of each customer trading on foreign futures

markets.

To implement these revisions, the Commission proposed to define the

term ``30.7 customer'' in Sec. 30.1 to mean any person, whether

domiciled within or outside of the U.S., that engages in foreign

futures or foreign options transactions through the FCM. The Commission

also proposed to amend Sec. 1.3(rr) to match structurally the

definition of the term ``customer funds'' in Sec. 1.3(gg) \565\ and to

define the term ``foreign futures or foreign options secured amount''

to mean ``all money, securities and property received by an FCM for, or

on behalf of, ``30.7 customers'' to margin, guarantee, or secure

foreign futures and foreign options transactions, and all funds

accruing to ``30.7 customers'' as a result of such foreign futures and

foreign options transactions.'' The effect of the proposed amendments

is to adopt the Net Liquidating Equity Method for foreign futures and

foreign options by requiring an FCM to set aside in separate accounts a

sufficient amount of funds to cover the full account balances (i.e.,

the Net Liquidating Equities) of both the U.S. and foreign-domiciled

customers.

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\565\ The Commission recently adopted final regulations that

revised the definitions in Sec. 1.3. In this rulemaking, Sec.

1.3(gg) was renumbered as 1.3(jjj) and re-designated ``futures

customer funds.'' The substance of the definition, however, was not

revised and the final rulemaking has no impact on the analysis in

this rulemaking. See 77 FR 66288 (Nov. 2, 2012).

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The Commission also proposed to amend Sec. 30.7(a) to allow an FCM

to use an internal credit risk model to compute the appropriate market

deductions, or haircuts, on readily marketable securities deposited by

customers that have account deficits. The proposal is consistent with

the proposed amendments for computing haircuts on securities under

Sec. 1.32(b) in section II.N. above. The result of these amendments as

discussed should be consistency between the methodologies applied in

the 4d segregation calculation and the Sec. 30.7 calculation.

Consistent with proposed changes in Sec. 1.20(i) and part 22, the

Commission also proposed to add language to Sec. 30.7(a) to provide

that an FCM must hold residual interest in accounts set aside for the

benefit of 30.7 customers equal to the sum of all margin deficits

(i.e., undermargined amounts) for such accounts, to provide an

equivalent clear mechanism for ensuring that the funds of one 30.7

customer are not margining or guaranteeing the positions of another

30.7 customer

With the exception of the residual interest proposal, the

Commission did not receive any comments on the various proposed

amendments discussed above, including its proposal to eliminate the

``Alternative Method'' and to require FCMs to use the ``Net Liquidating

Equity Method'' to compute the amount of funds they must set aside in

separate accounts for the benefit of its foreign futures or foreign

options customers. Accordingly, the amendments referred to above, with

the exception of the residual interest proposal as discussed further

below, are being adopted by the Commission.\566\

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\566\ See section II.R.4. below for a discussion of the residual

interest proposal. CFA stated that it generally supported the

proposed amendments to Sec. 30.7 and treating customers from all

parts of the globe in a similar manner. CFA Comment Letter at 9

(Feb. 13, 2013).

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2. Funds Held in Non-U.S. Depositories

The Commission proposed to amend Sec. 30.7(c) to limit the amount

of 30.7 customers' funds that an FCM could hold in non-U.S.

jurisdictions. Under the proposal, an FCM must hold 30.7 customer funds

in the U.S., except to the extent that the funds held outside of the

U.S. are necessary to margin, guarantee, or secure (including any

prefunding obligations) the foreign futures or foreign options

positions of an FCM's 30.7 customers. The proposal further allowed an

FCM to deposit additional 30.7 customer funds outside of the U.S. up to

a maximum of 10 percent of the total amount of funds required to be

held by non-U.S. brokers or foreign clearing organizations for 30.7

customers as a cushion to meet anticipated margin requirements. The

proposal also provided that the FCM must hold 30.7 customer funds under

the laws and regulations of the foreign jurisdiction that provide the

greatest degree of protection to such funds; and that the FCM may not

by contract or otherwise waive any of the protections afforded customer

funds under the laws of the foreign jurisdiction.

Several comments were received on the proposal. Pilot Flying J

supported the requirement that 30.7 customer funds, if held outside of

the U.S., must be held under the laws of the foreign jurisdiction that

provides the funds with the greatest degree of protection.\567\

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\567\ Pilot Flying J Comment Letter at 2 (Feb. 14, 2013).

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FIA and Jefferies each recommended that an FCM be permitted to

maintain an excess of up to 50 percent of the amount an FCM is required

to deposit with a foreign broker to maintain customer foreign futures

and foreign options positions, a position that they

[[Page 68574]]

stated is consistent with Sec. 1.17 that requires an FCM to incur a

capital charge for unsecured receivables due from a foreign broker

greater than 150 percent of the amount required to maintain positions

in accounts with the foreign broker.\568\ FIA recommended that, at a

minimum, a cushion of 20 percent should be provided.\569\ FIA stated

that the proposal is more restrictive than the provisions of Sec.

1.49, which set out the terms and conditions pursuant to which an FCM

may hold futures customers' segregated funds and Cleared Swaps

Collateral outside of the U.S. and suggested that the proposal be

revised to permit an FCM to hold funds comprising the foreign futures

and foreign options secured amount in depositories outside of the U.S.

to the same extent that an FCM may hold futures customer segregated

funds and Cleared Swaps Collateral outside of the U.S.\570\ They

further recommended that the ``10% limitation'' apply only to funds

deposited with a foreign broker or foreign clearing organization.\571\

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\568\ FIA Comment Letter at 37 (Feb. 15, 2013); Jefferies Bache

Comment Letter at 6 (Feb. 15, 2013).

\569\ FIA Comment Letter at 37 (Feb. 15, 2013).

\570\ Id. See also RJ O'Brien Comment Letter at 11 (Feb.15,

2013).

\571\ FIA Comment Letter at 37 (Feb. 15, 2013).

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RCG requested the Commission to clarify application of Sec.

30.7(c) as it relates to banks located outside the U.S. that FCMs use

for settlement purposes, and how the limitation applies to variation

amounts.\572\

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\572\ RCG Comment Letter at 7 (Feb. 12, 2013).

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Jefferies stated that the proposed rule disadvantages customers who

may no longer deposit ``customer owned'' securities and would instead

have to prefund their obligations with cash.\573\

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\573\ Jefferies Bache Comment Letter at 6 (Feb. 15, 2013).

---------------------------------------------------------------------------

Advantage stated that FCMs typically must maintain a relationship

with a foreign bank in order to meet cutoff times for payment of fees

and clearing on foreign exchanges and that if an FCM can't maintain

funds at a foreign institution, it may inhibit its ability to trade

foreign futures.\574\ The effect, they asserted, could be that U.S.

FCMs will be required to use non-U.S. brokers that are not regulated by

the Commission for their foreign futures business.\575\ They further

requested that the Commission clarify how the prohibition on keeping

non-margin foreign futures funds in an institution outside the U.S.

would apply to Sec. 30.7(b), which appears to allow such funds to be

held at a bank or trust company outside the U.S.\576\

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\574\ Advantage Letter at 8 (Feb. 15, 2013).

\575\ Id. at 9.

\576\ Id.

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In response to commenter concerns, the Commission is adopting the

amendments generally as proposed, but the final rule will permit an FCM

to post with depositories outside of the U.S. sufficient funds to cover

the full margin obligations imposed by foreign brokers or foreign

clearing organizations on the FCM's 30.7 customers' positions, plus an

additional amount equal to 20 percent of the required margin on such

positions.

The Commission is increasing the amount of 30.7 customer funds that

an FCM may hold in a foreign jurisdiction in response to the comments.

The Commission is adopting this regulation to provide greater

protection to both U.S. and foreign-domiciled customers in the event of

the insolvency of the FCM. Recent experience has demonstrated that

funds held outside of the U.S, at depositories subject to foreign

insolvency regimes, present challenges and potential delays in the

ability of the Trustee to return customer property to the customers of

the FCM. In increasing the amount of funds an FCM may hold outside of

the U.S. from 10 percent of the required margin to 20 percent of the

required margin, the Commission is striving to strike a proper balance

that would not interfere with the ability of 30.7 customers to trade on

foreign markets (and the ability of FCMs to facilitate such

transactions by allowing them to meet their 30.7 customers' margin and

other financial obligations to foreign brokers and clearing

organizations), with the Commission's desire to provide 30.7 customers

with an appropriate level of protection in the event of the insolvency

of an FCM. The Commission believes that, to the maximum extent

commercially practicable, funds deposited by 30.7 customers that are

not required to margin positions with foreign brokers or foreign

clearing organizations should be held within in the U.S. to provide

greater assurance that such funds would be subject to the bankruptcy

provision of U.S. law and the Commission's regulations under the

jurisdiction of U.S. courts.

The Commission further notes that the 20 percent limitation is

based upon the amount of margin required on open positions. In response

to RCG's request for clarification, FCMs may transfer funds to foreign

depositories to cover variation margin calls and exclude such funds

from the calculation of the 20 percent ``cushion.'' In addition, the

Commission notes that FCMs may deposit 30.7 customer funds with any of

the foreign depositories listed under Sec. 30.7(b), provided that the

FCMs do not exceed the 20 percent limit on the amount of funds that are

permitted to be held in foreign jurisdictions. The Commission believes

that the ability to post variation margin in foreign jurisdictions and

an additional 20 percent cushion should allow FCMs to conduct foreign

futures activities on behalf of their customers, while also providing

additional protections to the current regulatory regime.

3. Commingling of Positions in Foreign Futures and Foreign Options

Accounts

Commission staff previously issued an Advisory stating that while

it was desirable for FCMs to hold only a customer's foreign futures

transactions (and the funds supporting such transactions) in such

customer's foreign futures account, this limitation was not mandatory

and that the FCM could also hold such customer's unregulated

transactions (and the funds supporting such transactions) in the

foreign futures accounts.\577\ Thus, pursuant to this Advisory, FCMs

were permitted to commingle the funds supporting a customer's foreign

futures and options transactions with such customer's unregulated

transactions, including over-the-counter transactions. The Advisory was

issued before the passage of Dodd-Frank, section 724(a) of which

established in section 4d(f) of the CEA a segregation regime for the

funds of cleared swaps customers, and the Commission's promulgation of

part 22, implementing that statute.

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\577\ CFTC Advisory No. 87-4 (Nov. 18, 1987).

---------------------------------------------------------------------------

In response to an FIA recommendation at a public roundtable held in

advance of the Commission's publication of the proposal, the Commission

proposed to amend Sec. 30.7 by adopting new paragraph (e) to prohibit

an FCM from commingling funds from unregulated transactions with funds

for foreign futures and options transactions in part 30 secured

accounts, except as authorized by Commission order. The prohibition on

holding unregulated transactions or other non-foreign futures or

foreign option transactions in part 30 set aside accounts is consistent

with the treatment applicable under section 4d(a)(2) of the Act for

segregated accounts and section 4d(f) of the Act for Cleared Swaps

Customers' accounts.

The Commission noted in the proposal that when part 30 was being

adopted, commenters cited back office operational difficulties with

establishing multiple ``customer'' account classes or origins.\578\

Given the technological changes during the intervening decades, and the

new statutory and regulatory

[[Page 68575]]

framework, these concerns should no longer dictate the advisability of

commingling the funds of regulated foreign futures and foreign options

transactions with unregulated transactions.

---------------------------------------------------------------------------

\578\ See 52 FR 28980, 28985-28986.

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New Sec. 30.7(e) extends the prohibition against commingling of

customer funds currently found in section 4d(a)(2) futures customer

accounts and section 4d(f) Cleared Swaps Customer Accounts to 30.7

customer accounts, except as otherwise permitted by Commission

regulation or order.

CIEBA stated that it supported the prohibition on the commingling

of funds deposited by futures customers, Cleared Swaps Customers, and

30.7 customers.\579\ Nodal requested that the Commission make explicit

in the adopting release that 30.7 accounts may continue to hold

customer funds to margin contracts traded on a market that is pending

designation as a contact market at the time the rules become effective,

until such market is registered as a DCM or upon the withdrawal or

denial of the DCM application.\580\ LCH.Clearnet noted that while it

does not have a position on whether the Commission should prohibit

commingling of 30.7 customer funds with the funds of futures customers

and Cleared Swaps Customers, if adopted, it urged the Commission to

preserve the ability to allow such commingling pursuant to a Commission

rule or order.\581\

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\579\ CIEBA Comment Letter at 4 (Feb. 20, 2013).

\580\ Nodal Comment Letter at 1-2 (Jan. 21, 2013).

\581\ LCH.Clearnet Comment Letter at 6-7 (Jan. 25, 2013).

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The Commission is adopting new Sec. 30.7(e) as proposed. As it

noted in the proposal, should there be a need to permit commingling of

funds, the Commission will continue to have the ability to permit such

commingling under the formalities of processes associated with a

Commission order or rule pursuant to section 4d of the CEA. Absent such

a rule or order, however, protection for such customer property would

not be available under the Commission's part 190 regulations or the

Bankruptcy Code, and thus such commingling would not be permitted. In

addition, the Commission does not agree with Nodal's request that FCMs

may continue to hold margin funds in 30.7 accounts for positions that

are executed on markets that are pending approval as designed contract

markets. As noted above, a purpose of Sec. 30.7(e) is to enhance the

protection of 30.7 customers by prohibiting the commingling of 30.7

customer funds with funds held by an FCM for unregulated transactions.

Commingling of unregulated transactions with regulated transactions

could also impede the resolution of 30.7 customer claims in the event

of the insolvency of the FCM carrying the funds.

4. Further Harmonization With Treatment of Customer Segregated Funds

The Commission proposed to adopt new paragraphs (f) and (k) in

Sec. 30.7, to extend regulatory provisions from Sec. Sec. 1.20, 1.21,

1.22 and 1.24, that previously were applicable only to 4d segregated

funds, to funds set aside as the foreign futures or foreign options

secured amount under Sec. 30.7. These proposed requirements would make

clear that: (1) FCMs would not be permitted to use funds set aside as

the foreign futures or foreign options secured amount other than for

the benefit of 30.7 customers; (2) FCMs must hold sufficient residual

interest in 30.7 accounts to make sure that 30.7 customer funds of one

30.7 customer are not used to margin, secure or guarantee the

obligations of other customers; (3) funds set aside as the foreign

futures or foreign options secured amount should not be invested in any

obligations of clearing organizations or boards of trade; and (4) no

funds placed at foreign brokers should be included as funds set aside

as the foreign futures or foreign options secured amount unless those

funds are on deposit to margin the foreign futures or foreign options

positions of 30.7 customers. In addition to extending the existing

Commission regulations noted above to Sec. 30.7, the Commission also

proposed a new requirement prohibiting an FCM from imposing any liens

or allowing any liens to be imposed on funds set aside as the foreign

futures or foreign options secured amount. This requirement parallels

that currently applicable to cleared swap customers with respect to the

segregation of Cleared Swaps Collateral.\582\

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\582\ See Sec. 22.2(d)(2).

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As discussed above, the Commission received several comments

regarding the residual interest requirements set forth in the

Proposal.\583\ While most of the commenters focused on the impact of

the Proposed Residual Interest Requirement to the futures market, some

of the more general comments would also apply to the foreign futures or

foreign options market. Given the statutory prohibition in sections

4d(a) and 4d(f) of the Act against using one customer's funds to

margin, secure or guarantee the obligations of another customer, FCMs

that participate in the swaps and futures market may not ``use'' one

customer's property to margin another customer's positions.

Nonetheless, the Commission clarified that an FCM does not ``use'' a

customer's funds until the time of settlement.\584\

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\583\ See sections II.G.9. and II.Q. above for discussion of the

Proposed Residual Interest Requirement.

\584\ See section II.G.9. above.

---------------------------------------------------------------------------

The Commission recognizes that the statutory prohibitions set forth

in sections 4d(a) and 4d(f) of the Act apply to the futures and swaps

markets. Conversely, as discussed above, the proposed changes to Sec.

30.7 were intended to provide a more coordinated approach to the

regulations governing foreign futures and foreign options, with

standards that are consistent with those for the futures and swaps

markets. These regulations, including regulations governing how an FCM

holds funds for customers trading on non-U.S. markets, would greatly

enhance the protection of customer funds and avoid regulatory

arbitrage. Such consistency would, to the extent practicable and

appropriate, contribute to the goal of having customer protection

across futures, swaps and foreign futures markets be substantively

similar.

The Commission did not receive any comments opposing the concept of

having consistent residual interest requirements across markets. The

Commission did, however, receive comments regarding the additional

complexities associated with trading foreign futures and foreign

options.\585\ As such, the Commission is adopting residual interest

requirements in part 30 that are substantively similar to the amended

requirement in part 1, but with a modification as to the time by which

an FCM must maintain such residual interests that will give FCMs the

flexibility necessary to account for differences in the regulatory

requirements and market practices applicable to foreign brokers and

clearing organizations in other jurisdictions. Thus, the Commission is

revising Sec. 30.7(f) as follows.

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\585\ See Roundtable Tr. at 266-267 (Feb. 5, 2013).

---------------------------------------------------------------------------

Regulation 30.7(f)(1)(i) sets forth the general requirement that an

FCM may not use, or permit the use of, the funds of one 30.7 customer

to purchase, margin or settle the trades, contracts, or commodity

options of, or to secure or extend credit to, any person other than

such 30.7 customer. Regulation 30.7(f)(1)(ii)(A) states that the

undermargined amount for a 30.7 customer's account is the amount, if

any (i.e., the must be amount equal to or

[[Page 68576]]

greater than zero), by which the total amount of collateral required

for that 30.7 customer's positions in that account at a specified time

exceeds the value of the 30.7 customer funds in that account, as

calculated in new Sec. 30.7(f)(2)(ii). Regulation 30.7(f)(1)(ii)(B)

requires FCMs to perform a residual interest buffer calculation, at the

close of each business day, based on the information available to the

FCM at that time, by calculating (1) the undermargined amounts, based

on the clearing initial margin that will be required to be maintained

by that FCM for its 30.7 customers, at each clearing organization of

which the FCM is a member, at any settlement that will occur before

6:00 p.m. Eastern Time on the following business day for each such

clearing organization less (2) any debit balances referred to in Sec.

30.7(f)(2)(B)(iv) that is included in such undermargined amounts.

In addition, and for the reasons set forth above, pursuant to Sec.

30.7(f)(1)(ii)(C)(1) FCMs must maintain residual interest prior to 6:00

p.m. Eastern Time on the date referenced in Sec. 30.7(f)(1)(ii)(B) in

segregated funds that is equal to or exceeds the computation set forth

in (ii)(B). Moreover, Sec. 30.7(f)(1)(ii)(C)(2) provides that an FCM

may reduce the amount of residual interest required in Sec.

30.7(f)(1)(ii)(C)(1) to account for payments received from or on behalf

of undermargined 30.7 customers (less the sum of any disbursements made

to or on behalf of such customers) between the close of business the

previous business day and 6:00 p.m. Eastern Time on the following

business day. Regulation 30.7(f)(1)(ii)(D) provides that for purposes

of Sec. 30.7(f)(1)(ii)(B), an FCM should include, as clearing initial

margin, customer initial margin that the FCM will be required to

maintain, for that FCM's 30.7 customers, at a foreign broker, and, for

purposes of Sec. 30.7(f)(1)(ii)(C), must do so by 6:00 p.m. Eastern

Time. In other words, Sec. 30.7(f)(1)(ii)(D) is intended to make clear

that the requirements with respect to 30.7 customer funds that are used

by an FCM that clears through a foreign broker are parallel to the

requirements applied to 30.7 customer funds that are used when an FCM

clears directly on a clearing organization.

Finally, to provide greater clarity, the Commission is adding a new

subparagraph (2) to paragraph (f), which sets out the requirements as

to the FCM's calculation of the Net Liquidating Equities of their 30.7

customers. Because of the addition of new subparagraph (2), the

Commission is renumbering proposed Sec. 30.7(f)(2) and (f)(3) to Sec.

30.7(f)(3) and (f)(4), and since the Commission did not receive any

comments on the substantive provisions of these paragraphs, it is

adopting them as proposed.

The Commission did not receive any comments on the substantive

provisions of proposed Sec. 30.7(k) and is adopting this new

paragraphs as proposed.

MFA, however, requested confirmation that the Commission's prior

guidance with respect to a customer's authority to grant liens or

security interests on its own Cleared Swaps Customer Account under part

22 would also be applicable to customers on their foreign futures or

foreign options secured amount under Sec. 30.7.\586\ The Commission

agrees with this position and hereby confirms the applicability of its

prior guidance.\587\

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\586\ MFA Comment Letter at 10 (Feb. 15, 2013).

\587\ Specifically, In the Final LSOC Release the Commission

clarified:

an FCM may not, under any circumstances, grant a lien to any

person (other than to a DCO) on its Cleared Swaps Customer Account,

or on the FCM's residual interest in its Cleared Swaps Customer

Account. On the other hand, a Cleared Swaps Customer may grant a

lien on the Cleared Swaps Customer's individual cleared swaps

account (an `FCM customer account') that is held and maintained at

the Cleared Swaps Customer's FCM.

77 FR at 6352.

In addition, Commission Staff issued an interpretive letter that

stated:

Regulation 22.2(d) does not prohibit a Cleared Swaps Customer

from granting security interests in, rights of setoff against, or

other rights in its own Cleared Swaps Customer Collateral,

regardless of whether those assets are held in the Cleared Swaps

Customer's FCM customer account. Furthermore, nothing in the rule is

intended to inhibit this right of the Cleared Swaps Customer.

CFTC Letter No. 12-28 at 2 (Oct. 17, 2012).

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5. Harmonization With Other Commission Proposals

The Commission also proposed various other amendments to its part

30 regulations to harmonize the rules with those applicable to U.S.

customers under other Commission regulations.

As discussed in section II.I. above, the Commission is adopting in

this release new limitations on withdrawals of segregated funds in

Sec. 1.23. The amendments provide for an FCM's residual interest in

segregated funds, and permit withdrawals from segregated funds for the

proprietary use of the FCM to the extent of such residual interest,

subject to the requirement that the withdrawal must not occur prior to

the completion of the daily segregation computation for the prior day,

and should the withdrawal (individually or aggregated with other

withdrawals) exceed 25 percent of the prior day residual interest, the

withdrawal must be subject to specific approvals by senior management

and appropriately documented, and further subject to a complete

prohibition on withdrawals of residual interest to the extent necessary

to maintain proper residual interest to cover undermargined amounts.

The Commission proposed and is adopting paragraph (g) of Sec. 30.7 to

apply the same restrictions on withdrawals of an FCM's residual

interest in funds set aside as the foreign futures or foreign options

secured amount.

Current Sec. 30.7(g) was recently adopted by the Commission to

provide that the investment of Sec. 30.7 funds be subject to the

investment limitations contained in Sec. 1.25.\588\ As proposed, the

Commission is moving this permitted investment requirement to a new

paragraph Sec. 30.7(h), and further is adopting a new paragraph Sec.

30.7(i) to make clear that FCMs are solely responsible for any losses

resulting from the permitted investment of funds set aside as the

foreign futures or foreign options secured amount. New paragraph Sec.

30.7(i) is intended to apply the same standard as is being adopted in

the amendment to Sec. 1.29 for segregated funds discussed above.

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\588\ 76 FR 78776, 78802 (December 19, 2011).

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The Commission also proposed and is adopting an amended paragraph

(j) to Sec. 30.7 to clarify the circumstances under which an FCM may

make secured loans to 30.7 customers and to adopt the same restriction

on unsecured lending to 30.7 customers as has been adopted with respect

to futures customers and 4d segregated funds in the amendment to Sec.

1.30 discussed above.

Finally, the Commission proposed and is adopting an amended

paragraph (l) to Sec. 30.7 to require the daily computation of the

foreign futures or foreign options secured amount and the filing of

such daily computation with the Commission and DSROs, as well as to

require the FCM to provide investment detail of the foreign futures or

foreign options secured amount as of the middle and end of the month.

The amendments to paragraph (l) of Sec. 30.7 are intended to be

consistent with the requirements for the daily segregation calculation

for segregated customer funds and the provision of the segregation

investment detail which are adopted in Sec. 1.32.

No comments were received on the above proposals and the Commission

is adopting the amendments as proposed.

S. Sec. 3.3: Chief Compliance Officer Annual Report

Regulation 3.3 requires each FCM (as well as swap dealers and major

swap participants) to designate an individual to serve as its CCO. The

CCO is required

[[Page 68577]]

to be vested with the responsibility and authority to develop, in

consultation with the FCM's board of directors or senior officer,

appropriate policies and procedures to fulfill the duties set forth in

the Act and Commission regulations relating to the FCM's activities as

an FCM. Regulation 3.3(e) also requires the FCM's CCO to prepare an

annual compliance report that includes a description of any non-

compliance events that occurred during the last reporting period along

with the action taken to address such events. The annual compliance

report currently is required to be filed electronically with the

Commission simultaneously with the FCM's certified annual financial

report, and in no event later than 90 days after the firm's fiscal year

end.

The Commission proposed a conforming amendment to Sec. 3.3(f)(2)

to reflect the amendments to Sec. 1.10(b)(1)(ii), discussed in section

II.A. above, that require an FCM to file its annual certified financial

statements with the Commission within 60 days of the firm's fiscal year

end. In this regard, the Commission proposed to require that each FCM

file the CCO annual report with the Commission simultaneously with the

filing of the firm's certified annual report, and in no event later

than 60 days after the FCM's fiscal year end.

The NFA commented that it supported the proposal.\589\ No other

comments were received. The Commission has determined to amend Sec.

3.3 as proposed.

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\589\ NFA Comment Letter at 9 (Feb. 15, 2013).

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III. Compliance Dates

The final regulations will be effective January 13, 2014. The

compliance date for the regulations will be the effective date, subject

to the following exceptions:

A. Financial Reports of FCMs: Sec. 1.10

An FCM that is not dually-registered as a BD currently is required

to submit its certified annual report to the Commission within 90 days

of the firm's year end date. The Commission has amended Sec.

1.10(b)(1)(ii) to require such certified annual report to be submitted

within 60 days of the firm's year end date.

The Commission recognizes that many FCMs have contracted with

public accountants to perform the current year's audit examination, and

that those audits are currently in process. In order to allow the

current year audits to be completed, the Commission is setting a

compliance date for Sec. 1.10(b)(1)(ii) for FCMs with years ending

after June 1, 2014. This date will also coincide with several other

compliance dates affecting public accountants discussed under Sec.

1.16 below.

B. Risk Management Program for FCMs: Sec. 1.11

Section 1.11 requires each FCM that carries customer funds to

establish a risk management program. RJ O'Brien requested that the

Commission provide at least one year for FCMs to comply with the new

risk management regulations in the event the proposed Risk Management

Program is adopted. RJ O'Brien stated that the new requirements would

likely necessitate a period of time for firms to reorganize, develop

the policies and procedures, implement the policies and procedures,

acquire adequate personnel, and conduct extensive training of new and

existing employees. Advantage stated ``that most aspects of proposed

Sec. 1.11 are appropriate and unlikely to be burdensome as FCMs

typically have most (if not all) of these requirements in place.''

\590\

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\590\ Advantage Comment Letter at 2 (Feb. 15, 2013).

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The Commission recognizes that some FCMs may need a sufficient

period of time to develop and implement a risk management program that

complies with Sec. 1.11, but believes that many firms already maintain

programs that comply with many of the requirements in Sec. 1.11.

Accordingly, FCMs must file their initial Risk Management Program

within 180 days of the effective date of the regulation. The filings

must be made via electronic transmission to the Commission using the

WinJammer electronic filing system.

C. Qualifications and Reports of Accountants: Sec. 1.16

The Commission is amending Sec. 1.16 to require a public

accountant to meet certain qualification standards in order to be

qualified to conduct audits of FCMs. The Commission is amending Sec.

1.16(b) to require that the public accountant: (1) Must be registered

with the PCAOB; (2) must have undergone a PCAOB inspection; and (3) may

not be subject to a temporary or permanent bar to engage in the audit

of public issuers or BDs as a result of a PCAOB disciplinary action.

The Commission is further amending Sec. 1.16(c) to require that the

public accountant's audit report must state whether the audit was

conducted in accordance with PCAOB auditing standards.

The Commission is establishing a compliance date of June 1, 2014

for the amendment to Sec. 1.16(b)(1) that requires a public accountant

to be registered with the PCAOB in order to conduct an audit of an FCM.

The Commission also is establishing a compliance date of June 1, 2014

for the amendment to Sec. 1.16(c) that requires a public accountant to

conduct an audit of an FCM in accordance with the standards issued by

the PCAOB. A compliance date of June 1, 2014 will allow current year

audits to be completed without interruption, and provides sufficient

time for public accountants that audit FCMs to register with the PCAOB

if such public accountants are not already registered. In addition, a

June 1, 2014 compliance date will align the Commission's requirements

for the use of PCAOB standards in the audit of an FCM with the SEC

audit standards for public accountants auditing BDs.\591\ Without such

alignment, public accounts of a dually-registered FCM/BD would have to

issue two different audit reports; one audit report to the SEC for an

examination conducted under PCAOB audit standards, and a second audit

report for the Commission for an examination conducted under U.S. GAAS.

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\591\ The SEC recently amended its regulations to require public

accountants to conduct audits of BDs pursuant to the audit standards

issued by the PCAOB. This requirement is effective for audits of BDs

with a year-end of June 1, 2014 or later. See 78 FR 51910 (Aug. 21,

2013).

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The Commission also is establishing a compliance date of December

31, 2015 for the requirement in Sec. 1.16 that a public accountant

must have undergone an inspection by the PCAOB in order to qualify to

conduct an audit of an FCM. The extension of the compliance date to

December 31, 2015 will provide additional time for the PCAOB to conduct

inspections of public accountants that registered with, but have not

been inspected by, the PCAOB.

Lastly, the compliance date for the amendment to Sec. 1.16(b)(1)

the provides that a public accountant may not be subject to a temporary

or permanent bar to engaging in the audit of public issuers or BDs as a

result of a PCAOB disciplinary action is the effective date of the

amendment. The Commission believes that if a public accountant is

registered with the PCAOB and is subject to a PCAOB disciplinary action

that temporarily or permanently bars the public accountant from

auditing public issuers, the public accountant is not qualified to

conduct audits of FCMs.

D. Minimum Financial Requirements for FCMs

The Commission is amending the capital rule to require an FCM to

incur a capital charge for undermargined

[[Page 68578]]

customer, noncustomer, and omnibus accounts that are undermargined more

than one business day after a margin call is issued by the FCM. For

example, if an account is undermargined on Monday and the FCM issues a

margin call on Tuesday, the FCM would have to take a reduction to

capital equal to the amount of the margin call that was not met by

close of business Wednesday.

The Commission is establishing a compliance date for the revised

timeframe for the capital charges required by Sec. 1.17(c)(5)(viii)

and (ix) of one year following publication of this rule in the Federal

Register. The compliance date provides FCMs with a period of time that

the Commission believes is sufficient to adjust its systems for issuing

and collecting margin from customers and provides customers with an

opportunity to adjust their operations, as necessary, to meet its

margin obligations on a reduced timeframe for the current regulation.

E. Written Acknowledgment Letters: Sec. Sec. 1.20, 1.26, and 30.7

The Commission is amending Sec. Sec. 1.20(d) and (g), 1.26(b), and

30.7(d) to require FCMs and DCOs, as applicable, to obtain standard

form acknowledgment letters from each depository that the FCMs or DCOs

use to hold customer funds.\592\ The Commission is further requiring

FCMs and DCOs to use Template Letters set forth in appendices to the

regulations.

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\592\ The regulations, however, provide that an FCM is not

required to obtain an acknowledgment letter from a DCO if the DCO

maintains rules that have been submitted to the Commission and that

provide for the segregation of customer funds in accordance with all

relevant provisions of the Act and Commission regulations or orders.

See Sec. Sec. 1.20(d)(1) and 30.7(d)(1).

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The Commission is establishing a compliance date of 180 days after

the effective date of the regulations in order to provide FCMs and DCOs

with sufficient time to obtain from depositories new acknowledgment

letters that conform to the Template Letters.

F. Undermargined Amounts: Sec. Sec. 1.22(c), 30.7(f)

The Commission received several comments on the appropriate timing

for the effectiveness of the Proposed Residual Interest Requirement. At

the public roundtable held on February 5, 2013, several panelists

argued that the Proposed Residual Interest Requirement would require

substantial time to implement in order to change the behavior of all

futures markets participants.\593\ In addition, FIA asserted that

implementation would require multiple years and ``radical'' changes to

processing procedures for futures market participants,\594\ and RCG

requested that the Commission provide ``with a period of time not less

than one year from the promulgation of the relevant final rules for

FCMs to implement them.'' \595\

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\593\ See Roundtable Tr. at 252-255, 257, 266-267 (Feb. 5,

2013).

\594\ See FIA Comment Letter at 21 (Feb. 15, 2013).

\595\ See RCG Comment Letter at 8 (Feb. 12, 2013).

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As discussed above, the residual interest requirements set forth in

part 22 are the requirements that are currently in place today. As

such, FCMs are expected to continue meeting their regulatory

requirements. With respect to the residual interest requirements set

forth in Sec. Sec. 1.22(c) and 30.7(f), the Commission recognizes that

these requirements represent a significant change in current market

practice. Given the costs associated with compliance with these

requirements, as well as comments received from the interested parties

requesting sufficient time to achieving compliance with these

requirements, the Commission has determined that a phased compliance

schedule for Sec. 1.22(c) is necessary and appropriate. The phased

compliance schedule for Sec. 1.22(c) is set forth in Sec.

1.22(c)(5)(iii). However, the Residual Interest Deadline of 6:00 p.m.

Eastern Time in Sec. 1.22(c)(5)(ii) shall begin one year following the

publication of this rule in the Federal Register.\596\ With regards to

the residual interest requirements set forth in Sec. 30.7(f), the

Commission is establishing a compliance date of one year following the

publication of this rule in the Federal Register.

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\596\ For further discussion regarding the phase-in schedule for

the requirements in Sec. 1.22(c), see section II.G.9.

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G. SRO Minimum Financial Surveillance: Sec. 1.52

The Commission amended Sec. 1.52 to require each SRO to establish

a supervisory program to oversee their member FCMs' compliance with SRO

and Commission minimum capital and related reporting requirements, the

obligation to properly segregated customer funds, risk management

requirements, financial reporting requirements, and sales practices and

other compliance requirements. The Commission also amended Sec.

1.52(c) to require each SRO to engage an ``examinations expert'' at

least once every three years to evaluate the quality of the supervisory

oversight program and the SRO's application of the supervisory program.

The SRO must obtain a written report from the examinations expert with

an opinion on whether the supervisory program is reasonably likely to

identify a material weakness in internal controls over financial and/or

regulatory reporting, and in any of the other areas that are subject to

the supervisory program.

The Commission established a compliance date in amended Sec.

1.52(e) that requires each SRO to submit a supervisory program to the

Commission for review, together with the examinations expert's report

on the supervisory program, within 180 days of the effective date of

the amendments to Sec. 1.52, or such other time as may be approved by

the Commission. The Commission further revised Sec. 140.91(10) to

delegate the authority to extend the time period for the submission of

the initial supervisory program to the Director of the Division of Swap

Dealer and Intermediary Oversight and the Director Division of Clearing

and Risk, with the concurrence of the General Counsel or, in his or her

absence, a Deputy General Counsel.\597\

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\597\ The Commission also amended Sec. 1.52(d)(2)(ii)(H) to

provide that a Joint Audit Committee must submit an initial Joint

Audit Program to the Commission, along with an examinations expert's

report on the Joint Audit Program, within 180 days of the effective

date of the regulation. The Director of the Division of Swap Dealer

and Intermediary Oversight and the Director of the Division of

Clearing and Risk also are authorized under Sec. 1.52(d)(2)(ii)(H)

an Sec. 140.91(10), with the concurrence of the General Counsel or,

in his or her absence, a Deputy General Counsel, to extend the

initial filing deadline if warranted.

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Commission staff will consult with the SROs to assess their

progress in preparing an initial supervisory program, including the

examinations expert's review, and may adjust compliance dates as

appropriate.

H. Public Disclosures by FCMs: Sec. 1.55

The Commission has amended Sec. 1.55(b) by revising the Risk

Disclosure Statement to include several additional disclosures intended

to provide customers and potential customers with enhanced information

to further their understanding of the risks of engaging in the futures

markets. The Commission recognizes that FCMs will be required to revise

the Risk Disclosure Statement to implement the revisions, and is

establishing a compliance date for the amendments to 1.52(b) of 90 days

after the effective date of the amendments. The Commission believes

that this provides sufficient time for FCMs to revise the Risk

Disclosure Statement and to modify their systems, if necessary, in the

case of firms that

[[Page 68579]]

provide electronic account opening documents.

The Commission also amended Sec. 1.55(i)-(k) to require each FCM

to disclose to customers all information that would be material to the

customers' decision to entrust funds to, or otherwise do business with,

the FMC, including its business, operations, risk profile, and

affiliates. The Commission is establishing a compliance date of 180

days after the effective date of the regulation to provide adequate

time for FCMs to develop the required disclosures and make them

available to the public.

The Commission also amended Sec. 1.55(o) to require each FCM to

disclose on its Web site certain current and historical information

regarding its holding of customer funds, and its certified annual

report. The Commission is establishing a compliance date of 180 days

after the effective date of the regulation to provide FCMs with

sufficient time to modify electronic systems, and make any additional

operational changes, necessary for the firms to comply with the

requirements.

IV. Cost Benefit Considerations

Statutory Mandate To Consider the Costs and Benefits of the

Commission's Action: Commodity Exchange Act Section 15(a)

Section 15(a) of the Act requires the Commission to consider the

costs and benefits of its actions before promulgating a regulation

under the Act or issuing certain orders. Section 15(a) further

specifies that the costs and benefits shall be evaluated in light of

the following five broad areas of market and public concern: (1)

Protection of market participants and the public; (2) efficiency,

competitiveness and the financial integrity of futures markets; (3)

price discovery; (4) sound risk management practices; and (5) other

public interest considerations. The Commission considers the costs and

benefits resulting from its discretionary determinations with respect

to the section 15(a) considerations.

In the NPRM, the Commission established, based on the subject

matter of the proposals, that it did not consider any of the proposals

contained therein to have any significant impact on price discovery.

The Commission received no responses from commenters with respect to

its analysis regarding price discovery. For the remaining areas, the

Commission addressed, section by section, the qualitative substantial

benefits perceived to be obtained from the regulatory proposals

contained in the NPRM. Where reasonably possible, the Commission has

estimated costs quantitatively associated with such proposals section

by section. The Commission asked specifically and generally for

comments with respect to its analysis of benefits and such cost

estimates, and requested information from commenters where the

Commission qualitatively considered but could not reasonably

quantitatively estimate costs.

The underlying purpose of the regulations adopted herein as stated

in the NPRM was to bolster the protection of customers and customer

funds, in response to the misuse or mishandling of customer funds at

specific FCMs like MFGI or PFGI. Further, the purpose of certain

proposals was to provide regulators the means by which to detect and

deter the misuse or mishandling of customer funds by FCMs, including

bolstering standards for the examination and oversight of FCMs by SROs

and public accountants. In addition to the significant benefits to the

protection of market participants and the public, the Commission

determined that a strong package of reforms, including enhanced

information and disclosures available to customers, adopted in light of

the recent FCM failures resulting in and from misuse of customer funds,

would be extremely beneficial to restore trust in the financial

integrity of futures markets. The Commission also included certain

proposals intended to both increase the protection of customer funds

and strengthen FCM risk management, specific to customer funds

processes and procedures.

As stated in the NPRM, a loss of trust in the financial integrity

of futures markets could deter market participants from the benefits of

using regulated, transparent markets and clearing. The overarching

purpose of the reforms contained in this rulemaking is to produce the

benefits that accrue by virtue of avoiding similar defaults in the

future. This prevents the costs certain to follow, including lost

customer funds, decreased market liquidity that follows from a crisis

in confidence, and the potential for the failure of one FCM to cause

losses in other clearing members.\598\

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\598\ The failure of one clearing member could lead to losses

for other clearing members if the losses due to the first member's

failure are large enough to exhaust the guarantee fund and require

additional capital infusion from other clearing members.

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In this rulemaking, the Commission adopted new rules and amended

existing rules to improve the protection of customer funds. The content

of the Commission's adopted new rules and amended rules can be

categorized in seven parts: (1) requiring FCMs to implement extensive

risk management programs including written policies and procedures

related to various aspects of their handling of customer funds; (2)

increasing reporting requirements for FCMs related to segregated

customer funds, including daily reports to the Commission and DSRO; (3)

requiring FCMs to establish target amounts of residual interest to be

maintained in segregated accounts as well as creating restrictions and

increased oversight for FCM withdrawals out of such residual interest

in customer segregated accounts, specifically including clear sign off

and accountability from senior management for such withdrawals; (4)

strengthening requirements for the acknowledgment letters that FCMs and

DCOs must obtain from their depositories; (5) eliminating the

Alternative Method for calculating 30.7 customer funds segregation

requirements and requiring FCMs to include foreign investors' funds in

segregated accounts; (6) strengthening the regulatory requirements

applicable to SRO and DSRO oversight of FCMs, including regulating

oversight provided under the function of a Joint Audit Committee that

would establish standards for, and oversee the execution of, FCM

audits; and (7) requiring FCMs to provide additional disclosures to

investors.

Overview of the Costs and Benefits of the Proposed Rules and Amendments

in Light of the 15(a) Considerations--Protection of Market Participants

and the Public

The Commission designed the adopted reforms to improve the

protection of customer funds. The Commission expects each of the seven

categories identified above to significantly increase the levels of

protection for customer funds. Requiring FCMs to implement risk

management programs that include documented policies and procedures

regarding various aspects of handling customer funds helps to protect

customer funds by promoting robust internal risk controls and reducing

the likelihood of errors or fraud that could jeopardize customer funds.

In addition, by requiring each FCM to document certain policies and

procedures, the rules enable the Commission, DSROs, and other auditors

to evaluate each FCM's compliance with their own policies and

procedures. Moreover, the requirement that FCMs establish a program for

quarterly audits by independent or external people that is designed to

identify any breach of the policies and procedures helps to ensure

[[Page 68580]]

regular, independent validation that the procedures are followed

diligently. Audits of this sort provide more thorough review of

internal procedures than the Commission or DSROs are able to perform

regularly with existing resources, which provides helpful scrutiny of

each FCM's procedures on a regular basis. This, together with the

requirement that FCMs establish a program of governing supervision that

is designed to ensure the policies required in Sec. 1.11 are followed,

will tend to promote compliance with the FCM's own policies and

procedures. And by promoting such compliance, the requirements reduce

the risk of operational errors, lax risk management, and fraud, and

thus the risk of consequent loss of customer funds.

Increasing reporting requirements for FCMs related to segregated

customer funds helps the Commission and DSRO identify FCMs that should

be monitored more closely in order to safeguard customer funds.

Moreover, by making some additional reported information public, the

rules facilitate additional market discipline that further promotes

protection of customer funds.

Creating restrictions and increased oversight for FCM withdrawals

out of its residual interest in customer segregated accounts, and

requiring review by senior management for large withdrawals protects

customers by helping to ensure that such withdrawals do not cause

segregated account balances to drop below required amounts, which are,

in turn, designed to prevent losses of customer funds. Moreover,

requiring personal accountability by senior management for withdrawals

that affect the balance of such accounts promotes more effective

oversight of customer segregated accounts.

The acknowledgments and commitments depositories are required to

make through Sec. Sec. 1.20, 1.26, and 30.7 provide additional

protection for customer funds by, among other things, requiring

depositories that accept customer funds to acknowledge that customer

funds cannot be used to secure the FCM's obligations to the depository.

Such an acknowledgment provides additional protection of customer funds

and fosters prompt transfer in the event of an FCM's default.

In addition, depositories must agree in the acknowledgment letter

to give the Commission and DSROs read-only electronic access to an

FCM's segregated accounts, which benefits customers by enabling the

Commission and DSROs to review the accounts for discrepancies between

the FCM's reports and the balances on deposit at various depositories.

These enhancements to oversight provide an additional mechanism by

which customers would be protected against a shortfall in customer

funds due to operational errors or fraud.

Requiring FCMs to include foreign-domiciled customers' funds in

segregated accounts benefits all customers placing funds on deposit for

use in trading foreign futures and foreign options. Because neither the

Bankruptcy Code nor the Commission's part 190 regulations distinguish

between foreign-domiciled and U.S. domiciled customers at the point

customer funds are distributed, any shortfall in available funds would

be shared among all such customers. As discussed below, the Commission

understands that most, if not all, FCMs currently compute secured

amount requirements for both U.S.-domiciled and foreign-domiciled

customers. However, incorporating foreign-domiciled customers within

the calculations required for 30.7 customers ensures that both groups

are fully protected. Similarly, eliminating the Alternative Method

provides additional protection to customer funds by ensuring that FCMs

are not allowed to reduce their segregation requirements for 30.7

accounts during a time of financial strain. As discussed below, this

change provides protection to both U.S-domiciled and foreign-domiciled

customers with funds in 30.7 accounts.

The provisions in Sec. 1.52 include additional requirements for

both the supervisory program for SROs as well as for the formation of a

Joint Audit Committee to oversee the implementation and operation of a

Joint Audit Program that directs audits of FCMs by DSROs. By requiring

both the SRO supervisory programs and the Joint Audit Program to comply

with U.S. generally accepted audit standards, to develop written

policies and procedures, to require controls testing as well as

substantive testing, and to have an examinations expert review the

programs at least once every two years, the amendments help to ensure

that audits of FCMs by SROs or DSROs are thorough, effective, and

continue to incorporate emerging best practices for such audits. As a

consequence, the amendments help to ensure that audits are as effective

as possible at identifying potential fraud, strengthening internal

controls, and verifying the integrity of FCMs' financial reports, each

of which tend to provide protection for FCMs' customers,

counterparties, and investors.

In addition Sec. 1.55 requires disclosure of firm-specific risks

to customers. This additional information should be helpful to

customers when selecting an FCM to deposit their funds. In doing so,

the rules promote market discipline that incents FCMs to manage their

risks carefully and assists customers in understanding how their funds

are held and what risks may be relevant to the safety of their funds.

Last, FCMs maintaining residual interest in customer accounts is an

important aspect of protection for customer funds. While an FCM's

residual interest is not exhausted, it may be used to meet the FCM's

obligations to each customer without using another customer's funds to

do so. All else being equal, the larger the residual interest, the less

likely that market participants will lose customer funds posted as

collateral, with associated detriment to members of the public with

interests in such market participants.

Efficiency, Competitiveness and Financial Integrity of Futures Markets

The proposed amendments should increase the efficiency and

financial integrity of the futures markets by ensuring that FCMs have

strong risk management controls that are subject to multiple and

enhanced external checks, by enhancing reporting requirements,

facilitating increased oversight by the Commission and DSROs, by

allowing FCMs flexibility in the development of newly required policies

and procedures wherever the Commission has determined that such

flexibility is appropriate, and by requiring FCMs to implement training

regarding the handling of customer funds. In addition, the rules

include some requirements that many industry participants have

requested as necessary for the adequate protection of customers and

also highlighted as best practices already adopted within the industry.

Requiring such standards to be adopted by all FCMs promotes the

competitiveness of futures markets by preventing an FCM from skimping

on customer protection safeguards. There are also provisions in the

proposal that permit FCMs that are not BDs to implement certain

securities net capital haircuts that apply to jointly registered FCM/

BDs by the SEC. This enhances competition between FCMs that are not

dually registered and jointly registered FCM/BDs with respect to such

requirements.

Smaller FCMs may have more difficulty than large FCMs in absorbing

the additional costs created by the requirements of the rules

(particularly Sec. 1.22). It is possible that some smaller FCMs may

elect to stop operating as FCMs as a result of these costs. The

Commission does not anticipate,

[[Page 68581]]

however, that the rules will have a material effect on FCM pricing due

to reduced competition (although the increased costs may affect

pricing).

More specifically, the amendments to Sec. Sec. 1.10, 1.11, 1.12,

1.32, 22.2, and 30.7 increase reporting requirements for FCMs related

to segregated customer funds, including daily, bi-monthly, and

additional event-triggered reports to the Commission and DSROs. The

expanded range and frequency of information that the Commission and

DSRO receive under the proposed regulations enhances their ability to

monitor each FCM's segregated accounts, which promotes the integrity of

futures markets by helping to ensure proper handling of customer funds

at FCMs.

In addition, the changes facilitate increased oversight by the

Commission and DSROs by including additional notification requirements,

obligating FCMs to alert the Commission when certain events occur that

could indicate an FCM's financial strength is deteriorating or that

important operational errors have occurred. Such notifications should

enable the Commission and DSROs to increase monitoring of such FCMs to

ensure that customer funds are handled properly in such circumstances.

The rules also require FCMs to obtain an acknowledgment letter from

depositories that should give the Commission and DSROs electronic

access to view customer accounts at each depository when requested by

the Commission. That should enable both the Commission and DSROs to

verify the presence of customer funds which would provide a safeguard

against fraud and would promote the integrity of markets for futures,

cleared options, and cleared swaps.

The rules also require FCMs to establish policies and procedures

regarding several aspects of how they handle customer funds. The rules

should give FCMs the flexibility, where appropriate, to develop

policies and procedures tailored to the unique composition of their

customer base, size, and other operational disincentives. This flexible

approach protects FCMs from additional regulatory compliance costs that

could otherwise result from rules requiring every FCM to operate in

exactly the same way without sacrificing the additional accountability

that results from written policies and procedures that the Commission

or DSRO can review and use as the basis for FCM audits.

The requirement that FCMs provide annual training to all finance,

treasury, operations, regulatory, compliance, settlement and other

relevant employees regarding the segregation requirements for

segregated funds, for notices under Sec. 1.12, procedures for

reporting non-compliance, and the consequences of failing to comply

with requirements for segregated funds, should enhance the integrity of

the futures markets by promoting a culture of compliance by the FCM's

personnel. The training should help to ensure that FCM employees

understand the relevant policies and procedures, that they are

empowered and incented to abide by them, and that they know how to

report non-compliance to appropriate authorities.

The rules allow FCMs that are not dual registrants (i.e., are not

both FCMs and BDs) to follow the same procedures as dual registrants

when determining what regulatory capital haircut applies to certain

types of securities in which the FCM invests its own capital or

customer funds. This change is needed as the SEC has proposed a change

for BDs which would permit joint registrants to possibly apply a lower

regulatory haircut for certain securities, but which would not be

applicable to FCMs that are not dual registrants without this rule.

Therefore, the rule should help to ensure that FCMs that are not dual

registrants are not competitively disadvantaged and are able to

continue applying the same regulatory capital haircuts for such

securities as joint registrants.

Last, residual interest is an important aspect of protection for

customer funds because it enables the FCM to ensure that it can meet

its obligations to each customer without using another customer's funds

to do so. All else being equal, the larger the residual interest, the

more secure are customer funds. This contributes to confidence in U.S.

futures markets and their financial integrity. Adequate residual

interest improves the competition between FCMs, inasmuch as FCMs are

competing less by transferring risks from customers with deficit funds

to customers with surplus funds.

Sound Risk Management

The amendments should promote sound risk management by facilitating

market discipline, enhancing internal controls, enabling the Commission

and DSROs to monitor FCMs for compliance with those controls, by

reducing the risk that an FCM's financial strain could interfere with

customers' ability to manage their positions, by requiring FCMs to

notify the Commission in additional circumstances that could indicate

emerging financial strain, and by requiring senior management to be

involved in the process of setting targets for residual interest.

The reporting requirements should enhance market discipline by

providing additional information to investors regarding the location of

their funds, and the size of residual interest buffer that an FCM

targets and maintains in its segregated accounts. This additional

information should be valuable to customers selecting an FCM and

monitoring the location of their funds deposited with the FCM which

should promote market discipline. For example, if an FCM were to

establish a low target for residual interest, or maintain a very low

residual interest, then market participants are likely to recognize

this as a practice that could increase risk to the funds they have on

deposit at the FCM. Consequently, customers would likely either apply

pressure to the FCM to raise their target, or take their business to a

different FCM that maintains a larger residual interest in customer

fund accounts. This market discipline should incent FCMs to maintain a

level of residual interest that is adequate to ensure that a shortfall

does not develop in the customer segregated accounts.

The rules should also enhance FCM internal controls by requiring

them to establish a risk management program that includes policies and

procedures related to various aspects of how segregated customer funds

are handled. For example, FCMs are required to establish procedures for

continual monitoring of depositories where segregated customer funds

are held, and should have to establish a process for evaluating the

marketability, liquidity, and accuracy of pricing for Sec. 1.25

compliant investments.

In addition, documented policies and procedures should benefit the

FCM customers and the public by providing the Commission and DSROs

greater ability to monitor and enforce procedures that FCMs perform to

ensure that the protection of customer funds is achieved, with the

effect that the Commission should have a greater ability to address and

protect against operational errors and fraud that put customer funds at

risk of loss.

Further, through the amendments to Sec. 1.17(a)(4), FCMs will need

to manage their access to liquidity so as to be able to certify to the

Commission, at its request, that they have sufficient access to

liquidity to continue operating as a going concern. This rule should

provide the Commission with the flexibility to deal with emerging

liquidity drains at FCM s which may endanger customers, potentially

prior to instances of regulatory capital non-compliance,

[[Page 68582]]

allowing customer positions and funds to be transferred intact and

quickly to another FCM. This change should promote sound risk

management practices by helping to ensure that customers maintain

control of their positions without interruption.

The proposed additions to notification requirements established in

Sec. 1.12 should enhance the Commission's ability to identify

situations that could lead to financial strain for the FCM, which makes

it possible for the Commission to monitor further developments with

that FCM more carefully and to begin planning earlier for the

possibility that the FCM's customer positions may need to be

transferred to other FCMs, in the event that the FCM currently holding

those positions defaults. Advance notice helps to ensure customers'

positions are protected by enabling the Commission to work closely with

DCOs and DSROs to identify other FCMs that have requisite capital to

meet regulatory requirements if they were to take on additional

customer positions, thus facilitating smooth transition of those

positions in the event that it is necessary.

Last, FCMs maintaining residual interest in customer accounts is an

important aspect of protection for customer funds. While an FCM's

residual interest is not exhausted, it may be used to meet the FCM's

obligations to each customer without using another customer's funds to

do so. All else being equal, the larger the residual interest, the more

secure are customer funds. Moreover, these requirements will create

incentives for FCMs to monitor their customers' undermargined amounts,

thereby enhancing the FCM's risk management. By requiring that senior

management set the target for residual interest, and that they conduct

adequate due diligence in order to inform that decision, the rule

promotes both informed decision making about this important form of

protection, and accountability among senior management for this

decision, both of which are consistent with sound risk management

practices.

Other Public Interest Considerations

As discussed above, the recent failures of MFGI and PFGI, FCMs to

which customers have entrusted their funds, sparked a crisis of

confidence regarding the security of those funds. This crisis in

confidence could deter market participants from using regulated,

transparent markets and clearing which would create additional costs

for market participants and losses in efficiency and safety that could

create additional burdens for the public. The Commission hopes that

this rule will not only address the current crisis of confidence, but

that it will produce benefits for the public by virtue of avoiding

similar defaults in the future.

These amendments are not, however, without costs. First, the most

significant costs created by the amendments are those that result from

the increased amount of capital that FCMs are required to hold in

segregated accounts as part of establishing a target for their residual

interest and requiring residual interest for undermargined amounts.

Second, additional costs may be created by the amendments that incent

FCMs to hold additional capital, and prevent them from holding excess

segregated funds overseas. Third, operational costs are likely to arise

from amendments that result in the formation of a risk management unit

and adoption of new policies and procedures.

Multiple rule changes are expect to incent or require FCMs to

increase the amount of residual interest that they maintain in

segregated accounts including: (1) Requiring FCMs to establish a target

for residual interest that reflects proper due diligence on the part of

senior management; (2) disclosing the FCMs' targeted residual interest

publicly; (3) requiring them to report to the Commission and their

DSROs any time their residual interest drops below that target, and (4)

requiring FCMs to hold residual interest large enough to cover their

customers' undermargined amounts. In addition by restricting FCMs'

ability to withdraw residual interest from segregated accounts and

obligating FCMs to report to the Commission and their respective DSRO

each time the residual interest drops below the target, the regulations

should incent FCMs to hold additional capital, which is also likely to

be a significant cost.

When FCMs hold excess customer funds overseas, such funds will

likely be held at depositories that are themselves subject to foreign

insolvency regimes. These regimes may provide less effective

protections for customer funds than those applicable under U.S. law. By

prohibiting FCMs from holding some excess customer funds overseas, and

thereby reducing investment opportunities for customer funds, the

regulations may reduce the returns that FCMs can obtain on invested

customer funds.

And last, the requirements related to operational procedures are

likely to create significant costs, particularly related to creating

and documenting policies and procedures, as well as complying with

ongoing training, due diligence, and audit requirements. However, in

several cases the implementation costs of the changes should be minor.

For example, some proposed requirements should obligate FCMs to provide

the Commission and DSROs more regular access to information that FCMs

and their depositories are already required to maintain, or in some

cases are already reporting to their DSROs. The Commission also

anticipates that some of the changes proposed codify best practices for

risk management that many FCMs and DCOs may already follow. In such

cases, the costs of compliance would be mitigated by the compliance

programs or best practices that the firm already has in place.

Moreover, in other cases the changes codify practices that are already

required by SROs, and therefore would impose no additional costs.

The initial and ongoing costs of the rules for FCMs should vary

significantly depending on the size of each FCM, the policies and

procedures that they already have in place, and the frequency with

which they experience certain events that would create additional costs

under the rules. In the NPRM, the Commission estimated that the initial

operational cost \599\ of implementing the rules would be between

$193,000 and $1,850,000 per FCM.\600\ And the initial cost to the SROs

and DSROs would be between $41,100 and $63,500 per SRO or DSRO. The

Commission estimated

[[Page 68583]]

that the ongoing operational cost to FCMs would be between $287,000 and

$2,300,000 per FCM per year.\601\ As described below in Sec. 1.52, the

Commission did not have adequate information to determine the ongoing

cost of the proposed requirements for SROs and DSROs.

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\599\ The Commission was not able to quantify the costs that

would result from increased residual interest held in customer

segregated accounts, from increased capital held by the FCM, or from

lost investment opportunities due to restrictions on the amount of

funds that may be held overseas. The Commission did not have

sufficient data to estimate the amount of additional residual

interest FCMs are likely to need as a consequence of proposed, the

amount of additional capital they may hold for operational purposes,

the cost of capital for FCMs, or the opportunity costs FCMs may

experience because of restrictions on the amount of customer funds

they can hold overseas, each of which would be necessary in order to

estimate such costs.

\600\ The lower bound assumes an FCM requires the minimum

estimated number of personnel hours to be compliant with these new

rules and that, when possible, they already have policies,

procedures, and systems in place that would satisfy the proposed

requirements. The upper bound assumes an FCM requires the maximum

amount of personnel hours and do not have pre-existing policies,

procedures, and systems in place that would satisfy the proposed

requirements. The greatest amount of variation within in the range

would depend on the number of new depositories an FCM must establish

relationships with due to current depositories that would not be

willing to sign the required acknowledgment letter. The lower bound

assumes that an FCM does not need to establish any new relationships

with depositories. The Commission estimates that the largest FCMs

may have as many as 30 depositories, and as a conservative estimate,

the Commission assumes for the upper bound that an FCM would have to

establish new relationships with 15 depositories.

\601\ As above, the lower bound assumes that an FCM requires the

minimum estimated number of personnel hours to be compliant and that

for event-triggered costs, the FCM bears the minimum number of

possible events. The upper bound assumes an FCM requires the maximum

number of personnel hours to be compliant. It also assumes an FCM

has to notify the Commission pursuant to the proposed amendments in

Sec. 1.12 five times per year, and that an FCM withdraws funds from

residual interest for proprietary use 50 times per year. The

estimate does not include additional costs that would result if FCMs

increase the amount of residual interest or capital that they hold

in response to the proposed rules, or certain operational costs that

the Commission does not have sufficient information to estimate.

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On a minor note, the rules also harmonize the definition of

leverage ratio reporting with the definition established by a

registered futures association.

In the sections that follow, the Commission provides its analysis

of cost benefit considerations including comments received, section by

section, in light of the relevant 15(a) public interest, cost-benefit

considerations.

Consideration of Costs and Benefits Section by Section

Section 1.3(rr)--Definition of ``Foreign Futures or Foreign Options

Secured Amount''

The Commission adopted an amendment to Sec. 1.3(rr) replacing the

term ``foreign futures or foreign options customers'' with the term

``30.7 customers.'' The former only included U.S.-domiciled customers,

whereas the term ``30.7 customers'' includes both U.S.-domiciled and

foreign-domiciled customers who place funds in the care of an FCM for

trading on foreign boards of trade. This change expanded the range of

funds that the FCM must include as part of the foreign futures or

foreign options secured amount.

In addition, the definition of ``foreign futures or foreign options

secured amount'' was amended so that it is equal to the amount of funds

an FCM needs in order to satisfy the full account balances of each of

its 30.7 customers at all times. This definitional change is necessary

to implement the conversion in Sec. 30.7 from the ``Alternative

Method'' to the ``Net Liquidating Equity Method'' of calculating the

foreign futures or foreign options secured amount.

Costs and Benefits

These definitional changes determine how much funds are considered

part of the ``foreign futures or foreign options secured amount.''

However, the costs and benefits of these changes are attributable to

the substantive requirements related to the definitions and, therefore,

are analyzed with respect to changes adopted to Sec. 30.7 and

discussed below.

Section 1.10--Financial Reports of Futures Commission Merchants and

Introducing Brokers

The Commission adopted amendments to Sec. 1.10 revising the Form

1-FR-FCM by establishing a new schedule called the ``Cleared Swap

Segregation Schedule'' that is included in the FCM's monthly report,

together with the Segregation Schedule and Secured Amount Schedule. The

amendments also provide that the Cleared Swap Segregation Schedule is a

public document.\602\ The Commission also amended the Segregation

Schedule and the Secured Amount Schedule to include reporting of the

FCM's target for residual interest in the accounts relevant to that

Schedule, as well as a calculation of any surplus or deficit in

residual interest with respect to that target. The Commission also

required each FCM to report to the Commission monthly leverage

information.

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\602\ The Segregation Schedule and Secured Amount Schedule are

already public documents.

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Costs and Benefits

In the NPRM, the Commission considered the amendments to Sec. 1.10

to have significant benefits to the protection of market participants,

namely, customers. The Commission anticipated that continuing the

public availability of the Segregation Schedule and the Secured Amount

Schedule, with the addition of the Cleared Swaps Segregation Schedule,

would be beneficial to customers in assessing the financial condition

of the FCMs with whom they choose to transact. The Commission posited

that FCMs would have competing incentives to set higher or lower

targeted residual amounts, but that public disclosure would enhance the

quality of the assessment of a reasonable targeted amount of residual

interest. The Commission stated that providing publicly the additional

information would permit customers to weigh this consideration, along

with considerations of price, in selecting an FCM, benefiting the

protection of market participants. The Commission also stated that

requiring FCMs to report their leverage to the Commission on a monthly

basis would assist the Commission in monitoring each FCM's overall risk

profile, which would help the Commission to identify FCMs that should

be monitored more closely for further developments that could weaken

their financial position, enhancing the protection of market

participants.

The Commission could not quantitatively estimate the cost of FCMs

having an incentive by public disclosure to hold higher targeted

residual amounts in customer segregated accounts. The Commission did

consider that qualitatively it expected that costs would be incurred as

a result, as a return available to FCMs on restricted investments

permissible under Sec. 1.25 would likely be lower than returns on

capital not restricted by being held as target residual amounts subject

to the investment requirements of Sec. 1.25, and public disclosure

would, other factors being equal, give an incentive to FCMs to hold a

larger target residual amount.

The Commission estimated quantitatively costs associated with

system modifications to produce additional reports for leverage. The

Commission did not receive comments regarding its quantitative

estimates of those costs or its qualitative analysis that costs would

be associated with the amendments to Sec. 1.10, particularly the

public disclosure of the Cleared Swaps Segregation Schedule and the

changes to the Segregation Schedule and Secured Amount Schedule to

include the targeted residual amount. Specifically, the Commission

received no comments regarding the assumption that the target residual

amount would in fact be higher once publicly disclosed, or as to what

forms or costs associated with any additional capital that may be

required following disclosure of the target residual amount, if any at

all. Nor did the Commission receive comments discussing the

quantitative spread difference between Sec. 1.25 investments compared

to investments that are not subject to Sec. 1.25. Without comment as

to these cost drivers, the Commission is unable to accurately estimate

these costs.

The Commission received a comment from NFA to consider an

alternative to the regulatory language proposed for leverage ratio

reporting to refer to the formulation of leverage established by a

registered futures association.\603\ The Commission, believing that

this alternative would have no detrimental impact on the benefits

anticipated from obtaining reporting of leverage, modified the language

in the final regulation to conform to the alternative

[[Page 68584]]

suggested by NFA. The alternative language in the final regulation will

permit the leverage reporting requirement to stay harmonized with NFA's

leverage reporting requirement as NFA has indicated it intends to

update and refine the formulation, which will continue to provide the

Commission with information necessary to monitor FCMs for the

protection of market participants.\604\

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\603\ NFA Comment Letter at 8 (Feb. 15, 2013).

\604\ Id.

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The Commission received numerous comments regarding the benefits of

the public disclosure of the Segregation Schedule, Secured Amount

Schedule, and Cleared Swaps Segregation Schedule, and the amounts of

the FCM's targeted residual interest.\605\ Many commenters reiterated

the utility of, and value to, customers of the public availability of

the schedules and financial condition information of FCMs.\606\

However, several FCMs commented, and FIA expressed concern, that the

information would not be useful to customers and would be difficult for

customers to understand without understanding all the factors involved

in setting a target residual amount.\607\ These commenters were

concerned that customers may, to their detriment, overweigh the

consideration of the targeted residual amount.\608\ These comments are

discussed in detail at section II.P. above.

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\605\ See, e.g., SIFMA Comment Letter at 2 (Feb. 21, 2013); SUNY

Buffalo Comment Letter at 8 (Mar. 19, 2013); Vanguard Comment Letter

at 5-6 (Feb. 22, 2013).

\606\ Id.

\607\ See, e.g., FIA Comment Letter at 52 (Feb. 15, 2013); RJ

O'Brien Comment Letter at 6 (Feb. 15, 2013).

\608\ Id.

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The Commission understands the concerns of both sets of commenters

but believes that the protection of market participants is enhanced in

this circumstance by the greater availability of public information,

particularly concerning customer funds, to customers and potential

customers. Notwithstanding the concerns of FIA and several FCMs

particularly questioning the benefits of the public availability of the

targeted residual amount, the Commission believes that public

disclosure--and consequent market discipline--is an important

counterweight to other FCM incentives with respect to establishing the

target. The Commission herein has adopted numerous measures increasing

disclosures to customers, believing, on balance, that additional

disclosures regarding customer funds in particular to have significant

benefits to the protection of market participants. Greater availability

of information may also provide additional confidence in the financial

integrity of futures markets.

Finally, the Commission, in its consideration of costs and benefits

for the amendments to Sec. 1.10, asked questions for particular

comments on the costs and benefits of making public daily segregation

and secured amount calculations, or other more frequent calculations,

and solicited comments on alternatives. Similar to the comments on the

public availability of the Segregation Schedule, Secured Amount

Schedule, and the Cleared Swaps Segregation Schedule, some commenters

supported and other commenters opposed the public availability of daily

margin segregation calculations.

The Commercial Energy Working Group noted, generally, that the

Commission's proposals for the publication of information would be a

cost-effective mechanism to make FCMs more accountable to their

customers.\609\ The Commercial Energy Working Group posited that

additional costs of publication of daily segregation calculations

should be nominal.\610\ There were no other specific comments on the

costs of making publicly available daily or more frequent information.

The Commission proposed requiring daily segregation disclosures in the

amendments adopted to Sec. 1.55, and the benefits of such disclosures

will be further discussed in that section, although the only comment

received as to the costs of such publication of information was as

discussed herein.

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\609\ Commercial Energy Working Group Comment Letter at 2 (Feb.

12, 2013).

\610\ Id. at 3

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The NFA commented that the Commission should consider the

alternative of directing customers to its BASIC system where certain

financial information on FCMs would be available in one place, as

opposed to requiring FCMs to publish financial information, including

the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps

Segregation Schedule on their respective Web sites.\611\ NFA commented

that the Commission should carefully distinguish between categories of

information, as those meaningful to all customers which should be

readily available, meaningful to regulators but which may be sensitive

and subject to misinterpretation if made public, and meaningful to more

sophisticated customers that FCMs should be required to provide upon

request.\612\ The Commission believes enhanced benefits to the

protection of market participants and the financial integrity of

futures markets, and market discipline, are best achieved by the public

availability of the Segregation Schedules, Secured Amount Schedules,

and Cleared Swaps Segregation Schedules in their entirety on a monthly

basis, but also agrees with NFA's concern regarding the sensitivity of

information that may be readily available to regulators but not

publicly disclosed. The Commission does not agree that there may be a

benefit to distinguishing between categories of customers with respect

to public availability of information. The Commission agrees there

could be enhanced utility to customers by having schedules provided by

the NFA through its BASIC portal as an alternative, however, also notes

that NFA could implement this under the rule as adopted so long as the

schedules are required to be made publicly available and are not exempt

from public disclosure.

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\611\ NFA Comment Letter at 15 (Feb. 15, 2013).

\612\ Id. at 16.

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Section 1.11 Risk Management Program for Futures Commission Merchants

The Commission adopted new Sec. 1.11 requiring an FCM that carries

accounts for customers to establish a risk management unit that is

independent from the business unit handling customers or customer funds

and reports directly to senior management. In addition, each FCM must

establish and document a risk management program, approved by the

governing body of the FCM, that, at a minimum: (a) Identifies risks and

establishes risk tolerance limits related to various risks that are

approved by senior management; (b) includes policies and procedures for

detecting breaches of risk tolerance limits, and for reporting them to

senior management; (c) provides risk exposure reports quarterly and

whenever a material change in the risk exposure of the FCM is

identified; (d) includes annual review and testing of the risk

management program; and (e) meets specific requirements related to

segregation risk, operational risk, and capital risk.

Regarding segregation risk, each FCM must establish written

policies and procedures that require, at a minimum: (1) Documented

criteria for selecting depositories that would hold segregated funds;

(2) a program to monitor depositories on an ongoing basis; (3) an

account opening process that ensures the depository acknowledges that

funds in the account are customers' funds before any deposits are made

to the account, and that also ensures accounts

[[Page 68585]]

are titled appropriately; (4) a process for determining a residual

interest target for the FCM that involves due diligence from senior

management; (5) a process for the withdrawal of an FCM's residual

interest when such a withdrawal is not made for the benefit of the

FCM's customers; (6) a process for determining the appropriateness of

investing funds in Sec. 1.25 compliant investments; (7) procedures to

assure that securities and other non-cash collateral held as segregated

funds are properly valued and readily marketable and highly liquid; (8)

procedures that help to ensure appropriate separation of duties between

those who account for funds and are responsible for statutory and

regulatory compliance versus those who act in other capacities with the

company (e.g., those who are responsible for treasury functions); (9) a

process for the timely recording of all transactions; and (10) a

program for annual training of FCM employees regarding the requirements

for handling customer funds.

The new Sec. 1.11 requires automated financial risk management

controls that address operational risk, and written procedures

reasonably designed to ensure that an FCM has sufficient capital to be

in compliance with the Act and regulations and to meet its liquidity

needs for the foreseeable future.

Costs and Benefits

In the NPRM, the Commission provided a detailed discussion of the

significant benefits of the new risk management requirements for FCMs

to the protection of market participants and customer funds, sound risk

management, and directly as well as by extension, the financial

integrity of futures markets. Specifically, the Commission stated that

it considered the specific requirements of Sec. 1.11 to reduce the

negative impact of conflicts of interest on decision making relating to

customer funds, to result in stronger controls which could quickly

focus management attention on emerging risks and minimize the risk of a

breakdown in control at times of financial stress, and to promote more

formal responsibility and require specific accountability up the chain

of FCM management and governance for risk controls both generally and

specific to customer funds processes and procedures. Documentation

requirements for policies and procedures were considered beneficial to

promote Commission and SRO oversight of the tools chosen by FCMs in

putting the stronger controls in place, although the Commission also

determined that permitting flexibility with respect to the manner of

the policies and procedures would be beneficial to the efficiency of

FCMs in putting the new stronger and more rigorous requirements into

practice. The Commission considers the requirements adopted under Sec.

1.11 to be extremely important in eradicating the potential for poor

internal controls environments at FCMs, which could be susceptible to

fraud or operational error, which in turn could result in losses to

customer funds without clear and documented management accountability.

Documentation of the criteria for decision making and management

determinations with respect to choice of depositories, and other

management determinations impacting customer funds such as residual

interest and investment choices, as well as requiring periodic review

and testing of the risk management program, allows for an iterative

process with a clear purpose, the protection of customers and customer

funds, transparent to both Commission and SRO examination. Providing

clear factors which must be considered by FCMs in their adopted

practices, such as selection of depositories, was also considered by

the Commission to provide greater clarity to customers with respect to

determinations of significant consequence for customers, with a result

being likely enhanced market discipline coming from customers

evaluating FCMs. In many specific areas, the Commission considered the

requirements being adopted to greatly benefit risk management, the

protection of market participants and the financial integrity of

futures markets as the requirements would necessarily require FCMs to

improve internal management communication, internal controls,

management accountability, separation of duties, and training of

personnel in many respects. The Commission considered that FCMs were

already responsible under the Act and existing regulations for the

protection of customer funds. The adoption of Sec. 1.11 requires now

that FCMs develop written policies and procedures and put programs and

controls into practice, to ensure going forward that they have in place

consistent and reviewable processes to achieve the required outcomes

for protecting customers and customer funds. The Commission, in

adopting the rules, was however, cognizant that there would be

significant costs involved in compliance with Sec. 1.11, to the extent

that for some FCMs these processes and procedures were not already in

place or have no equivalent foundation. However, the Commission

considered an additional benefit to the requirements to be that there

would no longer be a competitive cost advantage to FCMs to not put in

place such important measures. Many FCMs are anticipated by the

Commission to already have in place strong internal controls and

practices similar to what is now specifically being required to be put

in place under Sec. 1.11, and those FCMs will not have to bear a

competitive disadvantage any longer for doing so with respect to

bearing the costs of such practices in order to adequately protect

customers. The Commission, cognizant of the significance of its

estimates of costs with respect to the requirements, adopted the

regulations in a manner that provides FCMs with flexibility in the

manner of adopting practices that fulfill the requirements. The

Commission did not receive specific comments on its quantitative

estimates of the initial and recurring costs of adopting Sec. 1.11.

The Commission did receive comments from several FCMs objecting to

the requirements of Sec. 1.11 to require the independence of risk

management from the business unit (defined to identify parties

responsible for customer business or dealing with customer funds or

supervising such lines of responsibility). RCG and Phillip Futures

cited the loss of a talent pool available to participate in risk

management as a negative consequence of the requirement.\613\ Phillip

Futures also recommended that the Commission consider as an alternative

that internal controls, senior leadership and training programs could

suffice in lieu of required separations between risk management and the

business unit.\614\ Phillip Futures contended that natural conflicts of

interest will always exist and can be mitigated by supervisory levels,

policies and procedures.\615\

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\613\ RCG Comment Letter at 5 (Feb. 12, 2013); Phillip Futures

Comment Letter at 2 (Feb. 14, 2013).

\614\ Phillip Futures Comment Letter at 2 (Feb. 14, 2013).

\615\ Id.

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CHS Hedging and RJ O'Brien cited the difficulty of a small or mid-

size FCM having a separate unit for risk management personnel, noting

it to be impracticable operationally or financially and not cost

effective.\616\ Frontier Futures generally commented that the costs

associated with requiring FCMs to increase risk management standards

for the purpose of protecting an FCM's customers from losses caused by

fellow customers, would be prohibitive to smaller FCMs being able

[[Page 68586]]

to continue operations, and is an area that FCMs were adept at and

already have a large incentive to properly manage.\617\ FIA asked for

clarification that Sec. 1.11 does not require formal structured risk

management units, provided that the FCM is able to identify all

personnel responsible for required risk management activities in order

to comply with the line reporting requirements and independence from

supervision by the business unit.\618\

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\616\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013); RJ

O'Brien Comment Letter at 9-10 (Feb. 15, 2013).

\617\ Frontier Futures Comment Letter at 2 (Feb. 14, 2013).

\618\ FIA Comment Letter at 55 (Feb. 15, 2013).

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The Commission understands the general concerns of commenters

regarding the costs of the requirements of Sec. 1.11, along with the

other new provisions being adopted herein by the Commission. The

Commission did provide clarity in section II.B. as requested by FIA,

which is intended to make clear the amount of flexibility available in

complying with the separation of duties of risk management adopted in

Sec. 1.11. However, the Commission notes that such separation as a

fixed requirement is particularly important to the protection of market

participants, as the Commission continues to believe conflicts of

interest to be a significant risk to the protection of customer funds

during periods of financial or operational stress absent such clear

reporting and accountability lines being established.

Section 1.12 Maintenance of Minimum Financial Requirements by Futures

Commission Merchants and Introducing Brokers

The changes to Sec. 1.12 alter the notice requirements so that it

is no longer acceptable to give ``telephonic notice to be confirmed, in

writing, by facsimile.'' Instead, all notices from FCMs must be made in

writing and submitted through an electronic submission protocol in

accordance with instructions issued or approved by the Commission

(currently, WinJammer).

In addition, the amendments to Sec. 1.12 require that if an FCM

has a shortfall in net capital, but is unable to accurately compute its

current financial condition, the FCM should not delay reporting the

under capitalization to the Commission. The FCM must communicate each

piece of information (knowledge of the shortfall and knowledge of the

financial condition of the FCM) to the Commission as soon as it is

known.

The Commission proposed requirements in paragraphs (i), (j), (k)

and (l) of Sec. 1.12 to identify additional circumstances in which the

FCM must provide immediate written notice to the Commission, relevant

SRO, and to the SEC if the FCM is also a BD. Those circumstances were:

(1) If an FCM discovers that any of the funds in segregated accounts

are invested in investments not permitted under Sec. 1.25; (2) if an

FCM does not have sufficient funds in any of its segregated accounts to

meet its targeted residual interest; (3) if the FCM experiences a

material adverse impact to its creditworthiness or ability to fund its

obligations; (4) whenever the FCM has a material change in operations

including changes to senior management, lines of business, clearing

arrangements, or credit arrangements that could have a negative impact

on the FCM's liquidity; and (5) if the FCM receives a notice,

examination report, or any other correspondence from a DSRO, the SEC,

or a securities industry SRO, the FCM must notify the Commission, and

provide a copy of the communication as well as a copy of its response

to the Commission. The Commission adopted the proposed additional

notification requirements with some changes in response to commenters,

narrowing the scope of certain of the new notification requirements.

Last, the Commission adopted a new paragraph (n) of Sec. 1.12 that

requires that every notice or report filed with the Commission pursuant

to Sec. 1.12 include a discussion of how the reporting event

originated and what steps have been, or are being taken, to address the

event.

Costs and Benefits

The benefits of requiring that notice to the Commission be given in

written form via specified forms of electronic communication not only

adapt the rule to account for modern forms of communication, but also

reduce the possibility of notification being delayed in reaching

appropriate Commission staff. Ensuring that important regulatory

notices go directly through electronic systems will result in

appropriate staff being alerted as soon as possible and that there are

no unnecessary delays to regulatory attention to the notice, which

should benefit the protection of market participants and the financial

integrity of futures markets, potentially significantly depending on

the importance of the issue being addressed.

For example, with respect to the adopted change in Sec.

1.12(a)(2), if an FCM knows that it does not have adequate capital to

meet the requirements of Sec. 1.17 or other capital requirements, and

is also not able to calculate or determine its financial condition, it

is likely that the FCM is in a period of extraordinary stress. In these

circumstances, time is of the essence for the solvency of the FCM and

for the protection of its customers and counterparties. Therefore, it

is important that the Commission, DSRO, and SEC (if the FCM is also a

BD) be notified immediately so that they can begin assessing the FCM's

condition, and if necessary, make preparations to allow the transfer of

the customers' positions to another FCM in the event that the FCM

currently holding those positions has insufficient regulatory capital.

These preparations help to ensure that the customers' funds are

protected in the event of the FCM's default, and that the positions of

its customers are transferred expeditiously to another FCM where those

customers may continue to hold and control those positions without

interruption.

The situations enumerated as adopted in Sec. 1.12(i) and (j) are

more specific indicators of potential or existing problems in the

customer segregated funds accounts. Notifying the Commission in such

circumstances enables it to monitor steps the FCM is taking to address

a shortfall in targeted residual interest, or to direct the FCM as it

takes steps to address improperly invested segregated funds. In either

case, the Commission will be able to closely monitor the FCM's actions,

benefiting the continued protection of customer segregated funds.

The Commission also asked questions in the NPRM regarding whether

public availability of Sec. 1.12 notices would enhance customer

protection, but did not propose to make the notifications public as it

did other additional disclosures relevant to customer funds, such as

the various segregation schedules. Comments were received both in favor

of and in opposition to public availability. One commenter, FHLB,

posited that the costs of public availability would be negligible

because the reporting would already be done and be done electronically,

and the benefit substantial, so that the Commission should require

public availability.\619\ However, other commenters, including RJ

O'Brien and FIA, raised concerns about potential detrimental market

impacts on FCMs from the public availability of Sec. 1.12 notices, at

odds with FHLB's assertion that FCMs could not be impacted by a ``run

on the bank'' scenario and that costs would be negligible, with RJ

O'Brien believing a main risk of public availability being precisely a

possibly disorderly and erroneous ``run on the bank'' scenario.\620\

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\619\ FHLB Comment Letter at 3 (Feb. 15, 2013).

\620\ FIA Comment Letter at 37 (Feb. 15, 2013); RJ O'Brien

Comment Letter at 10 (Feb. 15, 2013).

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[[Page 68587]]

The Commission, although in most circumstances believing there to

be substantial benefits to greater availability of public information

concerning segregated funds, declined to adopt any requirement for

public availability of Sec. 1.12 notices, weighing the comments

received, and recognizing an additional benefit to maintaining

equivalence of treatment with the SEC for joint registrants, whose

similar notices are not made public. The Commission agrees that the

risk of the possibility of a disorderly ``run on the bank'' scenario

from Sec. 1.12 notices being made immediately public would be too

great relative to the benefit of such publication. The possibility of

that result could exacerbate a potentially solvable problem at an FCM

and not result in the best protection of market participants. The

Commission is adopting other types of additional customer disclosures

required of FCMs under Sec. 1.55, which it believes are more

beneficial to the protection of customers and appropriate to the

disclosure purposes than the public availability of Sec. 1.12 notices.

The situations enumerated that were proposed in Sec. 1.12(k)

through (l) are circumstances indicating that the FCM is undergoing

changes that could indicate or lead to financial strain. Alerting the

Commission and relevant SROs in such circumstances will benefit the

protection of market participants by fostering their ability to monitor

such FCMs more closely in order to ensure that any developing problems

are identified quickly and addressed proactively by the FCM with the

oversight of the Commission and the relevant SROs. In response to

commenters who proposed alternatives, believing the proposals to be

overly broad and difficult to clearly comply with, the Commission

adopted the requirements but narrowed and provided additional detail

for the circumstances under which such notices would be required. The

Commission believes the requirements as adopted continue to provide the

intended benefits to the protection of market participants.

The proposed Sec. 1.12(m) requirement that the FCM notify the

Commission whenever it receives a notice or results of an examination

from its DSRO, the SEC, or a securities-industry SRO, was intended to

ensure that the Commission is aware of any significant developments

affecting the FCM that have been observed or communicated by other

regulatory bodies. Such communications could prompt the Commission to

heighten its monitoring of specific FCMs, or create an opportunity for

the Commission to work collaboratively and proactively with other

regulators and self-regulatory organizations to address any concerns

about how developments in the FCM's business could affect customer

funds.

The Commission adopted Sec. 1.12(m), with changes to address the

requests of commenters that the scope of the requirement needed to be

narrowed in order to provide the benefit intended without potentially

overly burdensome costs. TD Ameritrade, in particular, commented that

the volume of its filings with securities regulators would make the

Sec. 1.12(m) requirement both overly costly with respect to the

intended benefit, and also not likely to result in the benefit as

intended.\621\ The Commission believes the narrowed language adopted

for Sec. 1.12(m) should appropriately address the comment and provide

the benefit intended without overly burdensome costs.

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\621\ TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).

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The requirement that notifications to the Commission pursuant to

Sec. 1.12 include a discussion of what caused the reporting event and

what has been, or is being done about the event, would provide

additional information to Commission staff that would help them quickly

gauge the potential severity of related problems that have been or are

developing at the reporting FCM, IB, or SRO. The benefit of requiring

the additional information is that it will assist Commission or SRO

staff in determining whether the situation is likely to be corrected

quickly or to continue deteriorating. Commission staff may be best able

to protect market participants with appropriate and timely

intervention, with more information received initially regarding how a

potential regulatory problem is being handled.

The Commission made quantitative estimates of costs for the

amendments to Sec. 1.12 in the NPRM, including the new notice

requirements, the additional information required to be included in

notices, and monitoring that would be necessary in order for FCMs to

submit notices and received no comments specific to those estimates.

The Commission estimated the costs of requiring electronic filing of

notices for FCMs to be negligible as the filing system is already in

place, and received no comment on that estimate. The Commission asked

specific questions regarding costs for the additional notice

requirements and did not receive any response to such questions from

commenters.

Section 1.16 Qualifications and Reports of Accountants

The adopted changes to Sec. 1.16 require that in order for an

accountant to be qualified to conduct an audit of an FCM, the

accountant would have to be registered with the PCAOB, and have

undergone inspection by the PCAOB. In addition, the amendments also

would require that the governing body of the FCM ensure that the

accountant engaged for an audit is duly qualified, and specifies

certain qualifications that must be considered when evaluating an

accountant for such purpose. Finally, the amendments require the public

accountant to state in the audit opinion that the audit was conducted

in accordance with the auditing standards adopted by the PCAOB.

Costs and Benefits

The Commission adopted amendments to Sec. 1.16 primarily to obtain

the benefits of quality control and oversight of accountants and higher

standards to apply to certified audits of FCMs, for the greater

protection of market participants, and to increase the financial

integrity of futures markets. In at least one circumstance of FCM

failure, which was an impetus for the package of additional protections

to customer funds contained in the Proposal, the experience and quality

of the FCM auditor contributed to the audit failure and the inability

of an audit to be an effective additional check on the compliance and

financial integrity of FCMs and customer funds.\622\

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\622\ See In the Matter of Jeannie Veraja-Snelling, CFTC Docket

No. 13-29, available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfverajaorder082613.pdf.

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The Commission also considers the newly adopted requirement for the

governing body of the FCM to have accountability for assessing auditor

qualifications to be an appropriate tool to ensure responsibility for a

lack of conflicts, true independence and a quality audit by experienced

auditors to be connected back to the FCM's governing body and to be

clearly understood to be a responsibility of that governing body. The

Commission believes this enhanced accountability will benefit the

protection of market participants and promote the financial integrity

of futures markets by contributing to ensuring audit quality of FCMs.

In the NPRM, the Commission did not quantitatively estimate costs

associated with the amendments to Sec. 1.16, however, it qualitatively

considered the

[[Page 68588]]

likelihood that PCAOB registered accountants would be expected, all

else being equal, to have higher audit fees, thereby incurring

additional costs. The Commission requested, but did not receive,

quantitative information from commenters to better assess these costs.

However, the Commission did receive several comments regarding the

proposed amendments to Sec. 1.16 and the Commission altered some of

the proposed Sec. 1.16 requirements in response to such comments, as

discussed in section II.E. above.

One commenter, the AICPA, proposed that the Commission consider a

practice monitoring program, such as the AICPA peer review, as an

alternative to the PCAOB inspection requirement.\623\ The AICPA stated

it did not believe the PCAOB inspection requirement would have the

benefit of enhancing audit engagements in situations where inspections

are not required (i.e., non-issuer FCMs).\624\ The Commission does

believe the PCAOB inspection requirement will enhance audit quality

over time, particularly as inspections become required for the audits

of SEC registered BDs.

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\623\ AICPA Comment Letter at 3 (Feb. 11, 2013).

\624\ Id. at 2-3.

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However, in considering the practical impediments to registering

and becoming inspected by the PCAOB, the Commission made several

clarifications in adopting the amendments.\625\ Most notably, the

Commission extended the compliance date for inspection by the PCAOB

until December 31, 2015. As noted above in section II.E., based on the

Commission's most recent review, currently there are only seven CPA

firms (auditing fifteen FCMs) that would not meet this requirement. Six

of those firms are registered with the PCAOB as and indicate that they

will be subject to the PCAOB BD inspection program and will presumably

receive a PCAOB inspection in the future. Therefore, the Commission is

adopting the inspection requirement as proposed but has extended the

compliance date to December 31, 2015 in order to provide additional

time for accountants to be subject to PCAOB inspections.

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\625\ See additional discussion at section II.E. above.

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The Commission received no comments addressing costs associated

with an anticipated increase in audit fees for PCAOB registration. Nor

did the Commission receive comment as to any increased costs associated

with becoming PCAOB registered. Nonetheless, the Commission believes

that currently only one FCM audit firm is not PCAOB registered, and

would therefore be required to register to continue to conduct audits

of FCMs. Currently, a public accountant that audits less than 49 public

issuers is required to pay the PCAOB a registration fee of $500.\626\

Annual fees for public accountants with less 200 issuers also are $500

per year.\627\ Therefore, any costs associated with registering the one

and only existing accounting firm which would not be in compliance, or

any firm in the future that will need to register with the PCAOB, will

be nominal.

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\626\ See http://pcaobus.org/Registration/rasr/Pages/AnnualFees.aspx.

\627\ Id.

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Section 1.17 Minimum Financial Requirements for Futures Commission

Merchants and Introducing Brokers

Section 4f(b) of the Act provides that no person may be registered

as an FCM unless such person meets the minimum financial requirements

that the Commission has established by regulation. The Commission's

minimum capital requirements for FCMs are set forth in Sec. 1.17

which, among other things, provides that an FCM must cease operating as

an FCM and transfer its customers' positions to another FCM if the FCM

is not in compliance with the minimum capital requirements, or is

unable to demonstrate its compliance with the minimum capital

requirements. The Commission proposed to amend Sec. 1.17 by adding a

new provision that will authorize the Commission to require an FCM to

cease operating as an FCM and transfer its customer accounts if the FCM

is not able to certify and demonstrate sufficient access to liquidity

to continue operating as a going concern. Additionally, FCMs that are

also registered BDs will be allowed to use the SEC's BD approach \628\

to evaluate the credit risk of securities that the FCM invests in and

assign smaller haircuts \629\ to those that are deemed to be a low

credit risk.\630\ The Commission's amendment to Sec. 1.17(c)(5)(v)

allows FCMs that are not dual registrants to use the same approach.

Finally, the Commission has adopted amendments revising the period of

time that an FCM is permitted to wait before taking an undermargined

capital charge from three business days after the call is issued on a

customer's account to one business day, and from two business days

after the call is issued on a noncustomer or omnibus account to one

business day.

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\628\ Under the SEC proposal, a BD may impose the default

haircuts of 15 percent of the market value of readily marketable

commercial paper, convertible debt, and nonconvertible debt

instruments or 100 percent of the market value of nonmarketable

commercial paper, convertible debt, and nonconvertible debt

instruments. A BD, however, may impose lower haircut percentages for

commercial paper, convertible debt, and nonconvertible debt

instruments that are readily marketable, if the BD determines that

the investments have only a minimal amount of credit risk pursuant

to its written policies and procedures designed to assess the credit

and liquidity risks applicable to a security. A BD that maintains

written policies and procedures and determines that the credit risk

of a security is minimal is permitted under the SEC proposal to

apply the lesser haircut requirement currently specified in the SEC

capital rule for commercial paper (i.e., between zero and \1/2\; of

1 percent), nonconvertible debt (i.e., between 2 percent and 9

percent), and preferred stock (i.e., 10 percent).

\629\ In computing its adjusted net capital, an FCM is required

to reduce the value of proprietary futures and securities positions

included in its liquid assets by certain prescribed amounts or

percentages of the market value (otherwise known as ``haircuts'') to

discount for potential adverse market movements in the securities.

\630\ The adoption of the Commission's rule is conditional upon

the SEC adoption as final its proposed rule to eliminate references

to credit ratings.

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Costs and Benefits

In the NPRM, the Commission provided a detailed discussion of the

benefits the changes to Sec. 1.17 would provide. Regarding the

potential transfer of customer accounts if the FCM was unable to

certify and demonstrate sufficient access to liquidity to continue

operating as a going concern, several commentators stated that the

Commission should not adopt the rule before clearly articulated

objective standards were established and exigent circumstances that

would give the Commission authority to require an FCM to cease

operating were defined. The Commission understands the concerns of

commenters regarding the process by which the Commission, or the

Director of the Division of Swap Dealer and Intermediary Oversight

acting pursuant to delegated authority under Sec. 140.91(6), could

require immediate cessation of business as an FCM and the transfer of

customer accounts.

However, that same authority currently exists should a firm fail to

meet its minimum capital requirement. The Commission believes the

ability to certify, and if requested, demonstrate with verifiable

evidence, sufficient liquidity to operate as a going concern to meet

immediate financial obligations, is a minimum financial requirement

necessary to ensure an FCM will continue to meet its obligations as a

registrant under the Act. Moreover, because liquidity difficulties will

not be made transparent to the FCM's customers pursuant to 1.12, it is

especially important that the Commission be permitted to act.

[[Page 68589]]

Regarding the proposed amendment to Sec. 1.17(c)(5)(v) revising

the capital charge (or haircut) procedures for FCMs, the Commission

notes that it only impacts FCMs that are not dual registrants. Because

FCMs that are not dual registrants do not typically invest in

securities that would be subject to reduced haircuts under the SEC's

proposed rules, the change should not have a significant impact on the

capital requirements for such FCMs. The CFA believes that capital

models should be established by the relevant regulatory agencies for

use by FCMs or BDs and has serious concerns that internal models used

for calculating minimum capital requirements are prone to failure in

crisis.\631\ The Commission appreciates the CFA's concerns, however,

the Commission notes that for securities positions, Sec. 1.17

incorporates by reference the securities haircuts that a BD is required

to take in computing its net capital under the SEC's regulations.\632\

This is a result of the Commission's determination to defer to the SEC

in areas of its expertise, specifically with respect to market risk and

appropriate haircuts on securities positions.\633\ For FCMs that are

dually-registered as BDs, any changes adopted by the SEC to these

securities haircuts will be applicable under Sec. 1.17(c)(5)(v) unless

the Commission specifically provides an alternate treatment for

FCMs.\634\ The Commission's amendment merely allows FCMs that are not

dual registrants to follow the same rules as those that are dual

registrants. This change would harmonize the regulation of FCMs with

respect to minimal financial requirements and would place FCMs that are

not dual registrants on a more level playing field with those that are

dual registrants, which improves the competition between FCMs. The FCMs

that use their own internal models will also be subject to review by

regulators, including the SEC, SROs, or securities SROs.

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\631\ CFA Comment Letter at 4-5 (Feb. 13, 2013).

\632\ Commission Regulations 1.17(c)(5)(v) and 1.32(b) both

incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.

\633\ See 43 FR 15072, 15077 (Apr. 10, 1978) and 43 FR 39956,

39963 (Sept. 8, 1978).

\634\ See discussion adopting Sec. 1.17(c)(5)(vi) for options

haircuts, with respect to the applicability of provisions

incorporating by reference and referring to the rules of the SEC for

securities broker dealers also registered as futures commission

merchants. 43 FR 39956, 39964.

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Regulation 1.17(c)(5)(viii) required an FCM to take a capital

charge if a customer account is undermargined for three business days

after the margin call is issued. Likewise, Sec. 1.17(c)(5)(ix)

required an FCM to take a capital charge for noncustomer and omnibus

accounts that are undermargined for two business days after the margin

call is issued. These timeframes were appropriate when the capital

rules were adopted in the 1970s, when the use of checks and the mail

system were more prevalent for depositing margin with an FCM. They are

obsolete, however, in today's markets with the use of wire transfers to

meet margin obligations. Therefore, the Commission has amended Sec.

1.17(c)(5)(viii) and (ix) to require an FCM to take capital charges for

undermargined customer, noncustomer, and omnibus accounts that are

undermargined for more than one business day after a margin call is

issued.

FIA stated that while institutional and many commercial market

participants generally meet margin calls by means of wire transfers,

the proposal creates operational problems because it does not consider

delays arising from accounts located in other time zones that cannot

settle same day, or ACH settlements, or the requirement to settle or

convert certain non-U.S. dollar currencies.\635\ FIA also stated that a

substantial number of customers that do not have the resources of large

institutional customers (in particular members of the agricultural

community) depend on financing from banks to fund margin requirements,

which may require more than one day to obtain.\636\

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\635\ FIA Comment Letter at 26 (Feb. 15, 2013).

\636\ Id.

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RJ O'Brien objected to the proposed amendment because many

customers that use the markets to hedge commercial risk still meet

margin calls by check or ACH because of the impracticality and

costliness of wire transfers to their circumstances.\637\ RJ O'Brien

stated that in many cases, the costs of a wire transfer would exceed

the transaction costs paid by the client to its FCMs, and additionally,

that some customers in the farming and ranching community finance their

margin calls, which can require additional time to arrange for delivery

of margin call funds due to routine banking procedures.\638\ RJ O'Brien

also stated that if the proposal is adopted, FCMs that service non-

institutional clients will struggle to remain competitive and the

proposal may result in fewer clearing FCMs and greater systemic risk to

the marketplace.\639\ RJ O'Brien further stated that a loss of such

smaller FCMs will result in fewer options available to these ranchers,

farmers and other commercial market participants that wish to hedge

their commercial risks.\640\

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\637\ RJ O'Brien Comment Letter at 3-4 (Feb. 15, 2013).

\638\ Id.

\639\ Id.

\640\ Id.

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Other commenters expressed the general concern that the proposal

will harm the customers it is meant to protect by requiring more

capital to be kept in customer accounts, possibly forcing users to hold

funds at FCMs well in excess of their margin requirements.\641\ Those

commenters argued that such pre-funding could add significant financial

burdens to trading as customers find themselves having to provide

excess funds to their brokers which could increase their risk with

regard to the magnitude of funds potentially at risk in the event of

future FCM insolvencies.\642\ The commenters generally expressed

significant concerns that reducing margin calls to one day will harm

many customers as: (1) Many small businesses, farmers, cattle producers

and feedlot operators routinely pay by check and forcing them to use

wire transfers increases their cost of doing business; (2) clients who

make margin calls by ACH payments instead of wire transfers because ACH

is cheaper, would no longer be able to do so because there is a one-day

lag in availability of funds; and (3) foreign customers would not be

able to make margin calls due to time zone differences, the time

required to convert certain non-USD currencies, and for whom banking

holidays fall on different days.\643\

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\641\ NPPC Comment Letter at 2 (Feb. 14, 2013); NGFA Comment

Letter at 3 (Feb. 15, 2013); NEFI/PMAA Comment Letter at 3 (Jan. 14,

2013); AIM Comment Letter at 15 (Jan. 24, 2013); Amarillo Comment

Letter at 1 (Feb. 14, 2013); NCFC Comment Letter at 1 (Feb. 15,

2013); NFA Comment Letter at 12-13 (Feb. 15, 2013); FCStone Comment

Letter at 3 (Feb. 15, 2013); Advantage Comment Letter at 1-2 (Feb.

15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); CCC Comment

Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15,

2013); AIM resubmitted the comment letters of Premier Metal

Services, NEFI/PMAA, and the ISRI and indicated its support for the

recommendations therein (Jan. 14, 2013).

\642\ Id.

\643\ Id.

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The CCC stated that the proposed amendment to the capital rule

places an undue burden on the FCMs, which will likely result in FCMs

demanding that customers prefund trades to prevent market calls and

potential capital charges.\644\ The CCC also stated that the proposal

could result in forced liquidations of customer positions to ensure

that the FCM does not incur a capital charge.\645\

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\644\ CCC Comment Letter at 2-3 (Feb. 15, 2013).

\645\ Id.

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FIA and RJ O'Brien suggested alternatives to the Commission's

[[Page 68590]]

proposal. Both FIA and RJ O'Brien offered that an FCM be required to

take a capital charge for any customer margin deficit exceeding

$500,000 that is outstanding for more than one business day.\646\ FIA

further suggested that if the customer's margin deficit is $500,000 or

less, the FCM should take a capital charge if the margin call is

outstanding two business days or more after the margin call is

issued.\647\ RJ O'Brien also stated that the Commission should provide

at least a one year period of time for any changes to the timeframe for

taking a capital charge for undermargined accounts to be effective, and

that the Commission should require futures exchanges to increase their

margin requirements to 135% of maintenance margin to reduce the number

and frequency of margin calls.\648\

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\646\ FIA Comment Letter at 27 (Feb. 27, 2013); RJ O'Brien

Comment Letter at 4 (Feb. 15, 2013).

\647\ FIA Comment Letter at 27 (Feb. 15, 2013).

\648\ RJ O'Brien Comment Letter at 4 (Feb. 15, 2013).

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The NFA and FIA stated that if the Commission adopts the amendments

regarding residual interest as proposed, then the Commission should

consider whether a capital charge for undermargined accounts remains

necessary at all because the FCM will have already accounted for an

undermargined account by maintaining a residual interest sufficient at

all times to exceed the sum of all margin deficits; hence the capital

charges related to an undermargined account appear to impose an

additional financial burden without any necessary financial

protection.\649\

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\649\ NFA Comment Letter at 13 (Feb. 15, 2013).

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The Commission has considered the comments and is adopting the

amendments to Sec. 1.17(c)(5)(vii) and (ix) as proposed. The revised

regulation will provide the intended benefits to customers and the

marketplace. Commenters have stated that the proposal would increase

customer costs by requiring the prefunding of margin calls, which will

also potentially expose more customer funds to FCM control. Commenters,

however, did not provide any quantitative estimates or provide any

substantive analysis in support of their statements. In addition, the

Commission notes that much of this argument is based on the assumption

that FCMs would not be able to support the additional capital charge

through their existing excess capital. In addition, many FCMs utilize a

variety of funding sources from which additional capital may be

obtained, if required, and therefore costs could vary significantly

from one FCM to another FCM. Without quantitative estimates as to how

much excess capital FCMs typically maintain, would be required to

maintain, or the difference of these costs in relation to aged margin

calls between one and three days, the Commission cannot quantify any

increase in costs associated with this amendment.

Moreover, the Commission believes that the benefits of the final

regulation will enhance the protection of the markets and customers.

The Commission notes that the timely collection of margin is a critical

component of an FCM's risk management program and is intended to ensure

that an FCM holds sufficient funds deposited by account owners to meet

potential obligations to a DCO. As guarantor of the financial

performance of the customer accounts that it carries, the FCM is

financially responsible if the owner of an account cannot meet its

margin obligations to the FCM and ultimately to a DCO.

Regulation 39.13(g)(2) requires that a sufficient amount of funds

is maintained in an account to cover 99 percent of the observed market

moves over a specified period of time. Customers that maintain fully

margined accounts are exposed to greater risk to the safety of their

funds if some of the accounts of their fellow customers are

undermargined. The intent of the proposed amendment is to encourage an

FCM to require customers to promptly fund margin deficiencies, or to

reserve a sufficient amount of capital to cover the amount of the

deficiencies. As a consequence, the risk that a debit balance could

develop in a customer's account due to tardy margin call payments would

be reduced, and the amount of residual interest that the FCM would need

to maintain in the segregated accounts in order to protect against the

possibility that such debit balances could cause them to have less that

is required in their segregated accounts would also be reduced. This

provides benefits for the FCM by reducing the amount of capital that it

must contribute to the customer segregated accounts. Customers also

benefit by FCMs requiring more prompt payments on undermargined

accounts, as it is less likely that FCMs would close out the positions

of customers failing to meet margin obligations more quickly, reducing

the potential losses that would be passed on to non-defaulting

customers in the event of a default of a customer and a default of a

clearing member.

Section 1.20 Futures Customer Funds To Be Segregated and Separately

Accounted for

The amendments to Sec. 1.20 reorganize the section and alter the

substance of the section's requirements in certain places.

The final Sec. 1.20 includes Appendix A and Appendix B, which set

forth the Template Letters for the written acknowledgments that FCMs

and DCOs, respectively, must obtain from any depository with which they

open an account to hold futures customer funds. The rule requires FCMs

and DCOs to use the applicable Template Letter to obtain the required

acknowledgment before depositing any funds with a depository.

Regulation 1.20 also requires FCMs, DCOs, and depositories to file the

written acknowledgment with the Commission within three business days

of executing the letter, and to update the written acknowledgment

within 120 days of any changes to the business name, address, or

account numbers referenced in the letter.

The Commission received 15 comment letters related to the proposed

acknowledgment letter requirements. Some commenters addressed the costs

and benefits associated with these requirements; none of them, however,

provided any data to aid the Commission in estimating costs. In the

sections that follow, the Commission considers the benefits and costs

arising from the adoption of the acknowledgment letter requirements.

The Commission also discusses the corresponding comments accordingly.

Benefits

Regulation 1.20(d)(2) requires an FCM to use the Template Letter in

Appendix A to obtain a written acknowledgment from any depository that

holds futures customer funds. A depository accepting customer funds is

required to: (1) Acknowledge that the funds are customer segregated

funds subject to section 4d of the Act and the Commission's regulations

thereunder; (2) acknowledge and agree that the funds cannot be used to

secure any obligation of the FCM to the depository or used by the FCM

to secure or obtain credit from the depository; (3) agree to reply

promptly and directly to any request from the Commission or the FCM's

DSRO for confirmation of account balances or provision of any other

information regarding or related to an account; (4) agree that the

depository will allow the Commission and the FCM's DSRO to examine the

accounts at any reasonable time; and (5) acknowledge and agree that the

[[Page 68591]]

depository will provide the Commission with technological connectivity

necessary to permit read-only electronic access to the accounts.

Regulation 1.20(g)(4) requires a DCO to use the Template Letter in

Appendix B to obtain a written acknowledgment from any depository that

holds futures customer funds. The DCO Template Letter is largely the

same as the FCM Template Letter except that: (1) It does not require

read-only electronic access; and (2) it does not require the depository

to agree to Commission or DSRO examination of customer accounts.

These acknowledgments and commitments would result in important

benefits. First, by acknowledging that the funds are subject to the Act

and CFTC regulations, the depository recognizes that it must comply

with relevant statutory and regulatory requirements related to its

handling of those funds. Second, the depository acknowledges that

neither the FCM (or DCO) nor the depository is permitted to use

customer funds as belonging to any person other than the customer which

deposited them, i.e., an FCM or DCO cannot use customer funds to secure

its obligations to the depository. Third, the Template Letter for FCMs

constitutes written permission by the depository to allow Commission or

DSRO officials to examine the FCM's customer accounts at any reasonable

time and to provide the Commission with read-only electronic access to

those accounts. As a consequence, the Template Letters would enable

both the Commission and the DSRO to monitor actual balances at the

depository more readily. This would help to ensure that any discrepancy

between balances reported by the FCM on its daily customer segregation

account reports and balances actually held by the depository would be

identified quickly by the Commission or the DSRO. Moreover, with the

explicit agreement from the depository permitting the examination of

customer segregated accounts, both the Commission and DSRO would be

better able to move quickly to resolve a problem.

By requiring FCMs and DCOs to submit copies of the executed

Template Letters to both the Commission and, as applicable, an FCM's

DSRO, the Commission and DSROs would be better able to act quickly to

protect customer funds because the necessary legal permissions will be

in place. In addition, the Template Letters provide account information

such as account numbers, essential for management of an FCM or DCO

bankruptcy situation. Also, requiring that the Template Letters be

retained for five years past the time when customer segregated funds

are no longer held by a depository helps ensure that proper

documentation of all relevant acknowledgments and commitments is in the

possession of each party that relies upon the existence of those

commitments.

Commenters were generally supportive of adopting the Template

Letters. The Depository Bank Group stated that ``the acknowledgment

letters will help to facilitate a more efficient process for the

establishment and maintenance of customer segregated accounts by FCMs

and DCOs and serve to clarify the rights and responsibilities of

depository institutions holding customer segregated funds.'' \650\

Eurex expressed their appreciation for ``the potential convenience and

increases in certainty and transparency that such a standardized

approach would likely afford.'' \651\ CME stated its support for ``the

Commission's efforts to strengthen and standardize the form of

acknowledgment letters.'' \652\

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\650\ Depository Bank Group Comment Letter at 2 (Feb.15, 2013).

\651\ Eurex Comment Letter at 1 (Aug. 1, 2013).

\652\ CME Comment Letter at 7 (Feb. 15, 2013).

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Costs

To date, FCMs and DCOs have negotiated each acknowledgment letter

with depositories; accordingly, the use of standardized non-negotiable

language in the Template Letter may result in cost savings. However,

FCMs and DCOs are likely to bear some initial and ongoing costs as a

result of the requirement to use the Template Letters. Regarding

initial costs, some depositories may not be willing to sign the

Template Letter, which would require the FCM or DCO to move any

customer funds held by that depository to a different depository,

creating certain due diligence and operational costs. These cost

concerns were discussed in the comment letters from MGEX and RCG.\653\

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\653\ MGEX Comment Letter at 3 (Feb. 18, 2013) and RCG Comment

Letter at 7 (Feb. 12, 2013).

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In the NPRM, the Commission estimated that the cost of obtaining a

new acknowledgment letter from each existing depository is between

$1,300 and $4,200.\654\ The Commission estimated that FCMs and DCOs

would have approximately 1 to 30 depositories each, from which they

would need to obtain a new acknowledgment letter. Therefore, the

Commission estimated that the cost of obtaining new acknowledgment

letters from existing depositories would be between $2,700 and $82,000

per FCM or DCO.\655\ In addition, the Commission estimated that the

process of identifying new potential depositories, conducting necessary

due diligence, formalizing necessary agreements, opening accounts, and

transferring funds to a new depository would likely take between three

to six months and would likely require support from compliance

attorneys, as well as operations, risk management, and administrative

personnel. In the NPRM, the Commission estimated that the cost of

moving accounts from an existing depository that is not willing to sign

the letter would be between $50,000 and $102,000.\656\

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\654\ This estimate assumed 10-40 hours of time from a

compliance attorney and 10-20 hours from an office services

supervisor. The average compensation for a compliance attorney is

$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The

average compensation for an office services supervisor is $40.15/

hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per

hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures

were taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry.

\655\ Total figures are taken from previous calculation.

($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and

$2,735.99*30 = $82,079.69.

\656\ This estimate assumed one compliance attorney working

full-time for 3-6 months, 50-200 hours from an office services

supervisor, 80-160 hours of time from a risk management specialist,

and 40-60 hours from an intermediate accountant. The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *40

hours/week*4 weeks/month*3 months = $40,966.54 and $85.35 *40 hours/

week*4 weeks/month*6 months = $81,933.07. The average compensation

for an office services supervisor is $40.15/hour [$61,776.00 per

year/(2000 hours per year)*1.3 is $40.15 per hour]; $40.15*50 =

$2,007.72 and $40.15*200 = $8,030.88. The average compensation for a

risk management specialist is $65.33/hour [$100,500 per year/(2000

hours per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and

$268.84*160 = $10,452.00. The average compensation for an

intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and

$34.11*60 = $2,046.88. These figures were taken from the 2011 SIFMA

Report on Management and Professional Earnings in the Securities

Industry.

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There may be additional operational costs associated with any

changes that would necessitate updating the letter. The per-entity cost

of obtaining the letter from new depositories is likely to be the same

as it would be for obtaining the letter from existing depositories

(i.e., $1,300 and $4,200). In the NPRM, the Commission estimated that

the cost associated with changes that would require the acknowledgment

letter to be updated would be between $1,100 and $2,800 per year.\657\

---------------------------------------------------------------------------

\657\ This assumed 20-50 hours per year from an office manager

for operational costs. The average compensation for an office

manager is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 =

$55.82/hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This

figure was taken from the 2011 SIFMA Report on Management and

Professional Earnings in the Securities Industry.

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[[Page 68592]]

RCG discussed the need to develop policies and procedures as well

as train personnel.\658\ These costs were considered in the NPRM and

are discussed above. MGEX asserted, based on the Commission's estimates

in the NPRM, that the costs of using the Template Letters would

outweigh the benefits of using them. It did not, however, provide

further analysis as to the basis for its conclusion.\659\ In the NPRM,

the Commission quantified some of the potential costs and only

discussed the benefits qualitatively. Consequently, there is no direct

comparison between the costs and benefits based on the Commission's

estimates in the NPRM.

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\658\ RCG Comment Letter at 8 (Feb. 12, 2013).

\659\ MGEX Comment Letter at 3 (Feb.18. 2013).

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The Depository Bank Group, FIA, and Schwartz & Ballen expressed

concern that the Template Letters' standard of liability provision

would shift significant amount of risk onto depository institutions and

would likely increase the costs incurred in both monitoring for

violations and maintaining customer segregated accounts.\660\ As

discussed in the preamble, the Commission revised the language in the

Template Letters to address these concerns. FCStone and Schwartz &

Ballen commented that the proposed restriction on depositories placing

liens on customer accounts when there is an overdraft in an account

would likely lead to losses to depositories. As discussed in the

preamble, the Template Letter clarifies that liens on accounts are

permitted only in certain limited circumstances and that a depository

may not take a lien against a customer account to cover overdrafts. The

final Template Letters do not deny a depository the right to recover

funds advanced in the form of cash transfers, lines of credit,

repurchase agreements or other similar liquidity arrangements made in

lieu of liquidating non-cash assets held in an account or in lieu of

converting cash in one currency to cash in a different currency.

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\660\ Depository Bank Group Comment Letter at 2 (Feb. 15, 2013),

FIA Comment Letter at 40 (Feb. 15, 2013) and Schwartz & Ballen

Comment Letter at 6 (Feb. 15, 2013).

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The requirement, embedded in the FCM Template Letter, that

depositories provide the Commission with read-only electronic access to

customer accounts would create certain costs for depositories that

would likely be passed onto FCMs. ICI noted that the read-only access

requirement would result in a process that might be burdensome.\661\

The Commission does not have adequate data to estimate the cost for

establishing such a system and no data was provided by commenters to

aid the Commission in estimating such costs.\662\ The Commission also

has decided not to adopt the read-only electronic access requirement

for DCOs.\663\

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\661\ ICI Comment Letter at 5 (Jan. 14, 2013). Although ICI's

comments focused on MMMFs, some of the costs they discussed apply

generally to read-only access requirements.

\662\ The Commission intends to rely primarily on other means of

obtaining account information from depositories, and would activate

the read-only electronic access only in situations where it was

deemed necessary. The Commission will generally seek to obtain

account information from the NFA and CME automated daily segregation

confirmation system and/or from depositories directly prior to

requesting a depository to activate electronic access.

\663\ DCOs hold omnibus customer segregated accounts that do not

reflect funds attributable to individual clearing members or

customers.

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FCStone asserted that the ultimate costs of requiring Template

Letters will be borne by customers of FCMs.\664\ ICI noted that the

costs with respect to a MMMF Template Letter requirements would be

borne by all investors in a MMMF and not just by the FCMs.\665\ The

Commission, however, is unable to forecast how these costs will

ultimately be allocated.

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\664\ FCStone Comment Letter at (Feb. 15, 2013).

\665\ ICI Comment Letter at 5 (Jan. 14, 2013).

---------------------------------------------------------------------------

Section 1.22 Use of Customer Funds Restricted

Under current regulations, an FCM is not permitted to use one

customer's funds to purchase, margin, secure, or settle positions for

another customer. However, prior regulations did not specify how FCMs

should demonstrate compliance with this requirement. Revised regulation

1.22(c) provides such a mechanism.

Section 1.22(c)(1) defines the undermargined amount for an account.

Sections 1.22(c)(2) and (c)(4) require FCMs to compute, based on the

information available to the FCM as of the close of each business day,

(i) the undermargined amounts, based on the clearing initial margin

that will be required to be maintained by that FCM for its futures

customers, at each DCO of which the FCM is a member or FCM through

which the FCM clears, at the point of the daily settlement (as

described in 39.14) that will complete during the following business

day for each such DCO (or FCM through which the FCM clears) less (ii)

any debit balances referred to in 1.20(i)(4) included in such

undermargined amounts.

Moreover, under section 1.22(c)(3), an FCM is required to, prior to

the Residual Interest Deadline defined in section 1.22(c)(5), have

residual interest in the segregated account in an amount that is at

least equal to the computation set forth in section 1.22(c)(2).\666\

The amount of residual interest that an FCM must maintain may be

reduced to account for payments received from or on behalf of

undermargined futures customers between the close of the previous

business day and the Residual Interest Deadline.

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\666\ See note 395 above regarding the operation of the

requirement in Sec. 1.22(c)(3) where an FCM is subject to multiple

Residual Interest Deadlines.

---------------------------------------------------------------------------

Section 1.22(c)(5) defines the Residual Interest Deadline. During

an initial phase-in period, the Residual Interest Deadline is 6:00 p.m.

Eastern Time on the date of the settlement referenced in (c)(2)(i) or

(c)(4). On December 31, 2018, which is the expiration of the phase-in

period, the Residual Interest Deadline shifts to the time of the

settlement referenced in (c)(2)(i) or (c)(4). In the interim, paragraph

1.22(c)(5)(iii) requires Commission staff to solicit further public

comment and conduct further analysis in a report (the ``Report'') for

publication in the Federal Register regarding the practicability of

moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on

the date of settlement to the time of settlement (or to some other time

of day). The Report will discuss whether and on what schedule it would

be feasible to move the Residual Interest Deadline, and the cost and

benefits of such potential requirements. In addition, staff is

instructed to, using the Commission's Web site, solicit public comment

and conduct a public roundtable regarding specific issues to be covered

by the Report. Paragraph 1.22(c)(5)(iii)(B) provides that the

Commission may, taking into account the Report, (1) terminate the

phase-in period, in which case the phase-in shall end as of a date

established by Commission order published in the Federal Register,

which date shall be no less than one year after the date of such

Commission order, or (2) determine that it is necessary and appropriate

in the public interest to propose through rulemaking a different

Residual Interest Deadline. In that event, the Commission shall

establish by order published in the Federal Register, a phase-in

schedule.

Costs and Benefits

The requirement in Sec. 1.22(c) benefits customers whose accounts

are not undermargined by reducing the risk that their segregated funds

would be used to cover a shortfall in customer funds due

[[Page 68593]]

to a ``double default.'' \667\ When combined with the reporting

requirements in Sec. Sec. 1.10, 1.32, 22.2, and 30.7, the requirement

in Sec. 1.22(c) will further provide the Commission and the public

with information that should allow them to determine whether FCMs are

using one customer's funds to purchase, margin, secure or settle

positions for another customer.\668\

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\667\ See discussion of double defaults in sections I.D. and

II.G.9. above.

\668\ See the discussion in section II.G.9. above.

---------------------------------------------------------------------------

It would be difficult to quantify these benefits reliably. An

estimate would depend on the expected value of losses due to a double

default (i.e., a default of both a customer and the FCM) which, in

turn, depend on the probability of a double default and the magnitude

of deficits that would exist in customer accounts compared to the

amount of residual interest at the time of the double default. Given

the small number of historical examples, it is unlikely that any

estimate of probability would be reliable. Moreover, the magnitude of

the impact of a loss of customer funds is dependent on an estimate of

the amount of funds lost, a number that is also difficult to predict

with any reliability, as well as the loss of market confidence (which

may be even more important), which is also difficult to estimate

reliably.

As discussed above, the Commission has revised the residual

interest requirements in the final rule by adopting a point in time

approach.\669\ As a consequence, once the requirement in Sec. 1.22(c)

is phased in, FCMs will have several hours between the close of

business on a particular day (the point in time upon which the

calculation is based), and the time of day when the requisite amount of

residual interest must be held in segregation (that is, the time of the

daily settlement). Moreover, during the phase-in period described in

Sec. 1.22(c)(5), FCMs will initially have a longer period (until 6:00

p.m. Eastern Time on the following business day) to ensure that the

requisite amount of residual interest is held in segregation.

---------------------------------------------------------------------------

\669\ See the discussion in section II.G.9. above.

---------------------------------------------------------------------------

These adjustments to the final rule will avoid the need for FCMs

continuously to monitor whether they are maintaining residual interest

in their segregated customer accounts that is sufficient to cover the

sum of the undermargined amounts in customers' accounts. Instead, FCMs

will have to ensure that they are able to cover the sum of the

undermargined amounts in customers' accounts by the Residual Interest

Deadline. This should significantly reduce the amount of residual

interest that an FCM must maintain in segregated accounts on an ongoing

basis. In the absence of information regarding what specific changes

various market participants might make to their systems and operations

in order to expedite margin payments, it is not possible for the

Commission to provide an estimate of the costs of such technical

changes.

Moreover, the FCM's funding requirement will be reduced to the

extent that customers are able to reduce the undermargined amount in

their accounts prior to the Residual Interest Deadline. The Commission

expects that FCMs will work with customers during the phase-in period

to develop the systems and operational patterns that will be necessary

to facilitate more prompt margin calls and payments. As a consequence,

those FCMs' customers that do not already have the capability to make

margin payments before the Residual Interest Deadline may develop that

capability, which will further reduce the funding burden borne by FCMs.

The cost associated with maintaining sufficient residual interest

to cover undermargined amounts will also depend upon the policies and

procedures that FCMs put into place to meet the targeted residual

interest requirement set forth in Sec. 1.11. To the extent that the

undermargined amount is greater than the targeted residual interest

amount that an FCM maintains in its customer accounts, the FCM would

have to increase the amount of residual interest it maintains in the

customer segregated account by the time it is obligated to make

settlement payments to the DCO. Some FCMs may seek to avoid this

situation by requiring their customers to pre-fund (i.e., require

customers to provide initial margin for a position before the FCM sends

the position to a DCO to be cleared, and provide sufficient excess

margin to the FCM to reduce any undermargined amount). If the FCM

elects to increase the amount of residual interest that it maintains in

the customer segregated accounts, this would likely reduce the range of

investment options the FCM has for those additional funds and may

prompt the FCM to hold additional capital to meet operational needs.

Similarly, if the FCM requires additional margin from customers, that

will result in capital costs to those customers.

On the other hand, to the extent the FCM would otherwise maintain

targeted residual interest (i.e., to the extent the targeted residual

interest is greater than or is included within the undermargined

amount), then the rule would not create any additional funding costs.

Despite these revisions to the proposed rule, the Commission

recognizes that the requirements of final rule Sec. 1.22(c) will

create significant additional costs for FCMs and their customers.

Developing and implementing the systems and operational changes

necessary to facilitate more rapid margin payments will create costs

for FCMs and their customers. Those costs are likely to vary

significantly across FCMs depending on the infrastructure and

operational patterns that each FCM already has in place, and depending

on the specifications of the revised systems and operational patterns

that FCMs and customers develop in order to facilitate more rapid

margin payments.\670\

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\670\ In the absence of information regarding what specific

changes various market participants might make to their systems and

operations in order to expedite margin payments, it is not possible

for the Commission to provide an estimate of these costs.

---------------------------------------------------------------------------

In addition, the Commission expects that some FCMs may choose to

require some customers to increase the amount of margin they maintain

in their accounts. This is more likely for those customers who are

presently not able to make their margin payments prior to the Residual

Interest Deadline. Customers subject to increased pre-funding

requirements will bear costs from their cost of capital resulting from

pre-funding multiplied by the amount of the increased pre-funding

requirement. The cost of capital for each customer depends on the

investment strategy of the individual customer, and the amount of

increased pre-funding requirement is likely to vary depending on the

ability of the customer to respond to margin calls promptly and the

FCM's ability to cover the customer's deficits through increased

residual interest contributions.\671\

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\671\ Commenters did not provide, and the Commission does not

have, data characterizing the range of investment strategies used by

FCM customers, its impact on their cost of capital for additional

margin, the extent to which customers will not be able to develop

the ability to make more rapid margin payments, or the extent of the

margin requirements for those customers. In the absence of this

information it is not possible at this time to estimate the

additional cost associated with pre-funding requirements that some

customers may bear. These are subjects that may be addressed in the

Report.

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Last, whatever undermargined amounts are not addressed through

customer payments prior to the Residual Interest Deadline will have to

be covered through increased residual interest contributions from the

FCM.

The Commission expects that in order to comply with the

requirements of Sec. 1.22(c), FCMs may need to maintain

[[Page 68594]]

additional residual interest in order to cover the sum of undermargined

amounts in customers' accounts that still remain by the Residual

Interest Deadline on ordinary trading days, and are likely to acquire

and maintain access to additional liquidity that can be accessed

rapidly to meet the sum of customers' gross undermargined amounts in a

worst-case-scenario. Therefore, in order to estimate the cost of

additional residual interest that FCMs will maintain, it is necessary

to estimate the amount of additional residual interest that FCMs will

need to maintain in their segregated accounts during ordinary trading

days, the amount of additional residual interest that will be needed on

highly volatile trading days, the ratio of ordinary to highly volatile

trading days on an annual basis, the cost of capital for the additional

funds that are deposited into residual interest, and the cost to

maintain a revolving credit facility or some other source of funding

that can be accessed quickly and that is sufficient to cover the

projected largest undermargined amount in aggregate for customers'

accounts.

As discussed further below, the Commission believes that the point

in time approach adopted in this final rule will significantly reduce

the amount of additional residual interest that FCMs need to maintain

in their segregated accounts on an ongoing basis in order to comply

with Sec. 1.22(c).

Several commenters provided estimates of the cost of the ``at all

times'' portion of the proposal. FIA estimated that compliance with the

``at all times'' portion of the proposal would require FCMs or their

customers to deposit significantly in excess of $100 billion into

customer funds accounts beyond the sum required to meet initial margin

requirements, and that the annual financing costs for these increased

deposits will range from $810 million to $8.125 billion.\672\ FIA

estimated the highest single day customer margin deficits per FCM would

likely be between $196 million to $6.1 billion per FCM, depending on

the size and composition of the FCM's customer accounts.\673\ Jefferies

estimated that it would be required to increase its own residual

interest by $15 million (non-peak) or $30 million (peak),

respectively.\674\ Jefferies also stated that the industry would be

required to increase its residual interest by $49 billion (non-peak) or

$83 billion (peak) at a cost of approximately $2 billion (non-peak) or

$5 billion (peak), respectively.\675\ ISDA estimated that the highest

single day sum of gross customer margin deficits would likely be

approximately $73.2 billion for all FCMs combined, with a long term

funding impact of $335 billion.\676\

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\672\ FIA Comment Letter at 14, 16 (Feb. 15, 2013).

\673\ See FIA Comment Letter at 2-3 (June 20, 2013).

\674\ Id. at 8.

\675\ Id.

\676\ See ISDA Comment Letter at 4 (Feb. 15, 2013). ISDA used

market data for FCMs (November 30, 2012) available at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

---------------------------------------------------------------------------

While the Commission expects that the residual interest requirement

will create additional capital costs for most FCMs, the Commission

believes that the estimates presented by commenters include certain

assumptions that may lead to overstated costs. First, residual interest

that is not needed to be pledged as collateral for customers may be

invested overnight and during the day in investments that are

consistent with the requirements of Commission Regulation 1.25 (``Sec.

1.25 investments'').\677\ The return on residual interest would offset

a portion of the cost of funds. That is, the additional funds that FCMs

place in residual interest will both incur costs and generate returns

for the FCM. Estimates of the effective cost of the additional funds

that must be used to increase residual interest must account for

both.\678\ The returns on Sec. 1.25 investments have the potential to

reduce the effective cost of funds.

---------------------------------------------------------------------------

\677\ 17 CFR 1.25.

\678\ For example, FIA cited a historical cost of funds of

8.125% in January 1990. At that time, the constant maturity one

month Treasury yield was 7.86%, see http://mortgage-x.com/general/indexes/cmt_tcm_history.asp?f=m. Thus, using the cost of funds

proxy from the commenter, the cost of funds would be closer to

0.365% (calculated as 8.125% - 7.86% + 0.10% (for underwriting and

administrative overhead)).

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Second, both FIA and ISDA confound total residual interest with

additional residual interest by assuming that the total amount of

residual interest that would be required by the proposed rule is equal

to the additional amount of additional interest that would be required

by the rule. FCMs, in general, maintained some residual interest prior

to this rule, and are required to do so to comply with Sec. 1.23.\679\

Therefore, it is only the additional residual interest that is

necessary because of rule 1.22(c) that is relevant for consideration

here.

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\679\ See section II.G.10. above.

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Third, the Commission agrees with FIA that U.S. Treasury securities

are an appropriate proxy for the marginal cost of capital for a low-

risk project, such as funds to be placed in residual interest. FIA and

Jefferies did not explain why they chose long-dated maturities on the

yield curve for their estimates. Presumably, an FCM could borrow funds

at a much shorter maturity than five years, for example, a month or

less, potentially lowering borrowing costs substantially.

The Commission notes, and discusses further below, that FCMs might

mitigate costs by maintaining a credit facility that is sufficient to

cover most of their additional residual interest needs on unusually

volatile trading days, but that is not used on the majority of trading

days. This approach would not only lower the amount of capital needed,

but would also reduce the amount of time during which the capital is

borrowed. As discussed further below, the Commission is not able to

estimate accurately what fees banks would charge. However, the

Commission has considered that FCMs would bear an ongoing cost

associated with maintaining an open credit facility that is able to

provide rapid access to sufficient liquidity to meet any additional

residual interest requirements on highly volatile days.

As noted above, several commenters requested the Commission revise

the proposal to require that the residual interest calculation be made

once a day, specifically by the end of the business day.\680\ These

commenters suggested an alternative (the ``Industry Commenters'

Alternative'') by which, at this point in time, an FCM would be

required to maintain a residual interest in its customer funds accounts

at least equal to its customers' aggregate margin deficits for the

prior trade date. ISDA stated this alternative ``would rationally

reduce'' FCMs cost of compliance \681\ and that ``[f]or an FCM with

robust credit risk management systems, covering end-of-day customer

deficits should not be a significant cost.'' \682\ ISDA also noted that

at the end of the day ``typically, all customer calls have been met,

and all customer gains have been paid out; all achieved without the FCM

having recourse to its own funding resources.'' \683\ FIA asserted that

it would ``achieve the Commission's regulatory goals without imposing

the

[[Page 68595]]

damaging financial and operational burdens on FCMs, and the resulting

financial burdens on customers.'' \684\

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\680\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment

Letter at 23-25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5

(Jan. 25, 2013); Paul/Weiss Comment Letter at 4-5 (Feb. 15, 2013);

RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).

\681\ ISDA Comment Letter at 6 (Feb. 15, 2013).

\682\ ISDA Comment Letter at 2 (May 8, 2013).

\683\ Id. ISDA further observed that many FCM customers use

custodians across the world, and ``many customers cannot assure

payment of their morning FCM call before the end of the New York

day,'' and therefore recommended that Commission study the

feasibility of reducing the time in which customers have to meet

margin calls, if that is ``imperative.'' Id. at 3. This will be

addressed in the Report.

\684\ FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA

Comment Letter at 4 (May 8, 2013).

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ISDA and FIA evaluated the costs associated with requiring FCMs to

perform the residual interest calculation once each day at the close of

business on the first business day following the trade date.\685\ ISDA

estimated that ``removing the predictive element of FCM funding

requirements'' of the ``at all times'' method in favor of the Industry

Commenters' Alternative would permit markets to ``reap the efficiencies

of end-of-day accounting,'' \686\ thereby reducing the overall cost of

compliance with the regulation. ISDA estimated that for exchange-traded

futures, the costs associated with the alternative would be the cost of

covering the outstanding margin deficits of between 2% and 5% of an

FCM's futures customers, and thus that approach would impose only

``incremental funding requirements'' on FCMs.\687\ ISDA estimated that

the costs of the alternative would be even smaller for cleared swaps,

due to the ``more professional'' nature of the market.\688\ FIA

acknowledged that if FCMs were given until the end of the following

business day to ensure that the requisite amount of residual interest

was maintained, that approach would eliminate approximately 90-95% of

the anticipated additional residual interest that larger FCMs would

need to maintain in order to meet an at all times requirement.\689\ FIA

estimated the financing costs to FCMs of complying with the Industry

Commenters' Alternative, and concluded that the costs associated with

an at all times residual interest requirement would be approximately

ten times the costs associated with the Industry Commenters'

Alternative.\690\ Finally, the FIA concluded that the Industry

Commenters' Alternative would not ``impos[e] damaging financial and

operational burdens on FCMs . . . and the resulting financial burdens

on customers'' that would result from the at all times approach.\691\

---------------------------------------------------------------------------

\685\ ISDA Comment Letter at 1-2 (May 8, 2013); FIA Comment

Letter at 8-10 (June 20, 2013).

\686\ ISDA Comment Letter at 3 (May 8, 2013).

\687\ Id. at 3-4.

\688\ Id. at 4.

\689\ See FIA Comment Letter at 3 (June 20, 2013).

\690\ See FIA Comment Letter at 8-10 (June 20, 2013). While the

rates used by FIA in this exercise may be conservative, and the

Commission does not adopt these precise estimates, the exercise is

nevertheless illustrative and useful for the purpose of comparing

the costs of the at all times approach and the Industry Commenters'

Alternative.

\691\ Id. at 9.

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However, the point in time approach adopted in final rule Sec.

1.22(c) gives FCMs until the time of settlement with the DCO (typically

the beginning of the following business day for end of day margin calls

from the DCO), and also provides an extended phase-in period, during

which FCMs have until 6:00 p.m. Eastern Time on the date of such

settlement. After the phase-in period, and absent further Commission

action following the Report, the final rule does not provide FCMs until

the end of the following business day to ensure that the requisite

amount of residual interest is held, as would be the case in the

Industry Commenters' Alternative. Therefore, the Commission expects

that the point in time approach adopted by the Commission will reap

much, but not all, of the cost reduction discussed by the industry

commenters.\692\

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\692\ FIA estimated that the Industry Commenters' Alternative

would reduce the amount of additional residual interest that is

necessary by 90-95% when compared to the at all times approach. See

id. at 3 (June 20, 2013). See also ISDA Comment Letter at 1-2 (May

8, 2013).

---------------------------------------------------------------------------

During the phase-in period, FCMs would be subject to Industry

Commenters' Alternative (and, thus, all of those cost savings would be

realized).

The following analysis assumes that the Commission does not take

further action to modify the Residual Interest Deadline after

considering the results of the Report. It refers to estimates of

ongoing costs and benefits that only would be incurred and realized

after the end of the phase-in period.

The Commission expects that the post-phase-in form of Sec.

1.22(c)--with a point in time requirement corresponding to the time of

settlement--will achieve some, but not all of the cost reductions

associated with Industry Commenters' Alternative. Moreover, during the

phase-in period, the Commission anticipates that customers and FCMs

will improve their abilities to submit and receive margin payments

prior to the FCM's settlement with the DCO, and the Commission will be

examining this issue further in the Report. In light of these factors,

the Commission believes it is reasonable to suppose that the settlement

time approach will significantly reduce--perhaps by 25% to 50%--the

amount of additional residual interest that is needed on highly

volatile trading days, and by a greater amount on ordinary trading

days.

In order to reasonably estimate the potential range of the amount

of additional capital that is necessary on highly volatile trading

days, the Commission uses ISDA's formulation for the aggregate gross

deficit across all customers. ISDA estimated that on high volatility

days, the aggregate amount of all customers' gross margin deficits for

all FCMs would be equal to 60% of initial margin required by all

customers' positions. This estimate is based on an assumption that all

of an FCM's customers will be holding positions in the same commodity

(or that all commodities in which customers hold positions will move in

unison) and that either shorts or longs will predominate.\693\ This

approach is conservative because it does not take into account

diversification effects. For example, while some customers may hold

positions in energy products, which may be volatile on a particular

day, others may predominately hold positions in interest rates, which

may not be volatile on the same day. Moreover, because of the point in

time approach adopted by the Commission, FCMs will have time to react

to such changes.

---------------------------------------------------------------------------

\693\ See ISDA Comment Letter at 4-5 (Feb. 15, 2013).

---------------------------------------------------------------------------

The Commission's cost estimates for the amount of additional

residual interest that will be required reflect an effort to make a

reasonable assumption regarding the potential range of additional

residual interest that could be necessary on a volatile trading day.

The amount of additional residual interest that could reasonably be

expected to be necessary on an ordinary trading day would be much lower

because the aggregate of all customers' gross undermargined amounts

would be significantly lower on such days. However, commenters only

estimated the aggregate of customers' gross undermargined amounts on

highly volatile days. They did not estimate or provide data regarding

the aggregate of customers' gross undermargined amounts on ordinary

trading days. In the absence of either data or estimates from

commenters regarding undermargined amounts in customers' accounts on

ordinary trading days, the Commission is not able to quantify the

amount of additional residual interest needed by FCMs in ordinary

trading conditions, but believes that it is significantly less than

what is estimated above for volatile trading days.

Commenters did not identify what level of volatility they had in

view when offering estimates for additional residual interest that

would be necessary for a ``volatile'' trading day. For example,

commenters may have had in mind days that were volatile relative to

market conditions over the last year or two, or that are volatile

relative to the range of all possible outcomes. Context suggests

[[Page 68596]]

the latter assumption, since commenters asserted elsewhere that FCMs

would have to anticipate market movements in order to maintain

sufficient residual interest at all times to cover the sum of

customers' undermargined amounts during a highly volatile trading

day.\694\ Given this, the Commission notes that highly volatile days

are only a small fraction of all total trading days, and therefore, the

costs associated with additional residual interest required on such

highly volatile days would only accrue on a correspondingly small

fraction of the total trading days in a given year.

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\694\ See, e.g., LCH.Clearnet Comment Letter at 4-5 (Jan. 25,

2013) (noting that ``regardless of the amount of capital an FCM

dedicated to continuous compliance, FCMs would still be at risk of a

violation''). See also CMC Comment Letter at 2 (Feb. 15, 2013); CME

Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4, 13, 15

(Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); NPPC

Comment Letter at 2 (Feb. 15, 2013); TD Ameritrade Comment Letter at

4-5 (Feb. 15, 2013).

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FCMs would, however, bear an ongoing cost associated with

maintaining an open credit facility or some other source of funds that

is able to provide rapid access to sufficient liquidity to meet any

additional residual interest requirements when highly volatile days do

occur. The Commission does not have adequate data to estimate the cost

of this credit facility. Since it is not feasible to estimate the costs

to FCMs to cover the need for additional residual interest between the

times of the daily settlement and the end-of-day by obtaining intraday

lines of credit from lenders, the Commission has taken a conservative

approach, and has assumed, for the sake of quantification, that firms

will raise capital sufficient to meet their residual interest needs on

highly volatile trading days, and will keep that amount of capital on

all days, holding it either in residual interest or in liquid assets

that are available to be deposited into segregation.

The Commission is aware that the top-10 largest FCMs (ranked by

total amount of customer funds in section 4d(a)(2) segregated accounts

and 30.7 accounts as of November 30, 2012) are contained in bank

holding companies.\695\ Most of these bank holding companies have

short-term credit ratings of Moody's P-1, Standard & Poor's A-1, and

Fitch F1, while a few have holding companies with P-2, A-2, and F2

ratings. The FCM subsidiary usually derives its credit standing from

the bank holding company, with the rating of the FCM subsidiary being

often the same or sometimes one credit grade lower than the holding

company. To estimate the interest rate that a bank holding company

would charge its FCM subsidiary for funding additional residual

interest, the Commission is using as a proxy for the costs of these

funds the historical average of 30-day AA-financial commercial paper

(consonant with the short-term credit ratings of the bank holding

companies) minus the yield on the 4-week constant maturity U.S.

Treasury bill (to account for the return that FCMs will earn on

investments permitted under Regulation 1.25) and is adding 0.10% for

underwriting and administrative overhead costs to issue commercial

paper.\696\ This results in an average cost of funds of 0.35% for the

top-10 largest FCMs from July 2001 to July 2013. For the remaining

FCMs, the Commission is using as a proxy for the costs of funds the

difference between the prime rate and the yield on the 4-week constant

maturity U.S. Treasury bill. This results in an average cost of funds

of 3.25% from July 2001 to July 2013.\697\ The Commission is using

historical FCM data from November 30, 2012, even though there is more

recent data available, to be consistent with the data ISDA used in the

analysis in its comment letter.\698\ As of November 30, 2012, there was

approximately $147.1 billion in customer funds in section 4d(a)(2)

segregated accounts (excluding excess amounts contributed by

FCMs).\699\ The top-10 FCMs held approximately $111.7 billion in

section 4d(a)(2) segregated accounts,\700\ and the remaining FCMs held

approximately $35.4 billion in section 4d(a)(2) segregated

accounts.\701\

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\695\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

\696\ The Commission computes the average yields from July 2001

to July 2013. The constant maturity 4-week Treasury yield time

series with month observations begins in July of 2001. See http://www.federalreserve.gov/releases/H15/data.htm.

\697\ The Commission recognizes that there may be some FCMs with

weak credit ratings that would have to pay even more than the prime

interest rate to secure additional residual interest. See id.

\698\ The Commission believes that the November 30, 2012 FCM

data is typical. Moreover, this permits comparison with other

estimates in the comment letter.

\699\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

\700\ See id.

\701\ Id.

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ISDA estimated the potential future FCM funding requirement for

futures arising from the residual interest proposal by subtracting the

existing customer excess. ISDA estimated the futures excess to be

between $40-$70 billion and employed the midpoint of this range, $55

billion in its calculations. Using ISDA's point estimate for existing

customer excess of $55 billion, the Commission estimates there was, at

the top-10 FCMs, (55/177.1) (i.e., 31%) times $111.7 billion or

approximately $34.7 billion in existing customer excess in section

4d(a)(2) segregated accounts. Similarly, for the remaining FCMs, the

Commission estimates that there was approximately $11 billion in

customer excess in section 4d(a)(2) segregated accounts.\702\

---------------------------------------------------------------------------

\702\ That is, 31% of $35.4 billion and $2.3 billion,

respectively.

---------------------------------------------------------------------------

First, the Commission performs its calculations for the residual

interest projected in the section 4d(a)(2) segregated accounts based on

ISDA's assumption that residual interest were required ``at all

times.'' For the top-10 FCMs, the Commission subtracts $34.7 billion

from $111.7 billion giving approximately $77 billion in required

margin. The Commission uses ISDA's suggestion for additional residual

interest needed by FCMs and takes 60% of this figure, approximately

$46.2 billion, as the estimate for total residual interest needed. As

of November 30, 2012, the top-10 FCMs held approximately $6.5 billion

in residual interest.\703\ Using these figures, the top-10 FCMs would

need to fund approximately $39.7 billion in additional residual

interest. At a cost of funds of 0.35%, this would result in an annual

cost of $139 million for the top-10 FCMs based on the historical costs

of funds.

---------------------------------------------------------------------------

\703\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

---------------------------------------------------------------------------

For the remaining FCMs, the Commission subtracts $11 billion

(excess margin) from $35.4 billion (balance in 4d(a)(2) accounts)

leaving approximately $24.4 billion (required margin in 4d(a)(2)

accounts). Again, using ISDA's 60% formulation gives $14.6 billion in

total residual interest needed under an at all times approach. The

remaining FCMs are holding approximately $3.9 billion in residual

interest.\704\ Consequently, the remaining FCMs would need to fund

approximately $10.7 billion ($14.6 billion-$3.9 billion) in additional

residual interest. At a cost of funds of 3.25%, this gives the

historical annual cost of approximately $348 million.

---------------------------------------------------------------------------

\704\ See id.

---------------------------------------------------------------------------

For all FCMs, the aggregate annual cost is approximately $487

million (that is, $139 million plus $348 million) to fund the

additional residual interest needed by FCMs due to Sec. 1.22 if

residual interest were required at all times.

However, these figures change significantly if residual interest is

not required until the daily settlement. As

[[Page 68597]]

noted above, both FIA and ISDA estimate that the residual interest

requirement would be reduced by 90% or more if it were required to be

present at the end-of-day on the following business day. As discussed

above, the Commission estimates that using the point in time approach

with morning settlement (rather than end-of-day) will reduce the need

for additional residual interest by 25-50%. The midpoint of this range

is 37.5%. A reduction of 37.5% (as a consequence of moving to the point

in time approach) leaves a multiplier of 62.5%. Multiplying 62.5% by

ISDA's estimate (for the at all times approach) of 60% of required

margin results in a product of 37.5%.\705\ For the top-10 FCMs, the

Commission multiplies the $77 billion in required margin by 37.5%

giving approximately $28.9 billion in residual interest needed. The

top-10 FCMs are currently holding approximately $6.5 billion in

residual interest. The top-10 FCMs would be required to fund

approximately $22.4 billion ($28.9 billion-$6.5 billion) in additional

residual interest. At a cost of funds of 0.35%, this would result in an

annual cost of approximately $78 million for the top-10 FCMs.

---------------------------------------------------------------------------

\705\ The fact that the reduction of 37.5% (the midpoint of 25%

and 50%) multiplied by ISDA's estimate of 60% results in a product

that is also 37.5% is coincidental.

---------------------------------------------------------------------------

For the remaining FCMs, the Commission multiplies $24.4 billion

(required margin in 4d(a)(2) accounts) by 37.5% giving approximately

$9.2 billion. The remaining FCMs are holding $3.9 billion in residual

interest.\706\ Consequently, the remaining FCMs would be required to

fund approximately $5.3 billion ($9.2 billion-$3.9 billion) in

additional residual interest. At a cost of funds of 3.25%, this would

result in an annual cost of approximately $171 million with current

economic conditions. This result in a total annual cost of

approximately $249 million to fund the additional residual interest

needed by FCMs due to Sec. 1.22 using the Commission's assumption of

37.5% of initial margin needed for residual interest.

---------------------------------------------------------------------------

\706\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

---------------------------------------------------------------------------

As explained above, the final rule does not require FCMs to take

this approach. Instead, the Commission believes that firms are likely

to manage margin calls to reduce the sum of customers' gross

undermargined amounts prior to the time of settlement. They may also

mitigate costs by using revolving credit facilities or other temporary

sources of liquidity to meet, in part, the need for additional residual

interest on volatile trading days. The Commission received comments on

the proposed costs and benefits of Sec. 1.22. Several commenters

supported the proposal, noting that it would prevent customer funds

from being used to subsidize an FCM's obligations, reduce systemic

risk, and enhance customer protection, especially in the event of an

FCM bankruptcy.\707\ In particular, SIFMA stated that the proposal,

``in effect, shifts the costs and burdens of a margin shortfall from

customers with excess margin to customers with deficits, where it

properly belongs.'' \708\ In addition, Vanguard argued that the

``proposed changes correctly shift the risk to customers in deficit and

away from any excess margin transferred by other customers.'' \709\

---------------------------------------------------------------------------

\707\ See, e.g., CFA Comment Letter at 5-6 (Feb. 13, 2013);

CIEBA Comment Letter at 2-3 (Feb. 20, 2013); ICI Comment Letter at 3

(Jan. 14, 2013); Franklin Comment Letter at 2 (Feb. 15, 2013); Paul/

Weiss Comment Letter at 3 (Feb. 15, 2013); SIFMA Comment Letter at 2

(Feb. 21, 2013); Vanguard Comment Letter at 7-8 (Feb. 22, 2013).

\708\ SIFMA Comment Letter at 2 (Feb. 21, 2013).

\709\ Vanguard Comment Letter at 7 (Feb. 22, 2013).

---------------------------------------------------------------------------

On the other hand, a number of commenters interpreted the ``at all

times'' language to require FCMs to continuously calculate their

customers' aggregate margin deficits and stated that they believe such

a requirement is infeasible.\710\ As a result of this interpretation of

the proposal, these commenters argued that the proposal would

dramatically increase costs and create liquidity issues for FCMs and

their customers.\711\ Many commenters asserted that the proposal would

therefore result in FCMs requiring customers to pre-fund their

positions.\712\ FHLB cautioned that ``[w]hile it cannot be disputed

that a residual interest buffer should lower the risk that an FCM will

fall out of compliance with its segregation requirements, there will

likely be a real economic cost associated with maintaining whatever

residual interest buffers is established by an FCM.'' \713\ FHLB

further noted that the ``funds maintained by an FCM as residual

interest can reasonably be expected to earn less than the FCM's

unrestricted funds,'' thus, the proposal ``represents a real cost to

FCMs'' that will be passed on to customers.\714\ ISDA stated that the

proposal will make customers ``self-guaranteeing'' and diminish

reliance on the FCM, and that, while this would diminish overall risk

of FCM default, it comes at a very significant cost to market

participants, market volumes, and liquidity.\715\ CHS Hedging observed

that ``pre-funding accounts concentrates additional funds at FCMs,

which seems to contradict the spirit of the'' customer protection

rules.\716\

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\710\ See, e.g. Advantage Comment Letter at 6-8 (Feb. 15, 2013);

CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5

(Feb. 15, 2013); FIA Comment Letter at 4, 7-8, 13 (Feb. 15, 2013);

LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MFA Comment

Letter at 8 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb. 18,

2013); Newedge Comment Letter at 2 (Feb. 15, 2013); NPPC Comment

Letter at 2 (Feb. 15, 2013; RCG Comment Letter at 3 (Feb. 12, 2013);

TD Ameritrade Comment Letter at 4-5 (Feb. 15, 2013).

\711\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013)

(``The avalanche of buying or selling that this rule will induce

contradicts decades of effort by the industry to thwart market

panics and provide markets with liquidity and stability.''); CMC

Comment Letter at 2 (Feb. 15, 2013) (stating that the proposal

``could create liquidity issues and increase costs for FCMs and end

users. Such a decrease in liquidity could be substantial, and limit

the number and type of transactions FCMs clear, the number of

customers they service and the amount of financing they provide.'');

CME Comment Letter at 5-6 (Feb. 15, 2013) (``We believe that this

will be a significant and unnecessary drain on liquidity that will

make trading significantly more expensive for customers to hedge

financial or commercial risks. The liquidity drain will be

exacerbated to the extent that the demand for excess margin will

increase the costs and limit the activities of market makers.'').

\712\ See, e.g., FIA Comment Letter at 17 (Feb. 15, 2013); MFA

Comment Letter at 8 (Feb. 15, 2013); Newedge Comment Letter at 2

(Feb. 15, 2013).

\713\ FHLB Comment Letter at 3-4 (Feb. 15, 2013).

\714\ Id. at 4 n.5.

\715\ ISDA Comment Letter at 3 (Feb. 15, 2013) (noting that

``[e]ffectively doubling margins will damage futures and swaps

markets by destroying the value proposition for many liquidity

providers essential to the market's efficiency.''). See also ISDA

Comment Letter at 2-3 (May 8, 2013) (stating that the proposal would

cause customers to pre-fund margin, which ``would remake the cleared

swaps and futures markets into one exclusively for `self-

guaranteeing' customers,'' which ``would be damaging to markets by

destroying the incentives for continued participation by liquidity

providers essential to the markets' efficiency.'').

\716\ Id.

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As noted above, the Commission recognizes that some FCMs may

require their customers, or some subset of their customers, to increase

the margin they maintain in their accounts in order to cover possible

deficits that could materialize during the period of time it would

typically take that customer to respond to a margin call. This is

particularly the case if and when the Residual Interest Deadline moves

to the time of the daily settlement. However, the Commission expects

that the number of customers and the amount of additional margin

required from those customers would be significantly less than was

asserted by some of the commenters because of modifications made to the

final rule. As noted above, the final version of the rule allows FCMs

to meet the gross sum of the undermargined amounts several hours after

(and, during the phase-in period, at the end of the next business day

after)

[[Page 68598]]

the undermargined amount is calculated, which is expected to

significantly mitigate the need for FCMs to maintain a ``preventative

buffer'' of residual interest or additional customer margin that is

sufficient to cover customers' potential undermargined amounts in a

worst case scenario. Moreover, in cases where customers develop the

ability to submit margin payments prior to the Residual Interest

Deadline, there will not be any need for additional customer margin on

an ongoing basis. It is therefore likely that FCMs will require

additional customer margin on an ongoing basis in situations only where

(1) a particular customer is not be able to routinely make margin

payments prior to the Residual Interest Deadline, and (2) the sum of

the undermargined amounts in customers' accounts that cannot be

collected before the Residual Interest Deadline is a relatively large

compared to the amount of residual interest that the FCM otherwise

chooses to maintain.\717\

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\717\ The Commission expects that this would happen on normal

trading days. On highly volatile trading days, the Commission

expects that customers' gross undermargined amounts would likely be

covered by residual interest acquired through a line of credit or

credit facility, as discussed above, rather than through customer

pre-funding since the costs of the former are likely to be

considerably less than the costs of the latter.

However, the Commission does not, at this time, have data

regarding individual customers' historical gross undermargined

amounts and therefore does not have adequate information to estimate

the number of FCM and customer combinations where additional

customer margin would be required on an ongoing basis.

---------------------------------------------------------------------------

The Commission does not agree that increased residual interest

requirements are contrary to the spirit of the customer protection

rules. The rules are intended to provide additional protections to

funds held at FCMs, not to reduce the amount of funds held at FCMs. The

likelihood of customer defaults leading to an FCM default is reduced.

So, additional customer funds at FCMs are better protected with the

increased residual interest requirements in place.

Several commenters argued that the costs associated with the

proposal would decrease competition between FCMs.\718\ In particular,

FIA stated that the proposal may force a number of small to mid-sized

FCMs out of the market, which will decrease access to the futures

markets and increase costs for IBs, hedgers and small traders.\719\ In

addition, FIA argued that the proposal would significantly impair the

price discovery and risk management functions served by the

market.\720\ JSA argued that the proposal would be ``punitive in a

highly competitive environment that already places the midsize operator

at a disadvantage to his better capitalized multinational

competitors.'' \721\ Moreover, JSA stated that the cost of the proposal

would result in a higher cost of hedging, which would be prohibitive

and prompt agricultural users to walk away from the futures

market.\722\ The Congressional Committees requested that the Commission

consider these effects in drafting the final rule.\723\

---------------------------------------------------------------------------

\718\ See, e.g., CHS Hedging Comment Letter at 2 (Feb. 15,

2013); CME Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter

at 17 (Feb. 15, 2013); Frontier Futures Comment Letter at 3 (Feb.

15, 2013); Jefferies Comment Letter at 7 (Feb. 15, 2013); JSA

Comment Letter at 1-2 (Feb. 15, 2013); NCFC Comment Letter at 2

(Feb. 15, 2013); NIBA Comment Letter at 1 (Feb. 15, 2013).

\719\ See FIA Comment Letter at 17 (Feb. 15, 2013).

\720\ See id. at 4, 17.

\721\ JSA Comment Letter at 1 (Feb. 15, 2013).

\722\ Id. at 2.

\723\ See Congressional Committees Letter at 1 (Sept. 25, 2013).

---------------------------------------------------------------------------

Other commenters argued that the proposal would disproportionately

burden smaller FCMs and the customers of smaller FCMs.\724\ CME

asserted that, given this increase in cost, some customers may transfer

their accounts to the larger, better-capitalized FCMs to reduce the

cost of trading,\725\ but that agricultural customers ``likely will not

be able to transfer to the larger FCMs because they do not fit their

customer profile,'' thereby making these customers bear more of the

cost burden.\726\ Frontier Futures asserted that many small customers,

including most farmers, do not watch markets constantly. Therefore, it

would be difficult for them to meet margin calls on a moment's notice,

thereby causing FCMs to require significantly higher margins or to

liquidate customer positions where margin calls cannot be immediately

met.\727\ Frontier Futures also asserted that the proposal ``may force

a number of small to mid-sized FCMs out of the market,'' making it more

expensive, if not impossible, for IBs and small members to clear their

business, removing ``significant capital from the futures industry,''

and ``reducing stability to the markets as a whole.''\728\ RJ O'Brien

stated that the proposed residual interest requirement is impractical

because many farmers and agricultural clients still use checks and ACH

to meet margin calls.\729\ RJ O'Brien also stated that if the proposal

is adopted, FCMs that service non-institutional clients will struggle

to remain competitive and the proposal may result in fewer clearing

FCMs and greater systemic risk to the marketplace.\730\ Similarly, CME

stated that the proposed residual interest requirement would lead to

consolidation among FCMs, which will ``actually increase[ ] systemic

risk by concentrating risk among fewer market participants.'' \731\

---------------------------------------------------------------------------

\724\ See, e.g., CME Comment Letter at 5-6 (Feb. 15, 2013);

FCStone Comment Letter at 3 (Feb. 15, 2013); Global Commodity

Comment Letter at 1 (Feb. 13, 2013); Randy Fritsche Comment Letter

at 1 (Feb. 15, 2013); JSA Comment Letter at 1 (Feb. 15, 2013); NCBA

Comment Letter at 2 (Feb. 15, 2013); NCFC Comment Letter at 2 (Feb.

15, 2013); RJ O'Brien Comment Letter at 3 (Feb. 15, 2013); ICA

Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment Letter at 2

(Feb. 15, 2013).

\725\ CME Comment Letter at 6 (Feb. 15, 2013).

\726\ Id.

\727\ See Frontier Futures Comment Letter at 2-3 (Feb. 14,

2013).

\728\ Id.

\729\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013). See also

ICA Comment Letter at 1-2 (Feb. 15, 2013).

\730\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013).

\731\ CME Comment Letter at 6 (Feb. 15, 2013) (emphasis in

original).

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The Commission recognizes that smaller FCMs may have more

difficulty than large FCMs in absorbing the additional costs created by

the requirements in Sec. 1.22. In general, it is likely that smaller

FCMs have a larger percentage of customers who do not have requisite

personnel or systems to receive margin calls and make margin payments

in a matter of hours, thus creating a disproportionate need for pre-

funding or additional residual interest at smaller FCMs. Smaller FCMs

are also likely to have higher borrowing costs than larger FCMs, so the

impact of obtaining additional capital to meet increased residual

interest needs may be more significant for them. If increased costs

force some smaller FCMs out of the market, it is possible, though not

certain, that smaller customers could have difficulty finding

alternative FCMs to service their needs. However, as noted above, the

Commission believes that the changes made to Sec. 1.22(c), and the

extended phase-in period, in the final rule substantially reduce the

costs to FCMs and their customers when compared to the proposed version

of the requirement. By reducing the costs, these changes have also

reduced some of the associated burdens that would potentially be

disproportionately borne by smaller FCMs. The Commission does not agree

that a reduced number of FCMs would necessarily reduce competition in a

way that impacts the price of services. Any increases in costs to

customers are more likely the result of increased costs to the FCM that

are passed on to customers, which are the costs that have been

mitigated by changes to the final rule. Moreover, the Commission is

cognizant of the cost of an FCM failure where customers suffer a loss

of segregated funds, both in terms

[[Page 68599]]

of costs to the customers who lose such funds (or, if such funds are

ultimately recovered, the use of such funds) as well as the industry-

wide cost associated with a loss in confidence in the safety of

customer funds. These costs support the importance of increasing the

safety of the system. Moreover, the Commission will closely review

these issues as part of considering the Report.

The Commission disagrees with the comments that there would be a

consolidation of FCMs that would cause the rule to have a net effect of

increasing systemic risk. Instead, the Commission expects that the

overall effect of the final rule will be to significantly reduce

systemic risk. For example, as noted by CIEBA,\732\ the residual

interest requirement will likely reduce systemic risk by enabling FCMs

to ensure that they can meet all customer obligations at any time

without using another customer's funds to do so. Moreover, larger,

well-capitalized FCMs are more likely to be able to absorb losses than

less well-capitalized FCMs. To the extent that FCMs that are affiliated

with large financial institutions take on additional business as a

result of a potential reduction in the number of FCMs, the increase in

risk to these financial institutions is expected to be small relative

to their existing risk and to not materially increase the systemic risk

associated with these financial institutions. Finally, some of the

costs that commenters asserted could lead to a reduction in the number

of FCMs under the proposed rule have been mitigated by changes to the

final rule.

---------------------------------------------------------------------------

\732\ See CIEBA Comment Letter at 3 (Feb. 20, 2013).

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Several commenters also observed that the proposal would mark a

significant departure from current market practice and could have a

material adverse impact on the liquidity and smooth functioning of the

futures and swaps markets.\733\ The Commission has chosen to provide an

extended phase-in period for the requirement in Sec. 1.22(c) and

therefore does not expect that smooth functioning of the futures and

swap markets will be disrupted. If customers withdraw from the futures

and swap markets as a consequence of the additional costs, liquidity

could be negatively affected. However, the Commission believes that by

allowing FCMs several hours (and, during the phase-in period, until the

end of the next business day) after customer accounts become

undermargined to ensure that the requisite amount of residual interest

is on deposit, the costs associated with the requirement have been

mitigated, which reduces the likelihood that customers will be prompted

to withdraw from the markets due to related expenses.

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\733\ See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA

Comment Letter at 3 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb.

15, 2013).

---------------------------------------------------------------------------

The Commission also considered several additional alternative

proposals raised by the commenters.

Newedge suggested that the Commission consider less costly

alternatives to the proposed rule, such as allowing the FCM ``to count

guaranty fund deposits with [DCOs] as part of their residual interest''

or limiting the residual interest amount that an FCM must carry to only

a limited number of its largest customers.\734\ The Commission

believes, however, that the latter proposal is not consistent with the

statutory requirement that ``one customer's funds may not be used to

margin, guarantee, or pay another customer's obligations'' and

therefore did not adopt this suggestion. Regarding the former

alternative, guarantee funds held at the DCO are a critical part of the

waterfall that covers losses in the event of an FCM's default. One of

the primary purposes of the customer protection regime is to protect

customers from the risk of losses in the event that their FCM defaults.

Using funds that may be used to cover the FCM's proprietary losses

(i.e., the guarantee fund) to guarantee customers' funds could expose

customer funds to the FCM's losses in a double default scenario. The

Commission, therefore, does not believe that this alternative is

consistent with the goals of the customer protection regime.

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\734\ Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ

O'Brien Comment Letter at 5 (Feb. 15, 2013).

---------------------------------------------------------------------------

Frontier Futures suggested that firm firewalls be put in place

between customer funds and an FCM's proprietary funds in the form of

approval by an independent agency for an FCM to transfer customer

funds.\735\ Frontier Futures also recommended that FCMs ``do their

proprietary trading through another FCM thereby engaging the risk

management of a third party.'' \736\ The Commission has chosen not to

require FCMs to seek external approval before pulling excess residual

interest out of a customer segregated account, or to conduct their

proprietary trading through another FCM. The Commission expects that

the requirements in Sec. 1.23 will accomplish some of the same

benefits--ensuring that FCMs only withdraw significant portions of

excess residual interest when they have adequate information to ensure

that it is truly excess and that senior management is accountable for

such decisions--with greater efficiency and less operational costs.

Internal verification of residual interest balances and obtaining

signatures from individuals inside the organization is likely to be

considerably faster, and therefore more efficient and less costly.

---------------------------------------------------------------------------

\735\ See Frontier Futures Comment Letter at 3 (Feb. 14, 2013).

\736\ Id.

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Regarding the second proposal, it is not clear how the commenter

expected the third party FCM to augment the first FCM's risk management

or what specific type of risk would be addressed by such an

arrangement. A third party FCM would be responsible for collecting

margin and for making payments to the DCO for positions related to the

first FCM's proprietary positions. But this arrangement would not help

protect customers at the first FCM from ``fellow customer risk.''

Finally, some commenters requested that the Commission refrain from

adopting the proposal until it conducts further analysis with the

industry regarding the costs and benefits of such proposal.\737\

Further, the Congressional Committees requested that the Commission

weigh the costs and benefits of the final rule, and in particular

``carefully consider the consequences of changing the manner or

frequency in which `residual interest' . . . is calculated.'' \738\ The

``point in time'' approach adopted by the Commission in this final rule

and the extended phase-in period will significantly reduce (as compared

to the proposed rule) the amount of additional residual interest that

FCMs need to maintain in their segregated accounts on an ongoing basis

in order to comply with Sec. 1.22(c). As noted above, the final rule

will mitigate some, though not all of the costs associated with pre-

funding obligations that commenters expressed concern about, while

simultaneously ensuring that the statutory obligations are met and that

the corresponding protection from ``fellow customer risk'' is achieved.

---------------------------------------------------------------------------

\737\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC

Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at

2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF

Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9

(Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA

Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.

15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment

Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.

18, 2013).

\738\ Congressional Committees Comment Letter at 1 (Sept. 25,

2013).

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In light of these concerns and in response to the commenters'

requests, the Commission is directing staff to, within thirty months of

the publication

[[Page 68600]]

of this release, solicit further public comment, hold a public

roundtable, and conduct further analysis regarding the practicability

of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on

the date of settlement to the time of settlement (or to some other time

of day). The Report should include an analysis of whether and on what

schedule it would be feasible to move the Residual Interest Deadline,

and the costs and benefits of such potential requirements. All of this

will take place well before the expiration of the phase-in period. The

Commission will consider the Report and within nine months after the

publication of the Report may take additional action regarding the

phase-in period by Commission order and may change the Residual

Interest Deadline by rulemaking.

Section 1.23 Interest of Futures Commission Merchants in Segregated

Funds; Additions and Withdrawals

Revised Sec. 1.23 places new restrictions regarding an FCM's

withdrawal of residual interest funds not for the benefit of customers.

As adopted, an FCM cannot withdraw any residual interest funds not for

the benefit of customers unless it has prepared the daily segregation

calculation from the previous day and has adjusted the segregation

calculation for any activity or events that may have decreased residual

interest since the close of business the previous day. In addition, an

FCM is permitted to withdraw more than 25 percent of its residual

interest for purposes other than the benefit of customers within one

day only if it: (1) Obtains a signature from the CEO, CFO or other

senior official as described in Sec. 1.23(c)(1) confirming approval to

make such a withdrawal; and (2) sends written notice to the Commission

and the firm's DSRO indicating that the requisite approvals from the

CEO, CFO or other senior official have been obtained, providing reasons

for the withdrawal, listing the names and amounts of funds provided to

each recipient, and providing an affirmation from the signatory

indicating that he or she has knowledge and reasonable belief that the

FCM is still in compliance with segregation requirements after the

withdrawal.

In addition, if the FCM drops below its target threshold for

residual interest because of a withdrawal of residual interest not for

the benefit of customers, the next day it must either replenish

residual interest sufficient to surpass its target, or if senior

leadership believes that the original target is excessive, the FCM may

revise its target in accordance with its policies and procedures

established in Sec. 1.11. The amendments to Sec. 1.23 were also made

for Cleared Swaps and foreign futures at Sec. 22.17, and Sec. 30.7(g)

respectively, and the costs and benefits considerations of those

amendments are considered to be substantively the same.

Costs and Benefits

Restrictions on withdrawals of residual interest provide the

benefit of an additional layer of protection for customer funds

contained in segregated accounts. An FCM may withdraw residual interest

as long as it always maintains sufficient FCM funds in the account to

cover any shortfall that exists in all of its customers' segregated

accounts. However, as a practical matter, the segregation requirements

fluctuate constantly with market movements, and customer surpluses or

deficits also fluctuate depending on the speed with which customers

meet margin calls. As a consequence, the amount of residual interest an

FCM has in a segregated account similarly fluctuates. A sufficient

amount of residual interest to cover deficiencies in customers'

accounts at one point in time may appear insufficient by the next

settlement cycle in extreme market conditions. Therefore, it is

important for an FCM to maintain sufficient residual interest to cover

both current deficiencies in customer accounts as well as any

additional deficiencies that could develop over a relatively short

period of time. Restrictions on withdrawals of residual interest help

to ensure that the FCM maintains a stable base of residual interest and

not withdraw it for other liquidity needs when doing so may result in

jeopardizing customer funds in the segregated account if market

conditions change quickly.

Prohibiting any withdrawal of residual interest until the customer

segregation account calculations are complete for the previous day and

requiring the FCM take into account any subsequent developments in the

market or the account that could impact the amount of residual interest

before withdrawing funds protects customer funds by reducing the

likelihood that lack of current information could cause the FCM to make

a withdrawal from customer funds that is large enough to cause the

account to fall below its segregated funds requirement.

The adopted amendments require FCMs to take several steps in order

to remove more than 25 percent of their residual interest in a single

day. Large, single-day withdrawals of the FCM's residual interest in

the customer segregated account could be an indication of current or

impending capital or liquidity strains at the FCM. The additional steps

ensure that senior management is knowledgeable of and accountable for

such withdrawals, that no shortfall in the customer segregated accounts

is created by the withdrawals, and that the CFTC and DSRO are both

alerted to allow them to monitor the FCM and its segregated accounts

closely over subsequent days and weeks. Additional monitoring will help

to ensure that the integrity and sufficiency of the FCM's customer

segregated accounts are protected. In addition, notifying the CFTC and

DSRO gives both an opportunity to ask questions about the FCM's

reasonable reliance on its estimations of the adequacy of its funds

necessary to meet segregation requirements. Such questions may give the

Commission and DSRO comfort that the transaction does not indicate any

strain on the FCM's financial position, or conversely, may raise

additional questions and alert the CFTC and DSRO to the need for

heightened monitoring of the FCM or further investigation of its

activities. The amendment also adds protection by ensuring that the

Commission has records regarding the name and address of parties

receiving funds from any withdrawal of residual interest in segregated

funds not for the benefit of customers. Also, requiring an FCM to

replenish its residual funds the following day any time a withdrawal

causes it to drop below the FCM's target amount helps to ensure that

residual interest is not used by the firm to address liquidity needs in

other parts of the firm unless those needs are very short-term in

nature (i.e., less than 24 hours). Finally, the amendments are

consistent with rules imposed on all FCMs by the DSROs.

In the NPRM, the Commission qualitatively analyzed that the

amendments to Sec. 1.23 would create costs for FCMs and quantitatively

estimated costs associated with obtaining management approvals for

withdrawals exceeding 25 percent of the prior day's residual interest.

The restrictions on withdrawals were anticipated to potentially prevent

an FCM from withdrawing funds quickly in order to meet certain

operational needs, or to take advantage of specific investment

opportunities, and in general could be expected to result in an FCM

needing to hold additional capital outside of residual interest in

order to meet operational needs.

The Commission did not receive comments on its quantitative

estimates of the costs of obtaining management approvals. However, the

Commission

[[Page 68601]]

did receive comments on its qualitative analysis of costs, and also

received comments that the use of the prior day's actual residual

interest as the amount applicable to the restriction would provide a

disincentive to FCMs holding additional funds at DCOs as residual

interest, which commenters posited as less beneficial to the protection

of customers. Several commenters, including FIA and Jefferies suggested

the Commission utilize the targeted residual amount as the threshold

for notifications and withdrawal restrictions, in order to not

discourage FCMs from holding additional funds as residual

interest.\739\ FIA suggested that the qualitative analysis of the costs

was not sufficient and that the amendments would impose a tremendous

operational and financial burden on the industry, requiring the

development and implementation of entirely new systems to assure

compliance and detrimentally impacting liquidity.\740\ The Commission

believes however, that this comment is not directed to the withdrawal

restrictions as adopted or the necessity to replenish the targeted

residual interest amount, but instead directed at requirements with

respect to holding residual interest sufficient to cover customer under

margined amounts, which is addressed separately in the cost benefit

considerations for Sec. 1.22.

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\739\ See FIA Comment Letter at 29 (Feb. 15, 2013); Jefferies

Comment Letter at 4 (Feb. 15, 2013).

\740\ FIA Comment Letter at 13 (Feb. 15, 2013).

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Jefferies provided some quantitative estimates of the costs of

holding increased residual interest, specifically positing that even a

five percent increase in residual interest could cost Jefferies

$500,000.\741\ FIA posited that FCMs currently may increase residual

interest day-to-day for expected events, including during stressed

market conditions and for the purpose of currency facilitation, and to

impose withdrawal restrictions based on the actual, as opposed to

targeted, excess would reduce the actual likelihood of FCMs infusing of

additional proprietary funds in those circumstances.\742\

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\741\ Jefferies Comment Letter at 5 (Feb. 15, 2013).

\742\ FIA Comment Letter at 27-29 (Feb. 15, 2013).

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The Commission understands that establishing a target and holding

residual interest does have costs, but disagrees with the underlying

assumptions of the cost estimates provided by Jefferies. The cost

estimates provided by Jefferies imply the cost of holding additional

residual interest is the same as the FCM's cost of capital. However,

the cost considered for the amendments should be the difference in what

can be earned by more conservative investments permitted for segregated

funds versus otherwise if held by FCMs as unrestricted capital, unless

the targeted residual amount exceeds an FCM's minimum net capital

requirement. The costs of holding some amount of residual interest is

an existing cost of doing business as an FCM because, practically

speaking, there is a need to hold some amount of residual interest on a

day to day basis to remain in segregation compliance. Significant

minimum net capital requirements exist for FCMs, currently. Unless the

targeted residual interest in fact exceeds a firm's minimum net capital

requirement, the requirement to hold capital as residual interest in

customer segregated accounts is not a separate additional capital

requirement. Therefore, Jefferies' contention with respect to the costs

of the withdrawal restrictions being represented by the costs of

additional required capital for a firm is not persuasive. Such cost is

only an incremental cost of the newly adopted requirements of

establishing or publicizing targets or imposing withdrawal

restrictions. Further, the withdrawal restrictions adopted require a

one day delay, and management approval and regulatory notifications.

These are not absolute restrictions to the withdrawal of residual

interest funds and the costs considered and incentives or disincentives

created should not be analyzed as if they were. Even the replenishment

requirement adopted, with respect to withdrawals not for the benefit of

customers resulting in residual interest dropping below the target for

residual interest, in order to maintain the targeted residual amount,

provides an FCM with the flexibility to reassess the target as an

alternative. However, all these processes must be transparent to the

Commission, including the FCM's management's accountability for such

processes.

The Commission is not persuaded that the reduced incentives to

provide added funds to residual interest would be a reason to adopt an

alternative of using the targeted residual as opposed to the actual

prior day residual as the measurement for the 25 percent withdrawal

restriction, which is a requirement for notice and approval, and

therefore, not an absolute restriction. The rationales for adding funds

specific to certain anticipated events could just as easily provide a

clear basis for the management approval and notification process

required for the subsequent withdrawal of funds after those

circumstances, as opposed to making them unlikely to occur at all. The

benefits of clear management accountability and regulatory transparency

with respect to such practices and related operational risks (such as

potentially more volatile cash flows through segregated accounts not

for the benefit of customers) would still be obtained.

Section 1.25 Investment of Customer Funds

Regulation 1.25 sets forth the financial investments that an FCM or

DCO may make with customer funds. Among other things, Sec. 1.25

permits FCMs and DCOs to use customer funds to purchase securities from

a counterparty under an agreement for the resale of the securities back

to the counterparty. This type of transaction is referred to as a

reverse repurchase agreement and in effect, is a collateralized loan by

the FCM to its counterparty. Regulation 1.25(b)(3)(v) establishes a

counterparty concentration limit, prohibiting FCMs and DCOs from using

more than 25 percent of the total funds in the customer segregated

account to conduct reverse repos with a single counterparty. The

Commission's amendment expands the definition of a counterparty to

include additional entities under common ownership or control. Thus, as

adopted, the 25-percent counterparty concentration limit for reverse

repurchase agreements applies not only to a single counterparty, but to

all counterparties under common control or ownership. The additional

adopted changes to Sec. 1.25 are conforming amendments proposed in

order to harmonize this section with other amendments adopted in this

release.

Costs and Benefits

In the NPRM, the Commission discussed how the expansion of the

concentration limitation to counterparties under common control or

ownership is consistent with the original intention of the

concentration limitation, which was to mitigate the potential losses or

disruptions due to the default of a counterparty. The Commission has

elected to adopt the amendment as a further protection to customer

funds, because a default by one counterparty that is under common

control or ownership, may adversely impact all of the counterparties to

the reverse repurchase agreement and hence adversely impact the FCM and

the funds it holds for its customers. Because the amendment

incorporates the Commission's interpretation of the existing rule, it

does not alter the rule's meaning and, therefore, the amendment does

not create any incremental costs or benefits. Likewise, the additional

[[Page 68602]]

changes to Sec. 1.25 are conforming amendments proposed in order to

harmonize this section with other amendments proposed in this release,

and, therefore, do not create any incremental costs or benefits.

Because Sec. 1.25 sets forth the financial investments that an FCM

or DCO may make with customer funds, several members of the public

\743\ expressed their general opinions regarding the investment and

handling of customer funds by FCMs and DCOs. In general, all of the

commenters supported the position that FCMs and DCOs only be allowed to

make safe/non-speculative investments of customer funds and not be

allowed to add risk that customers are unaware of or do not sanction.

In addition, some of the commenters \744\ proposed that the Commission

amend its regulations to provide commodity customers with the ability

to ``opt out'' of granting FCMs the ability to invest customer funds

(including hypothecation and rehypothecation); seven \745\ of which

further requested that the Commission mandate that an FCM cannot

prevent a customer who so ``opts out'' from continuing to trade through

that FCM merely because the customer elected to ``opt out.''

Additionally, Vanguard requested that customers have immediate access

to the reports indicating that FCMs have failed to comply with various

mandates including compliance with Sec. 1.25 margin investment limits;

and that customers have access on a twice monthly basis to reports on

an FCM's actual investment of customer assets to determine whether such

investments are concentrated in more or less liquid assets as allowed

under Sec. 1.25.\746\ Although the Commission understands the concern

of the public regarding the safety and investment of customer funds,

because an ``opt out'' provision was not proposed by the Commission,

and would in any case not be effective due to pro-rata distribution in

an FCM bankruptcy, this alternative is not adopted in this final

rulemaking.

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\743\ Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche

Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14,

2013), Strelitz/California Metal X Comment Letter (Jan. 15, 2013),

Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI

Comment Letter at 5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan.

24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012),

Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp.

Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec.

17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert

Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment

Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17,

2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade

Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec.

17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff

Schlink Comment Letter (Dec. 18, 2012), Sam Jelovich Comment Letter

(Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark

Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment

Letter (Dec. 24, 2013), Po Huang Comment Letter (Dec. 24, 2012),

Aarynn Krall Comment Letter (Jan. 8, 2013), Vael Asset Management

Comment Letter (Jan. 10, 2013), Kos Capital Comment Letter (Jan. 11,

2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns

Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment Letter

(Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013).

\744\ NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal

Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at

5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke

Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter

(Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15,

2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy

Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec.

17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew

Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter

(Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012),

Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders

Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec.

18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew

Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter

(Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2013), Po

Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter

(Jan. 8, 2013), Vael Asset Management Comment (Jan. 10, 2013), Kos

Capital Comment (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13,

2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island

Coins Comment Letter (Jan. 14, 2013), and Clare Colreavy Comment

Letter (Jan. 9, 2013).

\745\ NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal

Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at

6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke

Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter

(Dec. 13, 2012); and Solomon Metals Corp. Comment Letter (Jan, 15,

2013).

\746\ Vanguard Comment Letter at 4-6 (Feb. 22, 2013).

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Section 1.26 Deposit of Instruments Purchased with Customer Funds

Regulation 1.26 requires an FCM or DCO that invests futures

customer funds in instruments described in Sec. 1.25 to obtain a

written acknowledgment from any depository holding such instruments.

The FCM or DCO must use the Template Letters in the appendices to Sec.

1.20, in accordance with the requirements established in Sec. 1.20.

The specifics of those requirements, as well as the costs and benefits

of them, are detailed in the discussion of costs and benefits for Sec.

1.20. If, however, an FCM or DCO invests funds with a money market

mutual fund (MMMF), the FCM or DCO must use the Template Letters in the

appendices of Sec. 1.26 rather than the acknowledgment letters in the

appendices of Sec. 1.20.\747\ The content of the Template Letters in

the appendices to Sec. 1.26 is identical to those in the appendices to

Sec. 1.20 except that they include three additional provisions related

specifically to funds held by the MMMF or its custodian. Specifically,

the Template Letters set out the requirements established in Sec.

1.25(c) that: (1) the value of the fund must be computed and made

available to the FCM or DCO by 9:00 a.m. on the following business day;

(2) the fund must be legally obligated to redeem shares and make

payments to its customers (i.e., the FCM or DCO) by the following

business day; and (3) the MMMF does not have any agreements in place

that would prevent the FCM or DCO from pledging or transferring fund

shares.

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\747\ Further, per Sec. 1.25(c)(3), the FCM or DCO shall obtain

the Sec. 1.26 Template Letter from ``an entity that has substantial

control over the [MMMF] shares purchased with customer funds and has

the knowledge and authority to facilitate redemption and payment or

transfer of the customer funds. Such entity may include the [MMMF]

sponsor or depository acting as custodian for [MMMF] shares.''

---------------------------------------------------------------------------

Benefits

The benefits are largely the same as for the Template Letters

required under Sec. 1.20, described above in the cost-and-benefit

section related to Sec. 1.20. However, there are benefits to requiring

FCMs and DCOs to obtain a different Template Letter from MMMFs with

respect to customer funds invested in MMMFs. Specifically, MMMFs or

their custodians (as applicable) are required to acknowledge their

additional obligations under Sec. 1.25(c).

Costs

The costs are largely the same as for the Template Letters required

under Sec. 1.20. The general concerns raised by commenters regarding

the costs arising from the Template Letters as well as the Commission's

responses are detailed in the discussion of costs for Sec. 1.20.

Section 1.29 Gains and Losses Resulting From Investment of Customer

Funds

Regulation 1.29 provides that an FCM or DCO may keep as its own any

interest or other gain resulting from the investment of customer funds

in financial instruments permitted under Sec. 1.25; however, the FCM

or DCO must manage the permitted investments consistent with the

objectives of preserving principal and maintaining liquidity. The

Commission's amendment also explicitly provides that although an FCM or

DCO is not required to pass the earnings on the investment of customer

funds back to its futures customers, the FCM or DCO is solely

responsible for any losses that result from its investment of customer

funds.

[[Page 68603]]

Costs and Benefits

In the NPRM, the Commission discussed how the amendment clarifies

that the allocation of losses on the investment of customer funds by an

FCM or DCO to its customers would result in the use of customer funds

in a manner that is not consistent with section 4d(a)(2) and Sec.

1.20, as customer funds can only be used for the benefit of futures

customers and limits withdrawals from futures customer accounts, other

than for the purpose of engaging in trading, to certain commissions,

brokerage, interest, taxes, storage or other fees or charges lawfully

accruing in connection with futures trading. This change was supported

by FIA, which stated its belief that the FCM's or DCO's responsibility

for losses in Sec. 1.25 investments ``is clear and is implicit in the

Act and the Commission's rules.'' \748\ The Commission believes that

market participants already recognize this responsibility and

obligation and direct the investment of customer funds accordingly.

Therefore, the Commission does not believe that the amendment to Sec.

1.29(b) will create any additional costs; however, the marketplace will

benefit in that the amendment provides clarity as to the FCM's or DCO's

sole responsibility for any losses resulting from the investment of

customer funds in the financial instruments listed under Sec. 1.25.

FIA filed a comment supporting the proposed amendments to Sec.

1.29.\749\ No other comments were received. The Commission has adopted

the amendments to Sec. 1.29 as proposed.

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\748\ FIA, ``Initial Recommendations for Customer Funds

Protection'' available at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

\749\ FIA Comment Letter at 30-31 (Feb. 15, 2013).

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Section 1.30 Loans by Futures Commission Merchants; Treatment of

Proceeds

The Commission adopted amendments to Sec. 1.30 to clarify that,

while an FCM may provide secured loans to a customer with adequate

collateral, it may not make loans to a customer on an unsecured basis

or use a customer's futures or options positions as security for a loan

from the FCM to that customer.

Costs and Benefits

The amendments prohibiting FCMs from providing unsecured loans to

customers and from using a customer's positions to secure loans made to

such customers reduce counterparty risk borne by the FCM. The former

prohibition prevents the FCM from accumulating exposures to customers

that have not margined their positions, while the latter prevents the

additional exposure that otherwise would result from using the same

collateral to secure two different risks (i.e., the risks associated

with the open positions and the risks associated with the secured

loan). Additionally, to the extent that the amendments would force

certain customers to obtain loans from another lender, it diversifies

the counterparty risk across multiple entities. The amendments also are

comparable to rules of the CME for its member firms.

The Commission did not quantitatively estimate the potential

increase to customers' operational costs due to the inability of

customers who need or desire to use borrowed funds to meet initial and

maintenance margin requirements to obtain loans necessary to fund their

futures or options positions from a third party lender. The Commission

requested, but did not receive, comments regarding the prevalence of

FCMs' extension of loans to customers and the potential costs customers

might bear if it were necessary to obtain loans from third parties

rather than from the FCMs with whom their segregated customer accounts

are held. Neither were any comments received generally suggesting a

qualitative burden in complying with the amendments.

Section 1.32 Reporting of Segregated Account Computation and Details

Regarding the Holding of Customer Funds

The adopted amendments to Sec. 1.32 allow an FCM that is not a

dual registrant to follow the same procedures as dual registrants (FCM/

BDs) when assessing a haircut to securities purchased with customer

funds if the FCM determines that those securities have minimal credit

risk. This is the same change as adopted in Sec. 1.17, except that in

Sec. 1.17 the amendment is with respect to the haircut for securities

purchased by an FCM with its own capital, whereas this amendment

applies to the haircut ascribed to the collateral value of securities

deposited by customers for the purpose of securing customer net debits.

The cost benefit considerations are the same as those analyzed with the

corresponding amendment to Sec. 1.17.

In addition, the adopted amendments (1) require FCMs to submit

their daily Segregation Schedules, Secured Amount Schedules, and

Cleared Swaps Segregation Schedules to the Commission and their DSROs

electronically by noon the following business day; (2) require that

twice per month, each FCM submits a detailed list of all the

depositories and custodians where customers' segregated funds are held,

including the amount of customer funds held by each entity and a break-

down of the different categories of Sec. 1.25 investments held by each

entity, further identifying if any of the depositories are affiliated

with the FCM; and (3) require that the detailed list of depositories be

submitted to the Commission electronically by 11:59 p.m. the following

business day and that both segregation and secured amount statements

and the detailed listing of depositories be retained by the FCM in

accordance with Sec. 1.31.

Costs and Benefits

Requiring FCMs to submit their daily segregation and secured amount

calculations to the Commission and DSROs will enable the Commission and

DSROs to better protect customer funds by more closely monitoring for

any discrepancies between the assets in segregated accounts reported by

the FCM and their depositories as reported to the DSRO and available to

the Commission through an aggregator of depository balances. The

ability of the Commission and DSRO to check for discrepancies more

regularly, without notice, is likely to provide an additional deterrent

to fraud. Moreover, it will enable both the Commission and DSROs to

monitor for any trends that would indicate that operational or

financial problems are developing at the FCM, which would give the

Commission an opportunity to enhance its supervision and to intervene,

if necessary, to protect customer segregated funds. In addition, the

amendments are consistent with the rules of SROs that currently require

each FCM to submit daily segregation and secured amount calculations to

the SROs.

The detailed list of depositories will provide additional

information to the Commission and DSROs beyond what is required under

Sec. Sec. 1.20, 1.26, and 30.7. First, the detailed list of

depositories will provide additional account detail including the types

of securities and investments that constitute each account's assets,

rather than just the total value. Second, the reports will account for

any pending transactions that would not necessarily be apparent from

the daily balances submitted to an aggregator by the depositories.

Third, FCMs will, in these reports, provide to the Commission and DSROs

a reconciled balance, which will not be included with balances provided

to the aggregator by depositories. Last, the FCM will be required to

specifically

[[Page 68604]]

identify any depositories that are affiliated with the FCM. Each of

these additional forms of information would enable the Commission and

DSROs to provide better oversight and create additional accountability

for the FCM, enhancing the protection of market participants.

FCMs are already calculating segregated funds information daily and

reporting the results to NFA via WinJammer by noon the following day.

Similarly, the detailed list of depositories that would be required to

be submitted twice per month is already required by NFA to be produced

and submitted to NFA via WinJammer.\750\ Requiring FCMs to submit these

reports to the Commission via the same platform is not expected to

create any additional costs.

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\750\ See Segregated Investment Detail Report at http://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/fcm-reporting.pdf.

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FIA commented in support of the amendments to Sec. 1.32 and asked

for clarification that on a daily basis, a single U.S. dollar

equivalent, as opposed to multiple currency by currency schedules, is

what is required to be filed.\751\ Jefferies commented that the

amendments to Sec. 1.32 will not achieve the benefit of transparency

to customers because of the way cash and investments are presented

separately from balances at other FCMs and DCOs.\752\ However, this

comment appears related to the requirements of disclosure to customers

of NFA's publicly available information, not the requirements of Sec.

1.32, which require similar information to be reported to the

Commission and DSROs. The Commission believes the detailed information

required, along with all the additional disclosures being provided to

customers in the amendments to all rules contained herein, do provide

sufficient transparency for customers to be able to assess the risks of

depositing funds with FCMs. The specific detailed amounts of cash and

securities held in segregation must be provided, by individual

depository, including DCOs, under the amendment to Sec. 1.32. The

Commission does not believe that customers will misinterpret the

liquidity of cash held at DCOs as opposed to other types of

depositories, and that therefore the requirements do not provide the

transparency intended, although the Commission understands that

Jefferies is concerned with the appearance of percentage calculations

that are provided publicly on NFA's portal. The Commission notes,

however, that the amendments to Sec. 1.32 do not require reporting of

any percentage calculations. There were no comments received regarding

the Commission's analysis that, due to the existing NFA requirements,

the Commission's amendments to Sec. 1.32 were not expected to result

in incremental costs for FCMs.

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\751\ FIA Comment Letter at 30-31 (Feb. 15, 2013).

\752\ See Jefferies Comment Letter at 3 (Feb. 15, 2013).

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With respect to the adopted changes to allow FCMs to utilize lower

haircuts applicable to the market value of customer securities, if such

securities are determined to have minimal credit risk, in determining

the allowance provided for securing net deficits of customers, the CFA

specifically objected to the ability of FCMs to obtain the benefit of

lower haircuts by utilizing the process of establishing credit risk

proposed in the amendment to the SEC's rule 15c3-1.\753\ However, the

Commission has determined that the ability of FCMs to utilize haircuts

lower than the standard deduction of 15% otherwise applicable under SEC

rule 15c3-1 should be equally available to FCMs along with jointly

registered BD/FCMs under the Commission's adopted amendment to the net

capital rule at Sec. 1.17, to promote equity and fairness of

competition between FCMs and joint BD/FCMs and to maintain uniformity

with the capital rule of the SEC for the treatment of securities as

much as practicable. The Commission believes, despite the CFA's

comments indicating the haircut could be manipulated, that the

collateral value haircut for the same security for the purpose of

securing net deficits should also be determined by reference to the net

capital haircut for the same security, and notes both have always been

determined by the SEC's net capital haircuts for securities. The

Commission believes the benefits of continuing to have such uniformity

are substantial. The alternative, which necessarily would be applying a

very substantial standard haircut to a debt security with minimal

credit risk collateralizing a short term obligation, would be overly

harsh and not accurately reflect the market risk to such collateral for

the stated purpose of valuing the extent to which the customer debit is

adequately secured. The Commission further notes that the SEC's rule,

which is the basis for these amendments at Sec. Sec. 1.17, 1.32 and

30.7, and the formulation adopted in these amendments, still provides a

standard, although lesser percentage, haircut, not a model-based

haircut, and also provides for an audit trail of the BD/FCM's

determinations supporting the determination of minimal credit risk,

which should prevent the ability of FCMs to manipulate the haircut, as

suggested by CFA.

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\753\ See CFA Comment Letter at 7 (Feb. 13, 2013).

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Section 1.52 Self-regulatory Organization Adoption and Surveillance of

Minimum Financial Requirements

The amendments to 1.52 revise the supervisory program that SROs are

required to create and adopt. In addition, for SROs that choose to

delegate the function to examine FCMs that are members of two or more

SROs to a DSRO, the amended rules require a plan that establishes a

Joint Audit Committee which, in turn, must propose, approve, and

oversee the implementation of a Joint Audit Program. The amended rules

specify a number of additional requirements for the SRO supervisory

program as well as for the Joint Audit Program.

Costs and Benefits

The amendments adopted to Sec. 1.52 provide significant additional

protection to market participants and customer of FCMs by helping to

ensure that SRO examinations of member FCMs are thorough, effective and

risk-based, and include evaluation and testing of internal controls as

well as meeting, as applicable, other objective criteria from related

professional audit standards. Specifically, an SRO's audit program must

be risk-based (e.g., the scope and focus of such examinations would be

determined by the risk profile that the SRO develops for each FCM) and

address ``all areas of risk to which FCM can reasonably be foreseen to

be subject,'' and that the examination itself includes both controls

testing as well as substantive testing. Requiring regulatory

examinations by SROs to include testing and review of internal controls

will help ensure that each FCM is not only compliant with capital and

segregation requirements at the time of the examination, but that they

continue to operate in such a manner without undetected internal

controls inadequacies that could jeopardize the FCM and its customers.

By requiring that the supervisory program for an SRO to adhere to

professional standards for auditing as applicable, the Commission is

provided with additional assurance as to standards for aspects of an

examination such as the adequacy of the evaluation of evidence obtained

supporting examination conclusions; the training and proficiency of the

examinations staff; due professional care in the performance of the

work; consideration of fraud, audit risk and materiality in conducting

an audit; planning and supervision; understanding the entity and its

environment and assessing the

[[Page 68605]]

risk of material misstatement; communication with those charged with

governance of the examined entity; and communicating internal control

matters identified in an examination. These benefits are obtained by

requiring SRO supervisory programs to include consideration of specific

issues and be carried out in compliance with professional standards as

may be applicable to non-financial audits. The Commission believes more

rigorous requirements and the application of professional standards in

carrying out such requirements will add additional protection to an

FCM's counterparties and customers.

The Commission also proposed to require SROs and as applicable the

JAC, to obtain an evaluation of the SRO's or JAC's supervisory program

at least once every two years from an examinations expert, defined as a

nationally recognized accounting and auditing firm with substantial

expertise in audits of FCMs, risk assessment and internal control

reviews, and that is an accounting and auditing firm that is acceptable

to the Commission (as delegated to the Director of the Division of Swap

Dealer and Intermediary Oversight). The benefits of such evaluation by

examinations experts were expected to be that the Commission would

ensure that the supervisory program and SRO audits continue to build on

best practices, which further promotes thorough and effective audits of

FCMs. The Commission quantitatively estimated costs for making

incremental changes to the requirements of the supervisory program for

each SRO and members of the JAC in the NPRM. The Commission did not

quantitatively estimate the ongoing costs of obtaining an evaluation by

an examinations expert or requiring examinations to comply with

professional standards, although the Commission did consider that

requiring such an evaluation and requiring compliance with such

standards and coverage of additional risks would add costs to

examinations by SROs and members of the JAC.

The Commission received many comment letters regarding the changes

proposed to Sec. 1.52. Several of the commenters objected to the

requirements for having a review of the examination program by an

examinations expert.\754\ Specifically, PWC raised concern with the

ability of nationally recognized accounting and auditing firms to be

able to issue any type of assurance without a reporting framework.\755\

NFA, MGEX, and CME all commented that costs would be prohibitive and

that benefits would be reduced because such an evaluation would be

duplicative to the functions of the Commission in review of the Joint

Audit Program. NFA commented that it attempted to obtain cost estimates

from a few nationally recognized firms but that such firms represented

that they were unable to provide cost information without a better

understanding of the type of review the Commission was proposing.\756\

CME commented that the quantitative estimates of the Commission for

revising the program were grossly underestimated.\757\ CME analogized

that requiring adherence to professional standards would result in

examination requirements similar to the average man hours applicable to

private and public company audits, which were represented at 1,951 and

17,457 respectively.\758\ CME represented that the costs of compliance

with professional standards and expanding the program were

prohibitively expensive and requested that only applicable provisions

should be carried into JAC protocols.\759\ CME commented that any

benefit from obtaining an evaluation from an examinations expert could

be obtained at a much reduced cost by including representatives from

such nationally recognized firms in the JAC meetings and in the current

process to develop JAC protocols, without obtaining a formal

assessment, which such firms would more likely to be willing to

do.\760\ CME further posited that if such alternative was not adopted,

the timeframe should be lengthened from two to three and a half

years.\761\ MGEX further commented that if such report were to be

required, highly qualified regional firms should be considered as well

as nationally recognized firms, as more competition would likely result

in more manageable costs.\762\

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\754\ CME, JAC, MGEX, NFA and PWC all commented objecting to or

raising concern with this aspect of the amendment to Sec. 1.52.

\755\ See PWC letter at 3 (Jan. 15, 2013).

\756\ See NFA Comment Letter at 5 (Feb. 15, 2013).

\757\ CME Comment Letter at 11 (Feb. 15, 2013).

\758\ Id.

\759\ Id.

\760\ Id.

\761\ See CME Comment Letter at 12-13 (Feb. 15, 2013).

\762\ See MGEX letter at 4 (Feb. 18, 2013).

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In consideration of the concerns of commenters, the Commission has

adopted revised amendments to the examinations expert requirement to

Sec. 1.52, which extend the time between evaluations required to three

years, and clarify that the standard for such evaluation should be that

of a consulting services report. The Commission also has considered the

comments of CME and others with respect to the costs and

inapplicability of many aspects of the PCAOB auditing standards to

regulatory examination and has adopted, in the revised amendments to

the professional standards requirements, that only such standards as

would be analogous to non-financial statement audits would be

applicable.

The JAC also filed an additional comment letter positing that the

requirements of proposed Sec. 1.52, requiring review of risk

management, would be duplicative to risk reviews required to be

performed by DCOs.\763\ Although the Commission agrees there may be

overlapping responsibilities between oversight performed by DCOs and

SROs which could result in duplicated costs, the primary focus of DCO

requirements are the protection of the DCO, not the protection of

customers and market participants. The Commission notes that the same

duplication could exist if an FCM were examined by each SRO of which it

was a member. The Commission already permits the Joint Audit Committee,

the Joint Audit Plan and the DSRO structure for the purpose of

mitigating duplicative examination work and costs. As stated in the

preamble, a DSRO may be able to fulfill parts of its examination

program by incorporating aspects of risk reviews and work already

performed by a DCO, but the DSRO would be responsible for ensuring any

such work was adequately and specifically incorporated into the DSRO

program, and oriented to ensuring the protection of customers and risks

to the FCM.

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\763\ See JAC Comment Letter at 3-4 (July 25, 2013).

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Additionally, the Commission notes it was not feasible to quantify

any costs associated with utilizing an examinations expert. This is

largely because several nationally recognized accounting firms

expressed their reluctance to provide such information.\764\ Such a

response is not surprising given the fact that reviewing a DSRO's

examination program is likely a unique and limited engagement for any

firm, which would require fully understanding the scope and

requirements of the review. Yet, the Commission notes there are several

capable firms which would meet the definition of ``examinations

expert'' and could perform the type of review required by the

regulation. Thus, the costs for performing such a service will likely

be competitive.

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\764\ See NFA Comment Letter at 5, n.2 (Feb. 15, 2013).

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[[Page 68606]]

Section 1.55 Public Disclosures by Futures Commission Merchants

Amended Sec. 1.55 significantly revises the disclosures that FCMs

are required to provide to prospective customers and the public,

detailed in Sec. 1.55(b). The new required provisions include a

statement that: (1) Customer funds are not protected by insurance in

the event of the bankruptcy or insolvency of the FCM, or if customer

funds are misappropriated; (2) customer funds are not protected by

SIPC, even if the FCM is a BD registered with the SEC; (3) customer

funds are not insured by a DCO in the event of the bankruptcy or

insolvency of the FCM holding the customer funds; (4) each customer's

funds are not held in an individual segregated account by an FCM, but

rather are commingled in one or more accounts; (5) FCMs may invest

funds deposited by customers in investments listed in Sec. 1.25; and

(6) funds deposited by customers may be deposited with affiliated

entities of the FCM, including affiliated banks and brokers. The

required additional disclosures must be provided as an addition to the

generic risk disclosure statement if used by an FCM as permitted under

Appendix A to Sec. 1.55.

In addition, the amendments at Sec. 1.55(i), (j) and (k) require

each FCM to provide a Firm Specific Disclosure Document that would

address firm specific information regarding its business, operations,

risk profile, and affiliates that would be material to a customer's

decision to entrust funds to and do business with the FCM.

The Firm Specific Disclosure Document is required to be made

available electronically, which may be a link to the FCM's Web site,

but must be provided in paper form upon request, and would provide

material information about: (1) General firm contact information; (2)

the names, business contacts, and backgrounds for the FCM's senior

management and members of the FCM's board of directors; (3) a

discussion of the significant types of business activities and product

lines that the FCM engages in and the approximate percentage of the

FCM's assets and capital devoted to each line of business; (4) the

FCM's business on behalf of its customers, including types of accounts,

markets traded, international businesses, and clearinghouses and

carrying brokers used, and the FCM's policies and procedures concerning

the choice of bank depositories, custodians, and other counterparties;

(5) a discussion of the material risks of entrusting funds to the FCM

and an explanation of how such risks may be material to its customers

\765\; (6) the name and Web site address of the FCM's DSRO and the

location of annual audited financial statements; (7) a discussion of

any material administrative, civil, criminal, or enforcement actions

pending or any enforcement actions taken in the last three years; (8) a

basic overview of customer fund segregation, FCM collateral management

and investments, and of FCMs and joint FCM/BDs; (9) information

regarding how customers may file complaints about the FCM with the

Commission or appropriate DSRO; (10) certain financial data from the

most recent month-end when the disclosure document is prepared; and

(11) a summary of the FCMs' current risk practices, controls and

procedures. FCMs are required to update the Firm Specific Disclosure

Document as and when necessary to make the information accurate and

complete, but at least annually.

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\765\ The material risks addressed must include, without

limitation, ``the nature of investments made by the futures

commission merchant (including credit quality, weighted average

maturity, and weighted average coupon); the futures commission

merchant's creditworthiness, leverage, capital, liquidity, principal

liabilities, balance sheet leverage and other lines of business;

risks to the futures commission merchant created by its affiliates

and their activities, including investment of customer funds in an

affiliated entity; and any significant liabilities, contingent or

otherwise, and material commitments.''

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The newly adopted Sec. 1.55(l) also requires FCMs to adopt

policies and procedures reasonably designed to ensure that advertising

and solicitation activities of such FCMs and any introducing brokers

associated with the FCMs are not misleading in connection with their

decision to entrust funds and do business with such FCMs.

FCMs are further required by Sec. 1.55(o) to disclose on their Web

sites their daily Segregation Schedule, daily Secured Amount Schedule,

and daily Cleared Swaps Segregation Schedule. Each FCM must maintain 12

months of such schedules on its Web site. Each FCM must disclose on its

Web site summary schedules of its adjusted net capital, net capital,

and excess net capital for the 12 most recent month-end dates, as well

as the Statement of Financial Condition, Segregation Schedule, Secured

Amount Schedule, Cleared Swaps Segregation Schedule, and all footnotes

related to the above statements and schedules from its most current

year-end annual report that is certified by an independent public

accountant.

Costs and Benefits

Current regulations require FCMs to provide a risk disclosure to

potential customers before accepting customer funds, which existing

risk disclosure statement primarily provides a customer with disclosure

of the market risks of engaging in futures trading. The revised

disclosure requirements of Sec. 1.55 provide customers with additional

information regarding certain non-firm-specific risks that have been

relevant in recent FCM bankruptcies and that could be relevant in the

event of future FCM bankruptcies or insolvencies.

The Firm Specific Disclosure Document required by this amendments

address firm-specific risk, which will give potential customers

additional information that they may use when conducting due diligence

and selecting an FCM. By requiring that the disclosure address several

specific topics, the public comparability of information on such topics

will be available, to potential customers conducting due diligence on

potential FCMs. The non-firm specific additional disclosures will

provide a significant benefit to the protection of market participants

as many customers in the aftermath of recent FCM bankruptcies revealed

fundamental misconceptions about the protection of their funds.

Specifically, certain customers did not fully understand how FCMs held

customer funds or the protections extended to such funds. Consequently,

certain customers did not make informed choices to help themselves or

to provide market discipline to their FCMs.

In the NPRM, the Commission described how each additional specific

risk disclosure was expected to benefit the protection of market

participants by providing more transparency and equal access to

information among all customers and the public, enhancing customer's

ability to make comparisons in choosing the FCMs with which they do

business. The specific benefits of each disclosure required by the

amendments were described in the NPRM, but the essential benefits

derived from each additional required disclosure, and the aggregate of

all the additional disclosures, are that they will result in more

educated consumers of FCM services, and that such consumers will,

through the greater transparency resulting from the additional

disclosures, be better able to enforce market discipline on aspects of

FCM business that are directly relevant to the risks customers accept

in dealing with and depositing funds with FCMs.

The Commission quantitatively estimated expected costs of providing

the additional general and firm specific disclosures in the NPRM and

did not receive any comments about its specific estimates. However, the

Commission

[[Page 68607]]

did receive many comments that supported the amendments to Sec. 1.55

reiterating the benefits perceived from transparency resulting from the

additional disclosures as are described at section II.P. and noting

that these amendments were particularly cost effective at providing

such benefits. FHLB stated ``[p]erhaps the most compelling argument for

additional public disclosure of certain information addressed in the

Proposed Customer Protection Rules is that the benefits should far

exceed the additional cost associated with mandating such public

disclosures.'' \766\ ACLI and the Commercial Energy Working Group both

stated ``the Proposed Customer Protection Rules represent a very cost-

effective approach/means to making FCMs more accountable to their

customers by providing current information that will enable customers

to conduct appropriate due diligence regarding prospective FCMs and to

actively monitor the financial condition and regulatory compliance of

the FCMs to which they have entrusted funds.'' \767\

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\766\ See FHLB Comment Letter at 3 (Feb. 15, 2013).

\767\ See ACLI Comment Letter at 2 (Feb. 15, 2013); Commercial

Energy Working Group Comment Letter at 2 (Feb. 13, 2013).

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FIA specifically commented with respect to the disclosures required

under Sec. 1.55(k) that FCMs that are part of public companies, or

dually registered BDs, or are part of a bank holding company, already

have disclosure requirements and that the Commission should confirm

that such an FCM may comply with this rule by making the annual reports

and amendments thereto available on its Web site, in order to avoid

duplicative or conflicting disclosure requirements.\768\ FIA further

commented that the level of detail required of privately owned FCM's

disclosure should be consistent with that provided in the annual

reports of publicly-traded companies.\769\ Newedge commented that all

FCMs should be required to disclose similar information in a standard

format, and the proposal of FIA to satisfy disclosure requirements by

linking to the annual report of a public company places firms without

annual report preparation requirements at a competitive disadvantage

and discriminates against smaller to mid-size FCMs.\770\

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\768\ See FIA Comment Letter at 43 (Feb. 15, 2013).

\769\ Id. at 44.

\770\ Newedge Comment Letter at 4 (Feb. 15, 2013).

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In the preamble discussion at section II.P., the Commission

clarified both that disclosures could be satisfied by linking to

appropriate existing relevant disclosures that were already required

for the same matters, but that the disclosures required by the

amendments are specific to the FCM and cannot be satisfied with more

general disclosure at a holding company level. The Commission believes

this clarification addresses the duplication concern raised by

commenters.

Several commenters posited concerns regarding the benefit of

various aspects of the mandated disclosures. The comments addressed the

disclosures of leverage, the targeted residual interest, customer

write-offs, and that such disclosures could in certain circumstances be

potentially misleading to customers.\771\ With respect to these

comments the Commission notes that with all aspects of the mandated

additional disclosures, appropriate explanations and additional

information to ensure sufficient context should be provided if

necessary to clarify anything that an FCM may regard as otherwise being

misleading. Concerns raised by commenters that customers may

inadequately assess risks particular to their FCM by inappropriately

focusing on only one aspect of disclosure, such as leverage, or

targeted residual interest, cannot be mitigated by declining wholesale

to make relevant information publicly available. Furthermore, FCMs are

free to supply additional context and information when they believe

that any Firm Specific Disclosure is misleading.

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\771\ See FCStone Comment Letter at 4 (Feb. 15, 2013); Phillip

Futures Inc. Comment Letter at 2 (Feb. 14, 2013); CHS Hedging

Comment Letter at 2 (Feb. 15, 2013); RJ O'Brien Comment Letter at 6-

9 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4 (Feb. 15,

2013); Advantage Comment Letter at 4 (Feb. 15, 2013); RCG Comment

Letter at 5-6 (Feb. 12, 2013).

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Certain commenters have requested that the Commission consider the

alternative to further require all Sec. 1.12 notices to be made

publicly available, which the Commission has declined to do as is

discussed in the costs and benefits discussion of Sec. 1.12. By

requiring FCMs to update the disclosures annually, as well as any time

there is a ``material change to its business operation, financial

condition and other factors material to the customer's decision to

entrust the customer's funds and otherwise do business with the futures

commission merchant,'' and requiring the FCM to provide each updated

disclosure to its customers, Sec. 1.55(i) makes FCMs responsible to

communicate with customers whenever such events occur. The Commission

notes that there may be overlap in circumstances which give rise to

notice obligations under Sec. 1.12 and which require updated public

disclosure, although the two are distinct and separate requirements.

This requirement helps to ensure that the FCM's financial condition,

business operations, or other important factors do not change in

material ways without customers being able to ascertain such changes,

and would likely prompt some customers to conduct additional due

diligence in such situations in order to determine whether their funds

are at risk, which would provide additional accountability for FCMs.

By requiring each FCM to adopt policies and procedures reasonably

designed to ensure that its advertising and solicitation activities are

not misleading to its FCM customers under Sec. 1.55(l), the Commission

is strengthening accountability for communication related to an FCM's

sales and solicitation activities which helps to ensure the purposes of

the other requirements for disclosure are not frustrated.

By requiring FCMs to provide their daily Segregation Schedules,

daily Secured Amount Schedules, and daily Cleared Swaps Segregation

Schedules, as well as the same schedules from the most recent certified

annual report, the requirements under Sec. 1.55(o) facilitate

transparency. Requiring each FCM to post the above schedules and data

on its Web site will help to ensure that market participants are aware

that it is available, and will improve the speed and efficiency of

obtaining it. Similarly, by requiring FCMs to provide a link to the Web

site of the NFA's Basic System facilitate transparency by promoting

awareness of the additional information that is public regarding each

FCM's investment of customer funds and by reducing the search costs for

obtaining that information.

Section 22.2 Futures Commission Merchants: Treatment of Cleared Swaps

and Associated Cleared Swap Customer Collateral

The adopted amendments to Sec. 22.2 incorporate changes with

respect to protection of funds for customers trading cleared swaps that

are identical to the changes proposed for protection of futures

customer funds.\772\ Those changes include: (1) Incorporating the same

change to haircutting procedures as adopted in Sec. 1.17 and Sec.

1.32 but for Cleared Swaps; (2) requiring the FCM to

[[Page 68608]]

send daily Segregation Calculations for Cleared Swaps to the Commission

and DSROs; and (3) requiring that segregated investment detail reports

be produced twice per month, listing assets on deposit at each

depository, and sent to Commission and DSROs electronically by 11:59

p.m. the following business day. Records of both reports are required

to be maintained in accordance with Sec. 1.31.

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\772\ As noted in section II.Q. above, the revisions to

Sec. Sec. 22.2(a) and (f) merely clarify that the calculation set

forth therein is the Net Liquidating Equity Method and thus, the

revision is not intended to, and should not be read to, change

current practice with respect to an FCM's residual interest

requirements for Cleared Swaps as set forth in Commission

regulations and JAC Update 12-03, and consistent with Staff

Interpretation 12-31.

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Costs and Benefits

As discussed above, amendments to Sec. 22.2(a) and (f) are not

intended to change existing practice and thus do not introduce new

costs. The other amendments to Sec. 22.2 noted above are substantively

similar to amendments to corresponding part 1 regulations and the

relevant costs and benefits are similar to the costs and benefits

discussed in those sections.

The amendments to Sec. 22.2 have the benefits of harmonizing the

protection of customer funds between Cleared Swaps and futures and

clarifying further the regulatory requirements for Cleared Swaps.

Section 22.17 Policies and Procedures Governing Disbursements of

Cleared Swaps Customer Collateral From Cleared Swap Customer Accounts

The newly adopted Sec. 22.17 imposes restrictions on an FCM's

withdrawal of its residual interest, and requires that if a withdrawal

of residual interest not for the benefit of customers causes the FCM to

fall below its targeted residual interest, that the funds be

replenished the following business day or the residual interest target

be lowered in accordance with its policies and procedures established

under Sec. 1.11.

Costs and Benefits

The costs and benefits are similar to those created by Sec. Sec.

1.23 and 1.11 but apply to customer funds in Cleared Swaps Customer

Accounts rather than customer segregated accounts, and therefore are as

described in Sec. Sec. 1.23 and 1.11, but incremental thereto with

respect to Cleared Swaps Customer Accounts.

Section 30.1 Definitions

Amendments adopted to Sec. 30.1 establishes new definitions for

``30.7 customer,'' ``30.7 account,'' and ``30.7 customer funds.'' The

first is defined as any foreign futures or foreign option customer,

together with any foreign-domiciled person who trades in foreign

futures or foreign options trough an FCM. ``30.7 account'' and ``30.7

customer funds'' are then defined accordingly. These definitions relate

to the existing terms ``foreign futures or foreign options customer,''

``foreign futures or foreign options customer account,'' and ``foreign

futures or foreign options customer funds,'' respectively. The term

``foreign futures or foreign options customer'' only includes U.S.-

domiciled customers that deposit funds with an FCM for use in trading

foreign futures or foreign options. The new definitions, on the other

hand, include both U.S. and foreign-domiciled customers that deposit

funds with an FCM for use in trading foreign futures or foreign

options.

Costs and Benefits

These definitions play a `gatekeeping' function with respect to

other rules by determining what customers are included as ``30.7

customers.'' However, the costs and benefits of these changes are

attributable to the substantive requirements related to the

definitions, and therefore are discussed in the cost benefit

considerations related to Sec. 30.7.

Section 30.7 Treatment of Foreign Futures or Foreign Options Secured

Amount

The adopted amendments to Sec. 30.7 (1) Incorporate the funds of

foreign-domiciled investors deposited with an FCM for investment in

foreign futures and foreign options within the protections provided in

Sec. 30.7; (2) eliminate the Alternative Method and require the Net

Equity Liquidation Method for calculating 30.7 customer segregation

requirements; (3) add specificity to the written acknowledgments that

FCMs and DCOs must obtain from their depositories by providing required

templates; \773\ (4) add restrictions on withdrawing from residual

interest not for the benefit of customers; \774\ (5) require that 30.7

customer funds deposited in a bank must be available for immediate

withdrawal at the request of the FCM; (6) clarify that the FCM is

responsible for any losses related to investing 30.7 customer funds in

investments that comply with Sec. 1.25; (7) add a prohibition against

making unsecured loans to customers or using the funds in the

customer's trading account as security for a loan; (8) require daily

segregation reports and a detailed list of depositories to be submitted

to the Commission and DSRO, and that targeted residual interest be

included in both of those reports; (9) allow FCMs that are not dual

registrants to use the BD procedure for assigning a smaller net capital

haircut to investments of 30.7 customer funds in certain types of

instruments with low default risk; (10) establish a limit on the amount

of funds in a 30.7 account that can be held outside the U.S.; and (11)

require FCMs to, at a specified point in time, maintain residual

interest in 30.7 accounts that is at least equal to the sum of all

undermargined amounts for 30.7 customers. With the exception of the

requirements with respect to limiting funds held outside the U.S., the

permissibility of certain depositories outside the U.S., and the

requirement that FCMs comply with the highest equivalent custody

requirement relevant in a different country, these requirements are

substantially similar to equivalent requirements adopted in Sec. Sec.

1.20, 1.22, 1.23, 1.29, 1.30, 1.32 and 22.2 and 22.17. As a result of

the adopted changes with the noted exceptions, the rules in Sec. 30.7

for the protection of 30.7 customer funds are substantially similar to

the rules for the protection of segregated customer funds under 4d(a)

and Sec. Sec. 1.11-1.32, and the rules for the protection of cleared

swaps customer funds under 4d(f) and in part 22. However, portions of

Sec. 30.7 are notably different from rules protecting futures customer

funds and cleared swap customer funds. These are: (1) the definition of

the minimum amount that must be deposited in a 30.7 account for each

30.7 customer is different than in the corresponding requirements in

Sec. Sec. 1.20 and 22.2, due to the possibility of a higher

requirement under a foreign regulatory regime; (2) the list of

acceptable depositories for 30.7 customer funds includes banks or

trusts outside of the U.S. with more than $1 billion in regulatory

capital, and various other participants of foreign boards of trade and

their depositories; (3) Sec. 30.7 limits the amount of funds from a

30.7 account that can be held outside the U.S; and (4) the Residual

Interest Deadline for 30.7 funds is 6:00 p.m. Eastern Time, whereas the

Residual Interest Deadline for futures customer funds will, after the

phase-in period and absent further Commission action, move back to the

time of the daily settlement.

---------------------------------------------------------------------------

\773\ The additional specificity incorporates the same

requirements for acknowledgment and agreement that are contained in

the templates in the appendices of Sec. Sec. 1.20 and 1.26.

\774\ The same requirements as are adopted for futures

customers' funds and Cleared Swaps Customers' Collateral, including

a requirement for the FCM to abide by its policies and procedures

required by new Sec. 1.11.

---------------------------------------------------------------------------

The third and fourth are the only substantive differences in the

custody regime created by the adopted amendments compared to the

custody regimes put in place in the corresponding sections for domestic

[[Page 68609]]

futures customer funds and cleared swaps customer funds.

Costs and Benefits

In the NPRM, the Commission stated it believed a significant

benefit of the amendments adopted to Sec. 30.7 would be the likelihood

that in an FCM insolvency, the full amount owed to customers trading

foreign futures and foreign options, whether such customers were

foreign or domestic domiciled, would be intact as required to be held

separately in 30.7 accounts. The Commission did not receive comments

objecting to the changes to the calculations or the required inclusion

of foreign-domiciled customers. The adopted changes also established

new regulations for the protection of customer funds deposited for

trading in foreign futures and options that, with limited exceptions,

are substantively identical to the new protections adopted for futures

customer funds and cleared swaps customer funds. Therefore, many of the

costs and benefits of the changes that are proposed are identical to

those described above in the cost-benefit considerations related to

Sec. Sec. 1.11-1.32 and part 22.

Various regulations designed to ensure that the new calculation

requirement for the segregation of 30.7 funds is met at all times would

also apply, including the Sec. 30.7(g) restrictions on an FCM's

withdrawal of its residual interest which is commingled with 30.7

customer funds, and policies and procedures developed by the FCM

pursuant to Sec. 1.11 that are designed to ensure safe handling of

such funds. Application of the additional protections designed for

customer funds will further ensure the protection of market

participants and provide, as much as possible, equivalent protections

between domestic and foreign futures trading with respect to the

treatment of funds held by the FCMs. The Commission did not

quantitatively estimate costs of the amendments to Sec. 30.7, but

requested comment as to any costs to FCMs, including whether FCMs would

need to obtain additional capital or obtain additional liquidity as a

result of formally foreclosing their abilities to utilize the

Alternative Method versus the Net Liquidating Equity segregation method

in funding operations. The Commission did not receive comments

addressing these questions, or addressing its analysis that costs and

benefits would be incremental to the costs and benefits analyzed with

respect to the same substantive provisions applicable to both 4d(a)

(futures) and 4d(f) (Cleared Swaps) segregated funds. Moreover, the

Commission believes any incremental costs associated with complying

with these changes to be minimal, since much of the industry is already

held to these standards as a result of previous rule changes made by

NFA to its rulebook.\775\

---------------------------------------------------------------------------

\775\ See NFA Interpretive Notice 9066 (Revised, July 1, 2013).

---------------------------------------------------------------------------

In the NPRM, the Commission proposed in Sec. 30.7(c) a limitation

on the amount of funds from a 30.7 account that can be held outside the

U.S. Funds held overseas are subject to different regulatory and

bankruptcy regimes that may not offer comparable protections for

customer funds, creating additional repatriation risks to those funds.

For example, if an FCM carrying 30.7 funds, some of which were held in

depositories outside the U.S., were to default, it is possible that the

Trustee would not be able to promptly recover sufficient funds to repay

all the FCM's obligations to 30.7 customers. As noted above, this is

especially true if the funds are deposited with a foreign affiliate of

the FCM, as the likelihood of coincident bankruptcies of affiliated

financial firms has been observed to be exceedingly high.\776\ In such

an event, the funds held at the foreign affiliate would be distributed

in accordance with the insolvency rules of the foreign jurisdiction. In

such a case each 30.7 customer would likely receive a pro-rata share of

the funds that the Trustee is able recover, when the Trustee is able to

recover them. The proposed limit on the amount of funds that can be

held outside the U.S. was intended to assure that as much of the

customers' funds as possible remain subject to the U.S. regulatory and

bankruptcy regimes, eliminating repatriation risk to those funds. By

eliminating this risk for a larger percentage of the 30.7 funds, the

proposed rule promotes higher recovery rates for 30.7 account funds if

the FCM defaults, which helps ensure that 30.7 customers receive the

largest (and most prompt) pro rata distribution possible.

---------------------------------------------------------------------------

\776\ See, e.g., Lehman, MFGI.

---------------------------------------------------------------------------

The Commission received comments from FIA, as well as others, that

the proposed percentage limitation of 10% of required margin was not

adequate in light of account volatility and other factors, and that the

limitation should only be applicable to funds deposited with foreign

brokers and that otherwise FCMs should be permitted to hold funds in a

bank or trust company outside the U.S. to the same extent that an FCM

may hold other customer segregated and Cleared Swaps Customer

collateral outside the U.S.\777\ Commenters including Jefferies and

Advantage stated that the limitations may inhibit FCMs from trading

foreign futures and that customers may need to utilize non-U.S. brokers

for their foreign futures business as a result, because they would not

be able to accept customer securities outside the U.S. and customers

would have to pre-fund with cash instead.\778\ In response to

commenters and upon consideration, the Commission is increasing the

limitation from 10% to 20%, but is declining to further expand the

permissibility of holding 30.7 funds outside the U.S. due to the

increased repatriation risk applicable to excess margin deposited

outside the U.S. for 30.7 funds for foreign futures and foreign

options.

---------------------------------------------------------------------------

\777\ FIA Comment Letter at 36-37 (Feb. 15, 2013); RJ O'Brien

Comment Letter at 11 (Feb. 15, 2013).

\778\ Jefferies Comment Letter at 6 (Feb. 15, 2013); Advantage

Comment Letter at 9 (Feb. 15, 2013).

---------------------------------------------------------------------------

For 30.7 accounts, an FCM must maintain residual interest that is

at least equal to undermargined amounts by 6:00 p.m. Eastern Time on

the following business day, which is substantively similar to the

Industry Commenters' Alternative discussed above in the cost and

benefit considerations related to Sec. 1.22. As noted there, FIA and

ISDA estimated that more than 90% of customer's margin deficits are

collected by FCMs by 6:00 p.m. Eastern Time on the next trading day.

Thus, the Commission estimates the additional requisite residual

interest needed for 30.7 accounts using the analysis described above

for futures customer accounts. As of November 30, 2012, there was

approximately $30 billion in 30.7 accounts (excluding, here, and in the

following amounts, excess amounts contributed by FCMs).\779\ At the

top-10 FCMs, there was approximately $27.7 billion in 30.7

accounts.\780\ For the remaining FCMs, there was approximately $2.3

billion in 30.7 accounts.\781\ Using ISDA's point estimate for excess

collateral deposited by customers,\782\ the Commission estimates that

there was, at the top-10 FCMs, approximately $8.6 billion (31% of $27.7

billion) of existing customer excess in 30.7 accounts. Similarly, for

the remaining FCMs, the Commission estimates that there was

approximately

[[Page 68610]]

$0.7 billion (31% of $2.3 billion) of customer excess corresponding to

30.7 accounts.

---------------------------------------------------------------------------

\779\ See http://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.

\780\ See id.

\781\ See id.

\782\ As discussed in the analysis of Sec. 1.22(c) above, ISDA

estimated the excess to be between $40 and $70 billion and employed

the midpoint of this range, $55 billion in its calculations. $55

billion is 31% of the total 177.1 billion held in both section

4d(a)(2) and part 30 secured accounts.

---------------------------------------------------------------------------

For the top-10 FCMs, the Commission subtracts $8.6 billion

(existing customer excess for these accounts) from $27.7 billion (total

funds held in these accounts) leaving approximately $19.1 billion in

required margin for 30.7 accounts for these FCMs. Multiplying ISDA's

60% required margin estimate (which assumed that the residual interest

requirement applies at all times) by 10% (i.e., 1-90%) gives 6% of the

required margin being needed in residual interest, or $1.1 billion for

these FCMs. As of November 30, 2012, the top-10 FCMs were holding

approximately $3.3 billion in residual interest in 30.7 accounts.\783\

Thus, it would appear that the top-10 FCMs are already holding

sufficient residual interest for 30.7 accounts. For the remaining FCMs,

the Commission subtracts $0.7 billion (existing customer excess for

these accounts) from $2.3 billion (total funds held in these accounts)

giving approximately $1.6 billion in required margin. Multiplying $1.6

billion by 6% gives approximately $96 million, but FCMs already

maintain over $1 billion in residual interest. Consequently, it would

appear that the remaining FCMs also already maintain enough residual

interest for 30.7 accounts.

V. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \784\ requires Federal

agencies, in promulgating regulations, to consider the impact of those

regulations on small entities. As stated in the NPRM, 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.\785\ The proposed

regulations would affect FCMs and DCOs.

---------------------------------------------------------------------------

\784\ 5 U.S.C. 601 et seq.

\785\ 47 FR 18618 (Apr. 30, 1982).

---------------------------------------------------------------------------

The Commission previously has determined that FCMs are not small

entities for purposes of the RFA, and, thus, the requirements of the

RFA do not apply to FCMs.\786\ The Commission's determination was

based, in part, upon the obligation of FCMs to meet the minimum

financial requirements established by the Commission to enhance the

protection of customers' segregated funds and protect the financial

condition of FCMs generally.\787\ The Commission also has previously

determined that DCOs are not small entities for the purpose of the

RFA.\788\ Accordingly, the Chairman, on behalf of the Commission,

certified pursuant to 5 U.S.C. 605(b) that the proposed regulations

would not have a significant economic impact on a substantial number of

small entities. The Commission then invited public comment on this

determination. The Commission received no comments.

---------------------------------------------------------------------------

\786\ Id. at 18619.

\787\ Id.

\788\ See 66 FR 45605, 45609 (Aug. 29, 2001).

---------------------------------------------------------------------------

B. Paperwork Reduction Act

The Paperwork Reduction Act (``PRA'') provides that a federal

agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information unless it displays a currently

valid control number issued by the Office of Management and Budget

(``OMB'').\789\ This final rulemaking contains several collections of

information that were submitted to OMB in the form of proposed

amendments to existing collection 3038-0024 and proposed revisions

thereto, as well as pre-existing collections 3038-0052 and 3038-0091.

There have been no substantive changes from the proposed rulemaking to

this final rulemaking that would require any adjustment to the

information collection burdens as they were originally proposed. As

required by OMB regulations, the Commission shall submit to OMB this

final rulemaking, together with ICRs that have been updated to include

the comment summary contained herein.

---------------------------------------------------------------------------

\789\ 44 U.S.C. 3501 et seq.

---------------------------------------------------------------------------

The collections contained in this rulemaking are mandatory

collections. In formulating burden estimates for the collections in

this rulemaking, to avoid double accounting of information collections

that already have been assigned control numbers by OMB, or are covered

as burden hours in collections of information pending before OMB, the

PRA analysis provided in the proposed rulemaking, along with the

information collection request (``ICR'') with burden estimates that

were incorporated into the rulemaking by reference and submitted to

OMB, accounted only burden estimates for collections of information

that have not previously been submitted to OMB. The Commission sought

comment on the collections of information contained in the proposed

rulemaking only to the extent that the collections in the proposed

rulemaking would increase the burden hours contained with respect to

each of the related currently valid or proposed collections.

The Commission received over 120 written submissions on the

proposed rulemaking. Many of these comments discussed in general the

need for, effectiveness of, and practicality of various proposed rules.

However, none of the commenters questioned the burden estimates

provided in the proposed rulemaking or the ICR that was submitted. To

the extent that there were comments on the need for, effectiveness and

practicality of various proposed rules, they related to the rulemaking

as a whole rather than the collections in particular. Accordingly,

those comments were addressed above, in the sections of the preamble of

this final rulemaking that relate specifically to the proposed rules at

issue.

As required by the PRA, the Commission submitted the proposed

amendments, in the form of information collection requests related to

collections 3038-0024, 3038-0052, and 3038-0091 on November 14, 2012,

the same date that the proposed rulemaking was published in the Federal

Register.\790\ The Commission did not receive public comments on any of

the proposed collections from OMB on or before January 13, 2013, within

the 60 days established for such comments in the PRA after the notice

of proposed rulemaking and the submission of the certified ICR to

OMB.\791\ Accordingly, the proposed amendments to collections 3038-

0024, 3038-0052, and 3038-0091 are deemed to be approved by operation

of the PRA.\792\ The Commission therefore, pursuant to OMB

regulations,\793\ requests the assignment of OMB control numbers to the

proposed amendments to collections 3038-0024, 3038-0052, and 3038-0091,

which were submitted to OMB for approval on November 14, 2012.

---------------------------------------------------------------------------

\790\ See 44 U.S.C. 3507(d)(1)(A), providing for an agency to

forward to the Director of OMB or his or her designee a notice of

proposed rulemaking with a collection of information subject to

notice and comment pursuant to the provisions of 44 U.S.C.

3506(c)(2)(B), on or before the date that the proposed rulemaking is

published in the Federal Register, together with the ICR in the form

required by OMB in 5 CFR 1320.8 and 1320.9.

\791\ See 44 U.S.C. 3507(d)(1)(B), cross-referencing 44 U.S.C.

3508. See also 5 CFR 1320.11(c).

\792\ See 44 U.S.C. 3507(3).

\793\ See 5 CFR 1320.11(i), implementing 44 U.S.C. 3507(d)(3).

[[Page 68611]]

Appendix 1 to Supplementary Information--Table of Comment Letters

------------------------------------------------------------------------

Abbreviation used (if applicable) Full name

------------------------------------------------------------------------

Advantage................................. Advantage Futures LLC.

AFMP Group................................ Agricultural Futures Market

Participants: AMCOT,

American Cotton Shippers

Association, American Farm

Bureau Federation, American

Feed Industry Association,

American Soybean

Association, CoBank,

Commodity Markets Council,

National Association of

Wheat Growers, National

Barley Growers Association,

National Cattlemen's Beef

Association, National Corn

Growers Association,

National Cotton Council,

National Council of Farmer

Cooperatives, National

Grain and Feed Association,

National Pork Producers

Council, National Sorghum

Producers, National

Sunflower Association,

North American Millers

Association, USA Rice

Federation, US Canola

Association, US Dry Bean

Council.

AIMA...................................... Alternative Investment

Management Association.

Amarillo.................................. Amarillo Brokerage Co.

ACLI...................................... American Council of Life

Insurers.

AFBF...................................... American Farm Bureau

Federation.

AICPA..................................... American Institute of

Certified Public

Accountants.

AIM....................................... American Iron & Metal.

BlackRock................................. BlackRock, Inc.

Depository Bank Group..................... BMO Harris Bank, Barclays

Bank, The Bank of New York

Mellon and Brown Brothers

Harriman & Co.

Center for Audit Quality.................. Center for Audit Quality.

CFA....................................... CFA Institute.

Chris Barnard............................. Chris Barnard.

CHS Hedging............................... CHS Hedging, Inc.

CME....................................... CME Group Inc.

CoBank.................................... CoBank.

Commercial Energy Working Group........... Commercial Energy Working

Group.

CIEBA..................................... Committee on Investment of

Employee Benefit Assets.

CCC....................................... Commodity Customer

Coalition.

Congressional Committees.................. Congress of the United

States: Frank D. Lucas,

House Committee on

Agricultural; Debbie

Stabenow, Senate Committee

on Agriculture, Nutrition,

and Forestry.

Deloitte.................................. Deloitte & Touche.

Ernst & Young............................. Ernst & Young LLP.

Eurex..................................... Eurex Clearing AG.

FHLB...................................... Federal Home Loan Banks.

Federal Reserve Banks..................... Federal Reserve Banks of New

York and Chicago.

FXCM...................................... Forex Capital Markets LLC.

Franklin.................................. Franklin Templeton

Investments.

Frontier Futures.......................... Frontier Futures, Inc.

FIA....................................... Futures Industry Association

(Collectively--Barclays,

State Street, Goldman

Sachs, others).

Global Commodity.......................... Global Commodity Analytics &

Consulting LLC.

ISRI...................................... Institute of Scrap Recycling

Industries, Inc.

ISDA...................................... International Swap Dealers

Association, Inc.

FCStone................................... INTL FCStone, Inc.

ICI....................................... Investment Company

Institute.

ICA....................................... Iowa Cattlemen's

Association.

Jefferies................................. Jefferies Bache, LLC.

JSA....................................... John Stewart and Associates.

JAC....................................... Joint Audit Committee.

Katten-FIA................................ Katten Muchin Rosenman LLP

on behalf of the Futures

Industry Association.

KPMG...................................... KPMG LLP.

Kripke Enterprises........................ Kripke Enterprises.

LCH.Clearnet.............................. LCH.Clearnet Group Limited.

MFA....................................... Managed Funds Association.

Manitoba.................................. Manitoba Corporation.

MGEX...................................... Minneapolis Grain Exchange,

Inc.

NCBA...................................... National Cattlemen's Beef

Association.

NCFC...................................... National Council of Farmer

Cooperatives.

NFA....................................... National Futures

Association.

NGFA...................................... National Grain and Feed

Association.

NIBA...................................... National Introducing Brokers

Association.

NPPC...................................... National Pork Producers

Council.

NEFI/PMAA................................. New England Fuel Institute

Petroleum Marketers

Association of America.

NYPC...................................... New York Portfolio Clearing,

LLC.

Newedge................................... Newedge USA, LLC.

Nodal..................................... Nodal Exchange, LLC.

Paul/Weiss................................ Paul, Weiss, Rifkind,

Wharton & Garrison LLP.

Phillip Futures Inc....................... Phillip Futures Inc.

Pilot Flying J............................ Pilot Travel Centers, LLC.

Premier Metal Services.................... Premier Metal Services, LLC.

Prudential................................ The Prudential Insurance

Company of America.

PWC....................................... PWC LLP.

Randy Fritsche............................ Randy Fritsche.

Rice Dairy LLC............................ Rice Dairy LLC.

[[Page 68612]]

 

RJ O'Brien................................ R.J. O'Brien & Associates,

LLC.

RCG....................................... Rosenthal Collins Group.

Schippers................................. Schippers Trading.

Schwartz & Ballen......................... Schwartz & Ballen LLP.

Security Benefit.......................... Security Benefit Life

Insurance Company.

SIFMA..................................... SIFMA Asset Management

Group.

Solomon Metals Corp....................... Solomon Metals Corp.

State Street.............................. State Street Corporation.

Steve Jones............................... Steve Jones.

SUNY Buffalo.............................. State University of New York

at Buffalo Law School.

TD Ameritrade............................. TD Ameritrade, Inc.

TCFA...................................... Texas Cattle Feeder

Association.

TIAA-CREF................................. TIAA-CREF.

Strelitz/California Metal X............... Tim Strelitz/California

Metal X.

Vanguard.................................. Vanguard.

------------------------------------------------------------------------

BILLING CODE 6351-01-P

[[Page 68613]]

Appendix 2 to Supplementary Information--CFTC Form 1-FR-FCM

[GRAPHIC] [TIFF OMITTED] TR14NO13.000

[[Page 68614]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.001

[[Page 68615]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.002

[[Page 68616]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.003

[[Page 68617]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.004

[[Page 68618]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.005

[[Page 68619]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.006

BILLING CODE 6351-01-C

List of Subjects

17 CFR Part 1

Brokers, Commodity futures, Consumer protection, Reporting and

recordkeeping requirements.

17 CFR Part 3

Associated persons, Brokers, Commodity futures, Customer

protection, Major swap participants, Registration, Swap dealers.

17 CFR Part 22

Brokers, Clearing, Consumer protection, Reporting and recordkeeping

requirements, Swaps.

17 CFR Part 30

Commodity futures, Consumer protection, Currency, Reporting and

recordkeeping requirements.

17 CFR Part 140

Authority delegations (Government agencies), Organization and

functions (Government agencies).

For the reasons stated in the preamble, the Commodity Futures

Trading Commission amends 17 CFR parts 1, 3, 22, 30, and 140 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, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,

9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as

amended by Title VII of the Dodd-Frank Wall Street Reform and

Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0

2. Amend Sec. 1.3 to revise paragraph (rr) to read as follows:

Sec. 1.3 Definitions.

* * * * *

(rr) Foreign futures or foreign options secured amount. This term

means all money, securities and property received by a futures

commission merchant from, for, or on behalf of 30.7 customers as

defined in Sec. 30.1 of this chapter:

(1) To margin, guarantee, or secure foreign futures contracts and

all money accruing to such 30.7 customers as the result of such

contracts;

(2) In connection with foreign options transactions representing

premiums payable or premiums received, or to guarantee or secure

performance on such transactions; and

(3) All money accruing to such 30.7 customers as the result of

trading in

[[Page 68620]]

foreign futures contracts or foreign options.

* * * * *

0

3. Amend Sec. 1.10 to:

0

a. Revise paragraph (b)(1)(ii);

0

b. Add paragraph (b)(5); and

0

c. Revise paragraphs (c)(1), (c)(2)(i), (d)(1)(v), (d)(2)(iv),

(d)(2)(vi), and (g)(2)(ii).

The revisions and addition read as follows:

Sec. 1.10 Financial reports of futures commission merchants and

introducing brokers.

* * * * *

(b) * * *

(1) * * *

(ii) In addition to the monthly financial reports required by

paragraph (b)(1)(i) of this section, each person registered as a

futures commission merchant must file a Form 1-FR-FCM as of the close

of its fiscal year, which must be certified by an independent public

accountant in accordance with Sec. 1.16, and must be filed no later

than 60 days after the close of the futures commission merchant's

fiscal year: Provided, however, that a registrant which is registered

with the Securities and Exchange Commission as a securities broker or

dealer must file this report not later than the time permitted for

filing an annual audit report under Sec. 240.17a-5(d)(5) of this

title.

* * * * *

(5) Each futures commission merchant must file with the Commission

the measure of the future commission merchant's leverage as of the

close of the business each month. For purpose of this section, the term

``leverage'' shall be defined by a registered futures association of

which the futures commission merchant is a member. The futures

commission merchant is required to file the leverage information with

the Commission within 17 business days of the close of the futures

commission merchant's month end.

(c) Where to file reports. (1) Form 1-FR filed by an introducing

broker pursuant to paragraph (b)(2) of this section need be filed only

with, and will be considered filed when received by, the National

Futures Association. Other reports or information provided for in this

section will be considered filed when received by the Regional office

of the Commission with jurisdiction over the state in which the

registrant's principal place of business is located (as set forth in

Sec. 140.02 of this chapter) and by the designated self-regulatory

organization, if any; and reports or other information required to be

filed by this section by an applicant for registration will be

considered filed when received by the National Futures Association. Any

report or information filed with the National Futures Association

pursuant to this paragraph shall be deemed for all purposes to be filed

with, and to be the official record of, the Commission.

(2)(i) All filings or other notices prepared by a futures

commission merchant pursuant to this section must be submitted to the

Commission in electronic form using a form of user authentication

assigned in accordance with procedures established by or approved by

the Commission, and otherwise in accordance with instructions issued by

or approved by the Commission, if the futures commission merchant or a

designated self-regulatory organization has provided the Commission

with the means necessary to read and to process the information

contained in such report. A Form 1-FR required to be certified by an

independent public accountant in accordance with Sec. 1.16 which is

filed by a futures commission merchant must be filed electronically.

* * * * *

(d) * * *

(1) * * *

(v) For a futures commission merchant only, the statements of

segregation requirements and funds in segregation for customers trading

on U.S. commodity exchanges and for customers' dealer options accounts,

the statement of secured amounts and funds held in separate accounts

for 30.7 customers (as defined in Sec. 30.1 of this chapter) in

accordance with Sec. 30.7 of this chapter, and the statement of

cleared swaps customer segregation requirements and funds in cleared

swaps customer accounts under section 4d(f) of the Act as of the date

for which the report is made; and

* * * * *

(2) * * *

(iv) For a futures commission merchant only, the statements of

segregation requirements and funds in segregation for customers trading

on U.S. commodity exchanges and for customers' dealer options accounts,

the statement of secured amounts and funds held in separate accounts

for 30.7 customers (as defined in Sec. 30.1 of this chapter) in

accordance with Sec. 30.7 of the chapter, and the statement of cleared

swaps customers segregation requirements and funds in cleared swaps

customer accounts under section 4d(f) of the Act as of the date for

which the report is made;

* * * * *

(vi) A reconciliation, including appropriate explanations, of the

statement of the computation of the minimum capital requirements

pursuant to Sec. 1.17 and, for a futures commission merchant only, the

statements of segregation requirements and funds in segregation for

customers trading on U.S. commodity exchanges and for customers' dealer

option accounts, the statement of secured amounts and funds held in

separate accounts for 30.7 customers (as defined in Sec. 30.1 of this

chapter) in accordance with Sec. 30.7 of this chapter, and the

statement of cleared swaps customer segregation requirements and funds

in cleared swaps customer accounts under section 4d(f) of the Act, in

the certified Form 1-FR with the applicant's or registrant's

corresponding uncertified most recent Form 1-FR filing when material

differences exist or, if no material differences exist, a statement so

indicating; and

* * * * *

(g) * * *

(2) * * *

(ii) The following statements and footnote disclosures thereof: the

Statement of Financial Condition in the certified annual financial

reports of futures commission merchants and introducing brokers; the

Statements (to be filed by a futures commission merchant only) of

Segregation Requirements and Funds in Segregation for customers trading

on U.S. commodity exchanges and for customers' dealer options accounts,

the Statement (to be filed by a futures commission merchant only) of

Secured Amounts and Funds held in Separate Accounts for 30.7 Customers

(as defined in Sec. 30.1 of this chapter) in accordance with Sec.

30.7 of this chapter, and the Statement (to be filed by futures

commission merchants only) of Cleared Swaps Customer Segregation

Requirements and Funds in Cleared Swaps Customer Accounts under section

4d(f) of the Act.

* * * * *

0

4. Add Sec. 1.11 to read as follows:

Sec. 1.11 Risk Management Program for futures commission merchants.

(a) Applicability. Nothing in this section shall apply to a futures

commission merchant that does not accept any money, securities, or

property (or extend credit in lieu thereof) to margin, guarantee, or

secure any trades or contracts that result from soliciting or accepting

orders for the purchase or sale of any commodity interest.

(b) Definitions. For purposes of this section:

(1) Business unit means any department, division, group, or

[[Page 68621]]

personnel of a futures commission merchant or any of its affiliates,

whether or not identified as such that:

(i) Engages in soliciting or in accepting orders for the purchase

or sale of any commodity interest and that, in or in connection with

such solicitation or acceptance of orders, accepts any money,

securities, or property (or extends credit in lieu thereof) to margin,

guarantee, or secure any trades or contracts that result or may result

therefrom; or

(ii) Otherwise handles segregated funds, including managing,

investing, and overseeing the custody of segregated funds, or any

documentation in connection therewith, other than for risk management

purposes; and

(iii) Any personnel exercising direct supervisory authority of the

performance of the activities described in paragraph (b)(1)(i) or (ii)

of this section.

(2) Customer means a futures customer as defined in Sec. 1.3,

Cleared Swaps Customer as defined in Sec. 22.1 of this chapter, and

30.7 customer as defined in Sec. 30.1 of this chapter.

(3) Governing body means the proprietor, if the futures commission

merchant is a sole proprietorship; a general partner, if the futures

commission merchant is a partnership; the board of directors if the

futures commission merchant is a corporation; the chief executive

officer, the chief financial officer, the manager, the managing member,

or those members vested with the management authority if the futures

commission merchant is a limited liability company or limited liability

partnership.

(4) Segregated funds means money, securities, or other property

held by a futures commission merchant in separate accounts pursuant to

Sec. 1.20 for futures customers, pursuant to Sec. 22.2 of this

chapter for Cleared Swaps Customers, and pursuant to Sec. 30.7 of this

chapter for 30.7 customers.

(5) Senior management means, any officer or officers specifically

granted the authority and responsibility to fulfill the requirements of

senior management by the governing body.

(c) Risk Management Program. (1) Each futures commission merchant

shall establish, maintain, and enforce a system of risk management

policies and procedures designed to monitor and manage the risks

associated with the activities of the futures commission merchant as

such. For purposes of this section, such policies and procedures shall

be referred to collectively as a ``Risk Management Program.''

(2) Each futures commission merchant shall maintain written

policies and procedures that describe the Risk Management Program of

the futures commission merchant.

(3) The Risk Management Program and the written risk management

policies and procedures, and any material changes thereto, shall be

approved in writing by the governing body of the futures commission

merchant.

(4) Each futures commission merchant shall furnish a copy of its

written risk management policies and procedures to the Commission and

its designated self-regulatory organization upon application for

registration and thereafter upon request.

(d) Risk management unit. As part of the Risk Management Program,

each futures commission merchant shall establish and maintain a risk

management unit with sufficient authority; qualified personnel; and

financial, operational, and other resources to carry out the risk

management program established pursuant to this section. The risk

management unit shall report directly to senior management and shall be

independent from the business unit.

(e) Elements of the Risk Management Program. The Risk Management

Program of each futures commission merchant shall include, at a

minimum, the following elements:

(1) Identification of risks and risk tolerance limits. (i) The Risk

Management Program shall take into account market, credit, liquidity,

foreign currency, legal, operational, settlement, segregation,

technological, capital, and any other applicable risks together with a

description of the risk tolerance limits set by the futures commission

merchant and the underlying methodology in the written policies and

procedures. The risk tolerance limits shall be reviewed and approved

quarterly by senior management and annually by the governing body.

Exceptions to risk tolerance limits shall be subject to written

policies and procedures.

(ii) The Risk Management Program shall take into account risks

posed by affiliates, all lines of business of the futures commission

merchant, and all other trading activity engaged in by the futures

commission merchant. The Risk Management Program shall be integrated

into risk management at the consolidated entity level.

(iii) The Risk Management Program shall include policies and

procedures for detecting breaches of risk tolerance limits set by the

futures commission merchant, and alerting supervisors within the risk

management unit and senior management, as appropriate.

(2) Periodic Risk Exposure Reports. (i) The risk management unit of

each futures commission merchant shall provide to senior management and

to its governing body quarterly written reports setting forth all

applicable risk exposures of the futures commission merchant; any

recommended or completed changes to the Risk Management Program; the

recommended time frame for implementing recommended changes; and the

status of any incomplete implementation of previously recommended

changes to the Risk Management Program. For purposes of this section,

such reports shall be referred to as ``Risk Exposure Reports.'' The

Risk Exposure Reports also shall be provided to the senior management

and the governing body immediately upon detection of any material

change in the risk exposure of the futures commission merchant.

(ii) Furnishing to the Commission. Each futures commission merchant

shall furnish copies of its Risk Exposure Reports to the Commission

within five (5) business days of providing such reports to its senior

management.

(3) Specific risk management considerations. The Risk Management

Program of each futures commission merchant shall include, but not be

limited to, policies and procedures necessary to monitor and manage the

following risks:

(i) Segregation risk. The written policies and procedures shall be

reasonably designed to ensure that segregated funds are separately

accounted for and segregated or secured as belonging to customers as

required by the Act and Commission regulations and must, at a minimum,

include or address the following:

(A) A process for the evaluation of depositories of segregated

funds, including, at a minimum, documented criteria that any depository

that will hold segregated funds, including an entity affiliated with

the futures commission merchant, must meet, including criteria

addressing the depository's capitalization, creditworthiness,

operational reliability, and access to liquidity. The criteria should

further consider the extent to which segregated funds are concentrated

with any depository or group of depositories. The criteria also should

include the availability of deposit insurance and the extent of the

regulation and supervision of the depository;

(B) A program to monitor an approved depository on an ongoing basis

to assess its continued satisfaction of the futures commission

merchant's established

[[Page 68622]]

criteria, including a thorough due diligence review of each depository

at least annually;

(C) An account opening process for depositories, including

documented authorization requirements, procedures that ensure that

segregated funds are not deposited with a depository prior to the

futures commission merchant receiving the acknowledgment letter

required from such depository pursuant to Sec. 1.20, and Sec. Sec.

22.2 and 30.7 of this chapter, and procedures that ensure that such

account is properly titled to reflect that it is holding segregated

funds pursuant to the Act and Commission regulations;

(D) A process for establishing a targeted amount of residual

interest that the futures commission merchant seeks to maintain as its

residual interest in the segregated funds accounts and such process

must be designed to reasonably ensure that the futures commission

merchant maintains the targeted residual amounts and remains in

compliance with the segregated funds requirements at all times. The

policies and procedures must require that senior management, in

establishing the total amount of the targeted residual interest in the

segregated funds accounts, perform appropriate due diligence and

consider various factors, as applicable, relating to the nature of the

futures commission merchant's business including, but not limited to,

the composition of the futures commission merchant's customer base, the

general creditworthiness of the customer base, the general trading

activity of the customers, the types of markets and products traded by

the customers, the proprietary trading of the futures commission

merchant, the general volatility and liquidity of the markets and

products traded by customers, the futures commission merchant's own

liquidity and capital needs, and the historical trends in customer

segregated fund balances, including undermargined amounts and net

deficit balances in customers' accounts. The analysis and calculation

of the targeted amount of the future commission merchant's residual

interest must be described in writing with the specificity necessary to

allow the Commission and the futures commission merchant's designated

self-regulatory organization to duplicate the analysis and calculation

and test the assumptions made by the futures commission merchant. The

adequacy of the targeted residual interest and the process for

establishing the targeted residual interest must be reassessed

periodically by Senior Management and revised as necessary;

(E) A process for the withdrawal of cash, securities, or other

property from accounts holding segregated funds, where the withdrawal

is not for the purpose of payments to or on behalf of the futures

commission merchant's customers. Such policies and procedures must

satisfy the requirements of Sec. 1.23, Sec. 22.17 of this chapter, or

Sec. 30.7 of this chapter, as applicable;

(F) A process for assessing the appropriateness of specific

investments of segregated funds in permitted investments in accordance

with Sec. 1.25. Such policies and procedures must take into

consideration the market, credit, counterparty, operational, and

liquidity risks associated with such investments, and assess whether

such investments comply with the requirements in Sec. 1.25 including

that the futures commission merchant manage the permitted investments

consistent with the objectives of preserving principal and maintaining

liquidity;

(G) Procedures requiring the appropriate separation of duties among

individuals responsible for compliance with the Act and Commission

regulations relating to the protection and financial reporting of

segregated funds, including the separation of duties among personnel

that are responsible for advising customers on trading activities,

approving or overseeing cash receipts and disbursements (including

investment operations), and recording and reporting financial

transactions. The policies and procedures must require that any

movement of funds to affiliated companies and parties are properly

approved and documented;

(H) A process for the timely recording of all transactions,

including transactions impacting customers' accounts, in the firm's

books of record;

(I) A program for conducting annual training of all finance,

treasury, operations, regulatory, compliance, settlement, and other

relevant officers and employees regarding the segregation requirements

for segregated funds required by the Act and regulations, the

requirements for notices under Sec. 1.12, procedures for reporting

suspected breaches of the policies and procedures required by this

section to the chief compliance officer, without fear of retaliation,

and the consequences of failing to comply with the segregation

requirements of the Act and regulations; and

(J) Policies and procedures for assessing the liquidity,

marketability and mark-to-market valuation of all securities or other

non-cash assets held as segregated funds, including permitted

investments under Sec. 1.25, to ensure that all non-cash assets held

in the customer segregated accounts, both customer-owned securities and

investments in accordance with Sec. 1.25, are readily marketable and

highly liquid. Such policies and procedures must require daily

measurement of liquidity needs with respect to customers; assessment of

procedures to liquidate all non-cash collateral in a timely manner and

without significant effect on price; and application of appropriate

collateral haircuts that accurately reflect market and credit risk.

(ii) Operational risk. The Risk Management Program shall include

automated financial risk management controls reasonably designed to

prevent the placing of erroneous orders, including those that exceed

pre-set capital, credit, or volume thresholds. The Risk Management

Program shall ensure that the use of automated trading programs is

subject to policies and procedures governing the use, supervision,

maintenance, testing, and inspection of such programs.

(iii) Capital risk. The written policies and procedures shall be

reasonably designed to ensure that the futures commission merchant has

sufficient capital to be in compliance with the Act and the

regulations, and sufficient capital and liquidity to meet the

reasonably foreseeable needs of the futures commission merchant.

(4) Supervision of the Risk Management Program. The Risk Management

Program shall include a supervisory system that is reasonably designed

to ensure that the policies and procedures required by this section are

diligently followed.

(f) Review and testing. (1) The Risk Management Program of each

futures commission merchant shall be reviewed and tested on at least an

annual basis, or upon any material change in the business of the

futures commission merchant that is reasonably likely to alter the risk

profile of the futures commission merchant.

(2) The annual reviews of the Risk Management Program shall include

an analysis of adherence to, and the effectiveness of, the risk

management policies and procedures, and any recommendations for

modifications to the Risk Management Program. The annual testing shall

be performed by qualified internal audit staff that are independent of

the business unit, or by a qualified third party audit service

reporting to staff that are independent of the business unit. The

results of the annual review of the Risk Management Program shall be

promptly reported to and reviewed by the chief compliance officer,

senior management, and governing body of the futures commission

merchant.

[[Page 68623]]

(3) Each futures commission merchant shall document all internal

and external reviews and testing of its Risk Management Program and

written risk management policies and procedures including the date of

the review or test; the results; any deficiencies identified; the

corrective action taken; and the date that corrective action was taken.

Such documentation shall be provided to Commission staff, upon request.

(g) Distribution of risk management policies and procedures. The

Risk Management Program shall include procedures for the timely

distribution of its written risk management policies and procedures to

relevant supervisory personnel. Each futures commission merchant shall

maintain records of the persons to whom the risk management policies

and procedures were distributed and when they were distributed.

(h) Recordkeeping. (1) Each futures commission merchant shall

maintain copies of all written approvals required by this section.

(2) All records or reports, including, but not limited to, the

written policies and procedures and any changes thereto that a futures

commission merchant is required to maintain pursuant to this regulation

shall be maintained in accordance with Sec. 1.31 and shall be made

available promptly upon request to representatives of the Commission.

0

5. Amend Sec. 1.12 to:

0

a. Revise paragraphs (a)(1) and (a)(2); (b)(1), (b)(2), and (b)(4);

(c); (d); (e); (f)(2) through (f)(4) and (f)(5)(i); (g); (h); and (i);

and

0

b. Add paragraphs (j), (k), (l), (m), and (n).

The revisions and additions read as follows:

Sec. 1.12 Maintenance of minimum financial requirements by futures

commission merchants and introducing brokers.

(a) * * *

(1) Give notice, as set forth in paragraph (n) of this section,

that the applicant's or registrant's adjusted net capital is less than

required by Sec. 1.17 or by other capital rule, identifying the

applicable capital rule. The notice must be given immediately after the

applicant or registrant knows or should have known that its adjusted

net capital is less than required by any of the aforesaid rules to

which the applicant or registrant is subject; and

(2) Provide together with such notice documentation, in such form

as necessary, to adequately reflect the applicant's or registrant's

capital condition as of any date on which such person's adjusted net

capital is less than the minimum required; Provided, however, that if

the applicant or registrant cannot calculate or otherwise immediately

determine its financial condition, it must provide the notice required

by paragraph (a)(1) of this section and include in such notice a

statement that the entity cannot presently calculate its financial

condition. The applicant or registrant must provide similar

documentation of its financial condition for other days as the

Commission may request.

(b) * * *

(1) 150 percent of the minimum dollar amount required by Sec.

1.17(a)(1)(i)(A);

(2) 110 percent of the amount required by Sec. 1.17(a)(1)(i)(B);

* * * * *

(4) For securities brokers or dealers, the amount of net capital

specified in Rule 17a-11(c) of the Securities and Exchange Commission

(17 CFR 240.17a-11(c)), must file notice to that effect, as set forth

in paragraph (n) of this section, as soon as possible and no later than

twenty-four (24) hours of such event.

(c) If an applicant or registrant at any time fails to make or keep

current the books and records required by these regulations, such

applicant or registrant must, on the same day such event occurs,

provide notice of such fact as specified in paragraph (n) of this

section, specifying the books and records which have not been made or

which are not current, and as soon as possible, but not later than

forty-eight (48) hours after giving such notice, file a report as

required by paragraph (n) of this section stating what steps have been

and are being taken to correct the situation.

(d) Whenever any applicant or registrant discovers or is notified

by an independent public accountant, pursuant to Sec. 1.16(e)(2), of

the existence of any material inadequacy, as specified in Sec.

1.16(d)(2), such applicant or registrant must give notice of such

material inadequacy, as provided in paragraph (n) of this section, as

soon as possible but not later than twenty-four (24) hours of

discovering or being notified of the material inadequacy. The applicant

or registrant must file, in the manner provided for under paragraph (n)

of this section, a report stating what steps have been and are being

taken to correct the material inadequacy within forty-eight (48) hours

of filing its notice of the material inadequacy.

(e) Whenever any self-regulatory organization learns that a member

registrant has failed to file a notice or report as required by this

section, that self-regulatory organization must immediately report this

failure by notice, as provided in paragraph (n) of this section.

(f) * * *

(2) Whenever a registered futures commission merchant determines

that any position it carries for another registered futures commission

merchant or for a registered leverage transaction merchant must be

liquidated immediately, transferred immediately or that the trading of

any account of such futures commission merchant or leverage transaction

merchant shall be only for purposes of liquidation, because the other

futures commission merchant or the leverage transaction merchant has

failed to meet a call for margin or to make other required deposits,

the carrying futures commission merchant must immediately give notice,

as provided in paragraph (n) of this section, of such a determination.

(3) Whenever a registered futures commission merchant determines

that an account which it is carrying is undermargined by an amount

which exceeds the futures commission merchant's adjusted net capital

determined in accordance with Sec. 1.17, the futures commission

merchant must immediately provide notice, as provided in paragraph (n)

of this section, of such a determination to the designated self-

regulatory organization and the Commission. This paragraph (f)(3) shall

apply to any account carried by the futures commission merchant,

whether a customer, noncustomer, omnibus or proprietary account. For

purposes of this paragraph, if any person has an interest of 10 percent

or more in ownership or equity in, or guarantees, more than one

account, or has guaranteed an account in addition to its own account,

all such accounts shall be combined.

(4) A futures commission merchant shall provide immediate notice,

as provided in paragraph (n) of this section, whenever any commodity

interest account it carries is subject to a margin call, or call for

other deposits required by the futures commission merchant, that

exceeds the futures commission merchant's excess adjusted net capital,

determined in accordance with Sec. 1.17, and such call has not been

answered by the close of business on the day following the issuance of

the call. This applies to all accounts carried by the futures

commission merchant, whether customer, noncustomer, or omnibus, that

are subject to margining, including commodity futures, cleared swaps,

and options. In addition to actual margin deposits by an account owner,

a futures commission merchant may also take account of favorable market

moves in determining whether

[[Page 68624]]

the margin call is required to be reported under this paragraph.

(5)(i) A futures commission merchant shall provide immediate

notice, as provided in paragraph (n) of this section, whenever its

excess adjusted net capital is less than six percent of the maintenance

margin required by the futures commission merchant on all positions

held in accounts of a noncustomer other than a noncustomer who is

subject to the minimum financial requirements of:

(A) A futures commission merchant, or

(B) The Securities and Exchange Commission for a securities broker

or dealer.

* * * * *

(g) A futures commission merchant shall provide notice, as provided

in paragraph (n) of this section, of a substantial reduction in capital

as compared to that last reported in a financial report filed with the

Commission pursuant to Sec. 1.10. This notice shall be provided as

follows:

(1) If any event or series of events, including any withdrawal,

advance, loan or loss cause, on a net basis, a reduction in net capital

(or, if the futures commission merchant is qualified to use the filing

option available under Sec. 1.10(h), tentative net capital as defined

in the rules of the Securities and Exchange Commission) of 20 percent

or more, notice must be provided as provided in paragraph (n) of this

section within two business days of the event or series of events

causing the reduction stating the reason for the reduction and steps

the futures commission merchant will be taking to ensure an appropriate

level of net capital is maintained by the futures commission merchant;

and

(2) If equity capital of the futures commission merchant or a

subsidiary or affiliate of the futures commission merchant consolidated

pursuant to Sec. 1.17(f) (or 17 CFR 240.15c3-1e) would be withdrawn by

action of a stockholder or a partner or a limited liability company

member or by redemption or repurchase of shares of stock by any of the

consolidated entities or through the payment of dividends or any

similar distribution, or an unsecured advance or loan would be made to

a stockholder, partner, sole proprietor, limited liability company

member, employee or affiliate, such that the withdrawal, advance or

loan would cause, on a net basis, a reduction in excess adjusted net

capital (or, if the futures commission merchant is qualified to use the

filing option available under Sec. 1.10(h), excess net capital as

defined in the rules of the Securities and Exchange Commission) of 30

percent or more, notice must be provided as provided in paragraph (n)

of this section at least two business days prior to the withdrawal,

advance or loan that would cause the reduction: Provided, however, That

the provisions of paragraphs (g)(1) and (g)(2) of this section do not

apply to any futures or securities transaction in the ordinary course

of business between a futures commission merchant and any affiliate

where the futures commission merchant makes payment to or on behalf of

such affiliate for such transaction and then receives payment from such

affiliate for such transaction within two business days from the date

of the transaction.

(3) Upon receipt of such notice from a futures commission merchant,

or upon a reasonable belief that a substantial reduction in capital has

occurred or will occur, the Director of the Division of Swap Dealer and

Intermediary Oversight or the Director's designee may require that the

futures commission merchant provide or cause a Material Affiliated

Person (as that term is defined in Sec. 1.14(a)(2)) to provide, within

three business days from the date of request or such shorter period as

the Division Director or designee may specify, such other information

as the Division Director or designee determines to be necessary based

upon market conditions, reports provided by the futures commission

merchant, or other available information.

(h) Whenever a person registered as a futures commission merchant

knows or should know that the total amount of its funds on deposit in

segregated accounts on behalf of customers trading on designated

contract markets, or the amount of funds on deposit in segregated

accounts for customers transacting in Cleared Swaps under part 22 of

this chapter, or the total amount set aside on behalf of customers

trading on non-United States markets under part 30 of this chapter, is

less than the total amount of such funds required by the Act and the

regulations to be on deposit in segregated or secured amount accounts

on behalf of such customers, the registrant must report such deficiency

immediately by notice to the registrant's designated self-regulatory

organization and the Commission, as provided in paragraph (n) of this

section.

(i) A futures commission merchant must provide immediate notice, as

set forth in paragraph (n) of this section, whenever it discovers or is<