2024-31177
[Federal Register Volume 90, Number 13 (Wednesday, January 22, 2025)]
[Rules and Regulations]
[Pages 7880-7940]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-31177]
[[Page 7879]]
Vol. 90
Wednesday,
No. 13
January 22, 2025
Part III
Commodity Futures Trading Commission
-----------------------------------------------------------------------
17 CFR Parts 1, 22, 30, et al.
Regulations To Address Margin Adequacy and To Account for the Treatment
of Separate Accounts by Futures Commission Merchants; Final Rule
Federal Register / Vol. 90, No. 13 / Wednesday, January 22, 2025 /
Rules and Regulations
[[Page 7880]]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 22, 30, and 39
RIN 3038-AF21
Regulations To Address Margin Adequacy and To Account for the
Treatment of Separate Accounts by Futures Commission Merchants
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is amending its regulations, adopted under the Commodity Exchange Act
(CEA), to require a futures commission merchant (FCM) to ensure a
customer does not withdraw funds from its account with the FCM if the
balance in the account after the withdrawal would be insufficient to
meet the customer's initial margin requirements; and relatedly, to
permit an FCM, subject to certain requirements, to treat the separate
accounts of a single customer as accounts of separate entities for
purposes of certain Commission regulations.
DATES:
Effective date: This rule is effective March 24, 2025.
Compliance dates: The compliance date for FCMs that are clearing
members of a derivatives clearing organization (DCO) as of the date of
publication of this rule in the Federal Register shall be July 21,
2025. The compliance date for all other FCMs shall be January 22, 2026.
FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel,
202-418-5092, [email protected]; Daniel O'Connell, Special Counsel,
202-418-5583, [email protected], Division of Clearing and Risk; Thomas
Smith, Deputy Director, 202-418-5495, [email protected]; Liliya
Bozhanova, Associate Director, 202-418-6232, [email protected];
Jennifer Bauer, Special Counsel, 202-418-5472, [email protected], Market
Participants Division; Jasmine Lee, Special Counsel, 202-418-5226,
[email protected], Division of Market Oversight, Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC
20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. The Commission's Customer Funds Protection Regulations
B. The Divisions' No-Action Position
C. The Commission's First Proposal
D. The Commission's Second Proposal
II. Regulations
A. Amendments to Regulation Sec. 1.3
B. Amendments to Regulation Sec. 1.17
C. Amendments to Regulations Sec. Sec. 1.20, 1.32, 22.2, and
30.7
D. Regulation Sec. 1.44(a)
E. Regulation Sec. 1.44(b)
F. Regulation Sec. 1.44(c)
G. Regulation Sec. 1.44(d)
H. Regulation Sec. 1.44(e)
I. Regulation Sec. 1.44(f)
J. Regulation Sec. 1.44(g)
K. Regulation Sec. 1.44(h)
L. Appendix A to Part 1
M. Amendments to Regulation Sec. 1.58
N. Amendments to Regulation Sec. 1.73
O. Amendments to Regulation Sec. 30.2
P. Amendments to Regulation Sec. 39.13
III. Cost Benefit Considerations
A. Introduction
B. Consideration of the Costs and Benefits of the Commission's
Action
C. Costs and Benefits of the Commission's Action as Compared to
Alternatives
D. Section 15(a) Factors
IV. Related Matters
A. Antitrust Considerations
B. Regulatory Flexibility Act
C. Paperwork Reduction Act
D. Congressional Review Act
I. Background
A. The Commission's Customer Funds Protection Regulations
Protection of market participants from misuses of customer assets
and avoidance of systemic risk are two of the fundamental purposes of
the CEA.\1\ The Commission has promulgated regulations designed to
protect customer assets, including regulations designed to ensure that
FCMs appropriately margin customer accounts and are not induced to
cover one customer's margin shortfall with another customer's funds.
The Commission has also promulgated regulations designed to diminish
the risk that a customer default in its obligations to an FCM that is a
clearing member of a DCO (clearing FCM) results in the clearing FCM in
turn defaulting on its obligations to a DCO, which could adversely
affect the stability of the broader financial system.
---------------------------------------------------------------------------
\1\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
---------------------------------------------------------------------------
Section 4d(a)(2) of the CEA and regulation Sec. 1.20(a) require an
FCM to separately account for, and segregate from its own funds, all
money, securities, and property it has received to margin, guarantee,
or secure the trades or contracts of its commodity customers.\2\
Additionally, section 4d(a)(2) of the CEA and regulation Sec. 1.22(a)
prohibit an FCM from using the money, securities, or property of one
customer to margin or settle the trades or contracts of another
customer.\3\ This requirement is designed to prevent an FCM from
treating customers disparately and to mitigate the risk that the FCM
will not maintain sufficient funds in segregation to pay all customer
claims if the FCM becomes insolvent.\4\ Section 4d(a)(2) of the CEA and
regulations Sec. Sec. 1.20 and 1.22 effectively require an FCM to add
its own funds into segregation in an amount equal to the sum of all
customer undermargined amounts, including customer account deficits, to
prevent the FCM from being induced to use one customer's funds to
margin or carry another customer's trades or contracts.\5\
---------------------------------------------------------------------------
\2\ 7 U.S.C. 6d(a)(2); 17 CFR 1.20(a).
\3\ 7 U.S.C. 6d(a)(2); 17 CFR 1.22(a).
\4\ Prohibition of Guarantees Against Loss, 46 FR 11668, 11669
(Feb. 10, 1981).
\5\ 7 U.S.C. 6d(a)(2); 17 CFR 1.20; 17 CFR 1.22; Prohibition of
Guarantees Against Loss, 46 FR at 11669.
---------------------------------------------------------------------------
Section 5b of the CEA,\6\ as amended by the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010,\7\ sets forth eighteen core
principles with which DCOs must comply to register and maintain
registration as DCOs with the Commission. In 2011, the Commission
adopted regulations for DCOs to implement Core Principle D, which
concerns risk management.\8\ These regulations include a number of
provisions that require a DCO to in turn require that its clearing
members take certain steps to support their own risk management to
mitigate the risk that such clearing members pose to the DCO.
---------------------------------------------------------------------------
\6\ 7 U.S.C. 7a-1.
\7\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\8\ Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D);
Derivatives Clearing Organization General Provisions and Core
Principles, 76 FR 69334, 69335 (Nov. 8, 2011).
---------------------------------------------------------------------------
One such regulation, Sec. 39.13(g)(8)(iii), provides that a DCO
shall require a clearing member to ensure that a customer does not
withdraw funds from its account with the clearing member unless the net
liquidating value plus the margin deposits remaining in the customer's
account after the withdrawal would be sufficient to meet the customer
initial margin requirements with respect to all products and swap
portfolios held in the customer's account that are cleared by the
DCO.\9\ Regulation Sec. 39.13(g)(8)(iii) thus establishes a ``Margin
Adequacy Requirement'' designed to mitigate the risk that a clearing
FCM fails to hold customer funds sufficient to cover the required
initial margin for the customer's cleared positions.\10\ In light
[[Page 7881]]
of the use of omnibus margin accounts, in which the funds of multiple
customers are held together, this safeguard is necessary to avoid the
misuse of customer funds by mitigating the likelihood that the clearing
FCM will effectively cover one customer's margin shortfall using
another customer's funds.\11\
---------------------------------------------------------------------------
\9\ 17 CFR 39.13(g)(8)(iii).
\10\ For purposes of this final rule, the Commission uses the
term ``Margin Adequacy Requirement'' to refer to this requirement,
which applies indirectly to clearing FCMs via the operation of DCO
rules, and the analogous requirement set forth in regulation Sec.
1.44(b) which will apply directly to all FCMs.
\11\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
---------------------------------------------------------------------------
In adopting the Margin Adequacy Requirement of regulation Sec.
39.13(g)(8)(iii), the Commission stated \12\ that the regulation was
consistent with the definition of ``Margin Funds Available for
Disbursement'' in the Margins Handbook \13\ prepared by the Joint Audit
Committee (JAC), a representative committee of U.S. futures exchanges
and the National Futures Association (NFA).\14\ The Commission noted
that although designated self-regulatory organizations (DSROs) reviewed
FCMs to determine whether they appropriately prohibited their customers
from withdrawing funds from their futures accounts, it was unclear to
what extent that requirement applied to cleared swap accounts when such
swaps were executed on a designated contract market (DCM) that
participated in the JAC.\15\ The Commission also noted that clearing
members that cleared only swaps that were executed on a swap execution
facility were not subject to the requirements of the JAC Margins
Handbook or review by a DSRO.\16\
---------------------------------------------------------------------------
\12\ Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR at 69379.
\13\ Joint Audit Committee Margins Handbook, available at http://www.jacfutures.com/jac/MarginHandBookWord.aspx.
\14\ JAC, JAC Members, available at http://www.jacfutures.com/jac/Members.aspx. Self-regulatory organizations, such as commodity
exchanges and registered futures associations (e.g., NFA), enforce
minimum financial and reporting requirements, among other
responsibilities, for their members. See regulation Sec. 1.3, 17
CFR 1.3. Pursuant to regulation Sec. 1.52(d), when an FCM is a
member of more than one self-regulatory organization, the self-
regulatory organizations may decide among themselves which of them
will assume primary responsibility for these regulatory duties and,
upon approval of such a plan by the Commission, the self-regulatory
organization assuming such primary responsibility will be appointed
the designated self-regulatory organization for the FCM. 17 CFR
1.52(d).
\15\ Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR at 69379.
\16\ Id.
---------------------------------------------------------------------------
Thus, although regulation Sec. 39.13(g)(8)(iii) was also designed
to apply these risk mitigation and customer protection standards to
futures and swap positions carried in customer accounts by clearing
FCMs, Commission regulations do not apply a Margin Adequacy Requirement
to non-clearing FCMs. Furthermore, regulation Sec. 39.13(g)(8)(iii)
does not require DCOs to apply a Margin Adequacy Requirement to the
positions carried by a clearing FCM that are not cleared at a
registered DCO (e.g., most foreign futures and foreign option
positions).\17\
---------------------------------------------------------------------------
\17\ The term ``foreign futures'' means any contract for the
purchase or sale of any commodity for future delivery made, or to be
made, on or subject to the rules of any foreign board of trade.
Regulation Sec. 30.1(a), 17 CFR 30.1(a). The term ``foreign
option'' means any transaction or agreement which is or is held out
to be of the character of, or is commonly known to the trade as, an
``option,'' ``privilege,'' ``indemnity,'' ``bid,'' ``offer,''
``put,'' ``call,'' ``advance guaranty'' or ``decline guaranty,''
made or to be made on or subject to the rules of any foreign board
of trade. 17 CFR 30.1(b).
---------------------------------------------------------------------------
B. The Divisions' No-Action Position
On July 10, 2019, the Division of Swap Dealer and Intermediary
Oversight (DSIO) (now Market Participants Division (MPD)) and the
Division of Clearing and Risk (DCR) (collectively, the Divisions)
published CFTC Letter No. 19-17, which, among other things, provides
staff guidance with respect to the processing of margin withdrawals
under regulation Sec. 39.13(g)(8)(iii) and announced a conditional and
time-limited no-action position for certain such withdrawals.\18\ The
advisory followed discussions with, and written representations from,
the Asset Management Group of the Securities Industry and Financial
Markets Association (SIFMA-AMG), the Chicago Mercantile Exchange (CME),
the Futures Industry Association (FIA), the JAC, and several FCMs,
regarding practices among FCMs and their customers related to the
handling of separate accounts of the same customer.\19\
---------------------------------------------------------------------------
\18\ CFTC Letter No. 19-17, July 10, 2019, available at https://www.cftc.gov/csl/19-17/download as extended by CFTC Letter No. 20-
28, Sept. 15, 2020, available at https://www.cftc.gov/csl/20-28/download; CFTC Letter No. 21-29, Dec. 21, 2021, available at https://www.cftc.gov/csl/21-29/download; CFTC Letter No. 22-11, Sept. 15,
2022, available at https://www.cftc.gov/csl/22-11/download; CFTC
Letter No. 23-13, Sept. 11, 2023, available at https://www.cftc.gov/csl/23-13/download; and CFTC Letter No. 24-07, June 24, 2024,
available at https://www.cftc.gov/csl/24-07/download.
\19\ See, e.g., SIFMA-AMG letter dated June 7, 2019 to Brian A.
Bussey and Matthew B. Kulkin (SIFMA-AMG Letter); CME letter dated
June 14, 2019 to Brian A. Bussey and Matthew B. Kulkin (CME Letter);
and FIA letter dated June 26, 2019 to Brian A. Bussey and Matthew B.
Kulkin (First FIA Letter).
---------------------------------------------------------------------------
CFTC Letter No. 19-17 used the term ``beneficial owner''
synonymously with the term ``customer,'' as ``beneficial owner'' was,
in this context, commonly used to refer to the customer that is
financially responsible for an account. Additionally, as discussed
further below, in the customer relationship context, FCMs often deal
directly with a commodity trading advisor acting as an agent of the
customer rather than with the customer itself. For the avoidance of
confusion (e.g., with regard to the terms ``owner'' or ``ownership,''
as those terms are used in Forms 40 and 102,\20\ or parts 17-20,\21\ or
with regard to the term ``beneficial owner,'' as that term may be used
by other agencies), this final rule uses only the term ``customer,''
except where directly quoting or paraphrasing a source that uses the
term ``beneficial owner.''
---------------------------------------------------------------------------
\20\ See CFTC, CFTC Form 40, Statement of a Reporting Trader,
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform40.pdf; see also CFTC,
Ownership & Control Reporting, available at https://www.cftc.gov/Forms/OCR/index.htm (discussing Ownership and Control Reporting
under Form 102).
\21\ See 17 CFR parts 17 (covering reports by reporting markets,
FCMs, clearing members, and foreign brokers), 18 (reports by
traders), 19 (reports by persons holding reportable positions in
excess of position limits and by merchants and dealers in cotton),
and 20 (large trader reporting for physical commodity swaps).
---------------------------------------------------------------------------
The written representations preceding the issuance of CFTC Letter
No. 19-17 included letters filed separately by SIFMA-AMG, CME, and FIA
(collectively, the ``Industry Letters''). Citing regulation Sec.
39.13(g)(8)(iii)'s requirements related to the withdrawal of customer
initial margin, and JAC Regulatory Alert #19-02 reminding FCMs of those
requirements,\22\ SIFMA-AMG and FIA explained that provisions in
certain FCM customer agreements provide that certain accounts carried
by the FCM that have the same customer are treated as accounts for
different legal entities (i.e., ``separate accounts'').\23\
---------------------------------------------------------------------------
\22\ JAC, Regulatory Alert #19-02, May 14, 2019, available at
http://www.jacfutures.com/jac/jacupdates/2019/jac1902.pdf.
\23\ SIFMA-AMG Letter; First FIA Letter.
---------------------------------------------------------------------------
As FIA explained, there are a variety of reasons why a customer may
want separate treatment for its accounts under such an agreement.\24\
For instance, an institutional customer, such as an investment or
pension fund, may allocate assets to investment managers \25\ under
investment management agreements that require each investment manager
to invest a specified portion of the customer's assets under management
in accordance with an agreed trading strategy, independent of the
trading that may be undertaken for the customer by the same or other
investment manager(s) acting on behalf of other accounts of the
[[Page 7882]]
customer.\26\ Under such a circumstances, an investment manager, in
order to implement its trading strategy effectively, may want assurance
that the portion of funds it has been allocated to manage is entirely
available to the investment manager, and will not be affected by the
activities of other investment managers who manage other portions of
the customer's assets and maintain separate accounts at the same FCM.
---------------------------------------------------------------------------
\24\ First FIA Letter.
\25\ The Industry Letters sometimes used the terms ``investment
manager'' and ``asset manager'' interchangeably.
\26\ Id.
---------------------------------------------------------------------------
Additionally, as FIA explained, a commercial enterprise may
establish separate agreements to leverage specific broker expertise on
products or to diversify risk management strategies.\27\ In such cases,
each separate account may be subject to a separate customer agreement,
which the FCM in many cases negotiates directly with the customer's
agent, which is often an investment manager.\28\
---------------------------------------------------------------------------
\27\ Id.
\28\ Id.
---------------------------------------------------------------------------
SIFMA-AMG and FIA asserted that, subject to appropriate FCM
internal controls and procedures, separate accounts should be treated
as separate legal entities for purposes of regulation Sec.
39.13(g)(8)(iii); i.e., separate accounts should not be combined when
determining an account's margin funds available for disbursement.\29\
SIFMA-AMG and FIA maintained that such separate account treatment
should not be expected to expose an FCM to any greater regulatory or
financial risk, and asserted that an FCM's internal controls and
procedures could be designed to assure that the FCM does not undertake
any additional risk as to the separate account.\30\ The Industry
Letters included a number of examples of such controls and
procedures.\31\
---------------------------------------------------------------------------
\29\ SIFMA-AMG Letter; First FIA Letter.
\30\ SIFMA-AMG Letter; First FIA Letter.
\31\ SIFMA-AMG Letter; First FIA Letter; CME Letter.
---------------------------------------------------------------------------
In its letter, SIFMA-AMG suggested that it would be possible to
allow for separate account treatment without undermining the risk
mitigation and customer protection goals of regulation Sec.
39.13(g)(8)(iii).\32\ SIFMA-AMG recognized that there may be some
instances, such as a customer default, in which separate account
margining would no longer be prudent.\33\ SIFMA-AMG stated that an FCM
could agree to first satisfy any amounts owed from agreed assets
related to a separate account, and continue to release funds until the
FCM provided the separate account with a notice of an event of default
under the applicable clearing account agreement, and determined that it
is no longer prudent to continue to separately margin the customer's
accounts, provided that such actions are consistent with the FCM's
written internal controls and procedures.\34\ SIFMA-AMG further stated
that, in such instance, the FCM would retain the ability to ultimately
look to funds in other accounts of the customer, including accounts
under different control, and the right to call the customer for
funds.\35\ CME similarly asserted that disbursements on a separate
account basis should not be permitted in certain circumstances, such as
financial distress, that fall outside the ``ordinary course of
business.'' \36\ Although CME asserted that the plain language of
regulation Sec. 39.13(g)(8)(iii) unambiguously forbids disbursements
on a separate account basis, CME noted that it would be amenable to the
Commission amending the regulation to permit such disbursements,
subject to certain such risk-mitigating conditions.\37\
---------------------------------------------------------------------------
\32\ SIFMA-AMG Letter.
\33\ Id.
\34\ Id.
\35\ Id.
\36\ CME Letter.
\37\ Id.
---------------------------------------------------------------------------
SIFMA-AMG and FIA requested that DCR confirm that it would not
recommend that the Commission initiate an enforcement action against a
DCO that permits its clearing FCMs to treat certain separate accounts
of a customer as accounts of separate entities for purposes of
regulation Sec. 39.13(g)(8)(iii),\38\ and confirm that a clearing FCM
may release excess funds from a separate customer account
notwithstanding an outstanding margin call in another account of the
same customer.\39\
---------------------------------------------------------------------------
\38\ FIA specifically noted that such a no-action position could
be conditioned on the FCM maintaining certain internal controls and
procedures. First FIA Letter.
\39\ SIFMA-AMG Letter; First FIA Letter; see also CME Letter.
---------------------------------------------------------------------------
In CFTC Letter No. 19-17, DCR stated that, in the context of
separate accounts, the risk management goals of regulation Sec.
39.13(g)(8)(iii) may effectively be addressed if a clearing FCM
carrying a customer with separate accounts meets certain conditions,
which were derived from the Industry Letters and specified in CFTC
Letter No. 19-17.\40\ DCR stated that it would not recommend that the
Commission take enforcement action against a DCO if the DCO permits its
clearing FCMs to treat certain separate accounts as accounts of
separate entities for purposes of regulation Sec. 39.13(g)(8)(iii)
subject to these conditions.\41\ The no-action position extended until
June 30, 2021, in order to provide staff with time to recommend, and
the Commission with time to consider, a rulemaking to implement on a
permanent basis requirements related to separate account treatment.\42\
CFTC Letter No. 20-28, published on September 15, 2020, extended the
no-action position until December 31, 2021 due to challenges presented
by the COVID-19 pandemic.\43\ CFTC Letter No. 20-28 stated that if the
process to consider codifying the no-action position provided for by
CFTC Letter No. 19-17 was not completed by that date, the Divisions
would consider further extending the no-action position.\44\ The
Divisions have continued to extend the no-action position in CFTC
Letter No. 19-17 as they have worked toward a final rule. The no-action
position currently expires on the earlier of June 30, 2025 or the
effective date of this final rule.\45\
---------------------------------------------------------------------------
\40\ CFTC Letter No. 19-17.
\41\ Id.
\42\ Id.
\43\ CFTC Letter No. 20-28.
\44\ Id.
\45\ CFTC Letter No. 24-07.
---------------------------------------------------------------------------
C. The Commission's First Proposal
On April 14, 2023, the Commission published in the Federal Register
a notice of proposed rulemaking designed to codify the no-action
position in CFTC Letter No. 19-17 (First Proposal).\46\ The First
Proposal proposed to amend regulation Sec. 39.13 to allow a DCO to
permit a clearing FCM to treat the separate accounts of customers as
accounts of separate entities for purposes of regulation Sec.
39.13(g)(8)(iii), if such clearing member's written internal controls
and procedures permitted it to do so, and the DCO required its clearing
members to comply with risk-mitigating requirements based on the
conditions in CFTC Letter No. 19-17.
---------------------------------------------------------------------------
\46\ Derivatives Clearing Organization Risk Management
Regulations to Account for the Treatment of Separate Accounts by
Futures Commission Merchants, 88 FR 22934 (Apr. 14, 2023) (First
Proposal).
---------------------------------------------------------------------------
The requirements for separate account treatment in the First
Proposal were substantially similar to the conditions in CFTC Letter
No. 19-17. However, certain such proposed requirements reflected
modification of the no-action conditions on which they were based,
including additional reporting requirements for clearing FCMs required
to cease disbursements on a separate account basis, an explicit process
for clearing FCMs to resume disbursements on a separate account basis,
and
[[Page 7883]]
provisions designed to further clarify the requirement that separate
accounts be on a one business day margin call.
The Commission originally proposed to codify the no-action position
in CFTC Letter No. 19-17 in part 39 to hew closely to the operation of
the no-action position itself. Under the First Proposal, DCOs would be
able to permit clearing FCMs to engage in separate account treatment,
provided such clearing FCMs complied with certain requirements, which
DCOs would be required to monitor and enforce through their rules.
The comment period for the First Proposal was extended once at the
request of a commenter and closed on June 30, 2023.\47\ The Commission
received comments from twelve commenters.\48\ Although commenters
generally supported codifying the no-action position in CFTC Letter No.
19-17, six commenters \49\ contended that the Commission should codify
the no-action position in its part 1 FCM regulations (where it would
apply directly to all FCMs) rather than in its part 39 DCO regulations
(where it would apply only to clearing FCMs, through the
instrumentality of DCO rules). Other commenters did not opine on
whether the proposed codification should be in part 1 versus part 39.
---------------------------------------------------------------------------
\47\ Derivatives Clearing Organization Risk Management
Regulations to Account for the Treatment of Separate Accounts by
Futures Commission Merchants, 88 FR 39205 (June 15, 2023).
\48\ The American Council of Life Insurers, CME, FIA,
Intercontinental Exchange, Inc., the JAC, MFA (formerly Managed
Funds Association), NFA, SIFMA-AMG, Symphony Communications
Services, LLC, and three individuals.
\49\ CME, FIA, Intercontinental Exchange, Inc., the JAC, NFA,
and SIFMA-AMG.
---------------------------------------------------------------------------
D. The Commission's Second Proposal
On February 20, 2024, the Commission voted to approve withdrawal of
the First Proposal and publish a notice of proposed rulemaking to
codify a Margin Adequacy Requirement similar to that of regulation
Sec. 39.13(g)(8)(iii), along with the no-action position in CFTC
Letter No. 19-17, in part 1 of its regulations, whereby it would be
applicable to all FCMs (Second Proposal).\50\ In the Second Proposal,
the Commission discussed and addressed comments received in response to
the First Proposal, including the comments that informed the
Commission's decision to withdraw the First Proposal and instead
propose to codify the no-action position of CFTC Letter No. 19-17 in
part 1.
---------------------------------------------------------------------------
\50\ Regulations to Address Margin Adequacy and To Account for
the Treatment of Separate Accounts by Futures Commission Merchants,
89 FR 15312 (Mar. 1, 2024) (Second Proposal). The Second Proposal
also contained supporting amendments in parts 1, 22, 30, and 39.
---------------------------------------------------------------------------
The notice of proposed rulemaking and withdrawal were published in
the Federal Register on March 1, 2024. The Commission is finalizing the
Second Proposal, with modifications responding to the comments
received. The bulk of the final rule will be contained in new
regulation Sec. 1.44. However, as explained below, the Commission is
also finalizing supporting amendments in regulations Sec. Sec. 1.3,
1.17, 1.20, 1.32, 1.58, 1.73, 22.2, 30.2, 30.7, and 39.13 to facilitate
implementation of regulation Sec. 1.44. The Commission is additionally
finalizing amendments to address inadvertent inconsistencies in
existing regulations.\51\
---------------------------------------------------------------------------
\51\ These are changes to regulation Sec. 1.3 (to clarify that
Saturday is not a business day); regulation Sec. 1.17(b) (to
reorganize the wording of the definition of the term ``business
day'' for capital purposes to be consistent with the wording in the
amendments to regulation Sec. 1.3, to clarify that the definition
of the term ``risk margin'' includes both customer and noncustomer
accounts, and to change the term ``FCM'' to read ``futures
commission merchant''); regulations Sec. Sec. 1.20(i), 30.7(f)(2),
and 22.2(f) (to revise the regulatory description of the calculation
of the total amount of funds that an FCM must hold in segregation
for futures customers, Cleared Swaps Customers, and 30.7 customers,
respectively, to align such description with the Commission's
financial forms and the instructions to such forms, reorganizing
regulations Sec. 22.2(f)); regulation Sec. 1.58(a) and (b) (to
clarify that gross margining requirements for omnibus accounts
carried for one FCM at another FCM apply to Cleared Swaps as well as
to futures and options on futures); and Sec. 30.2(b) (to clarify
that, in the context of the exclusion for applying certain
regulations to persons and transactions subject to the requirements
of part 30, existing regulations Sec. Sec. 1.41, 1.42, and 1.43
(which were added in the 2021 part 190 bankruptcy rulemaking) are
not excluded). These changes are discussed in greater detail in the
relevant sections below.
---------------------------------------------------------------------------
Regulation Sec. 1.44 is comprised of eight subsections. Regulation
Sec. 1.44(a) defines key terms solely for purposes of regulation Sec.
1.44. Regulation Sec. 1.44(b) incorporates, for all FCMs, and for all
accounts,\52\ the same Margin Adequacy Requirement that DCOs are
obligated in regulation Sec. 39.13(g)(8)(iii) to require their
clearing FCMs to apply. Regulation Sec. 1.44(c) makes clear that an
FCM can provide disbursements on a separate account basis only during
the ``ordinary course of business,'' a term that is defined in proposed
regulation Sec. 1.44(a). Regulation Sec. 1.44(d) explains how FCMs
may elect to engage in separate account treatment for one or more
customers. Regulation Sec. 1.44(e) enumerates the events that are
inconsistent with the ordinary course of business for purposes of
regulation Sec. 1.44 and contains requirements for FCMs related to
cessation of disbursements on a separate account basis upon the
occurrence of such events, and resumption of separate account
disbursements upon the cure of such events. Regulation Sec. 1.44(f)
contains the requirement that each separate account be on a ``one
business day margin call'' and sets out provisions designed to
establish how a one business day margin call is to be made and met for
purposes of regulation Sec. 1.44. Regulation Sec. 1.44(g) sets forth
capital, risk management, and segregation calculation requirements for
FCMs with respect to accounts for which the FCM has elected separate
treatment. Lastly, regulation Sec. 1.44(h) articulates information and
disclosure requirements for FCMs that engage in separate account
treatment.
---------------------------------------------------------------------------
\52\ Regulation Sec. 1.44(a) defines ``account'' to include
futures accounts and Cleared Swaps Customer Accounts, both of which
terms are defined in regulation Sec. 1.3, and 30.7 accounts. A 30.7
account means any account maintained by an FCM for or on behalf of
30.7 customers to hold money, securities, or other property to
margin, guarantee, or secure foreign futures or foreign options. 17
CFR 30.1(g).
---------------------------------------------------------------------------
II. Regulations
Section 8a(5) of the CEA \53\ authorizes the Commission ``to make
and promulgate such rules and regulations as, in the judgment of the
Commission, are reasonably necessary to effectuate any of the
provisions or to accomplish any of the purposes of'' the CEA. The
Commission is promulgating these rules pursuant to section 8a(5) as
reasonably necessary to effectuate sections 4d(a)(2) and 4d(f)(2) of
the CEA,\54\ providing for the segregation and protection of,
respectively, futures customer funds and Cleared Swaps Customer
Collateral, and section 4(b)(2)(A) of the CEA,\55\ providing for the
safeguarding of customers' funds in connection with foreign futures and
foreign option transactions. The Commission is also promulgating these
rules as reasonably necessary to effectuate section 4f(b) of the CEA,
which requires an FCM to meet minimum financial requirements prescribed
by the Commission as necessary to ensure that the FCM meets its
obligations.\56\ Moreover, the Commission is promulgating these rules
as reasonably necessary to accomplish the purposes of the CEA as set
forth in section 3(b); \57\ specifically, ``the avoidance of systemic
risk'' and ``protect[ing] all market participants from . . . misuses of
customer assets.''
---------------------------------------------------------------------------
\53\ 7 U.S.C. 12a(5).
\54\ 7 U.S.C. 6d(a)(2) and (f)(2).
\55\ 7 U.S.C. 6(b)(2)(A).
\56\ 7 U.S.C. 6f(b).
\57\ 7 U.S.C. 5(b).
---------------------------------------------------------------------------
Accordingly, the Commission believes that the amendments adopted
herein relating to the Margin Adequacy
[[Page 7884]]
Requirement, and the modification of this requirement to permit,
subject to certain further conditions, separate account treatment in
connection with the withdrawal of customer initial margin, support the
customer funds protection and risk management provisions and purposes
of the CEA. As further described below, the Commission also believes
that preventing the undermargining of customer accounts and mitigating
the risk of a clearing member default, or the default of a non-clearing
FCM, and the potential for systemic risk in either scenario, is
effectively addressed by the standards set forth in this final rule.
All FCMs are currently subject to a detailed set of requirements
designed to provide effective protection for customer funds. These
include, for futures accounts, regulations Sec. Sec. 1.20 (requiring
segregation of customer funds), 1.22 (requiring, inter alia, residual
interest to cover undermargined amounts), and 1.23 (requiring FCMs to
maintain residual interest in segregated accounts up to a targeted
amount that they determine based on specified considerations), as well
as similar regulatory obligations with respect to Cleared Swaps
Customer Accounts (respectively, regulations Sec. Sec. 22.2(d) and (f)
and 22.17), and 30.7 accounts (regulation Sec. 30.7).
Regulation Sec. 39.13(g)(8)(iii) provides, through the Margin
Adequacy Requirement, an additional layer of protection for customer
funds, but only with respect to FCMs that are clearing members of DCOs.
Prior to this final rule, there was no analogous Margin Adequacy
Requirement applicable to FCMs that are not clearing members of DCOs.
As discussed above, regulation Sec. 39.13(g)(8)(iii) is designed to
mitigate the risk that a clearing member fails to hold, from a
customer, funds sufficient to cover the required initial margin for the
customer's cleared positions and, in light of the use of omnibus margin
accounts, avoid the misuse of customer funds by reducing the likelihood
that the clearing member will cover one customer's margin shortfall
using another customer's funds.\58\ Accordingly, regulation Sec.
39.13(g)(8)(iii) provides risk mitigation benefits for DCOs, clearing
FCMs, and customers. The effect of the staff no-action position in CFTC
Letter No. 19-17 is to allow DCOs to permit clearing FCMs to engage in
separate account treatment for purposes of that provision, but subject
to conditions designed to maintain the provision's risk mitigating
effects.
---------------------------------------------------------------------------
\58\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
---------------------------------------------------------------------------
By establishing requirements for separate account treatment for all
FCMs through the addition of a similar Margin Adequacy Requirement to
part 1, the Commission seeks to replicate the regulatory structure
presented by the interaction of regulation Sec. 39.13(g)(8)(iii) and
the no-action position of CFTC Letter No. 19-17 for all FCMs, and
further the customer fund protection and risk mitigation purposes of
the CEA \59\ by implementing measures designed to further ensure that
all FCMs, whether clearing or non-clearing, do not create or exacerbate
an undermargining scenario.
---------------------------------------------------------------------------
\59\ Section 3(b) of the CEA, 7 U.S.C. 5(b) (It is the purpose
of the CEA to ensure the financial integrity of all transactions
subject to this Act and the avoidance of systemic risk and to
protect all market participants from misuses of customer assets'').
---------------------------------------------------------------------------
The requirements for separate account treatment established herein
are designed to (i) ensure that FCMs carry out separate account
treatment in a consistent and documented manner; (ii) monitor customer
accounts on a separate and combined basis; (iii) identify and act upon
instances of financial or operational distress that necessitate a
cessation of disbursements on a separate account basis; (iv) provide
appropriate disclosures to customers \60\ regarding separate account
treatment; and (v) apprise their DSROs when they apply separate account
treatment or when an event has occurred that would necessitate
cessation of disbursements on a separate account basis.\61\
---------------------------------------------------------------------------
\60\ In this final rule, references to a ``customer'' are to a
direct customer of the FCM in question. Thus, where non-clearing FCM
N clears through clearing FCM C, a customer (including a separate
account customer) of N is not considered a customer of C.
\61\ For the avoidance of doubt, the final rule permits an FCM
to decide to engage in separate account treatment for a set of
customers. It neither requires an FCM to engage in such treatment
nor requires a customer of an FCM that decides to engage in separate
account treatment for certain customers to choose to have its
accounts with such FCM treated as separate accounts of separate
entities. Thus, separate account treatment should involve an
affirmative decision by both the FCM and the customer.
---------------------------------------------------------------------------
The amendments are designed to extend the customer protection and
risk management benefits of regulation Sec. 39.13(g)(8)(iii) to all
FCMs and all of their customer accounts, and to provide an alternative
means of achieving those risk management goals if the FCM elects to
permit customers to maintain separate accounts.\62\ Additionally, as
discussed further below in the cost benefit considerations, because a
number of clearing FCMs have already implemented the conditions set
forth in CFTC Letter No. 19-17, some FCMs will have already
implemented, in significant part, the requirements established herein.
---------------------------------------------------------------------------
\62\ As a result, regulation Sec. 1.44 prohibits the
application of portfolio margining or cross-margining treatment
between separate accounts of the same customer, but would not
prohibit the application of such treatments within a particular
separate account of a customer.
---------------------------------------------------------------------------
The Commission received comment letters in response to the Second
Proposal from the JAC, FIA, SIFMA-AMG, CME, Intercontinental Exchange,
Inc. (ICE), the Options Clearing Corporation (OCC), and MFA (formerly
Managed Funds Association). Commenters supported the Commission's
proposal to codify the no-action position of CFTC Letter No. 19-17 and
the Commission's proposed approach to base that codification in part 1.
Certain commenters commented on the substantive requirements proposed,
as well as how the proposed requirements may interact with one another
and with other Commission regulations, and suggested modifications to
the Second Proposal. The Commission addresses these comments in the
discussion below. Additionally, the Commission posed specific questions
for comment in the Second Proposal. Although in three instances
commenters responded explicitly to these questions,\63\ FIA noted that
it considers its comment letter responsive to Questions 1-4, 6, and 7
in its discussion of proposed amendments to regulation Sec. 1.17 and
proposed regulation Sec. 1.44(d), (f), and (h), including proposed
requirements for the disclosure of information in the Disclosure
Document required by regulation Sec. 1.55(i).\64\
---------------------------------------------------------------------------
\63\ FIA (Question 4), the JAC (Question 5) and CME (Question
8).
\64\ FIA Comment Letter.
---------------------------------------------------------------------------
Questions 1 and 2 concerned the Second Proposal generally. In
Question 1, the Commission requested comment regarding whether, in
light of changes made in the Second Proposal relative to the First
Proposal, the Commission should consider any requirements for separate
account treatment additional to those contained in regulation Sec.
1.44 as proposed or modify or remove any of the proposed requirements.
In Question 2, the Commission requested comment regarding whether the
interaction between regulation Sec. 1.44(g)-(h) as proposed and other
regulations under parts 1, 22, and 30 affected by the proposed
requirements (e.g., regulations Sec. Sec. 1.17, 1.20, 1.22, 1.23,
1.32, 1.55, 1.58, 1.73, 22.2, 30.2, and 30.7) was sufficiently clear.
No commenters responded explicitly to these questions, although, as
indicated above, certain comments addressed the thematic issues these
questions raise.
[[Page 7885]]
A. Amendments to Regulation Sec. 1.3
The definitions contained in regulation Sec. 1.3 are key to
understanding and interpreting the Commission's regulations, including
part 1 FCM regulations. The Commission believes the provisions of
regulation Sec. 1.44 require an amendment to regulation Sec. 1.3.
The Commission proposed to amend the definition of ``business day''
in regulation Sec. 1.3. Prior to this final rule, regulation Sec. 1.3
provided, in relevant part, that ``business day'' meant any day other
than a Sunday or holiday. The term ``business day'' is intended to
encompass days on which banks and custodians are open in the United
States to facilitate payment of margin. For the avoidance of doubt,
``holiday'' in this context refers to holidays in the United States.
The Commission proposed to modify the definition of ``business day'' in
regulation Sec. 1.3 to confirm that the term encompasses any day other
than a Saturday, Sunday, or holiday.
The Commission notes that, in actual practice, Saturdays are
generally not treated as business days in the markets,\65\ by market
participants, or for regulatory purposes.\66\ The Commission proposed
to amend the definition of ``business day'' in regulation Sec. 1.3 to
conform to that reality. In connection with the proposed amendments to
regulation Sec. 1.3, in Question 3 of the Second Proposal, the
Commission requested comment regarding whether its proposal to revise
the definition of ``business day'' in regulation Sec. 1.3 would result
in any adverse consequences for any market participants. The Commission
did not receive any comments with respect to the proposed amendment to
the definition of ``business day'' in regulation Sec. 1.3 or
explicitly in response to Question 3. Accordingly, the Commission is
adopting the amendment to the definition of ``business day'' in
regulation Sec. 1.3 as proposed.
---------------------------------------------------------------------------
\65\ It is true that some markets are moving toward 24/7
operation. The Commission will continue to monitor these
developments, and consider further rulemaking in this area as
appropriate. Nonetheless, a definition of business days that
includes Saturday, but not Sunday, does not reflect present or
plausible future reality.
\66\ For instance, Saturdays are treated as non-business days
for purposes of swaps reporting under parts 43 and 45 of the
Commission's regulations, 17 CFR 43.1; 17 CFR 45.2, execution of
confirmations by swap dealers, 17 CFR 23.501(c)(5)(ii), and under
the Commission's part 39 DCO regulations, 17 CFR 39.2 (defining an
intraday business day period). See also, e.g., CFTC, Guidebook for
Part 17.00: Reports by Reporting Markets, Futures Commission
Merchants, Clearing Members, and Foreign Brokers, at 18, May 30,
2023 (noting that for purposes of part 17.00 reports, ``reporting
entities may elect to not consider Saturdays to be a business day,
as Saturday is not commonly known as such'').
---------------------------------------------------------------------------
B. Amendments to Regulation Sec. 1.17
Regulation Sec. 1.17 establishes minimum financial requirements
for FCMs. Regulation Sec. 1.17(a)(1)(i) provides that each person
registered as an FCM must maintain adjusted net capital equal to, or in
excess of, the greatest of: (1) $1 million (or $20 million if the FCM
is also registered as a swap dealer); (2) eight percent of the total
``risk margin'' required on the positions in customer and noncustomer
accounts \67\ carried by the FCM; (3) the amount of adjusted net
capital required by NFA as a registered futures association; or (4) for
an FCM registered as a securities broker or dealer with the Securities
and Exchange Commission (SEC), the amount of net capital required by
SEC rule Sec. 15c3-1.\68\ For purposes of regulation Sec.
1.17(a)(1)(i), the term ``risk margin'' is defined by paragraph (b)(8)
of that regulation to generally mean the level of maintenance margin or
performance bond required for customer and noncustomer positions
established by the applicable exchanges or clearing organizations.
---------------------------------------------------------------------------
\67\ The term ``noncustomer account'' generally means the
accounts of affiliates of an FCM or employees of an FCM. See 17 CFR
1.17(b)(4).
\68\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------
The Commission proposed several amendments to regulation Sec. 1.17
to reflect the regulatory capital treatment of separate accounts that
would result from the implementation of proposed regulation Sec. 1.44,
including the requirements contained in regulation Sec. 1.44(g)(3),
discussed below. As a general matter, the proposed amendments to
regulation Sec. 1.17 were designed to ensure that FCMs manage risk
with respect to separate accounts consistently, and cannot revert to
calculating minimum financial requirements on a combined account basis
where such calculations would tend to reflect less risk and reduced
financial requirements for a customer than if each of the customer's
separate accounts were treated as an account of a distinct customer
without regard to the same customer's other separate accounts.
Consistent with that intent, the Commission proposed to expand the
list of modifiers to the definition of the term ``risk margin'' for an
account by adding proposed paragraph (b)(8)(v) to regulation Sec.
1.17, providing that if an FCM carries separate accounts for separate
account customers pursuant to regulation Sec. 1.44, then the FCM shall
calculate the risk margin pursuant to regulation Sec.
1.17(a)(1)(i)(B)(1) as if each separate account is owned by a separate
entity.
The Commission notes that, under the amendments as proposed, risk
margin would be calculated on an individual basis for each separate
account. Calculating risk margin separately for each separate account
would eliminate the potential for portfolio margining offsets based on
positions between separate accounts of the same separate account
customer,\69\ which would either increase, or leave unchanged, the
total risk margin requirement, and thus the minimum adjusted net
capital requirement, for an FCM providing separate account
treatment.\70\ The proposed addition of paragraph (b)(8)(v) to
regulation Sec. 1.17 was intended to further clarify that, pursuant to
the Commission's FCM capital rule, an FCM that elects to permit
separate account treatment must compute the risk margin amount for
separate accounts as if each account is an account of a separate
entity.
---------------------------------------------------------------------------
\69\ As noted in regulation Sec. 39.13(g)(4), a DCO may allow
reductions in initial margin requirements for related positions if
the price risks with respect to such positions are significantly and
reliably correlated. This includes cases where (A) The products on
which the positions are based are complements of, or substitutes
for, each other. An example might be long versus short positions in
oil and natural gas, both of which may be used for generating
energy. However, portfolio margining is applicable only to accounts
for the same customer. See regulation Sec. 39.13(g)(8)(i)
(requiring collection of initial margin on a gross basis for each
clearing member's customer accounts). So, if a customer has, in a
single account, both long oil positions and short natural gas
positions, then the customer may benefit from a reduction in initial
margin requirements for the two risk-offsetting positions. However,
if those positions are in different separate accounts of the
customer under this this final rule, then the positions would not
lead to an initial margin reduction as the positions would not be
margined on a combined or portfolio basis.
\70\ As noted above, per regulation Sec. 1.17(a)(1)(i), the
adjusted net capital requirement for an FCM is the greatest of
several calculations, one of which is eight percent of the total
risk margin requirement as defined in regulation Sec. 1.17(b)(8).
Thus, a calculation that would increase, or leave unchanged, the
risk margin requirement would correspondingly increase, or leave
unchanged, the adjusted net capital requirement.
---------------------------------------------------------------------------
In proposing to amend the definition of the term ``risk margin'' in
regulation Sec. 1.17(b)(8) to reflect separate accounts, the
Commission noted that such amendment, and the resulting potential
increase in an FCM's minimum adjusted net capital requirement under
regulation Sec. 1.17(a)(1)(i), would also affect other regulations
that impose obligations on FCMs based on their level of adjusted net
capital.\71\ The Commission also
[[Page 7886]]
noted that the proposed amendments to the minimum capital requirements
would affect an FCM's obligation to provide certain notices to the
Commission and to the FCM's DSRO under regulation Sec. 1.12.\72\
---------------------------------------------------------------------------
\71\ For example, regulation Sec. 1.17(h) conditions an FCM's
ability to repay or prepay subordinated debt obligations on the FCM
maintaining an amount of adjusted net capital that, after taking
into effect the amount of the subordinated debt payment and other
subordinate debt payments maturing within a set time period, exceeds
the FCM's minimum adjusted net capital requirement by 120 percent to
125 percent, as specified in the applicable provision of regulation
Sec. 1.17(h). See, e.g., 17 CFR 1.17(h)(2)(vii) which generally
provides, subject to certain conditions, that an FCM may not make a
prepayment on an outstanding subordinated debt obligation if such
payment would result in the FCM maintaining less than 120 percent of
its minimum adjusted net capital requirement.
\72\ See, e.g., 17 CFR 1.12(a), which requires an FCM to provide
notice to the Commission and the FCM's DSRO if the FCM's adjusted
net capital at any time is less than the minimum required by
regulation Sec. 1.17.
---------------------------------------------------------------------------
The Commission additionally proposed to amend regulation Sec. 1.58
to provide that, where a clearing FCM carries an omnibus customer
account for a non-clearing FCM, and the non-clearing FCM applies
separate account treatment, then such non-clearing FCM must calculate
initial and maintenance margin for purposes of regulation Sec. 1.58(a)
separately for each separate account. These proposed amendments to
regulation Sec. 1.58 are discussed further below.
Second, the Commission proposed to amend regulation Sec.
1.17(c)(2), which defines ``current assets'' that an FCM may recognize
and include in computing its net capital. Regulation Sec. 1.17(c)(2)
currently defines ``current assets'' to include cash and other assets
or resources commonly identified as those that are reasonably expected
to be realized in cash or sold during the next 12 months. However,
regulation Sec. 1.17(c)(2)(i) provides that an FCM must exclude from
current assets any unsecured receivables resulting from futures,
Cleared Swaps, or 30.7 accounts that liquidate to a deficit or contain
a debit ledger balance only, provided, however, that the FCM may
include a deficit or debit ledger balance in current assets until the
close of business on the business day following the date on which the
deficit or debit ledger balance originated (provided, in turn, that the
account had timely satisfied the previous day's deficits or debit
ledger balances).
The Commission proposed to amend regulation Sec. 1.17(c)(2)(i) to
provide explicitly that if an FCM carries separate accounts for
separate account customers pursuant to proposed regulation Sec. 1.44,
then the FCM must treat each separate account as an account of a
separate entity for the calculation of net capital, with certain
limitations if deficits or debit ledger balances were not satisfied
across the separate accounts of one separate account customer in
accordance with the one business day requirements. As proposed, amended
regulation Sec. 1.17(c)(2)(i) would provide that the FCM must exclude
each unsecured separate account that liquidates to a deficit or
contains a debit ledger balance only from current assets in its
calculation of net capital, provided, however, that if the separate
account is subject to a call for margin by the FCM, it may be included
in current assets until the close of business on the business day
following the date on which the deficit or debit ledger balance
originated, provided that the separate account timely satisfied a
previous day's deficit or debit ledger balance in its entirety. As
proposed, amended regulation Sec. 1.17(c)(2)(i) further provides that,
if the separate account does not satisfy a previous day's deficit or
debit ledger balance in its entirety, then the deficit or debit ledger
balance for the separate account, and any other deficits or debit
ledger balances of the separate account customer in other separate
accounts carried by the FCM, shall not be included in current assets
until all such calls are satisfied in their entirety. The Commission's
proposed amendments were intended to provide the same capital treatment
to separate accounts as is currently provided customer accounts that
liquidate to deficits or contain debit ledger balances, and to be
consistent with corresponding conditions to the no-action position in
CFTC Letter No. 19-17.\73\
---------------------------------------------------------------------------
\73\ CFTC Letter No. 19-17. The letter provides that an ``FCM
shall record each separate account independently in the FCM's books
and records, i.e., the FCM shall record separate accounts as a
receivable (debit/deficit) or payable with no offsets between the
other separate accounts of the same customer.'' Id. (Condition 6).
The letter also provides that ``the receivable from a separate
account shall only be considered secured (a current/allowable asset)
based on the assets of that separate account, not on the assets held
in another separate account of the same customer.'' Id. (Condition
7).
---------------------------------------------------------------------------
Third, the Commission proposed to amend regulation Sec.
1.17(c)(4), which defines the term ``liabilities'' for purposes of an
FCM calculating its net capital. Regulation Sec. 1.17(c)(4) generally
defines the term ``liabilities'' to mean the total money liabilities of
an FCM arising in connection with any transaction whatsoever, including
economic obligations of an FCM that are recognized and measured in
conformity with generally accepted accounting principles. Regulation
Sec. 1.17(c)(4) also provides that for purposes of computing net
capital, an FCM may exclude from its liabilities funds held in
segregation for futures customers, Cleared Swaps Customers, and 30.7
customers, provided that such segregated funds are also excluded from
the FCM's current assets in computing the firm's net capital.
The Commission proposed to amend regulation Sec. 1.17(c)(4)(ii) to
explicitly provide that an FCM that carries the separate accounts of
separate account customers pursuant to proposed regulation Sec. 1.44
must compute the amount of money, securities, and property due to a
separate account customer as if each separate account of the separate
account customer is a distinct customer. The Commission further
proposed to amend regulation Sec. 1.17(c)(4)(ii) to provide that an
FCM, in computing its net capital, may exclude funds held in
segregation for separate account customers from the FCM's liabilities,
provided that funds held in segregation for separate account customers
are also excluded from the FCM's current assets. The purpose of the
proposed amendment is to ensure that an FCM, in computing its net
capital, reflects separate accounts in a consistent manner in
determining its total current assets and liabilities.
Fourth, the Commission proposed to amend regulation Sec.
1.17(c)(5), which defines the term ``adjusted net capital.'' Regulation
Sec. 1.17(c)(5)(viii) provides, in relevant part, that adjusted net
capital means net capital minus, among other items detailed in
regulation Sec. 1.17(c)(5), the amount of funds required in each
customer account to meet maintenance margin requirements of the
applicable board of trade or, if there are no such maintenance margin
requirements, clearing organization margin requirements applicable to
the account's positions. FCMs are allowed to apply (that is, to reduce
the amount of this deduction from capital by) ``calls for margin or
other required deposits which are outstanding no more than one business
day.'' \74\ However, once a customer fails to meet a margin call within
one business day, the FCM loses that one business day period for
receiving any of that customer's future margin calls, until the point
in time at which the customer is no longer undermargined.\75\
---------------------------------------------------------------------------
\74\ 17 CFR 1.17(c)(5)(viii).
\75\ Thus, if, due to activity on Monday, Customer A is
undermargined by $150, and the FCM calls Customer A for that margin
on Tuesday, then the FCM does not need to deduct that $150 from its
net capital in computing its adjusted net capital, so long as the
margin call is met by the close of business on Wednesday. Moreover,
if Customer A, due to activity on Tuesday, is undermargined by an
additional $100, and the FCM calls for that additional $100 on
Wednesday, then the FCM does not need to deduct that additional $100
on Wednesday. If Customer A meets the $150 call by close of business
Wednesday, and the $100 call by close of business on Thursday, then
no deduction need be taken for either the $150 or the $100 margin
calls. However, if Customer A fails to meet Tuesday's $150 call by
close of business on Wednesday, then the FCM must deduct both the
$150 from Tuesday and the $100 from Wednesday (thus a total of
$250), as well as any future undermargined amounts until Customer A
cures its entire undermargined amount. Again, once a customer fails
to meet a margin call within one business day, the FCM loses the one
business day period for that customer to meet any of its future
margin calls, until the point in time at which the customer is no
longer undermargined.
---------------------------------------------------------------------------
[[Page 7887]]
The Commission proposed to amend regulation Sec. 1.17(c)(5)(viii)
to provide that an FCM that carries separate accounts for a separate
account customer pursuant to proposed regulation Sec. 1.44 must
compute the amount of funds required to meet maintenance margin
requirements for each separate account as if the account was owned by a
distinct customer. However, if a margin call for any separate account
of a separate account customer is outstanding for more than one
business day, then (consistent with the treatment of multiple margin
calls for a single customer described in the previous paragraph), no
margin call for that separate account customer will benefit from the
one business day period until the point in time at which all margin
calls for the separate accounts of that separate account customer have
been met in full.
As discussed further below in the context of proposed regulation
Sec. 1.44(f), the concepts of margin calls that are outstanding no
more than one business day (for purposes of Sec. 1.17(c)(5)(viii)) and
meeting a one business day margin call (for purposes of Sec. 1.44(f))
are separate and distinct. It is possible that a separate account
customer may meet the test for the first, but not the second, or may
meet the test for the second, but not the first.
The proposed amendments to regulation Sec. 1.17 also include
certain technical changes designed to improve clarity and promote
consistency with other Commission regulations.\76\
---------------------------------------------------------------------------
\76\ E.g., changes to punctuation and substitution of ``level of
maintenance margin or performance bond required for the customer and
noncustomer positions'' for ``level of maintenance margin or
performance bond required for the customer or noncustomer
positions'' with respect to the meaning of risk margin for an
account. See, e.g., regulation Sec. 1.17(b)(8). The Commission is
further replacing the term ``FCM'' in regulation Sec. 1.17(b)(8)
with ``futures commission merchant.'' The Commission is also
reorganizing paragraph Sec. 1.17(c)(5)(viii) into sub-paragraphs
(A), (B), (C), and (D) to enhance clarity. The Commission is also
reorganizing the wording of the definition of the term ``business
day'' in regulation Sec. 1.17(b)(6) to read ``any day other than a
Saturday, Sunday, or holiday'' rather than ``any day other than a
Sunday, Saturday, or holiday.'' This change would align the wording
in this provision with the wording of the term ``business day'' in
regulation Sec. 1.3.
---------------------------------------------------------------------------
Commenters did not object to the Commission's proposed addition of
paragraph (b)(8)(v) to regulation Sec. 1.17, the Commission's proposed
amendments to regulation Sec. 1.17(c)(4)(ii), or the technical
amendments that the Commission proposed to regulation Sec. 1.17. FIA
welcomed the Commission's proposal to amend regulation Sec. 1.17 to
require FCMs that carry separate accounts to calculate the risk margin
component of the FCM's regulatory capital requirement as if the
separate accounts are owned by separate entities.\77\ The JAC did not
object to the proposed amendments to regulation Sec. 1.17(c)(2)(i),
but contended that the amendments would introduce a change from the
current requirements related to the treatment of separate account
debits and deficits in CFTC Letter No. 19-17 by requiring FCMs to look
across all separate accounts of a separate account customer when
determining one day debits or deficits to be considered current assets
for net capital, rather than making that determination solely on the
basis of each of the separate account customer's separate accounts
individually.\78\ The JAC noted that FCMs may require time to update
their regulatory systems and records to comply with the amendments as
proposed.\79\
---------------------------------------------------------------------------
\77\ FIA Comment Letter.
\78\ JAC Comment Letter.
\79\ Id.
---------------------------------------------------------------------------
The JAC also recommended that the Commission clarify how an FCM
should consider whether a separate account timely satisfied the
previous day's debit or deficits in its entirety, noting that, if
margin calls are only considered satisfied when receipts are settled
for purposes of proposed regulation Sec. 1.17(c)(2)(i), then margin
calls met in non-USD in one separate account may affect the current or
noncurrent classification of a debit or deficits in all separate
accounts of a separate account customer.\80\ As discussed further
below, JAC guidance provides that FCMs, subject to certain conditions,
may apply margin equity credit to an account for certain pending non-
USD transactions. The JAC noted that, depending on how margin calls are
considered satisfied, the proposed amendments may require FCMs
permitting separate account treatment to consider additional capital
needs.\81\
---------------------------------------------------------------------------
\80\ Id.
\81\ Id.
---------------------------------------------------------------------------
With respect to the proposed amendments to regulation Sec.
1.17(c)(5)(viii), the JAC agreed that proposed regulation Sec.
1.17(c)(5)(viii)(A) (requiring that if one margin call is noncurrent,
then all margin calls are noncurrent), is consistent with how, pursuant
to the JAC's guidance, FCMs currently calculate noncurrent margin calls
and account for noncurrent margin calls for purposes of determining
capital charges. The JAC did not take a position with respect to the
proposed amendments to regulation Sec. 1.17(c)(5)(viii)(B), but urged
the Commission (if adopting the amendments as proposed) to highlight in
its final rulemaking that the amendments would require that, if a
margin call for any separate account of a separate account customer is
outstanding for more than one business day, then the calculation of
current calls used in computing the separate account's undermargined
capital charge must account for the age of all margin calls in all
separate accounts of the separate account customer. The JAC noted that
the resulting look-across to all margin calls in all separate accounts
of a separate account customer could result in significant capital
charges for FCMs even where each separate account is meeting its calls
on a one business day basis as required by proposed regulation Sec.
1.44(f), due to the additional time for compliance with the one
business day margin requirement provided for holidays and foreign
currency wires as proposed in accordance with the practices followed
under CFTC Letter No. 19-17.\82\
---------------------------------------------------------------------------
\82\ Id.
---------------------------------------------------------------------------
Additionally, as the JAC noted in its comments with respect to the
proposed amendments to regulation Sec. 1.17(c)(2)(i), JAC Regulatory
Alert #14-06 provides that, when calculating the undermargined capital
charge and consistent with the treatment for residual interest, an FCM
may consider pending non-USD deposits, ACH payments, and checks as
received, subject to certain conditions.\83\ The JAC requested that the
Commission confirm
[[Page 7888]]
that pending non-USD deposits would be permitted to be considered as
received in computing the undermargined capital charge for all
customers under proposed regulation Sec. 1.17(c)(5)(viii)(A) and
(B).\84\
---------------------------------------------------------------------------
\83\ Id. Specifically, JAC Alert #14-06 provides that, at an
FCM's discretion, it may consider a non-USD deposit as pending in a
customer's account and included in the account's margin equity if
``(i) the FCM assesses that it is prudent to do so based on the
account's past history of satisfying margin calls and the
operational and credit risk profile of the account owner, (ii) the
account is on a 1-day wire transfer basis (i.e., the wire is
initiated on Day 2), (iii) the FCM has a sufficient basis that the
wire was actually initiated, (iv) the FCM continues to age the
pending non-U.S. Dollar receipts and retains the ability to
recognize a failed deposit immediately upon occurrence, and (v) the
FCM treats unsettled non-U.S. Dollar disbursements from the account
in the same manner.'' JAC Regulatory Alert #14-06, Nov. 4, 2014,
available at http://www.jacfutures.com/jac/jacupdates/2014/jac1406.pdf.
\84\ JAC Comment Letter.
---------------------------------------------------------------------------
The JAC also noted that, as the Commission has not proposed to
modify regulation Sec. 1.17(c)(5)(ix), requiring undermargined capital
charges for noncustomer and omnibus accounts, the JAC will assume that
FCMs will still be able to apply treatment for pending deposits as set
forth in JAC Regulatory Alert #14-06 to noncustomers and omnibus
accounts, unless the Commission amends the provision or confirms
otherwise.\85\
---------------------------------------------------------------------------
\85\ Id.
---------------------------------------------------------------------------
Additionally, the JAC requested that the Commission confirm that
for purposes of the undermargined capital charge for a customer account
under regulation Sec. 1.17(c)(5), maintenance margin requirements
include the risk component only, and non-cash collateral should be
valued at market value less applicable haircuts, including for separate
account customers.\86\ The JAC stated that performing such margin
calculations differently in order to comply with different regulatory
reporting requirements may prove burdensome for FCMs that permit
separate account treatment.\87\
---------------------------------------------------------------------------
\86\ Id.
\87\ Id.
---------------------------------------------------------------------------
FIA contended that the proposed amendments to regulation Sec.
1.17(c)(2)(i) and regulation Sec. 1.17(c)(5)(viii) are inconsistent
with the principle of separate account margining and how clearing FCMs
have understood the conditions of CFTC Letter No. 19-17.\88\ FIA argued
that, for purposes of calculating both current assets under regulation
Sec. 1.17(c)(2)(i) and charges against net capital for undermargined
accounts under regulation Sec. 1.17(c)(5)(viii), the Second Proposal
would effectively require FCMs to suspend the ordinary course of
business for purposes of both calculations in the event that any
separate account fails to satisfy its previous day's deficit or debit
ledger balance in its entirety within one business day (for purposes of
the calculation of current assets) or within the close of business at
the end of the second business day following the call (for purposes of
the undermargined capital charge).\89\ FIA noted that, on the basis of
the conditions of the no-action position in CFTC Letter No. 19-17,\90\
FCMs calculate current assets and undermargined capital charges for
each separate account as if each such account were owned by a separate
entity, and do not look across to other separate accounts of the same
customer for purposes of either calculation, unless the FCM is
suspending the ordinary course of business for any such account.\91\
---------------------------------------------------------------------------
\88\ FIA Comment Letter.
\89\ Id.
\90\ Specifically, requirements that FCMs electing separate
account treatment (i) record each separate account independently in
the FCM's books and records, including by recording each separate
account as a receivable (debit/deficit) or payable with no offsets
between the other separate accounts of the same customer; and (ii)
reflect the receivable from a separate account as secured (as a
current/allowable asset) based on the assets of that separate
account rather than on the assets held in another separate account
of the same customer.
\91\ FIA Comment Letter.
---------------------------------------------------------------------------
FIA asserted that these proposed revisions to regulation Sec. 1.17
would be costly for FCMs, which would be required to rebuild
operational and reporting systems, and to rewrite underlying
programming code, to perform the necessary look-across of all of the
separately margined accounts for the same separate account customer
whenever the separate account customer fails to timely satisfy the
previous day's deficit/debit ledger balance in its entirety for the
current asset calculation, or fails to settle a margin call by the end
of the day after the call for the undermargined capital charge
calculation.\92\
---------------------------------------------------------------------------
\92\ Id.
---------------------------------------------------------------------------
FIA also argued that these proposed revisions to regulation Sec.
1.17 would be punitive for FCMs, because they would impose capital
costs on FCMs without regard to any related financial or operational
risk. FIA included in its comment letter an example illustrating how an
FCM could be required to take a significant capital charge due to a
failure to meet a margin call timely in one separate account, even if
the separate account customer's other separate accounts, managed by
other investment managers, have margin calls that have not yet aged to
a point that the FCM would be required to take a capital charge under
existing regulation Sec. 1.17.\93\ FIA noted that a recent survey of
its members showed that, although the percentage of required margin for
separate accounts to total customer margin requirements varied from
less than one percent to over 20%, members uniformly reported material
potential capital implications measured by amount of margin required
for a single beneficial owner across its separate accounts.\94\
---------------------------------------------------------------------------
\93\ Id.
\94\ Id.
---------------------------------------------------------------------------
FIA recommended that the Commission modify its proposed amendments
to regulation Sec. 1.17 to require a look-across of all of a separate
account customer's separate accounts only where the ordinary course of
business has been suspended for the separate account customer.\95\ FIA
further recommended that such look-across be made subject to the
requirements defining the Commission's proposed one business day margin
call requirement in proposed regulation Sec. 1.44(f) so that FCMs can
continue taking the benefit of current assets and avoiding charges
against capital while client settlement in non-USD for separate
accounts is pending.\96\
---------------------------------------------------------------------------
\95\ Id.
\96\ Id.
---------------------------------------------------------------------------
Like the JAC, FIA discussed the application of margin equity credit
to accounts for pending non-USD margin deposits under JAC guidance.\97\
FIA noted this practice appears to be in tension with the Commission's
proposed amendments to regulation Sec. 1.17 and urged the Commission
to clarify that the Second Proposal was not adopted with the intention
of prohibiting such current treatment of pending non-USD transfers for
purposes of computing undermargined capital charges.\98\
---------------------------------------------------------------------------
\97\ Id.
\98\ Id.
---------------------------------------------------------------------------
In proposing to codify the no-action position of CFTC Letter No.
19-17 in part 1 of its regulations, the Commission considered the way
in which it would need to modify existing provisions of part 1 to
facilitate separate account treatment for FCMs. With respect to the
calculation of current assets as set forth in regulation Sec.
1.17(c)(2)(i) and the undermargined capital charge as set forth in
regulation Sec. 1.17(c)(5)(viii), the Commission proposed a more
conservative approach to risk management that would trigger inclusion
of debits or deficits (with respect to proposed regulation Sec.
1.17(c)(2)(i)) or outstanding margin calls (with respect to proposed
regulation Sec. 1.17(c)(5)(viii)) across a separate account customer's
separate accounts when a margin call made of such separate account
customer for purposes of either regulation is not satisfied timely.
Although CFTC Letter No. 19-17, which applied directly to DCOs, did not
speak explicitly to how FCMs should treat separate accounts for
purposes of these regulations, its provisions call for DCOs to require
FCMs to subject accounts receiving separate treatment to heightened
scrutiny and enhanced risk management practices, particularly with
respect to timely receipt of margin.
[[Page 7889]]
The Commission has considered the JAC's and FIA's assertions that
the proposed amendments to regulation Sec. 1.17(c)(2)(i) and
regulation Sec. 1.17(c)(5)(viii) would represent a deviation from how
FCMs have generally understood and applied the conditions of CFTC
Letter No. 19-17. The Commission further acknowledges that a separate
account customer's untimely payment of margin with respect to a
separate account for purposes of regulation Sec. 1.17(c)(2)(i) or
regulation Sec. 1.17(c)(5)(viii) does not necessarily indicate that
the separate account customer is out of the ordinary course of
business, as set forth in proposed regulation Sec. 1.44(a), with
respect to that separate account or any other separate account of such
customer. It follows that a separate account for which payment of
margin is untimely for purposes of regulation Sec. 1.17(c)(2)(i) or
regulation Sec. 1.17(c)(5)(viii) may not be indicative of financial or
operational distress in the same manner as would untimely payment of
margin for purposes of regulation Sec. 1.44. Unlike regulations Sec.
1.17(c)(2)(i) and Sec. 1.17(c)(5)(iii), which require an FCM to
reserve capital when the aggregate of a customer's accounts are,
respectively, in debit/deficit or undermargined beyond a defined period
of time to protect the FCM against potential losses or price exposure
if the liquidation of the customer's positions is required, regulation
Sec. 1.44 is designed to build in allowances to account for delays
resulting from differences in time zones as well as international
banking conventions in establishing requirements for meeting a one
business day margin call. The Commission accordingly appreciates, and
finds persuasive, FIA's comments to the effect that the proposed look-
across of separate accounts of a separate account customer who does not
timely meet a margin call for purposes of regulation Sec.
1.17(c)(2)(i) or Sec. 1.17(c)(5)(viii) may prove costly to implement
and operationally disruptive to deploy. The Commission also appreciates
the JAC's comments regarding the potential implementation and
compliance burden that the proposed requirements would pose for FCMs.
Accordingly, the Commission is adopting the amendments to
regulation Sec. 1.17 as proposed, but with two modifications. First,
the Commission is removing language from the proposed amendments to
regulation Sec. 1.17(c)(2)(i) that would have provided that, if a
separate account does not meet a previous day's margin call for a
deficit or debit balance, the FCM shall exclude all separate accounts
of that separate account customer carried by the FCM that have a
deficit or debit ledger balance from current assets under regulation
Sec. 1.17(c)(2)(i). Second, the Commission is modifying the language
of proposed regulation Sec. 1.17(c)(5)(viii)(B) to provide that, if a
call for margin or other required deposits for any separate account of
a particular separate account customer is outstanding for more than one
business day, then all outstanding margin calls for that separate
account shall be treated as if the margin calls are outstanding for
more than one business day, and shall be deducted from net capital
until all such calls have been met in full. In this manner, where a
separate account customer's separate account does not meet a previous
day's margin call for a deficit or debit balance under regulation Sec.
1.17(c)(2)(i), or has a margin call or other required deposits
outstanding for more than one business day under regulation Sec.
1.17(c)(5)(viii), then the FCM shall treat the separate account on a
standalone basis in determining current assets or the undermargined
capital charge, and need not look across to debits or deficits, or
outstanding margin calls, in the separate account customer's other
separate accounts.
As previously discussed, the Commission believes that separate
account treatment results in a conservative capital treatment due to
the impact of removing portfolio margining across separate accounts,
including in the calculation of the required capital based on risk
margin separately for each separate account. Even during a period
outside the ordinary course of business when disbursements on a
separate account basis are suspended, the Commission believes that net
capital treatment may in most instances continue to be more
conservative by maintaining separate treatment of separate accounts for
net capital calculation purposes. In consideration of the comments
received regarding the operational difficulties which FCMs may face
from being required to consolidate the treatment of separate accounts
for net capital calculations and the likely conservative effect of
maintaining separate treatment, the Commission is adopting the final
rules as modified, and further clarifies that even during a period of a
suspension of disbursements on a separate account basis, an FCM must
continue separate treatment for net capital calculations. However,
should an FCM itself cease treating the separate accounts separately,
such as by initiating any cross-default remedies across the separate
accounts of a separate account customer (thus indicating the FCM is
exercising legal remedies to collapse separate accounts for the purpose
of collection against the separate account customer), then continued
separate net capital treatment by the FCM of such accounts would no
longer be appropriate, as an FCM's exercise of cross-default remedies
that combine separate accounts would be inconsistent with an FCM's
continued election of separate account treatment.
The Commission additionally considered the JAC's and FIA's comments
with respect to the treatment of pending non-USD transfers. As the JAC
and FIA noted, JAC Regulatory Alerts #14-03 and #14-06 permit FCMs to
apply margin equity credit to an account for pending non-USD transfers
for certain purposes and subject to certain conditions. As the JAC
noted, the guidance provided by JAC Regulatory Alert #14-03 and #14-06
provides that, due to the inherent delays in the settlement of certain
foreign currency transfers, in determining a customer's or
noncustomer's margin status (under JAC Regulatory Alert #14-03) or
residual interest requirement (under JAC Regulatory Alert #14-06), an
FCM may, at its discretion, consider unsettled non-USD transactions as
pending in a customer's or noncustomer's account and include in the
account's margin equity if: (i) the FCM assesses that it is prudent to
do so based on the account's past history of satisfying margin calls
and the operational and credit risk profile of the account owner; (ii)
the account is on a one-day wire transfer basis (i.e., the wire is
initiated on the day the margin call is issued); (iii) the FCM has a
sufficient basis to believe that the wire was actually initiated; (iv)
the FCM continues to age the pending non-USD receipts and retains the
ability to recognize a failed deposit immediately upon occurrence; and
(v) the FCM treats unsettled non-USD disbursements from the account in
the same manner.\99\ Although the Commission did not discuss treatment
of pending non-USD transfers in the First Proposal, in the Second
Proposal, or in CFTC Letter No. 19-17, as discussed below, commenters
raised questions related to the treatment of pending non-USD transfers
in several
[[Page 7890]]
contexts, which the Commission has focused on in developing this final
rule.
---------------------------------------------------------------------------
\99\ See JAC, JAC Regulatory Alert #14-03, May 21, 2014,
available at http://www.jacfutures.com/jac/jacupdates/2014/jac1403.pdf; JAC, JAC Regulatory Alert #14-06, Nov. 4, 2014,
available at http://www.jacfutures.com/jac/jacupdates/2014/jac1406.pdf.
---------------------------------------------------------------------------
In the Second Proposal, the Commission noted that it sought to
enact a narrow codification, with respect to all FCMs, of the no-action
conditions of CFTC Letter No. 19-17.\100\ In particular, the Commission
does not seek to disrupt current, established margining practices at
FCMs, except where explicitly stated in this final rule. In considering
the JAC's and FIA's comments with respect to the treatment of pending
non-USD transfers, the Commission considers, in light of this
objective, that currently, and for the past ten years, subject to JAC
guidance, a number of FCMs have treated as received certain pending
non-USD transfers (i.e., those that are consistent with that guidance)
for certain purposes.
---------------------------------------------------------------------------
\100\ Second Proposal, 89 FR at 15317.
---------------------------------------------------------------------------
As the third condition, the FCM must also have a sufficient basis
to believe that the transfer was actually initiated for immediate
settlement (including, as the Commission understands, that the transfer
was actually initiated on the required one-day basis). The Commission
notes that, as each condition for the treatment of pending non-USD
transfers is a separate condition, the Commission expects that in order
to meet this third condition, an FCM would rely on evidence beyond the
factors identified in the first condition (i.e., the account's past
history of satisfying margin calls and the operational and credit risk
profile of the account owner). Further to this point, the requirement
that the FCM have a sufficient basis to believe that the transfer was
actually initiated indicates that an FCM would be expected to identify
a sufficient, factual basis to support its conclusion that a specific
transfer was initiated for immediate settlement consistent with the
banking practices relative to the jurisdiction from which the transfer
originated. The Commission expects that such sufficient factual support
would include at minimum an affirmative, written representation from
the customer that the specific transfer had actually been
initiated.\101\ The fourth condition requires the FCM to continue aging
pending non-USD receipts and have the ability to recognize a deposit
failure immediately when it occurs, both of which are critical to
complying with the requirements of regulation Sec. 1.17 (among other
Commission regulations) that require an FCM to be able to accurately
age outstanding margin calls. In particular, a transfer that does not
arrive by the day it is expected (consistent with banking practices
relative to the jurisdiction from which the transfer originated) should
be considered to have failed. The fifth condition requires consistent
treatment of pending non-USD transfers in an account: to the extent an
FCM treats pending non-USD deposits as received for certain purposes,
it must similarly treat pending non-USD disbursements as disbursed.
---------------------------------------------------------------------------
\101\ The Commission notes that a pattern wherein funds are not
timely received despite such representations would undermine the
satisfaction of the first condition; i.e., the account's past
history of satisfying margin calls.
---------------------------------------------------------------------------
The Commission has considered the history of FCMs' treatment of
pending non-USD transfers under the JAC guidance. Among other
information, the Commission has considered, with respect to separate
accounts under the terms of the no-action position, the criteria
applied to such treatment under the JAC guidance, the potential risks
and benefits of such treatment for FCMs and customers, and the
Commission's objectives in codifying the no-action position of CFTC
Letter No. 19-17. The Commission confirms that it does not intend for
the final rule to preclude FCMs from considering pending non-USD
transfers as received for purposes of computing the undermargined
capital charge pursuant to regulation Sec. 1.17(c)(5), consistent with
the JAC guidance as described above.\102\ In doing so, however, the
Commission notes that it expects that DSROs will diligently monitor
their FCMs to ensure compliance with the criteria for such treatment,
and will take appropriate supervisory steps where they find failures to
comply with such criteria, with particular focus on the requirement
that an FCM have a sufficient basis to believe that a non-USD transfer
classified as pending was in fact initiated, and the requirement that
an FCM treat pending non-USD disbursements in a manner consistent with
its treatment of pending non-USD receipts.
---------------------------------------------------------------------------
\102\ The Commission additionally confirms that the final rule
is not intended to preclude FCMs from treating as received pending
non-USD transfers, subject to the same five conditions listed in JAC
Regulatory Alerts #14-03 and #14-06 discussed above, for purposes of
calculating undermargined capital charges for noncustomer and
omnibus accounts under regulation Sec. 1.17(c)(5)(ix). As the JAC
noted in its comment letter, the Commission did not propose to amend
this provision.
---------------------------------------------------------------------------
Lastly, to respond to the JAC's request for clarification on the
subject, the Commission confirms that, for purposes of the
undermargined capital charge for a customer account under regulation
Sec. 1.17(c)(5), maintenance margin requirements include the risk
component only. The Commission further confirms that in computing the
value of the margin deposits of an account, including accounts of
separate account customers, non-cash collateral should be valued at
market value less applicable haircuts.
C. Amendments to Regulations Sec. Sec. 1.20, 1.32, 22.2, and 30.7
As previously stated, protecting market participants from misuses
of customer assets is one of the fundamental purposes of the CEA.\103\
Regulations Sec. Sec. 1.32, 22.2(g), and 30.7(l) are designed in part
to further this purpose by requiring each FCM carrying accounts for
futures customers, Cleared Swaps Customers, or 30.7 customers,
respectively, to perform a daily computation of, and to prepare a daily
record demonstrating compliance with, the FCM's obligation to hold a
sufficient amount of funds in designated customer segregated accounts
to meet the aggregate credit balances of all of the FCM's futures
customers, Cleared Swaps Customers, and 30.7 customers.\104\ An FCM is
required to prepare the daily segregation calculations reflecting
customer account balances as of the close of business each day, and to
submit the applicable segregation statements electronically to the
Commission and to the FCM's DSRO by noon the next business day.
---------------------------------------------------------------------------
\103\ Section 3(b) of the CEA, 7 U.S.C. 5(b); see also, e.g.,
CEA section 4d(a)(2), 7 U.S.C. 6d(a)(2); CEA section 4d(f)(2), 7
U.S.C. 6d(f)(2); CEA section 4b(2)(A), 7 U.S.C. 6b(2)(A).
\104\ Each FCM that carries accounts for futures customers,
Cleared Swaps Customers, and 30.7 customers is required to prepare
daily statements demonstrating compliance with the applicable
segregation requirements. For futures customers, the FCM must
prepare a daily Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Commodity Exchanges (17
CFR 1.32(a)) (``Futures Segregation Statement''); for Cleared Swaps
Customers, the FCM must prepare a daily Statement of Cleared Swaps
Customer Segregation Requirements and Funds in Cleared Swaps
Customer Accounts under section 4d(f) of the CEA (17 CFR 22.2(g)(1)-
(4)) (``Cleared Swaps Segregation Statement''); and for 30.7
customers, the FCM must prepare a daily Statement of Secured Amounts
and Funds Held in Separate Accounts for 30.7 Customers pursuant to
regulation 30.7 (17 CFR 30.7(l)(1)). The statements listed above are
part of the Commission's Form 1-FR-FCM, which contains the financial
reporting templates required to be filed by FCMs.
---------------------------------------------------------------------------
The Commission proposed to amend regulations Sec. Sec. 1.32, 22.2,
and 30.7 to provide that an FCM that permits separate accounts pursuant
to regulation Sec. 1.44 must perform its daily segregation
calculations, and prepare its daily segregation statements, by treating
the accounts of separate account customers as accounts of separate
entities. The amendments add new paragraph (l) to regulation Sec.
1.32, new paragraph (g)(11) to regulation Sec. 22.2, and new paragraph
[[Page 7891]]
(l)(11) to regulation Sec. 30.7. The purpose of the amendments is to
establish the manner in which these existing segregation and reporting
obligations apply to FCMs that permit separate accounts pursuant to
regulation Sec. 1.44. Regulations Sec. Sec. 1.32, 22.2, and 30.7
require an FCM to prepare one daily segregation computation, and submit
one segregation schedule, for the funds of its futures customers,
Cleared Swaps Customers, and 30.7 customers, respectively. The
amendments to regulations Sec. Sec. 1.32, 22.2(g), and 30.7(l) provide
that an FCM that permits separate accounts, in preparing such
computation and segregation schedule, is required to record each
separate account as if it were an account of a separate entity, and
include all separate accounts with other futures accounts, Cleared
Swaps Customer Accounts, and 30.7 accounts, as applicable, carried by
the FCM that are not separate accounts.
In addition, the amendments provide that an FCM, in computing its
segregation obligations, may offset a net deficit in a particular
separate account customer's separate account against the current value,
net of specified haircuts, of any readily marketable securities held by
the FCM for the separate account customer, provided that the readily
marketable securities are held as margin collateral for the specific
separate account that is in deficit. Readily marketable securities held
for other separate accounts of the separate account customer may not be
used to offset the separate account that is in deficit.\105\ The
amendments to regulations Sec. Sec. 1.32, 22.2(g), and 30.7(l) with
respect to the offsetting of a net deficit in a customer's account by
the value of readily marketable securities, less applicable haircuts,
held in the customer's account are consistent with how an FCM currently
offsets a net deficit in a customer's account that is margined by
securities. In addition, the amendments are consistent with the
separate account conditions to the no-action position in CFTC Letter
No. 19-17.\106\
---------------------------------------------------------------------------
\105\ I.e., if separate account customer S has separate accounts
A and B, then readily marketable securities held for separate
account A could not be used to offset a deficit in separate account
B, and vice versa.
\106\ See CFTC Letter No. 19-17 (providing, among other
conditions for separate account treatment, that ``[e]ach receivable
from a separate account shall be `grossed up' on the applicable
segregation, secured or cleared swaps customer statement; thus, an
FCM shall use its own funds to cover the debit/deficit of each
separate account.'').
---------------------------------------------------------------------------
The Commission also proposed to amend regulation Sec. 22.2(f) to
revise the regulatory description of the stated calculation of the
total amount of funds that an FCM is required to hold in segregation
for Cleared Swaps Customers. The amendment: (i) corrects an error
included in the drafting of the description of the calculation when the
regulation was originally adopted in 2012; and (ii) aligns the
regulatory text describing the segregation calculation set forth in
regulation Sec. 22.2(f) with the calculation performed on the Cleared
Swaps Segregation Statement that is submitted to the Commission each
day by FCMs with Cleared Swaps Customers pursuant to regulation Sec.
22.2(g). The amendment applies across FCMs with Cleared Swaps
Customers, whether or not such FCMs maintain separate accounts.
The segregation calculation required by regulation Sec. 22.2(f) is
intended to ensure that an FCM holds, at all times, a sufficient amount
of funds in segregation to cover its total financial obligation to all
Cleared Swaps Customers. Compliance with the segregation requirements
helps ensure that an FCM is not using the funds of one Cleared Swaps
Customer to cover a deficit in the Cleared Swaps Customer Account of
another Cleared Swaps Customer, and further helps ensure that an FCM
holds sufficient funds in segregation to transfer the Cleared Swaps
Customer Accounts, including the Cleared Swaps and the Cleared Swaps
Customer Collateral, to a transferee FCM if the transferor FCM becomes
insolvent.
To achieve the regulatory objective noted above, regulation Sec.
22.2(f)(2) currently requires an FCM to calculate its minimum
segregation requirement as the sum of the net liquidating equities of
each Cleared Swaps Customer Account with a positive account balance
carried by the FCM. The net liquidating equity of a Cleared Swaps
Customer Account is explicitly calculated as the sum of the market
value of any funds held in the Cleared Swaps Customer Account of a
Cleared Swaps Customer (including readily marketable securities), as
adjusted positively or negatively by, among other things, any
unrealized gains or losses on open Cleared Swaps positions, the value
of open long option positions and short option positions, fees charged
to the account, and authorized withdrawals. To the extent that the
calculation results in a net liquidating equity that is positive, the
Cleared Swaps Customer Account has a credit balance.\107\ To the extent
that the calculation results in a net liquidating equity that is
negative, the Cleared Swaps Customer Account has a debit balance.\108\
Regulation Sec. 22.2(f)(4) provides that an FCM must hold, at all
times, a sufficient amount of funds in segregation to meet the total
net liquidating equities of all Cleared Swaps Customer Accounts with
credit balances, and further provides that the FCM may not offset this
total by any Cleared Swaps Customer Accounts with debit balances.
---------------------------------------------------------------------------
\107\ 17 CFR 22.2(f)(3).
\108\ Id.
---------------------------------------------------------------------------
With respect to Cleared Swaps Customer Accounts with debit
balances, regulation Sec. 22.2(f)(5) further requires the FCM to
include in the total funds required to be held in segregation all debit
balances to the extent secured by readily marketable securities held
for the particular Cleared Swaps Customers that have debit balances.
The required addition of debit balance accounts in regulation Sec.
22.2(f)(5) was intended to be consistent with the long-standing Futures
Segregation Statement contained in the Form 1-FR-FCM and the Form 1-FR-
FCM Instructions Manual.\109\ An error, however, was made in drafting
the description of the details of the segregation calculation in
current regulation Sec. 22.2(f)(5). Specifically, as noted above,
regulation Sec. 22.2(f)(5) requires an FCM to include in the total
segregation requirement any Cleared Swaps Customer Accounts with debit
balances that are secured by readily marketable securities. However,
the full value of the readily marketable collateral is part of the
calculation of the net liquidating equity of the account. Therefore, a
Cleared Swaps Customer Account with a debit balance would never have
additional readily marketable securities available to offset a debit
balance.\110\
---------------------------------------------------------------------------
\109\ In adopting the final regulation Sec. 22.2(f), the
Commission stated that proposed regulation Sec. 22.2(f) set forth
an explicit calculation for the amount of Cleared Swaps Customer
Collateral that an FCM must maintain in segregation that did not
materially differ from the calculation of the amount of funds an FCM
is required to hold in segregation under the Form 1-FR-FCM for
futures customers. The Commission adopted final regulation Sec.
22.2(f) as proposed. Protection of Cleared Swaps Customer Contracts
and Collateral; Conforming Amendments to the Commodity Broker
Bankruptcy Provisions; Final Rule, 77 FR 6336, at 6352-6353 (Feb. 7,
2012).
\110\ For example, if a Cleared Swaps Customer Account was
comprised of cash of $300, securities of $200, and an unrealized
loss on open Cleared Swaps of $600, the account would have a net
equity debit balance of $100 under regulation Sec. 22.2(f). There
are no additional securities that the FCM may use to secure the $100
debit balance and, therefore, the FCM is required to increase its
segregation requirement by $100 to ensure that there are sufficient
funds in segregation to cover the FCM's obligation to all Cleared
Swaps Customers with a credit balance.
---------------------------------------------------------------------------
The segregation calculation required under regulation Sec. 1.32
for futures accounts, and the Commission's Form 1-FR-FCM and related
Form 1-FR-
[[Page 7892]]
FCM Instructions Manual, differs from the description as currently
written in regulation Sec. 22.2(f)(4) and (5) with respect to the
offsetting of debit balances by readily marketable securities.
Specifically, an FCM is required to calculate the net equity of each
futures customer excluding the value of any noncash collateral held in
the account.\111\ If the calculation results in a debit balance, the
FCM is permitted to offset the debit balance by the fair market value
of any readily marketable securities (after application of applicable
securities haircuts set forth in the regulation).\112\
---------------------------------------------------------------------------
\111\ The Form 1-FR-FCM Instructions Manual provides that a
customer account is in deficit when the combination of the account's
cash ledger balance, unrealized gain or loss on open futures
contracts, and the value of open option contracts liquidates to an
amount less than zero. The manual explicitly provides that ``[a]ny
securities used to margin the account are not included in
determining a customer's deficit.'' 1-FR-FCM Instructions Manual, p.
10-2. Accordingly, an FCM would exclude the value of any readily
marketable securities from the calculation of the customer's account
balance. The 1-FR-FCM Instructions Manual is available on the
Commission's website at: www.cftc.gov/sites/default/files/idc/groups/public/@iointermediaries/documents/file/1fr-fcminstructions.pdf.
\112\ 17 CFR 1.32(b). Applying the calculation in regulation
Sec. 1.32 to Cleared Swaps, if a Cleared Swaps Customer Account was
comprised of cash of $300, securities of $200, and an unrealized
loss on open Cleared Swaps of $600, the account would have a net
equity debit balance of $300, as the value of the securities is not
included in the calculation ($300 cash less $600 in unrealized
losses, results in a $300 debit balance). The FCM may offset the
$300 debit balance by $170, which represents the value of the
readily marketable securities held in the account as collateral
($200 fair market value of the securities, less a $30 haircut). The
FCM is then required to include $130 in its segregation requirement,
which represents the amount of the unsecured debit balance remaining
in the customer's account (i.e., $300 debit balance, less $170 value
of the securities after haircuts).
---------------------------------------------------------------------------
As noted above, the amendments to regulation Sec. 22.2(f)(4) and
(5) are intended to correct the description of the segregation
calculation and to make it consistent with: (i) how FCMs calculate
their total Cleared Swaps segregation obligations under regulation
Sec. 22.2(g), (ii) how FCMs report their total segregation
requirements on the Cleared Swaps Segregation Statement, and (iii) the
segregation calculation requirements for futures accounts under
regulation Sec. 1.32. Thus, the amendments are not expected to have
any effect on FCMs and their current practices.
In addition, the Commission proposed to amend regulations
Sec. Sec. 1.20(i) and 30.7(f), which require an FCM carrying futures
accounts and 30.7 accounts, respectively, to calculate its total
segregation requirements in a manner that is consistent with current
regulation Sec. 22.2(f). As with the amendment to regulation Sec.
22.2(f), the amendments to regulations Sec. Sec. 1.20(i) and 30.7(f)
apply across FCMs that maintain futures customer accounts or 30.7
customer accounts, respectively, whether or not such FCMs maintain
separate accounts. The Commission adopted current regulations
Sec. Sec. 1.20(i) and 30.7(f) in 2013. The final regulations, however,
did not include the provision set forth in regulation Sec. 22.2(f)(5)
requiring an FCM to include any secured debit balances in its
segregation requirement. This omission was unintentional, as the
Commission expressed its intent to ``mirror'' the requirements of
regulation Sec. 22.2(f) in regulation Sec. 1.20(i) (and effectively
regulation Sec. 30.7(f)).\113\
---------------------------------------------------------------------------
\113\ Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506, 68543 (Nov. 14, 2013) (discussing the
Commission's intent to adopt regulation Sec. 1.20(i) consistent
with the corresponding requirements in regulation Sec. 22.2(f));
id. at 68576 (discussing the Commission's intent for the daily
segregation calculation for 30.7 accounts to be consistent with the
requirements for the daily segregation calculations for futures
customer funds in regulation Sec. 1.32).
---------------------------------------------------------------------------
To address the omission, the Commission proposed to amend
regulations Sec. Sec. 1.20(i) and 30.7(f) to reflect the requirement
that an FCM include any unsecured customer debit balances, calculated
consistent with the amendments to regulation Sec. 22.2(f)(4) and (5)
that are discussed above, in the calculation of its futures and foreign
futures and foreign options segregation requirement. The amendments to
regulations Sec. Sec. 1.20(i) and 30.7(f) accurately describe and
reflect the existing segregation calculations for futures, foreign
futures, and Cleared Swaps as originally intended. The amendments to
regulations Sec. Sec. 1.20(i) and 30.7(f) are not expected to have any
impact on FCMs as the firms currently calculate their segregation
requirements by including customer unsecured debit balances.
The Commission did not receive any comments with respect to the
proposed amendments to regulations Sec. Sec. 1.20, 1.32, 22.2, and
30.7. Accordingly, the Commission is adopting the amendments to
regulations Sec. Sec. 1.20, 1.32, 22.2, and 30.7 as proposed.\114\
---------------------------------------------------------------------------
\114\ The Commission is making technical changes in the final
amendments with respect to regulations Sec. Sec. 1.20(i)(5)(ii),
1.32(b), 22.2(f)(5)(ii), and 30.7(f)(2)(v)(B) to correct the
citation to the SEC regulation defining ``ready market'' (Sec.
240.15c3-1(c)(11) rather than Sec. 241.15c3-1(c)(11)).
---------------------------------------------------------------------------
D. Regulation Sec. 1.44(a)
The Commission structured proposed regulation Sec. 1.44 so that
FCMs would be required to avoid returning margin to customers when
doing so would create or exacerbate a margin deficiency in the
customer's account; however, the proposed regulation then would allow
FCMs to provide for separate account treatment within the Commission's
broader regulatory framework for FCMs. As such, regulation Sec. 1.44,
as proposed, contains certain terms that are designed to operate in a
specific manner with respect to regulation Sec. 1.44, but that do not
apply, or do not apply in the same way, with respect to other of the
Commission's FCM regulations. The Commission therefore proposed to add
new regulation Sec. 1.44(a) to define certain terms only for purposes
of regulation Sec. 1.44. The Commission believes that regulation Sec.
1.44(a) is reasonably necessary to accomplishing the goals of
protecting customer funds and mitigating systemic risk because it
defines key terms in requirements that FCMs will need to apply to
ensure margin adequacy, and in requirements that FCMs will need to
apply when treating customer accounts separately for purposes of margin
adequacy.
The Commission proposed to define ``account'' for purposes of
proposed regulation Sec. 1.44 as meaning a futures account, a Cleared
Swaps Customer Account (both of which are defined in regulation Sec.
1.3, which definitions apply broadly to all CFTC regulations), or a
Sec. 30.7 account (as defined in regulation Sec. 30.1 \115\). The
Commission proposed this definition to implement the proposed Margin
Adequacy Requirement, including in the context of separate account
treatment, with respect to accounts of all three types for all FCMs,
consistent with comments received in response to the First Proposal.
---------------------------------------------------------------------------
\115\ 17 CFR 30.1.
---------------------------------------------------------------------------
ICE's comment letter indirectly addressed the definition of
``account'' in proposed regulation Sec. 1.44(a). ICE voiced support
for the Commission's proposal to permit FCMs to provide separate
account treatment for customers with regulation 30.7 accounts for
futures and options transactions traded on exchanges outside the United
States, but stated it does not believe it is necessary for the
Commission to distinguish regulation 30.7 accounts from futures and
Cleared Swap Customer accounts in connection with separate account
treatment.\116\ ICE also noted that there are references in proposed
regulation Sec. 1.44 to DCMs that should also include foreign
exchanges
[[Page 7893]]
in connection with regulation 30.7 accounts.\117\
---------------------------------------------------------------------------
\116\ ICE Comment Letter.
\117\ Including proposed regulation Sec. 1.44(b)(2) and (f)(7).
Id.
---------------------------------------------------------------------------
The Commission proposed to codify the Second Proposal principally
in part 1 (as opposed to in part 39) in light of comments received in
response to the First Proposal. This is designed to ensure that the
Margin Adequacy Requirement and requirements for separate account
treatment will apply directly to all FCMs and all FCM customers,
including futures customers, Cleared Swaps Customers, and 30.7 account
customers. The Commission is distinguishing these accounts in
regulation Sec. 1.44 to ensure that the regulation encompasses each
class of FCM customer.
The Commission agrees that certain references to DCMs that are
included in regulation Sec. 1.44 should be clarified to include
explicitly foreign exchanges in connection with 30.7 accounts, as
separate account customers may have foreign futures and foreign options
positions traded on such exchanges. Accordingly, as noted further below
in connection with regulation Sec. 1.44(b)(2) and 1.44(f)(7), in
adopting these provisions, the Commission is modifying them to refer to
``any designated contract market or other board of trade,'' in order to
encompass such foreign exchanges. The Commission did not receive any
other comments related to the definition of ``account'' in proposed
regulation Sec. 1.44(a) and is adopting that definition as proposed.
The Commission also proposed in proposed regulation Sec. 1.44(a)
to further define ``business day'' as having the same meaning as set
forth in regulation Sec. 1.3, but with the clarification that
``holiday'' refers to Federal holidays as established by 5 U.S.C. 6103.
The Commission also proposed in proposed regulation Sec. 1.44(a) to
define ``holiday'' as meaning Federal holidays as established by 5
U.S.C. 6103.
In Question 4 of the Second Proposal, the Commission sought
commenters' views on how the proposed definition of ``business day''
should address days when securities and other markets are closed.
(E.g., whether the Commission should address in the definition days
when such other markets are open or create an exception for days when
such markets are closed on a prescheduled basis.) The Commission sought
information on potential liquidity challenges or other risks that could
result from such an exception, as well as information on how FCMs and
customers currently address days when securities and other markets are
closed.
In its comment letter, FIA noted that neither the proposed
definitions of ``business day'' nor ``holiday'' in proposed regulation
Sec. 1.44(a) address days on which banks are open but futures and
securities markets are closed.\118\ FIA stated that, on such days,
transfers of non-cash collateral cannot settle, and separate account
customers settling initial margin calls with such collateral will,
under the proposed regulation, be deemed to have failed to meet a
margin call.\119\ In FIA's view, a separate account customer should not
be deemed to have failed to settle a margin call because securities
markets are closed.\120\ FIA suggested the Commission revise the
definition of ``holiday'' in proposed regulation Sec. 1.44(a) to
provide that holidays include ``any business day that is not a
securities settlement day in the United States.'' \121\ No other
commenters responded specifically to this question.
---------------------------------------------------------------------------
\118\ FIA Comment Letter.
\119\ Id.
\120\ Id.
\121\ Id.
---------------------------------------------------------------------------
The Commission acknowledges that, on days on which banks are open
but futures and securities markets are closed, customers, including
separate account customers, may be unable to use non-cash collateral to
aid in their meeting margin calls. However, FCMs and customers may
arrange for a variety of methods to settle margin calls, including bank
transfers. The Commission believes that, given the availability of such
funding mechanisms on days when banks are open but securities and other
markets are closed, introducing an exception that would allow for
additional delays in the payment of margin on such days may introduce
unnecessary additional risk of undermargining.
The Commission did not receive any other comments related to the
definitions of ``business day'' or ``holiday'' in proposed regulation
Sec. 1.44(a) and is adopting those definitions as proposed.
Relatedly, the Commission proposed to define ``one business day
margin call'' as a margin call that is issued and met in accordance
with the requirements of proposed regulation Sec. 1.44(f). The
Commission did not receive any comments with respect to this proposed
definition, but the Commission received comments related to the
substantive requirements defining a one business day margin call in
proposed regulation Sec. 1.44(f). The Commission addresses those
comments below in connection with that provision. The Commission is
adopting the definition of ``one business day margin call'' in
regulation Sec. 1.44(a) as proposed.
Under regulation Sec. 1.44, an FCM may provide disbursements on a
separate account basis only when it, and its customer, are operating
within the ``ordinary course of business,'' as that term is defined in
the proposed regulation. The Commission proposed to define ``ordinary
course of business'' as meaning the standard day-to-day operation of
the FCM's business relationship with its separate account customer, a
condition where there are no unusual circumstances that might indicate
either a materially increased level of risk that the separate account
customer may fail promptly to perform its financial obligations to the
FCM, or a decrease in the FCM's financial resilience. The Commission
proposed regulation Sec. 1.44(e) to set forth the circumstances that
would be inconsistent with the ordinary course of business, and the
occurrence of which would require a cessation of disbursements on a
separate account basis.
SIFMA-AMG contended that the definition of ``ordinary course of
business'' in proposed regulation Sec. 1.44(a) poses certain
regulatory compliance challenges.\122\ Specifically, SIFMA-AMG asserted
that the proposed definition does not sufficiently clarify the meaning
of ``standard day-to-day operation.'' \123\ SIFMA-AMG argued that FCMs
and DCOs would be required to continuously monitor for a series of
events, some of which would not appear to rise to the level of
significance to suggest that they are not within the ordinary course of
business, such as the failure of a customer to make a single margin
payment.\124\ SIFMA-AMG urged the Commission to better define
``ordinary course of business'' and consider an approach that presumes
operation in the ordinary course of business, with clearly delineated
events such as default or bankruptcy as the only instances that would
be considered outside the ordinary course of business.\125\
---------------------------------------------------------------------------
\122\ SIFMA-AMG Comment Letter.
\123\ Id.
\124\ Id.
\125\ Id.
---------------------------------------------------------------------------
SIFMA-AMG further contended that the Commission's proposed
definition of ``ordinary course of business'' fails to recognize that
FCMs must, under Commission regulations, manage risk effectively, and
that FCMs also have
[[Page 7894]]
commercial incentives to do so.\126\ SIFMA-AMG argued the proposed
definition of ``ordinary course of business'' is inconsistent with an
FCM's obligations, noting that an FCM's obligations under its Risk
Management Program (RMP) are intentionally fluid and are designed to
allow FCMs to tailor their RMP to the specific activities of the FCM
and its customers.\127\
---------------------------------------------------------------------------
\126\ Id.
\127\ Id.
---------------------------------------------------------------------------
In adopting regulation Sec. 1.44(a), the Commission has determined
to modify the definition of ``ordinary course of business'' in
consideration of SIFMA-AMG's comment. As an initial matter, the
Commission notes that under regulation Sec. 1.44 as proposed, events
inconsistent with the ordinary course of business are generally those
that the Commission would expect an FCM to become aware of through its
existing compliance function and procedures (e.g., with respect to
cessation of disbursements on a separate account basis for a separate
account customer, a failure to deposit margin timely; the occurrence
and declaration by the FCM of an event of default as defined in the
account documentation executed between the FCM and the separate account
customer; a good faith determination by the FCM's chief compliance
officer (CCO), one of its senior risk managers, or other senior
manager, following such FCM's own internal escalation procedures, that
the separate account customer is in financial distress; or the
insolvency or bankruptcy of the separate account customer or a parent
company of the customer; or, with respect to cessation of disbursements
on a separate account basis for any of an FCM's customers, a
determination in good faith by an FCM's CCO, senior risk managers, or
other senior management, that the FCM itself is under financial or
other distress; or the insolvency or bankruptcy of the FCM or a parent
company of the FCM) and notifications or directives from third parties.
The Commission notes that the list of events inconsistent with the
ordinary course of business proposed as part of regulation Sec.
1.44(e) is substantially the same as the list of events discussed in
CFTC Letter No. 19-17, which has been relied on by DCOs (and by
extension their clearing FCMs) successfully since 2019. As SIFMA-AMG
noted in its comment letter, FCMs have some discretion in managing risk
with respect to their (and their customers') activities, and FCMs
appear to have done so effectively under the conditions of CFTC Letter
No.19-17 for over five years. The Commission expects FCMs will under
regulation Sec. 1.44 similarly exercise risk management discretion to
identify when certain non-ordinary course of business events have
occurred.\128\
---------------------------------------------------------------------------
\128\ See, e.g., new regulation Sec. 1.44(e)(1)(iii) (``A good
faith determination by the futures commission merchant's chief
compliance officer, one of its senior risk managers, or other senior
manager, following such futures commission merchant's own internal
escalation procedures, that the separate account customer is in
financial distress, or there is significant and bona fide risk that
the separate account customer will be unable promptly to perform its
financial obligations to the futures commission merchant, whether
due to operational reasons or otherwise.'').
---------------------------------------------------------------------------
Additionally, the Commission notes that although failure to make a
single margin payment may not in itself represent a departure from the
ordinary course of business (hence the Commission's proposal,
consistent with the no-action conditions of CFTC Letter No. 19-17, to
include an exception to non-ordinary course of business conditions for
failure to pay margin due to certain unusual administrative errors or
operational constraints), as a general matter, ensuring timely payment
of margin is critical to the Commission's goal of providing for
separate account treatment in a manner that ensures the safety of
customer funds and effective risk mitigation.
Although the Commission believes default or bankruptcy of an FCM or
customer are not the only events that could represent a departure from
the ordinary course of business with respect to separate account
margining, the Commission agrees that the standard for what constitutes
the ordinary course of business can be more clearly defined.
Under the proposal, although the occurrence of any of the events
described in regulation Sec. 1.44(e) would be inconsistent with the
``ordinary course of business,'' it was also possible that some other,
unspecified, events might also be inconsistent with the ``ordinary
course of business.'' Accordingly, the Commission has modified
regulation Sec. 1.44(a) to close the set of such events by providing
that the ``ordinary course of business'' means the operation of the
FCM's business relationship with its separate account customer absent
the occurrence of one or more of the events specified in regulation
Sec. 1.44(e). In such manner, the ordinary course of business
continues, provided none of the events delineated in regulation Sec.
1.44(e) have occurred.
The Commission proposed to define ``separate account'' as meaning
any one of multiple accounts of the same separate account customer that
are carried by the same FCM. The Commission did not receive any
comments with respect to this proposed definition and is adopting it as
proposed.
The Commission proposed to define ``separate account customer'' as
meaning a customer for which the FCM has elected to engage in separate
account treatment. The Commission also did not receive any comments
with respect to this proposed definition and is adopting it as
proposed.
Lastly, the Commission proposed to define ``undermargined amount''
for an account as meaning the amount, if any, by which the customer
margin requirements with respect to all products held in that account,
exceed the net liquidating value plus the margin deposits currently
remaining in that account.\129\ The proposed definition noted that
``[f]or purposes of this definition, `margin requirements' shall mean
the level of maintenance margin or performance bond (including, as
appropriate, the equity component or premium for long or short option
positions) required for the positions in the account by the applicable
exchanges or clearing organizations.'' \130\ This clarification (which
was drawn from the definition of risk margin in regulation Sec.
1.17(b)(8)) is in recognition of the difference between exchange (or
clearing organization) requirements for ``initial margin'' and
``maintenance margin.'' However, here, unlike risk margin, the
Commission included the equity component or premium for long or short
option positions, as those are part of the total required level of
margin. ``Initial margin'' is the amount of margin (otherwise known as
``performance bond'' \131\ in this context) required to establish a
position. Some (though not all) contract markets and clearing houses
establish ``maintenance margin'' requirements that are less than the
corresponding initial margin
[[Page 7895]]
requirement. Where, due to adverse market movements, the amount of
margin on deposit is less than the initial margin requirement, but
greater than or equal to maintenance margin, the FCM is not required to
(though it may) call additional margin from the customer. Once the
amount of margin on deposit is less than the maintenance margin
required, the FCM must call the customer for enough margin to meet the
initial margin level.
---------------------------------------------------------------------------
\129\ The definition of ``undermargined amount'' in regulation
Sec. 1.44(a) is different from, and simpler than, the definitions
of ``undermargined amount'' for the purpose of residual interest
calculations in regulations Sec. Sec. 1.22(c)(1), 22.2(f)(6)(i),
and 30.7(f)(1)(ii). The calculations in the latter cases are
required to take into account information at the close of business
on day T-1 that will be used to calculate a residual interest
requirement on day T, as well as payments that may be received on
day T, and the elimination of double counting of debit balances.
\130\ The definition of ``undermargined amount'' in regulation
Sec. 1.44(a) further provides that, with respect to positions for
which maintenance margin is not specified, ``margin requirements''
shall refer to the initial margin required for such positions.
\131\ ``Performance bond'' secures the performance by a customer
to meet its variation margin payment obligations to its FCM (or the
performance of variation margin payment obligations of an FCM to the
clearinghouse, or to an intermediary upstream FCM).
---------------------------------------------------------------------------
The Commission used the term ``undermargined amount'' in connection
with proposed regulation Sec. 1.44(f) in defining the requirements for
making and meeting a one business day margin call, as well as in
proposed regulation Sec. 1.44(g) in setting legally segregated,
operationally commingled (LSOC) compliance calculations for separate
accounts.
In its comment letter, the JAC contended that the Commission's
proposed definition of ``undermargined amount'' in proposed regulation
Sec. 1.44(a) is inconsistent with industry practice and methodologies
for calculating the undermargined amount provided in the JAC Margins
Handbook.\132\ Specifically, proposed regulation Sec. 1.44(a) defines
``undermargined amount'' for an account as, ``the amount, if any, by
which the customer margin requirements with respect to all products
held in that account exceeds the net liquidating value plus the margin
deposits currently remaining in that account.'' Further, proposed
regulation Sec. 1.44(a) provides that, for purposes of such
definition, ``margin requirements'' means the ``level of maintenance
margin or performance bond (including, as appropriate, the equity
component or premium for long or short options positions) required for
the positions in the account by the applicable exchanges or clearing
organizations.''
---------------------------------------------------------------------------
\132\ JAC Comment Letter.
---------------------------------------------------------------------------
As the JAC explained, its Margins Handbook recognizes two methods
for determining the undermargined amount: the Net Liquidating Value
Method \133\ and the Total Equity Method.
---------------------------------------------------------------------------
\133\ Also referred to as the ``Risk Method'' or ``Pure SPAN
Method.''
---------------------------------------------------------------------------
For purposes of the Net Liquidating Value Method, the JAC Margins
Handbook defines the undermargined amount as: ``The amount by which
margin equity is less than the maintenance margin requirement.'' \134\
The JAC noted that, for purposes of this method, its Margins Handbook
defines margin equity as ``an account's net liquidating equity plus the
collateral value of acceptable margin deposits'' \135\ and defines the
maintenance margin requirement as: ``The minimum amount of margin
equity required to be maintained in an account.'' \136\
---------------------------------------------------------------------------
\134\ JAC Comment Letter (citing JAC Margins Handbook, Chapter
1, Definition of ``Undermargined Amount'').
\135\ Id. (citing JAC Margins Handbook, Chapter 1, Definition of
``Margin Equity'').
\136\ Id. (citing JAC Margins Handbook, Chapter 1, Definition of
``Maintenance Margin Requirement (MMR)''). The definition further
notes that the maintenance margin requirement is the actual risk
margin calculated by the SPAN[supreg] margin system. Id.
---------------------------------------------------------------------------
Under the alternative Total Equity Method, the undermargined amount
is the amount by which total equity plus the collateral value of
acceptable margin deposits is less than the risk maintenance margin
requirement adjusted for the option value.\137\
---------------------------------------------------------------------------
\137\ Id. (citing JAC Margins Handbook, Chapter 4, ``Margins
Calls''). The JAC noted that net long option value reduces the risk
margin requirement while net short option value increases it.
---------------------------------------------------------------------------
The JAC argued that, as proposed, the definition of ``undermargined
amount'' in proposed regulation Sec. 1.44(a) would require that, for
all customer accounts (not just the separate accounts of separate
account customers), an FCM include the equity component of long and
short options in both the margin equity and the margin
requirement.\138\ However, the JAC asserted, under the JAC Margins
Handbook, exchange rules, and industry practice, the equity component
of long and short options is included only in either the margin equity
(under the Net Liquidating Value Method) or margin requirement (under
the Total Equity Method).\139\ The JAC further asserted that currently,
option premium is already included in margin equity and is not a
component of the margin requirement.\140\
---------------------------------------------------------------------------
\138\ Id.
\139\ Id.
\140\ Id.
---------------------------------------------------------------------------
The JAC noted that, depending on the composition of an account, the
Second Proposal's definition of ``undermargined amount'' may result in
different undermargined amounts than the Net Liquidating Value Method
or Total Equity Method as those methods are applied today. The JAC
requested the Commission provide the specific calculation for inclusion
of the equity component of premium for long or short options positions
and provide further clarification as to the rationale for the apparent
proposed change in methodology.
FIA similarly commented that, although the proposed definition of
``undermargined amount'' in proposed regulation Sec. 1.44(a) appeared
to derive from the JAC Margins Handbook definition of the same term,
the definition as proposed may give the impression that the Commission
intends to codify a preference for the Net Liquidating Value Method to
the exclusion of the Total Equity Method alternative in the JAC Margins
Handbook. FIA recommended that the Commission amend the proposed
definition of ``undermargined amount'' in proposed regulation Sec.
1.44(a) to provide that ``undermargined amount'' for an account means
the account's margin deficiency, if any, computed in accordance with
applicable guidance of the JAC promulgated under regulation Sec.
1.52(d).
The Commission's proposed definition of ``undermargined amount'' is
based not on the Net Liquidating Value/Risk/Pure SPAN Method as set
forth in the JAC Margins Handbook but rather on the Margin Adequacy
Requirement in regulation Sec. 39.13(g)(8)(iii), which provides that a
DCO shall require its clearing members to ensure their customers do not
withdraw funds from their accounts with such clearing members unless
the net liquidating value plus the margin deposits remaining in a
customer's account after such withdrawal are sufficient to meet the
customer initial margin requirements with respect to all products and
swap portfolios held in such customer's account which are cleared by
the DCO. In that respect, it is not intended to evince a requirement to
determine the undermargined amount of an account specifically using the
Net Liquidating Value Method to the exclusion of the Total Equity
Method as set forth in the JAC Margins Handbook. In proposing the
definition of ``undermargined amount,'' the Commission sought to make
clear that an FCM's determination of the undermargined amount for a
separate account should account for the equity component or premium for
long or short options positions in computing the required level of
margin for an account. However, the Commission's intent was not to
change FCMs' current practice with respect to the way in which they
determine the undermargined amount for an account.
In its comment letter, the JAC noted that FCMs determine the
undermargined amount using either the Net Liquidating Value method or
the alternative Total Equity method set forth in the JAC Margins
Handbook, both of which incorporate the equity component for long or
short option positions (the former as part of margin equity and the
latter as part of margin requirements), and that margin
[[Page 7896]]
premium is already included as part of margin equity under either
method.
Having considered the JAC's and FIA's comments, relevant provisions
of the JAC Margins Handbook, and the Commission's objectives in
defining ``undermargined amount,'' the Commission is persuaded that
utilizing either the Net Liquidating Value method or the alternative
Total Equity method to determine an account's undermargined amount
generally will produce an identical result (with the exception, as the
JAC notes, of certain instances involving long options positions, in
which the Total Equity method will produce a greater margin deficiency,
resulting in a greater margin requirement, which would further serve to
mitigate risk).
Accordingly, in adopting the definition of ``undermargined amount''
in regulation Sec. 1.44(a), the Commission is removing the proposed
language stating that, for purposes of the definition of
``undermargined amount,'' the term ``margin requirements'' shall
``include[ ], as appropriate, the equity component or premium for long
or short option positions,'' based on the Commission's understanding,
in light of comments received, that under current practice, the equity
component is included as a matter of course in margin equity or margin
requirements, and the option premium is factored into margin
equity.\141\ The Commission believes the resulting definition is
consistent with the Net Liquidating Value method for determining an
undermargined amount, as set forth in the JAC's Margins Handbook.
Notwithstanding that definition, the Commission also believes an FCM's
use of the Total Equity method, as set forth in the JAC's Margins
Handbook, would also be consistent with that definition.
---------------------------------------------------------------------------
\141\ The Commission is also making a technical (grammatical)
change to the definition of ``undermargined amount'' in regulation
Sec. 1.44(a) to change ``by which the customer margin requirements
. . . exceeds the net liquidating value . . .'' to ``by which the
customer margin requirements . . . exceed the net liquidating value
. . . .''
---------------------------------------------------------------------------
In Question 5 of the Second Proposal, the Commission invited
commenters to provide feedback with respect to whether the definition
of ``undermargined amount'' should apply haircuts to the value of
customer collateral held by an FCM and, if so, whether the amount of
such haircuts should be based on SEC rule 240.15c3-1 and Commission
regulation Sec. 1.17(c)(5)(ii), or on some other basis. A haircut is a
reduction in the allowable value of an asset to account for market
risk. In its comment letter, the JAC stated that non-cash collateral on
deposit in a customer's account should be valued at market value less
applicable SEC and CFTC haircuts for determining the margin value of
collateral. No other commenters responded specifically to this
question. The Commission has determined, in adopting the definition of
``undermargined amount'' in regulation Sec. 1.44(a), to include in
that definition a requirement that collateral haircuts based on Rule
15c3-1 of the Securities and Exchange Commission (17 CFR 240.15c3-1)
and regulation Sec. 1.17(c)(5) be applied to the value of the margin
deposits held by an FCM to reflect potential market risk associated
with the value of the collateral if and when such collateral was
liquidated.
Accordingly, the Commission is adopting regulation Sec. 1.44(a) as
proposed, subject to the modifications discussed above with respect to
the definitions of ``ordinary course of business'' and ``undermargined
amount.''
E. Proposed Regulation Sec. 1.44(b)
The Commission proposed regulation Sec. 1.44(b) to require all
FCMs, whether clearing or non-clearing, to comply with the same Margin
Adequacy Requirement that DCOs are required to apply to their clearing
FCMs pursuant to regulation Sec. 39.13(g)(8)(iii). As proposed,
regulation Sec. 1.44(b) provides that an FCM shall ensure that a
customer does not withdraw funds from its accounts with such FCM unless
the net liquidating value (calculated as of the close of business on
the previous business day) plus the margin deposits remaining in the
customer's account after such withdrawal are sufficient to meet the
customer initial margin requirements with respect to all products held
in such customer's account, except as provided in proposed regulation
Sec. 1.44(c), which allows an FCM to permit disbursements on a
separate account basis under ordinary course of business
conditions.\142\
---------------------------------------------------------------------------
\142\ Consistent with the existing Margins Handbook, the Margin
Adequacy Requirement is based on initial margin requirements rather
than any lower maintenance margin requirement. See JAC Margins
Handbook at 10-1 (``Margin Funds Available for Disbursement = Net
Liquidating Value + Margin Deposits - Initial Margin Requirement >
0''); see also supra n. 13 and accompanying text.
---------------------------------------------------------------------------
In proposing regulation Sec. 1.44(b), the Commission sought to
articulate a standard for the calculation of margin adequacy that is
consistent with the Commission's requirements for calculation of
undermargined amounts for purposes of an FCM's residual interest
calculations.\143\ Regulations Sec. Sec. 1.22(c)(2), 22.2(f)(6)(ii),
and 30.7(f)(ii)(B) require each FCM to compute such undermargined
amounts based on the information available to the FCM as of the close
of each business day for futures customer accounts, Cleared Swaps
Customer Accounts, and 30.7 accounts, respectively.
---------------------------------------------------------------------------
\143\ Id.
---------------------------------------------------------------------------
In order to address circumstances in which the previous day (for
purposes of regulation Sec. 1.44(b)(1)'s margin adequacy calculation
requirements), excluding Saturdays and Sundays, is a holiday (as
defined in regulation Sec. 1.44(a)) on which markets, but not banks,
may be open, proposed regulation Sec. 1.44(b)(2) further provides
that, in such circumstances, the margin adequacy calculation shall
instead be made using the net liquidating value of an account as of the
close of business on such holiday where (i) any DCM on which the FCM
trades is open for trading; and (ii) an account of any of the FCM's
customers includes positions traded on such a market.\144\
---------------------------------------------------------------------------
\144\ Proposed regulation Sec. 1.44(b)(2), and proposed
regulation Sec. 1.44(f)(7), discussed below, are consistent with
JAC Regulatory Alert #22-02, which provides that an FCM must issue
margin calls to customers on holidays where futures markets are open
and U.S. banks are closed. The margin calls are calculated based on
information as of the close of the previous business day (i.e., the
business day prior to the holiday) and the FCM does not count the
holiday for purposes of aging the margin call. JAC Regulatory Alert
#22-01, Mar. 30, 2022, available at www.jacfutures.com.
---------------------------------------------------------------------------
The Commission notes that proposed regulation Sec. 1.44(b)'s
requirements related to the timing of the margin adequacy calculation
required by the same section are intended to represent a minimum
standard. The proposed requirements are not intended to prevent an FCM
from exercising its judgment in connection with good risk management
practice to prevent the disbursement of customer funds based on
intervening intraday market movements resulting in losses to a customer
account between the calculation benchmark set forth in proposed
regulation Sec. 1.44(b) and the time at which a customer requests to
withdraw funds. Ensuring that customers do not withdraw funds from
their accounts at FCMs if such withdrawal would create or exacerbate an
initial margin shortfall is reasonably necessary from a risk management
perspective to reduce the likelihood and magnitude of the risk that the
FCM must cover losses due to a default by the customer on obligations
that exceed the margin held by the FCM. Similarly, because customer
funds are held by an FCM in omnibus accounts, this
[[Page 7897]]
prohibition will reduce the likelihood and magnitude of the risk that
the FCM will effectively use the margin of other customers to ``margin
or guarantee the trades or contracts, or to secure or extend the credit
of'' a customer that was permitted to withdraw margin in a manner that
created or exacerbated an undermargined condition,\145\ whether the
duty to prevent such withdrawals falls on DCOs acting on their clearing
member FCMs (per regulation Sec. 39.13(g)(8)(iii)), or directly on
FCMs.
---------------------------------------------------------------------------
\145\ See CEA Sec. 4d(a)(2), 7 U.S.C. 6d(a)(2) (Providing that
an FCM may not use the money or property 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.'').
---------------------------------------------------------------------------
Because regulation Sec. 39.13(g)(8)(iii) applies only to DCOs
(which in turn can only apply regulation Sec. 39.13(g)(8)(iii)'s
Margin Adequacy Requirement to their clearing member FCMs), and given
the strong trend of the comments in favor of addressing these issues in
a manner that is uniform across all types of FCMs directly in part 1
rather than indirectly through part 39, the Commission continues to
view it as reasonably necessary to extend the requirement to prevent
such undermargining scenarios to all FCMs.
Accordingly, it is the Commission's judgment that regulation Sec.
1.44(b), which will apply a Margin Adequacy Requirement similar to that
of regulation Sec. 39.13(g)(8)(iii) directly to FCMs, both clearing
and non-clearing, is reasonably necessary to protect customer funds and
mitigate systemic risk, thus effectuating CEA section 4d(a)(2),
4d(f)(2), and 4(b)(2)(A) \146\ and accomplishing the purposes of
``avoidance of systemic risk'' and ``protecting all market participants
from . . . misuses of customer assets.'' \147\
---------------------------------------------------------------------------
\146\ 7 U.S.C. 6d(a)(2), 6d(f)(2), and 6(b)(2)(A).
\147\ CEA Sec. 3(b), 7 U.S.C. 5(b). See, as discussed above,
section 8a(5) of the CEA, 7 U.S.C. 12a(5), authorizing the
Commission to make and promulgate such rules and regulation as in
the Commission's judgment are reasonably necessary to effectuate any
of the provisions, or to accomplish any of the purposes, of the CEA.
---------------------------------------------------------------------------
The JAC discussed proposed regulation Sec. 1.44(b) in several
respects in its comment letter. First, the JAC asserted that proposed
regulation Sec. 1.44(b)(1) is unclear; specifically, because it is
unclear how the Commission is defining customer initial margin
requirements in light of its definition of the term ``margin
requirements,'' within the proposed definition of the term
``undermargined amount'' in proposed regulation Sec. 1.44(a), as
including ``the equity component or premium for long or short option
positions.'' \148\ As the JAC noted, proposed regulation Sec.
1.44(b)(1) would affect all customers, not just customers whose
accounts receive separate account treatment.\149\
---------------------------------------------------------------------------
\148\ JAC Comment Letter. The JAC reiterated additional points
in support of this contention that the Commission discusses above in
connection with the definition of ``undermargined amount'' in
regulation Sec. 1.44(a).
\149\ Id.
---------------------------------------------------------------------------
As discussed above in connection with regulation Sec. 1.44(a), the
Commission is adopting its proposed definition of ``undermargined
amount'' with modifications to remove language that the JAC identified
as inconsistent with exchange rules and industry practice, and the
Commission views an FCM's use of either of the Net Liquidating Value or
alternative Total Equity method set forth in the JAC Margins Handbook
as consistent with the Commission's objective in defining an account's
undermargined amount for purposes of regulation Sec. 1.44.
Second, the JAC contended that proposed regulation Sec. 1.44(b)
may impact the way some FCMs settle with customers on a daily
basis.\150\ Specifically, the JAC asserted, many FCMs initiate multiple
cash and/or collateral transactions within the same customer account on
the same business day in order to settle each individual currency
within the account, or may call initial margin separately from
variation margin within a single customer account, whether or not such
account is receiving separate account treatment.\151\ The JAC noted
this may result in a withdrawal of margin funds by a single customer
account or within a separate account when, in the aggregate, including
required margin on all positions and total margin equity, the account
was undermargined as of the close of business on the prior business
day.\152\ The JAC asserted this is a generally accepted practice,
provided certain controls are in place and adequate records are
maintained to demonstrate margin calls are issued, aged, and fully
initiated for immediate settlement to support any outgoing
disbursements.\153\ The JAC requested that the Commission confirm
whether such margin procedures will continue to be permissible for
separate and non-separate accounts, particularly with respect to the
funds available for disbursement to a customer.\154\
---------------------------------------------------------------------------
\150\ Id.
\151\ Id.
\152\ Id.
\153\ Id.
\154\ Id.
---------------------------------------------------------------------------
Relatedly, the JAC sought clarification regarding whether the
Second Proposal requires each separate account to settle a single
undermargined amount pursuant to proposed regulation Sec. 1.44(f) or
disburse a single excess margin amount pursuant to proposed regulation
Sec. 1.44(b), taking into account the aggregate of all positions and
currencies within the separate account.\155\ The JAC indicated that, to
the extent the proposed regulations would require a change in current
practice with respect to settlement of margin payments on a currency-
by-currency basis within a customer account (whether or not the account
is receiving separate treatment), then FCMs may be required to update
their regulatory records, risk programs, margin calculations, and
reporting for customer accounts.\156\
---------------------------------------------------------------------------
\155\ Id. The JAC provided the following example: a customer's
separate account has an overall undermargined amount at the close of
business on Monday of $2,000 USD (comprised of an undermargined
amount in GBP currency with a USD equivalent value of $6,000 and
funds in excess of its margin requirements in USD currency of
$4,000). The JAC requested the Commission clarify whether, although
the separate account was undermargined overall for Monday's close of
business, the FCM could allow the separate account customer to
withdraw on Tuesday the excess margin funds denominated in USD of
$4,000 while also issuing a margin call on Tuesday for the GBP
undermargined amount (for the USD equivalent value of $6,000), and
remain in compliance with proposed regulation Sec. 1.44(b) and, if
so, (i) whether there are certain requirements and controls that the
FCM must have in place; and (ii) how the different settlement
timeframes of the currencies would impact such permissibility,
including in cases where a specific currency cannot be initiated for
immediate settlement (e.g., if in the JAC's example, Tuesday is a
banking holiday in the UK, but not in the U.S.). Id.
\156\ Id.
---------------------------------------------------------------------------
In response to the JAC's comment, the Commission confirms that each
separate account would not be required to settle a single undermargined
amount or disburse a single excess margin amount pursuant to regulation
Sec. 1.44 as adopted herein. Rather, each receipt or disbursement
would add to or subtract from the available balance in a customer's
account, calculated using a single reference currency. As stated above,
regulation Sec. 1.44(b) as proposed would require an FCM to ensure
that a customer does not withdraw funds from its accounts with the FCM
unless the net liquidating value (calculated as of the close of
business on the previous business day) plus the margin deposits
remaining in the customer's account after the withdrawal are sufficient
to meet the customer initial margin requirements with respect to all
products held in the customer's account, except as provided for
pursuant to regulation Sec. 1.44(c), which sets forth the fundamental
requirements for separate account treatment.
[[Page 7898]]
The Commission notes that, for purposes of regulation Sec.
1.44(b), the net liquidating value is calculated based on the market
value of the positions in the customer's account. In proposing
regulation Sec. 1.44(b), the Commission noted that real-time
calculation of margin adequacy with respect to a potential withdrawal
may prove impracticable.\157\ In doing so, the Commission refers to the
fact that it may be impracticable for an FCM to calculate the market
value of the positions in a customer's account on a real-time basis.
---------------------------------------------------------------------------
\157\ Second Proposal, 89 FR at 15324.
---------------------------------------------------------------------------
However, the Commission does not believe it would be impracticable
for an FCM to account for payments received or disbursements made since
the close of business on the previous business day. Indeed, regulation
Sec. 1.22(c)(3)(ii) provides that an FCM may reduce the amount of
residual interest required to be maintained under regulation Sec.
1.22(c)(3)(i) to account for payments received from or on behalf of
undermargined futures customers (less the sum of any disbursements made
to or on behalf of such customers) between the close of business on the
previous business day and the Residual Interest Deadline.\158\
Regulations Sec. Sec. 22.2(f)(6)(iii)(B) and 30.7(f)(ii)(C)(2) permit
this practice as to the accounts of Cleared Swaps Customers and 30.7
customers, respectively.\159\
---------------------------------------------------------------------------
\158\ 17 CFR 1.22(c)(3)(ii).
\159\ 17 CFR 22.2(f)(6)(iii)(B); 17 CFR 30.7(f)(ii)(C)(2). See
also, e.g., JAC Comment Letter (discussing multi-settlement
margining procedures as well as treatment of pending non-USD
transfers for purposes of determining a customer's residual interest
requirement).
---------------------------------------------------------------------------
Similarly, in calculating margin adequacy under regulation Sec.
1.44(b), an FCM should consider payments received from or on behalf of
customers, including the separate accounts of separate account
customers, less the sum of any disbursements made to or on behalf of
such customers, between the close of business on the previous business
day and the time at which the FCM considers a disbursement to a
customer. In calculating the current balance in a customer's account,
an FCM may use either the currency exchange rates at the close of
business on the previous day, or at some later time. The FCM should be
consistent in both the sources of exchange rates that it uses and in
choosing the time as of which it will reference such exchange rates in
calculating the current balance in the customer's account. Moreover, in
doing so, the FCM must act consistently with regulation Sec.
1.49(e).\160\ Additionally, as discussed below, the Commission notes
that the final rule is not intended to preclude FCMs from, consistent
with JAC guidance, considering as received for purposes of regulation
Sec. 1.44(b)'s Margin Adequacy Requirement pending receipts
denominated in non-USD (and non-CAD, in light of regulation Sec.
1.44(f)(1)-(3)'s provisions for the timing of margin payments to meet a
one business day margin call standard) currencies.\161\ The Commission
expects that an FCM will, consistent with JAC guidance, also treat
pending non-USD (and non-CAD) disbursements in the same manner (i.e.,
as disbursed).
---------------------------------------------------------------------------
\160\ 17 CFR 1.49(e).
\161\ See the Commission's discussion of the JAC's guidance with
respect to pending non-USD transfers above in its discussion of
amendments to regulation Sec. 1.17.
---------------------------------------------------------------------------
Third, the JAC noted that although the Margin Adequacy Requirement
in proposed regulation Sec. 1.44(b) discusses determination of funds
available for withdrawal from customer accounts, the Commission in the
Second Proposal proposed only to establish a requirement to collect
margin from separate account customers (in proposed regulation Sec.
1.44(f)(1)) and did not propose a broader requirement for FCMs to
collect margin, analogous to the collection requirement in regulation
Sec. 39.13(g)(8)(ii), and applicable to all accounts carried by
clearing and non-clearing FCMs.\162\ The JAC further noted that, in the
absence of such a requirement, the requirements applicable to margin
collection are limited to requirements under exchange rules whereas
requirements applicable to disbursements to customers will be defined
by Commission regulations (unless the exchange or clearing organization
imposes a more stringent requirement).\163\
---------------------------------------------------------------------------
\162\ Id. Regulation Sec. 39.13(g)(8)(ii) provides, among other
things, that a DCO shall require its clearing members to collect
customer initial margin at a level that is not less than 100 percent
of the DCO's clearing initial margin requirements with respect to
each product and portfolio and commensurate with the risk presented
by each customer account. 17 CFR 39.13(g)(8)(ii).
\163\ JAC Comment Letter.
---------------------------------------------------------------------------
As discussed above, commenters to the First Proposal, including the
JAC, asked that the Commission codify requirements for the treatment of
separate accounts in its regulations that would apply to all FCMs. In
the Second Proposal, the Commission proposed to do just that. The
Commission discussed in the Second Proposal its intent to promulgate a
narrow codification, applied directly to FCMs, of the requirements for
margin disbursement set forth in regulation Sec. 39.13(g)(8)(iii),
subject to requirements based on the conditional no-action position in
CFTC Letter No. 19-17, including requirements for separate account
treatment that closely mirror the conditions in the no-action
position.\164\ The no-action position in CFTC Letter No. 19-17 and the
First Proposal concerned requirements for separate account treatment
for purposes of regulation Sec. 39.13(g)(8)(iii) regarding
disbursements of margin, and did not discuss requirements for
collection of margin outside of the separate account context.
Accordingly, the Commission considers the imposition of a requirement
for collection of margin analogous to regulation Sec. 39.13(g)(8)(ii)
to be out of scope for purposes of this rulemaking, although the
Commission may consider further amendments to its regulations in the
future to incorporate a separate margin collection requirement. As the
JAC's comment notes, margin collection requirements are currently set
by exchanges (as well as DCOs with respect to cleared transactions).
---------------------------------------------------------------------------
\164\ See Second Proposal, 89 FR at 15317.
---------------------------------------------------------------------------
The JAC also recommended that the Commission revise the Margin
Adequacy Requirement in proposed regulation Sec. 1.44(b) (and/or the
definition of ``account'' proposed in proposed regulation Sec.
1.44(a)) to ``include accounts of noncustomers who pose risk to the FCM
if such noncustomers are permitted to withdraw margin funds that would
create or exacerbate an undermargined situation, or not be required to
deposit and maintain sufficient margin to cover the risk of their
positions.'' \165\
---------------------------------------------------------------------------
\165\ The JAC noted the Commission could then consider allowing
separate account treatment for such noncustomers under the
provisions of proposed regulation Sec. 1.44(c)-(h).
---------------------------------------------------------------------------
The Commission appreciates the JAC's recommendation to consider
revising the Margin Adequacy Requirement to apply to the accounts of
noncustomers, which the Commission generally understands to encompass
accounts of certain affiliates and affiliated individuals of an FCM.
The Commission notes that the Margin Adequacy Requirement of regulation
Sec. 39.13(g)(8)(iii) does not apply with respect to withdrawals by
noncustomers, and neither CFTC Letter No. 19-17 nor the Commission's
proposals to codify the no-action position in that letter contemplated
the application of a Margin Adequacy Requirement, or requirements for
separate account treatment, with respect to noncustomers. The
Commission considers application of the Margin Adequacy Requirement in
proposed regulation Sec. 1.44(b) to noncustomers to
[[Page 7899]]
be outside the scope of this rulemaking, but will consider whether to
provide additional risk management requirements applicable to
noncustomers in the future.\166\
---------------------------------------------------------------------------
\166\ There are currently requirements relating to risk
assessment recordkeeping for FCMs with respect to affiliated persons
in regulations Sec. Sec. 1.14 and 1.15.
---------------------------------------------------------------------------
Lastly, as the Commission discusses above in connection with
amendments to regulation Sec. 1.17, the Commission received a number
of comments requesting that the Commission confirm whether FCMs may
consider as received pending non-USD transfers for purposes of certain
regulations, consistent with JAC guidance and current industry
practice. Although the Commission did not receive any such comments
specifically with respect to proposed regulation Sec. 1.44(b), for the
avoidance of doubt, the Commission confirms that the final rule is not
intended to preclude FCMs from considering as received pending non-USD
transfers, consistent with JAC guidance, when considering a
disbursement under regulation Sec. 1.44(b). However, in light of
regulation Sec. 1.44(f)(1)-(3), under which payment of margin in
Canadian dollars (CAD) is required to be settled pursuant to the timing
requirements for payment of margin in USD for purposes of meeting a one
business day margin call standard, the Commission expects that, when
considering pending non-USD transfers for purposes of regulation Sec.
1.44(b)'s Margin Adequacy Requirement, FCMs will treat pending CAD
transfers on the same basis as pending USD transfers (i.e., they will
not be treated as received or as disbursed). Additionally, a non-USD
transfer that ultimately is not received on a one business day basis,
as set forth in regulation Sec. 1.44(f), would be considered a failed
deposit and could no longer be considered pending, even if this was due
to administrative error or operational constraint. Thereafter, that
transfer would only be considered as received upon actual receipt.
Having considered comments received in response to proposed
regulation Sec. 1.44(b), the Commission is adopting regulation Sec.
1.44(b) as proposed, subject to modifications to regulation Sec.
1.44(b)(2), discussed above in connection with regulation Sec.
1.44(a), to address foreign exchanges related to regulation Sec. 30.7
accounts.\167\
---------------------------------------------------------------------------
\167\ Specifically, as adopted, regulation Sec. 1.44(b)(2)
provides, ``For purposes of [regulation Sec. 1.44(b)(1)] . . .
where the previous day (excluding Saturdays and Sundays) is a
holiday . . . where any designated contract market or other board of
trade on which the futures commission merchant trades is open for
trading, and where an account of any of the futures commission
merchant's customers includes positions traded on such a market, the
net liquidating value for such an account should . . . be calculated
as of the close of business on such holiday.''
---------------------------------------------------------------------------
F. Regulation Sec. 1.44(c)
The Commission proposed regulation Sec. 1.44(c) to establish the
fundamental requirements for separate account treatment. As a general
matter, these requirements are substantially the same as in CFTC Letter
No. 19-17, and in the First Proposal, except that the FCM may choose to
engage in separate account treatment without a requirement that a DCO
specifically authorize such treatment. As proposed, regulation Sec.
1.44(c) provides that an FCM may, only during the ordinary course of
business, as that term is defined in regulation Sec. 1.44, treat the
separate accounts of a separate account customer as accounts of
separate entities for purposes of regulation Sec. 1.44(b),\168\ if
such FCM elects to do so as specified in regulation Sec. 1.44(d).
Regulation Sec. 1.44(c) further provides that an FCM that has made
such an election shall comply with the risk-mitigating requirements set
forth in proposed regulation Sec. 1.44 and maintain written internal
controls and procedures designed to ensure such compliance.
---------------------------------------------------------------------------
\168\ As noted above, proposed regulation Sec. 1.44(b) is
intended to serve as an analog to regulation Sec. 39.13(g)(8)(iii)
for FCMs.
---------------------------------------------------------------------------
The Commission believes that permitting FCMs to treat the separate
accounts of separate account customers as accounts of separate entities
for purposes of regulation Sec. 1.44(b), subject to the risk-
mitigating requirements set forth in regulation Sec. 1.44,
accomplishes the CEA's purposes of promoting responsible innovation as
well as effective customer fund protection and risk mitigation.\169\
Compliance with those requirements can best be achieved if the FCM
maintains written internal controls and procedures designed to ensure
such compliance.
---------------------------------------------------------------------------
\169\ See CEA Sec. Sec. 3(b), 8a(5); see also, CEA section
4d(a)(2), 7 U.S.C. 6d(a)(2); CEA section 4d(f)(2), 7 U.S.C.
6d(f)(2); CEA section 4b(2)(A), 7 U.S.C. 6b(2)(A); CEA section
4f(b), 7 U.S.C. 6f(b).
---------------------------------------------------------------------------
In its comment letter, ICE stated that it does not object to the
specific requirements that would be imposed under proposed regulation
Sec. 1.44(c) where an FCM elects separate account treatment with
respect to a customer.\170\
---------------------------------------------------------------------------
\170\ ICE Comment Letter.
---------------------------------------------------------------------------
The Commission did not receive any other comments specific to
proposed regulation Sec. 1.44(c). Accordingly, the Commission is
adopting regulation Sec. 1.44(c) as proposed.
G. Regulation Sec. 1.44(d)
The Commission proposed regulation Sec. 1.44(d) to provide that an
FCM may elect to treat the separate accounts of a customer as accounts
of separate entities for purposes of proposed regulation Sec. 1.44(b).
As proposed, regulation Sec. 1.44(d)(1) provides that, to elect to
treat the separate accounts of a customer as accounts of separate
entities for purposes of regulation Sec. 1.44(b), the FCM shall
include the customer on a list of separate account customers maintained
in its books and records, and that such list shall include both the
identity of each separate account customer and the identity of each
separate account of such customer. The FCM would also be required to
keep this list current. Furthermore, as proposed, regulation Sec.
1.44(d)(2) provides that, when an FCM first chooses to include a
customer on a list of separate account customers, the FCM is required
to provide, within one business day, notification of the election to
allow separate account treatment for customers in accordance with the
process specified in regulation Sec. 1.12(n)(3).\171\ For the
avoidance of doubt, the notification of such election would remain a
one-time notification made the first time the FCM begins providing
separate account notification for any customer. Successive
notifications would not be required for each additional customer for
which the FCM provides separate account treatment. Furthermore, the FCM
would need only provide notification of the election and would not be
required to include the identity of the separate account customer. The
Commission believes that regulation Sec. 1.44(d) is reasonably
necessary to protect customer funds and mitigate systemic risk because
it is designed to enable DSROs to effectively monitor and regulate FCMs
that engage in separate account treatment, and to provide that FCMs
will have the records necessary to understand which accounts receive
separate account treatment for purposes of monitoring compliance with
the proposed regulation.
---------------------------------------------------------------------------
\171\ See 17 CFR 1.12(n)(3).
---------------------------------------------------------------------------
In its comment letter, the JAC stated that a complete and accurate
listing of separate accounts is critical to ensure that the
Commission's risk mitigating requirements can be effectively carried
out by an FCM, monitored by self-regulatory organizations (SROs) and
the Commission for compliance with such requirements, and monitored by
DCOs for customer gross margin reporting under proposed regulation
Sec. 39.13(g)(8)(i), and to assist DCOs and/or bankruptcy trustees in
porting accounts in the event of an FCM's
[[Page 7900]]
insolvency.\172\ The JAC asserted that, currently, when such listing
has been requested, certain FCMs offering separate account treatment
under the no-action position of CFTC Letter No. 19-17 include all of
the FCM's accounts or potential accounts on such listing rather than
only those accounts ``currently subject to separate account treatment
(i.e., beneficial owners that maintain more than one account at the FCM
which are being treated separately).'' \173\ The JAC recommended that
the Commission require only accounts currently receiving separate
account treatment to be included on such listing to ensure proper focus
and attention to the additional risks posed by separate account
treatment, effective monitoring of reporting of separate accounts, and
proper and efficient porting of separate accounts.\174\ The JAC also
recommended that the Commission require separate accounts to be clearly
identified as such in the FCM's books and records, including on the
separate account customer's statements to assist in ensuring a current,
accurate, and complete listing of accounts receiving separate
treatment.\175\
---------------------------------------------------------------------------
\172\ JAC Comment Letter.
\173\ Id.
\174\ Id.
\175\ Id.
---------------------------------------------------------------------------
The Commission notes that the recordkeeping requirement in
regulation Sec. 1.44(d)(1), described above, is substantially similar
to the corresponding condition in CFTC Letter No. 19-17 that an FCM
maintain a list of all separate accounts receiving separate account
treatment, indicating the beneficial owner and account numbers of such
accounts. For the avoidance of doubt, the Commission also believes that
the recordkeeping requirement in regulation Sec. 1.44(d)(1) as
proposed is consistent with the JAC's comment. It requires an FCM that
elects to treat separate accounts of a customer as accounts of separate
entities for purposes of regulation Sec. 1.44(b) to: (i) include the
customer on a list of separate account customers maintained in its
books and records; (ii) include on the list the identity of each
separate account customer; (iii) include on the list the identity of
each separate account of such customer; and (iv) keep the list current.
The definition of ``separate account customer'' in regulation Sec.
1.44(a) is ``a customer for which the [FCM] has made the election set
forth in [regulation Sec. 1.44(d)].'' The FCM would thus be required
to subject the customers on that list, as separate account customers,
to the requirements of regulation Sec. 1.44 for separate account
treatment, including regulation Sec. 1.44's one business day margin
call standard.
In its comment letter, ICE opined that it would be appropriate for
the Commission under proposed regulation Sec. 1.44(d) to require an
FCM to provide notice to DCOs of which it is a clearing member of
accounts that are subject to separate account treatment, so that the
DCO can comply with its obligations with respect to the margining of
such accounts under regulation Sec. 39.13(g).\176\
---------------------------------------------------------------------------
\176\ ICE Comment Letter.
---------------------------------------------------------------------------
The Commission designed the Second Proposal to codify the terms of
the no-action position in CFTC Letter No. 19-17 in a manner directly
applicable to FCMs and not through the instrumentation of DCO rules.
The Commission notes that under the conditions of CFTC Letter No. 19-
17, an FCM shall, on a one-time basis, provide notification to its DSRO
if it will apply separate account treatment a provided for in the no-
action position to any separate accounts. No such notification to a DCO
was a condition of the no-action position and, because the Commission
is modifying part 1 to apply a Margin Adequacy Requirement and
requirements for separate account treatment directly to FCMs, the
Commission views a requirement, imposed by the Commission, for an FCM
to provide to a DCO of which it is a clearing member the one-time
notification of commencement of separate account treatment as outside
the scope of this rulemaking. The Commission further notes that a DCO
has the discretion to put in place additional rules regarding
information its clearing members must provide, and could choose to
independently promulgate a requirement under DCO rules to provide
notification to such DCO the first time an FCM begins separate account
treatment for a customer.\177\ Regulation Sec. 39.13(g)(8)(iii), as
amended by this final rulemaking, requires a DCO to have rules
requiring that its clearing members do not withdraw funds from their
accounts in a manner that would lead to or exacerbate an undermargining
scenario, except as provided for in regulation Sec. 1.44, and DCOs
have discretion in how they choose to monitor for and enforce that
requirement.
---------------------------------------------------------------------------
\177\ See, e.g., ICE Clear Credit Rule 406(f) (``Each
Participant shall provide such reports to ICE Clear Credit with
respect to Non-Participant Parties and their related Client Related
Positions and Non-Participant Collateral . . . upon request of ICE
Clear Credit and upon such other basis, if any, as is provided in
the ICE Clear Credit Procedures.'').
---------------------------------------------------------------------------
FIA requested that the Commission clarify that any clearing FCM
that has already provided the notice required by proposed regulation
Sec. 1.44(d)(2) to its DSRO in compliance with the conditions of CFTC
Letter No. 19-17 shall be deemed to have complied with the requirement
of proposed regulation Sec. 1.44(d)(2) that an FCM provide
notification to its DSRO of the first time the FCM includes a customer
on its list of separate account customers.\178\
---------------------------------------------------------------------------
\178\ FIA Comment Letter.
---------------------------------------------------------------------------
As discussed above, in addition to requiring an FCM to maintain a
list of all separate accounts (indicating the beneficial owner and
account numbers) receiving separate account treatment, CFTC Letter No.
19-17 requires as a condition to separate account treatment that an FCM
shall, on a one-time basis, provide notification to its DSRO if it will
apply separate account treatment to any separate accounts. As proposed,
regulation Sec. 1.44(d)(2) adds to this requirement that such
notification shall be provided in accordance with the following
conditions: (i) the first time that the FCM includes a customer on the
list of separate account customers; (ii) within one business day; (iii)
to the Commission (in addition to the DSRO); and (iv) in accordance
with the process specified in regulation Sec. 1.12(n)(3). With respect
to the one-time notification that the FCM is required to provide to its
DSRO, the Commission recognizes that the requirements of regulation
Sec. 1.44(d)(2) are, in the main, substantially the same as those in
the corresponding condition of CFTC Letter No. 19-17. Notwithstanding
the timing and manner requirements of regulation Sec. 1.44(d)(2) as
proposed, recognizing that FCMs have successfully applied separate
account treatment under the conditions of CFTC Letter No. 19-17 for
over five years, the Commission confirms that a clearing FCM that has
already provided to its DSRO the one-time notification of commencement
of separate account treatment pursuant to the no-action conditions of
CFTC Letter No. 19-17 shall be deemed to have complied with the
analogous requirement of regulation Sec. 1.44(d)(2).
Having considered comments received with respect to proposed
regulation Sec. 1.44(d), the Commission is adopting regulation Sec.
1.44(d) as proposed.
H. Regulation Sec. 1.44(e)
As proposed, regulation Sec. 1.44(e) enumerates events that would
be inconsistent with the ordinary course of business, as that term is
defined in regulation Sec. 1.44(a), and sets forth
[[Page 7901]]
requirements related to the cessation and resumption of permitting
disbursements on a separate account basis upon, respectively, the
occurrence and cure of certain non-ordinary course of business events.
Each of these events would raise important concerns about the financial
resiliency of the FCM or one or more of its separate account
customers.\179\ As discussed above with respect to regulation Sec.
1.44(a), the list of events in regulation Sec. 1.44(e) will be the
exclusive set of events that are inconsistent with the ordinary course
of business for purposes of regulation Sec. 1.44.
---------------------------------------------------------------------------
\179\ For example, while the bankruptcy of an FCM or a separate
account customer would have direct effects, the bankruptcy of an
FCM's or separate account customer's parent company would also
portend financial challenges for, respectively, the FCM or separate
account customer (e.g., if the parent company decided to liquidate
its subsidiaries in bankruptcy). Experience in the bankruptcies of,
e.g., Refco and Lehman, demonstrates that when one member of an
affiliate financial company structure files for bankruptcy, other
affiliates soon follow.
---------------------------------------------------------------------------
These events are divided into two categories: (i) events that
concern the separate accounts of a particular separate account
customer, the occurrence of any one of which would require the FCM to
cease permitting disbursements on a separate account basis with respect
to all accounts of that customer; and (ii) events that concern the
financial status of the FCM itself, and the occurrence of any one of
which would require the FCM to cease permitting disbursements on a
separate account basis with respect to all of its separate account
customers.
Significantly, while a separate account customer is outside the
ordinary course of business as defined in regulation Sec. 1.44(a),
only the privilege of permitting disbursements on a separate account
basis, pursuant to regulation Sec. 1.44(c), is terminated (or
suspended). So long as a customer remains a separate account customer,
whether or not within the ordinary course of business, then the FCM is
required to comply with the requirements of regulation Sec. 1.44,
including with respect to the relevant provisions addressed in
regulations Sec. Sec. 1.17, 1.20, 1.22, 1.23, 1.32, 1.55, 1.58, 1.73,
22.2, 30.7, and 39.13(g)(8)(i) regarding that customer and all of that
customer's separate accounts. Similarly, if it is the FCM that is
outside the ordinary course of business, it is only the privilege of
permitting disbursements on a separate account basis with respect to
any of the FCM's separate account customers and their separate accounts
that is terminated (or suspended). The FCM continues to be required to
comply with the requirements in regulation Sec. 1.44, including with
respect to the relevant provisions described above, with respect to its
separate account customers and their separate accounts. Thus, for the
avoidance of doubt, a separate account customer that is outside the
ordinary course of business is still a separate account customer.
The first category of events is as follows:
(1)(i) The separate account customer, including any
separate account of such customer, fails to deposit initial margin or
maintain maintenance margin or make payment of variation margin or
option premium as specified in proposed regulation Sec. 1.44(f).\180\
---------------------------------------------------------------------------
\180\ I.e., the one business day margin call requirement.
---------------------------------------------------------------------------
(ii) The occurrence and declaration by the FCM of an event
of default as defined in the account documentation executed between the
FCM and the separate account customer.
(iii) A good faith determination by the FCM's CCO, one of
its senior risk managers, or other senior manager, following such FCM's
own internal escalation procedures, that the separate account customer
is in financial distress, or there is significant and bona fide risk
that the separate account customer will be unable promptly to perform
its financial obligations to the FCM, whether due to operational
reasons or otherwise.
(iv) The insolvency or bankruptcy of the separate account
customer or a parent company of such customer.
(v) The FCM receives notification that a board of trade, a
DCO, an SRO as defined in regulation Sec. 1.3 or section 3(a)(26) of
the Securities Exchange Act of 1934, the Commission, or another
regulator \181\ with jurisdiction over the separate account customer,
has initiated an action \182\ with respect to such customer based on an
allegation that the customer is in financial distress.
---------------------------------------------------------------------------
\181\ E.g., the SEC or a foreign regulator.
\182\ In this context, the term ``initiate an action'' is
intended to include the filing of a complaint or a petition to take
action against an entity, or an analogous process. The initiation or
conduct of an investigation would not be sufficient to constitute
``initiating an action'' in this context.
---------------------------------------------------------------------------
(vi) The FCM is directed to cease permitting disbursements
on a separate account basis, with respect to the separate account
customer, by a board of trade, a DCO, an SRO, the Commission, or
another regulator with jurisdiction over the FCM, pursuant to, as
applicable, board of trade, DCO, or SRO rules, government regulations,
or law.
The second set of events is as follows:
(2)(i) The FCM is notified by a board of trade, a DCO, an
SRO, the Commission, or another regulator with jurisdiction over the
FCM, that the board of trade, the DCO, the SRO, the Commission, or
other regulator, as applicable, believes the FCM is in financial or
other distress.
(ii) The FCM is under financial or other distress as
determined in good faith by its CCO, senior risk managers, or other
senior management.
(iii) The insolvency or bankruptcy of the FCM or a parent
company of the FCM.
As proposed, regulation Sec. 1.44(e)(3) provides that the FCM must
provide notice to its DSRO and to the Commission of the occurrence of
any of the events terminating (or suspending) disbursements on a
separate account basis for one or more separate account customers. The
notice must be provided to the DSRO and the Commission in accordance
with the process specified in regulation Sec. 1.12(n)(3). The notice
also must identify the event and, if applicable, the customer. The FCM
is required to provide such notice promptly in writing no later than
the next business day following the date on which the FCM identifies or
has been informed that the relevant event has occurred. The
notification required upon exiting the ordinary course of business is
intended to ensure that the Commission and DSROs will be apprised of
the occurrence of non-ordinary course of business events, so that they
may actively communicate with and monitor an FCM with respect to the
resolution of such events (e.g., where an FCM attempts to establish
that its customer has reentered ordinary course of business
conditions).
Regulation Sec. 1.44(e)(4), as proposed, provides an avenue for an
FCM that has experienced a non-ordinary course of business event with
respect to itself or a customer to return to the ordinary course of
business and resume disbursements on a separate account basis for
itself or its customers, as may be the case. Regulation Sec.
1.44(e)(4) provides that an FCM that has ceased permitting
disbursements on a separate account basis to a separate account
customer due to the occurrence of a non-ordinary course of business
event, with respect to that specific separate account customer, or with
respect to all such customers, may resume permitting disbursements to
such customer(s) on a separate account basis if such FCM reasonably
believes, based on new information, that those circumstances triggering
the event have been cured, and such FCM documents in writing the
factual basis and rationale for its
[[Page 7902]]
conclusion. However, regulation Sec. 1.44(e)(4) also provides that, if
the circumstances triggering cessation of such treatment were an action
or direction by a board of trade, a DCO, an SRO, the Commission, or
another regulator with jurisdiction over the separate account customer
or the FCM, then cure of those circumstances would require the
withdrawal or other appropriate termination of such action or direction
by that entity.
That permitting disbursements on a separate account basis should be
discontinued (or at least suspended) under certain circumstances is
reflected in CME's recommendation, preceding issuance of CFTC Letter
No. 19-17, that disbursements on a separate account basis be permitted
only during the ordinary course of business. As CME explained, FCMs
should maintain the flexibility to determine that either the customer
or the FCM itself is in distress and ``pause'' disbursements until the
customer's other account can demonstrably meet the call to deposit
funds.\183\ Similarly, as CME noted, an FCM should not be purposely
releasing funds to a customer when the customer's overall account is in
deficit, as doing so may create a shortfall in segregated, secured, or
Cleared Swaps Accounts in the event the FCM becomes insolvent.\184\
---------------------------------------------------------------------------
\183\ CME Letter.
\184\ Id.
---------------------------------------------------------------------------
However, the Commission acknowledges that in some instances, an FCM
or customer may exit a state of financial, operational, or other
distress, such that resumption of separate account disbursements would
be appropriate. By explicitly providing FCMs with an avenue to resume
disbursements on a separate account basis consistent with the
resumption of the ordinary course of business, the Commission seeks to
ensure that a temporary departure from the ordinary course of business,
once remedied, does not continue to preclude an FCM from applying (and
a customer from having applied to its accounts) separate account
treatment, and to incentivize transparency between FCMs and their DSROs
and Commission staff with respect to conditions at the FCMs or
customers that could indicate operational or financial distress and,
more generally, the risk management program at the FCM.
Regulation Sec. 1.44(e) is designed to ensure that disbursements
are permitted on a separate account basis only during the routine
operation of the FCM's business relationship with its customer. Certain
events signaling financial or operational distress of the FCM or
customer are inconsistent with the normal operation of the business
relationship between the FCM and its customer. The Commission believes
that, when such events occur, and throughout the duration of their
occurrence, suspending FCMs' ability to provide disbursements on a
separate account basis with respect to the Margin Adequacy Requirement
is reasonably necessary to protect customer funds and mitigate systemic
risk, and to effectuate section 4d of the CEA.
The JAC, noting the passage of time since the Divisions issued CFTC
Letter No. 19-17, requested that the Commission provide examples of
non-enumerated events that would constitute operating outside the
ordinary course of business, so that FCMs and their customers can
better understand the circumstances in which disbursements on a
separate account basis are not permitted.
In the Second Proposal, the Commission proposed to define the
``ordinary course of business'' as the ``standard day-to-day operation
of the futures commission merchant's business relationship with its
separate account customer,'' based on the similar definition in CFTC
Letter No. 19-17 (``standard day to day operation of the FCM's business
relationship with its customer''). Although in both CFTC Letter No. 19-
17 and proposed regulation Sec. 1.44(e) the Commission set forth
events that it would consider inconsistent with the ordinary course of
business, the Commission acknowledges that the Second Proposal's
proposed definition of ``ordinary course of business'' in conjunction
with the list of events inconsistent with the ordinary course of
business in proposed regulation Sec. 1.44(e) may have resulted in
confusion regarding the scope of events that the Commission will
consider inconsistent with the ordinary course of business for purposes
of regulation Sec. 1.44(a).
As discussed above in connection with SIFMA-AMG's comment related
to the definition of ``ordinary course of business'' in regulation
Sec. 1.44(a), the Commission is modifying the proposed definition of
``ordinary course of business'' in regulation Sec. 1.44(a) to make
clear that regulation Sec. 1.44(e) contains the complete list of
events that, for purposes of regulation Sec. 1.44, would cause a
separate account customer or an FCM providing separate account
treatment to fall outside the ordinary course of business, such that
the FCM would need to cease providing disbursements on a separate
account basis for one or more customers. Therefore, only the events
specifically enumerated in regulation Sec. 1.44(e) would place a
separate account customer or an FCM providing separate account
treatment outside the ordinary course of business, as defined in
regulation Sec. 1.44(a).
ICE, in its comment letter, stated that it did not object to the
list of events that would be inconsistent with the ordinary course of
business in proposed regulation Sec. 1.44(e).
The Commission did not receive any other comments directly related
to proposed regulation Sec. 1.44(e).\185\ Accordingly, the Commission
is adopting regulation Sec. 1.44(e) as proposed.\186\
---------------------------------------------------------------------------
\185\ Comments with respect to the Commission's proposed
definition of ``ordinary course of business,'' set forth in
regulation Sec. 1.44(a), are addressed above in connection with
that section.
\186\ As a matter of internal consistency and clarity, because
proposed regulation Sec. 1.44(e)(4) concerns the resumption of
disbursements on a separate account basis following a cessation of
such treatment due to non-ordinary course of business conditions,
the Commission is making a change in final regulation Sec.
1.44(e)(4), to substitute ``disbursements on a separate account
basis'' for ``separate account treatment,'' in providing, ``If the
circumstances triggering cessation of disbursements on a separate
account basis were an action or direction by one of the entities
described in paragraphs (e)(1)(v) or (vi), or paragraph (e)(2)(i),
of this section, then the cure of those circumstances would require
the withdrawal or other appropriate termination of such action or
direction by that entity.''
---------------------------------------------------------------------------
I. Regulation Sec. 1.44(f)
The Commission proposed regulation Sec. 1.44(f) to require that
each separate account must be on a one business day margin call,
subject to certain requirements designed to further define what
constitutes a one business day margin call. Providing for a one
business day margin call, as defined in this regulation Sec. 1.44(f),
ensures that margin shortfalls are timely corrected, and that a
customer's inability to meet a margin call is timely identified.
However, in certain circumstances, it may be impracticable for payments
to be received on a same-day basis due to the mechanics of
international payment systems (e.g., time zones and schedules of
correspondent banks). In promulgating requirements to define timely
payment of margin for purposes of the standard set forth in proposed
regulation Sec. 1.44(f), the Commission seeks to establish
requirements that reflect industry best practices among FCMs and
customers.\187\ The
[[Page 7903]]
Commission believes that regulation Sec. 1.44(f) is reasonably
necessary to protect customer funds and mitigate systemic risk, and to
effectuate CEA section 4d, because it is designed to limit the time in
which accounts receiving separate treatment may be undermargined, and
to do so in a manner that takes into consideration the way in which
that period may be affected by factors such as time zones,
international banking conventions, and (to an appropriate extent)
holidays.
---------------------------------------------------------------------------
\187\ An analysis by FIA indicated that, for the FCMs studied,
on average more than 90% of margin deficits were collected by the
close of business on the day following the market movements creating
such deficits. For a majority of the FCMs studied, 95% of margin
deficits were collected by that time. See Letter from Barbara
Wierzinski, General Counsel, FIA, to Melissa Jurgens, Secretary,
CFTC, Costs of the Proposed Residual Interest Requirement Compared
to the FIA Alternative, at 3, available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59283&SearchText=FIA.
---------------------------------------------------------------------------
Specifically, the Commission understands that, although margin
calls made in the morning in the U.S. Eastern Time Zone (ET) are
typically capable of being met on a same-day basis when margin is paid
in United States dollars (USD) and CAD, the operation of time zones and
banking conventions in other jurisdictions may necessitate additional
time when margin is paid in other currencies. For example, the
Commission understands, based on discussions with market participants,
that margin paid in Japanese yen (JPY) and certain other currencies is
typically received two business days after a margin call is issued, and
margin paid in British pounds (GBP), euros (EUR), and certain other
non-USD/CAD/JPY currencies is typically received one business day after
a margin call is issued.
In connection with proposed regulation Sec. 1.44(f), the
Commission requested comment (as Question 6) regarding whether, in
light of changes made in the Second Proposal relative to the First
Proposal, the regulatory framework set forth in proposed regulation
Sec. 1.44(f) appropriately balances practicability and burden with
risk management, as well as: (i) if not, what alternative approach
should be taken; and (ii) how such an alternative approach would better
balance practicability and burden with risk management. As part of this
request, the Commission requested comment on whether the standard of
timeliness for a one business day margin call set forth in proposed
regulation Sec. 1.44(f) presented practicability challenges and, if
so, what those challenges would be, and how the proposed standard of
timeliness could be improved. The Commission considers the comments
received in response to the margin payment timing requirements set
forth in proposed regulation Sec. 1.44(f)(1)-(3), and other provisions
of proposed regulation Sec. 1.44(f) that modify those requirements in
certain circumstances, to be generally responsive to this question. The
Commission discusses these comments below.
As proposed, regulation Sec. 1.44(f)(1) provides that, except as
explicitly provided in regulation Sec. 1.44(f), if, as a result of
market movements or position changes on the previous business day, a
separate account is undermargined (i.e., the undermargined amount for
the account is greater than zero), then the FCM shall issue a margin
call for that separate account for at least the amount necessary for
the separate account to meet the initial margin required by the
applicable exchanges or clearing organizations (including, as
appropriate, the equity component or premium for long or short option
positions) for the positions in the separate account.\188\ Such call
must be met by the applicable separate account customer no later than
the close of the Fedwire Funds Service on the same business day,
consistent with the industry standard for when 90-95% of margin
deficits are cured.\189\
---------------------------------------------------------------------------
\188\ The undermargined amount is based on maintenance margin,
which may be lower than initial margin. However, if an account falls
below the maintenance margin level, the amount of the margin call is
generally required to be the amount necessary to bring the account
back to the (potentially higher) initial margin level.
\189\ The Fedwire Funds Service is an electronic funds transfer
service commonly used for settlement and clearing arrangements. The
service currently closes at 7:00 p.m. ET. For purposes of the
Fedwire Funds Service, Federal Reserve Banks observe as holidays all
Saturdays, all Sundays, and the holidays listed on the Federal
Reserve Banks' Holiday Schedules. See The Federal Reserve,
Fedwire[supreg] Funds Service and National Settlement Service
Operating Hours and FedPayments[supreg] Manager Hours of
Availability, available at https://www.frbservices.org/resources/financial-services/wires/operating-hours.html. Because the Fedwire
Funds Service hours of operations may be subject to change, the
Commission has determined to tie the timeframe to fulfill the one
business day margin call requirements of proposed regulation Sec.
1.44(f) to the Fedwire Funds Service's closing rather than an
absolute time.
---------------------------------------------------------------------------
In light of challenges to same-day settlement posed by margining in
certain currencies, as described above, and in recognition of the
particular banking conventions around payments in other currencies, the
Commission proposed regulation Sec. 1.44(f)(2) to provide that payment
of margin in certain currencies listed in proposed Appendix A to part 1
shall be considered in compliance with the requirements of regulation
Sec. 1.44(f) provided they are received by the applicable FCM no later
than the end of the second business day after the day on which the
margin call is issued.
The Commission also proposed regulation Sec. 1.44(f)(3), which
provides that payment of margin in fiat currencies other than USD, CAD,
or the currencies listed in proposed Appendix A to part 1 shall be
considered in compliance with the requirements of regulation Sec.
1.44(f) if received by the applicable FCM no later than the end of the
business day after the business day on which the margin call was
issued.
In the Commission's view, a ``one business day margin call'' should
be defined beyond the term itself, in light of the effect of time zones
and international banking conventions that may cause a customer to be
unable to meet a call for margin in certain currencies on the day the
margin call is issued. Although FCMs may ensure that margin calls are
generally met within one business day, for purposes of separate account
treatment, the Commission wishes to ensure that such margin calls are
(subject to specified exceptions) always met on a one business day
basis. The Commission also notes that, with respect to the calculation
of balances in customers' accounts and the undermargined amount which
the FCM must include in its residual interest and LSOC compliance
calculations, such figures would be calculated on a separate account
basis, as discussed herein.\190\
---------------------------------------------------------------------------
\190\ See, e.g., JAC, Regulatory Alert, #18-02, at 2, June 6,
2018 (discussing undermargined accounts), regulation Sec.
1.44(g)(5).
---------------------------------------------------------------------------
The Commission received several comments with respect to the margin
payment timing framework for separate accounts set forth in proposed
regulation Sec. 1.44(f)(1)-(3).
As discussed above in connection with regulation Sec. 1.44(a), the
JAC contended that the Commission's proposed definition of the term
``undermargined amount'' would be inconsistent with existing industry
practice and the guidance for calculating a margin call in the JAC
Margins Handbook. As with respect to other provisions of proposed
regulation Sec. 1.44 that use or otherwise rely on the term
``undermargined amount,'' the JAC contended that the margin call
required under proposed regulation Sec. 1.44(f)(1) would be similarly
inconsistent with industry practice and JAC guidance.\191\ In doing so,
the JAC reiterated its comment that the Second Proposal's definition of
``undermargined amount'' would require FCMs to compute margin calls for
separate accounts as required under proposed regulation Sec.
1.44(f)(1) whereas FCMs would be required to
[[Page 7904]]
compute margin calls differently for non-separate account
customers.\192\
---------------------------------------------------------------------------
\191\ JAC Comment Letter. The JAC stated that, currently, FCMs
calculate a margin call using the following formula: Initial Margin
Requirement--Margin Equity--Outstanding Margins Calls = [a positive
balance represents the amount of margin call to be issued]. Id.
\192\ Id.
---------------------------------------------------------------------------
As discussed above in connection with regulation Sec. 1.44(a), the
Commission is modifying the definition of ``undermargined amount'' to
remove the language that the Commission believes created the identified
inconsistency and confirm that the Commission considers either of the
Net Liquidating Value or Total Equity methods set forth in the JAC
Margins Handbook to be consistent with the definition of
``undermargined amount'' that the Commission is adopting.
SIFMA-AMG urged the Commission to rescind the one business day
margin call standard set forth in proposed regulation Sec. 1.44(f)(1)-
(3).\193\ SIFMA-AMG contended that the Second Proposal does not
adequately appreciate the differences in operational workflows and risk
management processes currently in place and how they may differ
depending on markets, products, clients, custodians, and fund
structures.\194\ Specifically, SIFMA-AMG disagreed with the
Commission's proposal to require same-day margin calls to be met
regardless of the time the FCM issues them.\195\ SIFMA-AMG noted that,
for example, a 3:00 p.m. margin call would be required to be met on a
same-day basis under proposed regulation Sec. 1.44(f)(1), which would
not happen in the normal course of business.\196\ According to SIFMA-
AMG, depending on how late in the day an FCM issued the margin call,
managers may not be capable of meeting the call on a same-day basis,
due in part to the time needed for managers, as fiduciaries, to
validate the margin calls and instruct payments from the separate
account clients' custodians globally, who may impose earlier cutoff
times to meet same-day margin transfers or be subject to different time
zones and business days.\197\ Instead, SIFMA-AMG argued, the
Commission's timing requirements for meeting margin calls should take
into account the agreed call time in documents between FCMs and
customers.\198\ In SIFMA-AMG's view, the Commission's proposal
represents a prescriptive framework around timing and deadlines for
meeting margin calls that would eliminate the operational flexibility
originally provided in CFTC Letter No. 19-17, and a one business day
margin call should be deemed met so long as it is issued by the cutoff
time agreed between the FCM and its customer.\199\
---------------------------------------------------------------------------
\193\ SIFMA-AMG Comment Letter.
\194\ Id.
\195\ Id.
\196\ Id.
\197\ Id.
\198\ Id.
\199\ Id.
---------------------------------------------------------------------------
ICE, in its comment letter, noted it did not object to the proposed
one business day margin call standard as it would apply to FCMs.\200\
---------------------------------------------------------------------------
\200\ ICE Comment Letter.
---------------------------------------------------------------------------
The Commission proposed regulation Sec. 1.44(f), particularly the
margin payment timing framework set forth in regulation Sec.
1.44(f)(1)-(3), to more clearly define the concept of a ``one business
day margin call,'' as that term is used in CFTC Letter No. 19-17. CFTC
Letter No. 19-17 provided, among other conditions for separate account
treatment, that: (i) each separate account must be on a one business
day margin call; (ii) situations of administrative error or operational
constraints which prevent the call from being met within a one-day
period will not be considered a violation of such condition; and (iii)
in no case can customers and FCMs contractually arrange for longer than
a one business day period for a margin call to be met. The Commission
notes that the no-action conditions of CFTC Letter No. 19-17 would thus
appear to unambiguously provide that a margin call in a separate
account must be met within one business day, but do not explicitly
address certain practical challenges in applying such a standard, such
as how an FCM shall make, and a customer shall meet, a call for margin
paid in a currency that an FCM may be unable to practicably receive on
the same (or in some cases next) business day. Although SIFMA-AMG
appears to interpret this silence as promoting operational flexibility,
the Commission believes it may confuse FCMs as to their obligations
with respect to the margining of separate accounts, and may result in
interpretations that are inconsistent with the Commission's customer
funds protection and risk management goals in providing for the
separate treatment of accounts.
Furthermore, although regulation Sec. 1.44(f)(1)-(3) require a
margin call to be met on a one business day basis, as set forth in
regulation Sec. 1.44(f)(1)-(3), regardless of the time the call is
issued, the Commission did not prescribe a time by which a margin call
must be issued, recognizing that there may be legitimate operational
reasons as to why an FCM may need to issue margin calls to different
separate account customers at different times. The margin call
contemplated by regulation Sec. 1.44(f)(1)-(3) is based on market
movements or changes in positions on the previous business day, not as
of the day of the call itself.\201\ The Commission proposed this
standard to provide a clear cutoff time for the determination of a
margin call, and to allow a margin call to be reasonably made and met
on a one-day basis, based on the Commission's understanding that margin
calls to address market movements or changes in positions on a given
day are typically issued early on the next business day. For the
avoidance of doubt, FCMs and customers may agree on the time the margin
call required by regulations Sec. 1.44(f) should be made. If the call
is not made timely due to administrative error or operational
constraint as set forth in regulation Sec. 1.44(f)(5), discussed
below, then such failure would not be deemed a violation of regulation
Sec. 1.44's one business day margin call standard. However, to
require, as SIFMA-AMG suggests, only that a margin call be met if
issued by the cutoff time agreed between the FCM and its customer,
would be to effectively allow FCMs and customers to interpret the one
business day period on a customer-by-customer basis. This would be
contrary to the Commission's goal of providing clear standards around
the timely payment of margin to prevent separate accounts from becoming
undermargined, which is at the core of the Commission's risk-mitigation
goals.
---------------------------------------------------------------------------
\201\ For the avoidance of doubt, an FCM may also, in its
discretion, issue a call for margin based on same-day market
movements or changes in positions. The FCM could, consistent with
regulation Sec. 1.44(f)(1), make that call due either same-day or
next-day. For example, under regulation Sec. 1.44(f)(1), the FCM
would be required to make and collect, on Tuesday, a call for margin
based on market movements and changes of positions on Monday. If the
FCM determines to issue an additional margin call on Tuesday based
on market movements (or changes in positions, or volatility, or
other factors) on Tuesday, Sec. 1.44(f)(1) would require that that
call be collected no later than close of Fedwire on Wednesday.
However, the FCM could, in its discretion (in what would likely be
an unusual case) make that supplemental call also due on Tuesday (or
some earlier point in time on Wednesday). If that additional margin
call does not cover the margin required for all of Tuesday's market
movements and changes in positions, then the FCM would be required
to issue (and collect) a margin call for the difference on
Wednesday.
---------------------------------------------------------------------------
Accordingly, the Commission is adopting regulation Sec.
1.44(f)(1)-(3) as proposed.
The occurrence of a foreign holiday during which banks are closed
may also create difficulties in the payment of margin in a fiat
currency other than USD. Therefore, the Commission proposed regulation
Sec. 1.44(f)(4), which, as proposed, states that the relevant deadline
for payment of margin in fiat currencies other than USD may be extended
by up to one additional business day and still be considered in
compliance with the requirements of
[[Page 7905]]
proposed regulation Sec. 1.44(f) if payment is delayed due to a
banking holiday in the jurisdiction of issue of the currency. In
effect, as proposed, regulation Sec. 1.44(f)(4) provides one
additional business day for each nonconsecutive holiday in the
jurisdiction of issue of the currency in which margin is to be paid. As
proposed, regulation Sec. 1.44(f)(4) also provides that, for payments
of margin in EUR specifically, either the separate account customer or
the investment manager managing the separate account may designate one
country within the Eurozone with which they have the most significant
contacts for purposes of meeting margin calls in that separate account,
the banking holidays of which shall be referred to for such
purpose.\202\
---------------------------------------------------------------------------
\202\ With respect to margin payments in EUR, proposed
regulation Sec. 1.44(f)(4) was intended to prevent customers or
asset managers from leveraging banking holidays in a multiplicity of
jurisdictions, to circumvent requirements to pay margin timely.
---------------------------------------------------------------------------
The Commission designed regulation Sec. 1.44(f)(4) to provide FCMs
with a level of discretion in how they manage risk by allowing an FCM
to permit limited delays in margin payments due to non-U.S. banking
conventions. Regulation Sec. 1.44(f)(4) would not, however, require an
FCM to extend the deadline for payments of margin. In this manner, the
Commission sought to allow FCMs to exercise risk management judgment in
balancing, within limits, the risk management challenges caused by
extending the time before a margin call is met with the burdens
involved in requiring the client or asset manager to prefund potential
margin calls in advance of the holiday or to arrange to pay margin more
promptly in USD or another currency not affected by the holiday. The
Commission expected that FCM risk management decisions, including the
use of any extension permitted under regulation Sec. 1.44(f)(4), will
be made in consideration of relevant risk management factors; e.g., a
client's risk profile and market conditions, evaluated at the time the
risk management decisions are made.\203\
---------------------------------------------------------------------------
\203\ This expectation is consistent with the statement of the
directors of DCR and DSIO in issuing CFTC Letter No. 19-17. CFTC,
Statement by the Directors of the Division of Clearing and Risk and
the Division of Swap Dealer and Intermediary Oversight Concerning
the Treatment of Separate Accounts of the Same Beneficial Owner,
Sept. 13, 2019, available at https://www.cftc.gov/PressRoom/SpeechesTestimony/dcrdsiodirectorstatement091319 (``We fully expect
that DCOs and FCMs and their customers will agree that FCMs must
retain, at all times, the discretion to determine that the facts and
circumstances of a particular shortfall are extraordinary and
therefore necessitate accelerating the timeline and relying on the
FCM's protocol for liquidation or for accessing funds in the other
accounts of the beneficial owner held at the FCM.''). See also CFTC
Letter No. 20-28 (stating the same).
---------------------------------------------------------------------------
In the Second Proposal, with respect to proposed regulation Sec.
1.44(f)(4), the Commission requested comment (as Question 7) regarding
whether commenters believe it will be impracticable to comply with
proposed regulation Sec. 1.44(f)(4), as that section pertains to
payment of margin in EUR, including examples of operational or other
challenges that would result in such impracticability. To the extent
commenters have such practicability concerns, the Commission requested
comment regarding how, in the alternative, the Commission should seek
to achieve its goal of preventing evasion of the one business day
margin call standard, in light of differing banking holidays within the
national jurisdictions that comprise the Eurozone. The Commission
considers the comments received in response to proposed regulation
Sec. 1.44(f)(4) to be responsive to this question.
With respect to proposed regulation Sec. 1.44(f)'s provisions
regarding payment of margin in connection with Eurozone holidays, FIA
stated it does not believe motives of leveraging banking holidays in a
multiplicity of jurisdictions to circumvent margin payment timing
requirements are practicable or can be fairly ascribed to the
institutional asset owners and money managers whom, according to FIA,
comprise the predominant part of the group of customers who rely on
separate account margining.\204\ FIA contended that proposed regulation
Sec. 1.44(f)(4) would be unworkable, asserting that all investment
managers and many separate account customers maintain custodial
arrangements in multiple Eurozone jurisdictions and will be affected by
local public holidays, which vary widely across the Eurozone.\205\
---------------------------------------------------------------------------
\204\ FIA Comment Letter.
\205\ Id.
---------------------------------------------------------------------------
FIA noted, for example, that where a European state pension fund
contracts with two unaffiliated institutional money managers based in
France (i.e., two separate accounts of the same customer), and
custodies funds for one mandate with a bank in France and for the other
with a bank in Germany, and both managers designate France as their
jurisdiction of most significant contacts, an asset manager whose
custodian is in Germany will have no way of settling a EUR call
received from an FCM on October 3, which is German Unity Day, a
national holiday; and, under regulation Sec. 1.44(f)(4), as proposed,
the FCM is prohibited from extending the benefit of a one business day
extension to the separate account.\206\ FIA noted that asset owners
typically hardwire separate investment mandates to separate custodial
arrangements, and do not expect to be involved in settling margin calls
arising in connection with those separate mandates.\207\ Therefore, FIA
argued, in this example, the German custodian would not be able to pass
the margin call to the French custodian or directly onto the pension
fund.\208\
---------------------------------------------------------------------------
\206\ Id.
\207\ Id.
\208\ Id.
---------------------------------------------------------------------------
Furthermore, FIA asserted, FCMs would incur operational risk in
having to track the Eurozone holiday preferences of hundreds or
thousands of separate accounts, and FCMs will need to deploy new margin
day counting systems and protocols, including new coding for automated
systems.\209\ FIA further contended that, where such systems are
automated, the workflows imposed under the proposed regulation would
likely result in the need for more manual handling, which increases the
risk of operational error.\210\ FIA recommended that the Commission
revise proposed regulation Sec. 1.44(f)(4) to specify that, with
respect to payments in EUR, the banking holidays of any jurisdiction
within the Eurozone with which either the separate account customer or
the investment manager managing the separate account has significant
contacts shall be referred to for purposes of receiving the benefit of
a one business day extension of an EUR-denominated margin call in
consideration of non-U.S. local banking holidays.\211\
---------------------------------------------------------------------------
\209\ Id.
\210\ Id.
\211\ Id.
---------------------------------------------------------------------------
Additionally, with respect to proposed regulation Sec.
1.44(f)(4)'s provision for one additional business day to meet a margin
call in non-USD fiat currency to account for non-U.S. banking holidays,
FIA noted that a growing number of FCM institutional clients, managers,
and custodians are based in jurisdictions where there may be
consecutive holidays.\212\ In FIA's view, limiting the extension
available to such clients to a single business day forces the FCM to
choose between suspending disbursements on a separate account basis
simply due to holidays in the client's jurisdiction and exercising its
discretion not to suspend disbursements on a separate account basis in
the absence of any other reason to do so, thereby risking disciplinary
action by the Commission or the FCM's
[[Page 7906]]
DSRO.\213\ FIA urged the Commission to revise proposed regulation Sec.
1.44(f)(4) to provide that the deadline for payment of margin in non-
USD fiat currencies may be extended to the next business day following
any banking holiday in the jurisdiction of issue of the currency and
still be considered in compliance with the requirements of regulation
Sec. 1.44(f) if payment is delayed due to such banking holiday.\214\
---------------------------------------------------------------------------
\212\ Id.
\213\ Id.
\214\ Id.
---------------------------------------------------------------------------
SIFMA-AMG asserted it would be impractical for FCMs to comply with
proposed regulation Sec. 1.44(f), and further asserted that there does
not appear to be data or analysis to support the Commission's
position.\215\ SIFMA-AMG contended that, although the Commission
considers technical margin deficit scenarios from global business that
regularly navigate U.S. and non-U.S. bank holidays, it does not
consider that firms may plan for expected events, such as Golden Week
in Japan,\216\ by pre-funding accounts.\217\ According to SIFMA-AMG,
under the Commission's proposal, such an approach would be unmanageable
and unsustainable and would impose a regulatory burden without a
corresponding public policy benefit.\218\
---------------------------------------------------------------------------
\215\ SIFMA-AMG Comment Letter.
\216\ A period from April 29 to May 5 containing multiple public
holidays.
\217\ SIFMA-AMG Comment Letter.
\218\ Id.
---------------------------------------------------------------------------
SIFMA-AMG argued that requiring clients posting cash margin in EUR
to choose a country in the Eurozone and follow its holiday schedule
would, in the event different managers for the same client choose
different Eurozone countries, require the overhaul of agreements and
burden FCMs with additional monitoring responsibilities.\219\ SIFMA-AMG
recommended that the Commission provide greater flexibility to allow
for better risk management, asserting that, by avoiding having to
navigate the bank holidays of two different countries, a clearing
member can appropriately manage its risk based on its business and
customers.\220\
---------------------------------------------------------------------------
\219\ Id.
\220\ Id.
---------------------------------------------------------------------------
SIFMA-AMG stated that the base currency, custodian, and overall
global nature of investing complicate efforts to pre-fund ahead of
known holidays.\221\ SIFMA-AMG noted that, typically, margin payments
are made in the base currency of a fund, or the client and the FCM
effectuate single currency margining and the asset manager then
repatriates foreign currency balances.\222\ SIFMA-AMG asserted that
this process has been successfully implemented and that the Commission
should not attempt to establish or require particular methods of
achieving these goals.\223\
---------------------------------------------------------------------------
\221\ Id.
\222\ Id.
\223\ Id.
---------------------------------------------------------------------------
SIFMA-AMG stated that, when a global holiday approaches, firms are
asked by FCMs to prefund anticipated, expected initial and/or variation
margin, resulting in overcollateralization.\224\ SIFMA-AMG asserted
that prefunding margin is more operationally risky, particularly when
scaled across multiple jurisdictions and with a global client base,
because: (i) overcollateralization places excess risk at the FCM; (ii)
it is impractical to attempt to estimate what other market moves will
be in order to proactively overcollateralize and post margin; (iii)
different custodians have different cutoff times, which may not be met
ahead of a holiday; and (iv) prefunding leads to an inefficient process
of having to be credited back payments as opposed to paying what is
owed on a daily basis.\225\ SIFMA-AMG asserted that with large,
separate accounts, there is always margin on hand to meet volatile
market movements, and requiring prefunding as a precaution may be
unnecessary because of a firm's ability to pay cash when needed.\226\
SIFMA-AMG also contended that the Commission's belief that firms might
use holidays to gain a benefit with respect to required margin is
misguided and impractical.\227\
---------------------------------------------------------------------------
\224\ Id.
\225\ Id.
\226\ Id.
\227\ Id.
---------------------------------------------------------------------------
Additionally, SIFMA-AMG stated the Commission's Second Proposal
does not consider the product and foreign currency associated with a
particular trade, noting that a client may always be behind on margin
due to the client's or fund's location, the client custodian, the
product traded, and the clearinghouse.\228\ SIFMA-AMG stated the
Commission's regulations should consider all parties involved in a
transaction, such as the FCM, asset manager, clearinghouse, product,
and foreign currency associated with a particular trade.\229\
---------------------------------------------------------------------------
\228\ Id.
\229\ Id.
---------------------------------------------------------------------------
SIFMA-AMG requested that, to the extent the Commission is
considering the deadline for payment of margin in non-USD fiat
currencies may be extended by up to one additional business day and
still be considered in compliance with proposed regulation Sec.
1.44(f) if payment is delayed due to a banking holiday in the
jurisdiction of issue of the currency, the Commission confirm that
initiating a transfer on the same day would suffice to meet the
requirement.\230\
---------------------------------------------------------------------------
\230\ Id.
---------------------------------------------------------------------------
SIFMA-AMG contended FCMs should have discretion to consider a
deposit as pending in a customer's account, consistent with JAC
Regulatory Alert #14-03.\231\ Specifically, SIFMA-AMG argued, if the
FCM has a sufficient basis to believe the wire was actually initiated,
and based on its experience with the customer and its normal course of
business and consistent with its risk management program, then the FCM
should have discretion to treat the margin as received and credited to
a customer's margin equity.\232\ Otherwise, SIFMA-AMG stated, the
Commission should consider same-day initiation of a transfer as an
alternative to a grace or cure period to demonstrate compliance with
proposed regulation Sec. 1.44(f).\233\ SIFMA-AMG stated that utilizing
the time of initiation would effectively build into the regulation
notice that payment was not received, the cure for which would be
confirmation that the payment was initiated.\234\
---------------------------------------------------------------------------
\231\ Id.
\232\ Id.
\233\ Id.
\234\ Id.
---------------------------------------------------------------------------
In MFA's comment letter, MFA opined that the manner in which the
Second Proposal defined ``business day'' provided appropriate
extensions of time for circumstances in which U.S. markets are open,
but the day is a holiday in a non-U.S. jurisdiction.\235\
---------------------------------------------------------------------------
\235\ MFA Comment Letter.
---------------------------------------------------------------------------
The Commission is adopting regulation Sec. 1.44(f)(4) with
modifications in light of comments received.
Specifically, final regulation Sec. 1.44(f)(4) provides, in its
first sentence, ``The relevant deadline for payment of margin in fiat
currencies other than U.S. Dollars may be extended to the next business
day following any banking holiday in the jurisdiction of issue of the
currency, and still be considered in compliance with the requirements
of this paragraph (f) if payment is delayed due to such banking
holiday.'' Accordingly, final regulation Sec. 1.44(f)(4) provides an
extension to meet margin calls in non-USD fiat currency during
consecutive holidays.
Furthermore, in final regulation Sec. 1.44(f)(4), the Commission
eliminates the proposed provision regarding payments in EUR that a
would have
[[Page 7907]]
required the identification of the jurisdiction within the Eurozone
with which either the separate account customer or the relevant asset
manager has the most significant contacts; the banking holidays of
which would be referred to for purposes of receiving a one-day
extension for EUR-denominated payments.
The Commission views the one business day margin call standard set
forth in regulation Sec. 1.44(f) as a fundamental measure for
mitigating the risk to an FCM and its omnibus customer accounts for
futures, Cleared Swaps, or foreign futures and foreign options, as it
limits the time in which a customer's separate account may be
undermargined. However, noting that, in codifying the no-action
position of CFTC Letter No. 19-17, the Commission does not seek to
disrupt established margining practices, the Commission has considered,
and finds persuasive, comments submitted by FIA and SIFMA-AMG with
respect to the anticipated challenges associated with implementing
regulation Sec. 1.44(f)(4) as proposed, including the expected
difficulties associated with implementing and administering new
operational systems and renegotiating customer agreements. The
Commission also finds persuasive information submitted by commenters
regarding steps FCMs take currently to ensure customer accounts will
not be undermargined during non-U.S. banking holidays, including
instances in which there are consecutive non-U.S. banking holidays.
Furthermore, both FIA and SIFMA-AMG disputed that firms leverage
banking holidays (or that they practicably could) to gain a benefit
with respect to required margin, and the Commission did not receive any
comments indicating that such leveraging occurs, or that it is a
substantial risk.
In CFTC Letter No. 19-17, staff stated that a failure to deposit,
maintain, or pay margin or option premium due to administrative errors
or operational constraints would not constitute a failure to timely
deposit or maintain initial or variation margin that would place a
customer out of the ordinary course of business. This provision was
intended to prevent a clearing FCM from being excluded from relying on
the no-action position as a result of one-off exceptions, such as mis-
entered data, a flawed software update, or an unusual and unexpected
information technology outage (e.g., an unanticipated outage of the
Fedwire Funds Service).
The Commission proposed regulation Sec. 1.44(f)(5), which, as
proposed, provides that a failure with respect to a specific separate
account to deposit, maintain, or pay margin or option premium that was
called pursuant to regulation Sec. 1.44(f)(1), due to unusual
administrative error or operational constraints that a separate account
customer or investment manager acting diligently and in good faith
could not have reasonably foreseen, does not constitute a failure to
comply with the requirements of regulation Sec. 1.44(f). As proposed,
regulation Sec. 1.44(f)(4) also provides that, for such purposes, an
FCM's determination that the failure to deposit, maintain, or pay
margin or option premium is due to such administrative error or
operational constraints must be based on the FCM's reasonable belief in
light of information known to the FCM at the time the FCM learns of the
relevant administrative error or operational constraint.
FIA contended that proposed regulation Sec. 1.44(f)(5) results in
a proposal that is unnecessarily complex, disruptive of existing market
practice, and an inappropriate and unjustified departure from the
conditions of CFTC Letter No. 19-17.\236\ FIA further contended that
the proposed rule is overly prescriptive and inflexible, and would
increase systemic risk in margin settlement rather than mitigate
it.\237\ FIA argued that proposed regulation Sec. 1.44(f)(5) would
effectively require FCMs to suspend the ordinary course of business for
events that are not extraordinary or unusual at all, but are intrinsic
to the complexity and multiplicity of the components of the global
payment settlement system that FCMs and their customers rely on.\238\
---------------------------------------------------------------------------
\236\ FIA Comment Letter.
\237\ Id.
\238\ Id.
---------------------------------------------------------------------------
Specifically, FIA contended that, by reformulating CFTC Letter No.
19-17's standard for situations of administrative error or operational
constraints to require that such situations be ``unusual,'' and by
requiring FCMs to, in effect, document each determination of failure to
settle based on administrative error or operational constraints in
light of whether the separate account customer or investment manager
acting diligently and in good faith could have reasonably foreseen the
error or constraints giving rise to the settlement failure, the
Commission has made such standard unworkable.\239\ FIA asserted that,
when a separate account fails to settle within the applicable
timeframe, FCMs will have to make and document a complicated and
potentially highly speculative assessment of the facts under a legal
standard that is subjective and vague.\240\ FIA noted that this would
subject FCMs to the risk of being second-guessed by DSRO
examiners.\241\
---------------------------------------------------------------------------
\239\ Id.
\240\ Id.
\241\ Id.
---------------------------------------------------------------------------
Additionally, FIA noted, FCMs have invested significantly in
renovating operational and compliance systems in order to implement the
conditions of CFTC Letter No. 19-17.\242\ FIA argued that proposed
regulation Sec. 1.44(f)(5) will require material levels of new
investment in compliance, risk management, and operations time and
resources for no discernable risk management benefit.\243\ FIA
recommended the Commission strike the requirement that an
administrative error or operational constraint be ``unusual,'' and the
requirement that the error or constraint be one that a separate account
customer or investment manager acting diligently and in good faith
could not have reasonably foreseen.\244\
---------------------------------------------------------------------------
\242\ Id.
\243\ Id.
\244\ Id.
---------------------------------------------------------------------------
SIFMA-AMG similarly contended that proposed regulation Sec.
1.44(f)(5) would establish a standard that is subjective and ambiguous
and does not appropriately balance practicability and burden with risk
management.\245\ SIFMA-AMG opined that the Commission's proposal does
not make sufficiently clear the meaning of ``unusual,'' asserting that
the meaning of the term can be analyzed in any number of different
contexts and that the proposed regulation would therefore be difficult
to implement without factors or a determinative standard.\246\ SIFMA-
AMG stated that it believes the level of prescriptiveness of proposed
regulation Sec. 1.44(f)(5) is inconsistent with the Commission's
principles-based approach with respect to FCM regulation.\247\
---------------------------------------------------------------------------
\245\ SIFMA-AMG Comment Letter.
\246\ Id.
\247\ Id.
---------------------------------------------------------------------------
MFA similarly argued that the Commission should effectively revert
proposed regulation Sec. 1.44(f)(5) to the original language of the
corresponding condition in CFTC Letter No. 19-17 regarding instances
when administrative error or operational constraints do not result in a
non-ordinary course of business event.\248\ MFA, like FIA and SIFMA-
AMG, asserted that FCMs and their customers have already developed
procedures and controls to implement the conditions of CFTC Letter No.
19-17.\249\ MFA noted the Commission
[[Page 7908]]
historically has applied a more principles-based approach with respect
to margin regulation to recognize differences in FCMs and other market
participants, and contended that this practice has avoided the
interpretative challenges that would be created by the prescriptive
nature of proposed regulation Sec. 1.44(f)(5).\250\
---------------------------------------------------------------------------
\248\ MFA Comment Letter.
\249\ Id.
\250\ Id.
---------------------------------------------------------------------------
MFA opined that the Second Proposal revises the conditions of CFTC
Letter No. 19-17 to narrow them significantly and render them all but
unusable. Specifically, MFA contended that the term ``unusual'' is
subjective, and that, with the benefit of hindsight, any administrative
error or operational constraint could be argued to have been reasonably
foreseen.\251\ MFA further questioned how an FCM is to make a
determination that a failure to pay margin is due to administrative
error or operational constraint, who is required to approve such
determination, and whether it is expected that an FCM would be
obligated to escalate a proposed recommendation that an error or
constraint is unusual through its corporate governance
infrastructure.\252\ MFA argued that regulation Sec. 1.44(f)(5), as
proposed, would add unnecessary delay, complexity, and administrative
burden to an FCM, creating a disincentive for the FCM to develop and
present a record to support a determination that a failure to timely
pay margin was due to unusual administrative error or operational
constraints.\253\ MFA further argued that the burden imposed by
regulation Sec. 1.44(f)(5) as proposed would incentivize FCMs to
simply declare that an event was outside the ordinary course of
business and seek to eliminate separate account margining for the
client.\254\ With respect the requirement that an FCM's determination
of unusual administrative error or operational constraint be based on
its ``reasonable belief,'' MFA questioned whether an FCM is expected to
review the entire customer relationship to determine the frequency of
administrative errors or operational constraints before it has the
necessary information to form the basis of a determination.
---------------------------------------------------------------------------
\251\ Id.
\252\ Id.
\253\ Id.
\254\ Id.
---------------------------------------------------------------------------
MFA expressed concern that proposed regulation Sec. 1.44(f)(5)
would impede an FCM from exercising reasonable risk management
practices and would require the FCM to undergo a complex and time-
consuming analysis before determining whether to provide some form of
grace period to the underlying customer.\255\
---------------------------------------------------------------------------
\255\ Id.
---------------------------------------------------------------------------
The Commission proposed regulation Sec. 1.44(f)(5) to provide that
a single missed margin payment would not result in an FCM being
required to suspend disbursements on a separate account basis for a
customer, where the missed payment is the result of an unexpected,
unusual administrative error or operational constraint. As proposed,
regulation Sec. 1.44(f)(5) reflects the Commission's belief that
providing such an exception for any administrative error or operational
constraint could result in an FCM maintaining separate account
disbursements for a separate account customer that fails to make timely
margin payments on a frequent basis or because of known or avoidable
issues. At the same time, the Commission believes that limiting such
exceptions to specific events, or requiring that the FCM's
determination of administrative error or operational constraint be
based on a prescriptive set of criteria, could in fact increase the
risk that a single ``foot-fault'' (i.e., an unusual and inadvertent
failure), not explicitly addressed by Commission regulations, that
results in a missed margin payment, would result in suspension of
disbursements on a separate account basis, and may ultimately make
separate account treatment unworkable for FCMs and their customers.
The Commission recognizes that there could be a wide variety of
situations that may constitute administrative error or operational
constraints for purposes of regulation Sec. 1.44(f)(5), and, as
discussed further below, that, at the time an FCM learns of such
administrative error or operational constraint, a well-run FCM, may be
required to act expeditiously based on limited information concerning
such events, and in a manner consistent with its own risk management
processes and procedures. The Commission accordingly is not prescribing
the form or manner in which an FCM must document determinations of
administrative error or operational constraints, much less that such
determination be made following an exhaustive analysis. For the same
reason, the Commission is not prescribing specific procedures or lines
of escalation an FCM must implement in order to make a determination of
administrative error or operational constraint in compliance with
regulation Sec. 1.44(f)(5).
Moreover, a client's or asset manager's arrangements for paying
margin are not necessarily static. Where an administrative error or
operational constraint prevents the prompt payment of margin, the FCM
may be able to work with the client or asset manager so that steps are
taken to mitigate the likelihood of, or prevent, the recurrence of, the
circumstances that led to that result.
As discussed above, FIA, SIFMA-AMG, and MFA variously commented
that proposed regulation Sec. 1.44(f)(5) uses subjective and ambiguous
terms; in particular, the requirement that an administrative error or
operational constraint be ``unusual.'' The corresponding condition in
CFTC Letter No. 19-17, provides an exception to the one business day
margin call condition for margin payments that are untimely due to
administrative error or operational constraint, but does not contain an
express limiting principle with respect to the nature of the
administrative errors or operational constraints that would be within
its scope.
The Commission agrees with commenters that the ``unusual'' standard
could be read to be subjective and ambiguous, and does not
appropriately balance practicability and burden with risk management.
As such, the Commission is declining to retain in final regulation
Sec. 1.44(f)(5) the proposed requirement that an administrative error
or operational constraint be unusual. The Commission is also persuaded
by commenters' assertions that the requirement that the relevant
unusual administrative error or operational constraint be one that a
``separate account customer or asset manager acting diligently and in
good faith could not have reasonably foreseen'' may prove unworkable
and may ultimately introduce unnecessary delay and complexity to an
FCM's determination of the occurrence of an unusual administrative
error or operational constraint.
Accordingly, in adopting regulation Sec. 1.44(f)(5), the
Commission is eliminating the requirement that an administrative error
or operational constraint be ``unusual'' or one ``that a separate
account customer or asset manager acting diligently and in good faith
could not have reasonably foreseen.'' The Commission is otherwise
adopting regulation Sec. 1.44(f)(5) as proposed, with a change for
internal consistency.\256\
---------------------------------------------------------------------------
\256\ As proposed, regulation Sec. 1.44(f)(5) provides, in
part, that, ``A failure with respect to a specific separate account
to deposit, maintain, or pay margin or option premium that was
called pursuant to paragraph (f)(1) of this section, due to unusual
administrative error or operational constraints . . . does not
constitute a failure to comply with the requirements of this
paragraph (f).'' As discussed above, this provision is intended to
implement in regulation Sec. 1.44 the no-action condition providing
that ``[e]ach such separate account must be on a one business day
margin call'' and that ``[s]ituations of administrative error or
operational constraints which prevent the call from being met within
a one-day period will not be considered a violation of [the]
condition.'' CFTC Letter No. 19-17. Regulation Sec. 1.44(f)
requires separate accounts to be on a one business day margin call,
a concept which the provisions of regulation Sec. 1.44(f) further
define. While regulation Sec. 1.44(f)(1) provides a base
requirement to issue a margin call which must be met on a one-day
basis, other components of regulation Sec. 1.44(f) address how a
one business day margin call must be made and met in the context of
international banking conventions as well as holidays. For internal
consistency, the avoidance of confusion, and to ensure that the
exception provided in regulation Sec. 1.44(f)(5) applies in respect
of such other provisions informing the meaning of a one business day
margin call, in final regulation Sec. 1.44(f)(5), the Commission is
adjusting the reference to regulation Sec. (f)(1) to instead
reference regulation Sec. 1.44(f) generally.
---------------------------------------------------------------------------
[[Page 7909]]
Although not directly related to proposed regulation Sec.
1.44(f)(5), ICE suggested that the Commission revise regulation Sec.
1.56, which prohibits an FCM from representing that it will not call
for or collect margin, to make conforming changes to facilitate
separate account treatment.\257\ ICE asserted that it is concerned that
failing to do so may not allow FCMs to fully take advantage of
regulation Sec. 1.44, or may create uncertainty with respect to the
application of regulation Sec. 1.56 for a customer with separate
accounts.\258\
---------------------------------------------------------------------------
\257\ ICE Comment Letter.
\258\ Id.
---------------------------------------------------------------------------
The Commission appreciates ICE's comment. The Commission noted in
the Second Proposal that it seeks in this rulemaking only to directly
apply the Margin Adequacy Requirement encompassed by regulation Sec.
39.13(g)(8)(iii) to all FCMs and to enact a narrow codification of the
no-action position in CFTC Letter No. 19-17 as applicable to all FCMs,
and that it considers amendments to regulation Sec. 1.56 as outside
the scope of this rulemaking. The Commission believes regulation Sec.
1.56's prohibition of guarantees against loss with respect to ``any
commodity interest in any account carried by [an FCM]'' (emphasis
added) is sufficiently clear that such provision would apply to the
separate accounts of a separate account customer. As staff made clear
in CFTC Letters Nos. 19-17 and 20-28, separate account treatment is
consistent with regulation Sec. 1.56 so long as the FCM retains, at
all times, the discretion to access funds in the other separate
accounts of the beneficial owner held at the FCM.\259\
---------------------------------------------------------------------------
\259\ See, e.g., CFTC Letter No. 20-28.
---------------------------------------------------------------------------
The Commission additionally notes that the requirement that an FCM
provide separate account customers with a disclosure that under part
190 of the Commission's regulations that all separate accounts of a
separate account customer will be combined in the event of an FCM
bankruptcy, an original condition of the no-action position proposed as
regulation Sec. 1.44(h)(3), was included as a no-action condition due
to the fact that it would not possible to limit the losses in one
separate account from affecting another separate account of the
separate account customer in a default scenario.
The Commission proposed regulation Sec. 1.44(f)(6) to make clear
that it is establishing a maximum period in which a margin call must be
met for purposes of regulation Sec. 1.44, rather than establishing a
minimum time an FCM must allow. As proposed, regulation Sec.
1.44(f)(6) provides that an FCM would not be in compliance with the
requirements of proposed regulation Sec. 1.44(f) if it contractually
agrees to provide separate account customers with periods of time to
meet margin calls that extend beyond the time periods specified in
proposed regulation Sec. 1.44(f)(1)-(5),\260\ or engages in practices
that are designed to circumvent proposed regulation Sec. 1.44(f). As
proposed, regulation Sec. 1.44(f) would not preclude an FCM from
having customer agreements that provide for more stringent margining
requirements or applying more stringent margining requirements in
appropriate circumstances. The statement that these ``requirements
apply solely for purposes of this paragraph (f)'' means that such
requirements are not intended to apply to any other provision; e.g.,
they are not intended to define when an account is undermargined for
purposes of regulation Sec. 1.17. Conversely, the Commission did not
propose to prohibit contractual arrangements inconsistent with proposed
regulation Sec. 1.44(f). However, the FCM would not be permitted to
engage in separate account treatment under such arrangements.
---------------------------------------------------------------------------
\260\ For example, if an FCM and a customer contract for a grace
or cure period that would operate to make margin due and payable
later than the deadlines described herein, including a case where
the FCM would not have the discretion to liquidate the customer's
positions and/or collateral where margin is not paid by such time,
such an agreement would be inconsistent with the requirements
pursuant to which such FCM may engage in separate account treatment.
---------------------------------------------------------------------------
SIFMA-AMG urged the Commission to consider permitting FCMs to
continue having discretion to agree on a limited grace period, based on
their own credit assessment and consistent with their risk management
programs.\261\ SIFMA-AMG contended that such grace periods are
consistent with the objectives of ensuring the timely correction of
margin shortfalls or timely identification of a customer's inability to
meet a margin call.\262\
---------------------------------------------------------------------------
\261\ SIFMA-AMG Comment Letter.
\262\ Id.
---------------------------------------------------------------------------
SIFMA-AMG asserted that contractual grace periods can manifest in
scenarios other than separate account treatment, depending on a fund's
structure.\263\ For example, SIFMA-AMG noted, in instances where
subadvisors are hired for a specific fund and the investment firm is
managing the same fund with potentially the same FCM, removing the
grace period would mean that a single ``foot fault'' with respect to a
single asset manager can cause the FCM to revert to margining on a
gross basis, which would disrupt the ability of certain SIFMA-AMG
members to get excess margin back and could cause a lack of awareness
of a client's overall margin requirements.\264\ SIFMA-AMG further
asserted that this would incentivize customers to change FCMs and would
result in less transparency and opportunity for existing FCMs to cover
themselves if a client defaults.\265\
---------------------------------------------------------------------------
\263\ Id.
\264\ Id.
\265\ Id.
---------------------------------------------------------------------------
SIFMA-AMG contended that an FCM's inability to rely on the return
of excess margin due to ``foot faults'' at other managers could cause
further downstream failures and inadvertent consequences.\266\ For
example, SIFMA-AMG noted, excess margin is normally expected to be
returned based on data generated early in the morning, and managers may
anticipate that excess margin will be available to make additional
investments or execute new transactions, or to be used to cover other
margin or payment obligations due.\267\ However, SIFMA-AMG stated, if
later in the day, the excess margin unexpectedly is not returned due to
a ``foot fault'' at a separate manager, which such manager cannot
validate or challenge, there may not be time to either unwind the new
trades or investments, or to meet the other margin or payment demands,
which could lead to defaults on these and other obligations and
potentially trigger other cross-defaults.
---------------------------------------------------------------------------
\266\ Id.
\267\ Id.
---------------------------------------------------------------------------
SIFMA-AMG also asserted that certain sub-advised funds or separate
account clients are not able to hold cash as a buffer against this
scenario due to cash limits, which, in light of the proposed
regulation, would incentivize managers to move sub-advised funds or
separate account clients to FCMs where there is no overlap across such
sub-
[[Page 7910]]
advised funds or separate account clients. SIFMA-AMG contended that
this would result in less transparency and fewer assets available to
each FCM, potentially impairing FCMs' credit risk management, and
running counter to risk management goals where separate account
treatment results in an FCM holding more margin than it otherwise
would. Asserting that there may be occasions when additional time is
warranted to allow a customer to address delays in the payment of
margin that are not caused by administrative errors or operational
constraints, SIFMA-AMG recommended that the Commission reconsider its
position regarding grace periods.\268\
---------------------------------------------------------------------------
\268\ Id.
---------------------------------------------------------------------------
The Commission views grace periods as inconsistent with the risk
management goals of separate account treatment, although the Commission
reiterates that regulation Sec. 1.44, as proposed, does not prohibit
the use of grace periods with respect to the accounts of non-separate
account customers. The Margin Adequacy Requirement set forth in
regulation Sec. 1.44(b) provides that an FCM shall not allow a
customer to withdraw funds from its accounts if such withdrawal would
create or exacerbate an undermargining scenario in the customer's
account. Regulation Sec. 1.44(c)'s provision for an election for
separate account treatment for purposes of the Margin Adequacy
Requirement is premised on an FCM's ability to comply with risk
management requirements designed to ensure, in part, that margin for
separate accounts is paid timely, such that a separate account
customer's individual separate accounts do not become undermargined.
The Commission's one business day margin call standard is intended to
limit the window in which a customer's separate account may be
undermargined, thus limiting the risk to the FCM, and the FCM's omnibus
customer account for futures, Cleared Swaps, or foreign futures or
foreign options.
The Commission notes that while a single ``foot fault'' with
respect to a single manager theoretically could result in an FCM being
required to suspend disbursements on a separate account basis, the
error would not lead to that result if the FCM determines it
constitutes an administrative error or operational constraints as set
forth in regulation Sec. 1.44(f)(5). Additionally, the Commission
notes that, in light of the unpredictability of markets, it would
appear that an asset manager that puts its account in a position where
a failure to receive margin would result in an actual default would be
placing its customer at substantial risk.
As noted above, as proposed, regulation Sec. 1.44(f)(6) provides
that an FCM would not be in compliance with the requirements of
proposed regulation Sec. 1.44(f) if it contractually agrees to provide
separate account customers with periods of time to meet margin calls
that extend beyond the time periods specified in proposed regulation
Sec. 1.44(f)(1)-(5), or engages in practices that are designed to
circumvent proposed regulation Sec. 1.44(f). While the JAC did not
directly discuss proposed regulation Sec. 1.44(f)(6) in its comment
letter, the JAC noted that if an FCM and customer contract to arrange
for margins calls to be met in longer than one business day, then the
FCM is not making a bona fide attempt to collect margin within one
business day after the occurrence of the event giving rise to the
margin deficiency.\269\
---------------------------------------------------------------------------
\269\ JAC Comment Letter.
---------------------------------------------------------------------------
The Commission reiterates that regulation Sec. 1.44 is designed to
operate without prejudice to the rules or guidance of a DSRO, and that
a DSRO may promulgate and maintain rules and guidance with respect to
the treatment of customer accounts, including separate accounts, that
are more stringent than the regulations promulgated herein.
Although FIA in its comment letter did not directly discuss
proposed regulation Sec. 1.44(f)(6), FIA noted that, for the past
three years, examiners from CME's Financial and Regulatory Surveillance
Department have taken the position in financial and operational audits
of FCM clearing members for which CME serves as DSRO that any
contractual grace or cure period overlying a customer's failure to
satisfy a margin call (which is not qualified by reference to
administrative or operational reasons for failure) is a violation of
CME Rule 930.K.1, requiring clearing members to maintain full
discretion to determine when and under what circumstances positions in
any account shall be liquidated.\270\ FIA stated that it believes clear
guidance is needed with respect to permissibility of grace periods, and
requested the Commission communicate to CME and the JAC that they
should make their position with respect to the permissibility of grace
periods under CME rules known publicly through a market regulatory
notice so that all clearing member FCMs, buy-side managers, and asset
owners will receive the same message at the same time.\271\ This issue
would appear to have been addressed subsequent to FIA's comment.\272\
---------------------------------------------------------------------------
\270\ FIA Comment Letter.
\271\ Id.
\272\ Id. Following the close of the comment period, on October
15, 2024, CME published a bulletin reminding clearing members of
their responsibility to comply with CME Rule 930.K.1 and Chicago
Board of Trade, New York Mercantile Exchange, and COMEX Rule 930.K
(collectively, Rule 930.K). CME Group, Memorandum, Financial and
Regulatory Bulletin #24-02 re: Rule 930.K.--Liquidation of Accounts,
Oct. 15, 2024, available at https://www.cmegroup.com/notices/clearing/2024/10/frb-24-02.html. The bulletin notes that recent
disciplinary actions for violation of this rule highlight that
clearing members may need to review and update their account
agreements, and further notes that where a disciplinary committee
has found one clearing member's conduct to be a violation of
exchange rules, the public posting of the disciplinary action
provides notice to all clearing members and market participants that
such conduct is a rule violation. Id. CME further stated that, aside
from reasonable, one-day administrative or operational exceptions,
contractual language providing a period of time (i.e., a grace or
cure period) after a missed performance bond call before the
clearing member could take action (including liquidation of
positions) would violate Rule 930.K. Id.
---------------------------------------------------------------------------
With respect to FIA's comment, the Commission believes that DSROs,
in overseeing FCMs, should make clear the manner in which they will
apply their rules, and should not apply such rules in a disparate
manner to the entities for which they serve as DSRO.
Accordingly, the Commission is adopting regulation Sec. 1.44(f)(6)
as proposed, with a change for internal consistency.\273\
---------------------------------------------------------------------------
\273\ As proposed, regulation Sec. 1.44(f)(6) provides, ``A
futures commission merchant would not be in compliance with the
requirements of this paragraph (f) if it contractually agrees to
provide separate account customers with periods of time to meet
margin calls that extend beyond the time periods specified in
paragraph (f)(1) through (5) of this section, or engages in
practices that are designed to circumvent this paragraph (f).'' This
provision is intended to implement in regulation Sec. 1.44 the no-
action condition (part of the one business day margin call
condition) that, ``In no case can customers and FCMs contractually
arrange for longer than a one business day period for a margin call
to be met.'' CFTC Letter No. 19-17. As a matter of internal
consistency (with respect to the final clause of regulation Sec.
1.44(f)(6)), consistency with the corresponding no-action condition,
and to ensure that the time periods specified in the regulation
encompass banking holidays for which regulation Sec. 1.44(f)(7)
provides an exception to the timing requirements of regulation Sec.
1.44(f)(1), the Commission is adopting final regulation Sec.
1.44(f)(6) with a modification to reference paragraph (f) generally
in the first instance.
---------------------------------------------------------------------------
The Commission proposed regulation Sec. 1.44(f)(7) to provide an
exception to regulation Sec. 1.44(f)(1) with respect to certain
holidays (currently, Columbus Day and Veterans Day) on which some DCMs
may be open for trading, but on which banks are closed (and, therefore,
payment of margin may be difficult or impracticable). As proposed,
regulation Sec. 1.44(f)(7) only applies to an FCM if that FCM
intermediates trades on such a DCM, and to a separate account if that
[[Page 7911]]
separate account includes positions traded on such a DCM.
Paragraph (i) deals with margin calls based on undermargined
amounts in a separate account resulting from market movements on the
business day before the holiday. Such calls may be made on the holiday
but would be due by the close of Fedwire on the next business day after
the holiday.\274\
---------------------------------------------------------------------------
\274\ Additional days due to other provisions of proposed
regulation Sec. 1.44(f) would also be applicable.
---------------------------------------------------------------------------
Paragraph (ii) deals with margin calls based on undermargined
amounts resulting from market movements on the holiday. If, as a result
of such market movements, a separate account is undermargined by an
amount greater than the amount it was undermargined due to market
movements or position changes on the business day before the holiday,
the FCM shall issue a margin call for the separate account for at least
the incremental undermargined amount, which must be met by the
applicable separate account customer no later than the close of the
Fedwire Funds Service on the next business day after the holiday.\275\
---------------------------------------------------------------------------
\275\ To illustrate the operation of regulation Sec.
1.44(f)(7)(i)-(ii) as proposed, using Veterans Day (November 11) as
an example, and assuming that no relevant day falls on a weekend,
if, as a result of market movements on November 10, a separate
account is undermargined by $100, the FCM would issue a margin call
of at least $100 and, payment of that $100 would be due by the close
of Fedwire on November 12. If that separate account were to be
undermargined by a total of $160 as a result of market movements on
November 11, the FCM would issue a margin call for at least the
incremental amount ($160-$100 = $60) on November 12, and that
incremental $60 would also be due by the close of Fedwire on
November 12. If, instead, the separate account gained $60 on
November 11, the original margin call for $100 (issued on November
11) would still need to be met by the close of Fedwire on November
12. By contrast, if the separate account were not undermargined as a
result of market movements on November 10, but then became
undermargined by $60 as a result of market movements on November 11,
the FCM would issue a margin call in the amount of at least $60 on
November 12, and payment would be due by the close of Fedwire on
November 12.
---------------------------------------------------------------------------
Although ICE, in its comment letter, stated that it did not object
to the Commission's proposed standard for a one business day margin
call as it applies to FCMs,\276\ ICE recommended that the Commission
modify regulation Sec. 1.44(f)(7), as proposed, to extend to DCOs that
are open for clearing on a U.S. holiday to account for Cleared Swaps
that may not be traded on a DCM and for which margin requirements are
set by the DCO.\277\
---------------------------------------------------------------------------
\276\ ICE Comment Letter.
\277\ Id.
---------------------------------------------------------------------------
The Commission acknowledges that the same rationale for providing
the exception in proposed regulation Sec. 1.44(f)(7) with respect to
an FCM trading uncleared swaps on a DCM applies equally in respect of
an FCM with swaps cleared at a DCO: on days when DCOs are open, but
banks are closed, and margin requirements are set by the DCO, it may be
difficult or impracticable for FCMs to pay margin.
Accordingly, the Commission is adopting regulation Sec. 1.44(f)(7)
with the modification that its terms shall apply in the case of a
holiday where any DCM or other board of trade on which the FCM trades
is open for trading, or any DCO that clears the Cleared Swaps of such
FCM's Cleared Swaps Customers is open for clearing such swaps, and
where a separate account of any of the FCM's separate account customers
includes positions traded on such market or cleared at such a DCO.
Additionally, as discussed above in connection with regulation Sec.
1.44(a), final regulation Sec. 1.44(f)(7) will also refer to ``any
designated contract market or other board of trade,'' to explicitly
encompass foreign exchanges in connection with 30.7 accounts.
Lastly, the Commission proposed regulation Sec. 1.44(f)(8) to set
forth a procedure to adjust the scope of currencies in proposed
Appendix A to part 1. In proposing regulation Sec. 1.44(f)(8), the
Commission sought to ensure a more flexible process whereby members of
the public, or the Commission itself, may initiate a process to expand
or narrow proposed Appendix A to part 1 as may be required from time to
time, subject to public notice and comment. Regulation Sec.
1.44(f)(8), as proposed, provides that any person may submit to the
Commission any currency that such person proposes to add to or remove
from proposed Appendix A to part 1.
The submission must include a statement that margin payments in the
relevant currency cannot, in the case of a proposed addition, or can,
in the case of a proposed removal, practicably be received by the FCM
issuing a margin call no later than the end of the first business day
after the day on which the margin call is issued. The submitter would
be required to support such assertion with documentation or other
relevant supporting information, as well as any additional information
that the Commission requests.\278\ The Commission would be required to
review the submission and determine whether to propose to add the
relevant currency to, or remove it from, proposed Appendix A to part 1.
The Commission would also be required to issue such determination
through notice-and-comment rulemaking, with a comment period of no less
than thirty days. Proposed regulation Sec. 1.44(f)(8) also provides
that the Commission may propose to issue such a determination of its
own accord, without prompting by a submission from a member of the
public. As with a public submission, a Commission determination on its
own accord would be subject to notice and comment rulemaking, with a
public comment period of no less than thirty days.
---------------------------------------------------------------------------
\278\ Submitters may request confidential treatment for parts of
its submission in accordance with regulation Sec. 145.9(d).
---------------------------------------------------------------------------
The Commission did not receive any comments with respect to
proposed regulation Sec. 1.44(f)(8). Accordingly, the Commission is
adopting regulation Sec. 1.44(f)(8) as proposed.
J. Regulation Sec. 1.44(g)
As proposed, regulation Sec. 1.44(g) contains requirements related
to calculations for capital, risk management, and segregation of
customer funds. These provisions are substantially similar to the
corresponding no-action conditions in CFTC Letter No. 19-17, except
that they have been reorganized and subjected to minor changes to
account for their proposed inclusion in part 1 of the Commission's
regulations as well as the proposed introduction of new defined terms.
Regulation Sec. 1.44(g) is intended to ensure that an FCM treats
separate accounts in a consistent manner for purposes of risk
management. Many of its provisions are intended to ensure that an FCM
treats each separate account as a distinct account from all other
accounts of a separate account customer for purposes of the FCM
computing its regulatory capital and segregation of customer funds.
The Industry Letters preceding the issuance of CFTC Letter No. 19-
17 provided examples of controls an FCM could apply to mitigate the
risk of permitting disbursements on a separate account basis, and
discussed restrictions used in customer agreements providing for the
application of separate account treatment designed to ensure that a
customer's separate accounts are in fact treated separately on a
consistent basis in the FCM's management of risk. For instance, as FIA
noted in its June 26, 2019 letter, customer agreements that provide for
separate account treatment generally require that a separate account be
margined separately from any other account maintained for the customer
with the FCM, and assets held in one separate account should not
ordinarily be used to offset, or (absent default) meet, any obligations
of another separate account, including obligations
[[Page 7912]]
that it or another asset manager may have incurred on behalf of a
different account of the same customer.\279\ In that letter, preceding
issuance of CFTC Letter No. 19-17, FIA observed that these restrictions
serve to assure the customer, or the asset manager responsible for a
particular account, that the account will not be subject to
unanticipated interference that may exacerbate stress on a customer's
aggregate exposure to the FCM.\280\ Additionally, FIA noted that where
an FCM treats separate accounts as separate customers for risk
management purposes, the FCM may manage risk more conservatively
against the customer under the assumption that the customer has fewer
assets than it may in fact have.\281\
---------------------------------------------------------------------------
\279\ First FIA Letter.
\280\ Id.
\281\ Id.
---------------------------------------------------------------------------
These controls, and conditions for the consistent treatment of
separate accounts in an FCM's books and records for purposes of risk
management, constitute a key part of the no-action conditions of CFTC
Letter No. 19-17. The Commission considers such requirements as
reasonably necessary with respect to this final rule to ensure that
FCMs do not manage the risk posed by the separate accounts of certain
separate account customers, or the risk posed by certain such separate
accounts of such customers, in a disparate manner. Such disparate
treatment could reduce the risk-mitigating effects of such requirements
with respect to certain separate account customers and their separate
accounts, and could impair the ability of an FCM's DSRO or the
Commission to ascertain the extent to which certain customers' accounts
are in fact being treated separately. Thus, these requirements are
reasonably necessary to effectuate section 4d of the CEA.
Accordingly, as proposed, regulation Sec. 1.44(g) would apply to
all FCMs certain conditions in CFTC Letter No. 19-17 designed to
provide for consistent treatment of separate accounts. As proposed,
regulation Sec. 1.44(g) requires a separate account of a customer to
be treated separately from other separate accounts of the same customer
for purposes of certain existing computational and recordkeeping
requirements, which would otherwise be met by treating accounts of the
same customer on a combined basis. Because accounts subject to
regulation Sec. 1.44 would be risk-managed on a separate basis, the
Commission believes it is appropriate for the regulation to provide
that FCMs apply these risk-mitigating computational and recordkeeping
requirements on a separate account basis. The effect of the
requirements in these paragraphs is to augment the FCM's existing
obligations under various provisions of regulation Sec. 1.17.
As proposed, regulation Sec. 1.44(g)(1) provides that an FCM's
internal risk management policies and procedures shall provide for
stress testing as set forth in regulation Sec. 1.73, and credit limits
for separate account customers. Regulation Sec. 1.44(g)(1) further
provides that such stress testing must be performed, and the credit
limits must be applied, both on an individual separate account and on a
combined account basis. By conducting stress testing on both an
individual separate account and on a combined account basis, an FCM can
determine the potential for significant loss in the event of extreme
market conditions, and the ability of traders and FCMs to absorb those
losses, with respect to each individual separate account of a customer,
as well as with respect to all of the customer's separate accounts.
Additionally, by applying credit limits on both an individual separate
account basis (to address issues that may be specific to the particular
strategy governing the separate account) and on a combined account
basis (to address issues that may be applicable to the customer's
overall portfolio at the FCM), an FCM can better manage the financial
risks they incur as a result of carrying positions both for a
customer's separate account and for all of the customer's accounts. By
better managing the financial risks posed by customers and
understanding the extent of customers' risk exposures, FCMs can better
mitigate the risk that customers do not maintain sufficient funds to
meet applicable initial and maintenance margin requirements. Such FCMs
can also anticipate and mitigate the risk of the occurrence of certain
of the events detailed in regulation Sec. 1.44(e).
Regulation Sec. 1.44(g)(2), as proposed, provides that an FCM
shall calculate the margin requirement for each separate account of a
separate account customer independently from such margin requirement
for all other separate accounts of the same customer with no offsets or
spreads recognized across the separate accounts. An FCM would be
required to treat each separate account of a customer independently
from all other separate accounts of the same customer for purposes of
computing capital charges for undermargined customer accounts in
determining its adjusted net capital under regulation Sec. 1.17.
Regulation Sec. 1.44(g)(3), as proposed, provides that an FCM
shall, in computing its adjusted net capital for purposes of regulation
Sec. 1.17, record each separate account of a separate account customer
in the books and records of the FCM as a distinct account of a
customer, including recording each separate account with a net debit
balance or a deficit as a receivable from the separate account
customer, with no offsets between the other separate accounts of the
same separate account customer.
Regulations Sec. Sec. 1.20, 22.2, and 30.7 currently require an
FCM to maintain a sufficient amount of customer funds in segregated
accounts to meet its total obligations to all futures customers,
Cleared Swaps Customers, and 30.7 customers, respectively.\282\ In
order to ensure that the FCM holds sufficient funds in segregation to
satisfy the aggregate account balances of all customers with positive
net liquidating balances, the FCM is prohibited from netting the
account balances of customers with deficit or debit ledger balances
against the account balances of customers with credit balances.\283\
Each FCM is also required to prepare and submit to the Commission, and
to FCM's DSRO, a daily statement demonstrating compliance with its
segregation obligations.\284\
---------------------------------------------------------------------------
\282\ 17 CFR 1.20(a), 22.2(f)(2), and 30.7(a).
\283\ 17 CFR 1.20(i)(4), 22.2(f)(4), and 30.7(f)(2)(iv) for
futures customer accounts, Cleared Swaps Customer Accounts, and 30.7
accounts, respectively.
\284\ See 17 CFR 1.32(d), 22.2(g)(3), and 30.7(l)(3).
---------------------------------------------------------------------------
Regulation Sec. 1.44(g)(4), as proposed, provides that an FCM
shall, in calculating the amount of its own funds it is required to
maintain in segregated accounts to cover deficits or debit ledger
balances pursuant to regulations Sec. Sec. 1.20(i), 22.2(f), or
30.7(f)(2) in any futures customer accounts, Cleared Swaps Customer
Accounts, or 30.7 accounts, respectively, include any deficits or debit
ledger balances of any separate account as if the accounts are accounts
of separate entities. The purpose of regulation Sec. 1.44(g)(4) is to
ensure that an FCM that elects to permit separate account customers
treats separate accounts as if the accounts are accounts of separate
entities for purposes of computing the amount of funds the FCM is
required to hold in segregation for futures customers, Cleared Swaps
Customers, and 30.7 customers. Specifically, regulation Sec. 1.44(g)
would provide that an FCM may not offset a deficit or debit ledger
balance in the separate account of a separate account customer by any
credit balance in any other separate accounts of the same separate
account customer carried by the FCM. Regulation Sec. 1.44(g)
[[Page 7913]]
would impose the same obligations on separate accounts that are
currently imposed by regulations Sec. Sec. 1.20, 22.2, and 30.7 on
customer accounts that are not separate accounts. Regulation Sec.
1.44(g) is also consistent with CFTC Letter No. 19-17.\285\
---------------------------------------------------------------------------
\285\ CFTC Letter No. 19-17 provides that an ``FCM shall use its
own funds to cover the debit/deficit of each separate account.''
CFTC Letter No. 19-17.
---------------------------------------------------------------------------
Regulations Sec. Sec. 1.22, 22.2, and 30.7 currently prohibit an
FCM from using, or permitting the use of, the funds of one futures
customer, Cleared Swaps Customer, or 30.7 customer, respectively, to
purchase, margin, or settle the positions of, or to secure or extend
the credit of, any person other than such customer.\286\ To ensure
compliance with this prohibition, each FCM is required to compute, as
of the close of the previous business day, the total undermargined
amount of its customers' accounts and to maintain a sufficient amount
of the FCMs' own funds (i.e., residual interest) in the applicable
customer segregated accounts to cover the undermargined amounts.\287\
---------------------------------------------------------------------------
\286\ 17 CFR 1.22(a), 22.2(d), and 30.7(f)(1)(i).
\287\ An FCM is required to maintain a sufficient amount of its
own funds in segregation to cover the FCM's customers' undermargined
amounts by the residual interest deadline. The residual interest
deadline for futures customers and 30.7 customers is 6:00 p.m.
Eastern Time on the next business day. 17 CFR 1.22(c) & 30.7(f). The
residual interest deadline for Cleared Swaps Customers is the time
of settlement on the next business day of the applicable swaps
clearing organization. 17 CFR 22.2(f)(6).
---------------------------------------------------------------------------
The Commission proposed regulation Sec. 1.44(g)(5) to provide
that, for purposes of its residual interest and LSOC compliance
calculations, as applicable under regulations Sec. Sec. 1.22(c),
22.2(f)(6), and 30.7(f)(1)(ii), the FCM shall treat the separate
accounts of a separate account customer as if the accounts were
accounts of separate entities and include the undermargined amount of
each separate account, and cover such deficiency with its own funds.
The amendments would result in an FCM treating each separate account in
a manner comparable with the treatment currently provided to customer
accounts that are not separate accounts and are consistent with CFTC
Letter No. 19-17.\288\
---------------------------------------------------------------------------
\288\ CFTC Letter No. 19-17 provides that an ``FCM shall include
the margin deficiency of each separate account, and cover with its
own funds as applicable, for purposes of its [r]esidual [i]nterest
and LSOC compliance calculations.'' CFTC Letter No. 19-17 (Condition
10).
---------------------------------------------------------------------------
Regulation Sec. 1.11 requires an FCM that accepts customer funds
to margin futures, Cleared Swaps, or foreign futures and foreign
options to implement a risk management program designed to monitor and
manage the risks associated with the activities of the FCM.\289\ The
risk management program is required to address, among other risks,
segregation risk, and further requires an FCM to establish a targeted
amount of its own funds, or residual interest, that the firm will hold
in segregated accounts for futures customers, Cleared Swaps Customers,
and 30.7 customers to reasonably ensure that the FCM remains in
compliance with its obligation to hold, at all times, a sufficient
level of funds in segregation to cover its full obligation to its
customers.\290\ Regulation Sec. 1.23(c) further requires an FCM to
establish a targeted residual interest amount that is held in
segregation to reasonably ensure that the FCM remains in compliance, at
all times, with its customer funds segregation requirements.\291\
---------------------------------------------------------------------------
\289\ 17 CFR 1.11(c).
\290\ 17 CFR 1.11(e)(3)(i)(D).
\291\ 17 CFR 1.23(c).
---------------------------------------------------------------------------
The Commission proposed regulation Sec. 1.44(g)(6) to provide
that, in determining its residual interest target for purposes of
regulations Sec. Sec. 1.11(e)(3)(i)(D) and 1.23(c), the FCM must treat
separate accounts of separate account customers as accounts of separate
entities. In this regard, an FCM is required to consider the potential
impact to segregated funds and to the FCM's targeted residual interest
resulting from one or more separate accounts of a separate account
customer that are undermargined, or that contain deficits or debit
ledger balances, without taking into consideration the funds in excess
of the margin requirements maintained in other separate accounts of the
separate account customer.
Currently, Commission regulations require an FCM to maintain its
own capital, or residual interest, in customer segregated accounts in
an amount equal to or greater than its customers' aggregate
undermargined accounts.\292\ Additionally, each day, an FCM is required
to perform a segregated calculation to verify its compliance with
segregation requirements. The FCM must file a daily electronic report
showing its segregation calculation with its DSRO, and the DSRO must be
provided with electronic access to the FCM's bank accounts to verify
that the segregated funds reported are in fact maintained. The FCM must
also assure its DSRO that when it meets a margin call for customer
positions, it never uses value provided by one customer to meet another
customer's obligation.\293\ These requirements are intended to prevent
FCMs from being induced to cover one customer's margin shortfall with
another customer's excess margin and allow DSROs to verify that FCMs
are not in fact doing so. Regulation Sec. 1.44(g)(6) is designed to
ensure that margin deficiencies are calculated accurately for accounts
receiving separate treatment, and that such deficiencies are covered
consistent with existing Commission regulations. Regulation Sec.
1.44(g)(6) is also consistent with the conditions to the no-action
position in CFTC Letter No. 19-17.\294\
---------------------------------------------------------------------------
\292\ See, e.g., 17 CFR 1.22(c)(3); 17 CFR 22.2(f)(6)(iii)(A).
\293\ See, e.g., 17 CFR 22.2(g).
\294\ CFTC Letter No. 19-17 provides that the ``FCM shall factor
into its residual interest target customer receivables as computed
on a separate account basis.'' CFTC Letter No. 19-17 (Condition 9).
---------------------------------------------------------------------------
Citing proposed regulation Sec. 1.44(g)(5)'s requirement that an
FCM, for purposes of its residual interest and LSOC compliance
calculations, must ``treat the separate accounts of a separate account
customer as if the accounts were accounts of separate entities and
include the undermargined amount of each separate account, and cover
such undermargined amount with its own funds,'' the JAC reiterated its
comment that the definition of ``undermargined amount'' in proposed
regulation Sec. 1.44(a) defines the undermargined amount differently
than how the term is currently defined in the JAC Margins Handbook and
has been applied for purposes of an FCM's compliance with regulations
Sec. Sec. 1.22(c), 22.2(f)(6), and 30.7(f)(1)(ii).\295\ The JAC stated
that, given this discrepancy, for non-separate account customers, the
undermargined amount to be included in the residual interest
requirements and LSOC compliance calculations may be different than
that for separate account customers under proposed regulation Sec.
1.44(g)(5), and this change would require FCMs that permit separate
account treatment to bifurcate the manner in which they calculate their
requirements and update their regulatory reporting records.\296\
---------------------------------------------------------------------------
\295\ JAC Comment Letter. The JAC noted that, pursuant to JAC
Regulatory Alert #14-06, the undermargined amount or margin
deficiencies should be calculated for the residual interest
requirement as: Risk Maintenance Margin Requirement-Credit Net
Liquidating Value-Margin Collateral in Excess of Amounts to Secure
Debit/Deficits = Undermargined Amount (if amount < zero, then the
amount is zero.) The JAC also noted JAC Regulatory Alert #12-03
defines a similar calculation for the margin deficiencies to be
included in the LSOC compliance calculation in accordance with
regulation Sec. 22.2(f). Id.
\296\ Id.
---------------------------------------------------------------------------
As discussed above in connection with regulation Sec. 1.44(a), the
Commission is adopting its proposed definition of ``undermargined
amount''
[[Page 7914]]
with modifications to remove language that the JAC identified as
inconsistent with exchange rules and industry practice, and the
Commission views an FCM's use of either of the Net Liquidating Value or
alternative Total Equity method set forth in the JAC Margins Handbook
as consistent with the Commission's objective in defining an account's
undermargined amount for purposes of regulation Sec. 1.44.
Additionally, recalling its comment with respect to pending
receipts, the JAC noted it was unclear whether pending non-USD receipts
could be considered as received under proposed regulation Sec.
1.44(g)(5) based on the definition of ``undermargined amount'' in
proposed regulation Sec. 1.44(a).\297\
---------------------------------------------------------------------------
\297\ Id.
---------------------------------------------------------------------------
Consistent with its discussion of the JAC's and FIA's comments with
respect to treatment of pending non-USD transfers in connection with
amendments to regulation Sec. 1.17, the Commission confirms that the
final rule would not preclude an FCM from treating as received pending
non-USD transfers, consistent with the conditions in the JAC guidance
discussed above, for purposes of complying with regulation Sec.
1.44(g)(5).
ICE noted that it generally supports the risk management
requirements for separate accounts set forth in proposed regulation
Sec. 1.44(g).
The Commission did not receive any other comments regarding
proposed regulation Sec. 1.44(g). Accordingly, the Commission is
adopting regulation Sec. 1.44(g) as proposed.
K. Regulation Sec. 1.44(h)
As proposed, regulation Sec. 1.44(h) contains requirements related
to information and disclosures. As with the provisions in regulation
Sec. 1.44(g), these provisions are substantially similar to their
corresponding no-action conditions in CFTC Letter No. 19-17, except
that they have been reorganized and subject to minor changes to account
for their proposed inclusion in part 1 as well as the proposed
introduction of new defined terms. The Commission believes that
regulation Sec. 1.44(h) is reasonably necessary to protect customer
funds and mitigate systemic risk, and to effectuate section 4d of the
CEA, because it establishes requirements designed to ensure that FCMs
applying separate account treatment have the customer information
necessary to apply such treatment consistent with the risk mitigating
requirements of regulation Sec. 1.44 and, with respect to FCMs that
choose to apply separate account treatment, it establishes requirements
designed to inform customers of certain potential risks associated with
such treatment.
As proposed, regulation Sec. 1.44(h)(1) provides that an FCM shall
obtain from each separate account customer or, as applicable, the
manager of a separate account, information sufficient for the FCM to:
(i) assess the value of the assets dedicated to such separate account;
and (ii) identify the direct or indirect parent company of the separate
account customer, as applicable, if such customer has a direct or
indirect parent company.\298\ Regulation Sec. 1.44(h)(1) is intended
to ensure that FCMs have visibility with respect to customers'
financial resources appropriate to ensure that a customer's separate
account is adequately margined in light of those resources, and to
identify when a customer's financial circumstances would necessitate
the cessation of disbursements on a separate account basis. Regulation
Sec. 1.44(h)(1)(i) contemplates that, in certain instances, an asset
manager may manage one or more accounts under power of attorney on a
customer's behalf. In such cases, an FCM may obtain the requisite
financial information from the asset manager. Regulation Sec.
1.44(h)(1)(ii) is intended to ensure that FCMs have sufficient
information to identify the direct or indirect parent company of a
customer so that they may identify when a parent company of a customer
has become insolvent, for purposes of proposed regulation Sec.
1.44(e)(1)(iv).
---------------------------------------------------------------------------
\298\ The Commission understands that, in certain cases, such as
when a customer is a fund, the customer may not have a parent
company. In such cases, the requirement to obtain information
sufficient to identify the direct or indirect parent company would
not apply.
---------------------------------------------------------------------------
The Commission did not receive any comments with respect to
proposed regulation Sec. 1.44(h)(1), and accordingly is adopting that
provision as proposed.
As proposed, regulation Sec. 1.44(h)(2) provides that, where a
separate account customer has appointed a third-party as the primary
contact to the FCM, the FCM must obtain and maintain current contact
information of an authorized representative at the customer and take
reasonable steps to verify that such contact information is and remains
accurate, and that the person is in fact an authorized representative
of the customer. In many cases, an asset manager acts under a power of
attorney on behalf of a customer, and the FCM has little direct contact
with the customer. Regulation Sec. 1.44(h)(2) is designed to ensure
that FCMs have a reliable means of contacting separate account
customers directly if the asset manager fails to ensure prompt payment
on behalf of the customer.
The Commission did not receive any comments with respect to
proposed regulation Sec. 1.44(h)(2), and accordingly is adopting that
provision as proposed.\299\
---------------------------------------------------------------------------
\299\ The Commission is making a technical change to final
regulation Sec. 1.44(h)(2), to substitute ``representative of the
customer'' for ``representative at the customer,'' in recognition of
the fact that a customer may be a natural person.
---------------------------------------------------------------------------
Regulation Sec. 1.44 will not affect the Commission's bankruptcy
rules under part 190 of its regulations or any rights of a customer or
FCM in bankruptcy thereunder. In the event that an FCM electing
separate account treatment experiences a bankruptcy, the accounts of a
customer in each account class will be consolidated, and accounts of
the same customer treated separately for purposes of regulation Sec.
1.44 will not be treated separately in bankruptcy. To make this
limitation clear to customers and FCMs, the Commission proposed
regulation Sec. 1.44(h)(3), which provides that an FCM must provide
each separate account customer with a disclosure that, pursuant to part
190 of the Commission's regulations, all separate accounts of the
customer in each account class will be combined in the event of the
FCM's bankruptcy. As proposed, regulation Sec. 1.44(h)(3) provides
that the disclosure statement must be delivered directly to the
customer via electronic means, in writing or in such other manner as
the FCM customarily delivers disclosures pursuant to applicable
Commission regulations, and as permissible under the FCM's customer
documentation. Furthermore, the FCM must maintain documentation
demonstrating that the disclosure statement required by regulation
Sec. 1.44(h)(3) was delivered directly to the customer. The FCM must
also include the disclosure statement required by regulation Sec.
1.44(h)(3) on its website or within its Disclosure Document required by
regulation Sec. 1.55(i).
The Bankruptcy Reform Act of 1978 \300\ enacted subchapter IV of
chapter 7 of the Bankruptcy Code, title 11 of the U.S. Code, to add
certain provisions designed to afford enhanced protections to commodity
customer property and protect markets from the reversal of certain
transfers of money or other property, in recognition of the complexity
of the commodity business.\301\ The Commission enacted part 190 of its
regulations,\302\ to
[[Page 7915]]
implement subchapter IV. Under part 190, all separate accounts of a
customer in an account class will be combined in the event of an FCM's
bankruptcy.\303\ The Commission proposed regulation Sec. 1.44(h)(3) so
that customers receive full and fair disclosure as to the treatment of
their accounts in an FCM bankruptcy.
---------------------------------------------------------------------------
\300\ Public Law 95-598, 92 Stat. 2549.
\301\ Bankruptcy, 46 FR 57535, 57535-36 (Nov. 24, 1981).
\302\ 17 CFR part 190.
\303\ 17 CFR 190.08(b)(2)(i) and (xii) (``Aggregate the credit
and debit equity balances of all accounts of the same class held by
a customer in the same capacity . . . . Except as otherwise provided
in this paragraph (b)(2), all accounts that are . . . deemed to be
held by [a person] in its individual capacity shall be deemed to be
held in the same capacity . . . . Except as otherwise provided in
this section, an account maintained with a debtor by an agent or
nominee for a principal or a beneficial owner shall be deemed to be
an account held in the individual capacity of such principal or
beneficial owner.'').
---------------------------------------------------------------------------
In its comment letter, FIA requested that the Commission clarify
that any FCM that has already provided the disclosure specified in
proposed regulation Sec. 1.44(h)(3) pursuant to the identical
requirement of CFTC Letter No. 19-17 shall be deemed to have complied
with regulation Sec. 1.44(h)(3).\304\
---------------------------------------------------------------------------
\304\ FIA Comment Letter.
---------------------------------------------------------------------------
The Commission is adopting regulation Sec. 1.44(h)(3) as proposed.
However, the Commission recognizes that regulation Sec. 1.44(h)(3) is
virtually identical to a corresponding condition in CFTC Letter No. 19-
17,\305\ and that, under the terms of the no-action letter, as applied
by DCOs, FCMs permitting separate account treatment are required to
comply with the condition. Accordingly, the Commission confirms that,
to the extent an FCM has already provided the disclosure required by
regulation Sec. 1.44(h)(3) to its separate account customers
consistent with the no-action position in CFTC Letter No. 19-17, and
continues to provide such disclosure to new separate account customers,
then such FCM would be in compliance with the disclosure provision
requirement of regulation Sec. 1.44(h)(3).
---------------------------------------------------------------------------
\305\ Cf. CFTC Letter No. 19-17 (``The FCM shall provide each
beneficial owner using separate accounts with a disclosure that
under CFTC Part 190 rules all separate accounts of the beneficial
owner will be combined in the event of an FCM bankruptcy. The
disclosure statement required by this paragraph will be delivered
separately to the beneficial owner via electronic means in writing
or in such other manner as the FCM customarily delivers disclosures
pursuant to applicable CFTC regulations and as permissible under the
FCM's customer documentation. The FCM must maintain evidence that
such disclosure was delivered directly to the beneficial owner. The
FCM shall also include the disclosure on its website or within its
disclosure document required by Regulation 1.55(i).'').
---------------------------------------------------------------------------
As proposed, regulation Sec. 1.44(h)(4) provides that an FCM that
has made an election pursuant to regulation Sec. 1.44(d) shall
disclose in the Disclosure Document required by regulation Sec.
1.55(i) that it permits the separate treatment of accounts for the same
customer under the requirements of proposed regulation Sec. 1.44 and
that, in the event that separate account treatment for some customers
were to contribute to a loss that exceeds the FCM's ability to cover,
that loss may affect the segregated funds of all of the FCM's customers
in one or more account classes. Regulation Sec. 1.55 was adopted to
``advise new customers of the substantial risk of loss inherent in
trading commodity futures.'' \306\ The Commission amended regulation
Sec. 1.55 in 2013 to, among other things, add new paragraph (i)
requiring FCMs to disclose to customers ``all information about the
[FCM], including its business, operations, risk profile, and
affiliates, that would be material to the customer's decision to
entrust . . . funds to and otherwise do business with the [FCM] and
that is otherwise necessary for full and fair disclosure.'' \307\ Such
disclosures include material information regarding specific topics
identified in regulation Sec. 1.55(k), which include ``[a] basic
overview of customer funds segregation,'' as well as ``current risk
practices, controls, and procedures.'' \308\ These disclosures are
designed to ``enable customers to make informed judgments regarding the
appropriateness of selecting an FCM'' and to enhance the diligence that
a customer can conduct prior to opening an account and on an ongoing
basis.\309\
---------------------------------------------------------------------------
\306\ Adoption of Customer Protection Rules, 43 FR 31886, 31888
(July 24, 1978).
\307\ 17 CFR 1.55(i).
\308\ 17 CFR 1.55(k)(8) & (11).
\309\ Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506, 68564 (Nov. 14, 2013).
---------------------------------------------------------------------------
The Commission believes that the application of separate account
treatment for some customers of an FCM, is ``material to the . . .
decision to entrust . . . funds to and otherwise do business with the
[FCM]'' with respect to the customers of such FCM generally because, in
the event that separate account treatment for some customers were to
contribute to a loss that exceeds the FCM's ability to cover, that loss
might affect the segregated funds of all of the FCM's customers in one
or more account classes.\310\ Accordingly, the Commission proposed
regulation Sec. 1.44(h)(4) to ensure that customers are apprised of a
matter that is relevant to the FCM's risk management policies.
---------------------------------------------------------------------------
\310\ See 17 CFR 1.55(i).
---------------------------------------------------------------------------
In its comment letter, FIA contended that the Commission's proposed
firm-specific disclosure for regulation Sec. 1.55(i) under proposed
regulation Sec. 1.44(h)(4) is confusing and misleading.\311\ As
proposed, regulation Sec. 1.44(h)(4) provides that the disclosure
statement must apprise the customer that if separate account treatment
for some customers were to contribute to a loss that exceeds the FCM's
ability to cover, that loss may affect the segregated funds of all of
the FCM's customers in one or more account classes. FIA argued that
such language is confusing because it fails to specify how separate
account treatment for some customers might contribute to a loss that
exceeds the FCM's ability to cover.\312\ FIA noted any customer's
activity in any account could contribute to a loss, and FIA asserted
that such fellow-customer risk is already addressed in existing firm-
specific disclosure.\313\ FIA asserted that it is unclear how separate
account margining increases such risk, noting that, if anything,
separate account treatment generally mitigates credit risk to the
underlying asset owner, ensuring, in most cases, that the FCM holds
more collateral against the owner's consolidated portfolio of positions
than it would if it was net margining the portfolio as a single
account.\314\
---------------------------------------------------------------------------
\311\ FIA Comment Letter.
\312\ Id.
\313\ Id.
\314\ Id.
---------------------------------------------------------------------------
The Commission notes that, although separate account margining may
reduce risk in the sense that, generally, an FCM will hold more
collateral with respect to the portfolio of a separate account
customer, separate account margining is not risk-free. In adopting a
Margin Adequacy Requirement applicable to all FCMs similar to that
presently in regulation 39.13(g)(8)(iii), the Commission implements a
regulation designed to guard against the possibility that an FCM will
permit a withdrawal of customer funds that will lead to the customer's
account becoming undermargined. Regulation Sec. 1.44 operates to
permit the customer's separate accounts to be treated as accounts of
separate legal entities for purposes of the Margin Adequacy
Requirement, provided the FCM complies with specified requirements for
the treatment of separate accounts. Those requirements (including those
that would result in the FCM holding a greater amount of margin than it
would if it did not engage in separate account treatment) are designed
to mitigate the potential risk posed by the treatment of one customer's
separate account as the account of a separate legal entity without
reference to other separate
[[Page 7916]]
accounts of the same separate account customer.
Although the Commission believes FCMs have successfully complied
with the no-action conditions of CFTC Letter No. 19-17, where ensuring
margin adequacy is critical to protecting customer funds and mitigating
risk to an FCM and the broader financial system, FCMs that engage in
separate account treatment comply with margin adequacy in a materially
different manner than FCMs that do not engage in separate account
treatment, and are subject to additional requirements. The failure to
comply with such requirements could contribute to a loss that the FCM
is unable to cover. In light of considerations of protection of
customer funds, and the purpose of regulation Sec. 1.55(i) to provide
to customers ``all information . . . that would be material to the
customer's decision to entrust such funds to and otherwise do business
with'' the FCM, the Commission believes it is appropriate for FCMs to
apprise customers, whether separate account customers or otherwise, of
such risk of loss resulting from the FCM's separate treatment of
accounts.
Additionally, as proposed, regulation Sec. 1.44(h)(4)(i) provides
that an FCM that applies separate account treatment pursuant to
proposed regulation Sec. 1.44 must apply such treatment in a
consistent manner over time, and that if the election pursuant to
proposed regulation Sec. 1.44(d) for a separate account customer is
revoked, such election may not be reinstated during the 30 days
following such revocation. The Commission proposed this 30-day period
to prevent the possibility that, as discussed below, an FCM could
toggle its separate account treatment election for purposes other than
serving customers' bona fide commercial purposes.
Proposed regulation Sec. 1.44(h)(4)(i) is intended to ensure that
FCMs employ separate account treatment in a way that is consistent with
the customer protection and FCM risk management provisions of the CEA
and Commission regulations. The Commission recognizes that, although
bona fide business or risk management purposes may at times warrant
application or cessation of separate account treatment, FCMs should not
apply or cease separate account treatment for reasons, or in a manner,
that would contravene the customer protection and risk mitigation
purposes of the CEA and Commission regulations. For instance, an FCM
should not switch back and forth between separate and combined
treatment for customer accounts to achieve preferable margining
outcomes or offset margin shortfalls in particular accounts. The period
of 30 days was chosen to balance this goal with a recognition that,
after a sufficient period, the relevant circumstances for a particular
customer may change for reasons other than strategic switching. The
Commission recognizes that there are a wide variety of circumstances
that may indicate inconsistent application of separate account
treatment.
With respect to the 30-day toll on reinstatement of separate
account disbursements in proposed regulation Sec. 1.44(h)(4)(i), FIA
asserted that it is not aware that any FCM has ever ``toggled''
separate account treatment for any customer, and further asserted the
tolling period could have negative unintended consequences for
customers and overall market liquidity.\315\ FIA noted that separate
account margining is crucial for many institutional asset managers to
efficiently deploy their investment strategies across multiple
accounts, and if an FCM is forced to suspend separate account treatment
due to an event outside the ordinary course of business, the 30-day
minimum waiting period could significantly disrupt the trading and risk
management of affected customers even after the underlying issue is
resolved.\316\ FIA urged the Commission to adopt a more targeted, risk-
based approach that defers to FCMs' judgment.\317\ FIA asserted that
the only reasons an FCM is likely to have to suspend separate account
treatment against the wishes of its customer are those detailed in the
risk scenarios in proposed regulation Sec. 1.44(e), and the timeframe
within which separate account treatment should be restored in the wake
of any such event should be left to the FCM's risk management
discretion.\318\
---------------------------------------------------------------------------
\315\ FIA Comment Letter.
\316\ Id.
\317\ Id.
\318\ Id.
---------------------------------------------------------------------------
SIFMA-AMG similarly commented that its members are not aware of
instances in which an FCM might ``toggle'' separate account treatment,
noting that, in addition to significant regulatory obligations intended
to protect customers, including stringent risk management provisions,
FCMs who try to ``game'' a system to maintain separate account status
would lose the trust necessary to maintain these competitive,
longstanding commercial relationships.\319\ SIFMA-AMG also asserted
that, operationally, its members would not permit or give contract
authority for an FCM to switch back and forth between separate and
combined treatment for customer accounts in order to achieve more
preferable margining outcomes or offset margin shortfalls in particular
accounts.\320\ According to SIFMA-AMG, this would be highly unusual and
would be a significant deviation from industry practice.\321\
Additionally, SIFMA-AMG asserted that it did not find the rationale for
a tolling period of 30 days to be persuasive, and does not believe
there is any reason why such period should be considered appropriate or
sufficient.\322\ SIFMA-AMG expressed concern that such revocation could
cause harm to its business activities, in turn harming SIFMA-AMG
members' customers and their investments.\323\ SIFMA-AMG also expressed
concern that the tolling period could have a compounding effect on
markets and liquidity as well as risk management of FCMs and asset
managers, and should be removed or modified to be more flexible.\324\
---------------------------------------------------------------------------
\319\ SIFMA-AMG Comment Letter.
\320\ Id.
\321\ Id.
\322\ Id.
\323\ Id.
\324\ Id.
---------------------------------------------------------------------------
For the avoidance of doubt, the Commission confirms that the
proposed 30-day toll on the reinstatement of separate account treatment
was not intended to apply in instances in which the occurrence of
events outside the ordinary course of business, as enumerated in
regulation Sec. 1.44(e), have caused an FCM to terminate or suspend
disbursements on a separate account basis for a separate account
customer.
An event that is outside the ordinary course of business would mean
that the customer would, at least for a time, not be able to obtain
disbursements on a separate account basis, pursuant to regulation Sec.
1.44(c). During that time, the FCM would still be subject to the
requirements attendant upon separate account treatment of a customer's
account, including, e.g., those under regulations Sec. Sec. 1.44(f)
through (h), 1.58(c), and 1.73(c). It is only where the election
pursuant to regulation Sec. 1.44(d) for a particular customer's
account is affirmatively revoked that those requirements would cease to
be applicable, and it is only in that case that the 30-day toll period
would apply.
By contrast, if an FCM must cease providing disbursements to a
customer on a separate account basis because the customer's account is
no longer in the ``ordinary course of business,'' the FCM may permit a
resumption of disbursements on a separate account basis for the
separate account customer as soon as the requirements of regulation
Sec. 1.44(e)(4), regarding the
[[Page 7917]]
cure of non-ordinary course of business conditions and resumption of
separate account treatment, are met.
As discussed above, FIA and SIFMA-AMG stated in their comments that
they are not aware that any FCM has ever attempted to selectively use
separate account treatment to obtain an illegitimate economic
advantage. The Commission does not assume that establishes that there
is no possibility of separate account treatment being used in such
manner, and further submits that, if such strategic use of separate
account treatment is uncommon, then a toll on resumption of separate
account treatment following a revocation of an election for separate
account treatment should not represent a significant burden for FCMs or
customers. At the same time, the Commission is not aware of any such
instances of ``strategic switching'' occurring under the no-action
position, nor has any commenter discussed such issue as a significant
risk.
Accordingly, in adopting regulation Sec. 1.44(h)(4), including
regulation Sec. 1.44(h)(4)(i), the Commission is eliminating the
proposed 30-day tolling period for an FCM to reinstate an election for
separate account treatment. The Commission is also adopting regulation
Sec. 1.44(h)(4) with a technical change.\325\
---------------------------------------------------------------------------
\325\ The Commission is making a technical change in final
regulation Sec. 1.44(h)(4) to substitute the phrase ``pursuant to
the requirements'' for ``under the terms and conditions'' (``A
futures commission merchant that has made an election pursuant to
paragraph (d) of this section shall disclose in the Disclosure
Document required under paragraph 1.55(i) of this part that it
permits the separate treatment of accounts for the same customer
pursuant to the requirements of this Sec. 1.44 . . . .'').
---------------------------------------------------------------------------
L. Appendix A to Part 1
The Commission proposed Appendix A to part 1 to set forth those
currencies for which payment of margin shall be considered in
compliance with the one business day margin call requirements of
regulation Sec. 1.44(f) if received no later than the end of the
second business day after the day on which the margin call is
issued.\326\
---------------------------------------------------------------------------
\326\ As discussed above, the procedures for adding currencies
to or removing currencies from Appendix A to part 1 will be set
forth in regulation Sec. 1.44(f)(8).
---------------------------------------------------------------------------
The Commission understands that the list of currencies it included
in proposed Appendix A to part 1 is consistent with current industry
settlement conventions, based on the Commission staff's informational
discussions with industry professionals knowledgeable regarding such
conventions. The Commission proposed that the initial currencies under
proposed Appendix A to part 1 should be Australian dollar (AUD),
Chinese renminbi (CNY), Hong Kong dollar (HKD), Hungarian forint (HUF),
Israeli new shekel (ILS), Japanese yen (JPY), New Zealand dollar (NZD),
Singapore dollar (SGD), Turkish lira (TRY), and South African rand
(ZAR).
The Commission did not receive any comments with respect to
proposed Appendix A to part 1. Accordingly, the Commission is adopting
Appendix A to part 1 as proposed.
M. Amendments to Regulation Sec. 1.58
Regulation Sec. 1.58(a) currently provides that each FCM that
carries a commodity futures or commodity option position for another
FCM or a foreign broker on an omnibus basis must collect, and each FCM
and foreign broker whose account is so carried, must deposit initial
and maintenance margin on positions reportable under regulation Sec.
17.04 \327\ at a level of at least that established for customer
accounts by the rules of the relevant contract market. Regulation Sec.
1.58(a) is designed to ensure that where a clearing FCM (i.e., a
carrying FCM) carries a customer omnibus account for a non-clearing FCM
(i.e., a depositing FCM), the risk posed by the customers of the
depositing FCM continues to be appropriately mitigated through
margining of those positions (i.e., calculation of initial and
maintenance margins) on a gross basis at the depositing FCM. This is
analogous to the margining of positions of a clearing FCM on a gross
basis at the DCO.\328\
---------------------------------------------------------------------------
\327\ 17 CFR 17.04.
\328\ See regulation Sec. 39.13(g)(8)(i).
---------------------------------------------------------------------------
In proposing regulation Sec. 1.58(a) in 1981, the ``Commission
view[ed] with great concern the fact that [a significant] amount of
customer funds [was] being held by firms [i.e., non-clearing FCMs]
that, in comparison to clearing FCMs, generally have less capital and
are less equipped to handle the volatility of the commodity markets, a
concern which was highlighted by the . . . bankruptcies [of three FCMs]
which occurred during the last half of 1980.'' \329\ In light of the
segregation requirements at the time--which did not yet apply to
foreign futures and foreign options, and also did not apply to cleared
swaps (a category that did not then exist)--these requirements were
designed only to apply to futures and options. The requirement was
therefore tied to position reporting under regulation Sec. 17.04, a
reporting requirement that is limited to futures and options.
---------------------------------------------------------------------------
\329\ See Gross Margining of Omnibus Accounts, 46 FR 62864 (Dec.
29, 1981).
---------------------------------------------------------------------------
By 2011, industry practice had developed such that ``[u]nder
current industry practice, omnibus accounts report gross positions to
their clearing members and clearing members collect margins on a gross
basis for positions held in omnibus accounts.'' \330\ The Commission
thus required DCOs to require that clearing members post margin to DCOs
on a gross basis for both domestic futures and cleared swaps.\331\ The
Commission stated, as its rationale, that it continues to believe, as
stated in the notice of proposed rulemaking, that gross margining of
customer accounts will: (a) More appropriately address the risks posed
to a DCO by its clearing members' customers than net margining; (b)
will increase the financial resources available to a DCO in the event
of a customer default; and (c) with respect to cleared swaps, will
support the requirement in Sec. 39.13(g)(2)(iii) that a DCO must
margin each swap portfolio at a minimum 99 percent confidence
level.\332\
---------------------------------------------------------------------------
\330\ See Derivatives Clearing Organization General Provisions
and Core Principles, 76 FR 69334, 69375 (Nov. 8, 2011).
\331\ See id., regulation Sec. 39.13(g)(8)(i).
\332\ Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR 69375-69376.
---------------------------------------------------------------------------
The Commission also noted that, ``under certain circumstances gross
margining may also increase the portability of customer positions in an
FCM insolvency. That is, a gross margining requirement would increase
the likelihood that there will be sufficient collateral on deposit in
support of a customer position to enable the DCO to transfer it to a
solvent FCM.'' \333\
---------------------------------------------------------------------------
\333\ Id. at 69376 n. 133 (citing CPSS-IOSCO Consultative Report
[on the Principles for Financial Market Infrastructures], Principle
14: Segregation and Portability, Explanatory Notes 3.14.6 and
3.14.8, at 67-68).
---------------------------------------------------------------------------
At the time, with its focus on implementing rules for DCOs, the
Commission did not amend regulation Sec. 1.58 explicitly to require
gross margining for Cleared Swaps in omnibus accounts cleared by a non-
clearing FCM through a clearing FCM. However, reviewing the matter
presently, the Commission is of the view that the reasons for requiring
clearing FCMs to post margin at a DCO on a gross basis apply, mutatis
mutandis, to support requiring gross margining for omnibus customer
accounts of non-clearing FCMs for
[[Page 7918]]
Cleared Swaps in addition to domestic futures.\334\
---------------------------------------------------------------------------
\334\ By contrast, the Commission has imposed limits on holding
the foreign futures or foreign options secured amount outside the
United States. See regulation Sec. 30.7(c) (limiting such amounts
to 120% ``of the total amount of funds necessary to meet margin and
prefunding margin requirements'' that are ``established by rule,
regulation or order of foreign boards of trade or foreign clearing
organizations, or to meet margin calls issued by foreign brokers
carrying the 30.7 customers' foreign futures and foreign options
positions.'') Requiring an FCM to send a larger amount of 30.7 funds
upstream to a foreign broker or foreign clearing organization would
run counter to the regulation's goal of limiting such amounts.
Accordingly, the Commission did not propose to require gross
margining with respect to 30.7 accounts.
---------------------------------------------------------------------------
Accordingly, in the Second Proposal, the Commission proposed to
amend regulations Sec. 1.58(a) and (b). The Commission proposed to
amend regulation Sec. 1.58(a), addressing gross collection of margin
generally, to require that ``[e]ach futures commission merchant which
carries a futures, options, or Cleared Swaps position for another
futures commission merchant or for a foreign broker on an omnibus basis
must collect, and each futures commission merchant and foreign broker
for which an omnibus account is being carried must deposit, initial and
maintenance margin on each position so carried'' at a level no less
than that established for customer accounts by the rules of the
applicable contract market or other board of trade'' (or, if the board
of trade does not specify any such margin level, the level specified by
the relevant clearing organization), i.e., on a gross margin basis. The
Commission proposed to amend regulation Sec. 1.58(b), addressing
entitlement to spread or hedge margin treatment, to require that if an
FCM that ``carries a futures, options, or Cleared Swaps position for
another futures commission merchant or for a foreign broker on an
omnibus basis allows a position to be margined as a spread position or
as a hedged position in accordance with the rules of the applicable
contract market, the carrying futures commission merchant must obtain
and retain a written representation from the futures commission
merchant or from the foreign broker for which the omnibus account is
being carried that each such position is entitled to be so margined.''
Under regulation Sec. 1.58 as proposed to be amended, clearing FCM
initial and maintenance margin requirements for separate accounts of
the same customer are to be calculated on a gross basis as the margin
for accounts of distinct customers.\335\ The Commission believes it is
important to continuity of risk management that the same approach also
be applied in the case of a non-clearing (depositing) FCM whose
accounts are carried by a clearing (carrying) FCM, with respect to the
amount that depositing FCM is required to deposit, and that the
carrying FCM is required to collect.\336\ The Commission therefore
proposed to amend regulation Sec. 1.58 to add new paragraph (c)
providing that, where an FCM has established an omnibus account that is
carried by another FCM, and the depositing FCM has elected to treat the
separate accounts of a customer as accounts of separate entities for
purposes of regulation Sec. 1.44, then the depositing FCM must
calculate initial and maintenance margin for purposes of regulation
Sec. 1.58(a) separately for each separate account.\337\
---------------------------------------------------------------------------
\335\ See proposed regulation Sec. 1.44(g)(2).
\336\ As a result, each customer with accounts subject to
separate account treatment should be subject to the same or greater
margin requirements as such customer would be subject to if its
separate accounts were margined on a combined account basis.
\337\ If non-clearing FCM N has customers P and Q, and Q is a
separate account customer with separate accounts R, S, and T, then N
would calculate, on a gross basis, the margin requirements for
accounts P, R, S, and T, consistent with proposed regulation Sec.
1.58(c). That gross margin requirement, across those four accounts,
will be the amount that, consistent with regulation Sec. 1.58(a), N
must deposit and N's clearing FCM, C, must collect.
---------------------------------------------------------------------------
In its comment letter, the JAC discussed the Commission's proposal
to amend regulation Sec. 1.58(a) and (b) to extend the gross margin
requirements of domestic futures and options accounts to Cleared Swaps
accounts while specifically declining to require gross margining for
omnibus accounts of secured 30.7 futures and options positions held by
FCMs.\338\ The JAC noted that, although proposed regulation Sec.
1.58(a) allows an FCM carrying a secured 30.7 omnibus account to margin
that account on a net basis, the FCM would be able to margin the
account on a net basis even if the DCO, a non-U.S. clearinghouse, or
broker carrying an omnibus account were to collect margin on a gross
basis from the FCM.\339\ Thus, the FCM would be collecting less margin
than they are paying to the DCO, the non-U.S. clearinghouse, or the
carrying broker. The JAC recommended that the Commission consider
requiring gross margining for secured 30.7 omnibus accounts.\340\
Discussing the Commission's statement in the Second Proposal that
``[r]equiring an FCM to send a larger amount of 30.7 funds upstream to
a foreign broker or foreign clearing organization would run counter to
[regulation Sec. 30.7(c)'s] goal of limiting such amounts,'' the JAC
asserted that requiring a secured 30.7 omnibus account to be gross
margined under regulation Sec. 1.58 would only require the FCM to
collect gross margin (i.e., versus a lower net margin amount) from the
depositing FCM or foreign broker, not for the FCM to send the amount
along outside the U.S.\341\ The JAC contended that requiring gross
margining of secured 30.7 omnibus accounts will ensure the FCM's risk-
based capital requirement is accurately based on the risk margin
required for all customer and noncustomer positions.\342\
---------------------------------------------------------------------------
\338\ JAC Comment Letter.
\339\ Id.
\340\ Id.
\341\ Id.
\342\ Id.
---------------------------------------------------------------------------
CME also suggested that the Commission require FCMs to collect
margin on a gross basis for the foreign futures and foreign options
contracts in an omnibus account held by the clearing FCM, noting that
CME believes gross margining of customer positions is an important
element of risk management in the event of default by an FCM and is
essential to the Commission's stated goal in part 190 for porting
customers regardless of whether the non-DCO foreign clearing
organization collects margin on a gross or net basis.\343\
---------------------------------------------------------------------------
\343\ CME Comment Letter.
---------------------------------------------------------------------------
The Commission has not proposed to require gross margining of
secured 30.7 omnibus accounts and does not in this final rulemaking
adopt such a requirement, although the Commission may consider
proposing to do so in the future. The Commission notes that, with
respect to the accounts of foreign futures and foreign options
customers, unless an FCM is a direct clearing member of a non-U.S. DCO,
porting the positions of the FCM's customers may prove impracticable
because, to the extent the FCM clears through a foreign affiliate, the
foreign affiliate will likely be subject to foreign insolvency laws.
N. Amendments to Regulation Sec. 1.73
The Commission proposed to amend regulation Sec. 1.73 to add new
paragraph (c) providing that an FCM that is not a clearing member of a
DCO but that treats the separate accounts of a customer as accounts of
separate entities for purposes of proposed regulation Sec. 1.44 shall
comply with regulation Sec. 1.73(a) and (b) with respect to accounts
and separate accounts of separate account customers, as if the FCM were
a clearing member of a DCO. Regulation Sec. 1.73 currently sets forth
risk management requirements only for FCMs that are clearing members of
DCOs. The Commission proposed this amendment to ensure that, where non-
clearing FCMs are engaging in separate account
[[Page 7919]]
treatment, they are required to comply with the same baseline risk
management requirements with respect to those separate accounts as
their clearing counterparts do with respect to all accounts. In
particular, this amendment links regulation Sec. 1.73 to a non-
clearing FCM's compliance with proposed regulation Sec. 1.44(g)(1)'s
stress testing and credit limit requirements. Since 2019, clearing FCMs
have successfully applied regulation Sec. 1.73(a), in conjunction with
the no-action position's stress testing and credit limit
conditions,\344\ to manage the risk of accounts subject to separate
treatment.
---------------------------------------------------------------------------
\344\ CFTC Letter No. 19-17 (Condition 3).
---------------------------------------------------------------------------
In proposing to codify the no-action position in part 1 of the
Commission's regulations, the Commission believes it would be prudent
from a customer funds protection perspective, and a systemic risk
mitigation perspective, to ensure that any FCMs that provide for
separate account treatment, whether clearing or non-clearing, do so
subject to similarly heightened risk management requirements. The
Commission expects that, by applying the heightened risk management
requirements applicable to clearing FCMs to all of a non-clearing FCM's
accounts for a customer receiving separate treatment, a non-clearing
FCM will be better able to detect and prevent the emergence of risks
that could lead to operational or financial distress at such customer,
reducing the potential risk of a default (or a failure to maintain
adequate customer funds) by the non-clearing FCM.
The Commission did not receive any comments with respect to the
proposed amendments to regulation Sec. 1.73.
Accordingly, the Commission is adopting the amendments to
regulation Sec. 1.73 as proposed.\345\
---------------------------------------------------------------------------
\345\ The Commission is making one technical modification to the
final amendments to regulation Sec. 1.73. In final regulation Sec.
1.73(c), the Commission is changing ``[an FCM] . . . shall comply .
. . as if it was a clearing member of a [DCO]'' to ``[an FCM] . . .
shall comply . . . as if it were a clearing member of a [DCO].''
---------------------------------------------------------------------------
O. Amendments to Regulation Sec. 30.2
Regulation Sec. 30.2(b) currently excludes an FCM engaging in
foreign futures and foreign option transactions for 30.7 customers from
certain provision of the Commission's regulations, including regulation
Sec. 1.44, in recognition that such transactions are entered into on
contract markets that are subject to regulation by non-U.S.
authorities.\346\ Immediately prior to this final rule, regulation
Sec. 1.44 was reserved. The Commission proposed to amend regulation
Sec. 30.2(b) to remove regulation Sec. 1.44 from the list of excluded
regulations.\347\
---------------------------------------------------------------------------
\346\ For example, regulation Sec. 30.2 excludes persons and
foreign futures and foreign options transactions from the
segregation requirements of Sec. 1.20, which applies only to
futures customer funds and transactions. Regulation Sec. 30.7
addresses the segregation requirements of 30.7 customer funds.
\347\ As previously noted, immediately prior to this final rule,
regulation Sec. 1.44 was reserved and, accordingly, did not impose
any regulatory obligation on an FCM. However, at the time regulation
Sec. 30.2 was promulgated, regulation Sec. 1.44 addressed records
and reports of warehouses, depositories, and other similar entities.
This regulation was subsequently deleted.
---------------------------------------------------------------------------
The amendment to regulation Sec. 30.2(b) is consistent with the
imposition of the Margin Adequacy Requirement on 30.7 accounts and the
proposed definition of the term ``account'' in regulation Sec.
1.44(a), which would include 30.7 accounts in addition to futures
accounts and Cleared Swaps Customer Accounts.
The Commission also proposed to remove the exclusion of regulations
Sec. Sec. 1.41-1.43 from applicability to part 30. When regulation
Sec. 30.2 was promulgated in 1987 as part of the establishment of part
30,\348\ it explicitly provided that certain of its existing
regulations would not be applicable ``to the persons and transactions
that are subject to the requirements of'' part 30. At that time,
regulations Sec. Sec. 1.41-1.43 addressed, respectively, crop or
market information letters, filing of contract market rules with the
Commission, and warehouses, depositories, and other similar entities.
Those regulations were subsequently deleted, and those sections were
reserved.
---------------------------------------------------------------------------
\348\ Foreign Futures and Foreign Options Transactions, 52 FR
28980 (Aug. 5, 1987).
---------------------------------------------------------------------------
When the Commission revised its part 190 bankruptcy rules in 2021,
the Commission added, as regulations Sec. Sec. 1.41-1.43, designation
of hedging accounts, delivery accounts, and conditions on accepting
letters of credit as collateral. Each of these regulations was intended
to apply to foreign futures accounts. In this final rule, the
Commission amends regulation Sec. 30.2 to conform with that intention.
The Commission did not receive any comments with respect to the
proposed amendments to regulation Sec. 30.2.
Accordingly, the Commission is adopting the amendments to
regulation Sec. 30.2 as proposed.
P. Amendments to Regulation Sec. 39.13
Regulation Sec. 39.13(g)(8)(i) requires DCOs to collect customer
margin from their clearing members on a gross basis, that is, collect
margin ``equal to the sum of initial margin amounts that would be
required by the [DCO] for each individual customer within that account
if each individual customer were a clearing member.'' \349\ The
Commission proposed to add new regulation Sec. 39.13(g)(8)(i)(E) to
clarify that, for purposes of this regulation on gross margining, each
separate account of a separate account customer shall be treated as an
account of a separate individual customer.
---------------------------------------------------------------------------
\349\ 17 CFR 39.13(g)(3)(i)(A).
---------------------------------------------------------------------------
The Commission also proposed to amend regulation Sec.
39.13(g)(8)(iii) to provide that such paragraph shall apply except as
provided for in regulation Sec. 1.44. The Commission proposed this
amendment to ensure that the carve-out (represented by regulation Sec.
1.44(c)-(h)) to the Margin Adequacy Requirement (represented by
regulation Sec. 1.44(b)) that would apply to all FCMs is also
effectuated with respect to the Margin Adequacy Requirement applicable
to clearing members through DCOs pursuant to regulation Sec.
39.13(g)(8)(iii).
OCC commented that the Second Proposal makes clear, in defining the
conditions under which an FCM can offer separate account treatment,
that the Commission intended to make compliance with the requirements
for such treatment the responsibility of FCMs, and the responsibility
for monitoring such compliance that of the FCM's DSRO rather than any
DCO of which it is a member.\350\ OCC noted that, consistent with this,
the proposal would not require an FCM to notify a DCO of which it is a
member either of the FCM's initial election for separate account
treatment, or the occurrence of any non-ordinary course of business
event, which would have the effect of removing the DCO's visibility
into its members' separate account treatment practices.\351\
---------------------------------------------------------------------------
\350\ OCC Comment Letter.
\351\ Id.
---------------------------------------------------------------------------
With respect to the Margin Adequacy Requirement of regulation Sec.
39.13(g)(8)(iii), which, as proposed, would apply except as provided
for in Sec. 1.44, OCC noted that the requirements for determining
whether an FCM is operating in compliance with the requirements of
regulation Sec. 1.44 would require detailed knowledge of an FCM's
operational and risk management practices on an ongoing basis,
including, among other information, real-time knowledge of the timing
of each such customer's margin posting to the FCM, and information as
to the exact cause of any delay in posing margin.\352\ OCC expressed
concern that, without clarification, regulation Sec. 39.13(g)(8)(iii),
as amended, could be interpreted as imposing strict liability
[[Page 7920]]
on DCOs for their members' compliance with regulation Sec. 1.44.\353\
Accordingly, OCC recommended that the Commission modify regulation
Sec. 39.13(g)(8)(iii) to specify that a DCO will not be liable for
violating regulation Sec. 39.13(g)(8)(iii) on the basis of any failure
by any clearing member to comply with any requirement or requirements
of regulation Sec. 1.44.\354\
---------------------------------------------------------------------------
\352\ Id.
\353\ Id.
\354\ Id.
---------------------------------------------------------------------------
Although both regulation Sec. 1.44(b) and regulation Sec.
39.13(g)(8)(iii) contain a Margin Adequacy Requirement, the former
applies directly to FCMs whereas the latter applies to FCMs that are
clearing members of DCOs through the operation of DCO rules.
Accordingly, a DCO must have in place rules to effectuate the
requirements of regulation Sec. 39.13(g)(8)(iii) and must monitor and
enforce compliance with those rules, consistent with DCO Core Principle
H \355\ and regulation Sec. 39.17 \356\ regarding rule enforcement,
but a DCO is not itself responsible for enforcing regulation Sec.
1.44. Although the Commission disagrees that there are no instances in
which a DCO could be held liable with respect to a clearing member's
violation of regulation Sec. 1.44 (i.e., where the violation would
independently result in a violation of the Margin Adequacy Requirement
of regulation Sec. 39.13(g)(8)(iii), such as might result where the
DCO has actual knowledge of an actual or potential underlying violation
of regulation Sec. 1.44 which results in a violation of the DCO's
rules to effectuate the Margin Adequacy Requirement of regulation Sec.
39.13(g)(8)(iii)), the Commission agrees that, as a general matter,
regulation Sec. 1.44 is not designed to impose on a DCO responsibility
to meticulously supervise a clearing FCM's compliance with the
requirements of the regulation. Moreover, DCOs currently have the
responsibility to enforce their rules established pursuant to
regulation Sec. 39.13(g)(8)(iii), subject to CFTC Letter No. 19-17.
---------------------------------------------------------------------------
\355\ 7 U.S.C. 7a-1(c)(2)(H).
\356\ 17 CFR 39.17.
---------------------------------------------------------------------------
In its comment letter, CME agreed with the Commission's proposal to
add new regulation Sec. 39.13(g)(8)(i)(E) to clarify that, for
purposes of such provision, related to gross margining, each separate
account of a separate account customer shall be treated as an account
of a separate individual customer.\357\ CME however requested that the
Commission clarify, for purposes of ensuring accurate customer gross
margin, that an FCM must identify not only accounts eligible for
separate account margining, but also which accounts are currently
deploying the practice on the FCM's books.\358\ Consistent with its
response above to the JAC's similar comment with respect to the
recordkeeping requirement in regulation Sec. 1.44(d)(1), the
Commission confirms that such requirement, which requires an FCM to
keep current the required list of separate account customers and their
separate accounts, is intended to ensure that FCMs maintain a current
list of separate account customers and their accounts receiving
separate treatment. Thus, the FCM is required to apply the requirements
of regulation Sec. 1.44 applicable to separate account customers to
all customers on that list.
---------------------------------------------------------------------------
\357\ CME Comment Letter.
\358\ Id.
---------------------------------------------------------------------------
Additionally, in connection with proposed changes to regulation
Sec. 39.13(g)(8)(iii), the Commission requested comment with respect
to whether the Commission should remove regulation Sec.
39.13(g)(8)(iii), if the Commission includes the Margin Adequacy
Requirement and requirements regarding separate account treatment in
part 1 of its regulations as proposed (Question 8). In its comment
letter, CME agreed that it would be logical to delete regulation Sec.
39.13(g)(8)(iii) as regulation Sec. 1.44 will address withdrawals from
customer accounts at the clearing member.\359\ The Commission did not
receive any other comments in response to this question.
---------------------------------------------------------------------------
\359\ Id.
---------------------------------------------------------------------------
The Commission appreciates CME's comment and acknowledges that the
Margin Adequacy Requirement in regulation Sec. 39.13(g)(8)(iii) is
substantially the same as that in regulation Sec. 1.44(b) (albeit
applicable to FCMs through the instrumentation of DCO rules). The
Commission, however, notes that in requiring DCOs to prevent clearing
members from withdrawing margin such that it would lead to
undermargining in the customer's account, regulation Sec.
39.13(g)(8)(iii) provides for an additional layer of monitoring and
enforcement (in addition to FCMs' DSROs and the Commission), to ensure
that the Margin Adequacy Requirement is being met. Considering this
substantial oversight benefit and noting the low volume of responses to
this question, the Commission has determined to retain regulation Sec.
39.13(g)(8)(iii).
Accordingly, the Commission is adopting the amendments to
regulation Sec. 39.13 as proposed.
III. Cost Benefit Considerations
A. Introduction
Section 15(a) of the CEA requires the Commission to ``consider the
costs and benefits'' of its actions before promulgating a regulation
under the CEA or issuing certain orders.\360\ Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) protection of market
participants and the public; (2) efficiency; competitiveness, and
financial integrity of markets; (3) price discovery; (4) sound risk
management practices; and (5) other public interest considerations
(collectively referred to herein as the section 15(a) Factors).
Accordingly, the Commission considers the costs and benefits associated
with this final rule in light of the section 15(a) Factors. In
conducting its analysis, the Commission may, in its discretion, give
greater weight to any one of the five enumerated areas of concern. In
the sections that follow, the Commission considers: (1) the costs and
benefits of the final rule; (2) the alternatives contemplated by the
Commission and their costs and benefits; and (3) the impact of the
final rule on the section 15(a) Factors.
---------------------------------------------------------------------------
\360\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of a new rule or to determine whether
the benefits of the adopted rule outweigh its costs. Nonetheless, the
Commission has endeavored to assess the expected costs and benefits of
the final rule in quantitative terms, including Paperwork Reduction
Act-related costs, where practicable. In situations where the
Commission is unable to quantify the costs and benefits, the Commission
identifies and considers the costs and benefits of the applicable
amendments in qualitative terms. However, the Commission lacks the data
necessary to reasonably quantify all of the costs and benefits
considered below. In some instances, it is not reasonably feasible to
quantify the costs and benefits to FCMs with respect to certain
factors, such as market integrity. Additionally, any initial and
recurring compliance costs for any particular FCM will depend on its
size, existing infrastructure, practices, and cost structures.
Notwithstanding these types of limitations, the Commission otherwise
identifies and considers the costs and benefits of these final rule
amendments in qualitative terms.
In the following consideration of costs and benefits, the
Commission first
[[Page 7921]]
identifies and discusses the benefits and costs attributable to the
final rule amendments. Next, the Commission identifies and discusses
the benefits and costs attributable to the final rule amendments as
compared to alternatives to the final rule amendments. The Commission,
where applicable, then considers the costs and benefits of the final
rule amendments in light of the section 15(a) Factors.
The Commission notes that this consideration of costs and benefits
is based on, inter alia, its understanding that the derivatives markets
regulated by the Commission function internationally, with (1)
transactions that involve entities organized in the United States
occurring across different international jurisdictions, (2) some
entities organized outside of the United States that are prospective
Commission registrants, and (3) some entities that typically operate
both within and outside the United States, and that follow
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
final regulations on all relevant derivatives activity, whether based
on their actual occurrence in the United States or on their connection
with, or effect on, U.S. commerce.\361\
---------------------------------------------------------------------------
\361\ See, e.g., 7 U.S.C. 2(i).
---------------------------------------------------------------------------
In the Second Proposal, the Commission generally requested comment
on all aspects of its cost benefit considerations. The Commission also
included a number of questions for the purpose of eliciting cost and
benefit estimates from public commenters wherever possible.
1. Final Rule
The Commission is promulgating new regulations in part 1 of its
regulations designed to (1) further ensure that FCMs hold customer
funds sufficient to cover the required initial margin for the
customer's positions, by prohibiting an FCM from permitting customers
to withdraw funds from their accounts with such FCM unless the net
liquidating value plus the margin deposits remaining in the customer's
account after the withdrawal would be sufficient to meet the customer
initial margin requirements with respect to the products or portfolios
in the customer's account (i.e., the Margin Adequacy Requirement)
(regulation Sec. 1.44(b)) and (2) permit FCMs to treat the separate
accounts of a single customer as accounts of separate entities for
purposes of the Margin Adequacy Requirement, subject to requirements
designed to ensure that such separate account treatment is carried out
in a documented and consistent manner, and that FCMs, their DSROs, and
the Commission are apprised of, and able to respond to, conditions
that, for risk mitigation reasons, would necessitate the cessation of
disbursements on a separate account basis (regulation Sec. 1.44(c)-
(h)).\362\ The Commission is also adopting revisions to regulations in
parts 1, 22, and 30 of its regulations related to definitions, FCM
minimum financial requirements, reporting, collection of margin, and
clearing FCM risk management (amendments to regulations Sec. Sec. 1.3,
1.17, 1.20, 1.58, and 1.73, as well as Sec. Sec. 22.2 and 30.7), and
part 39 of its regulations related to DCO risk management (amendments
to regulation Sec. 39.13), to facilitate full implementation of the
Margin Adequacy Requirement and the requirements for separate account
treatment.
---------------------------------------------------------------------------
\362\ Regulation Sec. 1.44(a) provides definitions supporting
the other subsections of the regulation.
---------------------------------------------------------------------------
2. Baseline: Current Part 1 and Regulation 39.13(g)(8)(iii)
The Commission identifies the costs and benefits of the final
amendments relative to the baseline of the regulatory status quo. In
particular, the baseline that the Commission considers for the costs
and benefits of these final rule amendments is the Commission
regulations in effect immediately prior to the adoption of this final
rule; specifically, part 1 of the Commission's regulations (where the
operative part of the final rule would be codified) and regulation
Sec. 39.13(g)(8)(iii) (which contains the Commission's current Margin
Adequacy Requirement). In considering the costs and benefits of the
final rule against this baseline, the Commission considers the costs
and benefits for both clearing FCMs and non-clearing FCMs--the two
categories of market participants that will be directly affected by the
final rule. To the extent that certain FCMs that are clearing members
of DCOs have taken actions in reliance on CFTC Letter No. 19-17, the
Commission recognizes the practical implications of those actions on
the costs and benefits of the final rule.
a. Baseline With Respect to Clearing FCMs
Regulation Sec. 39.13(g)(8)(iii) currently provides that DCOs
shall establish a Margin Adequacy Requirement for their clearing FCMs
with respect to the products that the DCOs clear. Thus, under the
status quo baseline, clearing FCMs are, albeit indirectly (through the
operation of DCO rules designed to implement regulation Sec.
39.13(g)(8)(iii)), subject to the Margin Adequacy Requirement for
futures and Cleared Swaps. They are not, however, subject to the Margin
Adequacy Requirement for foreign futures that are not cleared by a
DCO.\363\ Under the baseline--which does not include the effect of CFTC
Letter No. 19-17 and its superseding letters--clearing FCMs are not
permitted to engage in separate account treatment with respect to the
Margin Adequacy Requirement.
---------------------------------------------------------------------------
\363\ While existing regulation Sec. 39.13(g)(8)(iii) does not
require DCOs to impose a Margin Adequacy Requirement on their
clearing FCMs with respect to such FCMs' foreign futures (part 30)
accounts, it may well be the case that such FCMs' existing systems
and procedures already apply that requirement to those accounts,
because it may be impracticable operationally to treat those
accounts differently from futures and Cleared Swaps Accounts. If
that assumption is correct, then the final part 1 Margin Adequacy
Requirement is unlikely to impose significant costs on, or cause
significant benefits with respect to, clearing FCMs.
---------------------------------------------------------------------------
b. Baseline With Respect to Non-Clearing FCMs
Immediately prior to the adoption of this final rule, Commission
regulations did not, either directly or indirectly, impose a Margin
Adequacy Requirement on non-clearing FCMs. Accordingly, non-clearing
FCMs had no need to engage in separate account treatment with respect
to such a requirement.
Additionally, immediately prior to the adoption of this final rule,
the Commission's part 1 regulations did not contain any requirements
specifically related to the separate treatment of accounts. As noted
above, under the baseline, clearing FCMs are not permitted to engage in
separate account treatment with respect to regulation Sec.
39.13(g)(8)(iii)'s Margin Adequacy Requirement, and non-clearing FCMs
previously had no need to engage in separate account treatment with
respect to the Margin Adequacy Requirement of regulation Sec.
39.13(g)(8)(iii) (because DCO rules addressing that regulation do not
apply to non-clearing FCMs). Additionally, a non-clearing FCM was not
permitted to treat the accounts of a single customer as accounts of
separate entities for purposes of regulatory requirements imposed by
the Commission (e.g., capital requirements under regulation Sec.
1.17).
[[Page 7922]]
B. Consideration of the Costs and Benefits of the Commission's Action
1. Benefits
a. Margin Adequacy Requirement (Regulation Sec. 1.44(b))
As discussed above, the Commission is (a) promulgating new
regulations in part 1 of its regulations designed to (1) further ensure
that FCMs hold customer funds sufficient to cover the required initial
margin for the customer's positions, and (2) permit FCMs to treat the
separate accounts of a single customer as accounts of separate entities
for purposes of such Margin Adequacy Requirement, subject to
requirements designed to mitigate the risk that such separate account
treatment could result in or worsen an undermargining scenario; and (b)
adopting supporting amendments in parts 1, 22, 30, and 39 to facilitate
the Margin Adequacy Requirement and requirements for separate account
treatment, namely through changes to definitions, amendment of certain
margin calculation requirements, application of certain risk management
requirements to non-clearing FCMs engaged in separate account
treatment, and amendment of regulation Sec. 39.13(g)(8)(iii)'s Margin
Adequacy Requirement to accommodate separate account treatment under
the final rule.
Existing regulation Sec. 39.13(g)(8)(iii) establishes a Margin
Adequacy Requirement, designed to mitigate the risk that a clearing
member fails to hold, from a customer, funds sufficient to cover the
required initial margin for the customer's cleared positions, and
thereby designed to avoid the risk that a clearing FCM will, whether
deliberately or inadvertently, misuse customer funds by using one
customer's funds to cover another customer's margin shortfall. DCO Core
Principle D, which concerns DCO risk management, imposes a number of
duties upon DCOs related to their ability to manage the risks
associated with discharging their responsibilities as DCOs, such as
measuring credit exposures, limiting exposures to potential default-
related losses, setting margin requirements, and establishing risk
management models and parameters.\364\ Among other requirements, Core
Principle D requires that the margin required from each member and
participant of a DCO be sufficient to cover potential exposures in
normal market conditions.\365\ Regulation Sec. 39.13 implements Core
Principle D, including through regulation Sec. 39.13(g)(8)(iii)'s
restrictions on withdrawal of customer initial margin.
---------------------------------------------------------------------------
\364\ Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D).
\365\ Section 5b(c)(2)(D)(iv) of the CEA, 7 U.S.C. 7a-
1(c)(2)(D)(iv).
---------------------------------------------------------------------------
With respect to clearing FCMs, because regulation Sec.
39.13(g)(8)(iii) already results in the application of a Margin
Adequacy Requirement to clearing FCMs through DCO rules in the context
of futures and Cleared Swaps, the benefits of a Margin Adequacy
Requirement in part 1 that applies directly to FCMs will be more
limited than the benefits with respect to non-clearing FCMs. However,
the Commission believes that, to the extent there are failures in
compliance with respect to margin adequacy, final regulation Sec.
1.44(b) will provide an additional avenue (i.e., through the Commission
and an FCM's DSRO) for monitoring and enforcement of margin adequacy
for clearing FCMs. Moreover, final regulation Sec. 1.44(b) will expand
the Margin Adequacy Requirement to apply to foreign futures
transactions cleared through both clearing and non-clearing FCMs.\366\
---------------------------------------------------------------------------
\366\ To the extent that FCMs already follow the Margin Adequacy
Requirement for foreign futures, e.g., for reasons of operational
convenience (for example, if a clearing FCM applies the Margin
Adequacy Requirement to its customer risk management for futures and
Cleared Swaps, it may be easier to also apply it in the context of
customer risk management for foreign futures than to have two
different approaches) or as a matter of prudent risk management, the
related costs and benefits would be reduced.
---------------------------------------------------------------------------
With respect to non-clearing FCMs, the Margin Adequacy Requirement
of final regulation Sec. 1.44(b) will result in similar benefits to
those currently experienced with respect to clearing FCMs under
regulation Sec. 39.13(g)(8)(iii). Regulation Sec. 39.13(g)(8)(iii)
provides that DCOs shall require clearing FCMs to ensure that their
customers do not withdraw funds from their accounts unless sufficient
funds remain to meet customer initial margin requirements with respect
to all products and swap portfolios held in the customers' accounts and
cleared by the DCO. This requirement is designed to prevent the
undermargining of customer accounts, and thus mitigate the risk of a
clearing member default and the consequences that could accrue to the
broader financial system.
Section 4d(a)(2) of the CEA and regulation Sec. 1.20(a) require an
FCM to separately account for and segregate all money, securities, and
property which it has received to margin, guarantee, or secure the
trades or contracts of its commodity customers, and section 4d(a)(2) of
the CEA and regulation Sec. 1.22(a) prohibit an FCM from using the
money, securities, or property of one customer to margin or settle the
trades or contracts of another customer.\367\
---------------------------------------------------------------------------
\367\ 7 U.S.C. 6d(a)(2); 17 CFR 1.20(a); 17 CFR 1.22(a).
---------------------------------------------------------------------------
The Commission believes that regulation Sec. 1.44(b), which will
apply a Margin Adequacy Requirement directly to FCMs, both clearing and
non-clearing, would further achieve the benefits of serving to protect
customer funds, and mitigating systemic risk that could arise from
misuse of customer funds, by applying the undermargining avoidance
requirements of regulation Sec. 39.13(g)(8)(iii) directly to all FCMs.
As noted above, this Margin Adequacy Requirement does not currently
apply to non-clearing FCMs. The Commission further believes that the
application of such a Margin Adequacy Requirement to all FCMs (and to
all three types of customer transactions, including (additionally)
foreign futures transactions), through more broadly preventing
undermargining situations, is reasonably necessary to effectuate CEA
sections 4d and 4(b)(2) and to accomplish the purposes of the CEA (from
section 3(b)) of ``avoidance of systemic risk'' and ``protecting all
market participants from . . . misuses of customer assets.''
b. Requirements for Separate Account Treatment (Regulation Sec.
1.44(c)-(h) and Supporting Amendments to Regulations Sec. Sec. 1.3,
1.17, 1.20, 1.32, 1.58, 1.73, 22.2, 30.2, 30.7, and 39.13(g)(8))
As discussed in section I.B above, there are a number of commercial
reasons why an FCM or customer may wish to treat the separate accounts
of a single customer as accounts of separate entities. Combination of
all accounts of the same customer within the same regulatory account
classification for purposes of margining and determining funds
available for disbursement may make it challenging for certain
customers and their asset managers to achieve certain commercial
purposes.\368\ For example, where a customer has apportioned assets
among multiple asset managers, neither the customer nor their asset
managers may be able to obtain certainty that the individual portion of
funds allocated to one asset manager will not be affected by the
activities of other asset managers.
---------------------------------------------------------------------------
\368\ See First FIA Letter.
---------------------------------------------------------------------------
Where FCMs are able to treat the separate accounts of a single
customer as accounts of separate entities for purposes of the Margin
Adequacy Requirement, customers benefit from being better able to
leverage the skills and expertise of asset managers and realize the
benefits of a balance of
[[Page 7923]]
investment strategies in order to meet specific commercial goals.
Moreover, as discussed further below, clearing FCMs and customers of
clearing FCMs already relying on the no-action position would also
obtain the benefit of continuing to leverage existing systems and
procedures to provide for separate account treatment.
The Commission believes that, where such separate account treatment
is offered, it should be subject to safeguards that mitigate the risk
that it will result in the undermargining of customer accounts. By
applying regulatory safeguards designed to preserve the goals of the
Margin Adequacy Requirement during such treatment, the final rule would
achieve the benefit of permitting separate account treatment in a
manner that would not contravene the customer funds protection and risk
mitigation purposes of the CEA and Commission regulations.
The Commission also believes that several years of successful
separate account activity based on the no-action conditions of CFTC
Letter No. 19-17 and its superseding letters by DCOs, clearing FCMs,
and customers demonstrate that separate account treatment can be
successfully applied, subject to certain safeguards.
As discussed above, sections 4d(a)(2) of the CEA and regulations
Sec. Sec. 1.20(a) and 1.22(a) require an FCM to account separately for
and segregate futures customer funds and prohibit FCMs from using one
customer's funds to cover another customer's margin shortfall \369\--
requirements which serve to further the CEA's purposes (as set forth in
section 3(b)) of protecting customer funds and avoiding systemic risk.
---------------------------------------------------------------------------
\369\ See also the analogous requirements in CEA Sec. Sec.
4d(f)(2) and 4(b), and regulations Sec. Sec. 22.2 and 30.7 (for,
respectively, Cleared Swaps and foreign futures).
---------------------------------------------------------------------------
Part 1 of the Commission's regulations contain the principal
regulations applicable to the operation of FCMs that support the above-
described statutory purposes and requirements. Such regulations include
requirements related to financial and other reporting, risk management,
treatment of customer funds, and recordkeeping, among others. As noted
above, the Commission believes that a Margin Adequacy Requirement,
directly applied to all FCMs and combined with separate account
treatment, can further effectuate CEA section 4d(a)(2)'s customer fund
protection and risk avoidance requirements \370\ while offering
commercial utility for a variety of market participants. However, prior
to the adoption of this final rule, part 1 did not contain any
regulations imposing such a Margin Adequacy Requirement, or governing
the manner in which separate account treatment may be conducted.
---------------------------------------------------------------------------
\370\ And, similarly, those of CEA section 4d(f)(2) and 4(b).
---------------------------------------------------------------------------
The final rule is designed to achieve the benefit of bridging this
gap by
(i) inserting a Margin Adequacy Requirement (regulation Sec.
1.44(b)) into part 1 to ensure further that an FCM (whether a clearing
or non-clearing FCM) does not permit margin withdrawals that would
create or exacerbate an undermargining situation,
(ii) allowing FCMs to treat the separate accounts of a single
customer as accounts of separate entities for purposes of the Margin
Adequacy Requirement, with the benefits discussed above (regulation
Sec. 1.44(c)),
(iii) establishing the manner in which FCMs may elect to engage in
separate account treatment for a particular customer, with the benefit
of identifying both for the FCM and its supervisory authorities (the
Commission and SROs) whether it is engaging in separate account
treatment, and, if so, for which customers, with the benefit of
facilitating effective regulatory/self-regulatory supervision
(regulation Sec. 1.44(d)),
(iv) setting forth financial and operational conditions for
customers and FCMs that would identify risk management issues that are
sufficiently significant to disqualify a particular separate account
customer from receiving (or an FCM with respect to all of its separate
account customers from making) disbursements on a separate account
basis (regulation Sec. 1.44(e)),
(v) requiring that separate accounts be on a one business day
margin call, while setting forth limited circumstances in which failure
to actually receive margin on a same-day basis may be excused, with the
benefit of limiting the extent of potential undermargining, (regulation
Sec. 1.44(f)), and
(vi) establishing requirements designed to ensure that separate
account treatment is carried out in a consistent and documented manner,
and carrying that treatment through to related FCM capital, customer
funds protection, and risk management requirements in part 1
(regulation Sec. 1.44(g)-(h)), with the benefit of further ensuring
that the risk management objectives of the Margin Adequacy Requirement
continue to be met during separate account treatment.
The revisions to regulations Sec. Sec. 1.3, 1.17, 1.20, 1.32,
1.58, 1.73, 22.2, 30.2, 30.7, and 39.13(g)(8)(i) are designed to define
terms used in regulation Sec. 1.44 and facilitate implementation of
provisions in regulation Sec. 1.44 that would affect compliance with
financial requirements for FCMs, collection of margin, and FCM risk
management. Additionally, a revision to regulation Sec.
39.13(g)(8)(iii) is intended to make clear that regulation Sec.
39.13(g)(8)(iii)'s Margin Adequacy Requirement, applicable directly to
DCOs and indirectly to clearing FCMs, and similar in substance to the
Margin Adequacy Requirement of regulation Sec. 1.44(b), does not
require DCOs to preclude separate account treatment carried out subject
to regulation Sec. 1.44.
The Commission believes that final regulation Sec. 1.44(c)-(h),
and the final supporting amendments to regulations Sec. Sec. 1.3,
1.17, 1.20, 1.32, 1.58, 1.73, 22.2, 30.2, 30.7, and 39.13 would benefit
both clearing FCMs and non-clearing FCMs, in addition to customers and
other market participants, by providing a comprehensive framework that
affirms the availability of separate account treatment, and sets forth
the manner in which such treatment can be carried out consistent with
the customer fund protection and risk avoidance objectives of
regulation Sec. 39.13(g)(8)(iii) (as applied via DCO rules, with
respect to clearing FCMs) and regulation Sec. 1.44(b)'s Margin
Adequacy Requirement (with respect to both clearing FCMs and non-
clearing FCMs).
The Commission additionally notes that the allowance of, and
requirements for separate account treatment in final regulation Sec.
1.44(c)-(h) are substantially similar to the conditions to the staff
no-action position in CFTC Letter No. 19-17. A number of clearing FCMs
have adopted some practices based on this no-action position provided
by Commission staff. As such, to the extent that some clearing FCMs
have relied on the no-action position, the actual costs and benefits of
the rule amendments as realized in the market may not be as significant
as a comparison of the rule to the regulatory baseline would
suggest.\371\
---------------------------------------------------------------------------
\371\ For those clearing FCMs that currently choose not to
engage in separate account treatment, and therefore, do not adhere
to CFTC Letter No. 19-17, but choose to do so following the adoption
of this final rule, the Commission submits that there will be
significant costs; similar to those faced by non-clearing FCMs. This
is discussed further below in the costs section.
---------------------------------------------------------------------------
Moreover, if the Commission were to allow the no-action position in
CFTC Letter No. 19-17 to expire, and did not adopt the proposed
regulation, then clearing FCMs that already engage in separate account
treatment consistent with the terms of CFTC Letter No. 19-17 would be
required to reverse those
[[Page 7924]]
changes. This could entail significant expenditures of funds and
resources in order to rework systems, procedures, and customer
documentation for such FCMs.\372\ Hence, actual benefits to the
regulation may accrue from the ability of many FCMs to avoid these
costs.
---------------------------------------------------------------------------
\372\ See Second FIA Letter. For instance, FIA noted that
clearing FCMs would again be required to review and amend customer
agreements, noting that negotiations to amend such agreements would
likely prove ``extremely difficult'' as ``advisers would seek to
assure that their ability to manage their clients' assets entrusted
to them would not be adversely affected by the actions (or
inactions) of another adviser.'' FIA letter dated May 11, 2022 to
Robert Wasserman (Third FIA Letter). FIA further noted that ``an
adviser may be less likely to use exchange-traded derivatives to
hedge its customers' cash market positions if the adviser could not
have confidence that it would be able to withdraw its customers'
excess margin as necessary to meet its obligations in other
markets.'' Id.
---------------------------------------------------------------------------
In connection with its discussion of the benefits of the proposed
requirements for separate account treatment, the Commission asked as
Question 9 what evidence can be provided that customers have been able
to achieve better performance by virtue of allowing separate account
treatment; and whether there is evidence of under margining due to
separate account treatment since CFTC Letter No. 19-17 was issued.
Additionally, as Question 10, the Commission asked whether there is
evidence of regulatory arbitrage between clearing FCMs and non-clearing
FCMs on the grounds that the latter are not currently subject to the
Margin Adequacy Requirement. No commenter responded to these questions.
2. Costs
The final rule (i) amends part 1 of the Commission regulations to
add a new requirement (regulation Sec. 1.44(b)) for FCMs to hold
customer funds sufficient to cover the required initial margin for the
customer's positions (the Margin Adequacy Requirement); (ii) amends
part 1 to, in the same new section (regulation Sec. 1.44(c)-(h)),
permit FCMs, subject to certain requirements and for purposes of the
Margin Adequacy Requirement, treat the accounts of a single customer as
accounts of separate entities; and (iii) amends existing regulations in
parts 1 and 39 to facilitate implementation of the new regulation. The
Commission herein discusses the costs related to each such set of
amendments with respect to clearing and non-clearing FCMs. There are
currently approximately 60 registered FCMs, and of these, the
Commission estimates that approximately 40 are clearing FCMs and
approximately 20 are non-clearing FCMs.\373\ While the final rule would
require all FCMs to comply with the Margin Adequacy Requirement, it
would not require FCMs to engage in separate account treatment, and the
Commission does not expect that all FCMs will engage in separate
account treatment. Accordingly, as noted in connection with the
Commission's discussion below related to the PRA, the Commission
estimates that 30 FCMs will choose to apply separate account treatment.
---------------------------------------------------------------------------
\373\ CFTC, Financial Data for FCMs, Aug. 31, 2024, available at
https://www.cftc.gov/MarketReports/financialfcmdata/index.htm.
---------------------------------------------------------------------------
a. Margin Adequacy Requirement (Regulation Sec. 1.44(b))
The Margin Adequacy Requirement of regulation Sec. 1.44(b)
requires FCMs to hold customer funds sufficient to cover the required
initial margin for customer positions. With respect to clearing FCMs,
the Commission estimates that the cost of compliance would be de
minimis. As discussed above, existing regulation Sec. 39.13(g)(8)(iii)
provides that a DCO shall require its clearing members to ensure that
their customers do not withdraw funds from their accounts with such
clearing members unless the net liquidating value plus the margin
deposits remaining in a customer's account after such withdrawal are
sufficient to meet the customer initial margin requirements with
respect to all products and swap portfolios held in such customer's
account which are cleared by the DCO. Thus, regulation Sec.
39.13(g)(8)(iii) applies a requirement that is substantively identical
to the Margin Adequacy Requirement of regulation Sec. 1.44(b)
indirectly to clearing FCMs, through the rules of their DCOs. Because
clearing FCMs are already functionally subject to the Margin Adequacy
Requirements of regulation Sec. 1.44(b) as a result of regulation
Sec. 39.13(g)(8)(iii), the Commission does not expect any significant
additional cost of compliance for clearing FCMs.
Prior to this final rule, non-clearing FCMs were not subject to a
Margin Adequacy Requirement promulgated by the Commission, and the
Commission expects that the costs for a non-clearing FCM to comply
could be significant. The Commission expects that compliance with the
Margin Adequacy Requirement for a non-clearing FCM may entail many of
the same types of costs noted below in connection with compliance with
separate account treatment requirements. Such costs could include
personnel, operational, and other costs related to updating internal
policies and procedures, updating or renegotiating customer
documentation, and implementing or configuring internal systems to
identify and prevent margin withdrawals that would be inconsistent with
the Margin Adequacy Requirement. The Commission expects that the
compliance costs for non-clearing FCMs could vary significantly
depending on factors such as the FCM's size, customer base, and
existing compliance infrastructure and resources. The extent to which
non-clearing FCMs need to develop new tools, policies, and procedures
may however be reduced, to the extent that such FCMs already
voluntarily take steps to avoid distributing funds back to their
customers in a manner that would create or exacerbate an undermargined
condition for a customer, as a means of managing risks to the FCM.
Moreover, while promoting margin adequacy is a policy goal of many
of the regulations promulgated under the CEA, there are potential costs
to individual investors of the Margin Adequacy Requirement. In general,
tightening the rules concerning margins can reduce the return to
investors, and some effects of this type could result from requiring
margin adequacy at non-clearing FCMs.
b. Requirements for Separate Account Treatment (Regulation Sec.
1.44(c)-(h) and Supporting Amendments to Regulations Sec. Sec. 1.3,
1.17, 1.20, 1.32, 1.58, 1.73, 22.2, 30.2, 30.7, and 39.13(g)(8))
In addition to the Margin Adequacy Requirement of regulation Sec.
1.44(b), the Commission is also adopting in regulation Sec. 1.44(c)-
(h) rules to allow FCMs to elect to apply separate account treatment
for purposes of the Margin Adequacy Requirement, and requirements for
the application of such treatment. The regulation would not require
FCMs to apply separate account treatment, and FCMs that do not
presently apply separate account treatment, and do not desire to do so
in the future, would generally not incur any costs related to the
application of such treatment. Furthermore, the Commission believes
that an FCM electing separate account treatment will do so because such
FCM believes the benefits of doing so will exceed the costs of doing
so.
With respect to FCMs that choose to engage in separate account
treatment under the final rule, the Commission expects that clearing
FCMs and non-clearing FCMs will generally incur the same types of
compliance costs, as there are no applicable requirements for separate
account treatment under the baseline with respect to either clearing
[[Page 7925]]
FCMs or non-clearing FCMs, and the requirements of the final rule
generally do not distinguish between clearing FCMs and non-clearing
FCMs.\374\
---------------------------------------------------------------------------
\374\ There are two distinctions between clearing and non-
clearing FCMs relevant to separate account compliance costs.
The first would not create a difference in costs: Gross
collection of margin without netting between separate accounts is
required by regulation Sec. 1.44(g)(2) and existing regulation
Sec. 39.13(g)(8)(i), as clarified by regulation Sec.
39.13(g)(8)(i)(E) for clearing FCMs, and regulation Sec. 1.58(c)
creates this requirement for non-clearing FCMs.
The second would create some difference in additional costs:
Under current regulation Sec. 1.73, clearing FCMs are required to
establish risk-based credit limits, screen orders for compliance
with those limits, and monitor adherence to those limits, as well as
conduct stress testing of positions that could pose material risk.
Non-clearing FCMs are not currently required to do these things.
Under regulations Sec. Sec. 1.44(g)(1) and 1.73(c), they would be
required to do so for separate account customers and separate
accounts, both on an individual separate account and aggregate
basis. As such, there are additional incremental costs faced by non-
clearing FCMs that choose separate account treatment.
---------------------------------------------------------------------------
The costs of the final rule related to application of separate
account treatment will likely vary across FCMs depending on the nature
of their existing rule and compliance infrastructures, and as such
would be difficult to quantify with precision. However, for those FCMs
that choose to engage in separate account treatment in a manner
consistent with the final rule, the costs of compliance could be
significant, and may vary based on factors such as the size and
existing compliance resources of a particular FCM, as well as the
extent to which the FCM's existing risk management policies and
procedures already incorporate risk management measures that overlap
with those required under the final rule. FCMs that wish to allow for
separate account treatment would likely incur costs in connection with
updating their policies and procedures, internal systems, customer
documentation and (re-)negotiation of customer agreements to allow for
separate account treatment under the conditions codified in the final
rule.
In a letter to the Commission staff dated April 1, 2022, FIA noted
that, ``For many [clearing] FCMs and their customers, the terms and
conditions of the no-action position . . . presented significant
operational and systems challenges,'' as clearing FCMs were required to
``(i) adopt new practices for stress testing accounts; (ii) review and
possibly change margin-timing expectations for non-US accounts; (iii)
undertake legal analysis to clarify interpretive questions; and (iv)
revise their segregation calculation and recordkeeping practices,'' as
well as engage in ``time-consuming documentation changes and customer
outreach.'' \375\
---------------------------------------------------------------------------
\375\ FIA letter dated Apr. 1, 2022 to Clark Hutchison and
Amanda Olear (Second FIA Letter).
---------------------------------------------------------------------------
FIA further described these challenges in a letter to the
Commission staff dated May 11, 2022, noting that in order to meet the
conditions of the no-action position, clearing FCMs were required to
review and in some cases amend customer agreements, and identify and
implement information technology systems changes.\376\ FIA also
asserted that clearing FCMs were likely required to revise internal
controls and procedures.\377\ FIA stated that while the costs incurred
by each clearing FCM varied depending on its customer base, among
larger clearing FCMs with a significant institutional customer base,
personnel costs would have included identifying and reviewing up to
3,000 customer agreements to determine which agreements required
modification, and then negotiating amendments with customers or their
advisers.\378\ FIA further stated that because the relevant provisions
of these agreements were not uniform, they generally required
individual attention.\379\
---------------------------------------------------------------------------
\376\ Third FIA Letter. FIA noted that these changes were
particularly challenging for FCMs that are part of a bank holding
company structure, as ``[m]odifying integrated technology
information systems across a bank holding company structure is
complicated, expensive and time-consuming.'' Id.
\377\ Id.
\378\ Id.
\379\ Id.
---------------------------------------------------------------------------
The Commission anticipates that similar costs would arise for FCMs
attempting to meet the requirements of the final rule.
Of the costs that FCMs would likely incur related to application of
separate account treatment, some costs would be incurred on a one-time
basis (e.g., updates to systems, procedures, disclosure documents, and
recordkeeping practices, and renegotiation of customer agreements with
separate account customers), and some would be recurring (e.g.,
monitoring compliance with the one-day margin call requirement and the
other conditions for ordinary course of business). However, those costs
could vary widely on an FCM-by-FCM basis, depending on factors such as
the number of customers at a particular FCM who wish to have separate
treatment applied to their accounts; thus, for some FCMs, ongoing costs
of maintaining compliance may be less significant.
While the Commission, in connection with its Paperwork Reduction
Act assessment below,\380\ estimates that certain reporting,
disclosure, and recordkeeping costs would not be significant on an
entity level, as FIA noted, taken as a whole, compliance with the
conditions that the regulation codifies could result in significant
operational and systems costs. In other words, the Commission
anticipates that FCMs may incur significant costs related to designing
and implementing new systems, or enhancing existing systems, to comply
with the final rule, as well as negotiation costs, even where direct
recordkeeping costs may not be significant on an entity-by-entity
basis.\381\
---------------------------------------------------------------------------
\380\ As discussed below, the Commission staff estimates total
annual costs of $10,292,580 across 7,530 respondents with respect to
reporting, disclosure, and recordkeeping requirements; however, as
certain such costs are one-time costs, the Commission staff expects
such figure would be reduced after the first year of application of
separate account treatment.
\381\ This may be true to a somewhat lesser extent with respect
to new entrants to the FCM business, in that those FCMs would incur
the cost of implementing policies, procedures, and systems that
comply with the requirements of the final rule, but would not need
to retrofit existing policies, procedures, and systems.
---------------------------------------------------------------------------
In terms of implementation costs relative to the baseline (that
does not consider the effects of NAL 19-17), the Commission believes
clearing FCMs and non-clearing FCMs will be subject to the same types
of costs related to application of separate account treatment.
As discussed above, a number of clearing FCMs have adopted some
current practices based not only upon regulation Sec.
39.13(g)(8)(iii)'s existing Margin Adequacy Requirement applicable to
clearing FCMs through the rules of such clearing FCMs' DCOs, but also
on the no-action position provided by Commission staff in CFTC Letter
No. 19-17, and decisions by DCOs to provide relief from their rules
adopting a Margin Adequacy Requirement in line with (and subject to the
conditions specified in) that staff no-action position. As such, to the
extent that clearing FCMs have relied on the no-action position, the
actual costs and benefits of the final rule amendments as realized in
the market may not be as significant as a comparison of the rule to the
regulatory baseline would suggest.\382\ Specifically, to the extent
clearing FCMs already rely on the effects of the no-action position,
the tools (e.g., software) and policies and procedures necessary to
comply with
[[Page 7926]]
the final rule on an ongoing basis will largely have already been
built, and the costs associated with compliance will largely have
already been incurred.\383\ (This would not apply to non-clearing FCMs,
who have had no need to rely on the effects of the no-action position.)
However, the Commission notes that because the provisions of the final
rule vary in some respects from the terms of the no-action position, at
least some additional costs are likely to be incurred by clearing FCMs
that already rely on the no-action position.
---------------------------------------------------------------------------
\382\ For those clearing FCMs that currently choose not to
engage in separate account treatment, and therefore, do not adhere
to CFTC Letter No. 19-17, but choose to do so following the adoption
of the final rule, the Commission submits that there will be
significant costs similar to non-clearing FCMs.
\383\ Communications from FIA indicate that significant
resources have, in fact, been expended to meet the conditions of the
no-action position of CFTC Letter No. 19-17. See Second FIA Letter.
---------------------------------------------------------------------------
In addition to compliance costs, one other type of costs should be
noted: The Commission is of the view that the risk mitigants in final
regulation Sec. 1.44(c)-(h) would achieve the benefits of the Margin
Adequacy Requirement while permitting separate account treatment.
However, there does exist a possibility that, despite these risk
mitigants, an undermargin condition could exist, followed by a default
by the customer to the FCM, and a consequent default by the FCM
upstream (either to a DCO or to a clearing FCM), where the losses due
to that default would be greater than they would have been absent
separate account treatment.
As Question 11, the Commission asked whether the descriptions of
the types of costs that would be incurred by FCMs to implement each of
the Margin Adequacy Requirement and Separate Account Treatment under
the proposed rules were appropriately comprehensive, and what data can
be provided about the magnitude of such costs, either by type or in the
aggregate. As Question 12, the Commission requested comment on the
extent to which FCMs that are not presently clearing members that rely
on the no-action position in CFTC Letter No. 19-17 would, following
implementation of the proposed regulation, seek to engage in separate
account treatment (requesting that commenters provide data where
available). As Question 13, the Commission requested comment regarding
whether there are FCMs that chose not to rely on the no-action position
in CFTC Letter No. 19-17 due to the conditions required to rely on that
position. The Commission further requested comment on how the
implementation of those conditions in the Second Proposal could be
modified to mitigate the burden of compliance while achieving the goals
of mitigating systemic risk and protecting customer funds.
No commenters responded to these questions; however, several
commenters submitted comments that dealt with potential costs,
generally qualitatively. For example, in commenting on the Commission's
definition of ``undermargined amount'' in proposed regulation Sec.
1.44(a), the JAC asserted that the proposed rule appeared to require
FCMs to perform margin calculations differently for compliance with
different regulatory reporting requirements (including, potentially,
bifurcated treatment for non-separate account customers and separate
account customers), which the JAC contended may prove burdensome for
FCMs that permit separate account treatment (e.g., such FCMs may be
required to update their regulatory reporting records).\384\ As
discussed above, the Commission has modified the final definition of
``undermargined amount'' to address the JAC's comment and make clear
that the final rule is not intended to alter the manner in which FCMs
determine the undermargined amount for a separate account or non-
separate account customer.
---------------------------------------------------------------------------
\384\ JAC Comment Letter.
---------------------------------------------------------------------------
In discussing the permissibility under the proposed regulation of
certain multi-settlement margining processes, the JAC also noted FCMs
may be required to undertake significant work to update their
regulatory records, risk programs, margin calculations, and reports for
separate account customers and non-separate account customers.\385\
While the Commission confirms above that the final rule is not intended
to preclude FCMs and their customers from, e.g., settling margin in
multiple currencies, and does not require the disbursement or
settlement of a single amount, the Commission nonetheless expects that,
as a general matter, some FCMs will be required to undertake
significant work to implement requirements for separate account
treatment (in particular, FCMs that have not provided such treatment
for customers previously but opt to do so following the adoption of
this final rule).
---------------------------------------------------------------------------
\385\ Id.
---------------------------------------------------------------------------
The JAC discussed in its comment letter that FCMs could be subject
to significant capital charges for separate accounts in light of the
requirement in proposed regulation Sec. 1.17(c)(5)(viii)(B) to require
the calculation of current calls used in computing a separate account's
undermargined capital charge based on the age of all margin calls in
all separate accounts of the separate account customer.\386\ With
respect to the requirement in proposed regulation Sec. 1.17(c)(2)(i),
which would have required FCMs to look across all separate accounts of
a separate account customer in determining one-day debits or deficits
for purposes of ascertaining current assets, the JAC noted that FCMs
permitting separate account treatment may need to consider additional
capital needs, particularly in the event that margin calls met in non-
USD currencies would be considered satisfied only when receipts are
settled.\387\ FIA similarly argued that the proposed revisions to
regulation Sec. 1.17 would likely be costly to FCMs because they would
require FCMs to rebuild operational and reporting systems to perform
the required look-across of separate accounts.\388\ Using a
quantitative example and information ascertained from a survey of FIA
members, FIA also argued that the proposed look-across could result in
capital treatment that, in FIA's view, would be punitive and without
regard to related financial or operational risk.\389\
---------------------------------------------------------------------------
\386\ Id.
\387\ Id.
\388\ FIA Comment Letter.
\389\ Id.
---------------------------------------------------------------------------
As discussed above, in this final rule, the Commission has
eliminated the requirement to look across separate accounts for
purposes of regulation Sec. 1.17(c)(2)(i) and regulation Sec.
1.17(c)(5)(viii)(B), and further confirms that the final rule is not
intended to preclude treatment of pending non-USD transfers as received
(subject to conditions identical to those set forth in JAC guidance)
for purposes of regulation Sec. 1.17(c)(5)(viii), among others.
Additionally, FIA asserted that the standard for determining the
occurrence of an unusual administrative error or operational constraint
that would excuse a margin fail under the one business day margin call
standard of regulation Sec. 1.44, set forth in proposed regulation
Sec. 1.44(f)(5), introduces subjectivity and complexity into routine
determinations that will require material levels of new investment in
compliance, risk management, and operations time and resources, for no
discernible risk management benefit.\390\ SIFMA-AMG opined that the
proposed regulation Sec. 1.44(f)(5) did not appropriately balance
practicability and burden with risk management,\391\ and MFA contended
that the proposed requirement would result in additional administrative
burdens on an FCM.\392\ FIA also contended that proposed regulation
Sec. 1.44(f)(4), which in part permits a separate account customer or
[[Page 7927]]
investment manager to designate the holiday schedule of a Eurozone
country to follow for purposes of regulation Sec. 1.44's one business
day margin call standard where margin is to be paid in EUR, will
require FCMs to deploy new margin day counting systems and
protocols.\393\ SIFMA-AMG argued that proposed regulation Sec.
1.44(f)(4) would be unmanageable and unsustainable, would impose a
regulatory burden without a corresponding public policy benefit, and
could require the overhaul of customer agreements and burden FCMs with
additional monitoring responsibilities.\394\ The Commission is adopting
regulation Sec. 1.44(f)(4) and 1.44(f)(5) with modifications in light
of comments received, and responds to FIA's and SIFMA-AMG's comments
above.
---------------------------------------------------------------------------
\390\ Id.
\391\ SIFMA-AMG Comment Letter.
\392\ MFA Comment Letter.
\393\ FIA Comment Letter.
\394\ SIFMA-AMG Comment Letter.
---------------------------------------------------------------------------
FIA also asserted that proposed regulation Sec. 1.44(h)(4)(i)'s
30-day stay on reinstating disbursements on a separate account basis
could have certain negative unintended consequences for customers and
market liquidity, if, due to an event outside the ordinary course of
business, an FCM were forced to suspend disbursements to customers on a
separate account basis (even after the underlying event was
resolved).\395\ SIFMA-AMG voiced similar concerns.\396\ Here, and
above, the Commission notes that the 30-day stay on reinstating
disbursements on a separate account basis is intended to apply only in
instances in which the election for separate account treatment for a
separate account customer pursuant to regulation Sec. 1.44(d) is
revoked. It will not apply where an event outside the ordinary course
of business has required cessation of disbursements on a separate
account basis, and that circumstance subsequently has been cured,
consistent with regulation Sec. 1.44(e)(4).
---------------------------------------------------------------------------
\395\ FIA Comment Letter.
\396\ SIFMA-AMG Comment Letter.
---------------------------------------------------------------------------
C. Costs and Benefits of the Commission's Action as Compared to
Alternatives
The Commission considered as an alternative to this final rule
codifying the no-action position absent the conditions. This
alternative would preserve the benefits of separate account treatment
for FCMs and customers. However, as discussed further below, the
conditions of the no-action position--codified herein on an FCM-wide
basis--are designed to permit separate account treatment only to the
extent that such treatment would not contravene the risk mitigation
goals of regulation Sec. 39.13 (and the Margin Adequacy Requirement of
regulation Sec. 1.44(b)). The Commission believes that codifying the
staff no-action position without the conditions would intensify risks
for DCOs, FCMs, and customers. For instance, without a requirement to
cease disbursements on a separate account basis in cases in which a
customer is in financial distress, it is more likely that an
undermargining scenario would be exacerbated, and a customer default to
the clearing FCM--and potentially a default of the clearing FCM to the
DCO--would be more likely. It would also forego applying the benefits
of the Margin Adequacy Requirement and specific risk-mitigating
requirements for separate account treatment to all FCMs.
D. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
effects of its actions in light of the following five factors:
1. Protection of Market Participants and the Public
Section 15(a)(2)(A) of the CEA requires the Commission, before
promulgating a regulation or issuing an order, to consider the costs
and benefits of the action in light of considerations of protection of
market participants and the public. The Commission believes that the
amendments adopted herein would strengthen the customer protection and
risk mitigation provisions of part 1 applicable to FCMs generally, and,
with respect to clearing FCMs, maintain the efficacy of protections for
customers and the broader financial system contained in Core Principle
D and regulation Sec. 39.13.
The Commission believes that the final rule's Margin Adequacy
Requirement will have a salutary effect on the protection of market
participants and the public. Section 4d(a)(2) of the CEA and the
Commission's implementing regulations under part 1 require FCMs to
segregate customer funds to margin trades and prohibit FCMs from using
one customer's funds to margin another customer's trades. The final
rule is designed to effectuate and support these requirements by
implementing requirements for FCMs to limit the potential for losses
from defaults and maintain margin sufficient to cover potential
exposures in normal market conditions \397\ by requiring FCMs to ensure
that their customers do not withdraw funds from their accounts if such
withdrawal would create or exacerbate an initial margin shortfall, and
to do so in a manner consistent with the Margin Adequacy Requirement in
regulation Sec. 39.13(g)(8)(iii) already applicable through DCO rules
to clearing FCMs. This requirement protects not only market
participants by requiring FCMs to ensure that adequate margin exists to
cover customer positions; it also protects the public from disruption
to the wider financial system by mitigating the risk that an FCM will
default due to customer nonpayment of variation margin obligations
combined with insufficient initial margin.
---------------------------------------------------------------------------
\397\ 7 U.S.C. 7a-1(c)(2)(D)(iii)-(iv).
---------------------------------------------------------------------------
The Commission also believes the requirements in the final rule for
carrying out separate account treatment will provide for separate
account treatment in a manner that protects market participants and the
public. While, with respect to clearing FCMs subject to the indirect
effects of current Sec. 39.13(g)(8)(iii), permitting separate account
treatment unavoidably creates some additional risk of a margin
deficiency, the conditions of the no-action position outlined in CFTC
Letter No. 19-17, and codified herein, as modified and applicable on an
FCM-wide basis, are designed to effectuate these customer protection
and risk mitigation goals notwithstanding an FCM's application of
separate account treatment (and the consequent additional risk). For
example, disbursements on a separate account basis are not permitted in
certain circumstances outside the ordinary course of business (e.g.,
where an FCM learns a customer is in financial distress, and thus may
be unable promptly to meet initial margin requirements, whether in one
or more separate accounts or on a combined account basis). The final
rule also puts in place requirements for FCMs designed to ensure that
they collect information sufficient to understand the value of assets
dedicated to a separate account, apply separate account treatment
consistently, and maintain reliable lines of contact for the ultimate
customer of the account. Clearing FCMs have, for over five years,
successfully relied on a no-action letter, as applied through their
DCOs, establishing conditions substantially similar to the requirements
for separate account treatment set forth in this final rule, and the
Commission believes that the codification of these conditions, as set
forth herein, supports protection of market participants and the
public.
[[Page 7928]]
2. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
Section 15(a)(2)(B) of the CEA requires the Commission to evaluate
the costs and benefits of its action in light of efficiency,
competitiveness, and financial integrity of futures markets. The
Commission believes that the final rule may carry potential
implications for the financial integrity of markets, but not for the
efficiency or competitiveness of markets, which the Commission believes
remain unchanged.
As stated above, the purposes of the Commission's customer funds
protection and risk management regulations include not just protection
of customer assets, but also mitigation of systemic risk: a customer in
default to an FCM may in turn trigger the FCM to default, either to the
DCO (if it is a clearing member) or to another FCM that is itself a
clearing member, with potentially cascading consequences for the
clearing FCM (if applicable) or the DCO and the wider financial system.
The Margin Adequacy Requirement of regulation Sec. 1.44(b) advances
those purposes directly. The final amendments permitting separate
account treatment reflect the Commission's conclusion that the
conditions of CFTC Letter No. 19-17, as codified herein, are sufficient
and appropriate to guard against such risks for purposes of the Margin
Adequacy Requirement.
In CFTC Letter No. 19-17, the Commission staff highlighted market
participants' concerns that the Commission should recognize ``diverse
practices among FCMs and their customers with respect to the handling
of separate accounts of the same beneficial owner'' as consistent with
regulation Sec. 39.13(g)(8)(iii). FIA, in particular, outlined several
business cases in which a customer may want to apply separate account
treatment, and each of SIFMA-AMG, FIA, and CME outlined controls that
clearing FCMs could apply to ensure that, in instances in which
separate account treatment is desired, such treatment can be applied in
a manner that effectively prevents systemic risk.\398\ By codifying in
part 1 a Margin Adequacy Requirement directly applicable to FCMs
similar to the Margin Adequacy Requirement of regulation Sec.
39.13(g)(8)(iii), and a modified version of the no-action position
provided for by CFTC Letter No. 19-17 and its superseding letters,
applicable to all FCMs, the Commission is promulgating a framework for
FCMs, whether clearing or non-clearing, to provide separate account
treatment for customers subject to enhanced customer fund and risk
mitigation protections, thereby ensuring FCMs can compete on services
offered to customers to address their financial needs, in a manner
consistent with the customer protection and risk mitigation goals of
the CEA.
---------------------------------------------------------------------------
\398\ See First FIA Letter; SIFMA-AMG Letter; CME Letter.
---------------------------------------------------------------------------
3. Price Discovery
Section 15(a)(2)(C) of the CEA requires the Commission to evaluate
the costs and benefits of its action in light of price discovery
considerations. The Commission believes that the final amendments will
not have a significant impact on price discovery.
4. Sound Risk Management Practices
Section 15(a)(2)(D) of the CEA requires the Commission to evaluate
the costs and benefits of its action in light of sound risk management
practices. As discussed above, the CEA sets forth requirements
providing that an FCM may not use one customer's funds to cover another
customer's margin shortfall. The Margin Adequacy Requirement of
regulation Sec. 1.44(b) serves these purposes by further ensuring that
FCMs do not allow customers to create or increase undermargining in
their accounts through withdrawals of funds. While, as discussed above,
clearing FCMs are already subject to this requirement as a result of
DCO rules adopted under regulation Sec. 39.13(g)(8)(iii), the final
rule also applies this requirement to non-clearing FCMs, and creates
another avenue to monitoring and enforcement of this requirement for
clearing FCMs.
Additionally, the Commission believes that the final rule will
ensure that application of the requirements for separate account
treatment occurs in a manner that continues to be consistent with the
CEA's customer fund protection and risk mitigation objectives. As
discussed above, the no-action position has been successfully used to
allow clearing FCMs to engage in separate account treatment in a manner
that is consistent with the protection of customer funds and the
mitigation of systemic risk, including by requiring the application of
separate account treatment in a consistent manner, and requiring
regulatory notifications and the cessation of disbursements on a
separate account basis in certain instances of operational or financial
distress. The Commission believes codification of the no-action
conditions, and the Margin Adequacy Requirement they address, applied
directly to all FCMs, promotes sound FCM risk management
practices.\399\
---------------------------------------------------------------------------
\399\ See, e.g., First FIA Letter (describing use of separate
account treatment for hedging purposes).
---------------------------------------------------------------------------
5. Other Public Interest Considerations
Section 15(a)(2)(e) of the CEA requires the Commission to evaluate
the costs and benefits of its action in light of other public interest
considerations. The Commission is identifying a public interest benefit
in codifying the Divisions' no-action position, where the efficacy of
that position has been demonstrated. In such a situation, the
Commission believes it serves the public interest and, in particular,
the interests of market participants, to engage in notice-and-comment
rulemaking, where it seeks and considers the views of the public in
amending its regulations, rather than for market participants to
continue to rely on a time-limited no-action position that can be
easily withdrawn, provides less long-term certainty for market
participants, and offers a more limited opportunity for public input.
In promulgating this final rule, the Commission sought and considered
public comment both as to the proposed regulation generally and as to
specific aspects of the proposal (including costs and benefits).
As Question 14, the Commission requested comment, including any
available quantifiable data and analysis, concerning its analysis of
the section 15(a) factors. No commenters responded to this question.
IV. Related Matters
A. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA in issuing any order or adopting any Commission
rule or regulation.\400\
---------------------------------------------------------------------------
\400\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
did not identify any anti-competitive effects in the NPRM. The
Commission requested comment on whether the proposed regulation
implicates any other specific public interest to be protected by the
antitrust laws, as well as on whether the proposed regulation is
anticompetitive and, if it is, what the anticompetitive effects are.
The Commission did not receive any comments in response to these
requests.
[[Page 7929]]
The Commission confirms its determination that this final rule is
not anti-competitive and has no anti-competitive effects. Given this
determination, the Commission has not identified any less anti-
competitive means of achieving the purposes of the CEA.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires agencies to consider
whether their rules have a significant economic impact on a substantial
number of small entities and, if so, provide a regulatory flexibility
analysis with respect to such impact.\401\ The rules adopted herein
would require all FCMs to ensure that they do not permit their
customers to withdraw funds from their accounts unless the net
liquidating value plus the margin deposits remaining in the account are
sufficient to meet the customer initial margin requirements for such
accounts, but would also establish requirements under which FCMs could
engage in separate account treatment. The Commission has previously
established certain definitions of ``small entities'' to be used by the
Commission in evaluating the impact of its regulations on small
entities in accordance with the RFA.\402\ The Commission has previously
determined that FCMs are not small entities for the purpose of the
RFA.\403\ Accordingly, the Chairman, on behalf of the Commission,
hereby certifies pursuant to 5 U.S.C. 605(b) that these final rules
will not have a significant economic impact on a substantial number of
small entities.
---------------------------------------------------------------------------
\401\ 5 U.S.C. 601 et seq.
\402\ Bankruptcy Regulations, 86 FR 19324, 19416 (Apr. 13, 2021)
(citing Policy Statement and Establishment of Definitions of ``Small
Entities'' for Purposes of the Regulatory Flexibility Act, 47 FR
18618 (Apr. 30, 1982)).
\403\ See id. (citing New Regulatory Framework for Clearing
Organizations, 66 FR 45604, 45609 (Aug. 29, 2001); Customer Margin
Rules Relating to Security Futures, 67 FR 53146, 53171 (Aug. 14,
2002)).
---------------------------------------------------------------------------
C. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) \404\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any ``collection of
information'' as defined by the PRA. Under the PRA, an 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. The Office of Management and Budget (OMB) has assigned to this
new collection the control number 3038-0121.
---------------------------------------------------------------------------
\404\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
The PRA is intended, in part, to minimize the paperwork burden
created for individuals, business, and other persons as a result of the
collection of information by Federal agencies, and to ensure the
greatest possible benefit and utility of information created,
collected, maintained, used, shared, and disseminated by or for the
Federal government. The PRA applies to all information, regardless of
form or format, whenever the Federal government is obtaining, causing
to be obtained, or soliciting information, and includes required
disclosure to third parties or the public, of facts or opinions, when
the information collection calls for answers to identical questions
posed to, or identical reporting or recordkeeping requirements imposed
on, ten or more persons.
This final rule will result in a new collection of information
within the meaning of the PRA, as discussed below. Responses to this
collection of information would be required to obtain a benefit.
Specifically, FCMs would be required to respond to the collection in
order to obtain the benefit of engaging in separate account treatment
for purposes of regulation Sec. 1.44.\405\ Beyond the reporting,
disclosure, and recordkeeping provisions identified below, the
Commission does not believe the final rule imposes any other new
collections of information that require approval of OMB under the PRA.
The Commission requests that OMB approve OMB control number 3038-0121
in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------
\405\ As noted below in connection with recordkeeping
requirements, the final rule may also contain recordkeeping
implications under the PRA for certain separate account customers/
asset managers to the extent an FCM considers pending non-USD
transfers as received for certain purposes.
---------------------------------------------------------------------------
The Commission will protect proprietary information it may receive
according to the Freedom of Information Act and 17 CFR part 145,
``Commission Records and Information.'' In addition, section 8(a)(1) of
the CEA strictly prohibits the Commission, unless specifically
authorized by the CEA, from making public ``data and information that
would separately disclose the business transactions or market positions
of any person and trade secrets or names of customers.'' \406\ The
Commission also is required to protect certain information contained in
a government system of records according to the Privacy Act of 1974, 5
U.S.C. 552a.
---------------------------------------------------------------------------
\406\ 7 U.S.C. 12(a)(1).
---------------------------------------------------------------------------
1. Information Provided by Reporting Entities/Persons
The final rule applies directly to FCMs. All FCMs that engage in
separate account treatment, both those that are clearing members of
DCOs and those that are not, would be subject to certain reporting,
disclosure, and recordkeeping requirements to comply with the
requirements for separate account treatment specified in regulation
Sec. 1.44.
While the Commission staff estimates burden hours and costs using
current part 1 and regulation Sec. 39.13(g)(8)(iii) as a baseline, the
Commission notes that FCMs that are clearing members of DCOs are
already effectively subject to the Margin Adequacy Requirement, in
order to comply with rules that their DCOs have established in order to
in turn comply with the DCO's obligations under regulation Sec.
39.13(g)(8)(iii). Thus, the Commission notes that many clearing FCMs
already are subject to the conditions of the no-action position, which
are substantially similar to the requirements for separate account
treatment under this final rule. For these clearing FCMs, the
Commission expects that any additional cost or administrative burden
associated with complying with the final rule would be reduced.\407\
---------------------------------------------------------------------------
\407\ However, the Commission expects that FCMs that do not
currently rely on the no-action position, but choose to apply
separate account treatment following the adoption of this final
rule, would incur new costs. This would include all non-clearing
FCMs that choose to apply separate account treatment following the
adoption of this final rule.
---------------------------------------------------------------------------
a. Reporting Requirements
The final rule contains two reporting requirements that could
result in a collection of information from ten or more persons over a
12-month period.
There are currently approximately 60 registered FCMs.\408\ The
Commission staff estimates that slightly less than half of all FCMs
would engage in separate account treatment under the final rule,
resulting in approximately 30 respondents.
---------------------------------------------------------------------------
\408\ See CFTC, Selected FCM Financial Data as of August 31,
2023, available at https://www.cftc.gov/sites/default/files/2023-10/01%20-%20FCM%20web page%20Update%20-%20August%202023.xlsx.
---------------------------------------------------------------------------
First, regulation Sec. 1.44(d)(2) provides that, to the extent an
FCM elects to treat the separate accounts of a customer as accounts of
separate entities pursuant to the terms of regulation Sec. 1.44, the
FCM must provide a one-time notification to its DSRO and to the
Commission that it will apply such treatment. The Commission staff
estimates this would result in a total of one response per respondent
on a one-time basis, and that
[[Page 7930]]
respondents could expend up to $268, based on an hourly rate of
$268,\409\ to comply with regulation Sec. 1.44(d)(2). This would
result in an annual burden of 30 hours and an aggregated cost of $8,040
(30 respondents x $268).
---------------------------------------------------------------------------
\409\ This figure is rounded to the nearest dollar and based on
the annual mean wage for U.S. Bureau of Labor Statistics (BLS)
category 13-2061, ``Financial Examiners.'' BLS, Occupational
Employment and Wages, May 2023 [hereinafter ``BLS Data''], available
at https://www.bls.gov/oes/current/oes_nat.htm. This category
consists of professionals who ``[e]nforce or ensure compliance with
laws and regulations governing financial and securities institutions
and financial and real estate transactions.'' BLS, Occupational
Employment and Wages, May 2023: 13-2061 Financial Examiners,
available at https://www.bls.gov/oes/current/oes132061.htm.
According to BLS, the mean salary for this category in the context
of Securities, Commodity Contracts, and Other Financial Investments
and Related Activities is $116,520. This number is divided by 1,800
work hours in a year to account for sick leave and vacations and
multiplied by 4 to account for retirement, health, and other
benefits or compensation, as well as for office space, computer
equipment support, and human resources support. This number is
further multiplied by 1.0357 to account for the 3.57% change in the
Consumer Price Index for Urban Wage-Earners and Clerical Workers
between May 2023 and September 2024 (298.382 to 309.046). BLS, CPI
for Urban Wage Earners and Clerical Workers (CPI-W), U.S. City
Average, All Items--CWUR0000SA0, available at https://www.bls.gov/data/#prices. Together, these modifications yield an hourly rate of
$268. The rounding and modifications applied with respect to the
estimated average burden hour cost for this occupational category
have been applied with respect to each occupational category
discussed as part of this analysis.
---------------------------------------------------------------------------
Second, regulation Sec. 1.44(e)(3) requires an FCM engaging in
separate account treatment to communicate promptly in writing to its
DSRO and to the Commission the occurrence of certain enumerated ``non-
ordinary course of business'' events. The Commission staff estimates
that each such FCM may experience two non-ordinary course of business
events per year, either with respect to themselves, or a customer. For
purposes of determining the number of responses, the Commission staff
anticipates that additional notifications of substantially the same
information, and at substantially the same time, by means of electronic
communication to both the DSRO and the Commission would not materially
increase the time and cost burden for such FCM. Therefore, for purposes
of these estimates, the Commission staff treats a set of notifications
sent to the DSRO and to the Commission as a single response.\410\
Accordingly, the Commission staff estimates a total of two responses
per respondent on an annual basis. In addition, the Commission staff
estimates that each response would take eight hours. This yields a
total annual burden of 480 hours (2 responses x 8 hours/response x 30
respondents). In addition, the Commission staff estimates that each
respondent could expend up to $4,288 annually, based on an hourly rate
of $268, to comply with this requirement.\411\ This would result in an
aggregated cost of $128,640 per annum (30 respondents x $4,288).
---------------------------------------------------------------------------
\410\ The Commission staff applies the same assumption to
notifications to DSROs and the Commission with respect to regulation
Sec. 1.44(d)(2) and regulation Sec. 1.44(e)(3).
\411\ See BLS Data (category 13-2061, ``Financial Examiners,''
in Securities, Commodity Contracts, and Other Financial Investments
and Related Activities).
---------------------------------------------------------------------------
The aggregate information collection burden estimate associated
with the reporting requirements is as follows: \412\
---------------------------------------------------------------------------
\412\ This estimate reflects the aggregate information
collection burden estimate associated with the reporting
requirements for the first annual period following implementation of
the final rule. Because regulation Sec. 1.44(d)(2) will result in a
one-time reporting requirement, the Commission staff estimates that
for each subsequent annual period, the number of reports, burden
hours, and burden cost will be reduced accordingly.
---------------------------------------------------------------------------
Estimated number of respondents: 30.
Estimated number of reports: 90.
Estimated annual hours burden: 510.
Estimated annual cost: $136,680.
b. Disclosure Requirements
The final rule contains three disclosure requirements that could
affect ten or more persons in a 12-month period.
First, regulation Sec. 1.44(h)(3)(i) requires an FCM to provide
each customer using separate accounts with a disclosure that, pursuant
to part 190 of the Commission's regulations, all separate accounts of
the customer will be combined in the event of the FCM's bankruptcy. The
Commission staff estimates that this would result in a total of 1
response per respondent on a one-time basis, and that each respondent
is likely to spend one hour to comply with this requirement for a total
of 1 annual burden hour and up to $268 annually, based on an hourly
rate of $268.\413\ This would result in an annual burden of 30 hours (1
response/respondent x 1 hour/response x 30 respondents) and an
aggregated cost of $8,040 (30 respondents x $268). This estimate
reflects one initial disclosure distributed simultaneously to all
existing separate account customers. The Commission staff expects that,
on a going forward basis, this disclosure would be included in standard
disclosures for new customers and would therefore not result in any
additional costs.
---------------------------------------------------------------------------
\413\ This figure is based on the annual mean wage of $264,110
for BLS category 23-1011, ``Lawyers,'' in Securities, Commodity
Contracts, and Other Financial Investments and Related Activities,
available at https://data.bls.gov/oes/#/indOcc/Multiple%20occupations%20for%20one%20industry.
---------------------------------------------------------------------------
Second, regulation Sec. 1.44(h)(3)(iii) requires that an FCM
engaging in separate account treatment include the disclosure statement
required by regulation Sec. 1.44(h)(3) on its website or within its
Disclosure Document required by regulation Sec. 1.55(i). If the FCM
opts to update its Disclosure Document, the Commission staff estimates
that this requirement would result in a total of one response on a one-
time basis, and that each respondent could expend up to $608 annually,
based on an hourly rate of $608,\414\ to comply with regulation Sec.
1.44(h)(3)(iii). This would result in an estimated 30 burden hours
annually (1 response x 1 hour/response x 30 respondents) and an
aggregated cost of $18,240 (30 respondents x $608). This estimate
reflects one updated disclosure distributed simultaneously to existing
customers. If the FCM opts to include the disclosure on its website,
the Commission staff estimates that this requirement would result in a
total of one response on a one-time basis, and that each respondent
could expend up to $324 annually, based on an hourly rate of $324, to
comply with regulation Sec. 1.44(h)(3)(iii).\415\ This would result in
an estimated 30 burden hours annually (1 response x 1 hour/response x
30 respondents) and an aggregated cost of $9,720 (30 respondents x
$324). The Commission staff expects that once the disclosure is
included in the Disclosure Document required by regulation Sec.
1.55(i) or posted on the FCM's website, the FCM would not incur any
additional costs.
---------------------------------------------------------------------------
\414\ This figure is based on the annual mean wage of $264,110
for BLS category 23-1011, ``Lawyers,'' in Securities, Commodity
Contracts, and Other Financial Investments and Related Activities,
available at https://data.bls.gov/oes/#/indOcc/Multiple%20occupations%20for%20one%20industry.
\415\ This figure is based on the annual mean wage of $140,970
for BLS category 15-1254, ``Web Developers,'' in Securities,
Commodity Contracts, and Other Financial Investments and Related
Activities. BLS Data, available at https://www.bls.gov/oes/current/oes_nat.htm.
---------------------------------------------------------------------------
Third, regulation Sec. 1.44(h)(4) requires an FCM that has made an
election pursuant to regulation Sec. 1.44(d) to treat the separate
accounts of a customer as accounts of separate entities for purposes of
regulation Sec. 1.44(b), to disclose in the Disclosure Document
required under regulation Sec. 1.55(i) that it permits the separate
treatment of accounts for the same customer under the requirements of
regulation Sec. 1.44. The Commission staff estimates that this would
result in a total of one response per respondent on a one-time basis,
and
[[Page 7931]]
that respondents could expend up to $608 annually, based on an hourly
rate of $608,\416\ to comply with regulation Sec. 1.44(h)(4). This
would result in an estimated 30 burden hours annually (1 response x 1
hour/response x 30 respondents) and an aggregated cost of $18,240 (30
respondents x $608). This estimate reflects an initial updated
disclosure distributed simultaneously to existing customers. The
Commission staff expects that once this disclosure is made, the
disclosure would be included in the Disclosure Document required by
regulation Sec. 1.55(i) going forward and would not result in any
additional costs.
---------------------------------------------------------------------------
\416\ See BLS Data (category 23-1011, ``Lawyers,'' in
Securities, Commodity Contracts, and Other Financial Investments and
Related Activities).
---------------------------------------------------------------------------
The aggregate information collection burden estimate associated
with the disclosure requirements is as follows: \417\
---------------------------------------------------------------------------
\417\ For purposes of this analysis, the Commission staff
calculates the aggregate information collection burden assuming that
respondents choose to include the disclosure statement required by
regulation Sec. 1.44(h)(3) on their websites and within their
Disclosure Document required by regulation Sec. 1.55(i), in order
to comply with regulation Sec. 1.44(h)(3)(iii). Additionally, this
estimate reflects the aggregate information collection burden
estimate associated with the disclosure requirements for the first
annual period following implementation of the final rule. Because
each of regulation Sec. 1.44(h)(3)(i), Sec. 1.44(h)(3)(iii), and
Sec. 1.44(h)(4) would result in a one-time disclosure requirement
for PRA purposes, the Commission staff estimates that for each
subsequent annual period the number of respondents, reports, burden
hours, and burden cost would be reduced accordingly.
---------------------------------------------------------------------------
Estimated number of respondents: 30.
Estimated number of reports: 120.
Estimated annual hours burden: 120.
Estimated annual cost: $54,240.
c. Recordkeeping Requirements
The final rule contains four recordkeeping requirements that could
affect ten or more persons in a 12-month period.
First, regulation Sec. 1.44(d)(1) provides that, to elect to treat
the separate accounts of a customer as accounts of separate entities,
for purposes of the Margin Adequacy Requirement, the FCM shall include
the customer on a list of separate account customers receiving such
treatment maintained in its books and records. The Commission staff
estimates that this would result in a total of 125 responses per
respondent on a one-time basis at a rate of 15 minutes per
response,\418\ and that respondents could expend up to $8,375 annually
per respondent, based on an hourly rate of $268,\419\ to comply with
regulation Sec. 1.44(d)(1). This would result in an estimated 938
burden hours annually (125 responses x 15 minutes/response x 30
respondents) and an aggregated cost of $251,250 per annum (30
respondents x $8,375).
---------------------------------------------------------------------------
\418\ The Commission does not expect a significant time burden
required to record that an individual customer is receiving separate
account treatment and add such customer to a list of customers
receiving separate account treatment.
\419\ Financial Examiners.
---------------------------------------------------------------------------
Second, regulation Sec. 1.44(e)(4) provides that an FCM that has
ceased permitting disbursements on a separate account basis to a
separate account customer due to the occurrence of a non-ordinary
course of business event may resume permitting disbursements on a
separate account basis if the FCM reasonably believes, based on new
information, that the circumstances leading to cessation of
disbursements on a separate account basis have been cured, and the FCM
documents in writing the factual basis and rationale for its conclusion
that such circumstances have been cured. Where the Commission staff
have estimated above that an FCM may experience two non-ordinary course
of business events per year, the Commission staff conservatively
estimate that in each case the conditions leading to cessation of
disbursements on a separate account basis would be cured. Accordingly,
the Commission staff estimates that documenting the cure of each non-
ordinary course of business event would require two recordkeeping
responses per respondent on an annual basis, resulting in a total of 60
annual responses, and that respondents are likely to spend two hours to
complete the required recordkeeping tasks.\420\ This would result in a
total of 120 annual burden hours (2 responses x 2 hours/response x 30
respondents) and up to $1,072 annually per respondent, based on an
hourly rate of $268,\421\ to comply with this requirement. This would
result in an aggregated cost of $32,160 per annum (30 respondents x
$1,072).
---------------------------------------------------------------------------
\420\ Regulation Sec. 1.44(e)(4) requires the FCM to document
in writing the factual basis and rationale for its conclusion that
the circumstances leading to the cessation of separate account
treatment for one or more separate account customers has been cured
but does not otherwise prescribe the form or manner for such
documentation. Nor does it require that such documentation be
voluminous. As such, the Commission staff estimates that two hours
per response may be reasonable in most instances.
\421\ Financial Examiners.
---------------------------------------------------------------------------
Third, regulation Sec. 1.44(h)(2) provides that where a separate
accounts customer has appointed a third-party as the primary contact to
the FCM, the FCM must obtain and maintain current contact information
of an authorized representative(s) at the customer and take reasonable
steps to verify that such contact information is and remains accurate
and that such person is in fact an authorized representative of the
customer. The Commission staff estimates this would result in a total
of 125 responses per respondent on an annual basis at one hour per
response,\422\ and that respondents could expend up to $20,250
annually, based on an hourly rate of $162.\423\ This would result in an
estimated 3,750 burden hours annually (125 responses x 1 hour/response
x 30 respondents) and an aggregated cost of $607,500 per annum (30
respondents x $20,250).
---------------------------------------------------------------------------
\422\ FIA stated that while the costs incurred by each FCM to
comply with the conditions of CFTC Letter No. 19-17 varies depending
on customer base, among larger FCMs with a significant institutional
customer base, personnel costs would have included identifying and
reviewing up to 3,000 customer agreements to determine which
agreements required modification, and then negotiating amendments
with customers or their advisors. Applying a 25% upward adjustment
to account for the passage of time, potential onboarding of new
customers, and application to non-clearing FCMs, the Commission
staff estimates that there are 3,750 customers of FCMs whose
accounts could be in scope for the final rule, with an average of
125 customers per FCM (among 30 FCMs).
\423\ This figure is based on the annual mean wage of $70,470
for BLS category 43-6012, ``Legal Secretaries & Administrative
Assistants'' in the New York City Metropolitan Area, one of the top
paying metropolitan areas for this category. BLS Data, available at
https://www.bls.gov/oes/current/oes436012.htm.
---------------------------------------------------------------------------
Fourth, regulation Sec. 1.44(h)(3)(ii) requires that an FCM
maintain documentation demonstrating that the part 190 disclosure
statement required by regulation Sec. 1.44(h)(3)(i) was delivered
directly to the customer. The Commission staff estimates that this
would result in a total of 125 responses per respondent on a one-time
basis at an estimated six minutes per response, and that respondents
could expend up to $2,025 annually, based on an hourly rate of $162, to
comply with regulation Sec. 1.44(h)(3)(ii). This would result in an
estimated 375 burden hours annually (125 responses x 6 minutes/response
x 30 respondents) and an aggregated cost of $60,750 (30 respondents x
$2,025). This estimate reflects initial recordkeeping of documentation
that the disclosure was delivered to existing customers subject to
separate account treatment. The Commission staff estimates that, once
such recordkeeping is complete, the recordkeeping required by
regulation Sec. 1.44(h)(3)(ii) would be required only with respect to
new customers who receive disclosures pursuant to regulation Sec.
1.44(h)(3)(ii), and the costs and burden hours associated with
regulation Sec. 1.44(h)(3)(ii) would be reduced accordingly.\424\
---------------------------------------------------------------------------
\424\ This estimate reflects the aggregate information
collection burden estimates associated with the disclosure
requirements for the first annual period following implementation of
the final rule. Because, as noted above, regulation Sec.
1.44(h)(3)(i) would result in a one-time recordkeeping requirement
as to each customer (i.e., once the disclosure is provided to
existing customers, it would need to be provided only to new
customers on a going forward basis), the Commission staff estimates
that for each subsequent annual period the number of reports, burden
hours, and burden cost would be reduced accordingly.
---------------------------------------------------------------------------
[[Page 7932]]
Lastly, to the extent FCMs treat pending non-USD transfers as
received, consistent with JAC guidance, for certain purposes,\425\ as
discussed above, the Commission appreciates that an FCM's application
of the condition in JAC guidance that an FCM has a sufficient basis to
believe that the wire supporting the transfer was actually initiated
may result in recordkeeping for customers/asset managers. The
Commission staff estimates that this would result in a total of 1
response per respondent, 125 times per year,\426\ at an estimated one
minute per response, and that respondents could expend up to $1,220
annually, based on an hourly rate of $574, to perform the relevant
recordkeeping.\427\ This would result in an estimated 15,938 burden
hours annually (125 responses x 1 minute (approximately 0.017 hours)/
response x 7,500 respondents) \428\ and an aggregated cost of
$9,150,000 (7,500 respondents x $1,220). The Commission notes that
while certain other provisions of the final rule may result in
recordkeeping requirements, the Commission anticipates that any burden
associated with these requirements is likely to be de minimis and
therefore does not expect these provisions to increase the
recordkeeping burden for FCMs.
---------------------------------------------------------------------------
\425\ I.e., with respect to the final amendments to regulation
Sec. 1.17(c)(5)(viii), with respect to regulation Sec.
1.17(c)(5)(ix) as discussed in the JAC's comment letter, and with
respect to final regulation Sec. 1.44(b) and (g)(5).
\426\ A response would only be necessary on days when a
respondent has been called for margin due to an undermargined
condition, and is meeting that call with at least one currency other
than USD (or CAD). A conservative estimate of the frequency of this
happening is on half of the trading days in a year for each
respondent.
\427\ This figure is based on the annual mean wage of $249,260
for BLS category 11-3031, ``Financial Managers,'' in Securities,
Commodity Contracts, and Other Financial Investments and Related
Activities, available at https://www.bls.gov/oes/current/oes113031.htm.
\428\ The Commission staff has estimated that there are 3,750
separate account customers and further estimates that each customer
has an average of three separate accounts, and that two thirds of
these accounts settle at least in part in currencies other than USD
and CAD. While the same asset manager may, in fact, manage multiple
separate accounts, the Commission is treating each separate account
as a separate respondent.
---------------------------------------------------------------------------
The aggregate information collection burden estimate associated
with the recordkeeping requirements is as follows:
Estimated number of respondents: 7,530.
Estimated number of reports: 948,810.
Estimated annual hours burden: 21,121.
Estimated annual cost: $10,101,660.
The Commission invited, but did not receive, any public comments
related to the proposed information collection requirements.
D. Congressional Review Act
Pursuant to the Congressional Review Act (5 U.S.C. 801 et seq.),
the Office of Information and Regulatory Affairs designated this rule
as not a ``major rule,'' as defined by 5 U.S.C. 804(2).
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
17 CFR Part 22
Brokers, Clearing, Consumer protection, Reporting and
recordkeeping, Swaps.
17 CFR Part 30
Consumer protection.
17 CFR Part 39
Clearing, Clearing organizations, Commodity futures, Consumer
protection.
For the reasons set forth in the preamble, the Commodity Futures
Trading Commission amends 17 CFR chapter I as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues 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
(2012).
0
2. Amend Sec. 1.3 by revising the definition of ``business day'' to
read as follows:
Sec. 1.3 Definitions.
* * * * *
Business day. This term means any day other than a Saturday,
Sunday, or holiday. In all notices required by the Act or by the rules
and regulations in this chapter to be given in terms of business days
the rule for computing time shall be to exclude the day on which notice
is given and include the day on which shall take place the act of which
notice is given.
* * * * *
0
3. Amend Sec. 1.17 by:
0
a. Republishing paragraph (b) introductory text;
0
b. Revising paragraphs (b)(6) and (b)(8) introductory text;
0
c. Adding paragraph (b)(8)(v);
0
d. Republishing paragraphs (c) introductory text and (c)(2)
introductory text;
0
e. Revising paragraph (c)(2)(i);
0
f. Republishing paragraph (c)(4) introductory text;
0
g. Revising paragraph (c)(4)(ii);
0
h. Republishing paragraph (c)(5) introductory text; and
0
i. Revising paragraph (c)(5)(viii).
The republications, revisions, and additions read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
* * * * *
(b) For the purposes of this section:
* * * * *
(6) Business day means any day other than a Saturday, Sunday, or
holiday.
* * * * *
(8) Risk margin for an account means the level of maintenance
margin or performance bond required for the customer and noncustomer
positions by the applicable exchanges or clearing organizations, and,
where margin or performance bond is required only for accounts at the
clearing organization, for purposes of the futures commission
merchant's risk-based capital calculations applying the same margin or
performance bond requirements to customer and noncustomer positions in
accounts carried by the futures commission merchant, subject to the
following.
* * * * *
(v) If a futures commission merchant carries separate accounts for
separate account customers pursuant to Sec. 1.44, the futures
commission merchant shall calculate the risk margin pursuant to this
section as if the separate accounts are owned by separate entities.
* * * * *
(c) Definitions: For the purposes of this section:
* * * * *
(2) The term current assets means cash and other assets or
resources commonly identified as those which are reasonably expected to
be realized in cash or sold during the next 12 months. ``Current
assets'' shall:
(i) Exclude any unsecured commodity futures, options, cleared
swaps, or other Commission regulated account containing a ledger
balance and open trades, the combination of which liquidates to a
deficit or containing a debit ledger balance only. For purposes
[[Page 7933]]
of this paragraph (c)(2)(i), a futures commission merchant that carries
separate accounts for separate account customers pursuant to Sec. 1.44
shall treat each separate account as if it is the account of a separate
entity, apply only margin collateral held for the particular separate
account in determining if the deficit or debit ledger balance is
secured, and exclude from current assets a separate account that
liquidates to a deficit or contains a debit ledger balance only.
Provided, however, that any deficit or debit ledger balance in an
account listed above, including a separate account, which is the
subject of a call for margin or other required deposits may be included
in current assets until the close of business on the business day
following the date on which such deficit or debit ledger balance
originated provided that the account had timely satisfied, through the
deposit of new funds, the previous day's deficit or debit ledger
balance, if any, in its entirety.
* * * * *
(4) The term liabilities means the total money liabilities of an
applicant or registrant arising in connection with any transaction
whatsoever, including economic obligations of an applicant or
registrant that are recognized and measured in conformity with
generally accepted accounting principles. ``Liabilities'' also include
certain deferred credits that are not obligations but that are
recognized and measured in conformity with generally accepted
accounting principles. For the purposes of computing ``net capital,''
the term ``liabilities'':
* * * * *
(ii) Excludes, in the case of a futures commission merchant, the
amount of money, securities and property due to customers which is held
in segregated accounts in compliance with the requirements of the Act
and these regulations. For purposes of this paragraph (c)(4)(ii), a
futures commission merchant that carries separate accounts of a
separate account customer pursuant to Sec. 1.44 shall compute the
amount of money, securities and property due to the separate account
customer as if the separate accounts were accounts of separate
entities. A futures commission merchant may exclude money, securities
and property due to customers, including separate account customers,
only if such money, securities and property held in segregated accounts
have been excluded from current assets in computing net capital;
* * * * *
(5) The term adjusted net capital means net capital less:
* * * * *
(viii)(A) In the case of a futures commission merchant, for
undermargined customer accounts, the amount of funds required in each
such account to meet maintenance margin requirements of the applicable
board of trade, or if there are no such maintenance margin
requirements, clearing organization margin requirements applicable to
such positions, after application of calls for margin or other required
deposits which are outstanding no more than one business day. If there
are no such maintenance margin requirements or clearing organization
margin requirements, then the amount of funds required to provide
margin equal to the amount necessary, after application of calls for
margin or other required deposits outstanding no more than one business
day, to restore original margin when the original margin has been
depleted by 50 percent or more. If, however, a call for margin or other
required deposits for an undermargined customer account is outstanding
for more than one business day, then no such call for that
undermargined customer account shall be applied until all such calls
for margin have been met in full.
(B) If a futures commission merchant carries separate accounts for
one or more separate account customers pursuant to Sec. 1.44, the
futures commission merchant shall compute the amount of funds required
under paragraph (c)(5)(viii)(A) of this section to meet maintenance
margin requirements for each separate account as if the account is
owned by a separate entity, after application of calls for margin or
other required deposits which are outstanding no more than one business
day. If, however, a call for margin or other required deposits for any
separate account of a particular separate account customer is
outstanding for more than one business day, then all outstanding margin
calls for that separate account shall be treated as if the margin calls
are outstanding for more than one business day, and shall be deducted
from net capital until all such calls have been met in full.
(C) If a customer account or a customer separate account deficit or
debit ledger balance is excluded from current assets in accordance with
paragraph (c)(2)(i) of this section, such deficit or debit ledger
balance amount shall not also be deducted from current assets under
this paragraph (c)(5)(viii).
(D) In the event that an owner of a customer account, or a customer
separate account pursuant to Sec. 1.44, has deposited an asset other
than cash to margin, guarantee or secure the account, the value
attributable to such asset for purposes of this paragraph (c)(5)(viii)
shall be the lesser of:
(1) The value attributable to the asset pursuant to the margin
rules of the applicable board of trade, or
(2) The market value of the asset after application of the
percentage deductions specified in this paragraph (c)(5);
* * * * *
0
4. Amend Sec. 1.20 by revising paragraph (i)(4) and adding paragraph
(i)(5) to read as follows:
Sec. 1.20 Futures customer funds to be segregated and separately
accounted for.
* * * * *
(i) * * *
(4) The futures commission merchant must, at all times, maintain in
segregation an amount equal to the sum of any credit and debit balances
that the futures customers of the futures commission merchant have in
their accounts. Notwithstanding the preceding sentence, a futures
commission merchant must add back to the total amount of funds required
to be maintained in segregation any futures customer accounts with
debit balances in the amounts calculated in accordance with paragraph
(i)(5) of this section.
(5) The futures commission merchant, in calculating the total
amount of funds required to be maintained in segregation pursuant to
paragraph (i)(4) of this section, must include any debit balance, as
calculated pursuant to this paragraph (i)(5), that a futures customer
has in its account, to the extent that such debit balance is not
secured by ``readily marketable securities'' that the particular
futures customer deposited with the futures commission merchant.
(i) For purposes of calculating the amount of a futures account's
debit balance that the futures commission merchant is required to
include in its calculation of its total segregation requirement
pursuant to this paragraph (i)(5), the futures commission merchant
shall calculate the net liquidating equity of each futures account in
accordance with paragraph (i)(2) of this section, except that the
futures commission merchant shall exclude from the calculation any
noncash collateral held in the futures customer account as margin
collateral. The futures commission merchant may offset the debit
balance computed under this paragraph (i)(5) to the extent of any
``readily marketable securities,'' subject
[[Page 7934]]
to percentage deductions (i.e., ``securities haircuts'') as specified
in paragraph (f)(5)(iv) of this section, held for the particular
futures customer to secure its debit balance.
(ii) For purposes of this section, ``readily marketable'' shall be
defined as having a ``ready market'' as such latter term is defined in
Rule 15c3-1(c)(11) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(11)).
(iii) In order for a debit balance to be deemed secured by
``readily marketable securities,'' the futures commission merchant must
maintain a security interest in such securities, and must hold a
written authorization to liquidate the securities at the discretion of
the futures commission merchant.
(iv) To determine the amount of such debit balance secured by
``readily marketable securities,'' the futures commission merchant
shall:
(A) Determine the market value of such securities; and
(B) Reduce such market value by applicable percentage deductions
(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vi)). Futures commission merchants that establish and enforce
written policies and procedures to assess the credit risk of commercial
paper, convertible debt instruments, or nonconvertible debt instruments
in accordance with Rule 240.15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)) may apply the lower
haircut percentages specified in Rule 240.15c3-1(c)(2)(vi) for such
commercial paper, convertible debt instruments and nonconvertible debt
instruments.
* * * * *
0
5. Amend Sec. 1.32 by:
0
a. Removing from paragraph (b) the reference ``17 CFR 241.15c3-
1(c)(2)(vi)'' and adding in its place ``17 CFR 240.15c3-1(c)(2)(vi)''
wherever it appears, and
0
b. Adding paragraph (l).
The addition reads as follows:
Sec. 1.32 Reporting of segregated account computation and details
regarding the holding of futures customer funds.
* * * * *
(l) A futures commission merchant that carries futures accounts for
futures customers as separate accounts for separate account customers
pursuant to Sec. 1.44 shall:
(1) Calculate the total amount of futures customer funds on deposit
in segregated accounts carried as separate accounts of separate account
customers on behalf of such futures customers pursuant to paragraph
(a)(1) of this section and the total amount of futures customer funds
required to be on deposit in segregated accounts carried as separate
accounts of separate account customers on behalf of such futures
customers pursuant to paragraph (a)(2) of this section by including the
separate accounts of the separate account customers as if the separate
accounts were accounts of separate entities;
(2) Offset a net deficit in a particular futures account carried as
a separate account of a separate account customer in accordance with
paragraph (b) of this section against the current market value of
readily marketable securities held only for the particular separate
account of such separate account customer; and
(3) Document its segregation computation in the Statement of
Segregation Requirements and Funds in Segregation of Customers Trading
on U.S. Commodity Exchanges required by paragraph (c) of this section
by incorporating and reflecting the futures accounts carried as
separate accounts of separate account customers as accounts of separate
entities.
0
6. Add Sec. 1.44 to read as follows:
Sec. 1.44 Margin Adequacy and Treatment of Separate Accounts
(a) Definitions. These following definitions apply only for
purposes of this section, except to the extent explicitly noted:
Account means a futures account as defined in Sec. 1.3, a Cleared
Swaps Customer Account as defined in Sec. 1.3, or a 30.7 account as
defined in Sec. 30.1 of this chapter.
Business day has the meaning set forth in Sec. 1.3, with the
clarification that ``holiday'' has the meaning defined in paragraph (a)
of this section.
Holiday means Federal holidays as established by 5 U.S.C. 6103.
One business day margin call means a margin call that is issued and
met in accordance with the requirements of paragraph (f) of this
section.
Ordinary course of business means the operation of the futures
commission merchant's business relationship with its separate account
customer absent the occurrence of one or more of the events specified
in paragraph (e) of this section.
Separate account means any one of multiple accounts of the same
separate account customer that are carried by the same futures
commission merchant.
Separate account customer means a customer for which the futures
commission merchant has made the election set forth in paragraph (d) of
this section.
Undermargined amount for an account means the amount, if any, by
which the customer margin requirements with respect to all products
held in that account exceed the net liquidating value plus the margin
deposits currently remaining in that account. For purposes of this
definition, ``margin requirements'' shall mean the level of maintenance
margin or performance bond required for the positions in the account by
the applicable exchanges or clearing organizations. Market risk
collateral haircuts based on Rule 15c3-1 of the Securities and Exchange
Commission (17 CFR 240.15c3-1) and Sec. 1.17(c)(5) shall be applied to
the value of the margin deposits held by a futures commission merchant.
With respect to positions for which maintenance margin is not
specified, ``margin requirements'' shall refer to the clearing
organization margin requirements applicable to such positions.
(b) Ensuring adequacy of customer initial margin. (1) A futures
commission merchant shall ensure that a customer does not withdraw
funds from its accounts with such futures commission merchant unless
the net liquidating value (calculated as of the close of business on
the previous business day) plus the margin deposits remaining in the
customer's account after such withdrawal are sufficient to meet the
customer initial margin requirements with respect to all products held
in such customer's account, except as provided in paragraph (c) of this
section.
(2) For the purposes of paragraph (b)(1) of this section, where the
previous day (excluding Saturdays and Sundays) is a holiday, as defined
in paragraph (a) of this section, where any designated contract market
or other board of trade on which the futures commission merchant trades
is open for trading, and where an account of any of the futures
commission merchant's customers includes positions traded on such a
market, the net liquidating value for such an account should instead be
calculated as of the close of business on such holiday.
(c) Separate account treatment with respect to withdrawal of
customer initial margin. A futures commission merchant may, only during
the ``ordinary course of business'' as that term is defined in this
section, treat the separate accounts of a separate account customer as
accounts of separate entities for purposes of paragraph (b) of this
section if such futures commission merchant elects to do so as
specified in paragraph (d) of this section. A futures commission
merchant that has made such an election shall comply with the
[[Page 7935]]
requirements set forth in this section, and maintain written internal
controls and procedures designed to ensure such compliance.
(d) Election to treat a customer's accounts as separate accounts.
(1) To elect to treat the separate accounts of a customer as accounts
of separate entities for purposes of paragraph (b) of this section, the
futures commission merchant shall include the customer on a list of
separate account customers maintained in its books and records. This
list shall include the identity of each separate account customer,
identify each separate account of such customer, and be kept current.
(2) The first time that the futures commission merchant includes a
customer on the list of separate account customers, it shall, within
one business day, provide notification of the election to allow
separate account treatment for customers to its designated self-
regulatory organization and to the Commission. The notice shall be
provided in accordance with the process specified in Sec. 1.12(n)(3).
(e) Events inconsistent with the ordinary course of business. (1)
The following events are inconsistent with the ordinary course of
business with respect to the separate accounts of a particular separate
account customer, and the occurrence of any such event would require
the futures commission merchant to cease permitting disbursements on a
separate account basis with respect to all accounts of the relevant
separate account customer:
(i) The separate account customer, including any separate account
of such customer, fails to deposit initial margin or maintain
maintenance margin or make payment of variation margin or option
premium as specified in paragraph (f) of this section.
(ii) The occurrence and declaration by the futures commission
merchant of an event of default as defined in the account documentation
executed between the futures commission merchant and the separate
account customer.
(iii) A good faith determination by the futures commission
merchant's chief compliance officer, one of its senior risk managers,
or other senior manager, following such futures commission merchant's
own internal escalation procedures, that the separate account customer
is in financial distress, or there is significant and bona fide risk
that the separate account customer will be unable promptly to perform
its financial obligations to the futures commission merchant, whether
due to operational reasons or otherwise.
(iv) The insolvency or bankruptcy of the separate account customer
or a parent company of such customer.
(v) The futures commission merchant receives notification that a
board of trade, a derivatives clearing organization, a self-regulatory
organization as defined in Sec. 1.3 or section 3(a)(26) of the
Securities Exchange Act of 1934, the Commission, or another regulator
with jurisdiction over the separate account customer, has initiated an
action with respect to such customer based on an allegation that the
customer is in financial distress.
(vi) The futures commission merchant is directed to cease
permitting disbursements on a separate account basis, with respect to
the separate account customer, by a board of trade, a derivatives
clearing organization, a self-regulatory organization, the Commission,
or another regulator with jurisdiction over the futures commission
merchant, pursuant to, as applicable, board of trade, derivatives
clearing organization or self-regulatory organization rules, government
regulations, or law.
(2) The following events are inconsistent with the ordinary course
of business with respect to the separate accounts of all separate
account customers of the futures commission merchant, and the
occurrence of any such event would require the futures commission
merchant to cease permitting disbursements on a separate account basis
with respect to any of its customers:
(i) The futures commission merchant is notified by a board of
trade, a derivatives clearing organization, a self-regulatory
organization, the Commission, or another regulator with jurisdiction
over the futures commission merchant, that the board of trade, the
derivatives clearing organization, the self-regulatory organization,
the Commission, or other regulator, as applicable, believes the futures
commission merchant is in financial or other distress.
(ii) The futures commission merchant is under financial or other
distress as determined in good faith by its chief compliance officer,
senior risk managers, or other senior management.
(iii) The insolvency or bankruptcy of the futures commission
merchant or a parent company of the futures commission merchant.
(3) The futures commission merchant must provide notice to its
designated self-regulatory organization and to the Commission of the
occurrence of any of the events enumerated in paragraph (e)(1) or (2)
of this section. The notice must identify the event and (if applicable)
the customer, and be provided promptly in writing, and in any case no
later than the next business day following the date on which the
futures commission merchant identifies or has been informed that such
event has occurred. Such notice must be provided in accordance with the
process specified in Sec. 1.12(n)(3).
(4) A futures commission merchant that has ceased permitting
disbursements on a separate account basis to a separate account
customer due to the occurrence of any of the events enumerated in
paragraph (e)(1) of this section with respect to a specific separate
account customer (or in paragraph (e)(2) with respect to all of its
separate account customers) may resume permitting disbursements on a
separate account basis to that customer (or, respectively, all
customers) if such futures commission merchant reasonably believes,
based on new information, that those circumstances have been cured, and
such futures commission merchant documents in writing the factual basis
and rationale for that conclusion. If the circumstances triggering
cessation of disbursements on a separate account basis were an action
or direction by one of the entities described in paragraph (e)(1)(v) or
(vi) or (e)(2)(i) of this section, then the cure of those circumstances
would require the withdrawal or other appropriate termination of such
action or direction by that entity.
(f) Requirements: One business day margin call. Each separate
account must be on a one business day margin call. The following
provisions apply solely for purposes of this paragraph (f):
(1) Except as explicitly provided in this paragraph (f), if, as a
result of market movements or changes in positions on the previous
business day, a separate account is undermargined (i.e., the
undermargined amount for that account is greater than zero), the
futures commission merchant shall issue a margin call for the separate
account for at least the amount necessary for the separate account to
meet the initial margin required by the applicable exchanges or
clearing organizations (including, as appropriate, the equity component
or premium for long or short option positions) for the positions in the
separate account, and that call must be met by the applicable separate
account customer no later than the close of the Fedwire Funds Service
on the same business day.
(2) Payment of margin in currencies listed in appendix A to this
part shall be considered in compliance with the requirements of this
paragraph (f) if received by the applicable futures
[[Page 7936]]
commission merchant no later than the end of the second business day
after the day on which the margin call is issued.
(3) Payment of margin in fiat currencies other than U.S. Dollars,
Canadian Dollars, or currencies listed in Appendix A to this part shall
be considered in compliance with the requirements of this paragraph (f)
if received by the applicable futures commission merchant no later than
the end of the business day after the day on which the margin call is
issued.
(4) The relevant deadline for payment of margin in fiat currencies
other than U.S. Dollars may be extended to the next business day
following any banking holiday in the jurisdiction of issue of the
currency, and still be considered in compliance with the requirements
of this paragraph (f) if payment is delayed due to such banking
holiday.
(5) A failure with respect to a specific separate account to
deposit, maintain, or pay margin or option premium that was called
pursuant to this paragraph (f), due to administrative error or
operational constraints, does not constitute a failure to comply with
the requirements of this paragraph (f). For these purposes, a futures
commission merchant's determination that the failure to deposit,
maintain, or pay margin or option premium is due to such administrative
error or operational constraints must be based on the futures
commission merchant's reasonable belief in light of information known
to the futures commission merchant at the time the futures commission
merchant learns of the relevant administrative error or operational
constraint.
(6) A futures commission merchant would not be in compliance with
the requirements of this paragraph (f) if it contractually agrees to
provide separate account customers with periods of time to meet margin
calls that extend beyond the time periods specified in this paragraph
(f), or engages in practices that are designed to circumvent this
paragraph (f).
(7) In the case of a holiday where any designated contract market
or other board of trade on which the futures commission merchant trades
is open for trading, or any derivatives clearing organization that
clears the Cleared Swaps of such futures commission merchant's Cleared
Swaps Customers is open for clearing such swaps, and where a separate
account of any of the futures commission merchant's separate account
customers includes positions traded on such a market or cleared at such
a derivatives clearing organization, then for any such separate
account:
(i) If, as a result of market movements or changes in positions on
the business day before the holiday, a separate account is
undermargined, the futures commission merchant shall issue a margin
call for the separate account for at least the undermargined amount,
and that call must be met by the applicable separate account customer
no later than the close of the Fedwire Funds Service on the next
business day after the holiday, and,
(ii) If, as a result of market movements or changes in positions on
the holiday, a separate account is undermargined by an amount greater
than the amount it was undermargined as a result of market movements or
changes in positions on the business day before the holiday, the
futures commission merchant shall issue a margin call for the separate
account for at least the incremental undermargined amount, and that
call must be met by the applicable separate account customer no later
than the close of the Fedwire Funds Service on the next business day
after the holiday.
(8) Any person may submit to the Commission any currency that such
person proposes should be added to or removed from appendix A to this
part.
(i) A submission pursuant to this paragraph (f)(8) shall include:
(A) A statement that margin payments in the relevant currency
cannot, in the case of a proposed addition, or can, in the case of a
proposed removal, practicably be received by the futures commission
merchant issuing a margin call no later than the end of the first
business day after the day on which the margin call is issued;
(B) Documentation or other information sufficient to support the
statement contemplated by paragraph (f)(8)(i)(A) of this section; and
(C) Any additional information specifically requested by the
Commission.
(ii) A submitter pursuant to paragraph (f)(8)(i) of this section
that wishes to request confidential treatment for portions of its
submission may do so in accordance with the procedures set out in Sec.
145.9(d).
(iii) The Commission shall review a submission made pursuant to
this paragraph (f)(8) and determine whether to propose to add the
relevant currency to, or remove the relevant currency from, appendix A
to this part.
(iv) If the Commission proposes to add a currency to or remove a
currency from appendix A to this part, the Commission shall issue such
determination through notice and comment rulemaking, and shall provide
a public comment period of no less than thirty days.
(v) The Commission may, of its own accord and absent a submission
pursuant to this paragraph (f)(8), propose to issue a determination to
add a currency to or remove a currency from appendix A to this part
pursuant to the procedure set forth in paragraph (f)(8)(iv) of this
section.
(g) Requirements: Calculations for capital, risk management, and
segregation. (1) The futures commission merchant's internal risk
management policies and procedures shall provide for stress testing and
credit limits as set forth in Sec. 1.73 for separate account
customers. Such stress testing must be performed, and the credit limits
must be applied, both on an individual separate account and on a
combined account basis.
(2) A futures commission merchant shall calculate the margin
requirement for each separate account of a separate account customer
independently from such margin requirement for all other separate
accounts of the same customer with no offsets or spreads recognized
across the separate accounts.
(3) A futures commission merchant shall, in computing its adjusted
net capital for purposes of Sec. 1.17, record each separate account of
a separate account customer in the books and records of the futures
commission merchant as a distinct account of a customer. This includes
recording each separate account with a net debit balance or a deficit
as a receivable from the separate account customer, with no offsets
between the other separate accounts of the same separate account
customer.
(4) A futures commission merchant shall, in calculating the amount
of its own funds it is required to maintain in segregated accounts to
cover deficits or debit ledger balances pursuant to Sec. 1.20(i),
Sec. 22.2(f), or Sec. 30.7(f)(2) of this chapter in any futures
customer accounts, Cleared Swaps Customer Accounts, or 30.7 accounts,
respectively, include any deficits or debit ledger balances of any
separate accounts as if the accounts are accounts of separate entities.
(5) For purposes of its residual interest and legally segregated
operationally commingled compliance calculations, as applicable under
Sec. Sec. 1.22(c), 22.2(f)(6), and 30.7(f)(1)(ii) of this chapter, a
futures commission merchant shall treat the separate accounts of a
separate account customer as if the accounts were accounts of separate
entities and include the undermargined amount of each separate account,
and cover such undermargined amount with its own funds.
[[Page 7937]]
(6) In determining its residual interest target for purposes of
Sec. Sec. 1.11(e)(3)(i)(D) and 1.23(c), the futures commission
merchant must consider the impact of calculating customer receivables
for separate account customers on a separate account basis.
(h) Requirements: information and disclosures. (1) A futures
commission merchant shall obtain from each separate account customer
or, as applicable, the manager of a separate account, information
sufficient for the futures commission merchant to:
(i) Assess the value of the assets dedicated to such separate
account; and
(ii) Identify the direct or indirect parent company of the separate
account customer, as applicable, if such customer has a direct or
indirect parent company.
(2) Where a separate account customer has appointed a third-party
as the primary contact to the futures commission merchant, the futures
commission merchant must obtain and maintain current contact
information of an authorized representative of the customer, and take
reasonable steps to verify that such contact information is and remains
accurate, and that the person is in fact an authorized representative
of the customer.
(3) A futures commission merchant must provide each separate
account customer a disclosure that, pursuant to part 190 of the
Commission's regulations (17 CFR part 190), all separate accounts of
the customer in each account class will be combined in the event of the
futures commission merchant's bankruptcy.
(i) The disclosure statement required by this paragraph (h)(3) must
be delivered directly to the customer via electronic means, in writing
or in such other manner as the futures commission merchant customarily
delivers disclosures pursuant to applicable Commission regulations, and
as permissible under the futures commission merchant's customer
documentation.
(ii) The futures commission merchant must maintain documentation
demonstrating that the disclosure statement required by this paragraph
(h)(3) was delivered directly to the customer.
(iii) The futures commission merchant must include the disclosure
statement required by this paragraph (h)(3) on its website or within
its Disclosure Document required by paragraph 1.55(i).
(4) A futures commission merchant that has made an election
pursuant to paragraph (d) of this section shall disclose in the
Disclosure Document required under Sec. 1.55(i) that it permits the
separate treatment of accounts for the same customer pursuant to the
requirements of this section and that, in the event that separate
account treatment for some customers were to contribute to a loss that
exceeds the futures commission merchant's ability to cover, that loss
may affect the segregated funds of all of the futures commission
merchant's customers in one or more account classes.
(i) A futures commission merchant that applies separate account
treatment pursuant to this section shall apply such treatment in a
consistent manner over time.
0
7. Revise Sec. 1.58 to read as follows:
Sec. 1.58 Gross collection of exchange-set margins.
(a) Each futures commission merchant which carries a futures,
options on futures, or Cleared Swaps position for another futures
commission merchant or for a foreign broker on an omnibus basis must
collect, and each futures commission merchant and foreign broker for
which an omnibus account is being carried must deposit, initial and
maintenance margin on each position so carried at a level no less than
that established for customer accounts by the rules of the applicable
contract market or other board of trade. If the contract market or
other board of trade does not specify any such margin level, the level
required will be that specified by the relevant clearing organization.
(b) If the futures commission merchant which carries a futures,
options on futures, or Cleared Swaps position for another futures
commission merchant or for a foreign broker on an omnibus basis allows
a position to be margined as a spread position or as a hedged position
in accordance with the rules of the applicable contract market, the
carrying futures commission merchant must obtain and retain a written
representation from the futures commission merchant or from the foreign
broker for which the omnibus account is being carried that each such
position is entitled to be so margined.
(c) Where a futures commission merchant has established an omnibus
account that is carried by another futures commission merchant, and the
depositing futures commission merchant has elected to treat the
separate accounts of a futures customer or a Cleared Swaps Customer as
accounts of separate entities for purposes of Sec. 1.44, the
depositing futures commission merchant shall calculate the required
initial and maintenance margin for purposes of paragraph (a) of this
section separately for each such separate account.
0
8. Amend Sec. 1.73 by adding paragraph (c) to read as follows:
Sec. 1.73 Clearing futures commission merchant risk management.
* * * * *
(c) A futures commission merchant that is not a clearing member of
a derivatives clearing organization, but that treats the separate
accounts of a customer as accounts of separate entities for purposes of
Sec. 1.44, shall comply with paragraphs (a) and (b) of this section
with respect to the accounts and separate accounts of separate account
customers as if it were a clearing member of a derivatives clearing
organization.
0
9. Add appendix A to part 1 to read as follows:
Appendix A to Part 1--Treatment of Certain Foreign Currencies for
Margin Adequacy Requirements Under Regulation 1.44
Payment of margin in currencies listed in this Appendix A shall
be considered in compliance with the requirements of Regulation
1.44(f) of Part 1 of the Commission's regulations (17 CFR 1.44(f))
if received by the applicable futures commission merchant no later
than the end of the second business day after the day on which the
margin call is issued.
Currency
Australian dollar (AUD)
Chinese renminbi (CNY)
Hong Kong dollar (HKD)
Hungarian forint (HUF)
Israeli new shekel (ILS)
Japanese yen (JPY)
New Zealand dollar (NZD)
Singapore dollar (SGD)
South African rand (ZAR)
Turkish lira (TRY)
PART 22--CLEARED SWAPS
0
10. The authority citation for part 22 continues to read as follows:
Authority: 7 U.S.C. 1a, 6d, 7a-1 as amended by Pub. L. 111-203,
124 Stat 1376.
0
11. Amend Sec. 22.2 by
0
a. Republishing the paragraph (f) heading;
0
b. Revising paragraphs (f)(4) and (5);
0
c. Republishing the paragraph (g) heading; and
0
d. Adding paragraph (g)(11).
The republications, revisions, and addition to read as follows:
Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swaps Customer Collateral.
* * * * *
(f) Requirements as to amount.* * *
(4) The futures commission merchant must, at all times, maintain in
[[Page 7938]]
segregation, in its FCM Physical Locations and/or its Cleared Swaps
Customer Accounts at Permitted Depositories, an amount equal to the sum
of any credit and debit balances that the Cleared Swaps Customers of
the futures commission merchant have in their accounts. Notwithstanding
the preceding sentence, a futures commission merchant must add back to
the total amount of funds required to be maintained in segregation any
Cleared Swaps Customer Accounts with debit balances in the amounts
calculated in accordance with paragraph (f)(5) of this section.
(5) The futures commission merchant, in calculating the total
amount of funds required to be maintained in segregation pursuant to
paragraph (f)(4) of this section, must include any debit balance, as
calculated pursuant to this paragraph (f)(5), that a Cleared Swaps
Customer has in its account, to the extent that such debit balance is
not secured by ``readily marketable securities'' that the particular
Cleared Swaps Customer deposited with the futures commission merchant.
(i) For purposes of calculating the amount of a Cleared Swaps
Customer Account's debit balance that the futures commission merchant
is required to include in its calculation of its total segregation
requirement pursuant to this paragraph (f)(5), the futures commission
merchant shall calculate the net liquidating equity of each Cleared
Swaps Customer Account in accordance with paragraph (f)(2) of this
section, except that the futures commission merchant shall exclude from
the calculation any noncash collateral held in the Cleared Swaps
Customer Account as margin collateral. The futures commission merchant
may offset the debit balance computed under this paragraph (f)(5) to
the extent of any ``readily marketable securities,'' subject to
percentage deductions (i.e., ``securities haircuts'') as specified in
paragraph (f)(5)(iv) of this section, held for the particular Cleared
Swaps Customer to secure its debit balance.
(ii) For purposes of this section, ``readily marketable'' shall be
defined as having a ``ready market'' as such latter term is defined in
Rule 15c3-1(c)(11) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(11)).
(iii) In order for a debit balance to be deemed secured by
``readily marketable securities,'' the futures commission merchant must
maintain a security interest in such securities, and must hold a
written authorization to liquidate the securities at the discretion of
the futures commission merchant.
(iv) To determine the amount of such debit balance secured by
``readily marketable securities,'' the futures commission merchant
shall:
(A) Determine the market value of such securities; and
(B) Reduce such market value by applicable percentage deductions
(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vi)). Futures commission merchants that establish and enforce
written policies and procedures to assess the credit risk of commercial
paper, convertible debt instruments, or nonconvertible debt instruments
in accordance with Rule 240.15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)) may apply the lower
haircut percentages specified in Rule 240.15c3-1(c)(2)(vi) for such
commercial paper, convertible debt instruments and nonconvertible debt
instruments.
* * * * *
(g) Segregated account; Daily computation and record.* * *
(11) A futures commission merchant that carries Cleared Swaps
Accounts for Cleared Swaps Customers as separate accounts for separate
account customers pursuant to Sec. 1.44 of this chapter shall:
(i) Calculate the total amount of Cleared Swaps Customer Collateral
on deposit in segregated accounts on behalf of Cleared Swaps Customers
pursuant to paragraph (g)(1)(i) of this section and the total amount of
Cleared Swaps Customer Collateral required to be on deposit in
segregated accounts on behalf of Cleared Swaps Customers pursuant to
paragraph (g)(1)(ii) of this section by including the separate accounts
of the separate account customers as if the separate accounts were
accounts of separate entities;
(ii) Offset a net deficit in a particular Cleared Swaps Customer
Account carried as a separate account of a separate account customer in
accordance with paragraphs (f)(4) and (5) and (g)(1)(ii) of this
section against the current market value of readily marketable
securities held only for the particular separate account of such
separate account customer; and
(iii) Document its segregation computation in the Statement of
Cleared Swaps Customer Segregation Requirements and Funds in Cleared
Swaps Customer Accounts under 4d(f) of the CEA required by paragraph
(g)(2) of this section by incorporating and reflecting the Cleared
Swaps Customer Accounts carried as separate accounts of separate
account customers as accounts of separate entities.
PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS
0
12. The authority citation for part 30 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6c, and 12a, unless otherwise
noted.
0
13. Amend Sec. 30.2 by revising paragraph (b) to read as follows:
Sec. 30.2 Applicability of the Act and rules.
* * * * *
(b) The provisions of Sec. Sec. 1.20 through 1.30, 1.32,
1.35(a)(2) through (4) and (c) through (i), 1.36(b), 1.38, 1.39, 1.40,
1.45 through 1.51, 1.53, 1.54, 1.55, 1.58, 1.59, 33.2 through 33.6, and
parts 15 through 20 of this chapter shall not be applicable to the
persons and transactions that are subject to the requirements of this
part.
0
14. Amend Sec. 30.7 by:
0
a. Republishing the paragraph (f) and (f)(2) headings;
0
c. Revising paragraph (f)(2)(iv);
0
d. Adding paragraph (f)(2)(v);
0
e. Republishing the paragraph (l) heading; and
0
f. Adding paragraph (l)(11).
The republications, revisions, and additions read as follows:
Sec. 30.7 Treatment of foreign futures or foreign options secured
amount.
* * * * *
(f) Limitations on use of 30.7 customer funds.
* * * * *
(2) Requirements as to amount.* * *
(iv) The futures commission merchant must, at all times, maintain
in segregation an amount equal to the sum of any credit and debit
balances that 30.7 customers of the futures commission merchant have in
their accounts. Notwithstanding the preceding sentence, a futures
commission merchant must add back to the total amount of funds required
to be maintained in segregation any 30.7 accounts with debit balances
in the amounts calculated in accordance with paragraph (f)(2)(v) of
this section.
(v) The futures commission merchant, in calculating the total
amount of funds required to be maintained in segregation pursuant to
paragraph (f)(2)(iv) of this section, must include any debit balance,
as calculated pursuant to this paragraph (f)(2)(v), that a 30.7
customer has in its account, to the extent that such debit balance is
not secured by ``readily marketable securities'' that the particular
30.7 customer deposited with the futures commission merchant.
(A) For purposes of calculating the amount of a 30.7 account's
debit balance that the futures commission merchant is required to
include in its calculation of
[[Page 7939]]
its total segregation requirement pursuant to this paragraph (f)(2)(v),
the futures commission merchant shall calculate the net liquidating
equity of each 30.7 account in accordance with paragraph (f)(2)(ii) of
this section, except that the futures commission merchant shall exclude
from the calculation any noncash collateral held in the 30.7 account as
margin collateral. The futures commission merchant may offset the debit
balance computed under this paragraph (f)(2)(v) to the extent of any
``readily marketable securities,'' subject to percentage deductions
(i.e., ``securities haircuts'') as specified in paragraph (f)(2)(v)(D)
of this section, held for the particular 30.7 customer to secure its
debit balance.
(B) For purposes of this section, ``readily marketable'' shall be
defined as having a ``ready market'' as such latter term is defined in
Rule 15c3-1(c)(11) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(11)).
(C) In order for a debit balance to be deemed secured by ``readily
marketable securities,'' the futures commission merchant must maintain
a security interest in such securities, and must hold a written
authorization to liquidate the securities at the discretion of the
futures commission merchant.
(D) To determine the amount of such debit balance secured by
``readily marketable securities.'' To do so, the futures commission
merchant shall:
(1) Determine the market value of such securities; and
(2) Reduce such market value by applicable percentage deductions
(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vi)). Futures commission merchants that establish and enforce
written policies and procedures to assess the credit risk of commercial
paper, convertible debt instruments, or nonconvertible debt instruments
in accordance with Rule 240.15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)) may apply the lower
haircut percentages specified in Rule 240.15c3-1(c)(2)(vi) for such
commercial paper, convertible debt instruments and nonconvertible debt
instruments.
* * * * *
(l) Daily computation of 30.7 customer secured amount requirement
and details regarding the holding and investing of 30.7 customer funds.
* * * * *
(11) A futures commission merchant that carries 30.7 accounts for
30.7 customers as separate accounts for separate account customers
pursuant to Sec. 1.44 of this chapter shall:
(i) Calculate the total amount of 30.7 customer funds on deposit in
30.7 accounts on behalf of 30.7 customers pursuant to paragraph (l)(1)
of this section and the total amount of 30.7 customer funds required to
be on deposit in segregated accounts on behalf of 30.7 customers
pursuant to paragraph (l)(1) of this section by including the separate
accounts of the separate account customers as if the separate accounts
were accounts of separate entities;
(ii) Offset a net deficit in a particular 30.7 account carried as a
separate account of a separate account customer in accordance with this
paragraph (l) against the current market value of readily marketable
securities held only for the particular separate account of such
separate account customer; and
(iii) Document its segregation computation in the Statement of
Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers
pursuant to Commission Regulation 30.7 required by paragraph (l)(3) of
this section by incorporating and reflecting the 30.7 accounts carried
as separate accounts of separate account customers as accounts of
separate entities.
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
0
15. The authority citation for part 39 continues to read as follows:
Authority: 7 U.S.C. 2, 6(c), 7a-1, and 12a(5); 12 U.S.C. 5464;
15 U.S.C. 8325; section 752 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, title VII, sec. 752, July
21, 2010, 124 Stat. 1749.
0
16. Amend Sec. 39.13 by:
0
a. Republishing the paragraph (g) and (g)(8) headings;
0
c. Adding paragraph (g)(8)(i)(E); and
0
d. Revising paragraph (g)(8)(iii).
The republications, addition, and revision read as follows:
Sec. 39.13 Risk management.
* * * * *
(g) Margin requirements--
* * * * *
(8) Customer margin--
* * * * *
(i) * * *
(E) For purposes of this paragraph (g)(8)(i), each separate account
of a separate account customer (as such terms are defined in Sec. 1.44
of this chapter) shall be treated as an account of a separate
individual customer.
* * * * *
(iii) Withdrawal of customer initial margin. A derivatives clearing
organization shall require its clearing members to ensure that their
customers do not withdraw funds from their accounts with such clearing
members unless the net liquidating value plus the margin deposits
remaining in a customer's account after such withdrawal are sufficient
to meet the customer initial margin requirements with respect to all
products and swap portfolios held in such customer's account which are
cleared by the derivatives clearing organization, except as provided
for in Sec. 1.44 of this chapter.
* * * * *
Issued in Washington, DC, on December 20, 2024, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Regulations To Address Margin Adequacy and To Account for
the Treatment of Separate Accounts by Futures Commission Merchants--
Commission Voting Summary and Chairman's and Commissioner's Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioner Goldsmith
Romero voted in the affirmative. Commissioners Johnson and Pham
voted to concur. Commissioner Mersinger voted in the negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
Since 2019, derivatives clearing organizations (DCOs) and
futures commission merchants (FCMs) faithfully relied on guidance
and a no-action position issued through CFTC Staff Letter 19-17 \1\
to comply with DCO rules. In the several years during which the
original letter was issued, DCOs and FCMs invested accordingly in
anticipation that the Commission would act diligently and engage the
Commission in the process to implement appropriate relief on a
permanent basis. I am pleased today that, consistent with my
commitment to improving rules and codifying longstanding staff
positions through rulemakings that benefit from the engagement and
expertise of
[[Page 7940]]
our entire Commission, the CFTC is issuing a final rule that
allocates greater protections and more importantly, provides long
awaited certainty.
---------------------------------------------------------------------------
\1\ CFTC Letter No. 19-17, July 10, 2019, available at https://www.cftc.gov/csl/19-17/download as extended by CFTC Letter No. 20-
28, Sept. 15, 2020, available at https://www.cftc.gov/csl/20-28/download; CFTC Letter No. 21-29, Dec. 21, 2021, available at https://www.cftc.gov/csl/21-29/download; CFTC Letter No. 22-11, Sept. 15,
2022, available at https://www.cftc.gov/csl/22-11/download; CFTC
Letter No. 23-13, Sept. 11, 2023, available at https://www.cftc.gov/csl/23-13/download; and CFTC Letter No. 24-07, June 24, 2024,
available at https://www.cftc.gov/csl/24-07/download.
---------------------------------------------------------------------------
I fully support the final rule which protects customer funds,
promotes effective DCO and FCM risk management, and balances risk
management with practicability. To ensure that the final rule was
workable, there were numerous discussions and extensive engagement
between staff and industry, in addition to two notices of proposed
rulemaking.\2\ This final rule is the culmination of these efforts
and serves as an example of effective collaboration with industry
yielding positive results.
---------------------------------------------------------------------------
\2\ On April 14, 2023, the Commission published in the Federal
Register a notice of proposed rulemaking designed to codify the no-
action position in CFTC Letter No. 19-17. Derivatives Clearing
Organization Risk Management Regulations to Account for the
Treatment of Separate Accounts by Futures Commission Merchants, 88
FR 22934 (Apr. 14, 2023) (First Proposal). The First Proposal sought
to codify the provisions of CFTC Letter No. 19-17 in regulation
39.13, where it would have applied directly to DCOs, and only
indirectly to FCMs that are clearing members of DCOs through DCO
rules. The Second Proposal, which withdrew the First Proposal,
sought to codify these provisions in part 1 of the Commission's
regulations, which apply to FCMs directly. Regulations To Address
Margin Adequacy and To Account for the Treatment of Separate
Accounts by Futures Commission Merchants, 89 FR 15312 (Mar. 1, 2024)
(Second Proposal). The final rule follows from the Second Proposal.
---------------------------------------------------------------------------
I thank Alicia Lewis in my office, and staff in the Division of
Clearing and Risk, Market Participants Division, Office of the
General Counsel, and the Office of the Chief Economist for their
work on the final rule.
Appendix 3--Concurring Statement of Commissioner Caroline D. Pham
I respectfully concur on the Regulations to Address Margin
Adequacy and to Account for the Treatment of Separate Accounts by
Futures Commission Merchants (FCMs) (Separate Accounts Final Rule).
I am pleased that the Separate Accounts Final Rule has resolved two
critical issues with the proposed rule that were unworkable because
of (1) conflicts of law under U.S. banking and securities regulation
and foreign banking law, and operational realities regarding the
cross-border movement of funds, and (2) lack of regulatory clarity
for the handling of administrative errors and operational
constraints. In particular, the significant changes in the proposed
rule from existing regulatory requirements under CFTC Letter No. 19-
17, which FCMs have implemented and complied with for the past 5
years, were not supported by robust cost-benefit analysis to justify
imposing overly burdensome new rules. I greatly appreciate the
support of Chairman Behnam and the efforts by CFTC staff to address
my concerns, and the engagement with my fellow Commissioners.
I would like to thank Daniel O'Connell, Bob Wasserman, and Clark
Hutchison in the Division of Clearing and Risk for their work on the
Separate Accounts Final Rule and the significant time and effort
spent working with my office, especially to reconsider the
requirements for a one business day margin call and circumstances
involving banking holidays in the eurozone, and ``unusual''
administrative errors and operational constraints.\1\ I applaud
their dedication to strengthening our markets and addressing the
public comments.
---------------------------------------------------------------------------
\1\ Statement of Commissioner Caroline D. Pham in Support of the
Treatment of Separate Accounts Proposal (Feb. 20, 2024), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement022024b.
[FR Doc. 2024-31177 Filed 1-14-25; 4:15 pm]
BILLING CODE 6351-01-P