2024-04107
[Federal Register Volume 89, Number 42 (Friday, March 1, 2024)]
[Proposed Rules]
[Pages 15312-15363]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-04107]
[[Page 15311]]
Vol. 89
Friday,
No. 42
March 1, 2024
Part III
Commodity Futures Trading Commission
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17 CFR Parts 1, 22 et al.
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Regulations To Address Margin Adequacy and To Account for the Treatment
of Separate Accounts by Futures Commission Merchants; Proposed Rule
Federal Register / Vol. 89 , No. 42 / Friday, March 1, 2024 /
Proposed Rules
[[Page 15312]]
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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: Notice of proposed rulemaking; withdrawal.
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SUMMARY: On April 14, 2023, the Commodity Futures Trading Commission
(Commission or CFTC) published a notice of proposed rulemaking (First
Proposal) that proposed to amend the derivatives clearing organization
(DCO) risk management regulations adopted under the Commodity Exchange
Act (CEA) to permit futures commission merchants (FCMs) that are
clearing members of DCOs (clearing FCMs), subject to specified
requirements, to treat separate accounts of a single customer as
accounts of separate legal entities for purposes of certain Commission
regulations. In light of comments received supporting direct
application of separate account treatment requirements to FCMs in the
Commission's regulations, the Commission has determined to withdraw the
First Proposal. The Commission now proposes regulations to require an
FCM to ensure that a customer does not withdraw funds from its account
with the FCM if the balance in such account after such withdrawal would
be insufficient to meet the customer's initial margin requirements, and
relatedly, to permit an FCM, in certain circumstances and subject to
certain conditions, to treat the separate accounts of a single customer
as accounts of separate entities for purposes of certain Commission
regulations (Second Proposal). The proposed amendments would establish
the conditions under which an FCM may engage in such separate account
treatment.
DATES: Comments must be received on or before April 22, 2024.
ADDRESSES: You may submit comments, identified by RIN 3038-AF21, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged. All
comments must be submitted in English, or if not, accompanied by an
English translation. Comments will be posted as received to https://comments.cftc.gov. You should submit only information that you wish to
make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act, a petition for confidential treatment of
the exempt information may be submitted according to the procedures
established in Sec. 145.9 of the Commission's regulations. The
Commission reserves the right, but shall have no obligation, to review,
pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the proposed determination and order will be retained in
the public comment file and will be considered as required under the
Administrative Procedure Act and other applicable laws, and may be
accessible under the FOIA.
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]; Joshua Beale,
Associate Director, 202-418-5446, [email protected]; Jennifer Bauer,
Special Counsel, 202-418-5472, [email protected], Market Participants
Division, 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 and It's Withdrawal
D. The Commission's Second Proposal
II. Proposed Regulations
A. Proposed Amendments to Regulation Sec. 1.3
B. Proposed Amendments to Regulation Sec. 1.17
C. Proposed Amendments to Regulations Sec. Sec. 1.20, 1.32,
22.2, and 30.7
D. Proposed Regulation Sec. 1.44(a)
E. Proposed Regulation Sec. 1.44(b)
F. Proposed Regulation Sec. 1.44(c)
G. Proposed Regulation Sec. 1.44(d)
H. Proposed Regulation Sec. 1.44(e)
I. Proposed Regulation Sec. 1.44(f)
J. Proposed Regulation Sec. 1.44(g)
K. Proposed Regulation Sec. 1.44(h)
L. Proposed Appendix A to Part 1
M. Proposed Amendments to Regulation Sec. 1.58
N. Proposed Amendments to Regulation Sec. 1.73
O. Proposed Amendments to Regulation Sec. 30.2
P. Proposed Amendments to Regulation Sec. 39.13(g)(8)
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
I. Background
A. The Commission's Customer Funds Protection Regulations \1\
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\1\ For purposes of completeness and explanation of the basis
for this Second Proposal, the Commission restates its explanation of
its customer funds protection regulations, as stated in the First
Proposal. See Derivatives Clearing Organization Risk Management
Regulations to Account for the Treatment of Separate Accounts by
Futures Commission Merchants, 88 FR 22934, 22935-22936 (Apr. 14,
2023) (First Proposal).
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Two of the fundamental purposes of the CEA are the avoidance of
systemic risk and the protection of market participants from misuses of
customer assets.\2\ The Commission has promulgated a number of
regulations in furtherance of those objectives, 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. In addition to protecting customer assets,
the current regulations serve the purpose of avoidance of systemic risk
by mitigating the risk that a customer default in its obligations to a
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.
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\2\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
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Section 4d(a)(2) of the CEA and Commission regulation Sec. 1.20(a)
require an FCM to separately account for and segregate from its own
funds all money, securities, and property which it has
[[Page 15313]]
received to margin, guarantee, or secure the trades or contracts of its
commodity customers.\3\ Additionally, section 4d(a)(2) of the CEA and
Commission 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.\4\ This requirement is
designed to prevent disparate treatment of customers by an FCM and
mitigate the risk that there will be insufficient funds in segregation
to pay all customer claims if the FCM becomes insolvent.\5\ 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.\6\
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\3\ 7 U.S.C. 6d(a)(2); 17 CFR 1.20(a).
\4\ 7 U.S.C. 6d(a)(2); 17 CFR 1.22(a).
\5\ Prohibition of Guarantees Against Loss, 46 FR 11668, 11669
(Feb. 10, 1981).
\6\ 7 U.S.C. 6d(a)(2); 17 CFR 1.20; 17 CFR 1.22; Prohibition of
Guarantees Against Loss, 46 FR at 11669.
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Section 5b of the CEA,\7\ as amended by the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010,\8\ 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.\9\ 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 in
order to mitigate the risk that such clearing members pose to the DCO.
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\7\ 7 U.S.C. 7a-1(b).
\8\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\9\ 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).
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Specifically, Commission regulation Sec. 39.13(g)(8)(iii) provides
that a DCO shall require an FCM clearing member to ensure that a
customer does not withdraw funds from its account with such 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 the products or portfolios in the customer's account, which
are cleared by the DCO.\10\ Regulation Sec. 39.13(g)(8)(iii) thus
establishes a ``Margin Adequacy Requirement,'' designed to mitigate the
risk that an FCM clearing member fails to hold, from a customer, funds
sufficient to cover the required initial margin for the customer's
cleared positions.\11\ In light of the use of omnibus margin accounts,
where the funds of multiple customers are held together, this safeguard
is necessary to ``avoid the misuse of customer funds'' \12\ by
mitigating the likelihood that the clearing member will effectively
cover one customer's margin shortfall using another customer's funds.
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\10\ 17 CFR 39.13(g)(8)(iii).
\11\ For purposes of this proposed rulemaking, 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
proposed regulation Sec. 1.44(b) which would apply directly to all
FCMs.
\12\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
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In adopting the Margin Adequacy Requirement of regulation Sec.
39.13(g)(8)(iii), the Commission stated \13\ that the regulation was
consistent with the definition of ``Margin Funds Available for
Disbursement'' in the Margins Handbook \14\ prepared by the Joint Audit
Committee (JAC), a representative committee of U.S. futures exchanges
and the National Futures Association (NFA).\15\ The Commission noted
that while 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.\16\ 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.\17\
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\13\ Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR at 69379.
\14\ JAC Margins Handbook, available at http://www.jacfutures.com/jac/MarginHandBookWord.aspx.
\15\ Joint Audit Committee, 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 Commission
regulation Sec. 1.3, 17 CFR 1.3. Pursuant to Commission 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).
\16\ Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR at 69379.
\17\ Id.
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Thus, 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. However,
Commission regulations do not apply a Margin Adequacy Requirement to
non-clearing FCMs, and regulation Sec. 39.13(g)(8)(iii) does not
require DCOs to apply that 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).\18\
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\18\ 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. 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).
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B. The Divisions' No-Action Position \19\
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\19\ For purposes of completeness and explanation of the basis
for this Second Proposal, the Commission restates its explanation of
the no-action position contained in CFTC Letter No. 19-17, as stated
in the First Proposal. See First Proposal, 88 FR 22936-22937.
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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
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.\20\ 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
[[Page 15314]]
customer.\21\ 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 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, or parts 17-20, or with
regard to the term ``beneficial owner,'' as that term may be used by
other agencies), this proposed rulemaking uses only the term
``customer,'' except where directly quoting or paraphrasing a source
that uses ``beneficial owner.''
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\20\ 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; and 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.
\21\ 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).
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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'').\22\ 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,\23\ 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'').\24\
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\22\ The Commission notes that while CME disagreed with certain
aspects of FIA's letter that fall beyond the scope of this
rulemaking, CME's letter noted that CME was ``amenable to the
Commission amending Rule 39.13(g)(8)(iii) to allow a DCO to permit
a[n] FCM to release excess funds from a customer's separate account
notwithstanding an outstanding margin call in another account of the
same customer provided that certain specified risk-mitigating
conditions . . . are satisfied.'' CME Letter.
\23\ JAC, Regulatory Alert #19-02, May 14, 2019, available at
http://www.jacfutures.com/jac/jacupdates/2019/jac1902.pdf.
\24\ SIFMA-AMG Letter; First FIA Letter.
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As FIA explained, there are a variety of reasons why a customer may
want separate treatment for its accounts under such an agreement.\25\
For instance, an institutional customer, such as an investment or
pension fund, may allocate assets to investment managers 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 managers acting on behalf of other accounts of the
customer.\26\ In such a situation, an investment manager may, in order
to implement its trading strategy effectively, 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.
Additionally, 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 negotiates
directly with, in many cases, the customer's agent, which often will be
an investment manager.\28\
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\25\ First FIA Letter.
\26\ See id.
\27\ Id.
\28\ Cf. id.
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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\
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\29\ SIFMA-AMG Letter; First FIA Letter.
\30\ SIFMA-AMG Letter; First FIA Letter.
\31\ SIFMA-AMG Letter; First FIA Letter; CME Letter.
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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
treatment would no longer be appropriate.\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 separate
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\ While 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\
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\32\ SIFMA-AMG Letter.
\33\ Id.
\34\ Id.
\35\ Id.
\36\ CME Letter.
\37\ Id.
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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\
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\38\ FIA specifically noted that such a no-action position could
be conditioned on the FCM maintaining certain internal controls and
procedures.
\39\ SIFMA-AMG Letter; First FIA Letter; see also CME Letter.
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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
[[Page 15315]]
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 determine whether to conduct and, if so, conduct, a rulemaking
to implement a permanent solution.\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, DSIO and DCR would consider further extending
the no-action position.\44\ The Divisions published CFTC Letter No. 21-
29, further extending the no-action position until September 30,
2022.\45\ On September 15, 2022, the Divisions published CFTC Letter
No. 22-11, which further extended the no-action position until the
earlier of September 30, 2023 or the effective date of any final
Commission action relating to regulation Sec. 39.13(g).\46\ As with
CFTC Letter No. 21-29, this extension was issued in order to provide
additional time for the Commission to consider a rulemaking. As
discussed further below, while the Commission proposed a rulemaking to
codify the no-action position in CFTC Letter No. 19-17, the Commission
has determined to withdraw that proposed rulemaking in light of
comments received and propose a new rulemaking in part 1 of its
regulations to both impose a Margin Adequacy Requirement (as discussed
herein) and simultaneously provide for separate account treatment. On
September 11, 2023, the Divisions published CFTC Letter No. 23-13,
extending the no-action position until the earlier of June 30, 2024 or
the effective date of any final Commission action relating to
regulation Sec. 39.13(g),\47\ to provide further time for staff to
develop and for the Commission to consider the Second Proposal, and to
receive and consider comments thereon and consider and adopt a final
rule.
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\40\ CFTC Letter No. 19-17.
\41\ Id.
\42\ Id.
\43\ CFTC Letter No. 20-28.
\44\ Id.
\45\ CFTC Letter No. 21-29.
\46\ CFTC Letter No. 22-11.
\47\ The Commission notes that this Second Proposal amends Sec.
39.13(g) to refer to proposed regulation Sec. 1.44.
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C. The Commission's First Proposal and its Withdrawal
On April 14, 2023, the Commission published in the Federal Register
a notice of proposed rulemaking--the First Proposal--designed to codify
the no-action position in CFTC Letter No. 19-17.\48\ The First Proposal
proposed to amend regulation Sec. 39.13 to add new paragraph (j)
allowing 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 conditions specified in
proposed regulation Sec. 39.13(j).
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\48\ First Proposal.
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The conditions for separate account treatment in proposed
regulation Sec. 39.13(j) were substantially similar to the conditions
specified in CFTC Letter No. 19-17. However, certain conditions in
proposed regulation Sec. 39.13(j) reflected modification of the
conditions in CFTC Letter No. 19-17 on which they were based. Such
modifications included adding further reporting requirements for
clearing members required to cease separate account treatment, an
explicit process for clearing members to resume separate account
treatment, and provisions designed to further clarify the requirement
that separate accounts be on a one business day margin call.
The comment period for the First Proposal was extended once at the
request of a commenter and closed on June 30, 2023.\49\ The Commission
received comments from twelve commenters.\50\ While commenters
generally supported codifying the no-action position in CFTC Letter No.
19-17, six commenters \51\ 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 its part 39 DCO regulations
(where it applies only to clearing FCMs, through the instrumentality of
DCOs). Other commenters did not opine on whether the proposed
codification should be in part 1 versus part 39.
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\49\ Derivatives Clearing Organization Risk Management
Regulations to Account for the Treatment of Separate Accounts by
Futures Commission Merchants, 88 FR 39205 (June 15, 2023).
\50\ American Council of Life Insurers (ACLI), CME, FIA,
Intercontinental Exchange, Inc. (ICE), JAC, Managed Funds
Association (MFA), NFA, SIFMA-AMG, Symphony Communications Services,
LLC, and three individuals.
\51\ CME, FIA, ICE, JAC, NFA, and SIFMA-AMG.
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The Commission originally proposed to codify the no-action position
in CFTC Letter No. 19-17 in part 39 in order to hew closely to the
operation of the no-action position: DCOs could choose to permit
clearing FCMs to engage in separate account treatment, provided such
clearing FCMs complied with certain conditions.
In its comment responding to the First Proposal, CME recommended
codification in part 1 to extend the benefits of separate account
treatment to all FCMs equally, whether or not they are clearing members
of one or more DCOs.\52\ CME asserted that codification in part 1 would
eliminate the risk that a current or future DCO chooses not to permit
separate account treatment, noting that CME's own clearing members have
invested significant time and effort in conforming their policies,
systems, and practices to comply with the no-action conditions and
related JAC advisory notices.\53\ As CME further contended, under the
First Proposal, if one DCO chose not to permit separate account
treatment, then an FCM would have to exclude contracts cleared through
that DCO from its customers' separate accounts.\54\ CME argued that
this would likely make separate margining operationally infeasible,
noting that the First Proposal acknowledged that an FCM's futures
account for a customer includes all futures products that the FCM
clears for the customer, and the initial margin requirement for the
account would be the total of the initial margin the FCM charges the
customer for each contract in the account, in each case regardless of
the DCO at which the contracts are cleared.\55\
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\52\ CME Comment Letter.
\53\ Id. (citing regulations Sec. Sec. 1.17, 1.20 and 22.2).
\54\ Id.
\55\ Id.
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CME also asserted that the First Proposal would effectively create
two sets of reporting requirements applicable only to those FCM
clearing members who choose to implement separate account margining at
one or more DCOs, with new reporting requirements that conflict with
regulations in part 1 that require calculation of deficits across all
accounts of a single beneficial owner.\56\
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\56\ Id.
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CME further asserted that codification in part 39 would create new
burdens for DCOs related to conducting examinations for compliance and
the composition of DCO Chief Compliance Officer (CCO) reports, and
would allow
[[Page 15316]]
for disparate implementation by DCOs.\57\ CME additionally opined that
certain proposed requirements in the First Proposal were outside the
scope of DCOs' risk management responsibilities and instead should be
applied directly to FCMs.\58\
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\57\ Id.
\58\ Id.
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In its comment, FIA contended that rules that affect the
obligations of FCMs should be set out in part 1, and, similar to CME,
argued that, if the no-action position is codified in part 1, then non-
clearing FCMs and FCMs that maintain 30.7 accounts for 30.7 customers
pursuant to part 30 of the Commission's regulations would be able to
provide consistent treatment to customers with the same enhanced risk
management standards set forth in the no-action position.\59\ FIA also
asserted that codification in part 1 would allow an FCM to control
whether enhanced standards and separate account treatment are offered
to a specific customer, rather than requiring each DCO to manage and
control whether separate account treatment is permitted.\60\ FIA
additionally contended that the terms and conditions under which
separate account treatment should be permitted or prohibited is a
decision that the Commission, rather than individual DCOs, should
make.\61\
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\59\ FIA Comment letter. As set forth in Commission regulations,
the term ``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
option positions. 17 CFR 30.1(g). The term ``30.7 customer'' means
any person who trades foreign futures or foreign options through an
FCM, except for the owner or holder of a proprietary account as
defined in regulation Sec. 1.3. 17 CFR 30.1(f).
\60\ Id.
\61\ Id. FIA noted that FCMs collect customer margin across DCOs
and, if a DCO was to deny its clearing FCMs the right to provide
separate account treatment, or establish different standards, such
FCMs would effectively be denied the right to provide separate
account treatment for their customers. Id.
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In its comment, ICE supported part 1 codification on the basis that
the no-action conditions are mainly relevant to the operation of an FCM
and its relationship with its customers, rather than the operation of a
DCO.\62\ ICE also argued that supervision of FCM compliance with
requirements related to separate accounts would be more consistently
applied if not done at the individual DCO level.\63\ ICE noted that
functions of supervision, examination, and surveillance of the
relationship between FCMs and customers are typically performed by an
FCM's DSRO under Commission regulation Sec. 1.52, rather than by
DCOs.\64\ ICE further contended that it would be more efficient for an
FCM to address issues related to separate account treatment with a
single DSRO rather than each DCO of which it is a member, and that
imposing on DCOs additional burden and costs of supervising separate
account treatment conditions may disincentivize DCOs from permitting
FCMs to engage in separate account treatment.\65\
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\62\ ICE Comment Letter. For instance, ICE contended that DCOs
would not be well-placed to administer or enforce ensuring FCMs
verify the identity of authorized representatives of clients, and
recommended that if the Commission believes it necessary to
establish steps clearing FCMs must take to identify such
representatives, that it applies those requirements directly to such
FCMs. Id. ICE also contended that a DSRO would be better placed than
a DCO to readily assess whether an FCM is applying separate account
treatment consistently. Id.
\63\ Id.
\64\ Id.
\65\ Id.
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In its comment, the JAC opined that conditions for separate account
treatment should be stringent enough to mitigate to the maximum extent
possible the additional risks to other customers of an FCM that
separate account treatment presents, but noted that, in any case, part
39 DCO regulations do not fall under the JAC's self-regulatory
organization surveillance authority.\66\ Similar to CME, the JAC also
asserted that the First Proposal lacked clarity regarding whether it
contemplated bifurcated reporting requirements, because the First
Proposal provided that a clearing FCM would need to calculate certain
separate account customer balances for capital and segregation
differently than under parts 1, 22, or 30, but did not include
amendments to those regulations.\67\ Thus, the JAC argued, it was
unclear whether the JAC would continue to review and monitor an FCM's
financial statements prepared in accordance with those regulations,
while a DCO would monitor the FCM's different computations prepared in
accordance with proposed regulation Sec. 39.13(j).\68\ The JAC also
noted that the First Proposal did not provide for separate account
treatment for non-clearing FCMs and Commission regulation Sec. 30.7
customers.\69\
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\66\ JAC Comment Letter.
\67\ Id.
\68\ Id.
\69\ Id.
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Like other commenters, NFA argued that codification in part 1 would
provide a clear path for an FCM's DSRO to examine it for compliance
with separate account treatment requirements, and would provide greater
clarity to non-clearing FCMs regarding whether they are permitted to
engage in separate account treatment.\70\
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\70\ NFA Comment Letter.
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SIFMA-AMG recommended incorporating the First Proposal's
conditions, with modifications, in Commission regulations Sec. Sec.
1.11 and 1.56, and argued that codification in part 1 would directly
establish obligations for the FCM, rather than indirect obligations
applied through the DCO, with respect to separate treatment of customer
accounts within the CFTC's regulatory framework.\71\ SIFMA-AMG also
argued that codification in part 1 would clarify that the regulatory
obligations of the proposed regulation are the FCM's, and not the DCO's
obligation to evaluate and determine if the FCM's behavior was
appropriate.\72\
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\71\ SIFMA-AMG Comment Letter.
\72\ Id.
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In light of these comments, the Commission has determined to
propose codification of the underlying Margin Adequacy Requirement
(i.e., that an FCM should not permit a customer to withdraw margin
funds from that customer's accounts with the FCM if the net liquidating
value plus the margin deposits remaining in such accounts after such
withdrawal would be insufficient to meet the customer's initial margin
requirements) \73\ along with the conditional modification of that
requirement embodied in CFTC Letter No. 19-17, in part 1 of its
regulations. The Commission believes codification in part 1 can be
effectuated in a manner that provides appropriate flexibility for
market participants, enhanced risk management and protection of
customer funds along with appropriate flexibility for a larger number
of FCMs, and more efficient supervision of compliance with the no-
action conditions proposed to be codified, while maintaining the
effectiveness of those conditions. Therefore, the Commission formally
withdraws its First Proposal, and proposes this new rulemaking to
provide for separate account treatment through part 1 of its
regulations.
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\73\ As discussed further below, this requirement, which
currently is effectively applied only to clearing FCMs, and
predominately to part 1 (futures customer) and part 22 (Cleared
Swaps Customer) accounts, would through codification in part 1
effectively apply to all FCMs, including those that are not members
of a DCO, and would apply to all FCMs' 30.7 accounts.
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Separate from the question of whether the proposed codification
should be in part 1 versus part 39, commenters provided feedback
related to the proposed codification of individual no-action
conditions. These comments are discussed below. The Commission notes
[[Page 15317]]
that, with some exceptions that it believes are helpful to
understanding differences between the First Proposal and this Second
Proposal, certain comments that appear to be premised specifically on
the First Proposal's proposed codification in part 39 in contrast to
part 1 are not discussed, as the Commission no longer proposes to
codify the no-action position in part 39.
In addition to the comments noted above, FIA supported amending
regulation Sec. 1.56 to add a new paragraph recognizing (i) the right
of an FCM to allow a customer to withdraw excess funds from a separate
account while there is an outstanding margin call in another separate
account, and (ii) that an FCM may agree that, in the absence of certain
conditions, it will not use excess funds from one account to meet an
obligation in another account without the customer's consent.\74\ ACLI,
MFA, and SIFMA-AMG additionally supported codification of
interpretation of regulation Sec. 1.56.\75\
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\74\ FIA Comment Letter. The Commission also received comments
from two individuals generally supportive of the First Proposal.
Additionally, the Commission received a comment from Symphony
Communication Services, LLC, describing ways in which the
commenter's technological capabilities could facilitate compliance
with certain components of the First Proposal. Lastly, the
Commission received a comment from an individual requesting that the
Commission provide a chart explaining to what extent and subject to
what conditions portfolio-based margining is available across
specific products and scenarios. The Commission considers this
request outside the scope of this Second Proposal.
\75\ ACLI Comment Letter; MFA Comment Letter; SIFMA-AMG Comment
Letter.
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While appreciating those comments, the Commission seeks in this
Second Proposal to engage in a narrower task: to directly apply the
Margin Adequacy Requirement to all FCMs, while enacting a narrow
codification (with respect to all FCMs) of the no-action position in
CFTC Letter No. 19-17 with respect to the current Margin Adequacy
Requirement embodied in regulation Sec. 39.13(g)(8)(iii). Amendments
to regulation Sec. 1.56 are outside the scope of the proposed
rulemaking.
As such, where an FCM elects to apply separate account treatment,
such treatment shall apply only for purposes of proposed regulation
Sec. 1.44 (inclusive of the Margin Adequacy Requirement of proposed
regulation Sec. 1.44(b)), including requirements that flow through to,
e.g., Commission regulations Sec. Sec. 1.17, 1.20, 1.32, 1.58, 1.73,
22.2, 30.7, the gross margining requirement of regulation Sec.
39.13(g)(8)(i), and the Margin Adequacy Requirement of proposed
regulation Sec. 39.13(g)(8)(iii). Nothing in this rulemaking is
intended to affect the requirements of regulation Sec. 1.56 or, unless
otherwise expressly indicated, any other Commission regulation.
D. The Commission's Second Proposal
For the reasons discussed above, the Commission proposes to codify
the Margin Adequacy Requirement, along with the no-action position in
CFTC Letter No. 19-17, in part 1. The bulk of the proposed regulation
will be contained in new Commission regulation Sec. 1.44, which is
presently reserved. However, as explained below, the Commission also
proposes supporting amendments in Commission 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 proposed regulation Sec. 1.44. The
Commission is also proposing a number of amendments to address
inadvertent inconsistencies in existing regulations.\76\
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\76\ These are proposed 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 proposed 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)),
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 and futures), and
Sec. 30.2(b) (to clarify, 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 proposed changes are discussed
in more detail in the relevant sections below.
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The Commission's Second Proposal represents in part a
reorganization of the First Proposal. The First Proposal largely
mirrored the organization of the no-action position in CFTC Letter No.
19-17, first providing that a DCO could allow a clearing FCM to engage
in separate account treatment (so long as such clearing FCM complied
with certain conditions), then explaining specific circumstances that
would disqualify a clearing FCM from engaging in separate account
treatment, and finally providing the specific risk-mitigating
conditions with which the clearing FCM would be required to comply in
order to provide separate account treatment.
Proposed regulation Sec. 1.44 is comprised of eight paragraphs.
First, proposed regulation Sec. 1.44(a) defines key terms solely for
purposes of proposed regulation Sec. 1.44. Second, proposed regulation
Sec. 1.44(b) incorporates for all FCMs, and for all accounts,\77\ the
same Margin Adequacy Requirement that DCOs are obligated in regulation
Sec. 39.13(g)(8)(iii) to require their clearing FCMs to apply. Third,
proposed regulation Sec. 1.44(c) makes clear that an FCM can engage in
separate account treatment only during the ``ordinary course of
business,'' a term that is defined in proposed regulation Sec. 1.44.
Fourth, proposed regulation Sec. 1.44(d) explains how FCMs may elect
to engage in separate account treatment for one or more customers.
Fifth, proposed regulation Sec. 1.44(e) enumerates events inconsistent
with the ordinary course of business and contains requirements for FCMs
related to cessation of separate account treatment upon the occurrence
of such events, and resumption of separate account treatment upon the
cure of such events. Sixth, proposed regulation Sec. 1.44(f) contains
the requirement that each separate account be on a ``one business day
margin call'' and sets out regulations designed to explain the meaning
of a one business day margin call for purposes of proposed regulation
Sec. 1.44. Seventh, proposed regulation Sec. 1.44(g) sets forth
capital, risk management, and segregation calculation requirements with
which FCMs would be required to comply with respect to accounts for
which the FCM has elected separate treatment. Eighth, proposed
regulation Sec. 1.44(h) sets out information and disclosure
requirements for FCMs that engage in separate account treatment.
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\77\ Proposed 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).
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In its comment responding to the First Proposal, the JAC
recommended adding two additional conditions for separate account
treatment. First, the JAC supported adding a condition requiring a
clearing FCM's risk-based capital requirement to be adjusted to capture
the risk of accounts receiving separate treatment.\78\ As discussed
below, the Commission is proposing to amend regulation Sec. 1.17 to
revise an FCM's risk-based capital requirement to capture the risks of
separate accounts. Second, the JAC supported adding a condition
requiring accounts treated as separate accounts to be identified as
[[Page 15318]]
such in an FCM's books and records, including on customer
statements.\79\ The Commission's proposed regulation Sec. 1.44(d)(1),
as discussed below, would provide that an FCM must include each
separate account customer on a list of separate account customers
maintained in its books and records. While an FCM may elect to
specifically identify separate accounts as such in customer statements,
the Commission expects that FCMs will be able to readily identify all
of their customer accounts receiving separate treatment.
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\78\ JAC Comment Letter.
\79\ Id.
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II. Proposed Regulations
Section 8a(5) of the CEA \80\ authorizes the Commission ``to make
and promulgate such rules and regulation 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 proposing these rules pursuant to section 8a(5) as
reasonably necessary to effectuate sections 4d(a)(2) and 4d(f)(2),\81\
providing for the segregation and protection of, respectively, futures
customer funds and Cleared Swaps Customer Collateral, and
4(b)(2)(A),\82\ providing for the safeguarding of customers' funds in
connection with foreign futures and foreign option transactions. As
additional authority, the Commission is also proposing these rules as
reasonably necessary to effectuate section 4f(b), which requires an FCM
to meet minimum financial requirements prescribed by the Commission as
necessary to ensure that the firm meets its obligations.\83\ Moreover,
as further additional authority, the Commission is also proposing these
rules as reasonably necessary to accomplish the purposes of the CEA as
set forth in section 3(b); \84\ specifically, ``the avoidance of
systemic risk'' and ``protect[ing] all market participants from . . .
misuses of customer assets.''
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\80\ 7 U.S.C. 12a(5).
\81\ 7 U.S.C. 6d(a)(2) and (f)(2).
\82\ 7 U.S.C. 6(b)(2)(A).
\83\ 7 U.S.C. 6f(b).
\84\ 7 U.S.C. 5(b).
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Accordingly, the Commission preliminarily believes that the
amendments proposed herein relating to the Margin Adequacy Requirement,
and the modification of this requirement to permit, subject to certain
prescribed 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 preliminarily believes
that preventing the under-margining 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 the proposed
regulation.
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), 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
requirements 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 an additional layer of
protection, but only with respect to FCMs that are clearing members of
DCOs. There is 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 mitigating the likelihood that the clearing
member will effectively cover one customer's margin shortfall using
another customer's funds.\85\ Regulation Sec. 39.13(g)(8)(iii)
provides a risk mitigation provision for DCOs, clearing FCMs, and
customers. The effect of the staff no-action position 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.
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\85\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
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Where it is now proposing to establish requirements for separate
account treatment for all FCMs by adding a similar Margin Adequacy
Requirement to part 1, the Commission seeks to replicate the same
regulatory structure on an all-FCM basis, and furthers the customer
fund protection and risk mitigation purposes of the CEA \86\ by
implementing measures designed to further ensure that all FCMs, whether
clearing or non-clearing, do not create or exacerbate an under-
margining scenario.
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\86\ Section 3(b) of the CEA, 7 U.S.C. 5(b) (It is the purpose
of this Act 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)
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Similar to the First Proposal, the requirements for separate
account treatment proposed herein are designed to ensure that FCMs
carry out separate account treatment in a consistent and documented
manner, monitor customer accounts on a separate and combined basis,
identify and act upon instances of financial or operational distress
that necessitate a cessation of separate account treatment, provide
appropriate disclosures to customers \87\ regarding separate account
treatment, and apprise their DSROs when they apply separate account
treatment or an event has occurred that would necessitate cessation of
separate account treatment.\88\
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\87\ In this proposal, 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.
\88\ For the avoidance of doubt, the Second Proposal permits an
FCM to elect to engage in separate account treatment. It neither
requires an FCM to engage in such treatment nor requires a customer
of an FCM that elects to engage in separate account treatment to
elect to have its accounts with such FCM treated as separate
accounts of separate entities. Thus, separate account treatment
requires an affirmative election of both the FCM and the customer.
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The Second Proposal is 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 under the
proposal.\89\ 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, a number
of FCMs will have already implemented, in significant part, the
requirements proposed herein.
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\89\ As a result, proposed regulation Sec. 1.44 would prohibit
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.
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Request for Comment
Question 1: The Commission requests comment regarding whether, in
light of changes made in this Second Proposal relative to the First
Proposal, it should consider any conditions additional to those
contained in proposed regulation Sec. 1.44 below, or modify or remove
any of the conditions proposed herein.
Question 2: The Commission requests comment regarding whether the
[[Page 15319]]
interaction between proposed regulation Sec. 1.44(g) through (h) and
other regulations under parts 1, 22, and 30 affected by the proposed
requirements therein (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) is sufficiently
clear.
A. Proposed Amendments to Regulation Sec. 1.3
The definitions contained in Commission 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 proposed regulation Sec. 1.44 necessitate an amendment
to regulation Sec. 1.3.
The Commission proposes to amend the definition of ``business day''
in regulation Sec. 1.3. Current regulation Sec. 1.3 provides, in
relevant part, that ``business day'' means any day other than a Sunday
or holiday. The Commission proposes to expand this definition to
confirm that the term encompasses any day other than a Saturday,
Sunday, or holiday. This term, which is applicable to proposed
regulation Sec. 1.44(f), setting forth the requirement that separate
accounts be on a one business day margin call, is similar to the
proposed definition of ``United States business day,'' which appeared
in the First Proposal.\90\ As in the First Proposal, however, the term
is intended to encompass days on which banks and custodians are open in
the United States to facilitate payment of margin. Thus, for the
avoidance of doubt, ``holiday'' in this context refers to holidays in
the United States.
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\90\ Under the First Proposal, the term ``United States business
day'' referred to weekdays not including federal holidays as
established by 5 U.S.C. 6103.
---------------------------------------------------------------------------
The Commission notes that, notwithstanding the current definition
of the term in regulation Sec. 1.3, which is used in a variety of
regulations, in actual practice, Saturdays are generally not treated as
business days in the markets,\91\ by market participants, or for
regulatory purposes.\92\ The Commission is thus proposing to change the
definition of ``business day'' in regulation Sec. 1.3 to conform to
that reality.
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\91\ 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.
\92\ 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'').
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Request for Comment
Question 3: The Commission requests 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.
B. Proposed Amendments to Regulation Sec. 1.17
Regulation Sec. 1.17 currently establishes minimum financial
requirements for FCMs. In this regard, 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 \93\ 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.\94\ For purposes of
regulation Sec. 1.17(a)(1)(i), the term ``risk margin'' is defined by
paragraph (b)(8) of regulation Sec. 1.17 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.
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\93\ 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).
\94\ 17 CFR 240.15c3-1.
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The Commission is proposing 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 conditions contained in proposed regulation Sec.
1.44(g)(3) discussed below. These proposed amendments were not part of
the First Proposal. As a general matter, the proposed amendments to
regulation Sec. 1.17 are designed to ensure that FCMs risk manage
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 the above intent, the Commission is proposing 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 proposed 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
proposed regulation, 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.\95\ Therefore, the proposal to treat
separate accounts as accounts of separate entities 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.\96\ The proposed addition of paragraph
(b)(8)(v) to regulation Sec. 1.17 is 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
[[Page 15320]]
accounts as if each account is an account of a separate entity.
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\95\ As noted in regulation Sec. 39.13(g)(4), a DCO may allow
reduction 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, they 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 proposal, the positions would not lead to an initial
margin reduction as the positions would not be margined on a
combined or portfolio basis.
\96\ As noted above, per regulation Sec. 1.17(a)(1)(i), the
adjusted net capital requirement for an FCM is the greatest of a
number of 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 the same, the risk
margin requirement would correspondingly increase, or leave the
same, the adjusted net capital requirement.
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The Commission further notes that the proposed amendment to the
definition of the term ``risk margin'' in regulation Sec. 1.17(b)(8)
to reflect separate accounts, and the resulting potential increase in
an FCM's minimum adjusted net capital requirement under regulation
Sec. 1.17(a)(1)(i), would also impact other regulations that impose
obligations on FCMs based on their level of adjusted net capital. 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).\97\
The proposed amendments to the minimum capital requirements would also
impact an FCM's obligation to provide certain notices to the Commission
and to the FCM's DSRO under Commission regulation Sec. 1.12.\98\
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\97\ 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.
\98\ See, e.g., 17 CFR 1.12(a), which requires an FCM to provide
notice to the Commission and the firm's DSRO if the FCM's adjusted
net capital at any time is less than the minimum required by
regulation Sec. 1.17.
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The Commission additionally notes that, as discussed further below,
it is additionally proposing 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 proposes 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. Regulation
Sec. 1.17(c)(2)(i), however, 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 is proposing 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. Accordingly, 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 previous day's debit or deficits in
its entirety. If the separate account does not satisfy a previous day's
deficit in its entirety, then the deficit for the separate account, and
any other deficits 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 proposed
amendment to regulation Sec. 1.17(c)(2)(i) would provide the same
capital treatment to separate accounts as is currently provided
customer accounts that liquidate to deficits or contain debit ledger
balances, and is consistent with corresponding conditions to the no-
action position in CFTC Letter No. 19-17.\99\
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\99\ CFTC Letter No. 19-17. CFTC Letter No. 19-17 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.) CFTC Letter No. 19-17 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.)
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Third, the Commission proposes 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 is proposing 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 is further
proposing 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 proposes 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.'' However, once a customer fails to meet a margin call within one
business day, the FCM loses the one business day ``grace period'' for
receiving any of that customer's future margin calls, until the point
in time at which the customer is no longer undermargined.
[[Page 15321]]
Thus, if, due to activity on Monday, Customer A is undermargined by
$150, and the FCM calls Customer A for that margin on Tuesday, 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, 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 ``grace period'' for that customer meeting any of its
future margin calls, until the point in time at which the customer is
no longer undermargined.
The Commission proposes 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 grace 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 Commission notes that its proposed amendments to regulation
Sec. 1.17 also include a number of technical changes designed to
improve clarity and promote consistency with other Commission
regulations.\100\
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\100\ 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., proposed
regulation Sec. 1.17(b)(8). The Commission is further proposing to
replace the term ``FCM'' in regulation Sec. 1.17(b)(8) with
``futures commission merchant.'' The Commission is also proposing to
reorganize paragraph Sec. 1.17(c)(5)(viii) into sub-paragraphs (A),
(B), (C), and (D) to enhance clarity. The Commission is additionally
proposing to reorganize 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 with the wording of the term ``business day'' in proposed
regulation Sec. 1.3.
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C. Proposed Amendments to Regulations Sec. Sec. 1.20, 1.32, 22.2, and
30.7
As previously stated, a fundamental purpose of the CEA is to
provide for the protection of market participants from misuses of
customer assets.\101\ 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.\102\ 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.
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\101\ Section 3(b) of the CEA, 7 U.S.C. 5(b).
\102\ 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)
through (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
Commission 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.
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The Commission is proposing to amend regulations Sec. Sec. 1.32,
22.2, and 30.7 to provide that an FCM that permits separate accounts
pursuant to proposed 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 proposed amendments would add new paragraph (l)
to regulation Sec. 1.32, new paragraph (g)(11) to regulation Sec.
22.2, and new paragraph (l)(11) to regulation Sec. 30.7. The purpose
of the proposed amendments is to establish the manner in which these
existing segregation and reporting obligations apply to FCMs that
permit separate accounts pursuant to proposed 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 each of its futures customer funds, Cleared Swaps Customer
Collateral, and 30.7 customer funds, respectively. The proposed
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, would be required to record each
separate account as if it was 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 proposed amendments would 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 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 accounts that is in deficit.\103\ The
proposed 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
[[Page 15322]]
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 proposed amendments are consistent with
the separate account conditions to the no-action position in CFTC
Letter No. 19-17.\104\
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\103\ 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.
\104\ 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.'').
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The Commission is also proposing 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 proposed amendment would (i) correct
an error included in the drafting of the description of the calculation
when the regulation was originally adopted in 2012; and (ii) align 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 proposed amendment would be applicable 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 firm. 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.\105\ To the extent
that the calculation results in a net liquidating equity that is
negative, the Cleared Swaps Customer Account has a debit balance.\106\
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.
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\105\ 17 CFR 22.2(f)(3).
\106\ Id.
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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.\107\ An error, however, was made in drafting
the description of the details of the segregation calculation in
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.\108\
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\107\ 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).
\108\ 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.
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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-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.\109\ 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).\110\
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\109\ 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.
\110\ 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).
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As noted above, the proposed 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
[[Page 15323]]
with how FCMs calculate their total Cleared Swaps segregation
obligations under regulation Sec. 22.2(g), with how FCMs report their
total segregation requirements on the Cleared Swaps Segregation
Statement, and with the segregation calculation requirements for
futures accounts under regulation Sec. 1.32. Thus, the proposed
amendments are not expected to have any effect on FCMs.
In addition, the Commission is proposing 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 proposed amendment to regulation
Sec. 22.2(f), the proposed 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)).\111\
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\111\ 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).
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To address the omission, the Commission is proposing to amend
regulations Sec. Sec. 1.20(i) and 30.7(f) to reflect the requirement
for an FCM to include in the calculation of its futures and foreign
futures segregation requirement any unsecured customer debit balances,
calculated consistent with the proposed amendments to regulation Sec.
22.2(f)(4) and (5) that are discussed above. The proposed amendments to
regulations Sec. Sec. 1.20(i) and 30.7(f) would accurately describe
and reflect the existing segregation calculations for futures, foreign
futures, and Cleared Swaps as originally intended. The proposed
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.
D. Proposed Regulation Sec. 1.44(a)
Proposed regulation Sec. 1.44 will represent a discrete set of
regulations, first directly requiring FCMs to avoid returning margin to
customers where doing so would create or exacerbate a margin deficiency
in the customer's account, but then allowing FCMs to provide for
separate account treatment within the Commission's broader regulatory
framework for FCMs. As such, proposed regulation Sec. 1.44 contains a
number of terms that are specific to proposed regulation Sec. 1.44,
but are not applicable, or are not applicable in the same manner, with
respect to other of the Commission's FCM regulations. The Commission
therefore proposes to add new regulation Sec. 1.44(a) to define
certain terms ``only for purposes of this section'' (i.e., proposed
regulation Sec. 1.44).
The Commission proposes 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). This
definition is intended to implement the proposed Margin Adequacy
Requirement and requirements for separate account treatment subject to
such Margin Adequacy Requirement, with respect to accounts of all three
types. This definition was not included in the First Proposal.
The Commission also proposes 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.
As noted above, this definition is similar to the definition of
``United States business day'' included in the First Proposal. In its
comment responding to the First Proposal, FIA noted that the term
``United States business day'' accounts for days that banks are open,
but may not encompass days when other markets, such as securities
markets, are closed, which could make it difficult to meet margin calls
by liquidating certain instruments.\112\ The Commission requests
further comment on this term, below.
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\112\ FIA Comment Letter.
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Relatedly, the Commission proposes 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 First
Proposal did not include this definition, although it contained
provisions that, similar to proposed regulation Sec. 1.44(f), further
explained when an FCM would be considered in compliance with a one
business day margin call. As noted above, this definition (along with
all of the definitions in proposed regulation Sec. 1.44(a)) applies
only for purposes of proposed regulation Sec. 1.44, thus, this
definition of ``one business day margin call'' is not intended to apply
in any other context.
Under proposed regulation Sec. 1.44, an FCM may engage in separate
account treatment 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 proposes 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
a materially increased level of risk that the separate account customer
may fail promptly to perform its financial obligations to the FCM, or
decreased financial resilience on the part of the FCM. As noted in the
proposed definition, proposed regulation Sec. 1.44(e) sets out
circumstances that are inconsistent with the ordinary course of
business, and the occurrence of which would require a cessation of
separate account treatment. This definition of ``ordinary course of
business'' is unchanged from the First Proposal, except that it
replaces the term ``customer'' with the term ``separate account
customer.'' Comments received regarding the definition of ``ordinary
course of business'' are addressed in connection with proposed
regulation Sec. 1.44(e) below, which enumerates events that are
inconsistent with the ordinary course of business.
The Commission also proposes 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 definition of this term
is the same as in the First Proposal, except that it replaces
``customer'' with ``separate account customer'' and excludes the
criteria that the FCM be a clearing member of a DCO. The Commission did
not receive comments on the definition of this term in the First
Proposal.
As noted above, the Commission proposes to define ``separate
account customer'' as meaning a customer for
[[Page 15324]]
which the FCM has elected to engage in separate account treatment. This
definition was not included in the First Proposal.
Lastly, the Commission proposes 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,
exceeds the net liquidating value plus the margin deposits currently
remaining in that account.\113\ The definition notes that for 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.\114\ This clarification (which is 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, in distinction to risk margin, the equity
component or premium for long or short option positions is included,
since those are part of the total required level of margin. ``Initial
margin'' is the amount of margin (otherwise known as ``performance
bond'' \115\ 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 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.
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\113\ The definition of ``undermargined amount'' in proposed
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.
\114\ The definition of ``undermargined amount'' in proposed
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.
\115\ ``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).
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The Commission uses this term 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 regulation Sec.
1.44(g) in setting LSOC compliance calculations for separate accounts.
This definition was not included in the First Proposal.
Request for Comment
Question 4: How should the proposed definition of ``business day''
address days when securities and other markets are closed? For
instance, should the Commission 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? (E.g., a requirement rolls
over to the next day that the market is open.) What liquidity
challenges or other risks would result from such an exception? How do
FCMs and customers currently address these cases?
Question 5: In the proposed definition of ``undermargined amount''
in proposed regulation Sec. 1.44(a), the term ``margin deposits
currently remaining'' does not include a deduction for ``haircuts'' on
non-cash collateral or collateral posted in alternate currencies. This
is consistent with the approach taken with respect to calculating
undermargined amounts for purposes of determining requirements for
residual interest in regulations Sec. Sec. 1.22(c)(1), 22.2(f)(6)(i),
and 30.7(f)(1)(ii). By contrast, in a number of cases, Commission
regulations require FCMs, in determining the amount of customer debit/
deficit balances secured by readily marketable securities, to apply
securities haircuts set forth in SEC Rule 15c3-1(c)(2).\116\ Similarly,
some exchanges require members, in determining the amount of margin
they are required to collect from their customers, to apply haircuts to
securities collateral in amounts consistent with SEC Rule 240.15c3-1,
and to apply haircuts to commodities in amounts consistent with the
inventory haircuts specified in Commission regulation Sec.
1.17(c)(5)(ii).\117\
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\116\ See, e.g., regulations Sec. Sec. 1.32(b) and
22.2(f)(5)(iii).
\117\ See, e.g., CME Rule 930.C, ICE Futures U.S. Rule 5.03(j).
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Should the definition of ``undermargined amount'' apply haircuts to
the value of customer collateral held by the FCM? If so, should the
amount of such haircuts be based on SEC rule 240.15c3-1 and Commission
regulation Sec. 1.17(c)(5)(ii), or some other basis?
E. Proposed Regulation Sec. 1.44(b)
As discussed above, the Commission proposes regulation Sec.
1.44(b) to apply directly to FCMs, whether clearing or non-clearing,
the same Margin Adequacy Requirement that DCOs are required to apply to
their clearing FCMs pursuant to regulation Sec. 39.13(g)(8)(iii).
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 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 for separate account treatment under
ordinary course of business conditions.\118\
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\118\ 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 p. 10-1 (``Margin Funds Available for Disbursement = Net
Liquidating Value + Margin Deposits-Initial Margin Requirement
>=0''); see also supra n. 14 and accompanying text.
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The Commission acknowledges that real-time calculation of margin
adequacy with respect to a potential withdrawal may prove
impracticable. Instead, the Commission seeks to articulate a standard
for the time as of which such calculation shall be made that is
consistent with the Commission's requirements for calculation of
undermargined amounts for purposes of an FCM's residual interest
calculations. 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. To ensure such consistency,
proposed regulation Sec. 1.44(b)(1) provides that the sufficiency of
the amount in a customer's account to meet customer initial margin
requirements following a potential withdrawal shall be calculated as of
close of business on the previous business day.
In order to address circumstances in which the previous day is a
holiday on which markets, but not banks, may be open, proposed
regulation Sec. 1.44(b)(2) further provides that, for purposes of
[[Page 15325]]
proposed regulation Sec. 1.44(b)(1)'s margin adequacy calculation
requirements, where the previous day (excluding Saturdays and Sundays)
is a holiday, as defined in proposed regulation Sec. 1.44(a), where
any DCM on which the FCM trades is open for trading, and where an
account of any of the FCM's customers includes positions traded on such
a market, the margin adequacy calculation shall instead be made as of
the close of business on such holiday.\119\
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\119\ 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.
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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, and 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, in that it
reduces the likelihood and extent of the risk that the FCM must cover
losses due to a default by the customer on obligations that exceed the
margin actually held by the FCM. Similarly, because customer funds are
held by an FCM in omnibus accounts, this prohibition will reduce the
likelihood and extent 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,\120\ whether the duty to prevent such
withdrawals falls on DCOs acting on their member FCMs, or directly on
FCMs. 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 uniform among all types of FCMs directly in part 1 rather than
indirectly through part 39, the Commission now views it as reasonably
necessary to extend to all FCMs the requirement to prevent such under-
margining scenarios.
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\120\ Cf. CEA 4d(a)(2), 7 U.S.C. 6d(a)(2) (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.'')
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Accordingly, the Commission preliminarily believes that proposed
regulation Sec. 1.44(b), which will apply a similar Margin Adequacy
Requirement directly to FCMs, both clearing and non-clearing, would
further serve to protect customer funds and mitigate systemic risk,
thus effectuating CEA section 4d(a)(2), 4d(f)(2), and 4(b)(2)(A) \121\
and accomplishing the purposes of ``avoidance of systemic risk'' and
``protecting all market participants from . . . misuses of customer
assets.'' \122\
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\121\ 7 U.S.C. 6d(a)(2), 6d(f)(2), and 6(b)(2)(A).
\122\ CEA 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.
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F. Proposed Regulation Sec. 1.44(c)
Proposed regulation Sec. 1.44(c) sets forth the fundamental terms
and conditions for separate account treatment. As a general matter,
those terms and conditions 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 DCO specifically
authorizing such treatment. Proposed regulation Sec. 1.44(c) provides
that an FCM may, only during the ordinary course of business, as that
term is defined in proposed regulation Sec. 1.44, treat the separate
accounts of a separate account customer as accounts of separate
entities for purposes of proposed regulation Sec. 1.44(b),\123\ if
such FCM elects to do so as specified in proposed regulation Sec.
1.44(d). Proposed regulation Sec. 1.44(c) further provides that an FCM
that has made such an election shall comply with the risk-mitigating
conditions set forth further in proposed regulation Sec. 1.44 and
maintain written internal controls and procedures designed to ensure
such compliance.
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\123\ 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.
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The Commission preliminarily believes that permitting FCMs to treat
the separate accounts of separate account customers as accounts of
separate entities for purposes of proposed regulation Sec. 1.44(b),
subject to the risk-mitigating conditions set forth further in proposed
regulation Sec. 1.44, accomplishes the CEA's purpose of promoting
responsible innovation, while also maintaining continuity of robust
customer fund protection and risk mitigation.\124\ Compliance with
those conditions can best be achieved if the FCM maintains written
internal controls and procedures designed to ensure such compliance.
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\124\ See CEA 3(b), 8a(5).
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G. Proposed Regulation Sec. 1.44(d)
Proposed regulation Sec. 1.44(d) provides 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). In order to
do so, an FCM shall include the customer on a list of separate account
customers maintained in its books and records. Such list shall include
the identity of each separate account customer, as well as the identity
of each separate account of such customer. The FCM is required to keep
such list current. Furthermore, the first time that an FCM chooses to
include a customer on a list of separate account customers, the FCM is
required to provide notification of the election to allow separate
account treatment for customers in accordance with the process
specified in regulation Sec. 1.12(n)(3).\125\ 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 a 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. Proposed
regulation Sec. 1.44(d) is intended to ensure that DSROs are able
effectively to monitor and regulate FCMs that engage in separate
account treatment, and that FCMs have the records necessary to
understand which accounts receive separate account treatment for
purposes of monitoring
[[Page 15326]]
compliance with the proposed regulation.
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\125\ See 17 CFR 1.12(n)(3). Once an FCM provides notice in the
first instance that it will apply separate account treatment to one
or more customers, it would not be required to provide the same
notification each time it applies separate account treatment to a
new or additional customer.
---------------------------------------------------------------------------
The First Proposal proposed to require a clearing FCM to (i)
provide a one-time notification to its DSRO and any DCO of which it is
a clearing member that it will apply such treatment; (ii) maintain and
keep current a list of all separate accounts receiving such treatment;
and (iii) conduct a review of such records of accounts receiving
separate treatment no less than quarterly.
With respect to the proposed one-time notice requirement for
separate account treatment, the JAC in its comment contended that such
notice (and other notices required under the First Proposal) should be
made to any DCO permitting separate account treatment of which a
clearing FCM is a member, but should not be required to be provided to
the clearing FCM's DSRO, as monitoring for compliance with separate
account treatment requirements would not fall under the oversight of
the DSRO.\126\ Because the Commission is no longer proposing to codify
the no-action position in CFTC Letter No. 19-17 in part 39, it is no
longer proposing to require that notifications made to DSROs
additionally be made to every DCO of which the notifying FCM is a
member. Furthermore, the Commission believes notice to the Commission,
and to DSROs (who review FCMs' compliance with the Commission's part 1
regulations) pursuant to proposed regulation Sec. 1.44(d)(2) is
proper.
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\126\ JAC Comment Letter.
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With respect to the proposed recordkeeping requirement, CME opined
in its comment that clearing FCMs should be required to be able to
produce, upon request of the relevant DCO or the Commission, a current
list of accounts receiving separate treatment.\127\ The Commission
believes such requirement is already provided for by the requirement in
proposed regulation Sec. 1.44(d) to maintain and keep current such a
list, combined with Commission regulation Sec. 1.31(d)'s requirement
for records entities to produce regulatory records promptly upon
request by Commission representatives.
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\127\ CME Comment Letter.
---------------------------------------------------------------------------
The Commission notes that, in proposing the recordkeeping
requirement in this Second Proposal, it has determined not to include
the First Proposal's proposed requirement that an FCM review records of
accounts receiving separate treatment no less than quarterly, as the
Commission views the objective of such requirement--the keeping of
accurate and current records--as being subsumed by this Second
Proposal's proposed requirement to maintain and keep current a list of
accounts receiving separate treatment.
H. Proposed Regulation Sec. 1.44(e)
Proposed regulation Sec. 1.44(e) enumerates events that would be
inconsistent with the ordinary course of business, as that term is
defined in proposed regulation Sec. 1.44(a), and sets forth
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.\128\
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\128\ For example, while the bankruptcy of an FCM or a separate
account customer would have direct effects, the bankruptcy of an FCM
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.
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These events are divided into two categories: (i) those that
concern the separate accounts of a particular separate account
customer, 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 accounts of that customer; and (ii) those 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.
It is important to note, however, that under this proposal, while a
separate account customer is outside the ordinary course of business as
defined in proposed regulation Sec. 1.44(a), it is only the privilege
of permitting disbursements on a separate account basis, pursuant to
proposed regulation Sec. 1.44(c), with respect to that customer and
that customer's separate accounts, that 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 in proposed regulation Sec. Sec. 1.44(g)
and (h), 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) with respect to 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. Sec. 1.44(g) and (h),
including with respect to the relevant provisions described above, with
respect to all of its separate account customers and their separate
accounts.
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).\129\
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\129\ I.e., the one business day margin call requirement.
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(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, a self-regulatory organization (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 \130\ with jurisdiction over the
separate account customer, has initiated an action \131\ with respect
to such customer based on an allegation that the customer is in
financial distress.
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\130\ E.g., the SEC or a foreign regulator.
\131\ 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.
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(vi) The FCM is directed to cease permitting disbursements
on a separate account basis, with respect to the
[[Page 15327]]
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.
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 suspending or terminating separate account treatment
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 would be 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, and will actively communicate with and
monitor an FCM with respect to the resolution of such events (i.e.,
where an FCM attempts to reenter ordinary course of business
conditions).
Proposed regulation Sec. 1.44(e)(4) 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 separate account treatment for itself or its
customers, as may be the case. Proposed 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 conclusion. However, proposed regulation Sec.
1.44(e)(4) also provides that, if the circumstances triggering
cessation of separate account 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 separate account treatment 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.\132\
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.\133\ 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 treatment would be appropriate. By
explicitly providing FCMs with an avenue to resume separate account
treatment consistent with the resumption of the ordinary course of
business, the Commission seeks 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.
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\132\ CME Letter.
\133\ Id.
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Proposed 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 for separate account
treatment with respect to the Margin Adequacy Requirement is reasonably
necessary to accomplish the goals of protecting customer funds and
mitigating systemic risk.
The list of non-ordinary course of business events proposed herein,
as well as the criteria and process for an FCM to resume separate
account treatment, remains the same as proposed in the First Proposal,
except that the Commission has changed certain aspects of the proposed
regulation to account for placement of the requirement in part 1 (and
thus applicability to all FCMs, including non-clearing FCMs), and
notification of non-ordinary course of business events to the
Commission and to the FCM's DSRO through the process specified by
regulation Sec. 1.12(n)(3) (i.e., deleting the First Proposal's
separate requirement for a clearing FCM to provide notice to any DCO of
which it is a member that it has experienced a non-ordinary course of
business event (in addition to its DSRO, as provided for in CFTC Letter
No. 19-17), and deleting the requirement for a clearing FCM to provide
separate notice to its DSRO and any DCO of which it is a member that it
will resume separate account treatment).
In its comment responding to the First Proposal, CME recommended
that the Commission add certain additional events to the list of non-
ordinary course of business events: (1) when an FCM is under-
capitalized; (2) when an FCM is not in compliance with segregated,
secured, or Cleared Swaps requirements; (3) when an FCM has filed
notice of non-current books and records; and (4) when an FCM has filed
notice of a material inadequacy in internal controls that impact its
ability to remain in compliance with Commission regulations.\134\ The
JAC similarly recommended adding as non-ordinary course of business
event (1) when an FCM does not maintain required CFTC capital, futures
customer funds, 30.7 customer funds, Cleared Swaps Customer Collateral,
residual interest compliance or LSOC compliance, or does not comply
with the First Proposal's financial computation requirements; and (2)
when the FCM does not maintain current books and records or has a
[[Page 15328]]
material inadequacy in internal controls.\135\ The foregoing events are
generally matters for which an FCM must already make a report to, inter
alia, the Commission and the DSRO pursuant to regulation Sec.
1.12.\136\
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\134\ CME Comment Letter.
\135\ JAC Comment Letter.
\136\ See, e.g., regulation Sec. 1.12, which requires an FCM to
provide written notice to the Commission and to the firm's DSRO if
the FCM is undercapitalized (regulation Sec. 1.12(a)); maintains a
level of adjusted net capital that is below established ``early
warning levels'' (regulation Sec. 1.12(b)); fails to maintain
current books and records (regulation Sec. 1.12(c)); discovers or
is notified by an independent public accountant of the existence of
any material inadequacy in the firm's accounting system, the
internal accounting controls, or the procedures for safeguarding
customer and firm assets (regulation Sec. 1.12(d)); is
undersegregated with respect to futures customer funds, Cleared
Swaps Customer Collateral, or 30.7 customer funds (regulation Sec.
1.12(h)); or does not hold sufficient funds in segregated accounts
to meet targeted residual interest amounts or maintains an amount of
residual interest that is less than the sum of the undermargined
amounts in customer accounts (regulation Sec. 1.12(j)).
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CME additionally opined that the Commission should make clear that
any FCM undergoing an event that in the FCM's opinion is inconsistent
with the ordinary course of business should be considered outside the
ordinary course of business until such event is resolved, and clarify
that the list of non-ordinary course of business events is not
exhaustive and is subject to the discretion of the FCM in accordance
with its risk management practices.\137\
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\137\ CME Comment Letter.
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In this Second Proposal, the Commission has determined not to
adjust the list of non-ordinary course of business events, or add
additional conditions to exiting or resuming separate account
treatment, because the Commission believes the list of non-ordinary
course of business events proposed herein is sufficiently flexible to
capture CME and JAC's recommended additional non-ordinary course of
business events, and is therefore not exhaustive.\138\ In addition, the
FCM's DSRO will generally have received notification of the occurrence
of these events consistent with the requirements of regulation Sec.
1.12, and could, if it deems necessary, take action that would result
in the suspension of separate account treatment pursuant to proposed
regulation Sec. 1.44(e)(1)(vi) or (e)(2)(i).
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\138\ E.g., proposed regulation Sec. 1.44(e)(1)(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.) could encompass a wide variety of conditions that
could result in a cessation of separate account treatment.
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FIA opposed the further definition of ``ordinary course of
business'' through enumerated events, arguing that as long as a
customer timely meets margin requirements and is not subject to
bankruptcy, an FCM should be permitted to allow separate account
treatment.\139\ The Commission notes that, while there may be
commercial and operational merits to FIA's more flexible proposed
approach, a number of non-ordinary course of business events are
anticipatory--intended to result in cessation of separate account
treatment when the customer is in distress, but before such customer
reaches the point of bankruptcy or not being able to post margin. FIA's
comment also does not consider non-ordinary course of business events
occurring at the FCM, rather than just at the customer.
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\139\ FIA Comment Letter.
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FIA additionally asserted that requirements in the First Proposal
for DCOs permitting separate account treatment to require their
clearing FCMs to communicate to their DSRO and any DCO of which they
are a member (i) the occurrence of non-ordinary course of business
events and (ii) the resumption of a state of ordinary course of
business, would create a new filing requirement without any perceived
benefit and incorrectly imply that separate accounts and their
customers pose particular risk management challenges.\140\ The
Commission notes that, as a condition of the staff no-action position
provided in CFTC Letter No. 19-17, a DCO permitting separate account
treatment needed to require a clearing FCM to report to its DSRO the
occurrence of a non-ordinary course of business event. The First
Proposal's proposed requirement to include any DCO of which a clearing
FCM is a member as an additional recipient for reports required of the
FCM, would no longer apply under this proposal.
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\140\ Id.
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The JAC in its comment argued that an FCM exiting or reentering the
ordinary course of business (as well as starting separate account
treatment) should not be required to notify its DSRO of that fact on
grounds that monitoring for compliance with the proposed separate
account treatment does not fall under the oversight responsibilities of
an SRO, DSRO, or the JAC, and that it would not make sense for a DCO to
implement rules that would require a clearing FCM to notify its DSRO of
activity specifically governed by the DCO's rules.\141\ Under this
Second Proposal, however, separate account treatment will be governed
by the Commission's part 1 regulations, and thus would fall within
oversight responsibilities of an SRO or DSRO, or the oversight program
maintained by the JAC.
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\141\ JAC Comment Letter.
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The Commission further notes that, under this Second Proposal, the
notice requirements for FCMs (to provide notice to the Commission and
DSRO of the occurrence of a non-ordinary course of business event via
the process set forth in regulation Sec. 1.12(n)(3)) are substantially
similar to their counterparts in CFTC Letter No. 19-17 (requiring
notice of a non-ordinary course of business event to a DSRO, although
not expressly to the Commission), and that the Commission is not now
proposing a separate requirement for notice to DCOs of exit from and
reentry into separate account treatment (or of initiation of separate
account treatment).
In its comment, SIFMA-AMG asserted that the Commission's proposed
definition of ``ordinary course of business'' did not provide clarity
on the meaning of ``standard day-to-day operation,'' noting that DCOs
instead would be required to continuously monitor for a series of
events.\142\ SIFMA-AMG also asserted that some non-ordinary course of
business events do not appear to rise to the level of significance to
suggest they are not ordinary course of business, such as the failure
of a customer to make a maintenance margin payment, and that other
events require discretion and subjective analysis.\143\ SIFMA-AMG
recommended the Commission redefine the term ``ordinary course of
business'' and clearly delineate events such as default or bankruptcy
that are limited instances that would not be considered ordinary course
of business. SIFMA-AMG did not propose an alternative
[[Page 15329]]
definition of ``ordinary course of business.''
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\142\ SIFMA-AMG Comment Letter. With respect to continuous
monitoring, there are six events (proposed regulation Sec.
1.44(e)(1)(i) through (vi)) that are ``inconsistent with the
ordinary course of business with respect to the separate accounts of
a particular separate account customer.'' The first three of these
include a payment default and determinations by the FCM or its
employees, all of which should otherwise be monitored by an FCM as
part of its normal risk management. The last two involve cases where
the FCM either ``receives notification'' or ``is directed,'' neither
of which requires monitoring by the FCM. By proposed regulation
Sec. 1.44(e)(1)(iv), the FCM is required to monitor whether a
separate account customer has become ``insolvent or bankrupt''--
conditions that SIFMA-AMG agrees are outside the ordinary course of
business. Monitoring for the insolvency or bankruptcy of a client
would also appear to be a basic part of an FCM's credit risk
management, regardless of separate account treatment.
\143\ Id.
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As discussed above, the Commission notes that a number of non-
ordinary course of business events are anticipatory, and thus are
intended to result in cessation of separate account treatment before a
customer or FCM reaches the point of default or bankruptcy. Proposed
regulation Sec. 1.44(e) is intended to provide concrete criteria for
when a customer or FCM is operating outside the Commission's definition
of ``ordinary course of business'' in proposed regulation Sec. 1.44(a)
that are sufficiently flexible to account for the myriad ways in which
a customer or FCM can enter a state of financial or operational
distress, such that providing for separate account treatment would no
longer be prudent from a risk management perspective.
I. Proposed Regulation Sec. 1.44(f)
Proposed regulation Sec. 1.44(f) requires 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 proposing
requirements to define timely payment of margin for purposes of the
standard set forth in proposed regulation Sec. 1.44(f), the
Commission's goal is to establish requirements that reflect industry
best practices among FCMs and customers.\144\
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\144\ 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.
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Specifically, the Commission understands that, while 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 Canadian dollars (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.
Proposed regulation Sec. 1.44(f)(1) provides that, except as
explicitly provided in proposed 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), 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.\145\ 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.\146\
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\145\ 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.
\146\ 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,
proposed regulation Sec. 1.44(f)(2) provides that payment of margin in
certain currencies listed in proposed Appendix A to part 1 shall be
considered in compliance with the requirements of proposed 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.
Furthermore, proposed regulation Sec. 1.44(f)(3) provides that
payment of margin in fiat currencies other than USD, CAD, or currencies
listed in proposed Appendix A to part 1 shall be considered in
compliance with the requirements of proposed 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 First Proposal, the Commission proposed that:
Subject to certain exceptions, if the margin call is
issued by 11:00 a.m. ET on a United States business day (as that term
was proposed to be defined), it must be met by the applicable customer
no later than the close of the Fedwire Funds Service on the same United
States business day. In no case can a clearing member contractually
agree to delay issuing such a margin call until after 11:00 a.m. ET on
any given United States business day or to otherwise engage in
practices that are intended to circumvent the one business day margin
call standard by causing such delay.
Payment of margin in JPY shall be considered in compliance
with the requirements of the one business day margin call standard if
received by the applicable clearing member by 12:00 p.m., ET, on the
second United States business day after the business day on which the
margin call is issued.\147\
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\147\ In the First Proposal, the Commission requested comment on
whether there are other currencies besides JPY where the relevant
banking conventions render payment before the second U.S. business
day after a margin call is issued impracticable; to specifically
identify any such currencies; and to provide specifics about the
operational issues involved with respect to each such currency.
---------------------------------------------------------------------------
Payment of margin in fiat currencies other than USD, CAD,
or JPY shall be considered in compliance with the requirements of the
one business day margin call standard if received by the applicable
clearing member by 12:00 p.m., ET, on the United States business day
after the business day on which the margin call is issued.
With respect to the timing of margin payments, CME, in its comment
in response to the First Proposal, opined that the Commission should
encourage FCMs to collect margin in all currencies as quickly as
feasible.\148\ While the
[[Page 15330]]
Commission does encourage FCMs to collect margin in all currencies as
quickly as feasible, the Commission understands that compliance
challenges could arise with respect to FCMs attempting to determine
whether they are meeting an ``as quickly as feasible'' standard, and
chooses to maintain the more definite standard set forth in this
proposed regulation, subject to certain revisions with respect to the
specific margin payment timing requirements as discussed below.
---------------------------------------------------------------------------
\148\ CME Comment Letter. In addition, the Commission requested
comment on whether, in anticipation of potential developments with
respect to the use of central bank digital currencies or other
digital assets, the proposed regulation should explicitly address
the timing of payment of margin in digital assets. CME, the only
commenter to respond to this question, opined that this question
should be addressed in a separate request for comment. Id. The
Commission is not proposing to address the timing of margin payments
in digital assets in the present proposal, other than to note that,
under regulation Sec. 1.44(f) as currently proposed, payments of
margin in digital assets that are not fiat currencies (i.e., are not
created by a government), and are not listed in proposed Appendix A
to part 1, would be due on a same-day basis. To the extent that the
future development and use of digital fiat currencies results in a
situation where general practice is to settle payments in such
currencies on a same-day basis, the Commission would address this in
a subsequent rulemaking.
---------------------------------------------------------------------------
CME also opined that the Commission should treat all currencies
equally where relevant banking conventions render payment impracticable
before the second U.S. business day after a margin call is made (i.e.,
such provision should not pertain solely to JPY).\149\
---------------------------------------------------------------------------
\149\ Id.
---------------------------------------------------------------------------
In this Second Proposal, the Commission again requests comment
regarding the inclusion of currencies with respect to proposed Appendix
A to part 1 (i.e., currencies for which payment of margin may be
impracticable before the second business day after a margin call is
made) and proposes a process for the addition or removal of currencies
with respect to proposed Appendix A to part 1 on a going-forward basis.
FIA commented that the one business day margin call requirements in
the First Proposal were at once too broad with exceptions that were too
narrow.\150\ FIA asserted that while neither the CEA nor Commission
regulations specify when an FCM must make a margin call, all customer
accounts are subject to a one business day margin call under certain
CME and ICE Futures U.S. rules as well as the JAC Margins
Handbook.\151\ FIA further noted that while neither the CEA nor
Commission regulations specify when a margin call must be met, the JAC
Margins Handbook provides that margin calls must be met within a
``reasonable time,'' defined as ``less than five business days for
customers and less than four business days for noncustomers and omnibus
accounts . . . counted from and includ[ing] the day the account became
undermargined,'' and CME rules provide that a clearing member may deem
a ``reasonable time'' to mean one hour.\152\
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\150\ FIA Comment Letter. SIFMA-AMG voiced similar concerns,
arguing that the Commission's proposal was overly prescriptive and
did not consider legitimate reasons for why firms may have different
margin call deadlines.
\151\ Id.
\152\ Id.
---------------------------------------------------------------------------
FIA also asserted that Commission regulations (e.g., regulations
Sec. Sec. 1.22(c) and 1.17(c)(5)(viii)) already provide a strong
incentive to ensure margin calls are met no later than the following
(or, at the latest, second) business day after the event giving rise to
the margin call, and that FCMs generally do make margin calls within
one business day.\153\ Additionally, FIA argued that the proposed
regulation would impose a new recordkeeping requirement because FCMs
would have to record the precise time a margin call is issued and,
likely, met.\154\ FIA recommended that instead the Commission should
instead provide that FCM policies and procedures assure all margin
calls are met on no more than a one business day margin call basis
except as a result of administrative error or operational
constraint.\155\
---------------------------------------------------------------------------
\153\ Id.
\154\ Id.
\155\ Id.
---------------------------------------------------------------------------
With respect to the timing of margin payments in JPY, FIA argued
that the Commission's proposal was too restrictive and that such
requirement should focus on the date payment is irrevocably initiated
rather than received.\156\ With respect to the timing of margin
payments in CAD, JPY, and other non-USD currencies, FIA opined that the
Commission's proposal was arbitrary and unworkable.\157\
---------------------------------------------------------------------------
\156\ Id.
\157\ Id.
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In the Commission's view, a ``one business day margin call'' should
be defined beyond the term itself. FIA did not propose any such
definition, and the Commission believes market participants should have
clarity with respect to the criteria for a one business day margin
call, with clear lines with respect to what conduct is and is not
compliant. Additionally, while 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. With respect to FIA's comment that the definition of a one
business day margin call should be based on when payment is irrevocably
initiated, the Commission believes such suggestion may be
impracticable, given the challenge to an FCM in having information that
will reliably prove when a customer has initiated payment and
information on whether and when such payments are ``irrevocable.''
However, in the Second Proposal, the Commission has deleted its
prior proposed specific timing requirements with respect to the making
and meeting of margin calls on a one business day basis. Instead, if an
account is undermargined as a result of the prior day's market moves, a
margin call must be made and met on a same-day basis, with the
allowance of either one or two additional business days for margin
payments in certain non-USD/CAD currencies.\158\ The Commission expects
such alteration will also address FIA's concerns regarding the
recording of precise timestamps with respect to when margin calls have
been made or met.
---------------------------------------------------------------------------
\158\ Such requirement would not apply to margin calls made in
light of intraday market movements.
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In its comment, the JAC requested that the Commission clarify that
its one business day margin call requirements do not impact existing
regulations regarding the aging of margin calls or clearing FCMs'
financial reporting, regardless of the time of day the FCM issues the
margin call or if the customer is outside the U.S.\159\ The Commission
believes the proposed regulation accomplishes this by specifying that
the definitions contained within proposed regulation Sec. 1.44(a)
apply only for purposes of proposed regulation Sec. 1.44, and that the
margin payment timing requirements of proposed regulation Sec. 1.44(f)
apply solely for purposes of proposed regulation Sec. 1.44.
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\159\ JAC Comment Letter.
---------------------------------------------------------------------------
The JAC also requested that the Commission clarify that its
proposed codification does not affect the balances recorded in
customers' accounts, or the undermargined amount which the FCM must
include in its residual interest and LSOC compliance calculations.\160\
The Commission notes, 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
[[Page 15331]]
would be calculated on a separate account basis, as discussed
herein.\161\
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\160\ Id.
\161\ See, e.g., JAC, Regulatory Alert, #18-02, at 2, June 6,
2018 (discussing undermargined accounts), proposed regulation Sec.
1.44(g)(5).
---------------------------------------------------------------------------
The JAC further requested that the Commission clarify that,
notwithstanding its proposed one business day margin call requirements,
a margin call must be issued to the customer within one business day
after the event giving rise to the margin deficiency, even if the call
cannot be made until after 11:00 a.m. ET, and even if the business day
is not a business day in the customer's jurisdiction. The Commission
believes proposed regulation Sec. 1.44(f)(1) addresses this comment by
removing the link to the specific time of 11:00 a.m. ET. Rather, if as
a result of market moves or position changes on the prior business day,
a separate account is undermargined, then the FCM is required to 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), and that 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 regardless of what time the margin call was
issued, subject to the proposed limited one or two business-day
exception for margin payments posted by separate account customers in
certain non-USD/CAD currencies, and other exceptions explicitly
provided for in proposed regulation Sec. 1.44(f).
The JAC additionally contended that receipts and disbursements from
separate accounts should occur on the same day.\162\ The Commission
believes this standard will in the main be met where, under the
proposed regulation, customers will be required to meet any margin call
on the day it is issued, with the limited exceptions discussed in the
previous paragraph of one or two business days for payments of margin
in certain non-USD/CAD currencies.
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\162\ Id.
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With respect to the timing of margin payments in non-USD/CAD
currencies, the JAC argued that the Commission should adopt a mechanism
to provide timely and efficient changes to payment timelines for
meeting a one business day margin call, and that such authority should
rest solely with the Commission, rather than with individual DCOs, in
order to ensure consistency and avoid confusion where some separately
margined accounts may contain positions with one or more DCO.\163\
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\163\ Id.
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The proposed procedure outlined herein to remove currencies from or
add currencies to proposed Appendix A to part 1 as set forth in
proposed regulation Sec. 1.44 is intended to address this
comment.\164\
---------------------------------------------------------------------------
\164\ This procedure is intended to seek the aid of market
participants in ``evaluating when a particular foreign currency is
eligible for one-day or two-day settlement,'' and thus, on an
ongoing basis, matching proposed Appendix A to part 1 to current
industry conventions. Cf. FIA Comment Letter.
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While ICE did not object to the Commission's proposed margin
payment timing framework in the First Proposal, ICE recommended that
the Commission clarify that the proposed regulation would not affect
stricter margin call timeframes established by DCOs for clearing
members.
While such clarification may not be required in light of the
applicability of proposed regulation Sec. 1.44 to all FCMs regardless
of clearing membership and removal of the proposed codification from
part 39, for the avoidance of doubt, the Commission states explicitly
that the proposed regulation is not intended to affect or prohibit more
stringent risk management requirements, including margin call
timeframes, that may be established by DCOs with respect to their
members. The Commission confirms that an FCM that is a member of a DCO
is obligated to comply with such DCO's margin call timeframes, applied
in a manner consistent with DCO rules, including those that are more
stringent than those addressed in proposed regulation Sec. 1.44.\165\
This is consistent with the approach taken with respect to other risk
management measures, such as capital requirements.\166\
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\165\ Cf. Sec. 39.17(a)(1) (A DCO shall maintain adequate
arrangements and resources for the effective monitoring and
enforcement of compliance (by its clearing members) with the rules
of the DCO.).
\166\ Compare, e.g., regulation Sec. 1.17(a)(1) (setting
adjusted net capital requirements with an absolute minimum of $1
million, with CME Rule 970.A.1 (setting minimum capital requirements
with an absolute minimum of $5 million).
---------------------------------------------------------------------------
In its comment, MFA argued that the proposed regulation failed to
consider that legitimate reasons exist for firms to impose different
margin call deadlines for different clients, and asserted that CFTC
Letter No. 19-17 instead recognized such operational complexities by
affording firms greater operational flexibility in prescribing margin
cutoff times.\167\
---------------------------------------------------------------------------
\167\ MFA Comment Letter.
---------------------------------------------------------------------------
As discussed above, in this Second Proposal, the Commission has
eliminated time-of-day-specific requirements for when margin calls must
be made and met in favor of a general same-day requirement.
In its comment, SIFMA-AMG argued that the Commission should abandon
its proposed currency-based three-tiered margin payment timing scheme,
arguing that the allowance of grace periods permits for flexibility and
serves to address issues posed by operational complexities.\168\ For
example, SIFMA-AMG further argued that the Commission's proposal did
not consider what would happen if different managers for the same
client chose different Eurozone countries to follow for purposes of
banking holidays, and did not account for parties that may be located
in different time zones. The Commission believes it is important from a
risk mitigation perspective to preserve a one business day margin call
standard, in accordance with industry best practice for prompt
fulfillment of margining requirements, and further believes it
important from a perspective of regulatory certainty that there be
clear lines drawn around the meaning of a one business day margin call.
In this Second Proposal, by eliminating prescriptive margin payment
timing requirements in favor of a requirement that a margin call be
made and met on a same-day basis, with limited extensions for payment
of margin in certain currencies, the Commission seeks to implement a
standard more flexible and capable of addressing operational
complexities than the standard set forth in the First Proposal. With
respect to the specific examples raised by SIFMA-AMG, different
managers, of different separate accounts, for the same customer
(client), would not be precluded from using different countries for
purposes of banking holidays, as each such separate account would be
separately margined. Nonetheless, if that were to create operational
difficulties for the customer, then the customer could resolve those
issues with the managers. Additionally, the Commission again invites
comment on those currencies for which margin payments should be
considered compliant if made by the second business day after a margin
call is issued.
---------------------------------------------------------------------------
\168\ SIFMA-AMG Comment Letter.
---------------------------------------------------------------------------
The occurrence of a foreign holiday during which banks are closed
may also create difficulties in payment of margin in a fiat currency
other than USD. Therefore, the Commission proposes regulation Sec.
1.44(f)(4), which states that the relevant deadline for payment of
margin in fiat currencies other than USD may be extended by up to one
[[Page 15332]]
additional business day and still be considered in compliance with the
requirements of proposed regulation Sec. 1.44(f) if payment is delayed
due to a banking holiday in the jurisdiction of issue of the currency.
For payments in EUR, 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,
and whose banking holidays shall be referred to for purposes of
compliance with the regulation.\169\
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\169\ With respect to margin payments in EUR, proposed
regulation Sec. 1.44(f)(4) is intended to prevent customers or
investment managers from leveraging banking holidays in a
multiplicity of jurisdictions, to circumvent requirements to pay
margin timely.
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Proposed regulation Sec. 1.44(f)(4) is designed 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. Proposed regulation Sec. 1.44(f)(4) would not, however,
require an FCM to extend the deadline for payments of margin. Here, the
Commission is seeking 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 investment 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 expects that FCM risk management decisions,
including the use of any extension permitted under proposed 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.\170\ The Commission included this proposed requirement in the
First Proposal in substantively the same form.
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\170\ 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).
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In its comment in response to the First Proposal, the JAC argued
that this proposed requirement would create a new recordkeeping
requirement for clearing FCMs, and recommended that the Commission
clarify that it does not impact the requirements of any other CFTC
regulations or SRO rules related to margin calls.\171\ As noted above,
the Commission believes the proposed regulation addresses this comment
in making clear that the requirements in proposed regulation Sec.
1.44(f) for meeting a one business day margin call apply solely for
purposes of proposed regulation Sec. 1.44(f).
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\171\ JAC Comment Letter.
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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).
Accordingly, the Commission proposes regulation Sec. 1.44(f)(5),
which 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 proposed 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,\172\ does not constitute a failure
to comply with the requirements of proposed regulation Sec. 1.44(f).
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.\173\ The Commission included this proposed requirement in
the First Proposal in substantially the same form, with one change.
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\172\ One would expect administrative errors at a well-run money
manager to be unusual and unforeseen. For the avoidance of doubt,
``unforeseen'' refers to the particular occurrence of a constraint
or error; for example, the fact that some small percentage of errors
may be foreseen does not mean that any particular error is foreseen
(and ``unusual'' means that such percentage should indeed be small).
Moreover, an unusual and unforeseen administrative error or
operational constraint that prevents payment might occur at one of a
number of points in the payment chain beyond the money manager:
Examples include an error or operational failure on the part of the
bank that the money manager instructs to send a wire transfer to the
FCM, an error or operational failure on the part of the bank (for
cash) or custodian (for securities) designated to receive margin on
behalf of the FCM, or an error or operational failure on the part of
a bank in the middle of a chain between the sending bank and the
FCM's bank (particularly in the context of transfers of foreign
currency).
\173\ The Commission is proposing to establish this
reasonableness standard for an FCM's determination that a failure to
timely deposit, maintain, or pay margin or option premium on the
basis of administrative error or operational constraints. The
Commission believes the proposed standard confers significant
discretion upon FCMs to assess the disposition of their customers
while requiring that FCMs act reasonably and on the basis of current
and relevant information, diligently gathered.
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The current proposal adds the term ``with respect to a specific
separate account'' to make clear that ``unusual'' is based on a
particular separate account, not the FCM's business with respect to
separate accounts as a whole.\174\
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\174\ Consider an FCM with two dozen separate account customers,
with an average of four separate accounts per customer, resulting in
96 separate accounts for that FCM. If each separate account has an
exception only once per year, that would result in a total of 96
exceptions, or around two per week, for the FCM. While the
Commission does not intend to set a prescriptive definition of
``unusual'' in this context, it may nonetheless be seen that once
per year is unusual, while twice per week is not.
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In its comment in response to the First Proposal, FIA argued that
the Commission's proposed standards for ``unusual'' and ``unforeseen''
are too subjective and would unnecessarily expose FCMs to enforcement
actions, noting that unusual or unforeseen events are often outside an
FCM's control.\175\ FIA did not, however, propose alternative
standards.
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\175\ FIA Comment Letter. FIA observes that ``An FCM should not
be subject to administrative sanctions for matters over which the
FCM has no control.'' Id. The requirements of regulation Sec. 1.44
are consistent with that principle.
The consequence of a separate account customer failing to meet a
one-day margin call for reasons that fall outside the scope of an
``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'' is that the
customer is outside the ``ordinary course of business,'' and that
thus the FCM must cease treating the separate accounts of the
separate account customer as accounts of separate entities for
purposes of margin distribution under regulation Sec. 1.44(b). That
action--which would be required to be taken by the FCM--is not an
administrative sanction on the FCM, which likely would not have
direct control over financial and operational conditions at its
customer, but rather a measure, designed to protect the FCM and the
markets more broadly, that has a negative effect on the customer
(rather than the FCM).
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[[Page 15333]]
Similarly, MFA in its comment argued that FCMs, asset managers, and
customers benefit from agreed-upon grace periods for shortfalls
resulting from administrative or operational issues unrelated to
ability to pay, and argued that use of terms such as ``unusual,''
``diligently and in good faith'' are subjective.\176\ MFA argued that
the Commission should remove the condition now encompassed by proposed
regulation Sec. 1.44(f)(5).
---------------------------------------------------------------------------
\176\ MFA Comment Letter.
---------------------------------------------------------------------------
In its comment, SIFMA-AMG argued that the Commission should remove
or re-propose the standard that failure to meet margin obligations
``due to unusual administrative error or operational constraints that a
customer or investment manager acting diligently and in good faith
could not have reasonably foreseen'' does not constitute a failure to
comply with the one business day margin call requirement, on the basis
that this proposed provision is ambiguous.
The Commission believes the further criteria for determining the
existence of an administrative error or operational constraint provide
a clearer definition of the meaning of these terms. The Commission
additionally believes that, while FCMs engaged in separate account
treatment should not enter agreements that obviate the risk-mitigating
purpose of requiring margin calls be met on a one business day basis,
proposed regulation Sec. 1.44(f)(5) strikes a reasonable balance in
ensuring that FCMs and customers are not forced to cease separate
account treatment as a result of unusual and unexpected, one-off
errors.
It should also be noted that the provisions of paragraph (f) of
proposed regulation Sec. 1.44 are subject to the language that ``the
following provisions apply solely for the purposes of this paragraph
(f).'' This is separate from, e.g., requirements for margin aging under
regulation Sec. 1.17(c)(5)(viii), which requires payment by the end of
the business day after the business day on which the margin call is
made.
For example, if a margin call for a separate account is made on
Tuesday based on events on Monday, and the margin call is to be met in
JPY, payment by close of business on Thursday would be timely for
purposes of proposed regulation Sec. 1.44(f), because JPY is a
currency listed in proposed Appendix A to part 1, and that payment
would be considered in compliance with the requirements of paragraph
(f) of regulation Sec. 1.44 ``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.'' However, payment
for that margin call would not be timely for purposes of regulation
Sec. 1.17(c)(5)(viii) unless received by close of business on
Wednesday.
On the other hand, if that margin call is to be made in USD or CAD,
and it is not received until Wednesday, and there is no ``unusual
administrative error or operational constraints that a customer or
investment manager acting diligently and in good faith could not have
reasonably foreseen'' (i.e., proposed regulation Sec. 1.44(f)(5) does
not apply), then, while payment by Wednesday is timely for purposes of
regulation Sec. 1.17(c)(5)(viii), after the close of business on
Tuesday, the separate account customer would be out of compliance with
the one business day margin call called for by proposed regulation
Sec. 1.44(f).
Proposed regulation Sec. 1.44(f)(6) states 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. Sec. 1.44(f)(1)
through (5),\177\ or engages in practices that are designed to
circumvent proposed regulation Sec. 1.44(f). The Commission proposes
this provision, which was included in the First Proposal in
substantively the same form, in order to make clear that it is
establishing a maximum period of time in which a margin call must be
met for purposes of this regulation, rather than establishing a minimum
time that an FCM must allow. 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 does 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.
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\177\ 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 conditions under
which such FCM may engage in separate account treatment.
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In its comment, CME argued that the proposed regulation could
create confusion by incorrectly implying that customers not utilizing
separate account treatment may be given contractual terms providing for
a period of time longer than one business day to satisfy a margin call
or may otherwise restrict the FCM's discretion as to liquidation in
contravention of CME Group Exchange rules.\178\
---------------------------------------------------------------------------
\178\ CME Comment Letter.
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In its comment, the JAC similarly contended that the Commission
incorrectly implied that an FCM may contractually agree to a grace or
cure period for any customers that are not treated as separate
accounts, and recommended that the Commission make clear that if an FCM
and customer contract for margin calls to be met on a longer than one
business day basis, then the FCM is not making a bona fide attempt to
collect margin within one business day after the event giving rise to
the margin deficiency.\179\
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\179\ JAC Comment Letter.
---------------------------------------------------------------------------
The Commission notes that it is not proposing this regulation to
conform to the rules of a particular DCO, to the extent the DCO may
prohibit such grace or cure periods, and further notes that this
proposed regulation does not prevent a DCO from maintaining and
enforcing rules that apply more stringent risk management standards to
their clearing members than are set forth therein.
Proposed regulation Sec. 1.44(f)(7) is an exception to proposed
regulation Sec. 1.44(f)(1), dealing with the special case of certain
holidays (i.e., 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). It only applies
to an FCM if that FCM trades on such a DCM, and to a separate account
if that 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.\180\
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\180\ 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
[[Page 15334]]
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 as a result of market
movements or position changes 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.
The following uses Veterans Day (November 11) as an example, and
assumes 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.
In its comment letter, the JAC also opined that if the Commission
addresses unscheduled banking holidays or U.S. securities market
closures, the Commission should make clear that any such provisions
apply only to determining if a margin call is considered one-day and do
not govern how such holidays or closures are considered for any other
purpose.\181\ The Commission believes the proposed regulation addresses
this comment in making clear that the requirements in proposed
regulation Sec. 1.44(f) for meeting a one business day margin call
apply solely for purposes of proposed regulation Sec. 1.44(f).
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\181\ JAC Comment Letter.
---------------------------------------------------------------------------
CME asserted that unscheduled closings of banks or securities
markets should be handled on an industry-wide basis, based on facts and
circumstances specific to each such situation, and not prescriptively,
noting that CME, FIA, SIFMA, and many other exchanges and clearing
organizations have worked to establish protocols for these
scenarios.\182\ Such unscheduled closings (for, e.g., a national day of
mourning) would fall under the rubric of an ``unusual . . . operational
constraint[ ].''
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\182\ Id.
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In its comment letter, SIFMA-AMG recommended the Commission
preserve the flexibility of a limited discretionary grace period,
stating that the proposed regulation would mean that a ``single `foot
fault' '' with respect to a single manager could cause an FCM to revert
to margining on a gross basis.
The Commission believes the requirement of a one business day
margin call, as set forth in the no-action position and further
expanded on in the Second Proposal, is a core component of mitigating
the risk that separate account treatment will result in the under-
margining of one or more separate accounts. The effect of a one
business day margin call is to limit the time during which a customer
account (or, here, a customer's separate account) is undermargined, and
thus to limit the risk to the FCM (and the FCM's omnibus customer
account for futures, Cleared Swaps, or foreign futures or foreign
options). One business day is industry best practice. The Commission
notes that a ``single,'' one-off error with respect to a single manager
would also not under the proposed regulation result in a reversion to
margining on a customer basis if such error meets the criteria for an
unusual and unforeseen administrative error or operational constraint
discussed above.
Lastly, the Commission proposes 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 seeks 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. Proposed regulation Sec.
1.44(f)(8) 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 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. The submitter would need to
support such assertion with documentation or other relevant supporting
information, as well as any additional information that the Commission
requests.\183\ 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.
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\183\ Submitters may request confidential treatment for parts of
its submission in accordance with Commission regulation Sec.
145.9(d).
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Request for Comment
Question 6: The Commission requests comment regarding whether, in
light of changes made in this 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. If not, what alternative approach should be taken? How
would such an alternative approach better balance those considerations?
In particular, the Commission requests comment on whether the proposed
standard of timeliness for a one business day margin call set forth in
proposed regulation Sec. 1.44(f) presents practicability challenges
and, if so, what those challenges are, and how the proposed standard of
timeliness could be improved.
Question 7: Proposed regulation Sec. 1.44(f)(4) provides 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 proposed regulation
Sec. 1.44(f) if payment is delayed due to a banking holiday in the
jurisdiction of issue of the currency. Proposed regulation Sec.
1.44(f)(4) further provides that, for payments in EUR, either the
separate account customer or
[[Page 15335]]
the investment manager managing the separate account may designate one
country within the Eurozone that they have the most significant
contacts with for purposes of meeting margin calls in that separate
account, whose banking holidays shall be referred to for such purpose.
As noted above, this provision is intended to prevent customers or
investment managers from leveraging banking holidays in a multiplicity
of jurisdictions to circumvent requirements to pay margin promptly.
Separately from Question 6 above, the Commission requests comment
specifically in relation to proposed regulation Sec. 1.44(f)(4), with
respect to:
(1) 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. For example, if a customer selects Eurozone
Country A as the jurisdiction that is most significant to their
operations for purposes of meeting margin calls in separate accounts,
but also uses a bank in Eurozone Country B to meet margin payments in
EUR, would a banking holiday in Country B (but not Country A) make it
impracticable for the customer to pay margin in compliance with
proposed regulation Sec. 1.44(f)(3)? Commenters are requested to
provide examples of operational or other challenges that would result
in such impracticability.
(2) To the extent commenters have such practicability concerns,
how, in the alternative, should the Commission seek to achieve its
goal, discussed above, 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?
J. Proposed Regulation Sec. 1.44(g)
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, and to corresponding
conditions included in the First Proposal, except that they have been
reorganized and subject 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. Many of these 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 proposed provisions are also
intended to ensure that an FCM treats separate accounts in a consistent
manner for purposes of risk management.
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 that it or another investment manager may have incurred on
behalf of a different account of the same customer.\184\ 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.\185\ 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.\186\
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\184\ First FIA Letter.
\185\ Id.
\186\ Id.
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Accordingly, proposed regulation Sec. 1.44(g) would, if adopted,
apply to all FCMs certain conditions in CFTC Letter No. 19-17. These
conditions are designed to provide for consistent treatment of separate
accounts. 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 proposed regulation Sec. 1.44 would be risk-managed on a
separate basis, the Commission believes it is appropriate for the
proposed 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.
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. Proposed 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 account of a
customer, as well as with respect to all of the customer's 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 be in a better position to
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, and
anticipate and mitigate the risk of the occurrence of certain of the
events detailed in proposed regulation Sec. 1.44(e).
Proposed regulation Sec. 1.44(g)(2) 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.
Proposed regulation Sec. 1.44(g)(3) 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
[[Page 15336]]
accounts of the same separate account customer, with respect to
separate account customers, comply with certain additional requirements
in computing its adjusted net capital for purposes of regulation Sec.
1.17.
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.\187\ 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.\188\
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.\189\
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\187\ 17 CFR 1.20(a), 22.2(f)(2), and 30.7(a).
\188\ 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.
\189\ See 17 CFR 1.32(d), 22.2(g)(3), and 30.7(l)(3).
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Proposed regulation Sec. 1.44(g)(4) 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 proposed 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, proposed 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 separate
account customer carried by the FCM. Proposed regulation Sec. 1.44(g)
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. Proposed regulation
Sec. 1.44(g) is also consistent with CFTC Letter No. 19-17.\190\
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\190\ 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.
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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.\191\ 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.\192\
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\191\ 17 CFR 1.22(a), 22.2(d), and 30.7(f)(1)(i).
\192\ 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).
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The Commission is proposing 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 proposed 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. The proposal is also
consistent with CFTC Letter No. 19-17.\193\
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\193\ 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).
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Commission 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.\194\ 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.\195\ Regulation 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.\196\
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\194\ 17 CFR 1.11.
\195\ 17 CFR 1.11(e)(3)(i)(D).
\196\ 17 CFR 1.23(c).
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The Commission is proposing to adopt 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.\197\ 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 funds are 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.\198\
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.
Proposed
[[Page 15337]]
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. Proposed regulation Sec. 1.44(g)(6)
is also consistent with the conditions to the no-action position in
CFTC Letter No. 19-17.\199\
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\197\ See, e.g., 17 CFR 1.22(c)(3); 17 CFR 22.2(f)(6)(iii)(A).
\198\ See, e.g., 17 CFR 22.2(g).
\199\ 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).
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With respect to the provisions in the First Proposal corresponding
to the provisions in proposed regulation Sec. 1.44(g), the Commission
received a comment from FIA. With respect to proposed regulation Sec.
1.44(g)(1), FIA noted that FCMs are already required under regulation
Sec. 1.73 to provide for stress testing and credit limits for all
customers, including separate account customers.\200\ FIA asserted that
stress testing for separate accounts would provide no additional risk
management benefits when they do not account for all of a customer's
underlying assets.\201\
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\200\ FIA Comment Letter.
\201\ Id.
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Regulation Sec. 1.73 does not presently provide for stress testing
on a separate account basis, and does not apply to non-clearing FCMs.
As discussed further below, the Commission believes that it is
appropriate to apply these risk management requirements, including
requirements for stress testing, to non-clearing FCMs with respect to
the separate accounts of their separate account customers, and that
doing so on such basis could allow FCMs to detect potential
deficiencies, the correction of which would prevent the occurrence of
conditions that would necessitate a cessation of separate account
treatment. The separate requirement to additionally conduct stress
testing on a combined account basis is intended to serve as a backstop
so that an FCM can have a view of all of a customer's actual holdings.
If the customer does default, the FCM will have to liquidate all of the
customer's holdings. Understanding the extent to which the positions
within separate accounts may be additive (and perhaps create more
concentrated positions when considered together) is also important to
an FCM's ability to manage risk.
K. Proposed Regulation Sec. 1.44(h)
Proposed regulation Sec. 1.44(h) contains requirements related to
information and disclosures. As with the provisions in proposed
regulation Sec. 1.44(g), these provisions are substantially similar to
their corresponding no-action conditions in CFTC Letter No. 19-17, and
to corresponding conditions included in the First Proposal, 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.
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.\202\ Proposed 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, and to identify when a customer's
financial circumstances would necessitate the cessation of separate
account treatment. Proposed regulation Sec. 1.44(h)(1)(i) contemplates
that, in certain instances, an investment 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
investment manager. Proposed 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).
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\202\ 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.
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In its comment in response to the First Proposal, CME asserted that
if the parent of an FCM has multiple relationships with a customer
(e.g., prime brokerage or lending), it should be sufficient that the
FCM's parent has this information and can provide it to the Commission
upon request. The Commission believes that if an asset manager is
managing a specified set of assets, then it is relevant for the FCM to
know the size of that set of assets. Additionally, the requirement to
gather information sufficient to identify the direct or indirect parent
of the customer is intended to ensure that the FCM understands who the
parent is so that it can be aware if the parent becomes insolvent or
otherwise experiences a non-ordinary course of business event. That an
FCM's parent may hold such information does not necessarily mean that
the FCM has such information readily available--a goal this proposed
provision is designed to accomplish.
In its comment, FIA argued that this provision was unnecessary as
the proposed requirement is already consistent with proper risk
management or otherwise required by applicable law.\203\ FIA further
argued that this provision may imply that an FCM has obligations with
regard to separate account customers that do not exist for other
customers. The Commission notes that to the extent 31 CFR 1010.230,
which pertains to the identification of beneficial owners, does not
contain specific requirements related to the identification of direct
or indirect parent companies, or the value of assets dedicated to
separate accounts, proposed regulation Sec. 1.44(h)(1) is designed to
capture such information; additionally, while proposed regulation Sec.
1.44 makes clear that its requirements are applicable to FCMs that
provide separate account treatment for customers, it does not state
that it is intended to supersede any other requirements related to
ascertaining the identity of beneficial owners (i.e., customers). FIA
additionally opposed any further amendment to this provision that would
require an FCM to obtain any specific information or documentation, or
prescribe the schedule by which an FCM must update such information;
the Commission in this Second Proposal has determined not to propose
such further requirements and expects that FCMs will obtain the
requisite information in a time and manner consistent with the FCM's
existing risk management policies.
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\203\ FIA Comment Letter (citing 31 CFR 1010.230).
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In its comment, the JAC asserted that further clarity is needed on
how clearing FCMs should determine the value of assets dedicated to
separate accounts, and that such information should be updated at least
annually and more often as facts and circumstances warrant. The
Commission recognizes that there may exist significant diversity among
separate account customers in the nature of customer positions,
underlying assets, and frequency with which such assets change in terms
of size and composition. The Commission does not wish to set a
prescriptive, one-size-fits-all standard in the method and frequency of
the valuation contemplated by proposed regulation Sec. 1.44(h)(1), and
[[Page 15338]]
believes an FCM should be able to value assets in a manner consistent
with its otherwise appropriate risk management policies.
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 investment manager acts under a
power of attorney on behalf of a customer, and the FCM has little
direct contact with the customer. Proposed regulation Sec. 1.44(h)(2)
is designed to ensure that FCMs have a reliable means of contacting
separate account customers directly if the investment manager fails to
ensure prompt payment on behalf of the customer. Under the First
Proposal, a DCO would have needed to require that a clearing FCM
engaged in separate account treatment review and, if necessary, update
the relevant contact information no less than annually. The Commission
has determined to omit the requirement of an annual review from this
Second Proposal for the avoidance of confusion with respect to the
requirement to maintain current contact information for authorized
representatives as, in the Commission's view, reasonable steps to
verify that contact information remains accurate may, depending on the
circumstances, necessitate review and update of such information on a
basis more or less frequent than annually.
In its comment in response to the First Proposal, FIA opposed
required annual updates of contact information for customer
representatives, asserting that FCMs are in regular contact with
investment managers and will have current contact information for them.
While FCMs may communicate regularly with investment managers, and
generally have current contact information for them, the Commission
notes that its intent is to enable the FCM to have contact information
for the customer, in addition to having contact information for the
investment manager, in order to enable the FCM to contact the customer
directly if the FCM has problems with the account manager. As noted
above, in this Second Proposal, the Commission has omitted the annual
update requirement, but will require that customer representative
contact information be kept current. The Commission considers it
prudent risk management practice that the FCM maintain a line of
contact to the customer of a separate account, and this is consistent
with a condition of the no-action position.
In its comment, the JAC argued that the Commission should require a
corporate resolution or similar document authorizing a representative
at a customer to represent the customer if the customer is not an
individual. The JAC opined that maintaining current contact information
for authorized representatives of customers with associated corporate
resolutions or similar documentation should already be part of a
clearing FCM's policies and procedures (noting that most such FCMs
likely already review such information on at least an annual basis),
and noted that the additional cost of adding such a requirement would
likely be de minimis. The Commission notes that the proposed regulation
already would require FCMs to take reasonable steps to verify that the
authorized representative of a customer is in fact an authorized
representative of the customer. While the proposed regulation would not
preclude an FCM from requiring from a customer a corporate resolution
authorizing a representative to represent a customer in order for the
FCM to comply with this requirement, the Commission wishes to preserve
a degree of flexibility in how FCMs may choose to verify the identity
and authorization of customer representatives, and is not at this time
prescribing specific means of verifying such information.
Proposed 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
proposed regulation Sec. 1.44 will not be treated separately in
bankruptcy. To make this limitation clear to customers and FCMs, the
Commission proposes 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. The disclosure statement required by
proposed regulation Sec. 1.44(h)(3) 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 proposed
regulation Sec. 1.44(h)(3) was delivered directly to the customer.
Additionally, the FCM must include the disclosure statement required by
proposed regulation Sec. 1.44(h)(3) on its website or within its
Disclosure Document required by Commission regulation Sec. 1.55(i).
The Bankruptcy Reform Act of 1978 \204\ 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.\205\ The Commission enacted part 190 of its
regulations, 17 CFR part 190, to 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.\206\ The Commission
proposes to adopt 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.
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\204\ Public Law 95-598, 92 Stat. 2549.
\205\ Bankruptcy, 46 FR 57535, 57535-36 (Nov. 24, 1981).
\206\ 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.).
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Proposed regulation Sec. 1.44(h)(4) provides that an FCM that has
made an election pursuant to proposed 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 terms and conditions of proposed regulation Sec.
1.44. A similar provision was included in the First Proposal as
proposed regulation Sec. 39.13(j)(13). Regulation Sec. 1.55 was
adopted to advise new customers of the substantial risk of loss
inherent in trading commodity futures.\207\ The Commission amended
regulation Sec. 1.55 in 2013 to, among other things, add new paragraph
(i) requiring FCMs to disclose to customers
[[Page 15339]]
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.\208\ 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.\209\ These disclosures are designed to
``enable customers to make informed judgments regarding the
appropriateness of selecting an FCM'' and enhance the diligence that a
customer can conduct prior to opening an account and on an ongoing
basis.\210\ 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.\211\ Accordingly, the
Commission proposes 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.
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\207\ Adoption of Customer Protection Rules, 43 FR 31886, 31888
(July 24, 1978).
\208\ 17 CFR 1.55(i).
\209\ 17 CFR 1.55(k)(8), (11).
\210\ Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506, 68564 (Nov. 14, 2013).
\211\ See 17 CFR 1.55(i).
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In its comment in response to the First Proposal, the JAC contended
that the Disclosure Document should be provided directly to the
authorized representative of a customer to ensure the customer has a
complete understanding of how its accounts will be combined in FCM
bankruptcy. The JAC also requested that the Commission clarify what is
meant by ``delivered separately'' to the underlying customer. The
Commission notes that in this Second Proposal, ``delivered separately''
has been changed to ``delivered directly,'' to clarify that the
Disclosure Document must be provided specifically to the customer.
The JAC also contended that the regulation Sec. 1.55(i) disclosure
should be expanded ``not only to indicate that the FCM permits separate
account treatment, but also to include a thorough discussion of
additional risks to other customers as highlighted by the Commission in
the Preamble discussion.'' \212\ In the Commission's view, the proposed
conditions for separate account treatment are intended to achieve the
same risk management objectives that would otherwise be achieved
through application of the Margin Adequacy Requirement, and an FCM that
complies with those conditions would not subject customers other than
separate account customers to substantial additional or different
risks. Nonetheless, while such risks may not be substantial, they
cannot be said to be nonexistent, and so the Commission is adding in
proposed regulation Sec. 1.44(h)(4) to the disclosure proposed in the
First Proposal the language 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.''
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\212\ JAC Comment Letter.
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Additionally, the JAC recommended that the Commission address how
separate account treatment may impact a pro rata distribution in the
event of a clearing FCM bankruptcy. For the avoidance of doubt, the
Commission confirms that, if an FCM disburses funds to a customer
receiving separate treatment which would not otherwise have been
available if the accounts were treated on a gross basis, the FCM
subsequently declares bankruptcy and, as a result of the separate
account disbursement, the customer has a smaller amount of funds on
deposit when its separate accounts are combined in bankruptcy, then the
customer may share in any shortfall in customer funds at the FCM to a
lesser extent than would a customer not subject to separate account
treatment. This result is an inherent risk of separate account
treatment, but is not unique; any customer that reduces their amount of
margin on deposit at an FCM shortly before the FCM goes into bankruptcy
(either by reducing excess margin, or reducing the risk of their
positions and withdrawing the resulting margin excess) would similarly
benefit.
Additionally, 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 proposes this 30-day period to further ensure that FCMs will
conduct a diligent and thorough review to confirm that the
circumstances leading to cessation of separate account treatment have
been cured, and 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)(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, while 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 in order to achieve more 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 of time, 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.
L. Proposed Appendix A to Part 1
As discussed above, the Commission proposes 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 proposed 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. As discussed above, the procedures for adding
currencies to or removing currencies from proposed Appendix A to part 1
would be set forth in proposed regulation Sec. 1.44(f)(8).
In the First Proposal, the Commission proposed that margin paid in
JPY would receive two-business day treatment and requested that
commenters indicate which, if any, additional currencies would require
similar treatment. In its comment, FIA stated, based on its members'
knowledge and experience, considering time zone limitations and
[[Page 15340]]
industry settlement conventions, that the following currencies may also
require such treatment: Australian dollar (AUD), Chinese renminbi
(CNY), Hong Kong dollar (HKD), Hungarian forint (HUF), Israeli new
shekel (ILS), New Zealand dollar (NZD), Singapore dollar (SGD), South
African rand (ZAR), and Turkish lira (TRY).\213\ The Commission is
persuaded by this analysis, and understands that the list of currencies
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 proposes that the initial currencies under
proposed Appendix A to part 1 should be AUD, HKD, HUF, ILS, NZD, SGD,
ZAR, TRY, and CNY. The Commission would welcome further comment
indicating industry settlement conventions for other currencies.
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\213\ FIA Comment Letter.
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M. Proposed 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 Commission
regulation Sec. 17.04 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.\214\
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\214\ See Sec. 39.13(g)(8)(i).
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In proposing regulation Sec. 1.58(a), 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.'' \215\ 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.
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\215\ See Gross Margining of Omnibus Accounts, 46 FR 62864 (Dec.
29, 1981).
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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.'' \216\ 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.\217\ The
Commission stated, as its rationale, that it
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\216\ See Derivatives Clearing Organization General Provisions
and Core Principles, 76 FR 69334, 69375 (Nov. 8, 2011).
\217\ See id., regulation Sec. 39.13(g)(8)(i).
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.\218\
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\218\ 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.'' \219\
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\219\ Id. at 69376 n. 133 (citing CPSS-IOSCO Consultative Report
[on PFMI], Principle 14: Segregation and Portability, Explanatory
Notes 3.14.6 and 3.14.8, at 67-68).
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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 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 Cleared Swaps in addition to domestic futures.\220\
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\220\ 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 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 is not proposing to require gross margining with respect
to 30.7 accounts.
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Accordingly, the Commission is proposing to amend regulations Sec.
1.58(a) and (b) to require, in the case of (a), addressing gross
collection of margin generally, that each 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, and, in the case
of (b), addressing entitlement to spread or hedge margin treatment,
that where an FCM 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 this proposal, clearing FCM initial and maintenance margin
requirements for separate accounts of the same customer are proposed to
be calculated on a gross basis as the margin for accounts of distinct
customers.\221\ The Commission preliminarily believes
[[Page 15341]]
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.\222\ The Commission is therefore
proposing 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 proposed 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.\223\
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\221\ See proposed regulation Sec. 1.44(g)(2).
\222\ 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.
\223\ 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.
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N. Proposed Amendments to Regulation Sec. 1.73
The Commission proposes 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 receiving separate
treatment, 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 proposes this
amendment to ensure that, where non-clearing FCMs are engaging in
separate account 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 will link with 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,\224\
to manage the risk of accounts subject to separate treatment. 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 would 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.
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\224\ CFTC Letter No. 19-17 (Condition 3).
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O. Proposed Amendments to Regulation Sec. 30.2
Commission 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.\225\ Regulation Sec. 1.44 is currently reserved,
and the Commission is proposing to amend regulation Sec. 30.2(b) to
remove regulation Sec. 1.44 from the list of excluded
regulations.\226\
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\225\ 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. Commission regulation Sec.
30.7 addresses the segregation requirements of 30.7 customer funds.
\226\ Regulation Sec. 1.44 is currently reserved and,
accordingly, does not impose any regulatory obligation on an FCM.
When 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.
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The proposed amendment to regulation Sec. 30.2(b) is consistent
with the proposed 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 is also proposing 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,\227\ 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.
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\227\ Foreign Futures and Foreign Options Transactions, 52 FR
28980 (Aug. 5, 1987).
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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. However, regulation Sec. 30.2
was not amended to conform with that intention. The Commission proposes
to address that now.
P. Proposed Amendments to Regulation Sec. 39.13(g)(8)
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.\228\ The Commission
proposes 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.
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\228\ 17 CFR 39.13(g)(3)(i)(A).
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The Commission also proposes 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 proposes this
amendment to ensure that the carve-out (represented by proposed
regulation Sec. 1.44(c) through (h)) to the Margin Adequacy
Requirement (represented by proposed 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).
Question 8: If the Commission includes the Margin Adequacy
Requirement and requirements regarding separate account treatment in
[[Page 15342]]
Part 1 of its regulations as proposed, should the Commission remove
regulation 39.13(g)(8)(iii)?
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.\229\ 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 the proposed regulation 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 proposed regulation; (2) the alternatives contemplated
by the Commission and their costs and benefits; and (3) the impact of
the proposed regulation on the Section 15(a) Factors.
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\229\ 7 U.S.C. 19(a).
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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 proposed amendments in quantitative terms, including Paperwork
Reduction Act (PRA)-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 proposed 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. The Commission welcomes comments on any such costs,
especially by clearing FCMs, who may be better able to provide
quantitative costs data or estimates, based on their respective
experiences relating to the application of CFTC Letter No. 19-17.
Notwithstanding these types of limitations, the Commission otherwise
identifies and considers the costs and benefits of these proposed rule
amendments in qualitative terms.
In the following consideration of costs and benefits, the
Commission first identifies and discusses the benefits and costs
attributable to the proposed rule amendments. Next, the Commission
identifies and discusses the benefits and costs attributable to the
proposed rule amendments as compared to alternatives to the proposed
rule amendments. The Commission, where applicable, then considers the
costs and benefits of the proposed 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
proposed 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.\230\
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\230\ See, e.g., 7 U.S.C. 2(i).
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The Commission generally requests comment on all aspects of its
cost-benefit considerations, including the identification and
assessment of any costs or benefits not discussed herein; the potential
costs and benefits of the alternatives that the Commission discussed in
this release; data and any other information to assist or otherwise
inform the Commission's ability to quantify or qualitatively describe
the costs and benefits of the proposed rule amendments; and
substantiating data, statistics, and any other information to support
positions posited by commenters with respect to the Commission's
discussion. Commenters may also suggest other alternatives to the
proposed approach where the commenters believe that the alternatives
would be appropriate under the CEA and would provide a more appropriate
cost-benefit profile.
The Commission is also including a number of questions for the
purpose of eliciting cost and benefit estimates from public commenters
wherever possible. Quantifying other costs and benefits, such as the
effects of potential changes in the behavior of FCMs resulting from the
proposal are inherently harder to measure. Thus, the Commission is
similarly requesting comment through questions to help it better
quantify these impacts. Due to these quantification difficulties, for
this NPRM (Second Proposal), the Commission offers the following
qualitative discussion of its costs and benefits.
1. Proposed Regulation
The Commission is proposing to promulgate 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)
(proposed 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 conditions
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
such separate account treatment (proposed regulation Sec. 1.44(c)
through (h)).\231\ The Commission is also proposing to revise
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 (proposed 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 (proposed
[[Page 15343]]
amendments to regulation Sec. 39.13), to facilitate full
implementation of the Margin Adequacy Requirement and conditions for
separate account treatment.
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\231\ Proposed regulation Sec. 1.44(a) provides definitions
supporting the other paragraph of the regulation.
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2. Baseline: Current Part 1 and Regulation 39.13(g)(8)(iii)
The Commission identifies the costs and benefits of the proposed
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 proposed rule amendments is the Commission
regulations now in effect; specifically, part 1 of the Commission's
regulations (where the operative part of the proposed regulation 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 proposed regulation 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
would be directly affected by the proposed regulation. 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 proposed regulation.
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.\232\ 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.
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\232\ 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, the proposed part 1 Margin Adequacy
Requirement is unlikely to impose significant costs on, or cause
significant benefits with respect to, clearing FCMs. The Commission
seeks comment on the validity of that assumption.
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b. Baseline With Respect to Non-Clearing FCMs
Commission regulations do not, either directly or indirectly,
impose a Margin Adequacy Requirement on non-clearing FCMs. Accordingly,
they currently have no need to engage in separate account treatment
with respect to such a requirement.
The Commission's current part 1 regulations do 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 have 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 would not
be 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).
B. Consideration of the Costs and Benefits of the Commission's Action
1. Benefits
a. Margin Adequacy Requirement (Proposed Regulation Sec. 1.44(b))
As discussed above, the Commission is proposing to (a) promulgate
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 under-margining
scenario; and (b) make 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 proposed regulation.
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.\233\ 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.\234\ 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.
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\233\ Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D).
\234\ Section 5b(c)(2)(D)(iv) of the CEA, 7 U.S.C. 7a-
1(c)(2)(D)(iv).
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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 preliminarily believes that, to the extent there are
failures in compliance with respect to margin adequacy, proposed
regulation Sec. 1.44(b) will provide an additional avenue (i.e.,
through the Commission) for monitoring and enforcement of margin
adequacy for clearing FCMs. Moreover, proposed regulation Sec. 1.44(b)
will expand the Margin Adequacy Requirement to apply to foreign futures
transactions cleared
[[Page 15344]]
through both clearing and non-clearing FCMs.\235\
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\235\ 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.
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With respect to non-clearing FCMs, the Margin Adequacy Requirement
of proposed 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 under-
margining 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.\236\
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\236\ 7 U.S.C. 6d(a)(2); 17 CFR 1.20(a); 17 CFR 1.22(a).
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The Commission preliminarily believes that proposed 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
under-margining 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 preliminarily 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 under-margining
situations, is reasonably necessary to better effectuate CEA section
4d(a)(2) and to better 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 (Proposed Regulation
Sec. 1.44(c) Through (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 investment managers to achieve certain commercial
purposes.\237\ For example, where a customer has apportioned assets
among multiple investment managers, neither the customer nor their
investment managers may be able to obtain certainty that the individual
portion of funds allocated to one investment manager will not be
affected by the activities of other investment managers.
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\237\ See First FIA Letter.
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Where FCMs are able to treat the separate accounts of a single
customer as accounts of separate entities for purposes of the proposed
Margin Adequacy Requirement, customers benefit from being better able
to leverage the skills and expertise of investment managers, and
realize the benefits of a balance of 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 under-margining of customer accounts. By
applying regulatory safeguards designed to preserve the goals of the
Margin Adequacy Requirement during such treatment, the proposal 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, section 4d(a)(2) of the CEA and Commission
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 \238\--requirements which serve to further the CEA's purposes
(as set forth in section 3(b)) of protecting customer funds and
avoiding systemic risk.
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\238\ 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).
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Part 1 of the Commission's regulations contain the principle
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 CEA section 4d(a)(2)'s customer fund protection
and risk avoidance requirements \239\ while offering commercial utility
for a variety of market participants. However, part 1 does not
currently contain any regulations imposing such a Margin Adequacy
Requirement, or governing the manner in which separate account
treatment may be conducted.
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\239\ And, similarly, those of CEA section 4d(f)(2) and 4(b).
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The proposed regulation is designed to achieve the benefit of
bridging this gap by
(i) inserting a Margin Adequacy Requirement (proposed 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 under-margining 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
[[Page 15345]]
discussed above (proposed 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 (proposed
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 (or an FCM with respect to all of its separate account
customers) from separate account treatment, with the benefit of
mitigating risk by suspending separate account treatment under such
circumstances (proposed regulation Sec. 1.44(e)),
(v) requiring that separate accounts be on a one business day
margin call, while setting forth limited circumstances where failure to
actually receive margin on a same-day basis may be excused, with the
benefit of limiting the extent of potential under-margining, (proposed
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 (proposed
regulation Sec. 1.44(g) through (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.
Proposed 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 proposed regulation Sec. 1.44 and facilitate
implementation of provisions in proposed regulation Sec. 1.44 that
would affect compliance with financial requirements for FCMs,
collection of margin, and FCM risk management. Additionally, a proposed
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 proposed
regulation Sec. 1.44(b), does not require DCOs to preclude separate
account treatment carried out subject to proposed regulation Sec.
1.44.
The Commission preliminarily believes that proposed regulation
Sec. 1.44(c) through (h), and proposed 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 proposed
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 proposed regulation
Sec. 1.44(c) through (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 proposed rule amendments as realized in the market
may not be as significant as a comparison of the rule to the regulatory
baseline would suggest.\240\
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\240\ 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 after this proposed
regulation were to be adopted, 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.
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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 changes. This could entail significant
expenditures of funds and resources in order to rework systems,
procedures, and customer documentation for such FCMs.\241\ Hence,
actual benefits to the regulation may accrue from the ability of many
FCMs to avoid these costs.
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\241\ 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.
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Request for Comment
Question 9: What evidence can be provided that customers have been
able to achieve better performance by virtue of allowing separate
account treatment? Is there evidence of under margining due to separate
account treatment since CFTC Letter No. 19-17 was issued?
Question 10: Is there 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?
2. Costs
The proposed regulation would (i) amend part 1 of the Commission
regulations to add a new requirement (proposed 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) amend part 1 to, in the same new section,
(proposed regulation Sec. 1.44(c-h)) permit FCMs, subject to certain
conditions and for purposes of the Margin Adequacy Requirement, treat
the accounts of a single customer as accounts of separate entities; and
(iii) amend existing regulations in parts 1 and 39 to facilitate
implementation of the proposed 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 60 registered
FCMs, and of these, the Commission estimates that approximately 40 are
clearing FCMs and approximately 20 are non-clearing FCMs.\242\ While
the proposed regulation 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.\243\ Accordingly, as
noted in connection with the Commission's discussion below related to
the PRA, the Commission estimates that 30 FCMs
[[Page 15346]]
will choose to apply separate account treatment.
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\242\ CFTC, Financial Data for FCMs, Sept. 20, 2023, available
at https://www.cftc.gov/MarketReports/financialfcmdata/index.htm.
\243\ See CME Comment Letter (noting that 14 of 42 clearing FCMs
at CME had notified CME that they intended to avail themselves of
the no-action position in CFTC Letter No. 19-17, but that a number
of these firms did not ultimately implement separate account
treatment).
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a. Margin Adequacy Requirement (Proposed Regulation Sec. 1.44(b))
The Margin Adequacy Requirement of proposed regulation Sec.
1.44(b) would require 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 proposed requirement indirectly to clearing FCMs,
through the rules of their DCOs. Because clearing FCMs are already
functionally subject to the Margin Adequacy Requirements of proposed
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.
Non-clearing FCMs are not currently 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 proposed 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 in 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 (Proposed Regulation
Sec. 1.44(c) Through (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 proposed
regulation Sec. 1.44(b), the Commission is also proposing in proposed
regulation Sec. 1.44(c) through (h) rules to allow FCMs to apply
separate account treatment for purposes of the Margin Adequacy
Requirement, and requirements for the application of such treatment.
The proposed 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 to
allow for 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 proposed regulation, 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 FCMs or non-clearing FCMs, and the requirements of the
proposed regulation generally do not distinguish between clearing FCMs
and non-clearing FCMs.\244\
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\244\ 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 proposed regulation Sec. 1.44(g)(2) and existing
regulation Sec. 39.13(g)(8)(i), as clarified by proposed regulation
Sec. 39.13(g)(8)(i)(E) for clearing FCMs, and proposed 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 proposed 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.
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The costs of the proposed regulation 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 proposed regulation, 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 proposed 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
proposed regulation.
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.'' \245\
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\245\ FIA letter dated Apr. 1, 2022 to Clark Hutchison and
Amanda Olear (Second FIA Letter).
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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
[[Page 15347]]
position, clearing FCMs were required to review and in some cases amend
customer agreements, and identify and implement information technology
systems changes.\246\ FIA also asserted that clearing FCMs were likely
required to revise internal controls and procedures.\247\ 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.\248\ FIA further stated that because
the relevant provisions of these agreements were not uniform, they
generally required individual attention.\249\
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\246\ 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.
\247\ Id.
\248\ Id.
\249\ Id.
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The Commission anticipates that similar costs would arise for FCMs
attempting to meet the requirements of the proposed separate accounts
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,\250\ 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 proposed regulation would codify 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 proposed regulation, as well as negotiation costs,
even where direct recordkeeping costs may not be significant on an
entity-by-entity basis.\251\
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\250\ As discussed below, the Commission staff estimates total
annual costs of $1,700,010 across 30 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.
\251\ 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 conditions of the proposed regulation, but would not
need to retrofit existing policies, procedures, and systems.
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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 proposed rule amendments as realized
in the market may not be as significant as a comparison of the rule to
the regulatory baseline would suggest.\252\ 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 the proposed regulation on an ongoing basis will largely
have already been built, and the costs associated with compliance will
largely have already been incurred.\253\ (This would not apply to non-
clearing FCMs, who have no current need to rely on the effects of the
no-action position.) However, the Commission notes that because the
provisions of the proposed regulation 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.
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\252\ 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 after this proposed
regulation were to be adopted, the Commission submits that there
will be significant costs similar to non-clearing FCMs.
\253\ Communications from FIA indicate that significant
resources have, in fact, been expended to meet the conditions of the
NAL. See Second FIA Letter.
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In addition to compliance costs, one other type of costs should be
noted: The Commission is of the view that the risk mitigants in
proposed regulation Sec. 1.44(c) through (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 under-margin 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.
Question 11: Are 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
appropriately comprehensive? What data can be provided about the
magnitude of these costs, either by type or in the aggregate?
Question 12: The Commission requests 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.
Commenters are requested to provide data where available.
Question 13: The Commission requests comment regarding whether
there are FCMs that chose not to rely on the no-action position
provided by CFTC Letter No. 19-17 due to the conditions required to
rely on that position. The Commission further requests comment on how
the implementation of those conditions in the current rulemaking
proposal could be modified to mitigate the burden of compliance while
achieving the goals of mitigating systemic risk and protecting customer
funds.
C. Costs and Benefits of the Commission's Action as Compared to
Alternatives
The Commission considered as an alternative to the proposed
regulation
[[Page 15348]]
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--proposed to be 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 proposed regulation Sec. 1.44(b)). The Commission
preliminarily 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 separate
account treatment in cases in which a customer is in financial
distress, it is more likely that an under-margining 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 to evaluate
the costs and benefits of a proposed regulation in light of
considerations of protection of market participants and the public. The
Commission preliminarily believes that the amendments proposed 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 proposed regulation'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 proposed
regulation 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 \254\ 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.
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\254\ 7 U.S.C. 7a-1(c)(2)(D)(iii) through (iv).
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The Commission also believes the requirements in the proposed
regulation 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 proposed to be 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, separate account
treatment is 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 proposed regulation would also put 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 four years, successfully relied
on a no-action letter, as applied through their DCOs, establishing
conditions substantially similar to the conditions in the proposed
rule, and the Commission believes codification of these conditions, as
proposed herein, supports protection of market participants and the
public.
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 a proposed regulation in light of efficiency,
competitiveness, and financial integrity of futures markets. The
Commission preliminarily believes that the proposed regulation may
carry potential implications for the financial integrity of markets,
but not for the efficiency or competitiveness of markets, which the
Commission preliminarily 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 cascading consequences for the clearing FCM (if
applicable) or the DCO and the wider financial system. The proposed
Margin Adequacy Requirement advances those purposes directly. The
proposed amendments permitting separate account treatment reflect the
Commission's preliminary conclusion that the conditions of CFTC Letter
No. 19-17, as proposed to be codified herein, are sufficient and
appropriate to guard against such risks for purposes of the proposed
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.\255\ By proposing to
codify in part 1 a Margin Adequacy
[[Page 15349]]
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
proposing 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.
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\255\ See First FIA Letter; SIFMA-AMG Letter; CME Letter.
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3. Price Discovery
Section 15(a)(2)(C) of the CEA requires the Commission to evaluate
the costs and benefits of a proposed regulation in light of price
discovery considerations. The Commission preliminarily believes that
the proposed 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 a proposed regulation 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 proposed Margin Adequacy
Requirement serves these purposes by further ensuring that FCMs do not
allow customers to create or increase under-margining 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 proposed
regulation will also apply this requirement to non-clearing FCMs, and
will create another avenue to monitoring and enforcement of this
requirement for clearing FCMs.
Additionally, the Commission believes that the proposed regulation
will ensure that application of the proposed regime 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 separate account
treatment in certain instances of operational or financial distress.
The Commission preliminarily 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.\256\
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\256\ See, e.g., First FIA Letter (describing use of separate
account treatment for hedging purposes).
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5. Other Public Interest Considerations
Section 15(a)(2)(e) of the CEA requires the Commission to evaluate
the costs and benefits of a proposed regulation 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.
Request for Comment
Question 14: The Commission requests comment, including any
available quantifiable data and analysis, concerning its analysis of
the Section 15(a) factors.
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.\257\
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\257\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the proposed regulation implicates any
other specific public interest to be protected by the antitrust laws.
The Commission has considered the proposed regulation to determine
whether it is anticompetitive and has preliminarily identified no
anticompetitive effects. The Commission requests comment on whether the
proposed regulation is anticompetitive and, if it is, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
proposed regulation is not anticompetitive and has no anticompetitive
effects, the Commission has not identified any less anticompetitive
means of achieving the purposes of the CEA. The Commission requests
comment on whether there are less anticompetitive means of achieving
the relevant purposes of the CEA that would otherwise be served by
adopting the proposed regulation.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires agencies to consider
whether the rules they propose will 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.\258\ The
rules proposed 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 conditions 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.\259\ The Commission has
previously determined that FCMs are not small entities for the purpose
of the RFA.\260\ Accordingly, the Chairman, on behalf of the
Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that these
proposed rules will not have a significant economic impact on a
substantial number of small entities.
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\258\ 5 U.S.C. 601 et seq.
\259\ 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)).
\260\ 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)).
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C. Paperwork Reduction Act
The PRA \261\ imposes certain requirements on Federal agencies in
[[Page 15350]]
connection with their conducting or sponsoring any collection of
information as defined by the PRA. Any 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 not yet assigned a control
number to the new collection.
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\261\ 44 U.S.C. 3501 et seq.
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This proposed rulemaking would result in a new collection of
information within the meaning of the PRA, as discussed below. The
Commission therefore is submitting this proposal to OMB for review, in
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. If adopted,
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.
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.\262\ 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.
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\262\ 7 U.S.C. 12(a)(1).
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1. Information Provided by Reporting Entities/Persons
The proposed regulation 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 conditions specified in proposed 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 proposed regulation. For these
clearing FCMs, the Commission expects that any additional cost or
administrative burden associated with complying with the proposed
regulation would be reduced.\263\
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\263\ However, the Commission expects that FCMs that do not
currently rely on the no-action position, but choose to apply
separate account treatment after (and if) the proposed regulation is
finalized, would incur new costs. This would include all non-
clearing FCMs that choose to apply separate account treatment after
(and if) the proposed regulation is finalized.
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a. Reporting Requirements
The proposed regulation 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 61 registered FCMs.\264\ The
Commission staff estimates that slightly less than half of all FCMs
would engage in separate account treatment under the proposed
regulation, resulting in approximately 30 respondents.
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\264\ 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%20webpage%20Update%20-%20August%202023.xlsx.
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First, proposed 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 proposed
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 respondents could expend
up to $273, based on an hourly rate of $273,\265\ to comply with the
proposed regulation. This would result in an annual burden of 30 hours
and an aggregated cost of $8,190 (30 respondents x $273).
---------------------------------------------------------------------------
\265\ 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 2022 [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 2022: 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 $117,270. 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 1.0494 to account for the 4.94% change in the
Consumer Price Index for Urban Wage-Earners and Clerical Workers
between May 2022 and September 2023 (288.022 to 302.257). 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
$273. 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, proposed 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.\266\ 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 * 8 hours/response * 30 respondents). In addition, the
Commission staff estimates that each respondent could expend up to
$4,368 annually, based on an hourly rate of $273, to comply with this
requirement.\267\ This would result in an aggregated cost of $131,040
per annum (30 respondents x $4,368).
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\266\ The Commission staff applies the same assumption to
notifications to DSROs and the Commission with respect to proposed
regulation Sec. 1.44(d)(2) and proposed regulation Sec.
1.44(e)(3).
\267\ Financial Examiners.
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The aggregate information collection burden estimate associated
with the proposed reporting requirements is as follows: \268\
---------------------------------------------------------------------------
\268\ This estimate reflects the aggregate information
collection burden estimate associated with the proposed reporting
requirements for the first annual period following implementation of
the proposed regulation. Because proposed regulation Sec.
1.44(d)(2) would 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 would be
reduced accordingly.
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[[Page 15351]]
Estimated number of respondents: 30.
Estimated number of reports: 90.
Estimated annual hours burden: 510.
Estimated annual cost: $139,230.
b. Disclosure Requirements
The proposed regulation contains three disclosure requirements that
could affect ten or more persons in a 12-month period.
First, proposed 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 125 responses per respondent on a one-time basis, and that
respondents are likely to spend one hour to comply with this
requirement for a total of 125 annual burden hours and up to $19,500
annually, based on an hourly rate of $156.\269\ This would result in an
annual burden of 3,750 hours and an aggregated cost of $585,000 (30
respondents x $19,500). This estimate reflects an initial disclosure
distributed to existing customers subject to separate account
treatment. 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.
---------------------------------------------------------------------------
\269\ This figure is based on the annual mean wage of $67,070
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. https://www.bls.gov/oes/current/oes436012.htm.
---------------------------------------------------------------------------
Second, proposed regulation Sec. 1.44(h)(3)(iii) requires that an
FCM engaging in separate account treatment include the disclosure
statement required by proposed 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 proposed requirement would result
in a total of one response on a one-time basis, and that each
respondent could expend up to $580 annually, based on an hourly rate of
$580,\270\ to comply with the proposed regulation. This would result in
an estimated 30 burden hours annually and an aggregated cost of $17,400
(30 respondents x $580). This estimate reflects one updated disclosure
distributed to existing customers. If the FCM opts to include the
disclosure on its website, the Commission staff estimates that this
proposed requirement would result in a total of one response on a one-
time basis, and that each respondent could expend up to $293 annually,
based on an hourly rate of $293, to comply with the proposed
regulation.\271\ This would result in an estimated 30 burden hours
annually and an aggregated cost of $8,790 (30 respondents x $293). 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.
---------------------------------------------------------------------------
\270\ BLS 2022 Data for BLS Category 23-1011, ``Lawyers,'' in
Securities, Commodity Contracts, and Other Financial Investments and
Related Activities, https://data.bls.gov/oes/#/indOcc/Multiple%20occupations%20for%20one%20industry (mean annual salary of
$248,830).
\271\ This figure is based on the annual mean wage for BLS
category 15-1254, ``Web Developers.'' According to BLS, the mean
salary for this category in the context of Securities, Commodity
Contracts, and Other Financial Investments and Related Activities is
$125,760.
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Third, proposed regulation Sec. 1.44(h)(4) requires an FCM that
has made an election pursuant to regulation Sec. 1.44(d) 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 terms and conditions 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 that respondents could expend up to
$580 annually, based on an hourly rate of $580,\272\ to comply with the
proposed regulation. This would result in an estimated 30 burden hours
annually and an aggregated cost of $17,400 (30 respondents x $580).
This estimate reflects an initial updated disclosure distributed 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.
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\272\ Lawyers.
---------------------------------------------------------------------------
The aggregate information collection burden estimate associated
with the proposed disclosure requirements is as follows: \273\
---------------------------------------------------------------------------
\273\ 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
proposed regulation Sec. 1.44(h)(3) on their websites and within
their Disclosure Document required by proposed regulation Sec.
1.55(i), in order to comply with proposed regulation Sec.
1.44(h)(3)(iii). Additionally, this estimate reflects the aggregate
information collection burden estimate associated with the proposed
disclosure requirements for the first annual period following
implementation of the proposed regulation. Because each of proposed
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.
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Estimated number of respondents: 30.
Estimated number of reports: 3,840.
Estimated annual hours burden: 3,840.
Estimated annual cost: $628,590.
c. Recordkeeping Requirements
The proposed regulation contains four recordkeeping requirements
that could affect ten or more persons in a 12-month period.
First, 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 the Margin Adequacy Requirement, the FCM
shall include the customer on a list of separate account customers
maintained in its books and records receiving such treatment. The
Commission staff estimates that this would result in a total of 125
responses per respondent on a one-time basis, and that respondents
could expend up to $8,531 annually, based on an hourly rate of
$273,\274\ to comply with the proposed regulation. This would result in
an estimated 938 burden hours annually and an aggregated cost of
$255,930 per annum (30 respondents x $8,531).
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\274\ Financial Examiners.
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Second, proposed 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 separate
account treatment 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 separate account treatment 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, and that
[[Page 15352]]
respondents could expend up to $1,092 annually, based on an hourly rate
of $273,\275\ to comply with this requirement. This would result in an
aggregated cost of $32,760 per annum (30 respondents x $1,092).
---------------------------------------------------------------------------
\275\ Financial Examiners.
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Third, proposed 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,\276\ and that
respondents could expend up to $19,500 annually, based on an hourly
rate of $156.\277\ This would result in an estimated 3,750 burden hours
annually and an aggregated cost of $585,000 per annum (30 respondents x
$19,500).
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\276\ 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. The Commission staff estimates,
based on the 30 largest FCMs by customer assets in segregation as of
the Commission's FCM financial data report for May 31, 2022, that
there are 3,750 customers of FCMs whose accounts could be in scope
for the proposed regulation, with an average of 125 customers per
FCM.
\277\ This figure is based on the annual mean wage of $67,070
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.
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Fourth, proposed regulation Sec. 1.44(h)(3)(ii) requires that an
FCM maintain documentation demonstrating that the part 190 disclosure
statement required by proposed 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, and that respondents could expend up to $1,950 annually,
based on an hourly rate of $156, to comply with the proposed
regulation. This would result in an estimated 375 burden hours annually
and an aggregated cost of $58,500 (30 respondents x $1,950). 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 proposed
regulation Sec. 1.44(h)(3)(ii) would be required only with respect to
new customers who receive disclosures pursuant to proposed regulation
Sec. 1.44(h)(3)(ii), and the costs and burden hours associated with
proposed regulation Sec. 1.44(h)(3)(ii) would be reduced
accordingly.\278\
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\278\ This estimate reflects the aggregate information
collection burden estimates associated with the proposed disclosure
requirements for the first annual period following implementation of
the proposed regulation. Because, as noted above, proposed
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.
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The Commission notes that while certain other provisions of the
proposed regulation 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.
The aggregate information collection burden estimate associated
with the proposed reporting requirements is as follows:
Estimated number of respondents: 30.
Estimated number of reports: 11,310.
Estimated annual hours burden: 5,183.
Estimated annual cost: $932,190.
2. Information Collection Comments
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission will consider public comments on this proposed collection of
information regarding:
Evaluating whether the proposed collection of information
is necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
Evaluating the accuracy of the estimated burden of the
proposed collection of information, including the degree to which the
methodology and the assumptions that the Commission employed were
valid;
Enhancing the quality, utility, and clarity of the
information proposed to be collected; and
Reducing the burden of the proposed information collection
requirements on registered entities, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques; e.g., permitting electronic
submission of responses.
Organizations and individuals desiring to submit comments on the
proposed information collection requirements should send those comments
to:
The Office of Information and Regulatory Affairs, Office
of Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
(202) 395-6566 (fax); or
[email protected] (email).
Please provide the Commission with a copy of submitted comments so
that, if the Commission determines to promulgate a final rule, all such
comments can be summarized and addressed in the final rule preamble.
Refer to the ADDRESSES section of this notice of proposed rulemaking
for comment submission instructions to the Commission. A copy of the
supporting statements for the collections of information discussed
above may be obtained by visiting RegInfo.gov. OMB is required to make
a decision concerning the collection of information between 30 and 60
days after publication of this document in the Federal Register.
Therefore, a comment is best assured of receiving full consideration if
OMB receives it within 30 days of publication of this notice of
proposed rulemaking. Nothing in the foregoing affects the deadline
enumerated above for public comment to the Commission on the proposed
rules.
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.
[[Page 15353]]
For the reasons set forth in the preamble, the Commodity Futures
Trading Commission proposes to amend 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 the paragraph heading of paragraph (b);
0
b. Revising paragraph (b)(6);
0
c. Revising introductory text of paragraph (b)(8);
0
d. Adding new paragraph (b)(8)(v);
0
e. Republishing the paragraph heading of paragraph (c);
0
f. Republishing the paragraph heading of paragraph (c)(2);
0
g. Revising paragraph (c)(2)(i);
0
h. Republishing the paragraph heading of paragraph (c)(4);
0
i. Revising paragraph (c)(4)(ii);
0
j. Republishing the paragraph heading of (c)(5); and
0
k. 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 of this part, 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 of this
paragraph (c)(2)(i), a futures commission merchant that carries
separate accounts for separate account customers pursuant to Sec. 1.44
of this part 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. If a separate account does not meet a
previous day's margin call for a deficit or debit balance, the futures
commission merchant shall exclude all separate accounts of that
separate account customer carried by the futures commission merchant
that have a deficit or debit ledger balance from current assets under
this paragraph.
* * * * *
(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 of this part 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
[[Page 15354]]
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 of this
part, 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 all separate accounts of that separate
account customer 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) of this section.
(D) In the event that an owner of a customer account, or a customer
separate account pursuant to Sec. 1.44 of this part, 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) of this section 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 paragraph (c)(5) of this section;
* * * * *
0
4. Amend Sec. 1.20 by revising paragraph (i)(4) and adding new
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 above, 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 (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 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 (Sec.
241.15c3-1(c)(11) of this title).
(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 (Sec. 240.15c3-1(c)(2)(vi)
of this title). 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 (Sec. 240.15c3-1(c)(2)(vi) of this title) 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 adding new paragraph (l) to read 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 of this part shall:
(i) 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;
(ii) 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
(iii) 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
[[Page 15355]]
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 of this
part, a Cleared Swaps Customer Account as defined in Sec. 1.3 of this
part, 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 of this part,
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 standard day-to-day operation
of the futures commission merchant's business relationship with its
separate account customer. Events specified in paragraph (e) of this
section are inconsistent with the ordinary course of business.
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 exceeds 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 (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. 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 (1) above, where the previous day
(excluding Saturdays and Sundays) is a holiday, as defined in Sec.
1.44(a) of this chapter, where any designated contract market 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
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 paragraph
1.12(n)(3) of this part.
(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 of this part or Sec. 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
[[Page 15356]]
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 paragraphs (e)(1) or
(e)(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 paragraph 1.12(n)(3) of this
part.
(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 separate account treatment 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.
(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 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 by up to one additional
business day and still be considered in compliance with the
requirements of this paragraph (f) if payment is delayed due to a
banking holiday in the jurisdiction of issue of the currency. For
payments in Euro, either the separate account customer or the
investment manager managing the separate account may designate one
country within the Eurozone that they have the most significant
contacts with for purposes of meeting margin calls in that separate
account, whose banking holidays shall be referred to for this purpose.
(5) 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 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 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 paragraph (f)(1)
through (5) of this section, or engages in practices that are designed
to circumvent this paragraph (f).
(7) In the case of a holiday where any designated contract market
on which the futures commission merchant trades is open for trading,
and where a separate account of any of the futures commission
merchant's separate account customers includes positions traded on such
a market, 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
[[Page 15357]]
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) of this chapter.
(iii) The Commission shall review a submission made pursuant to
paragraph (f)(8) of this section 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 paragraph (f)(8) of this section, 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 of this part 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 of this part, 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. Sec. 1.20(i),
22.2(f), or 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.
(6) In determining its residual interest target for purposes of
Sec. Sec. 1.11(e)(3)(i)(D) and 1.23(c) of this part, 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 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.
(3) A futures commission merchant must provide each separate
account customer 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 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) of this chapter.
(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 paragraph 1.55(i) of this part that
it permits the separate treatment of accounts for the same customer
under the terms and conditions of this Sec. 1.44 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. If the election pursuant to paragraph (d)
of this section for a
[[Page 15358]]
separate account customer is revoked, it may not be reinstated during
the 30 days following such revocation.
0
7. Amend Sec. 1.58 by revising paragraphs (a) and (b) and adding new
paragraph (c) 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 of this part,
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 new paragraph (c) 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 of this part, 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 was a clearing member of a
derivatives clearing organization.
0
9. Add new 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 Table 1 of this
Appendix A shall be considered in compliance with the requirements
of Regulation 1.44(f) of Part 1 of the Commission's regulations 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.
Table 1 to Appendix A
------------------------------------------------------------------------
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 heading of paragraph (f);
0
b. Revising paragraphs (f)(4) and (5);
0
c. Republishing the paragraph heading of paragraph (g); and
0
d. Adding new paragraph (g)(11).
The republications, revisions, and additions read as follows:
Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swaps Customer Collateral.
* * * * *
(f) Requirement as to amount.
* * * * *
(4) The futures commission merchant must, at all times, maintain in
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 above, 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 (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 (Sec.
241.15c3-1(c)(11) of this title).
(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
[[Page 15359]]
(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 (Sec. 240.15c3-1(c)(2)(vi)
of this title). 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 (Sec. 240.15c3-1(c)(2)(vi) of this title) 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 heading of paragraph (f);
0
b. Republishing the paragraph heading of paragraph (f)(2);
0
c. Revising paragraph (f)(2)(iv);
0
d. Adding paragraph (f)(2)(v);
0
e. Republishing the paragraph heading of paragraph (l); 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 above, 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 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 (Sec.
241.15c3-1(c)(11) of this title).
(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 (Sec. 240.15c3-1(c)(2)(vi)
of this title). 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 (Sec. 240.15c3-1(c)(2)(vi) of this title) 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.
* * * * *
[[Page 15360]]
(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 heading of paragraph (g);
0
b. Republishing the paragraph heading of paragraph (g)(8);
0
c. Adding paragraph (g)(8)(i)(E); and
0
d. Revising paragraph (g)(8)(iii).
The republications, addition and revision to 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 February 23, 2024, by the
Commission.
Robert Sidman,
Deputy 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 Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioners Goldsmith
Romero, Mersinger, and Pham voted in the affirmative. Commissioner
Johnson voted to concur. No Commissioner voted in the negative.
Appendix 2--Statement of Commissioner Kristin N. Johnson
Introduction
The Commodity Futures Trading Commission (Commission or CFTC)
has adopted several key regulations that establish guardrails to
protect against the misuse or misapplication of customer funds. The
Commodity Exchange Act (CEA) and Commission regulations establish
critical protections for customers to help prevent them from losing
money as a result of losses caused by their futures commission
merchant (FCM) or their fellow customers at the FCM. These include
Sections 4 and 4d of the CEA and Parts 1, 22, and 30 of the
Commission regulations, which require an FCM to segregate its own
funds from those of its customers and prohibit an FCM from using one
customer's funds to cover the losses of another.
A foundational principle of the Commission's customer protection
regime is a prohibition against the use of one customer's funds to
cover the liabilities of another customer. It is difficult to
overstate the importance of regulations that prevent this kind of
misuse, particularly when customer funds are commingled in a single
omnibus account.
The Commission must not weaken regulations intended to reinforce
these protections. Determining whether a regulation might result in
weakening these protections requires careful qualitative and
quantitative assessment and evaluation of (un)anticipated risks and
thoughtful reinforcement of robust risk management requirements.
The Commission is amending an existing customer protection
provision under CFTC Regulation 39.13(g)(8)(iii). This regulation
establishes a margin adequacy requirement by prohibiting the
withdrawal of funds by a customer of a clearing FCM if such
withdrawal would result in the account being undermargined. The
purpose of Commission Regulation 39.13(g)(8)(iii) is to mitigate the
risk that a clearing member, using an omnibus margin account, fails
to hold sufficient funds from one customer to cover that customer's
initial margin requirements and effectively covers the customer's
margin shortfall using another customer's funds.
The proposed amendment would codify the requirements of CFTC
Regulation 39.13(g)(8)(iii) in Part 1 of the Commission's
regulations governing FCMs, thus extending the requirements to non-
clearing FCMs as well, but would permit an FCM to treat the separate
accounts of a single customer, or beneficial owner, as accounts of
separate entities, subject to certain risk-mitigation conditions
(Proposed Rule).\1\ This amendment thus allows disbursements on a
separate account basis such that a customer may withdraw funds from
one account even if its other account is undermargined, so long as
the customer is in compliance with the relevant risk-management
conditions.
---------------------------------------------------------------------------
\1\ This would permit non-clearing FCMs to engage in separate
account treatment and would allow FCMs, rather than DCOs, to
determine whether or not to permit their customers to elect such
treatment.
---------------------------------------------------------------------------
It is indisputable that the Proposed Rule introduces risks that
do not exist under CFTC Regulation 39.13(g)(8)(iii). Permitting a
customer to withdraw ``excess'' margin from one account when it has
insufficient margin in another account could exacerbate the
customer's overall margin deficiency and any shortfall in the FCM's
customer account, amplify default risk, and increase fellow-customer
risk. Prior to finalizing this rule, it is imperative that the
Commission understand the potential risks that may arise by
permitting disbursements on a separate account basis.
Customer asset protections are essential to the individuals and
institutional businesses whose assets are held by an intermediary
and therefore may be at risk. As I have stated previously,
creating and enforcing effective, well-tailored rules governing the
custody, investment, and preservation of customer funds must be
among the Commission's highest priorities. Without these rules and
rigorous enforcement, our markets would lack the foundation of trust
upon which every transaction is built.\2\
---------------------------------------------------------------------------
\2\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Preserving Trust and Preventing the Erosion of Customer Protection
Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323.
[[Page 15361]]
---------------------------------------------------------------------------
I am supportive of careful, well-tailored, workable, and
practical regulations that do not undermine or weaken customer
protection. I strongly believe that the Commission would have
benefited from a formal report detailing relevant risk management
concerns that may arise as a result of introducing the Proposed
Rule. Among other issues outlined below, the Commission would
benefit from receiving data and analysis that details the potential
risk management consequences attendant to adopting the Proposed Rule
as well as any related measures that may mitigate risk management
concerns.
Before adopting a final rule, the Commission, through supporting
data and analyses, must assure itself that the Proposed Rule
accomplishes the customer protection and risk management goals of
regulation 39.13(g)(8)(iii).
Call for Supporting Risk Management Data and Analyses
The Commission is amending CFTC Regulation 39.13(g)(8)(iii) to
permit disbursements on a separate accounts basis, subject to
certain risk-mitigating conditions.
As I have said before, permitting disbursements on a separate
accounts basis is inconsistent with the plain language of CFTC
Regulation 39.13(g)(8)(iii), which was adopted by the Commission
following the 2008-2009 financial crisis pursuant to the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act),
and introduces new or additional risks. I am, however, supportive of
solutions that are grounded in data and analyses demonstrating that
an amendment to CFTC Regulation 39.13(g)(8)(iii) achieves the same
goals and objectives underpinning this regulation.
It would be helpful, in the context of evaluating the Proposed
Rule, to have a sufficiently robust analysis of the sufficiency and
adequacy of the risk-mitigating measures that have been in place
since 2019.
The Commission should conduct a study to assess any additional
risks and the scope and magnitude of such risks. Alongside a formal
report offering a data-driven analysis, commentators should include
comprehensive analyses and evidence indicating that the adoption of
the Proposed Rule does not increase risks to our markets, or, if
there are increased risks, that the risk-mitigation measures adopted
by the Commission are effective. We also welcome feedback on other
measures to ensure that FCMs maintain robust risk-management
practices.
Margin Adequacy Requirement
In order to register, and maintain registration, as a
derivatives clearing organization (DCO), a clearinghouse must
demonstrate the ability, and continue, to comply with the core
principles for DCOs set forth in Section 5b of the CEA. The core
principles were added to the CEA by the Commodity Futures
Modernization Act of 2000 (CFMA). In implementing the CFMA, the
Commission did not adopt implementing rules and regulations, but
instead promulgated guidance for DCOs on compliance with the core
principles.
Section 725(c) of the Dodd-Frank Act amended Section 5b(c)(2) of
the CEA to expressly confirm that the Commission may adopt
implementing rules and regulations pursuant to its rulemaking
authority under Section 8a(5) of the CEA.
The Commission adopted CFTC Regulation 39.13(g)(8)(iii) in 2011.
The adoption was part of a broader rulemaking to implement certain
provisions of the Dodd-Frank Act governing the activities of DCOs,
including Core Principle D--risk management--requiring each DCO to
ensure that its risk management framework is sufficient to manage
the risks associated with discharging the responsibilities of a DCO
through the use of appropriate tools and procedures. CFTC
regulations require DCOs to collect initial margin from their
customers on a gross basis, even if customer collateral is held in
an omnibus account.
Under CFTC Regulation 39.13(g)(8)(iii), a DCO must 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.'' \3\
---------------------------------------------------------------------------
\3\ 17 CFR 39.13 (g)(8)(iii).
---------------------------------------------------------------------------
The purpose of this regulation is to mitigate the risk that a
clearing member, using an omnibus margin account, fails to hold
sufficient funds from one customer to cover such customer's initial
margin requirements and effectively covers such customer's margin
shortfall using another customer's funds.
In the Preamble to the Proposed Rule, the Commission recognizes,
[i]n light of the use of omnibus margin accounts, where 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 member will effectively cover one customer's
margin shortfall using another customer's funds.\4\
---------------------------------------------------------------------------
\4\ Regulations to Address Margin Adequacy and to Account for
the Treatment of Separate Accounts by Futures Commission Merchants
(Voting Draft) at 7.
An omnibus account structure creates a potential dilution of the
pool of funds available to U.S. customers in the event of a
bankruptcy of the FCM to the extent the FCM's customer account is
undermargined. In a bankruptcy proceeding, customer property is
distributed pro rata and so all customers share in any shortfall in
the customer account of a particular class.
Concerns With Separate Accounts
In 2019, the Joint Audit Committee (JAC) issued a regulatory
alert providing an interpretation of the requirements of CFTC
Regulation 39.13(g)(8)(iii).\5\ Under the JAC's interpretation,
separate accounts of the same customer were to be combined for the
purpose of determining the amount of margin funds available for
disbursement from any of the accounts.
---------------------------------------------------------------------------
\5\ See JAC, Regulatory Alert #19-02 (May 14, 2019), http://www.jacfutures.com/jac/jacupdates/2019/jac1902.pdf.
---------------------------------------------------------------------------
This interpretation was inconsistent with the prevailing
practices, including as documented under customer agreements, among
FCMs, and FCM customers with respect to the treatment of separate
accounts.
FCMs would establish separate accounts for customers for
commercial purposes. For example, ``such accounts are: (i)
separately contracted for with different asset management firms;
(ii) established as a separate investment portfolio within the same
asset management firm; (iii) established by a commercial entity for
the purpose of a commodity or margin financing arrangement and
secured by the lender as a secondary security interest; or (iv)
necessary to separately account for or settle obligations of
separate branches established pursuant to separate legal/country
jurisdictions.'' \6\ Although separate accounts may be owned by the
same customer or beneficial owner, FCMs did not combine those
accounts for margin purposes.
---------------------------------------------------------------------------
\6\ See, e.g., Letter from SIFMA AMG to Brain A. Bussey, Dir. at
Div. of Clearing and Risk, CFTC, & Matthew B. Kulkin, Dir. at Div.
of Swap Dealer and Intermediary Oversight, CFTC (June 7, 2019),
https://www.sifma.org/wp-content/uploads/2021/01/Request-for-Interpretation-Rule-1.56b-and-Rule-39.131.pdf.
---------------------------------------------------------------------------
In response to the JAC's interpretation, several industry trade
associations requested that the Commission provide time limited no-
action relief with respect to the treatment of separate accounts by
FCMs.\7\ Specifically, they requested that the Commission interpret
Commission Regulation 39.13(g)(8)(iii) to permit separate accounts
of the same customer to ``be treated as separate legal entities''
therefore not combined when determining an account's margin funds
available for disbursement.'' \8\
---------------------------------------------------------------------------
\7\ Id.
\8\ Id.
---------------------------------------------------------------------------
The separate account treatment permits margin to be withdrawn
from one account of a customer while another account of that same
customer faces a margin call, it creates the risk that a customer
will withdraw funds from the account in surplus and then later
default on the margin call, leaving the FCM with fewer resources to
cover the resulting losses.
Separate Account Treatment
In 2019, the Commission issued a time-limited, temporary no-
action letter that permitted disbursements on a separate account
basis, subject to certain conditions that mitigate the risk of
default and strengthen an FCM's risk-management of customers granted
separate account treatment. The Commission aimed to achieve the
customer protection and risk management goals of CFTC Regulation
39.13(g)(8)(iii).
In 2023, the Commission approved a proposed rule to codify, in
Part 39 governing DCOs, the staff no-action position regarding the
treatment of separate accounts of a single customer by an FCM that
is a clearing
[[Page 15362]]
member of a DCO. In April 2023, the Commission published in the
Federal Register a notice of proposed rulemaking that would codify
the no-action letter.
Following comments to the proposed rule supporting direct
application of separate account treatment to FCMs (both clearing and
non-clearing), the Commission proposes to withdraw the original
proposal in favor of the Proposed Rule.\9\
---------------------------------------------------------------------------
\9\ This would permit non-clearing FCMs to engage in separate
account treatment and would allow FCMs, rather than DCOs, to
determine whether or not to permit their customers to elect such
treatment.
---------------------------------------------------------------------------
The Proposed Rule codifies (with important changes, including
the establishment of a margin adequacy requirement applicable to
clearing and non-clearing FCMs and increased specificity in the one-
day margin requirement) the existing no-action position under which
FCMs are permitted to treat different accounts of the same
beneficial owner as separate accounts for purposes of permitting
margin withdrawals.
Sufficiency of Risk-Mitigation Conditions
The Proposed Rule permits separate account treatment subject to
risk-management standards. The customer protections built into this
Proposed Rule help to mitigate the risk that it creates,
particularly by requiring customers receiving separate account
treatment to meet margin calls the same day they are made (referred
to as the one-day margin requirement), and requiring separate
account treatment to cease when the customer or the FCM is no longer
operating in the ordinary course of business. In many ways, the
enhanced requirements for FCMs to maintain internal controls and
policies and procedures designed to ensure compliance with the
Proposed Rule strengthen the risk-management compliance practices of
FCMs.
One-day margin requirement. Under the one-day margin
requirement, a separate account customer must meet any margin call
by the close of the Fedwire Funds Service on the same day.\10\ This
requirement is subject to enumerated exemptions, including for
payments in certain foreign currencies where the mechanics of
international payment systems would make compliance with the one-day
margin requirement impractical.\11\
---------------------------------------------------------------------------
\10\ See e.g., Proposed 17 CFR 1.44(f).
\11\ Id.
---------------------------------------------------------------------------
Ordinary course of business. Under the Proposed Rule, separate
account treatment for a customer would cease if the customer or its
FCM ceased operating in the ordinary course of business--the day-to-
day operation of the FCM's relationship with its customer.\12\ These
events include a failure to meet the one-day margin call as well as
an event of default, financial distress, other distress, insolvency,
bankruptcy, or an inability to perform financial obligations. These
events are standard across all FCMs that elect separate account
treatment.\13\
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\12\ See e.g., Proposed 17 CFR 1.44(c).
\13\ See e.g., Proposed 17 CFR 1.44(e).
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These two requirements work together to mitigate the risk of
default by a customer that benefits from separate account treatment.
The ordinary course of business standard works to prevent an
insolvent or soon-to-be insolvent beneficial owner from continuing
to receive separate account treatment. And the one-day margin
requirement creates a cap on the amount of time during which an
insolvent or soon-to-be insolvent beneficial owner could take funds
out of one account while failing to meet a margin call for another
account.
Conclusion
As I have previously noted,
[s]ince the earliest days of federal prudential and market
regulation in our nation, thought leaders have advocated for
regulation that preserves customer assets held by others. In his
book published in 1914--Other People's Money--former Supreme Court
Justice Louis Brandeis advocated for similar reforms that safeguard
the assets of financial markets customers.\14\
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\14\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Closing a Gap, Preserving Market Integrity and Protecting Clearing
Member Funds Held by Derivatives Clearing Organizations (Dec. 18,
2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121823b.
Under the CEA, the Commission is directed to ``protect all
market participants from . . . misuses of customer assets.'' \15\
For these reasons articulated above, I concur with the Proposed
Rule.
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\15\ 7 U.S.C. 5(b).
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The final rule addressing these issues, however, must be
supported by data and analyses indicating the potential risks
arising from the Proposed Rule and how such risks will be managed. I
look forward to comments on this Proposed Rule, particularly
comments that demonstrate the sufficiency or adequacy of the risk-
mitigation conditions in the Proposed Rule.
I would like to thank the staff of the Division of Clearing and
Risk for their thoughtful work on this rule and for their
willingness to incorporate feedback from my office into the proposed
amendments published today.
Appendix 3--Statement of Support of Commissioner Caroline D. Pham
I support the Notice of Proposed Rulemaking on the Regulations
to Address Margin Adequacy and to Account for the Treatment of
Separate Accounts by Futures Commission Merchants (FCMs) (Treatment
of Separate Accounts Proposal or NPRM), as well as the Commission's
withdrawal of the first proposal on this issue (2023 Proposal).\1\
Today's Treatment of Separate Accounts Proposal gets the Commission
closer to the pragmatic approach it was striving for in the 2023
Proposal. To help ensure the Commission truly gets there in the
final rule, I highlight specific areas for public comment below.
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\1\ The Commission's first proposal on the matter was in April
2023. See Derivatives Clearing Organization Risk Management
Regulations to Account for the Treatment of Separate Accounts by
Futures Commission Merchants, 88 FR 22934 (Apr. 14, 2023) (2023
Proposal), https://www.federalregister.gov/documents/2023/04/14/2023-06248/derivatives-clearing-organization-risk-management-regulations-to-account-for-the-treatment-of.
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I would like to thank Daniel O'Connell and Bob Wasserman in the
Division of Clearing and Risk, and Jennifer Bauer and Joshua Beale
in the Market Participants Division, for their work on the NPRM. I
appreciate the staff's generosity with their time for briefings and
answering questions, as well as working with me to make revisions to
address my concerns.
As the Treatment of Separate Accounts Proposal explains, two of
the fundamental purposes of the Commodity Exchange Act (CEA) are the
avoidance of systemic risk and the protection of market participants
from misuses of customer assets.\2\ Regulation 39.13(g)(8)(iii)
requires that a CFTC-registered derivatives clearing organization
(DCO) requires its clearing members to ensure that their customers
do not withdraw funds from clearing member accounts, with one
exception.
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\2\ CEA section 4d(a)(2) Regulation 1.20(a) require an FCM to
separately account for and segregate from its own funds all money,
securities, and property which it has received to margin, guarantee,
or secure the trades or contracts of its commodity customers. 7
U.S.C. 6d(a)(2); 17 CFR 1.20(a). CEA section 4d(a)(2) and Regulation
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. 7 U.S.C. 6d(a)(2); 17 CFR 1.22(a).
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Clearing member customers can withdraw funds if the net
liquidating value plus the margin deposits remaining in the account
meet the customer's initial margin requirements with respect to all
products and swap portfolios cleared by the DCO that are held in the
customer's account. This is known as the ``Margin Adequacy
Requirement'' because it helps ensure a clearing member has, from a
customer, funds sufficient to cover the customer's cleared initial
margin requirements. And, in light of the use of omnibus margin
accounts, the Margin Adequacy Requirement avoids the clearing member
covering one customer's margin shortfall with another customer's
funds. Overall, this is one of the many CFTC rules that protects
customer funds.
The 2023 Proposal, among other things, proposed allowing DCOs to
permit clearing FCMs to treat the separate accounts of a single
beneficial owner, or customer, as accounts of separate legal
entities to satisfy the requirements of Regulation
39.13(g)(8)(iii),\3\ subject to multiple conditions. The 2023
Proposal was intended to accommodate certain FCM customer agreements
that provide that certain accounts carried by the FCM that have the
same beneficial owner are treated as accounts for
[[Page 15363]]
different legal entities for commercial purposes.
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\3\ As explained in the NPRM and the 2023 Proposal, the
Commission is proposing to codify the relief in CFTC Letter No. 19-
17, July 10, 2019, https://www.cftc.gov/csl/19-17/download as
extended by CFTC Letter No. 20-28, Sept. 15, 2020, https://www.cftc.gov/csl/20-28/download; CFTC Letter No. 21-29, Dec. 21,
2021, https://www.cftc.gov/csl/21-29/download; and CFTC Letter No.
22-11, Sept. 15, 2022, https://www.cftc.gov/csl/22-11/download; CFTC
Letter No. 23-13, Sept. 11, 2023, https://www.cftc.gov/csl/23-13/download.
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However, in response to comments, the Commission is now
withdrawing the 2023 Proposal and issuing the Treatment of Separate
Accounts Proposal. I commend this decision because I believe this
NPRM gets the Commission closer to what it set out to do in the 2023
Proposal: accommodate certain FCM customer agreements that provide
that certain accounts carried by the FCM that have the same
beneficial owner are treated as accounts for different legal
entities for commercial purposes.
To aid in this effort, I have highlighted specific areas for
public comment below.
Specific Areas for Public Comment
Ordinary Course of Business
I encourage commenters to review all of the definitions, in
particular those in proposed new Regulation 1.44. For instance, I am
particularly interested in whether the Commission has improved the
accuracy of the definition of ``ordinary course of business,'' along
with what constitutes events inconsistent with the ``ordinary course
of business'' in Regulation 1.44(e). As we learned with the 2023
Proposal, getting this right is pivotal to having the proposed
framework function as intended.
One Business Day Margin Call
As a second definitions example, I am interested in whether the
Commission has improved the definition of ``one business day margin
call'' along with its requirements in Regulation 1.44(f). Commenters
provided extensive comments on this provision, and while the NPRM
has improved on it, we need to be sure the proposed definition does
not impede FCM risk management practices and is consistent with the
law or standard practices in other jurisdictions and operationally
feasible.
The Treatment of Separate Accounts Proposal provides 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
Regulation 1.44(f) if payment is delayed due to a banking holiday in
the jurisdiction of issue of the currency.
Regulation 1.44(f)(4) further provides that, for payments in
EUR, either the separate account customer or the investment manager
managing the separate account may designate only one country within
the eurozone that they have the most significant contacts with for
purposes of meeting margin calls in that separate account, whose
banking holidays shall be referred to for such purpose.
Since the eurozone is comprised of 20 countries, each with their
own national laws and banking holidays, I am concerned that the CFTC
is imposing an overly prescriptive and unworkable requirement with
little practical benefit. I am interested in whether commenters
believe it will be impracticable to comply with Regulation
1.44(f)(4). I encourage commenters to look at Question 7 in the
NPRM--which staff added at my request--for specific examples and
additional prompts.
Other Circumstances Involving Banking Holidays
Similarly, the Treatment of Separate Accounts Proposal also
provides an exception from Regulation 1.44(f)(1), set forth in
Regulation 1.44(f)(7), for the special case of certain holidays when
some DCMs may be open for trading, but banks are closed. I am
interested in whether the Commission's expansion of the exception
from the 2023 Proposal fully resolves the issues raised by
commenters, or still poses operational or compliance issues for
FCMs.
Conclusion
Overall, I am pleased to support the Treatment of Separate
Accounts Proposal and hope we can get it right in the final rule. I
look forward to the comments on the NPRM.
[FR Doc. 2024-04107 Filed 2-29-24; 8:45 am]
BILLING CODE 6351-01-P