2016-19210
Federal Register, Volume 81 Issue 156 (Friday, August 12, 2016)
[Federal Register Volume 81, Number 156 (Friday, August 12, 2016)]
[Notices]
[Pages 53467-53475]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-19210]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
Order Exempting the Federal Reserve Banks From Sections 4d and 22
of the Commodity Exchange Act
AGENCY: Commodity Futures Trading Commission.
ACTION: Order.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is issuing an order to exempt Federal Reserve Banks
that provide customer accounts and other services to registered
derivatives clearing organizations that are designated financial market
utilities from Sections 4d and 22 of the Commodity Exchange Act
(``CEA'').
DATES: Effective Date: August 8, 2016.
FOR FURTHER INFORMATION CONTACT: Eileen A. Donovan, Deputy Director,
202-418-5096, [email protected]; M. Laura Astrada, Associate Director,
202-418-7622, [email protected]; or Parisa Abadi, Attorney-Advisor,
202-418-6620, [email protected], in each case, at the Division of
Clearing and Risk, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581; or Joe
Opron, Special Counsel, 312-596-0653, [email protected], Division of
Clearing and Risk, Commodity Futures Trading Commission, 525 West
Monroe Street, Suite 1100, Chicago, IL 60661.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Background
A. Designation of FMUs under Title VIII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act
B. Access to Federal Reserve Bank Accounts and Services
C. Proposed Order
III. Comment Letters
IV. Findings and Conclusions
V. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost and Benefit Considerations
VI. Order of Exemption
[[Page 53468]]
I. Introduction
On June 2, 2016, the Commission published in the Federal Register a
notice and request for public comment regarding a proposed Commission
order that would exempt, pursuant to Section 4(c) of the CEA,\1\
Federal Reserve Banks that provide customer accounts and other services
to systemically important derivatives clearing organizations
(``SIDCOs'') \2\ from Sections 4d and 22 of the CEA (the
``Proposal'').\3\ After consideration of the comments and for the
reasons set forth in the Proposal and in this release, the Commission
is issuing an order that exempts, subject to certain conditions,
Federal Reserve Banks that provide customer accounts and other services
to designated financial market utilities (``FMUs'') that are registered
derivatives clearing organizations (``Designated FMUs'') \4\ from
Sections 4d and 22 of the CEA. The exemption enables Federal Reserve
Banks to maintain customer accounts for Designated FMUs in accordance
with the standards set forth in the relevant Federal Reserve Bank
governing documents, as specified below.
---------------------------------------------------------------------------
\1\ 7 U.S.C. 6(c).
\2\ Under Commission Regulation 39.2, a SIDCO is defined as a
financial market utility that is a registered derivatives clearing
organization under Section 5b of the CEA, which is currently
designated by the Financial Stability Oversight Council to be
systemically important, and for which the Commission acts as the
Supervisory Agency pursuant to Section 803(8) of the Dodd-Frank Wall
Street Reform and Consumer Protection Act. See 17 CFR 39.2. See also
Section 803(8)(A) of the Dodd-Frank Act, which defines the term
Supervisory Agency as the Federal agency that has primary
jurisdiction over a designated financial market utility under
Federal banking, securities, or commodity futures laws. Section
803(8)(A) of the Dodd-Frank Act, Pub. L. 111-203, 124 Stat. 1376
(2010).
\3\ Notice of Proposed Order and Request for Comment on Proposal
to Exempt, Pursuant to the Authority in Section 4(c) of the
Commodity Exchange Act, the Federal Reserve Banks from Sections 4d
and 22 of the Commodity Exchange Act, 81 FR 35337 (June 2, 2016).
\4\ For the avoidance of doubt, the term ``Designated FMU''
includes the more narrow term ``SIDCO.''
---------------------------------------------------------------------------
II. Background
A. Designation of FMUs Under Title VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act
Title VIII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'') was enacted to mitigate risk in the
financial system and promote financial stability.\5\ Accordingly,
Section 804 of the Dodd-Frank Act requires the Financial Stability
Oversight Council (``Council'') to designate those FMUs that the
Council determines are, or are likely to become, systemically
important.\6\ An FMU includes ``any person that manages or operates a
multilateral system for the purpose of transferring, clearing, or
settling payments, securities, or other financial transactions among
financial institutions or between financial institutions and the
person.'' \7\
---------------------------------------------------------------------------
\5\ See Section 802(b) of the Dodd-Frank Act.
\6\ See Section 804(a) of the Dodd-Frank Act. The term
systemically important means a situation where the failure of or a
disruption to the functioning of a financial market utility could
create, or increase, the risk of significant liquidity or credit
problems spreading among financial institutions or markets and
thereby threaten the stability of the financial system of the United
States. Section 803(9) of the Dodd-Frank Act; see also Authority to
Designate Financial Market Utilities as Systemically Important, 76
FR 44763, 44774 (July 27, 2011).
\7\ Section 803(6)(A) of the Dodd-Frank Act.
---------------------------------------------------------------------------
On July 18, 2012, the Council designated eight FMUs as systemically
important under Title VIII.\8\ Two of these systemically important
FMUs, Chicago Mercantile Exchange, Inc. (``CME'') and ICE Clear Credit
LLC (``ICC''), are SIDCOs (and therefore, Designated FMUs). In
addition, the Options Clearing Corporation (``OCC''), which is a
registered derivatives clearing organization (``DCO'') but not a SIDCO,
is a Designated FMU. OCC was designated in its capacity as a securities
clearing agency; the Securities and Exchange Commission is its
Supervisory Agency.
---------------------------------------------------------------------------
\8\ See Press Release, Financial Stability Oversight Council,
Financial Stability Oversight Council Makes First Designations in
Effort to Protect Against Future Financial Crises (July 18, 2012),
available at http://www.treasury.gov/press-center/press-releases/Pages/tg1645.aspx.
---------------------------------------------------------------------------
B. Access to Federal Reserve Bank Accounts and Services
Section 806(a) of the Dodd-Frank Act permits the Board to authorize
a Federal Reserve Bank to establish and maintain an account for a
Designated FMU and provide to the Designated FMU the services listed in
Section 11A(b) of the Federal Reserve Act, subject to any applicable
rules, orders, standards, or guidelines prescribed by the Board.\9\ In
adopting regulations pursuant to Section 806(a) of the Dodd-Frank Act,
the Board noted that the ``terms and conditions for access to Federal
Reserve Bank accounts and services are intended to facilitate the use
of [Federal] Reserve Bank accounts and services by a designated FMU in
order to reduce settlement risk and strengthen settlement processes,
while limiting the risk presented by the designated FMU to the
[Federal] Reserve Banks.'' \10\ Accordingly, the Board ``expects that
[Federal] Reserve Banks would provide services that are consistent with
a designated FMU's need for safe and sound settlement processes under
account and service agreements generally consistent with the provisions
of existing [Federal] Reserve Bank operating circulars for such
services.'' \11\ Highlighting the importance of Federal Reserve Bank
operating circulars in this regard, the Board further requires that
designated FMUs be in compliance with existing operating circulars.\12\
---------------------------------------------------------------------------
\9\ The services listed in Section 11A(b) of the Federal Reserve
Act include wire transfers, settlement, and securities safekeeping,
as well as services regarding currency and coin, check clearing and
collection, and automated clearing house transactions. See 12 U.S.C.
248a(b). Section 806(a) of the Dodd-Frank Act also permits the Board
to authorize a Federal Reserve Bank to establish deposit accounts
under the first undesignated paragraph of Section 13 of the Federal
Reserve Act, 12 U.S.C. 342.
\10\ Financial Market Utilities (Regulation HH), 78 FR 14024,
14025 (Mar. 4, 2013).
\11\ Id.
\12\ See 12 CFR 234.5(b)(2) (setting forth rules to govern
Federal Reserve Bank accounts held by designated FMUs).
---------------------------------------------------------------------------
C. Proposed Order
The proposed Commission order would, subject to certain terms and
conditions, exempt Federal Reserve Banks that provide customer accounts
and other services to SIDCOs from Sections 4d and 22 of the CEA. In the
Proposal, the Commission emphasized the importance of protecting
customers and safeguarding customer funds, and highlighted the critical
role that SIDCOs play in the financial markets. The Commission
recognized that the failure of a SIDCO or a disruption to the
operations of a SIDCO could threaten the stability of the U.S.
financial system. As a result, the Commission determined that reducing
SIDCOs' credit and liquidity risks would better protect market
participants and the public, and would serve to promote the integrity
of the financial markets. The Commission explained that because Federal
Reserve Banks are the source of liquidity with regard to U.S. dollar
deposits, a SIDCO would face much lower credit and liquidity risk with
a deposit at a Federal Reserve Bank than it would with a deposit at a
commercial bank.
With respect to protecting customers and safeguarding customer
funds, the Commission explained that under Section 4d of the CEA, a
depository will be held liable for an improper transfer of customer
funds by an FCM or DCO if it knew or should have known that the
transfer was improper.\13\ The
[[Page 53469]]
Commission noted, however, that as this standard of liability was
developed, the unique nature of the Federal Reserve Banks was not taken
into account.\14\ The accounts and financial services provided by
Federal Reserve Banks are governed by account agreements, operating
circulars issued by Federal Reserve Banks for each service, the Federal
Reserve Act, and Federal Reserve regulations and policies, and, with
respect to book-entry securities services, the regulations of the
domestic issuer of the securities or the issuer's regulator (``Federal
Reserve Bank Governing Documents'').\15\ In the Proposal, the
Commission explained that the Federal Reserve Bank Governing Documents
limit a Federal Reserve Bank's liability in maintaining an account or
acting on such an instruction to actual damages that are incurred
solely by the account holder and that are proximately caused by the
Federal Reserve Bank's failure to exercise ordinary care or act in good
faith in accordance with the Federal Reserve Bank Governing Documents.
The Commission found the standard of liability as set forth in the
Federal Reserve Bank Governing Documents to be appropriate in the
context of Federal Reserve Banks, as this standard has been developed
to more appropriately reflect the unique nature of the Federal Reserve
Banks. Notably, the Commission argued that the Board has prescribed
detailed rules and standards that govern account services provided to
SIDCOs by the Federal Reserve Banks, which have been carefully
developed to provide clarity surrounding the provision of Federal
Reserve financial services and to promote consistency in the treatment
of deposit accounts at the Federal Reserve Banks for the benefit of the
U.S. financial system.\16\
---------------------------------------------------------------------------
\13\ See 81 FR at 35339. Further, the Commission requires a DCO
to obtain from each depository with which it deposits customer funds
a written acknowledgment that the customer funds are being held in
accordance with Section 4d of the CEA to ensure that the depository
has been informed that the deposited funds are those of customers.
\14\ See id. at 35340-35342.
\15\ The operating circulars of the Federal Reserve Banks began
having uniform terms and conditions across Federal Reserve Bank
districts as of January 2, 1998.
\16\ In fact, SIDCOs have established proprietary accounts with
one or more Federal Reserve Banks that are governed by the Federal
Reserve Bank Governing Documents.
---------------------------------------------------------------------------
The Commission noted its concern that exposing the Federal Reserve
Banks to the standard of liability set forth in Section 4d of the CEA,
as well as to potential third-party claims under Section 22 of the
CEA,\17\ could disrupt these goals and ultimately harm the U.S.
financial system and, by extension, U.S. taxpayers. Accordingly, the
Commission proposed that a Federal Reserve Bank acting as a depository
for SIDCO customer funds or otherwise providing account services to a
SIDCO would continue to be held to the standard of liability set forth
in the Federal Reserve Bank Governing Documents.
---------------------------------------------------------------------------
\17\ In the Proposal, the Commission explained that Section 22
of the CEA provides for private rights of action for damages against
persons who violate the CEA, or persons who willfully aid, abet,
counsel, induce, or procure the commission of a violation of the
CEA. See 81 FR at 35342; see also 7 U.S.C. 25. The Commission noted
that under the Federal Reserve Bank Governing Documents, the Federal
Reserve Banks are currently insulated from third-party claims. While
the Commission continues to believe that private claims empower
injured parties to seek compensation for damages where the
Commission lacks the resources to do so on their behalf, and the
prospect of such claims serves the public interest in deterring
misconduct, the Commission has determined that, for the reasons
discussed herein and in the Proposal, exempting the Federal Reserve
Banks from liability under Section 22 of the CEA would also serve
the public interest.
---------------------------------------------------------------------------
However, the Commission reiterated the importance of the
segregation requirements set forth in Section 4d of the CEA to make
sure that customer funds are used only for the purpose of margining,
securing, or guaranteeing their futures contracts and options on
futures contracts, and cleared swaps. Therefore, as a condition to the
proposed order, customer funds held at a Federal Reserve Bank would
continue to be required to be segregated from the funds deposited in
the SIDCO's proprietary account. In addition, Federal Reserve Banks
would be required to reply promptly and directly to any request for
confirmation of account balances or provision of any other information
regarding or related to the customer account(s) of a SIDCO that are
established pursuant to the CEA from the director of the Division of
Clearing and Risk of the Commission, or any successor division, or such
director's designees.
The Commission further noted that Title VIII of the Dodd-Frank Act
permits a Federal Reserve Bank to have access to confidential
supervisory information with respect to a SIDCO. The Commission
recognized, however, that the fact that Board supervisory staff may
have access to confidential supervisory information about a SIDCO could
create the false perception that Federal Reserve Bank staff responsible
for managing the SIDCO's account and financial services would gain
special knowledge about the SIDCO. As a result, the Commission
recognized that a Federal Reserve Bank acting as a depository for
customer funds could face greater scrutiny than a commercial bank
acting as such. Therefore, the proposed order included a statement
recognizing that, pursuant to the Wall Policy,\18\ information obtained
by the Board supervisory staff during the course of supervising SIDCOs
or any counterparty to a SIDCO will not be attributed by the Commission
to any Federal Reserve Bank providing accounts and financial services
to SIDCO account holders.
---------------------------------------------------------------------------
\18\ As discussed in greater detail in the Proposal, Board staff
has represented that it has a long-standing ``Wall Policy'' that
generally prohibits, subject to the limitations contained therein,
the sharing of confidential supervisory information with Federal
Reserve Bank account services staff, and requires that care be
exercised to avoid actual or apparent conflict between a Federal
Reserve Bank's role as a provider of financial services and its role
as a regulator, supervisor, and lender. See 81 FR at 35341; see also
Federal Reserve's Key Policies for the Provision of Financial
Services: Standards Related to Priced-Service Activities of the
Federal Reserve Banks (1984), available at http://www.federalreserve.gov/paymentsystems/pfs_standards.htm.
---------------------------------------------------------------------------
III. Public Comments
In response to its request for public comment on the Proposal, the
Commission received six comment letters.\19\ All six letters expressly
supported the issuance of an order exempting the Federal Reserve Banks
from Sections 4d and 22 of the CEA, citing such benefits as mitigating
systemic risk in the clearing and settlement system, reducing credit
and liquidity risks for Designated FMUs, and enhancing the protection
of customer funds.
---------------------------------------------------------------------------
\19\ Letters were submitted by CME, ICC, and OCC (each of which
is a Designated FMU), Minneapolis Grain Exchange, Inc. (which is a
DCO), American Council of Life Insurers, and the International Swaps
and Derivatives Association, Inc. The Commission also received one
non-substantive comment. All comments referred to herein are
available on the Commission's Web site, at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1703.
---------------------------------------------------------------------------
Specifically, ICC agreed that holding SIDCO customer funds at a
Federal Reserve Bank would decrease the SIDCO's credit, liquidity, and
operational risks. ICC also agreed that ``the existing limitations on
how Federal Reserve Banks hold assets provide adequate protections to
account holders,'' and ``such protections are consistent with the
customer protection initiatives of the CEA.'' \20\ ICC and the
International Swaps and Derivatives Association, Inc. (``ISDA'') both
noted that the use of a Federal Reserve Bank as a depository for SIDCO
customer funds would help to reduce systemic risk by reducing
interconnectedness in the financial system. ISDA observed that such
interconnectedness is particularly present when one firm simultaneously
acts as a custodial bank, settlement bank, and/or clearing member with
[[Page 53470]]
respect to one central counterparty.\21\ ISDA believes that reducing
this interconnectedness would positively impact SIDCO resilience during
a market disruption and promote safety and soundness in the cleared
derivatives markets by decreasing contagion risk. Furthermore, in
ISDA's view, customer accounts at Federal Reserve Banks would only
benefit derivatives customers and promote safety and soundness in the
cleared derivatives markets. ISDA believes that the strict limitations
on how the Federal Reserve Banks hold deposits adequately protect
customers without the additional safeguards provided under Sections 4d
and 22 of the CEA.
---------------------------------------------------------------------------
\20\ ICC Comment Letter at 2 (July 1, 2016).
\21\ ISDA Comment Letter at 2 (July 5, 2016).
---------------------------------------------------------------------------
The Commission requested comments regarding whether the proposed
exemption should be expanded to include not just SIDCOs but all
Designated FMUs (in other words, all registered DCOs that have been
designated as systemically important by the Council, regardless of
whether the Commission is the DCO's Supervisory Agency). In response,
OCC requested that the Commission expand the exemption.\22\ As
previously noted, OCC is currently designated by the Council to be
systemically important; however, it is not a SIDCO, as the Securities
and Exchange Commission is its Supervisory Agency. OCC commented that
Section 806(a) of the Dodd-Frank Act supports Federal Reserve Banks
acting as depositories for all Designated FMUs and not just SIDCOs. OCC
argued that denying it the opportunity to deposit segregated customer
funds in a Federal Reserve Bank account would undermine one of the
purposes of Title VIII and would place OCC at an unjustified
competitive disadvantage with respect to other Designated FMUs. ISDA
also urged the Commission to expand the exemption to include customer
accounts at a Federal Reserve Bank established by Designated FMUs given
the benefits associated with holding customer accounts with a Federal
Reserve Bank.
---------------------------------------------------------------------------
\22\ OCC Comment Letter at 1 (July 5, 2016).
---------------------------------------------------------------------------
Minneapolis Grain Exchange, Inc. (``MGEX'') requested that the
Commission expand the exemption to include customer accounts held at
Federal Reserve Banks by Subpart C DCOs.\23\ MGEX stated that limiting
access to Federal Reserve Bank services and accounts to SIDCOs creates
a competitive disadvantage to those DCOs that have not been designated
as systemically important because such DCOs would not have access to
these credit and liquidity risk reducing opportunities afforded to
SIDCOs.\24\ MGEX commented that this disadvantage may be more
pronounced for Subpart C DCOs because they are held to the same
standards as SIDCOs but do not have access to accounts at the Federal
Reserve Banks.\25\ MGEX recognized, however, that this is due to the
``restrictive wording'' of Section 806(a) of the Dodd-Frank Act, which
specifically limits access to Federal Reserve Bank accounts to
Designated FMUs, and the Commission cannot simply grant Subpart C DCOs
permission to have accounts at a Federal Reserve Bank.\26\ MGEX
requested that the Commission use alternative language in the exemptive
order, so as not to be SIDCO-specific, in the event that Federal
Reserve Banks are subsequently permitted to maintain accounts for
Subpart C DCOs in the future.
---------------------------------------------------------------------------
\23\ A Subpart C DCO is a DCO registered with the Commission
pursuant to Section 5b of the CEA that is not a SIDCO and has
elected to become subject to the requirements of Subpart C of Part
39 of the Commission's regulations. 17 CFR 39.2. MGEX has made this
election and is therefore a Subpart C DCO.
\24\ MGEX Comment Letter at 1 (July 5, 2016).
\25\ SIDCOs and Subpart C DCOs are required to comply with the
requirements set forth in Subpart C of Part 39 of the Commission's
regulations, as well as the requirements applicable to all DCOs,
which are set forth in Subparts A and B of Part 39. Subpart C,
together with the provisions in Subparts A and B, establish domestic
regulations that are consistent with the Principles for Financial
Market Infrastructures. As a result, SIDCOs and Subpart C DCOs are
considered qualified central counterparties for purposes of the
Basel capital requirements for central counterparties. See, e.g.,
Derivatives Clearing Organizations and International Standards, 78
FR 72476 (Dec. 2, 2013) (discussing the regulatory framework for
SIDCOs and Subpart C DCOs and providing further background on
qualified central counterparties).
\26\ MGEX Comment Letter at 2 (July 5, 2016).
---------------------------------------------------------------------------
CME supported the exemption, but noted that it would be
inconsistent with Commission Regulation 1.20(g)(4)(ii), which requires
that a DCO obtain from a Federal Reserve Bank acting as a depository
for customer funds a written acknowledgment that the customer funds are
being held in accordance with Section 4d of the CEA.\27\ CME noted,
however, that pursuant to the terms of the exemptive order, the Federal
Reserve Banks would be exempt from Section 4d.\28\ CME suggested that
the exemptive order and Commission Regulation 1.20(g)(4)(ii) be
harmonized.
---------------------------------------------------------------------------
\27\ 17 CFR 1.20(g)(4)(ii).
\28\ CME Comment Letter at 3 (July 1, 2016).
---------------------------------------------------------------------------
In addition, CME commented that, as a SIDCO account holder, it
would need multiple Federal Reserve Bank accounts in order to comply
with the segregation requirements set forth in the exemptive order.\29\
CME stated that, under the Federal Reserve Banks' Operating Circular 1,
a financial institution may maintain only one Master Account with a
Federal Reserve Bank, although the Federal Reserve Bank may, in its
discretion, allow multiple Master Accounts in certain situations. CME
noted that this may require a Federal Reserve Bank to exercise its
discretion under its standard policies and operating circulars to
permit the use of multiple Master Accounts for SIDCO account holders.
---------------------------------------------------------------------------
\29\ As a condition to the exemptive order, the Federal Reserve
Banks are required to segregate customer funds deposited by a
Designated FMU from the proprietary funds deposited by a Designated
FMU.
---------------------------------------------------------------------------
CME also stated that account agreements between the Federal Reserve
Banks and depository institution account holders typically include
certain set-off rights and liens in favor of the Federal Reserve Banks.
In this regard, CME commented that Federal Reserve Bank account
agreements may need to be tailored in order to provide comfort to SIDCO
clearing members, and customers of SIDCO clearing members, that their
margin deposits are ``bankruptcy remote'' from the SIDCO under
applicable bank capital requirements.\30\ Similarly, American Council
of Life Insurers (``ACLI'') requested that the Commission clarify ``for
the benefit of public customers who are the ultimate beneficiaries of
segregated accounts at commercial or federal banks, that customer
segregated funds (i.e., initial margin) shall never be used for any
other purpose under any circumstances, even the most exigent.'' \31\
---------------------------------------------------------------------------
\30\ CME Comment Letter at 4 (July 1, 2016).
\31\ ACLI Comment Letter at 2 (July 5, 2016).
---------------------------------------------------------------------------
IV. Findings and Conclusions
After careful review and consideration of the comments, and for the
reasons cited herein and set forth in the Proposal, the Commission has
determined that the requirements of Section 4(c) of the CEA have been
met with respect to exempting Federal Reserve Banks that provide
customer accounts and other services to Designated FMUs from Sections
4d and 22 of the CEA. The Commission is therefore issuing an order
granting the exemption essentially as proposed. However, the Commission
is making minor technical clarifications to the language of the order,
and is expanding the exemption to include those customer accounts that
are established pursuant to the CEA and that are held at Federal
Reserve Banks by Designated FMUs. The Commission agrees with OCC and
ISDA that Section 806(a) of the Dodd-Frank Act supports Federal
[[Page 53471]]
Reserve Banks acting as depositories for all Designated FMUs, not just
SIDCOs.
The Commission notes MGEX's request that the Commission expand the
exemption to include customer accounts held at Federal Reserve Banks by
any Subpart C DCO. However, the Commission further notes that Subpart C
DCOs are not currently eligible for Federal Reserve Bank accounts.\32\
Accordingly, the Commission is declining to expand the exemption to
include customer accounts held at Federal Reserve Banks by Subpart C
DCOs. As MGEX acknowledges, the Commission does not have the authority
to direct the Federal Reserve Banks to provide accounts and services to
Subpart C DCOs. If, in the future, a registered DCO that is not a
Designated FMU is able to establish an account at a Federal Reserve
Bank, the Commission may reconsider the scope of the exemption at that
time.
---------------------------------------------------------------------------
\32\ Federal Reserve Banks serve only account holders authorized
by statute, such as depository institutions and the U.S. government.
See, e.g., Federal Reserve Bank of Richmond, Consumer Issues and
Information, available at https://www.richmondfed.org/faqs/consumer/
(last visited Feb. 26, 2016) (stating that ``Federal Reserve Banks
are not authorized to open accounts for individuals[; rather, o]nly
depository institutions and certain other financial entities may
open an account at a Federal Reserve Bank''); see also Section
806(a) of the Dodd-Frank Act (authorizing accounts at a Federal
Reserve Bank for designated FMUs).
---------------------------------------------------------------------------
In response to CME's comment that the exemption would be
inconsistent with the acknowledgement letter requirements in Commission
Regulation 1.20(g)(4)(ii),\33\ the Commission agrees and has determined
to repeal this requirement \34\ in a separate Federal Register notice.
The exemptive order will render these provisions inapplicable, as the
Federal Reserve Banks that provide customer accounts and other services
to Designated FMUs would be exempt from Section 4d of the CEA.
---------------------------------------------------------------------------
\33\ 17 CFR 1.20(g)(4)(ii). Under Commission Regulation
1.20(g)(4)(ii), a DCO must obtain from a Federal Reserve Bank acting
as a depository for customer funds a written acknowledgement that
(A) The Federal Reserve Bank was informed that the customer funds
deposited therein are those of customers and are being held in
accordance with the provisions of section 4d of the CEA and
Commission regulations thereunder; and (B) The Federal Reserve Bank
agrees to reply promptly and directly to any request from Commission
staff for confirmation of account balances or provision of any other
information regarding or related to an account. Id.
\34\ Specifically, the Commission is revising paragraphs
(g)(4)(i) and (g)(4)(ii), and repealing paragraphs (g)(4)(ii)(A) and
(g)(4)(ii)(B).
---------------------------------------------------------------------------
In addition, CME commented that, as a SIDCO account holder, it
would need multiple Federal Reserve Bank accounts in order to comply
with the segregation requirements set forth in the exemptive order.\35\
CME noted that obtaining multiple Master Accounts may require a Federal
Reserve Bank to exercise its discretion under its standard policies and
operating circulars. The Commission agrees that this issue would appear
to be within the scope of the Federal Reserve's authority and not the
Commission's.
---------------------------------------------------------------------------
\35\ As a condition to the exemptive order, the Federal Reserve
Banks are required to segregate customer funds deposited by a
Designated FMU from the proprietary funds deposited by a Designated
FMU.
---------------------------------------------------------------------------
CME also noted that account agreements between the Federal Reserve
Banks and depository institution account holders typically include
certain set-off rights and liens in favor of the Federal Reserve Banks.
CME argued that Federal Reserve Bank account agreements may need to be
revised to make sure customer margin deposits are ``bankruptcy remote''
from the SIDCO under applicable bank capital requirements.\36\
Similarly, ACLI argued that the interests of customers in their
segregated funds should never be subordinated for the benefit of any
other party. The Commission agrees that a Designated FMU cannot grant
security interests in, rights of set-off against, or other rights in
customer collateral. Therefore, the Commission believes that a
Designated FMU's account agreement must be free from any rights of set-
off or liens on customer funds.
---------------------------------------------------------------------------
\36\ CME Comment Letter at 4 (July 1, 2016).
---------------------------------------------------------------------------
The exemptive order applies to all Federal Reserve Banks that
provide customer accounts and other services to Designated FMUs. It
requires that all money, securities, and property deposited into a
customer account established pursuant to the CEA by a Designated FMU
with a Federal Reserve Bank must be separately accounted for and not
commingled with the money, securities, and property deposited into the
account of any other person, including a proprietary account of the
Designated FMU depositing such funds.\37\ In addition, Federal Reserve
Banks must reply promptly and directly to any request for confirmation
of account balances or provision of any other information regarding or
related to the customer account(s) of a Designated FMU that are
established pursuant to the CEA from the director of the Division of
Clearing and Risk of the Commission, or any successor division, or such
director's designees.
---------------------------------------------------------------------------
\37\ The Commission is slightly modifying the language from the
proposed order so that the exemptive order makes clear that customer
funds deposited by a Designated FMU may not be commingled with funds
held in any other account at the Federal Reserve Banks, including
the Designated FMU's proprietary account. This language is included
in the order because, despite the exemption for the Federal Reserve
Banks, a Designated FMU is still subject to the requirements of
Section 4d of the CEA and Commission Regulation 1.20, which require
a DCO to separately account for and segregate customer funds.
Specifically, the Commission is changing the phrase ``separately
accounted for and segregated from'' in the proposed order to
``separately accounted for and not commingled with'' to more closely
mirror the language used in Section 4d. For purposes of this
exemption, customer funds held by the Federal Reserve Banks can meet
this standard so long as the customer funds are held in a separate
account and the funds in the customer account are not used to pay or
secure the obligations arising out of any other account.
---------------------------------------------------------------------------
In light of the foregoing, the Commission believes the exemption
would promote responsible economic and financial innovation and fair
competition, and is consistent with the ``public interest,'' as that
term is used in Section 4(c) of the CEA.
V. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \38\ requires federal
agencies, in promulgating rules, to consider whether those rules will
have a significant economic impact on a substantial number of small
entities and, if so, provide a regulatory flexibility analysis
respecting the impact. The Commission believes that the exemptive order
will not have a significant economic impact on a substantial number of
small entities. The exemption will impact Designated FMUs and Federal
Reserve Banks. The Commission has previously established certain
definitions of ``small entities'' to be used by the Commission in
evaluating the impact of its actions on small entities in accordance
with the RFA.\39\ The Commission has previously determined that DCOs,
including Designated FMUs, are not small entities for purposes of the
RFA.\40\ Similarly, the Commission believes that Federal Reserve Banks
are not small entities for purposes of the RFA.
---------------------------------------------------------------------------
\38\ 5 U.S.C. 601 et seq.
\39\ See 47 FR 18618, 18618-21 (Apr. 30, 1982).
\40\ See New Regulatory Framework for Clearing Organizations, 66
FR 45604, 45609 (Aug. 29, 2001).
---------------------------------------------------------------------------
Accordingly, the Commission does not expect the exemption to have a
significant impact on a substantial number of small entities.
Therefore, the Chairman, on behalf of the Commission, hereby certifies,
pursuant to 5 U.S.C. 605(b), that the exemption would not have a
significant economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
The purposes of the Paperwork Reduction Act of 1995 (``PRA'') \41\
are,
[[Page 53472]]
among other things, to minimize the paperwork burden to the private
sector, ensure that any collection of information by a government
agency is put to the greatest possible uses, and minimize duplicative
information collections across the government. The PRA applies to all
information, regardless of form or format, whenever the government is
obtaining, causing to be obtained or soliciting information, and
requires disclosure to third parties or the public, of facts or
opinions, when the information collection calls for answers to
identical questions posed to, or identical reporting or recordkeeping
requirements imposed on, ten or more persons. The PRA would not apply
in this case given that the exemption would not impose any new
recordkeeping or information collection requirements, or other
collections of information on ten or more persons that require approval
of the Office of Management and Budget.
---------------------------------------------------------------------------
\41\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
C. Cost and Benefit Considerations
1. Summary of Comments on the Costs and Benefits of the Proposed Order
The Commission requested comments on the costs and benefits
associated with the proposed order. The Commission requested but
received no comments providing data or other information to enable the
Commission to better quantify the expected costs and benefits
attributable to this exemption. In terms of qualitative cost and
benefit comments, OCC stated that Section 806(a) of the Dodd-Frank Act
supports Federal Reserve Banks acting as depositories for all
Designated FMUs and not just SIDCOs. OCC commented that limiting the
exemption to SIDCO customer accounts would place OCC at a competitive
disadvantage because, although OCC is a Designated FMU, it is not a
SIDCO. In addition, OCC argued that denying OCC the opportunity to
deposit customer funds at a Federal Reserve Bank would undermine the
purpose of Title VIII of the Dodd-Frank Act.
MGEX also supported the proposed exemption, but noted that DCOs
that are not designated as systemically important would not have the
same access to the credit and liquidity risk reducing opportunities
afforded to SIDCOs with access to Federal Reserve Bank accounts. MGEX
stated that limiting access to Federal Reserve Bank accounts to SIDCOs
would create a competitive disadvantage to those DCOs that are not
designated as systemically important, particularly Subpart C DCOs. MGEX
recognized that the Commission cannot grant Subpart C DCOs permission
to have accounts at a Federal Reserve Bank. However, MGEX argued that
the Commission should expand the exemption to cover customer accounts
maintained by Federal Reserve Banks for Subpart C DCOs in the event
that Federal Reserve Banks are subsequently permitted to maintain
accounts for Subpart C DCOs.
ICC commented that accounts at Federal Reserve Banks would reduce
credit, operational, and liquidity risks that are associated with
traditional deposit accounts. ISDA and ICC further noted that such
accounts may reduce interconnectedness in the cleared derivatives
market. CME commented that migrating a portion of the eligible assets
it has on deposit from clearing members to a Federal Reserve Bank may
have a number of positive effects on its clearing members and their
customers. ACLI stated that the proposed order would reduce overall
systemic risk that could arise from liquidity and other risks on
commercial banks where SIDCOs currently deposit their customer funds.
In the discussion that follows, the Commission considers the costs
and benefits of the exemptive order to the public and market
participants. It also considers the costs and benefits of the exemption
in light of the public interest factors enumerated in Section 15(a) of
the CEA.
2. Costs
This order is exemptive and provides the Federal Reserve Banks
relief from certain of the requirements in the CEA and attendant
Commission regulations. As with any exemptive rule or order, the
exemption in the order is permissive, meaning that the Federal Reserve
Banks are not required to rely on it. In addition, Designated FMUs are
not required to deposit customer funds with a Federal Reserve Bank.
Accordingly, the Commission assumes that interested parties would rely
on the exemption only if the anticipated benefits warrant the costs of
the exemption.
The exemptive order would exempt the Federal Reserve Banks from
Sections 4d and 22 of the CEA. All of the commenters generally
supported issuing this exemption. However, two commenters raised the
possibility that the proposed order could place them at a competitive
disadvantage. First, as discussed above, OCC argued that, under Title
VIII of the Dodd-Frank Act, a Federal Reserve Bank may be permitted to
maintain an account for a Designated FMU. OCC argued that, as a result,
it would be placed at a competitive disadvantage with respect to
SIDCOs. The Commission agrees that Title VIII of the Dodd-Frank Act
permits Federal Reserve Banks to maintain accounts for, and provide
services to, Designated FMUs, and not just SIDCOs. Accordingly, and as
discussed above, the Commission has determined to expand the exemption
to include customer accounts held at Federal Reserve Banks by
Designated FMUs generally, for purposes of consistency with Title VIII.
Second, MGEX argued that it would be placed at a competitive
disadvantage with respect to SIDCOs because, as a Subpart C DCO, MGEX
is held to the same standards as SIDCOs under the Commission's
regulations, but is not afforded the same opportunity to hold customer
accounts at a Federal Reserve Bank. The Commission has declined to
expand the exemption to include customer accounts held at Federal
Reserve Banks by Subpart C DCOs. Under Title VIII, the Board may
authorize a Federal Reserve Bank to maintain accounts only for
Designated FMUs. As MGEX recognizes, the Commission does not have the
authority to authorize a Federal Reserve Bank to maintain accounts for
Subpart C DCOs. Accordingly, the competitive disadvantage identified by
MGEX cannot be remedied by the Commission by expanding the scope of the
exemption. Moreover, the Commission does not believe it would be
appropriate to expand the scope of the exemption based on the
theoretical possibility that Federal Reserve Banks may one day be
permitted to provide accounts to Subpart C DCOs. In the event that a
Federal Reserve Bank is authorized to maintain an account for other
registered DCOs, the Commission may reconsider the scope of the
exemptive relief at that time.
3. Benefits
The exemption will benefit market participants by facilitating
Designated FMUs' use of Federal Reserve Banks as depositories for
customer funds. Whereas commercial banks present credit and liquidity
risks to a Designated FMU, its FCM clearing members, and the FCMs'
customers, the Federal Reserve Banks are substantially insulated from
such risks. As discussed in greater detail above, Title VIII of the
Dodd-Frank Act was enacted to mitigate systemic risk in the financial
system and to promote financial stability, in part, through an enhanced
supervisory framework for Designated FMUs. In addition to this
framework, Title VIII, and more specifically, Section 806(a) of the
Dodd-Frank Act, permits the Board to authorize a Federal Reserve Bank
to establish and maintain an account for a
[[Page 53473]]
Designated FMU and provide to the Designated FMU certain financial
services. By enacting Title VIII in general, and Section 806(a) in
particular, Congress recognized the importance of reducing systemic
risk and providing Designated FMUs with a potential safeguard during an
extraordinary liquidity event. The exemption would therefore help
promote Congress' goal of better preparing the U.S. financial system
for potential future liquidity events.\42\ Commenters generally agreed
that the exemption would benefit market participants by enhancing the
protection of customer funds. Commenters noted that accounts at Federal
Reserve Banks would decrease a SIDCO's credit, liquidity and
operational risk, and reduce interconnectedness in the cleared
derivatives market.
---------------------------------------------------------------------------
\42\ A Designated FMU's access to Federal Reserve Bank deposit
accounts is also consistent with the international standards set
forth in the Principles for Financial Market Infrastructures, which
acknowledge the protections afforded by central banks from such
credit and liquidity risks. See, e.g., CPSS-IOSCO, Principles for
Financial Market Infrastructures, ] 3.9.3 (noting that ``[c]entral
banks have the lowest credit risk and are the source of liquidity
with regard to their currency of issue''); see also Principles for
Financial Market Infrastructures, Key Consideration 8 (specifying
that a financial market infrastructure ``with access to central bank
accounts, payment services, or securities services should use these
services, where practical, to enhance its management of liquidity
risk'').
---------------------------------------------------------------------------
Moreover, the Federal Reserve Banks' standard of liability, as set
forth in the Federal Reserve Bank Governing Documents, is better suited
for the Federal Reserve Banks than Section 4d of the CEA, which was
designed to govern customer funds deposited with a commercial bank,
trust company, or DCO. Unlike commercial banks, Federal Reserve Banks
do not operate for profit and serve only account holders authorized by
statute, such as depository institutions and the U.S. government.
Indeed, each year they return to the U.S. Department of Treasury all
earnings in excess of Federal Reserve Bank operating and other
expenses, such as litigation expenses. By exempting the Federal Reserve
Banks from certain potential enforcement actions and private suits, the
exemption would reduce the Federal Reserve Banks' exposure to
litigation. Because the Federal Reserve Banks return their earnings to
the U.S. Department of Treasury's general fund, U.S. taxpayers could
benefit from the exemption. Therefore, the Commission believes that it
is appropriate to apply the Federal Reserve Banks' standard of
liability in order to facilitate the use of these accounts.
4. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its action before issuing an order under the
CEA.\43\ By its terms, Section 15(a) does not require the Commission to
quantify the costs and benefits of an order or to determine whether the
benefits of the order outweigh its costs. Rather, Section 15(a) simply
requires the Commission to ``consider the costs and benefits'' of its
action.
---------------------------------------------------------------------------
\43\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
Section 15(a) of the CEA further specifies that 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 futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. The Commission may in its
discretion give greater weight to any one of the five enumerated areas
and could in its discretion determine that, notwithstanding its costs,
a particular order is necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the CEA.
a. Protection of Market Participants and the Public
The exemption would serve to facilitate Designated FMUs' use of
Federal Reserve Banks as depositories for customer funds. Because the
Federal Reserve System is the nation's central bank, such accounts
would provide Designated FMUs with the lowest possible credit risk in
the event of a market disruption. Moreover, as Federal Reserve Banks
are the source of liquidity with regard to U.S. dollar deposits,
Designated FMUs with access to a deposit account at a Federal Reserve
Bank would also be better equipped to handle a liquidity event. Since
Designated FMUs have been so designated because of their importance to
the broader financial system, reducing these risks would protect market
participants and the public.
b. Efficiency, Competitiveness, and Financial Integrity
A temporary or permanent disruption to the operations of a
Designated FMU could cause widespread and significant damage to the
financial integrity of derivatives markets as a whole. Therefore, by
facilitating a Designated FMU's use of Federal Reserve Banks as
depositories for customer funds, the exemption would reduce liquidity
and credit risk to the Designated FMU, which would, in turn, promote
the financial integrity of the derivatives markets.
As noted above, two commenters raised concerns that the exemptive
order may result in a competitive disadvantage. The Commission has
addressed the concern of one commenter (OCC) by expanding the exemption
to include customer accounts held at Federal Reserve Banks by
Designated FMUs generally. On the other hand, the Commission does not
have the authority to take action to address the concerns of the other
commenter (MGEX).
The Commission does not anticipate the exemption will have a
significant impact on the efficiency of the derivatives markets.
c. Price Discovery
The Commission does not anticipate the exemption will have an
impact on the price discovery process.
d. Sound Risk Management Practices
The Commission believes that establishing segregated customer
accounts for Designated FMUs and enabling Designated FMUs to access
related services at a Federal Reserve Bank would improve a Designated
FMU's ability to manage liquidity risk and protect customer funds.
Additionally, the Commission believes that the availability of a
Federal Reserve Bank account could allow a Designated FMU to reduce its
concentration risk by adding an additional creditworthy depository in
which to diversify funds. Accordingly, the exemption promotes sound
risk management practices.
The Commission further notes that, notwithstanding the exemption
from Section 4d of the CEA, the Federal Reserve Banks are still
required to segregate customer funds deposited by a Designated FMU from
the proprietary funds deposited by a Designated FMU and to adhere to
the longstanding standards of liability that govern the Federal Reserve
Banks.
e. Other Public Interest Considerations
The Commission believes that facilitating a Designated FMU's access
to Federal Reserve Bank accounts will promote the public interest by
bolstering a Designated FMU's ability to conduct settlements with a
high degree of confidence under a wide range of stress scenarios,
thereby increasing the likelihood of the Designated FMU being able to
provide its customers with access to their funds in times of market
distress.
[[Page 53474]]
VI. Order of Exemption
After considering the above factors and the comment letters
received in response to the request for comments, the Commission has
determined to issue the following:
Order
Pursuant to Title VIII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act''), the Financial Stability
Oversight Council (``Council'') is required to designate those
financial market utilities (``FMUs'') that the Council determines are,
or are likely to become, systemically important. A derivatives clearing
organization registered with the Commodity Futures Trading Commission
(``Commission'') and designated by the Council as systemically
important is referred to herein as a ``Designated FMU''. Under Section
806(a) of the Dodd-Frank Act, the Board of Governors (``Board'') of the
Federal Reserve System is permitted to authorize a Federal Reserve Bank
to establish and maintain a deposit account for, among others, a
Designated FMU and provide certain services to the Designated FMU,
subject to any applicable rules, orders, standards, or guidelines
prescribed by the Board.
Designated FMUs are required to hold funds belonging to customers
of their clearing members in accounts subject to Section 4d of the
Commodity Exchange Act (``CEA''). In addition, Section 22 of the CEA
would provide for private rights of action for damages against persons
who violate Section 4d, or persons who willfully aid, abet, counsel,
induce, or procure the commission of a violation of Section 4d.
However, the Commission understands that deposit accounts maintained by
any Federal Reserve Bank would be governed by applicable account
agreements, operating circulars issued by Federal Reserve Banks for
each service, the Federal Reserve Act, and Federal Reserve regulations
and policies, and, with respect to book-entry securities services, the
regulations of the domestic issuer of the securities or the issuer's
regulator (``Federal Reserve Bank Governing Documents''). The Federal
Reserve Bank Governing Documents, as may be amended from time to time,
include, but are not limited to, Federal Reserve Bank Operating
Circular No. 6 (governing funds transfers through the Fedwire Funds
Service); Federal Reserve Bank Operating Circular No. 7 (governing the
maintenance of and transfer services for book-entry securities
accounts); 12 CFR part 210, subpart B (governing funds transfers
through the Fedwire Funds Service); and 31 CFR part 357, subpart B
(setting forth the U.S. Department of the Treasury's regulations
governing book-entry treasury bonds, notes, and bills).
The Commission understands that under the Federal Reserve Bank
Governing Documents, a Federal Reserve Bank has no requirement or
obligation to inquire as to the legitimacy or accuracy of the
instructions, or the transactions related to those instructions, or
compliance by the Designated FMU with its obligations under the CEA. To
the extent that liability may accrue under the Federal Reserve Bank
Governing Documents, the Commission understands that the Federal
Reserve Bank may be held liable only for actual damages that are (i)
incurred solely by the Designated FMU account holder, and (ii)
proximately caused by the Federal Reserve Bank's failure to exercise
ordinary care or act in good faith in accordance with the Federal
Reserve Bank Governing Documents. The Commission is issuing an
exemption to the Federal Reserve Banks in order to facilitate Federal
Reserve Banks' ability to establish customer accounts for Designated
FMUs.
Therefore, it is ordered, pursuant to Section 4(c) of the CEA, 7
U.S.C. 6(c), that the Federal Reserve Banks are granted an exemption
from Sections 4d and 22 of the CEA, subject to the terms and conditions
specified herein:
1. Segregation. Money, securities, and property deposited into a
customer account established pursuant to the CEA by a Designated FMU
with a Federal Reserve Bank shall be separately accounted for and not
commingled with the money, securities, and property deposited into the
account of any other person, including a proprietary account of the
Designated FMU depositing such funds.
2. Information Requests. Federal Reserve Banks must reply promptly
and directly to any request for confirmation of account balances or
provision of any other information regarding or related to the customer
account(s) of a Designated FMU that are established pursuant to the CEA
from the director of the Division of Clearing and Risk of the
Commission, or any successor division, or such director's designees.
3. Applicability to Federal Reserve Banks. Subject to the
conditions contained herein, the order applies to all Federal Reserve
Banks that provide customer accounts and other services to Designated
FMUs. In addition, pursuant to the Federal Reserve's Key Policies for
the Provision of Financial Services: Standards Related to Priced-
Service Activities of the Federal Reserve Banks, information obtained
by the Board of Governors of the Federal Reserve System or its
designees during the course of supervising Designated FMUs, pursuant to
Title VIII of the Dodd-Frank Act, or any counterparty to a Designated
FMU under any authority, shall not be attributed by the Commission to
any Federal Reserve Bank providing accounts and financial services to
Designated FMU account holders.
4. Reservation of Rights. This order is based upon the analysis set
forth above. Any material change in law or circumstances pursuant to
which this order is granted might require the Commission to reconsider
its finding that the exemption contained herein is appropriate and/or
consistent with the public interest and purposes of the CEA. Further,
the Commission reserves the right, in its discretion, to revisit any of
the terms and conditions of the relief provided herein, including but
not limited to, making a determination that certain entities described
herein should be subject to the Commission's full jurisdiction, and to
condition, suspend, terminate, or otherwise modify or restrict the
exemption granted in this order, as appropriate, upon its own motion.
Issued in Washington, DC, on August 8, 2016, by the Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Appendices to Order Exempting the Federal Reserve Banks From Sections
4d and 22 of the Commodity Exchange Act--Commission Voting Summary,
Chairman's Statement, and Commissioner's Statement
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioners Bowen and
Giancarlo voted in the affirmative. No Commissioner voted in the
negative.
Appendix 2--Statement of Chairman Timothy G. Massad
Today, the Commission continues its work to ensure the
resiliency of clearinghouses and protect customers in our markets.
To provide the necessary context for these efforts, it is useful to
look back at recent history.
Most participants in our markets will recall what happened at
the beginning of the financial crisis in September 2008, when the
Reserve Fund--a money market fund--``broke the buck'' following the
bankruptcy of Lehman Brothers. Redemptions were suspended and
investors were not able to make withdrawals. As a result, many
futures commission merchants (FCMs) were not able to access customer
funds invested in the Reserve Fund. Absent relief by the CFTC, many
would have been undercapitalized,
[[Page 53475]]
potentially ending up in bankruptcy. In addition, clearinghouses
could not liquidate investments in the Reserve Fund. And there could
have easily been a widespread run on money market funds, but for the
emergency actions taken by the U.S. government.
As a result of the crisis, as well as the collapse of MF Global,
the CFTC and our self-regulatory organizations took a number of
actions to better protect customer funds. We required customer funds
to be strictly segregated and limited the ways they can be invested.
We enhanced accounting and auditing procedures at FCMs, including by
requiring daily verification from depositories of the amounts
deposited by FCMs.
Today, CFTC rules require that customer funds be invested in
highly liquid assets and be convertible into cash within one
business day without a material discount in value. Our rules also
require that clearinghouses invest initial margin deposits in a
manner that allows them to promptly liquidate any such investment.
Over the last few years, the Securities and Exchange Commission
(SEC) has also taken action in response to the lessons of the
financial crisis, by adopting a number of measures to address the
potential vulnerabilities of money market funds. One such recent
reform, which takes effect in October of this year, sets forth the
circumstances where prime money market funds are permitted, or in
some circumstances required, to suspend redemptions in order to
prevent the risk of investor runs.
While we recognize the benefit of the SEC's new rule in
preventing investor runs, a suspension of redemptions by a money
market fund would mean investments in such funds are not accessible
and cannot be promptly liquidated. Such an event could result in
customers, FCMs, and clearinghouses being unable to access the funds
necessary to satisfy margin obligations.
Therefore, CFTC staff is today providing guidance making clear
that Commission rules prohibit a clearing member from investing
customer funds, or a clearinghouse from investing amounts deposited
as initial margin, in such money market funds.
Some industry participants have suggested we should interpret or
revise our rules to permit investments of at least some customer
monies in such money market funds unless and until redemptions are
suspended. We have declined to do so, as it would be too late to
protect customers at that point. Moreover, there are alternatives to
prime funds, including certain government money markets funds or
Treasury securities. In fact, investments in prime money market
funds represent a relatively small portion of the total customer
funds on deposit and the total initial margin deposits at
clearinghouses. Some of our clearinghouses and FCMs do not have any
investments in prime funds.
Staff has been careful not to be overly restrictive, and
therefore has issued no-action relief to allow FCMs to invest
certain ``excess'' proprietary funds held in customer accounts in
these money market funds. That is, our existing rules require FCMs
to deposit their own funds (i.e., targeted residual interest) into
customer accounts to make sure that there are sufficient funds in
the segregated customer accounts to cover all obligations due to
customers. FCMs frequently deposit an amount of their own funds that
is in excess of the targeted residual interest amount required under
our rules, and that excess amount can be withdrawn at any time.
Indeed, if an FCM should default, customers--and the system as a
whole--are better off if excess funds are on deposit, and we do not
wish to incentivize FCMs to withdraw such excess funds from the
segregated account. Therefore, the no action relief makes clear that
FCMs can continue to invest their own funds in excess of their
targeted residual interest in such money market funds, even though
they cannot invest the customer funds--or any proprietary funds they
are required to deposit--in this manner.
Finally, the Commission is taking action today that will further
ensure the safety of customer funds. We are issuing an order that
will help make it possible for systemically important clearinghouses
to deposit customer funds at Federal Reserve Banks. Our order makes
clear that a Federal Reserve Bank that opens such an account would
be subject to the same standards of liability that generally apply
to it as a depository, rather than any potentially conflicting
standard under the commodity laws.
Although Federal Reserve accounts for customer funds held by
systemically important clearinghouses do not exist today, they are
allowed under the Dodd-Frank Act, and we have been working with the
Board of Governors to facilitate them. The two clearinghouses
designated as systemically important in our markets have been
approved to open Federal Reserve Bank accounts for their proprietary
funds. We hope that with today's action, accounts for customer funds
can be opened soon. Doing so will help protect customer funds and
enhance the resiliency of clearinghouses.
I thank the dedicated CFTC staff and my fellow Commissioners for
their work on these matters.
Appendix 3--Concurring Statement of Commissioner Sharon Y. Bowen
I am pleased to concur with the two Commission actions: The
``Order Exempting the Federal Reserve Banks from Sections 4d and 22
of the Commodity Exchange Act'' and ``Written Acknowledgment of
Customer Funds from Federal Reserve Banks.'' I have long believed
that, in order to protect customer funds, we need to keep that money
at our central bank. In the event of a major market event, I, and I
believe the rest of the American people, would feel much better
knowing that investors' money is at the Federal Reserve instead of
at multiple central counterparties. I am glad that our agency and
the Federal Reserve have come to an agreement on an effective way to
accomplish this.
I am similarly pleased with the Division of Clearing and Risk's
(DCR) ``Staff Interpretation Regarding CFTC Part 39 In Light Of
Revised SEC Rule 2a-7,'' which clearly outlines the staff's
understanding that, given the limitations that the Securities and
Exchange Commission (SEC) has imposed on redemptions for prime money
market funds, that they are no longer considered Rule 1.25 assets.
This is the correct interpretation. The key feature in a Rule 1.25
asset is that it must be available quickly in times of crisis or
illiquidity. And we know that funds are more likely to close the
gates on redemptions when market dislocation happens. That is just
the time when futures commission merchants (FCMs) and customers
would need access to their money, and a multi-day delay can mean
catastrophe for some businesses.
For that very reason, I have concerns about the Division of Swap
Dealer and Intermediary Oversight's (DSIO) ``No-Action Relief With
Respect to CFTC Regulation 1.25 Regarding Money Market Funds.''
While the 4(c) exemption and the DCR interpretation are clearly
customer protection initiatives, the DSIO no action letter is not.
This no action letter would allow FCMs to keep money in segregated
customer accounts that actually would not be readily available in a
crisis. Thus, while it may appear that an FCM had considerable funds
available to settle customer accounts during a market dislocation,
in fact that would be only be an illusion; a portion of those funds
could be locked down behind the prime money market funds' gates and
therefore not actually be available when needed.
I do not think that the staff of the Commission should be
supporting this kind of ``window dressing''--giving the impression
of greater security than there actually is. If the funds are not
suitable investments for customer funds, then they are not suitable
for the additional capital that the FCMs put in those accounts to
protect against potential shortfalls. Having lived through
bankruptcies, such as MF Global and Peregrine, I have a healthy
respect for the importance of having strong clearing members with a
large cushion of funds that can be accessed when needed. This no
action letter undermines that effort. Given the importance of this
topic to the general public, we should at least have asked for
comments or even held a roundtable before making this change. I
therefore hope to reexamine this subject in the near future.
[FR Doc. 2016-19210 Filed 8-11-16; 8:45 am]
BILLING CODE 6351-01-P